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 81 full time and 9 part time individuals at December 31,
2004.



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION

AND RESULTS OF OPERATIONS



Overview



The following is managements discussion and analysis of the historical 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 2004 of $2.2 million, a 29.8% increase from 2003 net
income of $1.7 million. The increase in 2004 earnings was primarily due to increased loan volumes offset by a lower yield on earning assets. Earnings per diluted share were $0.52 compared to $0.41 per share in 2003.



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 $9.6 million for 2004, an increase of $1.5 million or 18.6% compared to $8.1 million in 2003. Total assets were $284.2 million as of December 31, 2004, a 22.8% increase over December 31, 2003 total assets of $231.3
million. The Companys return on average assets was 0.84% and 0.75% for the years ending December 31, 2004, and 2003, respectively. The Companys return on average equity was 12.48% and 10.60% for the years ending December 31, 2004, and
2003, respectively.



At December 31, 2004 the Banks gross loan portfolio
totaled $204.1 million. Of this amount, $42.3 million or 20.7% were commercial loans, $48.6 million or 23.8% were commercial real estate loans, $32.0 million or 15.7% were construction loans, $32.6 million or 16.0% were one- to four-family
residential mortgage loans, $28.2 million or 13.8% were home equity loans, and $20.4 million or 10.0% were consumer and other loans.



9



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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 31 and continuing to page 34. 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 31 and continuing on page
32 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, 2004 and
2003 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 22.8% during 2004 to $284.2 million from $231.3
million at December 31, 2003. Total deposits and securities sold under agreements to repurchase, the Companys primary sources of funds, increased $35.4 million or 17.8% to $234.7 million from $199.3 million at December 31, 2003. Time deposits
comprise the largest portion of the Banks total deposits, totaling $91.7 million or 40.4% of the Banks total deposits at December 31, 2004, compared to $73.6 million or 38.6% in 2003. Savings and money market accounts totaled $62.8
million or 27.7% of the Banks total deposits at December 31, 2004, compared to $52.6 million or 27.6% in 2003. NOW accounts totaled $32.8 million or 14.5% and $30.9 million or 16.2% of total deposits at December 31, 2004 and 2003,
respectively. Demand, noninterest bearing accounts totaled $39.5 million or 17.4% of total deposits at December 31, 2004 and $33.4 million or 17.5% at December 31, 2003. Securities sold under agreements to repurchase decreased $844 thousand or 9.6%
to $7.9 million from $8.7 million at December 31, 2003. Long-term borrowings were $25.0 million at December 31, 2004 compared to $10.0 million at December 31, 2003.



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 5.7%.



The Companys primary uses of
funds are for loans and investments. Loans, net of deferred costs and discounts and the allowance for credit losses, increased by $35.4 million or 21.0% to $202.3 million at December 31, 2004 from $167.1 million a year earlier. Loan balances
increased in all categories, with commercial loans increasing $1.1 million or 2.6%; real estate loans increasing $26.0 million or 31.1%; construction loans increasing by $7.2 million or 29.5%, and; installment and other consumer loans increasing
$894 thousand or 4.6%.



10



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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 15 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, 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. The net interest margin was 4.00% and
3.95% for the years ended December 31, 2004 and 2003, respectively. Net interest income for 2004 includes $44 thousand of interest collected on a cash basis related to loans on nonaccrual status, compared to $25 thousand of interest collected on
nonaccrual loans in 2003.



Interest Income



The Companys interest income increased $1.8 million or 15.5% for the year ended
December 31, 2004. The increase in interest income can be attributed to an increase in loan volume as average loans increased $34.1 million or 21.9%, offset by a decrease in loan yield to 6.13% for the year ended December 31, 2004 from 6.48% for the
year ended December 31, 2003. Contributing to the increase in interest income is an increase in investments and federal funds sold volume and an increase in the yield on federal funds sold. Average federal funds sold, other overnight investments and
investment securities increased $1.1 million or 2.2%, while the yield on federal funds sold, other investments and investment securities increased to 3.24% for the year ended December 31, 2004 from 2.84% for the year ended December 31, 2003.



Interest Expense



The Companys interest expense increased $273 thousand or 8.1% to $3.6 million for
2004, compared to $3.4 million for 2003. The increase in interest expense for the year ended December 31, 2004 can be attributed to additional Federal Home Loan borrowings and an increase in the cost of long term borrowings in the form of junior
subordinated debentures. Federal Home Loan Bank convertible advances totaled $25.0 million at December 31, 2004 and were at an average cost of 3.82% compared to $10 million at December 31, 2003 at an average cost of 4.50%. Long term borrowings in
the form of junior subordinated debentures had an average balance of $5 million for the year ended December 31, 2004 with a cost of 4.64% compared to $3.8 million at a cost of 4.28% for the year ended December 31, 2003.



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. The increase in provision was the result of higher overall loan volumes and net charge-offs of loans deemed uncollectible of $94 thousand for the year ended December
31, 2004 compared to net recoveries of $4 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



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. Noninterest income
decreased $59 thousand or 2.8% to $2.0 million from $2.1 million in 2003. Fees charged on deposit products increased $114 thousand or 9.5%, while mortgage banking fees totaled $239 thousand for the year ended December 31, 2004, a 46.7% decrease from
fees of $448 thousand for the year ended December 31, 2003. The Company does not fund mortgage loans sold in the secondary market, but receives commissions from investors who fund the loans.



11



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Noninterest Expense



Noninterest expense increased $413 thousand or 5.5% to $7.9 million at December 31, 2004, compared to $7.5 million at December 31, 2003. The increase in noninterest
expense was primarily due to increases in personnel expense, higher occupancy costs and higher data processing expenses.



Personnel expense increased $369 thousand or 8.8% to $4.6 million from $4.2 million, with $293 thousand related to salary increases and the remainder related to payroll
taxes and the higher costs of various employee benefit programs. Occupancy and equipment expense decreased $22 thousand or 2.2% due to lower depreciation and amortization.



Data processing expense increased $38 thousand or 4.5% due to increased account volumes and annual contractual increases from the
Banks core processor. Other expenses increased $73 thousand or 5.9% due to costs associated with loan production.



Provision for Income Taxes



The Company and the Bank file consolidated federal income tax returns and separate Maryland income tax returns. The Company recognized $1.2 million and $936 thousand in
income tax expense for the years ended December 31, 2004 and 2003, respectively, for an effective tax rate of 36.2% in 2004 and 35.9% in 2003.



Results of Operations for the Years Ended December 31, 2003 and 2002



Net Income



Net income for the year ended December 31, 2003 totaled $1.7 million, a 36.4% increase from 2002 earnings of $1.2 million. Earnings per diluted share were $0.41 compared
to $0.30 per diluted share for the year ended December 31, 2002.



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, 2003, was $8.1 million, representing an increase of $765 thousand or 10.4% from net interest income of $7.3 million for the year ended December 31, 2002. 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 $619 thousand or 5.7% in 2003 compared to 2002, primarily due to an increase in loan volume as average loans increased $22.0 million or 16.6% in 2003 while the loan yield decreased to 6.48%
for the year ended December 31, 2003 from 7.11% for the year ended December 31, 2002. Average federal funds sold, other overnight investments and investment securities increased $12.4 million or 32.8% with the yield on investment securities
decreasing to 2.84% for the year ended December 31, 2003 from 3.70% for the year ended December 31, 2002.



Interest Expense



Interest expense
decreased $146 thousand or 4.2% to $3.4 million in 2003 compared to $3.5 million in 2002. The decrease can be attributed to a decline in average certificate of deposit rates to 2.88% in 2003 from 3.75% in 2002.



Provision for Credit Losses



The Company recorded a provision for credit losses of $50 thousand for the year ended
December 31, 2003 compared to $25 thousand for the year ended December 31, 2002. See the discussion under the heading Credit Risk Management for greater analysis regarding the Allowance for Credit Losses and related provision.



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Noninterest Income



Noninterest income increased $444 thousand or 27.1% during 2003 compared to 2002. The increase was attributable to higher fees charged on deposit products, fees generated
by the Banks VISA check card, fees generated by the origination of brokered residential mortgage loans and rental income from leasing space at the Banks headquarters building.



Noninterest Expense



Noninterest expense increased $445 thousand or 6.3% to $7.5 million in 2003 from $7.1 million in 2002. 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)

|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|----------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                      |  | 2004 |           |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|Selected Financial Data                               |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|                                                      |  |      |           |   |     
|Total assets                                          |  | $    | 284,188   |   |      | $ | 231,338   |      |  | $ | 200,116   |   |  | $    | 166,681   |   |  | $ | 137,040   |  
|Total loans, net                                      |  |      | 202,296   |   |      |   | 167,123   |      |  |   | 145,735   |   |  |      | 111,347   |   |  |   | 87,411    |  
|Total deposits                                        |  |      | 226,834   |   |      |   | 190,577   |      |  |   | 163,989   |   |  |      | 144,884   |   |  |   | 118,020   |  
|Securities sold under agreement to repurchase         |  |      | 7,901     |   |      |   | 8,745     |      |  |   | 10,500    |   |  |      | 7,674     |   |  |   | 5,369     |  
|Long-term debt                                        |  |      | 30,000    |   |      |   | 15,000    |      |  |   | 10,000    |   |  |      |          |   |  |   |          |  
|Stockholders equity                                  |  |      | 18,662    |   |      |   | 16,448    |      |  |   | 15,078    |   |  |      | 13,860    |   |  |   | 13,362    |  
|                                                      |  |      |           |   |     
|Selected Operating Data                               |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|                                                      |  |      |           |   |     
|Interest income                                       |  | $    | 13,260    |   |      | $ | 11,477    |      |  | $ | 10,858    |   |  | $    | 10,901    |   |  | $ | 10,454    |  
|Interest expense                                      |  |      | 3,641     |   |      |   | 3,368     |      |  |   | 3,514     |   |  |      | 4,593     |   |  |   | 3,679     |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income                                   |  |      | 9,619     |   |      |   | 8,109     |      |  |   | 7,344     |   |  |      | 6,308     |   |  |   | 6,775     |  
|Provision for credit losses                           |  |      | 294       |   |      |   | 50        |      |  |   | 25        |   |  |      |          |   |  |   | 36        |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income after provision for credit losses |  |      | 9,325     |   |      |   | 8,059     |      |  |   | 7,319     |   |  |      | 6,308     |   |  |   | 6,739     |  
|Noninterest income                                    |  |      | 2,025     |   |      |   | 2,084     |      |  |   | 1,640     |   |  |      | 1,162     |   |  |   | 884       |  
|Noninterest expense                                   |  |      | 7,946     |   |      |   | 7,533     |      |  |   | 7,088     |   |  |      | 6,698     |   |  |   | 6,147     |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Income before income taxes                            |  |      | 3,404     |   |      |   | 2,610     |      |  |   | 1,871     |   |  |      | 772       |   |  |   | 1,476     |  
|Income tax expense                                    |  |      | 1,231     |   |      |   | 936       |      |  |   | 644       |   |  |      | 266       |   |  |   | 504       |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income                                            |  | $    | 2,173     |   |      | $ | 1,674     |      |  | $ | 1,227     |   |  | $    | 506       |   |  | $ | 972       |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Key Financial Ratios and Other Data                   |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average assets                              |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income divided by average assets                  |  |      | 0.84      | % |      |   | 0.75      | %    |  |   | 0.66      | % |  |      | 0.33      | % |  |   | 0.75      | %
|Return on average equity                              |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income divided by average equity                  |  |      | 12.48     | % |      |   | 10.60     | %    |  |   | 8.57      | % |  |      | 3.70      | % |  |   | 7.59      | %
|Equity to asset ratio                                 |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Average equity divided by average assets              |  |      | 6.73      | % |      |   | 7.11      | %    |  |   | 7.69      | % |  |      | 8.88      | % |  |   | 9.93      | %
|Diluted earnings per share (1), (2)                   |  | $    | 0.52      |   |      | $ | 0.41      |      |  | $ | 0.30      |   |  | $    | 0.13      |   |  | $ | 0.24      |  
|Book value per share (1), (2)                         |  | $    | 4.61      |   |      | $ | 4.08      |      |  | $ | 3.75      |   |  | $    | 3.46      |   |  | $ | 3.32      |  
|Tangible book value per share (1), (2)                |  | $    | 4.61      |   |      | $ | 4.08      |      |  | $ | 3.75      |   |  | $    | 3.46      |   |  | $ | 3.32      |  
|Number of shares outstanding (1), (2)                 |  |      | 4,050,480 |   |      |   | 4,031,932 |      |  |   | 4,022,947 |   |  |      | 4,009,183 |   |  |   | 4,020,820 |  
|Efficiency ratio                                      |  |      | 68.24     | % |      |   | 73.90     | %    |  |   | 78.90     | % |  |      | 89.67     | % |  |   | 80.26     | %
|Interest rate spread                                  |  |      | 3.71      | % |      |   | 3.67      | %    |  |   | 3.92      | % |  |      | 3.77      | % |  |   | 5.03      | %
|Net interest margin                                   |  |      | 4.00      | % |      |   | 3.95      | %    |  |   | 4.30      | % |  |      | 4.41      | % |  |   | 5.57      | %
|Risk based capital ratio  Tier 1                     |  |      | 11.14     | % |      |   | 12.17     | %    |  |   | 9.72      | % |  |      | 11.14     | % |  |   | 13.60     | %
|Risk based capital ratio  Total                      |  |      | 12.00     | % |      |   | 13.09     | %    |  |   | 10.74     | % |  |      | 12.64     | % |  |   | 14.80     | %

---

|(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, 2004, 2003 and 2002. 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, increased to
3.71% for the year ended December 31, 2004 from 3.67% at December 31, 2003.



Consolidated Average Balances, Yields and Rates

(Balances in thousands)



|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|---------------------------------------------------------------- |  | ----------------- | ------- | -------- | ----------------- | ---------- |  | ----------------- | -------------- |  | -------- | ------- | ---------- | - | ------ | -------------- | ------ | -------- |  | ---------- | ------- |  | - | ------ |  | ------ | -
|                                                                 |  | Years Ended       |        
|                                                                 |  | December 31, 2004 |         |          | December 31, 2003 |            |  | December 31, 2002 |               
|                                                                 |  | AverageBalance    |         | Interest |                   | Yield/Rate |  |                   | AverageBalance |  | Interest |         | Yield/Rate |   |        | AverageBalance |        | Interest |  | Yield/Rate |        
|Assets                                                           |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Interest Earning Assets                                          |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Federal funds sold and other overnight investments               |  | $                 | 10,606  |          | $                 | 157        |  | 1.48              | %              |  | $        | 17,618  |            | $ | 191    |                | 1.08   | %        |  | $          | 12,975  |  | $ | 217    |  | 1.67   | %
|Investment securities                                            |  |                   | 40,735  |          |                   | 1,507      |  | 3.70              | %              |  |          | 32,599  |            |   | 1,235  |                | 3.79   | %        |  |            | 24,845  |  |   | 1,183  |  | 4.76   | %
|Loans                                                            |  |                   | 189,130 |          |                   | 11,596     |  | 6.13              | %              |  |          | 155,067 |            |   | 10,051 |                | 6.48   | %        |  |            | 133,022 |  |   | 9,458  |  | 7.11   | %
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Total interest earning assets                                    |  |                   | 240,471 |          |                   | 13,260     |  | 5.51              | %              |  |          | 205,284 |            |   | 11,477 |                | 5.59   | %        |  |            | 170,842 |  |   | 10,858 |  | 6.36   | %
|Noninterest Earning Assets                                       |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Cash and due from banks                                          |  |                   | 7,607   |          |                   |            |  |                   |                |  |          | 6,540   |            |   |        |                |        |          |  |            | 5,827   |  |   |        |  |        |  
|Other assets                                                     |  |                   | 10,693  |          |                   |            |  |                   |                |  |          | 10,500  |            |   |        |                |        |          |  |            | 9,472   |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Total Assets                                                     |  | $                 | 258,771 |          |                   |            |  |                   |                |  | $        | 222,324 |            |   |        |                |        |          |  | $          | 186,141 |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Liabilities and Stockholders Equity                             |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Interest Bearing Deposits                                        |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|NOW accounts                                                     |  | $                 | 33,776  |          | $                 | 78         |  | 0.23              | %              |  | $        | 29,025  |            | $ | 58     |                | 0.20   | %        |  | $          | 22,321  |  | $ | 62     |  | 0.28   | %
|Money market accounts                                            |  |                   | 36,392  |          |                   | 354        |  | 0.97              | %              |  |          | 27,926  |            |   | 273    |                | 0.98   | %        |  |            | 26,608  |  |   | 386    |  | 1.45   | %
|Savings accounts                                                 |  |                   | 22,395  |          |                   | 87         |  | 0.39              | %              |  |          | 20,342  |            |   | 112    |                | 0.55   | %        |  |            | 17,357  |  |   | 185    |  | 1.07   | %
|Certificates of deposit                                          |  |                   | 79,523  |          |                   | 2,110      |  | 2.65              | %              |  |          | 73,390  |            |   | 2,114  |                | 2.88   | %        |  |            | 62,571  |  |   | 2,344  |  | 3.75   | %
|Repurchase agreements                                            |  |                   | 8,730   |          |                   | 159        |  | 1.82              | %              |  |          | 10,480  |            |   | 188    |                | 1.79   | %        |  |            | 8,752   |  |   | 232    |  | 2.65   | %
|Long term borrowing                                              |  |                   | 15,907  |          |                   | 617        |  | 3.82              | %              |  |          | 10,000  |            |   | 456    |                | 4.50   | %        |  |            | 6,685   |  |   | 305    |  | 4.56   | %
|Junior subordinated debt                                         |  |                   | 5,000   |          |                   | 236        |  | 4.64              | %              |  |          | 3,849   |            |   | 167    |                | 4.28   | %        |  |            |        |  |   |       |  | 0.00   | %
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Total interest bearing liabilities                               |  |                   | 201,723 |          |                   | 3,641      |  | 1.80              | %              |  |          | 175,012 |            |   | 3,368  |                | 1.92   | %        |  |            | 144,294 |  |   | 3,514  |  | 2.44   | %
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Noninterest Bearing Liabilities                                  |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Demand deposit accounts                                          |  |                   | 38,705  |          |                   |            |  |                   |                |  |          | 30,748  |            |   |        |                |        |          |  |            | 26,937  |  |   |        |  |        |  
|Other liabilities                                                |  |                   | 937     |          |                   |            |  |                   |                |  |          | 764     |            |   |        |                |        |          |  |            | 588     |  |   |        |  |        |  
|Stockholders Equity                                             |  |                   | 17,406  |          |                   |            |  |                   |                |  |          | 15,800  |            |   |        |                |        |          |  |            | 14,322  |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Total Liabilities and Stockholders Equity                       |  | $                 | 258,771 |          |                   |            |  |                   |                |  | $        | 222,324 |            |   |        |                |        |          |  | $          | 186,141 |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  
|Interest rate spread                                             |  |                   |         |          |                   |            |  | 3.71              | %              |  |          |         |            |   |        |                | 3.67   | %        |  |            |         |  |   |        |  | 3.92   | %
|Ratio of interest earning assets to interest bearing liabilities |  |                   |         |          |                   |            |  | 119.21            | %              |  |          |         |            |   |        |                | 117.30 | %        |  |            |         |  |   |        |  | 118.40 | %
|Net interest income and net interest margin                      |  |                   |         |          | $                 | 9,619      |  | 4.00              | %              |  |          |         |            | $ | 8,109  |                | 3.95   | %        |  |            |         |  | $ | 7,344  |  | 4.30   | %
|                                                                 |  |                   |         |          |                   |            |  |                   |                |  |          |         |            |   |        |                |        |          |  |            |         |  |   |        |  |        |  



14



---

Rate/Volume Analysis

(Dollars in thousands)



|                                                   |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  
|-------------------------------------------------- |  | --------------------- | ----- | - | ---------------- | - | ----- | ---- |  | - | ---------------- | - |  | --------------------- | ---- | - | ------ | - | ---- | - |  | ----------- | ----- |  | - | ------ | - |  | - | ---- | -
|                                                   |  | 2004 vs. 2003         |       |   | 2003 vs. 2002    |  
|                                                   |  |                       |       |   | 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                                              |  | $                     | 1,545 |   |                  | $ | 2,208 |      |  | $ | (544             | ) |  | $                     | (119 | ) |        | $ | 593  |   |  | $           | 1,567 |  | $ | (836   | ) |  | $ | (138 | )
|Investment securities                              |  |                       | 272   |   |                  |   | 309   |      |  |   | (30              | ) |  |                       | (7   | ) |        |   | 52   |   |  |             | 369   |  |   | (242   | ) |  |   | (75  | )
|Federal funds sold and other overnight investments |  |                       | (34   | ) |                  |   | (76   | )    |  |   | 71               |   |  |                       | (29  | ) |        |   | (26  | ) |  |             | 71    |  |   | (73    | ) |  |   | (24  | )
|                                                   |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  
|Total interest income                              |  |                       | 1,783 |   |                  |   | 2,441 |      |  |   | (503             | ) |  |                       | (155 | ) |        |   | 619  |   |  |             | 2,007 |  |   | (1,151 | ) |  |   | (237 | )
|                                                   |  |                       |       |   |                  |   |       |     
|Interest expense on:                               |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  
|NOW accounts                                       |  |                       | 20    |   |                  |   | 10    |      |  |   | 9                |   |  |                       | 1    |   |        |   | (4   | ) |  |             | 18    |  |   | (17    | ) |  |   | (5   | )
|Money market accounts                              |  |                       | 81    |   |                  |   | 83    |      |  |   | (1               | ) |  |                       | (1   | ) |        |   | (113 | ) |  |             | 19    |  |   | (126   | ) |  |   | (6   | )
|Savings accounts                                   |  |                       | (25   | ) |                  |   | 12    |      |  |   | (34              | ) |  |                       | (3   | ) |        |   | (73  | ) |  |             | 32    |  |   | (89    | ) |  |   | (16  | )
|Certificates of deposit                            |  |                       | (4    | ) |                  |   | 176   |      |  |   | (166             | ) |  |                       | (14  | ) |        |   | (230 | ) |  |             | 405   |  |   | (541   | ) |  |   | (94  | )
|Repurchase agreements                              |  |                       | (29   | ) |                  |   | (31   | )    |  |   | 3                |   |  |                       | (1   | ) |        |   | (44  | ) |  |             | 46    |  |   | (75    | ) |  |   | (15  | )
|Long term-borrowings                               |  |                       | 161   |   |                  |   | 269   |      |  |   | (68              | ) |  |                       | (40  | ) |        |   | 151  |   |  |             | 151   |  |   |       |   |  |   |     |  
|Junior subordinated debt                           |  |                       | 69    |   |                  |   | 50    |      |  |   | 15               |   |  |                       | 4    |   |        |   | 167  |   |  |             |      |  |   |       |   |  |   | 167  |  
|                                                   |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  
|Total interest expense                             |  |                       | 273   |   |                  |   | 569   |      |  |   | (242             | ) |  |                       | (54  | ) |        |   | (146 | ) |  |             | 671   |  |   | (848   | ) |  |   | 31   |  
|                                                   |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  
|Net interest income                                |  | $                     | 1,510 |   |                  | $ | 1,872 |      |  | $ | (261             | ) |  | $                     | (101 | ) |        | $ | 765  |   |  | $           | 1,336 |  | $ | (303   | ) |  | $ | (268 | )
|                                                   |  |                       |       |   |                  |   |       |      |  |   |                  |   |  |                       |      |   |        |   |      |   |  |             |       |  |   |        |   |  |   |      |  



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 2004 the Company borrowed an additional $15.0
million 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 40.4% of the deposit portfolio at December 31, 2004. Core deposits, considered to be noninterest bearing and interest bearing
demand deposit accounts, savings deposits and money market accounts, accounted for 59.6% of the deposit portfolio at December 31, 2004. This represents a 1.8% decrease in the percentage of core deposits to total deposits. Core deposits accounted for
61.4% of the deposit portfolio at December 31, 2003.



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.



15



---

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 $35.7 million at December 31, 2004 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, 2004:



(Dollars in thousands)



|                     |  |                                         |  |                                     |  |                       |  |        
|-------------------- |  | --------------------------------------- |  | ----------------------------------- |  | --------------------- |  | -------
|Three Months or Less |  | Greater than Three Months to Six Months |  | Greater than Six Months to One Year |  | Greater than One Year |  | Total  
|$2,350               |  | $1,605                                  |  | $8,889                              |  | $22,867               |  | $35,711
|                     |  |                                         |  |                                     |  |                       |  |        



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, 2004 and 2003, the average cost of these borrowings was 1.82% and 1.79%, respectively.



The Bank maintains a secured borrowing line with the Federal Home Loan Bank (FHLB) with the ability to draw up to $113.7 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, 2004, the Bank had
advances outstanding of $25.0 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,
2004, 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, 2004, and does not give effect to prepayment or extension of loans as a result of changes in general market rates.



16



---

Interest Sensitivity Gap Analysis

December 31, 2004 ($000)

|                                                                    |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|------------------------------------------------------------------- |  | ------------------ | ------- | - | ---------------------------------- | - | ------ | ----------------------------- |  | - | --------------- | -- |  | ----- | ------ | - |  | - | -------
|                                                                    |  | WithinThree Months |         |   | After Threebut withinTwelve Months |   |        | After Onebut withinFive Years |  |   | AfterFive Years |    |  | Total
|Assets                                                              |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|Federal funds sold and other overnight investments                  |  | $                  | 7,213   |   |                                    | $ |       |                               |  | $ |                |    |  | $     |       |   |  | $ | 7,213  
|Investment securities (1)                                           |  |                    | 23,833  |   |                                    |   | 6,969  |                               |  |   | 4,641           |    |  |       | 16,905 |   |  |   | 52,348 
|Loans (2) (3)                                                       |  |                    | 86,467  |   |                                    |   | 21,005 |                               |  |   | 48,336          |    |  |       | 47,563 |   |  |   | 203,371
|                                                                    |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|                                                                    |  | $                  | 117,513 |   |                                    | $ | 27,974 |                               |  | $ | 52,977          |    |  | $     | 64,468 |   |  | $ | 262,932
|                                                                    |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|Liabilities                                                         |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|Interest bearing liabilities                                        |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|NOW accounts                                                        |  | $                  | 32,844  |   |                                    | $ |       |                               |  | $ |                |    |  | $     |       |   |  | $ | 32,844 
|Money market accounts                                               |  |                    | 20,067  |   |                                    |   |       |                               |  |   |                |    |  |       |       |   |  |   | 20,067 
|Savings accounts                                                    |  |                    | 42,757  |   |                                    |   |       |                               |  |   |                |    |  |       |       |   |  |   | 42,757 
|Certificates of deposit (4)                                         |  |                    | 8,038   |   |                                    |   | 30,762 |                               |  |   | 52,893          |    |  |       |       |   |  |   | 91,693 
|Commercial repurchase agreements                                    |  |                    | 7,901   |   |                                    |   |       |                               |  |   |                |    |  |       |       |   |  |   | 7,901  
|Long-term borrowings                                                |  |                    |        |   |                                    |   |       |                               |  |   | 5,000           |    |  |       | 20,000 |   |  |   | 25,000 
|Junior subordinated debt                                            |  |                    |        |   |                                    |   |       |                               |  |   |                |    |  |       | 5,000  |   |  |   | 5,000  
|                                                                    |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|                                                                    |  | $                  | 111,607 |   |                                    | $ | 30,762 |                               |  | $ | 57,893          |    |  | $     | 25,000 |   |  | $ | 225,262
|                                                                    |  |                    |         |   |                                    |   |        |                               |  |   |                 |    |  |       |        |   |  |   |        
|Interest sensitivity gap                                            |  | $                  | 5,906   |   |                                    | $ | (2,788 | )                             |  | $ | (4,916          | )  |  | $     | 39,468 |   |  |   | 37,670 
|Cumulative interest sensitivity gap                                 |  | $                  | 5,906   |   |                                    | $ | 3,118  |                               |  | $ | (1,798          | )  |  | $     | 37,670 |   |  |   |        
|Cumulative interest sensitivity gap as a percentage of total assets |  |                    | 2.25    | % |                                    |   | 1.19   | %                             |  |   | (0.68           | )% |  |       | 14.33  | % |  |   |        

---

|(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 $599 thousand.
|--- | ------------------------------------------

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



Investment Portfolio



At December 31, 2004, the Banks investment portfolio, which totaled $54.4 million, consisted 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 $1,587,500 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, 2004, approximately 59.6% 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, 2004, 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)

|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|------------------ |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                   |  | 2004 |        | 2003 |   | 2002   |  | 2001 |        | 2000
|Available for Sale |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|U.S. Agency        |  | $    | 33,139 |      | $ | 28,167 |  | $    | 14,657 |      | $ | 23,346 |  | $ | 33,565
|Mortgage-backed    |  |      | 19,209 |      |   | 8,798  |  |      | 4,692  |      |   | 4,931  |  |   |      
|Equity Securities  |  |      | 2,092  |      |   | 1,004  |  |      | 858    |      |   | 718    |  |   | 718   
|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total Securities   |  | $    | 54,440 |      | $ | 37,969 |  | $    | 20,207 |      | $ | 28,995 |  | $ | 34,283
|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       



17



---

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, 2004

($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           |  | $                 |  |       | 0.00                          | % |        | $                        | 30,166 |  | 3.51 | %      |  | $     | 2,974 |  | 4.54 | %
|Mortgage-backed       |  |                   |  |       | 0.00                          | % |        |                          | 2,304  |  | 4.05 | %      |  |       | 1,640 |  | 4.44 | %
|                      |  |                   |   |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|Total Debt Securities |  | $                 |  |       | 0.00                          | % |        | $                        | 32,470 |  | 3.55 | %      |  | $     | 4,614 |  | 4.50 | %
|                      |  |                   |   |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  



|                      |  |                        |        |       |      |   |       |   |       
|--------------------- |  | ---------------------- | ------ | ----- | ---- | - | ----- | - | ------
|                      |  | Greater than Ten Years |        |       |     
|                      |  | Amount                 |        | Yield |      |   | Total
|Available for Sale    |  |                        |        |       |      |   |       |   |       
|U.S. Agency           |  | $                      |       |       | 0.00 | % |       | $ | 33,140
|Mortgage-backed       |  |                        | 15,264 |       | 4.25 | % |       |   | 19,208
|                      |  |                        |        |       |      |   |       |   |       
|Total Debt Securities |  | $                      | 15,264 |       | 4.25 | % |       | $ | 52,348
|                      |  |                        |        |       |      |   |       |   |       

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:



Years ended December 31,

($000)

|                                  |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  
|--------------------------------- |  | ------ | ------- | - | ------- | ----- | - | ------ | - | ------- | ------- |  | ----- | ------ |  | - | ------- | - |  | ------ | - |  | ------- | ------- | - | ------ | ----- | - | ------- | - | ------ | - |  | ----- | -
|                                  |  | 2004   |         |   | 2003    |       |   | 2002   |   |         | 2001    |  |       | 2000   | 
|                                  |  | Amount |         |   | Percent |       |   | Amount |   |         | Percent |  |       | Amount |  |   | Percent |   |  | Amount |   |  | Percent |         |   | Amount |       |   | Percent |  
|Commercial loans                  |  | $      | 42,248  |   |         | 20.7  | % |        | $ | 41,173  |         |  | 24.4  | %      |  | $ | 32,445  |   |  | 22.0   | % |  | $       | 24,368  |   |        | 21.5  | % |         | $ | 19,323 |   |  | 21.6  | %
|Real estate loans                 |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  
|Commercial                        |  |        | 48,628  |   |         | 23.8  | % |        |   | 44,214  |         |  | 26.2  | %      |  |   | 41,219  |   |  | 28.0   | % |  |         | 38,498  |   |        | 34.0  | % |         |   | 33,434 |   |  | 37.5  | %
|Construction                      |  |        | 32,004  |   |         | 15.7  | % |        |   | 24,713  |         |  | 14.6  | %      |  |   | 25,060  |   |  | 17.0   | % |  |         | 17,712  |   |        | 15.7  | % |         |   | 16,945 |   |  | 19.0  | %
|One-to four-family                |  |        | 32,571  |   |         | 16.0  | % |        |   | 18,869  |         |  | 11.2  | %      |  |   | 20,233  |   |  | 13.7   | % |  |         | 17,083  |   |        | 15.1  | % |         |   | 11,036 |   |  | 12.4  | %
|Home equity                       |  |        | 28,194  |   |         | 13.8  | % |        |   | 20,341  |         |  | 12.1  | %      |  |   | 14,319  |   |  | 9.7    | % |  |         | 6,568   |   |        | 5.8   | % |         |   | 4,372  |   |  | 4.9   | %
|Consumer loans                    |  |        | 20,325  |   |         | 10.0  | % |        |   | 19,431  |         |  | 11.5  | %      |  |   | 14,140  |   |  | 9.6    | % |  |         | 8,887   |   |        | 7.9   | % |         |   | 4,107  |   |  | 4.6   | %
|                                  |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  
|Total loans                       |  |        | 203,970 |   |         | 100.0 | % |        |   | 168,741 |         |  | 100.0 | %      |  |   | 147,416 |   |  | 100.0  | % |  |         | 113,116 |   |        | 100.0 | % |         |   | 89,217 |   |  | 100.0 | %
|                                  |  |        |         |   |         |       |   |        |   |        
|Less:                             |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  
|Deferred costs, (unearned income) |  |        | 158     |   |         |       |   |        |   | 14      |         |  |       |        |  |   | (103    | ) |  |        |   |  |         | (193    | ) |        |       |   |         |   | (250   | ) |  |       |  
|Allowance for credit losses       |  |        | (1,832  | ) |         |       |   |        |   | (1,632  | )       |  |       |        |  |   | (1,578  | ) |  |        |   |  |         | (1,576  | ) |        |       |   |         |   | (1,556 | ) |  |       |  
|                                  |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  
|Net loans receivable              |  | $      | 202,296 |   |         |       |   |        | $ | 167,123 |         |  |       |        |  | $ | 145,735 |   |  |        |   |  | $       | 111,347 |   |        |       |   |         | $ | 87,411 |   |  |       |  
|                                  |  |        |         |   |         |       |   |        |   |         |         |  |       |        |  |   |         |   |  |        |   |  |         |         |   |        |       |   |         |   |        |   |  |       |  



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, 2004 the Banks loan portfolio totaled $204.0 million, of which $42.2 million,
or 20.7%, was commercial loans; $48.6 million, or 23.8%, was commercial real estate loans; $32.0 million, or 15.7%, was construction loans; $32.6 million, or 16.0%, was one- to four-family residential mortgage loans; $28.2 million, or 13.8%, was
home equity loans, and; $20.4 million, or 10.0%, 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. These loans consist of lines of credit, which may require an annual repayment, adjustable-rate loans with terms of five to seven



18



---

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.



Year Ended December 31, 2004

($000)

|                  |  |                       |         |                                       |   |                     |  |                 |        |                 |   |       |  |   |   |  |   |        
|----------------- |  | --------------------- | ------- | ------------------------------------- | - | ------------------- |  | --------------- | ------ | --------------- | - | ----- |  | - | - |  | - | -------
|                  |  | Due inOne Yearor Less |         | Due afterOne Yearbut beforeFive Years |   | Due afterFive Years |  | NonaccrualLoans |        | 90 DaysPast Due |   | Total
|Real estate loans |  |                       |         |                                       |   |                     |  |                 |        |                 |   |       |  |   |   |  |   |        
|Construction      |  | $                     | 31,745  |                                       | $ | 259                 |  | $               |       |                 | $ |      |  | $ |  |  | $ | 32,004 
|Mortgage          |  |                       | 3,846   |                                       |   | 15,144              |  |                 | 13,581 |                 |   |      |  |   |  |  |   | 32,571 
|Commercial        |  |                       | 12,625  |                                       |   | 20,552              |  |                 | 15,451 |                 |   |      |  |   |  |  |   | 48,628 
|Commercial loans  |  |                       | 29,609  |                                       |   | 9,620               |  |                 | 2,707  |                 |   | 312   |  |   |  |  |   | 42,248 
|Home equity loans |  |                       | 28,119  |                                       |   |                    |  |                 | 75     |                 |   |      |  |   |  |  |   | 28,194 
|Consumer loans    |  |                       | 1,528   |                                       |   | 2,761               |  |                 | 15,749 |                 |   | 287   |  |   |  |  |   | 20,325 
|                  |  |                       |         |                                       |   |                     |  |                 |        |                 |   |       |  |   |   |  |   |        
|Total loans       |  | $                     | 107,472 |                                       | $ | 48,336              |  | $               | 47,563 |                 | $ | 599   |  | $ |  |  | $ | 203,970
|                  |  |                       |         |                                       |   |                     |  |                 |        |                 |   |       |  |   |   |  |   |        



($000)

|                  |  |                    |        |              |   |        |  |   |       
|----------------- |  | ------------------ | ------ | ------------ | - | ------ |  | - | ------
|                  |  | Due After One Year
|                  |  | FixedRate          |        | VariableRate |   | Total 
|Real estate loans |  |                    |        |              |   |        |  |   |       
|Construction      |  | $                  | 259    |              | $ |       |  | $ | 259   
|Mortgage          |  |                    | 15,539 |              |   | 13,186 |  |   | 28,725
|Commercial        |  |                    | 15,300 |              |   | 20,703 |  |   | 36,003
|Commercial loans  |  |                    | 8,590  |              |   | 3,737  |  |   | 12,327
|Home equity loans |  |                    | 75     |              |   |       |  |   | 75    
|Consumer loans    |  |                    | 3,743  |              |   | 14,767 |  |   | 18,510
|                  |  |                    |        |              |   |        |  |   |       
|Total loans       |  | $                  | 43,506 |              | $ | 52,393 |  | $ | 95,899
|                  |  |                    |        |              |   |        |  |   |       



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, 2004, was $3.7 million. These loans may be made with terms up to 25 years 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 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 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.



19



---

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, 2004, the Bank had construction loans, including land acquisition and development loans, totaling $32.0 million, or 15.7% of
the Banks total loan portfolio, of which $8.8 million consisted of one- to four-family residential construction loans, $9.8 million consisted of commercial real estate construction loans and $13.4 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, 2004, one- to four-family residential mortgage loans totaled $32.6 million, or 16.0% of total loans. Of the one-to four-family mortgage loans outstanding
at that date, $3.3 million were fixed-rate loans with terms of up to three years with a balloon payment at the end of the term, and $29.3 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 adjustments 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 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,
2004, home equity loans totaled $28.2 million, or 13.8% 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 85% of the market value
of the security property. Fixed-rate, fixed-term home equity loans are offered with terms up to ten years and 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. Unsecured



20



---

consumer loans are made with a maximum term of three years and a maximum loan amount based on a borrowers financial
condition. At December 31, 2004, consumer loans totaled $20.4 million or 10.0% of total loans outstanding. Consumer loans are generally originated in the Banks primary market area.



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 $294 thousand for the year ended December 31, 2004 and $50 thousand in 2003. 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 $35.2 million for the year ended December 31, 2004. The Bank recorded charge-offs of $105 thousand on loans deemed uncollectible and recovered $11 thousand of previously charged-off loans. As of December 31, 2004, the Banks allowance for
credit losses was $1.8 million or 0.90% of total loans and 305.8% of non-performing loans as compared to $1.6 million, or 0.97% of total loans and 6,044.4% of non-performing loans as of December 31, 2003. The Bank had total non-performing loans of
$599 thousand and $27 thousand at December 31, 2004 and December 31, 2003, respectively, and non-performing loans to total loans of 0.29% and 0.02% at December 31, 2004, and December 31, 2003, respectively. The increase in nonperforming assets from
December 31, 2003 is attributable to two commercial 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, 2004 the Bank had approximately $15.4 million in watch list loans
compared to $15.2 million at December 31, 2003.



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.



21



---

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)



|                      |  |        |       |          |      |   |        |      |          |  |      |        |  |          |       |  |      |  
|--------------------- |  | ------ | ----- | -------- | ---- | - | ------ | ---- | -------- |  | ---- | ------ |  | -------- | ----- |  | ---- | -
|                      |  | 2004   |       |          | 2003 |   |        | 2002 |         
|                      |  | Amount |       | Loan Mix |      |   | Amount |      | Loan Mix |  |      | Amount |  | Loan Mix |      
|Amount applicable to: |  |        |       |          |      |   |        |      |          |  |      |        |  |          |       |  |      |  
|Commercial            |  | $      | 597   |          | 20.7 | % |        | $    | 586      |  | 24.4 | %      |  | $        | 509   |  | 22.0 | %
|Real estate           |  |        |       |          |      |   |        |      |          |  |      |        |  |          |       |  |      |  
|Commercial            |  |        | 623   |          | 23.8 | % |        |      | 629      |  | 26.2 | %      |  |          | 567   |  | 28.0 | %
|Residential           |  |        | 79    |          | 29.8 | % |        |      | 21       |  | 23.3 | %      |  |          | 45    |  | 23.4 | %
|Construction          |  |        | 320   |          | 15.7 | % |        |      | 246      |  | 14.6 | %      |  |          | 250   |  | 17.0 | %
|Consumer              |  |        | 213   |          | 10.0 | % |        |      | 66       |  | 11.5 | %      |  |          | 83    |  | 9.6  | %
|Non specific          |  |        |      |          |      |   |        |      | 84       |  |      |        |  |          | 124   |  |      |  
|                      |  |        |       |          |      |   |        |      |          |  |      |        |  |          |       |  |      |  
|Total allowance       |  | $      | 1,832 |          |      |   |        | $    | 1,632    |  |      |        |  | $        | 1,578 |  |      |  
|                      |  |        |       |          |      |   |        |      |          |  |      |        |  |          |       |  |      |  



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)



|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                          |  | 2004 |         |   | 2003 |   |         | 2002 | 
|Total loans outstanding - at December 31                  |  | $    | 204,128 |   |      | $ | 168,755 |      |  | $ | 147,313 |  
|Average loans outstanding for the year                    |  |      | 189,130 |   |      |   | 155,067 |      |  |   | 133,022 |  
|                                                          |  |      |        
|Allowance for credit losses at beginning of period        |  | $    | 1,632   |   |      | $ | 1,578   |      |  | $ | 1,576   |  
|Provision charged to expense                              |  |      | 294     |   |      |   | 50      |      |  |   | 25      |  
|Chargeoffs:                                               |  |      |         |   |      |   |         |      |  |   |         |  
|Commercial loans                                          |  |      | 5       |   |      |   | 8       |      |  |   | 53      |  
|Consumer and other loans                                  |  |      | 100     |   |      |   | 18      |      |  |   | 19      |  
|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|Total                                                     |  |      | 105     |   |      |   | 26      |      |  |   | 72      |  
|Recoveries:                                               |  |      |         |   |      |   |         |      |  |   |         |  
|Residential/commercial real estate loans                  |  |      |        |   |      |   |        |      |  |   |        |  
|Commercial loans                                          |  |      | 1       |   |      |   | 12      |      |  |   | 47      |  
|Consumer and other loans                                  |  |      | 10      |   |      |   | 18      |      |  |   | 2       |  
|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|Total                                                     |  |      | 11      |   |      |   | 30      |      |  |   | 49      |  
|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|Net chargeoffs (recoveries)                               |  |      | 94      |   |      |   | (4      | )    |  |   | 23      |  
|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|Allowance for credit losses at end of year                |  | $    | 1,832   |   |      | $ | 1,632   |      |  | $ | 1,578   |  
|                                                          |  |      |         |   |      |   |         |      |  |   |         |  
|Allowance for credit losses as a percent of total loans   |  |      | 0.90    | % |      |   | 0.97    | %    |  |   | 1.07    | %
|Net chargeoffs (recoveries) as a percent of average loans |  |      | 0.05    | % |      |   | (0.02   | )%   |  |   | 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, 2004, significant fixed and determinable contractual obligations to third parties by payment date.



(Dollars in thousands)



|                                     |  |       |        |                   |   |                   |  |                    |       |                     |   |     |  |   |       
|------------------------------------ |  | ----- | ------ | ----------------- | - | ----------------- |  | ------------------ | ----- | ------------------- | - | --- |  | - | ------
|Payments due by Period               |  | Total |        | Less thanone year |   | One to threeyears |  | Three tofive years |       | More than fiveyears
|Long-term debt obligations           |  | $     | 25,000 |                   | $ |                  |  | $                  | 5,000 |                     | $ |    |  | $ | 20,000
|Junior subordinated debt obligations |  |       | 5,000  |                   |   |                  |  |                    |      |                     |   |    |  |   | 5,000 
|Operating lease obligations          |  |       | 1,062  |                   |   | 162               |  |                    | 154   |                     |   | 98  |  |   | 648   
|Data processing contracts            |  |       | 958    |                   |   | 311               |  |                    | 462   |                     |   | 185 |  |   |      
|                                     |  |       |        |                   |   |                   |  |                    |       |                     |   |     |  |   |       
|                                     |  | $     | 32,020 |                   | $ | 473               |  | $                  | 5,616 |                     | $ | 283 |  | $ | 25,648
|                                     |  |       |        |                   |   |                   |  |                    |       |                     |   |     |  |   |       



22



---

Off-Balance Sheet Arrangements



As of December 31, 2004, 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 2004, Stockholders Equity increased by $2.3 million or 13.5%
to $18.7 million from $16.4 million at December 31, 2003. The increase was primarily due to net income of $2.2 million and an increase in paid in capital of $88 thousand due to options exercised and expensed.



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 2004, 22,499 shares of common stock were granted under the 2000 Stock Incentive Plan. During 2004, 19,332 shares granted in prior years were forfeited, 16,347 shares
were exercised and 69,136 unrestricted shares and 732 restricted shares were added to effect the four-for-three stock split in the form of a stock dividend issued on December 3, 2004. At December 31, 2004, the Company had a total of 276,588 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 issued upon exercise of outstanding options, 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     |  | 279,521                                                                                         |  | $                                                                               | 4.88 |                                                                                                                                               | 162,401
|Equity compensation plans not approved by security holders |  |                                                                                                |  |                                                                                 |     |                                                                                                                                               |       
|                                                           |  |                                                                                                 |  |                                                                                 |      |                                                                                                                                               |        
|Total                                                      |  | 279,521                                                                                         |  | $                                                                               | 4.88 |                                                                                                                                               | 162,401
|                                                           |  |                                                                                                 |  |                                                                                 |      |                                                                                                                                               |        

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.



23



---

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, 2004, both the Companys and the Banks Tier 1 and Total Risk-based capital ratios were 11.1% and 12.0%,
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.



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.



Market Value and Dividend Information



The Companys common stock is listed on The NASDAQ Stock Market® SmallCap Market under the symbol
ANNB. The Companys stock began trading on October 1, 1997. The Company has traded an average daily volume of 3,898 shares during 2004. At December 31, 2004 the closing price was $9.18 per share.



The Companys high and low stock price during the last quarter of 2004 was $9.83 and
$7.15, respectively.



24



---

As of March 1, 2005 the Company has outstanding 4,055,590 shares of common stock 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 Company previously effectuated a four-for-three
stock split in the form of a stock dividend which was paid on August 24, 2001. The 2004 split added 746,740 shares to those previously outstanding.



The Company has not paid a cash dividend since the first quarter of 2002 and 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*:



|        |  |                   |      |           |   |                   |  |           |        |                   |   |           |  |      |      |     |   |          |  |   |      |  |   |      |  |   |       
|------- |  | ----------------- | ---- | --------- | - | ----------------- |  | --------- | ------ | ----------------- | - | --------- |  | ---- | ---- | --- | - | -------- |  | - | ---- |  | - | ---- |  | - | ------
|        |  | 2004              |      | 2003      |   | 2002             
|        |  | Stock Price Range |      | Per Share |   | Stock Price Range |  | Per Share |        | Stock Price Range |   | Per Share
|Quarter |  | High              |      | Low       |   | Dividend          |  | High      |        | Low               |   | Dividend  |  | High |      | Low |   | Dividend
|1st     |  | $                 | 8.14 |           | $ | 6.53              |  | $         | 0.0000 |                   | $ | 4.72      |  | $    | 4.20 |     | $ | 0.0000   |  | $ | 4.69 |  | $ | 3.26 |  | $ | 0.0100
|2nd     |  |                   | 7.71 |           |   | 6.95              |  |           | 0.0000 |                   |   | 5.59      |  |      | 4.31 |     |   | 0.0000   |  |   | 4.58 |  |   | 4.13 |  |   | 0.0000
|3rd     |  |                   | 7.65 |           |   | 6.83              |  |           | 0.0000 |                   |   | 6.89      |  |      | 5.39 |     |   | 0.0000   |  |   | 4.37 |  |   | 3.98 |  |   | 0.0000
|4th     |  |                   | 9.83 |           |   | 7.15              |  |           | 0.0000 |                   |   | 7.43      |  |      | 6.57 |     |   | 0.0000   |  |   | 4.20 |  |   | 3.68 |  |   | 0.0000

---

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



25



---

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, 2004
and 2003 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, 2004. 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, 2004 and 2003 and the results of their operations and their cash flows for each of the three
years in the period then ending December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.



/s/ Stegman & Company




Baltimore, Maryland

February 8, 2005



26



---

ANNAPOLIS BANCORP, INC.

Consolidated Balance Sheets ($000 except per share data)



|                                                                                                                                                    |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|December 31,                                                                                                                                        |  | 2004 |         |   | 2003 |  
|Assets                                                                                                                                              |  |      |         |   |      |   |         |  
|Cash and due from banks                                                                                                                             |  | $    | 7,455   |   |      | $ | 6,033   |  
|Federal funds sold                                                                                                                                  |  |      | 7,213   |   |      |   | 8,014   |  
|Investment securities available for sale                                                                                                            |  |      | 54,440  |   |      |   | 37,969  |  
|Loans, less allowance for credit losses of $1,832 and $1,632                                                                                        |  |      | 202,296 |   |      |   | 167,123 |  
|Premises and equipment, net                                                                                                                         |  |      | 6,998   |   |      |   | 6,936   |  
|Accrued interest receivable                                                                                                                         |  |      | 1,061   |   |      |   | 869     |  
|Deferred income taxes                                                                                                                               |  |      | 490     |   |      |   | 477     |  
|Investment in bank owned life insurance                                                                                                             |  |      | 3,510   |   |      |   | 3,356   |  
|Other assets                                                                                                                                        |  |      | 732     |   |      |   | 561     |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total assets                                                                                                                                        |  | $    | 284,195 |   |      | $ | 231,338 |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Liabilities and Stockholders Equity                                                                                                                |  |      |         |   |      |   |         |  
|Deposits                                                                                                                                            |  |      |         |   |      |   |         |  
|Noninterest bearing                                                                                                                                 |  | $    | 39,473  |   |      | $ | 33,385  |  
|Interest bearing                                                                                                                                    |  |      | 187,361 |   |      |   | 157,192 |  
|Securities sold under agreements to repurchase                                                                                                      |  |      | 7,901   |   |      |   | 8,745   |  
|Long-term borrowings                                                                                                                                |  |      | 25,000  |   |      |   | 10,000  |  
|Guaranteed preferred beneficial interests in junior subordinated debentures                                                                         |  |      | 5,000   |   |      |   | 5,000   |  
|Accrued interest payable and other liabilities                                                                                                      |  |      | 798     |   |      |   | 568     |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total liabilities                                                                                                                                   |  |      | 265,533 |   |      |   | 214,890 |  
|                                                                                                                                                    |  |     
|Stockholders Equity                                                                                                                                |  |      |         |   |      |   |         |  
|Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 4,050,480 shares in 2004 and 3,019,378 shares in
2003 |  |      | 41      |   |      |   | 30      |  
|Paid in capital                                                                                                                                     |  |      | 12,986  |   |      |   | 12,898  |  
|Retained earnings                                                                                                                                   |  |      | 5,877   |   |      |   | 3,704   |  
|Accumulated other comprehensive (loss) income                                                                                                       |  |      | (242    | ) |      |   | (184    | )
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total stockholders equity                                                                                                                          |  |      | 18,662  |   |      |   | 16,448  |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                          |  | $    | 284,195 |   |      | $ | 231,338 |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  



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



27



---

ANNAPOLIS BANCORP, INC.

Consolidated Statements of Income ($000)



|                                                                           |  |      |        |   |      |   |        |  |   |       
|-------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ |  | - | ------
|Years Ended December 31,                                                   |  | 2004 |        |   | 2003 |   | 2002  
|Interest Income                                                            |  |      |        |   |      |   |        |  |   |       
|Loans, including fees                                                      |  | $    | 11,596 |   |      | $ | 10,051 |  | $ | 9,458 
|Federal funds sold                                                         |  |      | 157    |   |      |   | 191    |  |   | 217   
|Mortgage-backed securities                                                 |  |      | 401    |   |      |   | 331    |  |   | 257   
|U.S. Treasury securities and obligations of other U.S. Government agencies |  |      | 1,106  |   |      |   | 904    |  |   | 926   
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Total interest income                                                      |  |      | 13,260 |   |      |   | 11,477 |  |   | 10,858
|Interest Expense                                                           |  |      |        |   |      |   |        |  |   |       
|Certificates of deposit, $100,000 or more                                  |  |      | 780    |   |      |   | 689    |  |   | 627   
|Other deposits                                                             |  |      | 1,849  |   |      |   | 1,868  |  |   | 2,350 
|Securities sold under agreements to repurchase                             |  |      | 159    |   |      |   | 188    |  |   | 232   
|Interest on long term borrowings                                           |  |      | 853    |   |      |   | 623    |  |   | 305   
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Total interest expense                                                     |  |      | 3,641  |   |      |   | 3,368  |  |   | 3,514 
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Net interest income                                                        |  |      | 9,619  |   |      |   | 8,109  |  |   | 7,344 
|Provision for Credit Losses                                                |  |      | 294    |   |      |   | 50     |  |   | 25    
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Net interest income after provision for credit losses                      |  |      | 9,325  |   |      |   | 8,059  |  |   | 7,319 
|Noninterest Income                                                         |  |      |        |   |      |   |        |  |   |       
|Service charges and fees on deposits                                       |  |      | 1,309  |   |      |   | 1,195  |  |   | 694   
|Mortgage banking fees                                                      |  |      | 239    |   |      |   | 448    |  |   | 315   
|Rental income                                                              |  |      | 174    |   |      |   | 170    |  |   | 167   
|Other income                                                               |  |      | 312    |   |      |   | 271    |  |   | 464   
|Net loss on sale of securities available for sale                          |  |      | (9     | ) |      |   |       |  |   |      
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Total noninterest income                                                   |  |      | 2,025  |   |      |   | 2,084  |  |   | 1,640 
|Noninterest Expense                                                        |  |      |        |   |      |   |        |  |   |       
|Personnel                                                                  |  |      | 4,586  |   |      |   | 4,217  |  |   | 3,885 
|Occupancy and equipment                                                    |  |      | 962    |   |      |   | 984    |  |   | 968   
|Data processing                                                            |  |      | 874    |   |      |   | 836    |  |   | 775   
|Marketing and advertising                                                  |  |      | 220    |   |      |   | 265    |  |   | 285   
|Other operating                                                            |  |      | 1,304  |   |      |   | 1,231  |  |   | 1,175 
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Total noninterest expense                                                  |  |      | 7,946  |   |      |   | 7,533  |  |   | 7,088 
|                                                                           |  |      |       
|Income Before Income Taxes                                                 |  |      | 3,404  |   |      |   | 2,610  |  |   | 1,871 
|Income Tax Expense                                                         |  |      | 1,231  |   |      |   | 936    |  |   | 644   
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Net Income                                                                 |  | $    | 2,173  |   |      | $ | 1,674  |  | $ | 1,227 
|                                                                           |  |      |        |   |      |   |        |  |   |       
|Basic Earnings per Share                                                   |  | $    | 0.54   |   |      | $ | 0.42   |  | $ | 0.31  
|Diluted Earnings per Share                                                 |  | $    | 0.52   |   |      | $ | 0.41   |  | $ | 0.30  



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



28



---

ANNAPOLIS BANCORP, INC.

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

For the years ending December 31, 2004, 2003 and
2002



|                                                                                |        |              |           |                 |    |  |                   |        |   |                                     |   |       |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|------------------------------------------------------------------------------- | ------ | ------------ | --------- | --------------- | -- |  | ----------------- | ------ | - | ----------------------------------- | - | ----- | ------------------------ |  | - | ------------------- | - |  | - | ------ | - |  | - | ----- | -
|                                                                                |        | Common Stock |           | Paid in Capital |    |  | Retained Earnings |        |   | AccumulatedOtherComprehensiveIncome |   |       | TotalStockholdersEquity |  |   | ComprehensiveIncome |  
|                                                                                | Shares |              | Par Value |                 |    |  |                   |       
|BALANCE January 1, 2002                                                         |        | 2,996,629    |           | $               | 30 |  | $                 | 12,796 |   |                                     | $ | 833   |                          |  | $ | 201                 |   |  | $ | 13,860 |   |  |   |       |  
|Net income                                                                      |        |             |           |                 |   |  |                   |       |   |                                     |   | 1,227 |                          |  |   |                    |   |  |   | 1,227  |   |  |   | 1,227 |  
|Dividends paid ($0.0298 per share)                                              |        |             |           |                 |   |  |                   |       |   |                                     |   | (30   | )                        |  |   |                    |   |  |   | (30    | ) |  |   |       |  
|Stock options exercised                                                         |        | 8,899        |           |                 |   |  |                   | 35     |   |                                     |   |      |                          |  |   |                    |   |  |   | 35     |   |  |   |       |  
|Issuance of restricted stock                                                    |        | 4,865        |           |                 |   |  |                   | 28     |   |                                     |   |      |                          |  |   |                    |   |  |   | 28     |   |  |   |       |  
|Unrealized loss on investment securities available for sale net of income taxes |        |             |           |                 |   |  |                   |       |   |                                     |   |      |                          |  |   | (42                 | ) |  |   | (42    | ) |  |   | (42   | )
|                                                                                |        |              |           |                 |    |  |                   |        |   |                                     |   |       |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|BALANCE DECEMBER 31, 2002                                                       |        | 3,010,393    |           |                 | 30 |  |                   | 12,859 |   |                                     |   | 2,030 |                          |  |   | 159                 |   |  |   | 15,078 |   |  |   | 1,185 |  
|                                                                                |        |              |           |                 |    |  |                   |        |   |                                     |   |       |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|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 |  
|                                                                                |        |              |           |                 |    |  |                   |        |   |                                     |   |       |                          |  |   |                     |   |  |   |        |   |  |   |       |  



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



29



---

ANNAPOLIS BANCORP, INC.

Consolidated Statements of Cash Flows ($000)



|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|Years Ended December 31,                                                          |  | 2004 |         |   | 2003 |   |         | 2002 | 
|Cash Flows from Operating Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $    | 2,173   |   |      | $ | 1,674   |      |  | $ | 1,227   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                     |  |      | 425     |   |      |   | 467     |      |  |   | 448     |  
|Provision for credit losses                                                       |  |      | 294     |   |      |   | 50      |      |  |   | 25      |  
|Proceeds from stock options exercised                                             |  |      | 66      |   |      |   | 26      |      |  |   | 35      |  
|Issuance of restricted stock                                                      |  |      | 15      |   |      |   | 13      |      |  |   | 28      |  
|Stock-based compensation                                                          |  |      | 18      |   |      |   |        |      |  |   |        |  
|Deferred income taxes                                                             |  |      | 17      |   |      |   | 63      |      |  |   | 1       |  
|Amortization of premiums and accretion of discounts, net                          |  |      | 14      |   |      |   | 9       |      |  |   | 24      |  
|Loss on sale of securities                                                        |  |      | (9      | ) |      |   |        |      |  |   |        |  
|(Increase) decrease in:                                                           |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest receivable                                                       |  |      | (192    | ) |      |   | (137    | )    |  |   | 123     |  
|Other assets                                                                      |  |      | (372    | ) |      |   | (233    | )    |  |   | (177    | )
|Increase (decrease) in                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest payable                                                          |  |      | 71      |   |      |   | (3      | )    |  |   | 62      |  
|Accrued income taxes, net of taxes refundable                                     |  |      | (61     | ) |      |   | (31     | )    |  |   | (62     | )
|Deferred loan origination fees                                                    |  |      | (144    | ) |      |   | (117    | )    |  |   | 90      |  
|Other liabilities                                                                 |  |      | 220     |   |      |   | 54      |      |  |   | 284     |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided from operations                                                 |  |      | 2,535   |   |      |   | 1,835   |      |  |   | 2,108   |  
|                                                                                  |  |      |        
|Cash Flows from Investing Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Proceeds from sales and maturities of securities available for sale               |  |      | 10,358  |   |      |   | 26,817  |      |  |   | 33,683  |  
|Purchase of securities available for sale                                         |  |      | (26,922 | ) |      |   | (45,108 | )    |  |   | (24,982 | )
|Net decrease (increase) in federal funds sold                                     |  |      | 801     |   |      |   | 7,515   |      |  |   | (1,819  | )
|Net increase in loans receivable                                                  |  |      | (35,323 | ) |      |   | (21,321 | )    |  |   | (34,503 | )
|Purchase of bank owned life insurance                                             |  |      |        |   |      |   |        |      |  |   | (3,110  | )
|Purchases of premises and equipment                                               |  |      | (440    | ) |      |   | (262    | )    |  |   | (187    | )
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash used by investing activities                                             |  |      | (51,526 | ) |      |   | (32,359 | )    |  |   | (30,918 | )
|                                                                                  |  |      |        
|Cash Flows from Financing Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|Time deposits                                                                     |  |      | 18,102  |   |      |   | 8,434   |      |  |   | 3,179   |  
|Other deposits                                                                    |  |      | 18,155  |   |      |   | 18,153  |      |  |   | 15,928  |  
|Securities sold under agreements to repurchase                                    |  |      | (844    | ) |      |   | (1,755  | )    |  |   | 2,826   |  
|Long term borrowings                                                              |  |      | 15,000  |   |      |   | 5,000   |      |  |   | 10,000  |  
|Payment of cash dividends                                                         |  |      |        |   |      |   |        |      |  |   | (30     | )
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                         |  |      | 50,413  |   |      |   | 29,832  |      |  |   | 31,903  |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |      | 1,422   |   |      |   | (692    | )    |  |   | 3,093   |  
|Cash and cash equivalents at beginning of year                                    |  |      | 6,033   |   |      |   | 6,725   |      |  |   | 3,632   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                          |  | $    | 7,455   |   |      | $ | 6,033   |      |  | $ | 6,725   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Supplemental Cash Flow Information                                                |  |      |         |   |      |   |         |      |  |   |         |  
|Interest paid, including interest credited to accounts                            |  | $    | 3,569   |   |      | $ | 3,368   |      |  | $ | 3,452   |  
|Income taxes paid                                                                 |  |      | 1,356   |   |      |   | 874     |      |  |   | 638     |  



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



30



---

ANNAPOLIS BANCORP, INC.



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

For the years ended December 31, 2004, 2003 and 2002



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 2003 and 2002 consolidated financial statements to conform with the 2004 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.



31



---

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.



32



---

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 2004, 2003, and 2002 has been estimated using the Black-Scholes option-pricing model with the
following assumptions:

|                        |  |       |   |  |       |   |  |       |  
|----------------------- |  | ----- | - |  | ----- | - |  | ----- | -
|                        |  | 2004  |   |  | 2003  |   |  | 2002  |  
|Dividend yield          |  | 0.00  | % |  | 0.00  | % |  | 0.00  | %
|Risk free interest rate |  | 3.94  | % |  | 3.77  | % |  | 4.66  | %
|Expected volatility     |  | 33.04 | % |  | 19.70 | % |  | 15.00 | %
|Expected life in years  |  | 7     |   |  | 7     |   |  | 10    |  



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:

|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                                                                                    |  | 2004 |       |   | 2003 |   |       | 2002 | 
|Net income as reported                                                                                                                                              |  | $    | 2,173 |   |      | $ | 1,674 |      |  | $ | 1,227 |  
|Add: Stock option employee compensation expense included in reported net income, net of related tax effect                                                          |  |      | 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 |  |      | (55   | ) |      |   | (75   | )    |  |   | (64   | )
|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|Proforma income                                                                                                                                                     |  | $    | 2,136 |   |      | $ | 1,599 |      |  | $ | 1,163 |  
|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|Basic earnings per share                                                                                                                                            |  |      |       |   |      |   |       |      |  |   |       |  
|As reported                                                                                                                                                         |  | $    | 0.54  |   |      | $ | 0.42  |      |  | $ | 0.31  |  
|Proforma                                                                                                                                                            |  | $    | 0.52  |   |      | $ | 0.40  |      |  | $ | 0.29  |  
|Diluted earnings per share                                                                                                                                          |  |      |       |   |      |   |       |      |  |   |       |  
|As reported                                                                                                                                                         |  | $    | 0.53  |   |      | $ | 0.41  |      |  | $ | 0.30  |  
|Proforma                                                                                                                                                            |  | $    | 0.51  |   |      | $ | 0.39  |      |  | $ | 0.29  |  



33



---

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



In January 2003, the Financial Accounting Standards Board (the
FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities (Interpretation No. 46), which explains identification of variable interest entities and the assessment of whether to consolidate
those entities. FIN 46 Revised (FIN 46R), issued in December 2003, replaces FIN 46. FIN 46R requires deconsolidation and re-characterization of the underlying consolidated debt obligation from the trust preferred securities obligation to
the junior subordinated debenture obligation that exists between a company and its statutory trusts. In March 2003, the Company issued trust preferred securities through a wholly-owned statutory trust formed for that purpose. In accordance with FIN
46R, the statutory trust has not been consolidated with the holding company.



In November 2003, the Emerging Issues Task Force (EITF) of the FASB issued EITF Abstract 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments
(EITF 03-1) effective for fiscal years ending after December 15, 2003. This abstract provides guidelines on the meaning of other-than-temporary impairment and its application to investments, in addition to requiring quantitative and
qualitative disclosures in the financial statements. These disclosures have been included in Note 3. In March 2004, the EITF issued a Consensus on Issue 03-1 (the Consensus) requiring that the provisions of EITF 03-1 be applied to
cost-method investments for annual periods ending after June 30, 2004. The Consensus also requires several additional disclosures for cost-method investments. The Company has implemented the guidelines of this Consensus. The adoption of the
Consensus did not have any impact on the Companys financial statements.



In March 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 105, Application of Accounting Principles to Loan Commitments, which provides
guidance regarding loan commitments that are accounted for as derivative instruments. In this SAB, the SEC determined that an interest lock commitment should generally be valued at zero at inception. The Company does not originate or fund mortgage
loans sold in the secondary market, but rather receives a broker fee. This SAB did not have any effect on the Companys financial position or results of operations.



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 $3.5 million.



3. INVESTMENT SECURITIES



Investment securities are summarized as follows:



|                             |  |               |        |                 |   |                  |  |                      |     |  |   |       
|---------------------------- |  | ------------- | ------ | --------------- | - | ---------------- |  | -------------------- | --- |  | - | ------
|                             |  | AmortizedCost |        | UnrealizedGains |   | UnrealizedLosses |  | Estimated Fair Value
|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
|                             |  |               |        |                 |   |                  |  |                      |     |  |   |       
|December 31, 2003            |  |               |        |                 |   |                  |  |                      |     |  |   |       
|Available for sale           |  |               |        |                 |   |                  |  |                      |     |  |   |       
|U.S. Government agency       |  | $             | 28,343 |                 | $ | 42               |  | $                    | 218 |  | $ | 28,167
|Mortgage-backed securities   |  |               | 8,900  |                 |   | 48               |  |                      | 150 |  |   | 8,798 
|Federal Home Loan Bank stock |  |               | 500    |                 |   |                 |  |                      |    |  |   | 500   
|Federal Reserve Bank stock   |  |               | 504    |                 |   |                 |  |                      |    |  |   | 504   
|                             |  |               |        |                 |   |                  |  |                      |     |  |   |       
|                             |  | $             | 38,247 |                 | $ | 90               |  | $                    | 368 |  | $ | 37,969
|                             |  |               |        |                 |   |                  |  |                      |     |  |   |       



Proceeds from the sale
of securities during 2004 were $1.9 million with realized net losses amounting to $9 thousand in 2004 on those sales compared to zero proceeds and no gains or losses in 2003 and 2002. Gains and losses are determined using the specific identification
method.



34



---

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, 2004 are as follows:





|                           |  |            |        |                                           |   |                       |  |   |     |  |   |    
|-------------------------- |  | ---------- | ------ | ----------------------------------------- | - | --------------------- |  | - | --- |  | - | ---
|                           |  |            |        | Continuous unrealized losses existing for |   | TotalUnrealizedLosses
|                           |  | Fair Value |        | Less than12 Months                        |   | More than 12 Months   | 
|December 31, 2004          |  |            |        |                                           |   |                       |  |   |     |  |   |    
|Available for sale         |  |            |        |                                           |   |                       |  |   |     |  |   |    
|U.S. Government agency     |  | $          | 21,110 |                                           | $ | 157                   |  | $ | 82  |  | $ | 239
|Mortgage-backed securities |  |            | 13,815 |                                           |   | 100                   |  |   | 90  |  |   | 190
|                           |  |            |        |                                           |   |                       |  |   |     |  |   |    
|                           |  | $          | 34,925 |                                           | $ | 257                   |  | $ | 172 |  | $ | 429
|                           |  |            |        |                                           |   |                       |  |   |     |  |   |    



The available-for-sale
investment portfolio has a fair value of approximately $54.4 million of which approximately $34.9 million of the securities have some unrealized losses from their purchase price. Of these securities, $21.1 million, or 60.4%, are government agency
bonds and $13.8 million, or 39.6% 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.



|                                 |  |                    |        |                     |   |       
|-------------------------------- |  | ------------------ | ------ | ------------------- | - | ------
|                                 |  | Available for Sale
|                                 |  | AmortizedCost      |        | EstimatedFair Value
|December 31, 2004                |  |                    |        |                     |   |       
|Due within one year              |  | $                  |       |                     | $ |      
|Due after one through five years |  |                    | 32,666 |                     |   | 32,470
|Due after five years             |  |                    | 20,049 |                     |   | 19,878
|Equity securities                |  |                    | 2,092  |                     |   | 2,092 
|                                 |  |                    |        |                     |   |       
|                                 |  |                    | 54,807 |                     |   | 54,440
|                                 |  |                    |        |                     |   |       
|December 31, 2003                |  |                    |        |                     |   |       
|Due within one year              |  | $                  | 351    |                     | $ | 353   
|Due after one through five years |  |                    | 20,763 |                     |   | 20,689
|Due after five years             |  |                    | 16,129 |                     |   | 15,923
|Equity securities                |  |                    | 1,004  |                     |   | 1,004 
|                                 |  |                    |        |                     |   |       
|                                 |  |                    | 38,247 |                     |   | 37,969
|                                 |  |                    |        |                     |   |       



At December 31, 2004,
2003 and 2002, investments available for sale with a carrying value of $13.2 million, $10.3 million and $16.8 million, respectively, were pledged as collateral for certain government deposits and for other purposes as required by law.



35



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4. LOANS AND ALLOWANCE FOR CREDIT LOSSES



Major classifications of loans are as follows:



|                                       |  |      |         |   |      |   |         |  
|-------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                       |  | 2004 |         |   | 2003 |  
|Real estate                            |  |      |         |   |      |   |         |  
|Commercial                             |  | $    | 71,830  |   |      | $ | 60,572  |  
|Residential                            |  |      | 69,567  |   |      |   | 47,565  |  
|Commercial                             |  |      | 42,248  |   |      |   | 41,173  |  
|Consumer                               |  |      | 20,325  |   |      |   | 19,431  |  
|                                       |  |      |         |   |      |   |         |  
|                                       |  |      | 203,970 |   |      |   | 168,741 |  
|Deferred loan origination costs (fees) |  |      | 158     |   |      |   | 14      |  
|Allowance for credit losses            |  |      | (1,832  | ) |      |   | (1,632  | )
|                                       |  |      |         |   |      |   |         |  
|                                       |  |      | (1,674  | ) |      |   | (1,618  | )
|                                       |  |      |         |   |      |   |         |  
|Loans, net                             |  | $    | 202,296 |   |      | $ | 167,123 |  
|                                       |  |      |         |   |      |   |         |  



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



|                                      |  |   |         |  |   |        
|------------------------------------- |  | - | ------- |  | - | -------
|Repricing or maturing within one year |  | $ | 107,973 |  | $ | 91,075 
|Maturing over one to five years       |  |   | 48,337  |  |   | 40,704 
|Maturing over five years              |  |   | 47,660  |  |   | 36,962 
|                                      |  |   |         |  |   |        
|                                      |  | $ | 203,970 |  | $ | 168,741
|                                      |  |   |         |  |   |        



Transactions in the
allowance for credit losses are as follows:



|                                |  |      |       |      |   |       |  |   |      
|------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                |  | 2004 |       | 2003 |   | 2002 
|Balance, beginning of the year  |  | $    | 1,632 |      | $ | 1,578 |  | $ | 1,576
|Provision charged to operations |  |      | 294   |      |   | 50    |  |   | 25   
|Recoveries                      |  |      | 11    |      |   | 30    |  |   | 49   
|Charge-offs                     |  |      | 105   |      |   | 26    |  |   | 72   
|                                |  |      |       |      |   |       |  |   |      
|Balance, end of year            |  | $    | 1,832 |      | $ | 1,632 |  | $ | 1,578
|                                |  |      |       |      |   |       |  |   |      



The balance of
nonaccrual and impaired loans is as follows:



|                                                      |  |      |     |      |   |      |  |   |    
|----------------------------------------------------- |  | ---- | --- | ---- | - | ---- |  | - | ---
|                                                      |  | 2004 |     | 2003 |   | 2002
|Total guaranteed by the Small Business Administration |  | $    |    |      | $ |     |  | $ | 37 
|Other nonaccrual loans                                |  |      | 599 |      |   | 27   |  |   | 18 
|Total nonaccrual loans and impaired loans             |  |      | 599 |      |   | 27   |  |   | 55 
|Average impaired loans                                |  |      | 141 |      |   | 86   |  |   | 112
|Related allowance for credit losses                   |  |      | 90  |      |   | 4    |  |   | 17 
|Interest collected                                    |  |      | 44  |      |   | 25   |  |   | 50 
|Balance of accrued interest not recorded              |  |      | 8   |      |   |     |  |   | 25 



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.



Loans that were 90 days or more past due, including nonaccrual loans were
zero at December 31, 2004 and 2003 and $1.3 million at December 31, 2002.



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:



|                                      |  |      |       |   |      |   |       |  
|------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                      |  | 2004 |       |   | 2003 |  
|Beginning balance                     |  | $    | 1,966 |   |      | $ | 2,329 |  
|Advances                              |  |      | 2,626 |   |      |   | 129   |  
|Repayments                            |  |      | (182  | ) |      |   | (492  | )
|Change in officers and directors, net |  |      | 697   |   |      |   |      |  
|                                      |  |      |       |   |      |   |       |  
|Ending balance                        |  | $    | 5,107 |   |      | $ | 1,966 |  
|                                      |  |      |       |   |      |   |       |  



36



---

5. CREDIT COMMITMENTS



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

|                                     |  |      |        |      |   |       
|------------------------------------ |  | ---- | ------ | ---- | - | ------
|Dollars in thousands                 |  | 2004 |        | 2003
|Loan commitments and lines of credit |  |      |        |      |   |       
|Construction                         |  | $    | 17,556 |      | $ | 26,639
|Other                                |  |      | 42,192 |      |   | 33,783
|                                     |  |      |        |      |   |       
|                                     |  | $    | 59,748 |      | $ | 60,422
|                                     |  |      |        |      |   |       
|Letter of credit                     |  |      |        |      |   |       
|Deposit secured                      |  | $    | 363    |      | $ | 351   
|Other                                |  |      | 709    |      |   | 634   
|                                     |  |      |        |      |   |       
|                                     |  | $    | 1,072  |      | $ | 985   
|                                     |  |      |        |      |   |       



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 $154,000 in BOLI income for 2004 and $133,000 in 2003.



7. PREMISES AND EQUIPMENT



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

|                                     |  |      |       |      |   |      
|------------------------------------ |  | ---- | ----- | ---- | - | -----
|                                     |  | 2004 |       | 2003
|Land, land improvements and building |  | $    | 6,206 |      | $ | 6,067
|Leasehold improvements               |  |      | 657   |      |   | 697  
|Furniture, fixtures, and equipment   |  |      | 1,897 |      |   | 2,057
|                                     |  |      |       |      |   |      
|                                     |  |      | 8,760 |      |   | 8,821
|Accumulated depreciation             |  |      | 1,762 |      |   | 1,885
|                                     |  |      |       |      |   |      
|Net premises and equipment           |  | $    | 6,998 |      | $ | 6,936
|                                     |  |      |       |      |   |      



Depreciation and
amortization expense was $425 thousand for 2004, $467 thousand for 2003 and $448 thousand for 2002.



9. LEASE COMMITMENTS



Lease obligations will require rent payments as follows:

|                |  |                        |      
|--------------- |  | ---------------------- | -----
|Period          |  | Minimum Rentals $(000)
|2005            |  | $                      | 162  
|2006            |  |                        | 96   
|2007            |  |                        | 58   
|2008            |  |                        | 50   
|2009            |  |                        | 48   
|Remaining years |  |                        | 648  
|                |  |                        |      
|                |  | $                      | 1,062
|                |  |                        |      



37



---

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 $178 thousand, $168 thousand and $149 thousand for 2004, 2003 and 2002, respectively.



10. DEPOSITS



Major classifications of deposits are as follows:



|                                  |  |      |         |      |   |        
|--------------------------------- |  | ---- | ------- | ---- | - | -------
|                                  |  | 2004 |         | 2003
|Demand, noninterest bearing       |  | $    | 39,473  |      | $ | 33,385 
|NOW accounts                      |  |      | 32,844  |      |   | 30,901 
|Savings and Money Market accounts |  |      | 62,824  |      |   | 52,554 
|Time deposits, $100,000 and over  |  |      | 35,711  |      |   | 22,475 
|Other time                        |  |      | 55,982  |      |   | 51,117 
|                                  |  |      |         |      |   |        
|                                  |  | $    | 226,834 |      | $ | 190,432
|                                  |  |      |         |      |   |        



Time deposits mature
as follows:



|                                      |  |   |        |  |   |       
|------------------------------------- |  | - | ------ |  | - | ------
|Repricing or maturing within one year |  | $ | 38,800 |  | $ | 41,881
|Maturing over one to three years      |  |   | 44,466 |  |   | 25,299
|Maturing over three to five years     |  |   | 8,427  |  |   | 6,412 
|                                      |  |   |        |  |   |       
|                                      |  | $ | 91,693 |  | $ | 73,592
|                                      |  |   |        |  |   |       



At December 31, 2004
and 2003 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:



|                                      |  |      |        |   |      |   |        |  
|------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                      |  | 2004 |        |   | 2003 |  
|Balance outstanding, at year end      |  | $    | 7,901  |   |      | $ | 8,745  |  
|Average balance during the year       |  |      | 8,730  |   |      |   | 9,780  |  
|Average interest rate during the year |  |      | 1.82   | % |      |   | 1.79   | %
|Maximum month-end balance             |  | $    | 10,538 |   |      | $ | 14,141 |  



12. LONG TERM BORROWINGS



The Company had other long term borrowings at December
31, 2004 and 2003 as follows:



|                                                           |  |      |        |      |   |       
|---------------------------------------------------------- |  | ---- | ------ | ---- | - | ------
|                                                           |  | 2004 |        | 2003
|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  |      |   |      
|FHLB 2.37% Advance due October 2014, Callable October 2006 |  |      | 10,000 |      |   |      
|                                                           |  |      |        |      |   |       
|Total                                                      |  | $    | 25,000 |      | $ | 10,000
|                                                           |  |      |        |      |   |       



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 5.70%. 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,



38



---

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, 2004 and 2003 totaled $236 thousand and $166 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, 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 $111 thousand in 2004, $111 thousand in 2003 and $95 thousand in 2002.



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 2004, 2003, and 2002 were $41.3 thousand, $48.6 thousand and $17.6 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.



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



|                                                       |  |                 |   |      |                              |      |                 |         |   |                              |   |                 |  |         |                               |  |   |     
|------------------------------------------------------ |  | --------------- | - | ---- | ---------------------------- | ---- | --------------- | ------- | - | ---------------------------- | - | --------------- |  | ------- | ----------------------------- |  | - | ----
|                                                       |  | 2004            |   | 2003 |                              | 2002
|                                                       |  | Number ofShares |   |      | WeightedAverageExercisePrice |      | Number ofShares |         |   | WeightedAverageExercisePrice |   | Number ofShares |  |         | WeightedAverageExercise Price
|Options Outstanding                                    |  |                 |   |      |                              |      |                 |         |   |                              |   |                 |  |         |                               |  |   |     
|Outstanding, beginning of year                         |  | 294,160         |   |      | $                            | 3.36 |                 | 275,873 |   |                              | $ | 3.08            |  | 332,399 |                               |  | $ | 2.84
|Granted                                                |  | 29,996          |   |      |                              | 7.77 |                 | 27,330  |   |                              |   | 6.05            |  | 43,333  |                               |  |   | 4.12
|Exercised                                              |  | (21,794         | ) |      |                              | 2.93 |                 | (9,043  | ) |                              |   | 2.91            |  | (11,864 | )                             |  |   | 2.47
|Forfeited                                              |  | (25,774         | ) |      |                              | 4.66 |                 |        |   |                              |   |                |  | (87,995 | )                             |  |   | 2.77
|                                                       |  |                 |   |      |                              |      |                 |         |   |                              |   |                 |  |         |                               |  |   |     
|Outstanding, end of year                               |  | 276,588         |   |      | $                            | 3.75 |                 | 294,160 |   |                              | $ | 3.36            |  | 275,873 |                               |  | $ | 3.08
|                                                       |  |                 |   |      |                              |      |                 |         |   |                              |   |                 |  |         |                               |  |   |     
|Weighted fair value of options granted during the year |  |                 |   |      | $                            | 4.88 |                 |         |   |                              | $ | 2.51            |  |         |                               |  | $ | 2.22



39



---

These options expire as follows:



|                |  |                               |      |               |         |           |        
|--------------- |  | ----------------------------- | ---- | ------------- | ------- | --------- | -------
|Expiration Date |  | WeightedAverageExercise Price |      | OptionsVested |         | Nonvested
|2007            |  | $                             | 3.72 |               | 16,752  |           |       
|2008            |  |                               | 6.09 |               | 7,998   |           |       
|2009            |  |                               | 2.70 |               | 28,976  |           |       
|2010            |  |                               | 2.42 |               | 42,662  |           | 10,666 
|2011            |  |                               | 2.75 |               | 46,993  |           | 39,658 
|2012            |  |                               | 4.12 |               | 17,333  |           | 26,000 
|2013            |  |                               | 7.23 |               | 1,911   |           | 7,643  
|2014            |  |                               | 7.77 |               |        |           | 29,996 
|                |  |                               |      |               |         |           |        
|                |  |                               |      |               | 162,625 |           | 113,963
|                |  |                               |      |               |         |           |        



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



|                               |  |                 |   |      |                               |      |                 |        |   |                               |   |     
|------------------------------ |  | --------------- | - | ---- | ----------------------------- | ---- | --------------- | ------ | - | ----------------------------- | - | ----
|                               |  | 2004            |   | 2003
|                               |  | Numberof Shares |   |      | WeightedAverageExercise Price |      | Numberof Shares |        |   | WeightedAverageExercise Price
|Restricted Shares              |  |                 |   |      |                               |      |                 |        |   |                               |   |     
|Outstanding, beginning of year |  | 5,866           |   |      | $                             | 2.42 |                 | 8,804  |   |                               | $ | 2.42
|Granted                        |  |                |   |      |                               |     |                 |       |   |                               |   |    
|Exercised                      |  | (2,933          | ) |      |                               | 2.42 |                 | (2,938 | ) |                               |   | 2.42
|Forfeited                      |  |                |   |      |                               |     |                 |       |   |                               |   |    
|                               |  |                 |   |      |                               |      |                 |        |   |                               |   |     
|Outstanding, end of year       |  | 2,933           |   |      | $                             | 2.42 |                 | 5,866  |   |                               | $ | 2.42
|                               |  |                 |   |      |                               |      |                 |        |   |                               |   |     



16. LINES OF CREDIT



The Bank is a member of the Federal Home Loan Bank system and may borrow
up to $113.7 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, 2004 or 2003.



18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)



THREE MONTHS ENDED



|                             |  |              |       |               |   |          |  |   |           |   |  |   |      
|---------------------------- |  | ------------ | ----- | ------------- | - | -------- |  | - | --------- | - |  | - | -----
|                             |  | December 31, |       | September 30, |   | June 30, |  |   | March 31,
|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 (loss)  |  |              | 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 
|                             |  |              |       |              
|2002                         |  |              |       |               |   |          |  |   |           |   |  |   |      
|Interest income              |  | $            | 2,800 |               | $ | 2,853    |  | $ | 2,668     |   |  | $ | 2,537
|Interest expense             |  |              | 868   |               |   | 914      |  |   | 885       |   |  |   | 847  
|Net interest income          |  |              | 1,932 |               |   | 1,939    |  |   | 1,783     |   |  |   | 1,690
|Provision for credit losses  |  |              | 25    |               |   |         |  |   |          |   |  |   |     
|Net income                   |  |              | 429   |               |   | 423      |  |   | 230       |   |  |   | 145  
|Comprehensive income         |  |              | 424   |               |   | 480      |  |   | 135       |   |  |   | 144  
|Earnings per share - basic   |  |              | 0.11  |               |   | 0.11     |  |   | 0.06      |   |  |   | 0.04 
|Earnings per share - diluted |  |              | 0.11  |               |   | 0.10     |  |   | 0.06      |   |  |   | 0.04 



40



---

19. INCOME TAXES



The components of income tax expense are as follows:

|         |  |      |       |      |   |      |  |   |    
|-------- |  | ---- | ----- | ---- | - | ---- |  | - | ---
|         |  | 2004 |       | 2003 |   | 2002
|Current  |  |      |       |      |   |      |  |   |    
|Federal  |  | $    | 1,040 |      | $ | 715  |  | $ | 578
|State    |  |      | 174   |      |   | 158  |  |   | 65 
|         |  |      |       |      |   |      |  |   |    
|         |  |      | 1,214 |      |   | 873  |  |   | 643
|Deferred |  |      | 17    |      |   | 63   |  |   | 1  
|         |  |      |       |      |   |      |  |   |    
|         |  | $    | 1,231 |      | $ | 936  |  | $ | 644
|         |  |      |       |      |   |      |  |   |    



The components of the
deferred taxes are as follows:

|                            |  |      |     |   |      |   |     |      |  |   |     |  
|--------------------------- |  | ---- | --- | - | ---- | - | --- | ---- |  | - | --- | -
|                            |  | 2004 |     |   | 2003 |   |     | 2002 | 
|Provision for credit losses |  | $    | (70 | ) |      | $ | (17 | )    |  | $ | (1  | )
|Revenues taxed not earned   |  |      |    |   |      |   | 54  |      |  |   | 28  |  
|Deferred compensation       |  |      | (14 | ) |      |   | (22 | )    |  |   |    |  
|Accrued expenses            |  |      |    |   |      |   | 6   |      |  |   | (29 | )
|Depreciation expense        |  |      | 55  |   |      |   | 37  |      |  |   | 3   |  
|Other                       |  |      | 46  |   |      |   | 5   |      |  |   |    |  
|                            |  |      |     |   |      |   |     |      |  |   |     |  
|Deferred tax expense        |  | $    | 17  |   |      | $ | 63  |      |  | $ | 1   |  
|                            |  |      |     |   |      |   |     |      |  |   |     |  



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

|                                                 |  |      |     |      |   |      |  |   |    
|------------------------------------------------ |  | ---- | --- | ---- | - | ---- |  | - | ---
|                                                 |  | 2004 |     | 2003 |   | 2002
|Deferred tax assets                              |  |      |     |      |   |      |  |   |    
|Allowance for credit losses                      |  | $    | 494 |      | $ | 424  |  | $ | 407
|Deferred compensation                            |  |      | 36  |      |   | 22   |  |   |   
|Revenue taxed not earned                         |  |      |    |      |   |     |  |   | 54 
|Unrealized loss on securities available for sale |  |      | 125 |      |   | 95   |  |   |   
|Accrued expenses                                 |  |      | 23  |      |   | 23   |  |   | 29 
|                                                 |  |      |     |      |   |      |  |   |    
|Total deferred tax assets                        |  |      | 678 |      |   | 564  |  |   | 490
|Deferred tax liabilities                         |  |      |     |      |   |      |  |   |    
|Depreciation                                     |  |      | 137 |      |   | 82   |  |   | 45 
|Other                                            |  |      | 51  |      |   | 5    |  |   |   
|Unrealized gain on securities available for sale |  |      |    |      |   |     |  |   | 82 
|                                                 |  |      |     |      |   |      |  |   |    
|Total deferred tax liabilities                   |  |      | 188 |      |   | 87   |  |   | 127
|                                                 |  |      |     |      |   |      |  |   |    
|Net deferred tax asset                           |  | $    | 490 |      | $ | 477  |  | $ | 363
|                                                 |  |      |     |      |   |      |  |   |    



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



|                                                                                |  |      |       |   |   |      |    |      |   |       |   |  |      |      |  |   |       |   |  |      |   
|------------------------------------------------------------------------------- |  | ---- | ----- | - | - | ---- | -- | ---- | - | ----- | - |  | ---- | ---- |  | - | ----- | - |  | ---- | --
|                                                                                |  | 2004 |       |   | % |      |    | 2003 |   |       | % |  |      | 2002 |  |   | %     |  
|Income before income taxes                                                      |  | $    | 3,404 |   |   |      |    |      | $ | 2,610 |   |  |      |      |  | $ | 1,871 |   |  |      |   
|                                                                                |  |      |       |   |   |     
|Taxes computed at the federal income tax rate                                   |  | $    | 1,157 |   |   | 34.0 | %  |      | $ | 887   |   |  | 34.0 | %    |  | $ | 636   |   |  | 34.0 | % 
|Increases (decreases) resulting from State income taxes, net of federal benefit |  |      | 122   |   |   | 3.6  | %  |      |   | 90    |   |  | 3.4  | %    |  |   | 43    |   |  | 2.3  | % 
|Nondeductible expenses                                                          |  |      | 4     |   |   | 0.1  | %  |      |   | 4     |   |  | 0.2  | %    |  |   | 4     |   |  | 0.2  | % 
|Nontaxable income                                                               |  |      | (52   | ) |   | (1.5 | )% |      |   | (45   | ) |  | (1.7 | )%   |  |   | (39   | ) |  | (2.1 | )%
|                                                                                |  |      |       |   |   |      |    |      |   |       |   |  |      |      |  |   |       |   |  |      |   
|Income tax expense                                                              |  | $    | 1,231 |   |   | 36.2 | %  |      | $ | 936   |   |  | 35.9 | %    |  | $ | 644   |   |  | 34.4 | % 
|                                                                                |  |      |       |   |   |      |    |      |   |       |   |  |      |      |  |   |       |   |  |      |   



41



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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, 2004 and 2003 are as follows:



|                                         |  |              |        |       |      |   |                              |   |        |  |     |                             |  |       |        |  |      |  
|---------------------------------------- |  | ------------ | ------ | ----- | ---- | - | ---------------------------- | - | ------ |  | --- | --------------------------- |  | ----- | ------ |  | ---- | -
|                                         |  | ActualAmount |        | Ratio |      |   | MinimumCapitalAdequacyAmount |   | Ratio  |  |     | To be WellCapitalizedAmount |  | Ratio |       
|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  | %
|                                         |  |              |        |       |      |  
|December 31, 2003                        |  |              |        |       |      |   |                              |   |        |  |     |                             |  |       |        |  |      |  
|Total capital (to risk-weighted assets)  |  |              |        |       |      |   |                              |   |        |  |     |                             |  |       |        |  |      |  
|Company                                  |  | $            | 23,264 |       | 13.1 | % |                              | $ | 14,217 |  | 8.0 | %                           |  |       |        |  |      |  
|Bank                                     |  | $            | 23,141 |       | 13.1 | % |                              | $ | 14,208 |  | 8.0 | %                           |  | $     | 17,760 |  | 10.0 | %
|Tier 1 capital (to risk-weighted assets) |  |              |        |       |      |   |                              |   |        |  |     |                             |  |       |        |  |      |  
|Company                                  |  | $            | 21,632 |       | 12.2 | % |                              | $ | 7,108  |  | 4.0 | %                           |  |       |        |  |      |  
|Bank                                     |  | $            | 21,509 |       | 12.2 | % |                              | $ | 7,104  |  | 4.0 | %                           |  | $     | 10,656 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |              |        |       |      |   |                              |   |        |  |     |                             |  |       |        |  |      |  
|Company                                  |  | $            | 21,632 |       | 9.4  | % |                              | $ | 9,241  |  | 4.0 | %                           |  |       |        |  |      |  
|Bank                                     |  | $            | 21,509 |       | 9.4  | % |                              | $ | 9,236  |  | 4.0 | %                           |  | $     | 11,545 |  | 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.



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.



|                                               |  |                |         |                     |   |                |  |                      |         |  |   |        
|---------------------------------------------- |  | -------------- | ------- | ------------------- | - | -------------- |  | -------------------- | ------- |  | - | -------
|                                               |  | 2004           |         | 2003               
|                                               |  | CarryingAmount |         | EstimatedFair Value |   | CarryingAmount |  | Estimated Fair Value
|December 31,                                   |  |                |         |                     |   |                |  |                      |         |  |   |        
|Financial assets                               |  |                |         |                     |   |                |  |                      |         |  |   |        
|Cash and due from banks                        |  | $              | 7,455   |                     | $ | 7,455          |  | $                    | 6,033   |  | $ | 6,033  
|Federal funds sold                             |  |                | 7,213   |                     |   | 7,213          |  |                      | 8,014   |  |   | 8,014  
|Investment securities (total)                  |  |                | 54,440  |                     |   | 54,440         |  |                      | 37,969  |  |   | 37,969 
|Loans, net                                     |  |                | 202,296 |                     |   | 201,937        |  |                      | 167,123 |  |   | 167,062
|Accrued interest receivable                    |  |                | 1,061   |                     |   | 1,061          |  |                      | 869     |  |   | 869    
|Financial liabilities                          |  |                |         |                     |   |                |  |                      |         |  |   |        
|Noninterest-bearing deposits                   |  | $              | 39,473  |                     | $ | 39,473         |  | $                    | 33,385  |  | $ | 33,385 
|Interest-bearing deposits                      |  |                | 187,361 |                     |   | 187,521        |  |                      | 157,192 |  |   | 157,701
|Securities sold under agreements to repurchase |  |                | 7,901   |                     |   | 7,901          |  |                      | 8,745   |  |   | 8,745  
|Long term borrowings                           |  |                | 25,000  |                     |   | 24,906         |  |                      | 10,000  |  |   | 10,245 
|Junior subordinated debt                       |  |                | 5,000   |                     |   | 5,000          |  |                      | 5,000   |  |   | 5,000  
|Accrued interest payable                       |  |                | 162     |                     |   | 162            |  |                      | 94      |  |   | 94     



42



---

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)                                                |  | 2004  |  | 2003  |  | 2002 
|Weighted average shares outstanding, basic                       |  | 4,050 |  | 4,028 |  | 4,019
|Common stock equivalents                                         |  | 96    |  | 79    |  | 27   
|                                                                 |  |       |  |       |  |      
|Average common shares and equivalents, fully diluted             |  | 4,146 |  | 4,107 |  | 4,046
|                                                                 |  |       |  |       |  |      
|Stock options outstanding that were antidilutive at December 31, |  |      |  |      |  | 17   
|                                                                 |  |       |  |       |  |      



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,                                  |  | 2004 |        |   | 2003 |  
|Assets                                        |  |      |        |   |      |   |        |  
|Cash and due from banks                       |  | $    | 68     |   |      | $ | 17     |  
|Due from subsidiaries                         |  |      |       |   |      |   |       |  
|Investment in subsidiaries                    |  |      | 23,657 |   |      |   | 21,481 |  
|Deferred income taxes and other assets        |  |      | 97     |   |      |   | 110    |  
|                                              |  |      |        |   |      |   |        |  
|Total assets                                  |  | $    | 23,822 |   |      | $ | 21,608 |  
|                                              |  |      |        |   |      |   |        |  
|Liabilities and Stockholders Equity          |  |      |        |   |      |   |        |  
|Junior subordinated debt                      |  | $    | 5,155  |   |      | $ | 5,155  |  
|Due to subsidiaries                           |  |      |       |   |      |   | 2      |  
|Other liabilities                             |  |      | 5      |   |      |   | 3      |  
|Stockholders Equity                          |  |      |        |   |      |   |        |  
|Common stock                                  |  |      | 41     |   |      |   | 30     |  
|Paid in capital                               |  |      | 12,986 |   |      |   | 12,898 |  
|Retained earnings                             |  |      | 5,877  |   |      |   | 3,704  |  
|Accumulated other comprehensive (loss) income |  |      | (242   | ) |      |   | (184   | )
|                                              |  |      |        |   |      |   |        |  
|Total liabilities and stockholders equity    |  | $    | 23,822 |   |      | $ | 21,608 |  
|                                              |  |      |        |   |      |   |        |  



Statement of
Income



|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|---------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|Years Ended December 31,                       |  | 2004 |       |   | 2003 |   |       | 2002 | 
|Interest income                                |  | $    |      |   |      | $ |      |      |  | $ |      |  
|Interest expense                               |  |      | 236   |   |      |   | 166   |      |  |   |      |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Net interest income                            |  |      | (236  | ) |      |   | (166  | )    |  |   |      |  
|Equity in undistributed income of subsidiaries |  |      | 2,234 |   |      |   | 1,741 |      |  |   | 1,305 |  
|Dividends from subsidiary                      |  |      | 205   |   |      |   | 145   |      |  |   | 25    |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Total income                                   |  |      | 2,203 |   |      |   | 1,720 |      |  |   | 1,330 |  
|Noninterest expense                            |  |      |       |   |      |   |       |      |  |   |       |  
|Compensation                                   |  |      | 34    |   |      |   | 13    |      |  |   | 44    |  
|Legal                                          |  |      | 14    |   |      |   | 28    |      |  |   |      |  
|Shareholder communications                     |  |      | 119   |   |      |   | 114   |      |  |   | 112   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Total expense                                  |  |      | 167   |   |      |   | 155   |      |  |   | 156   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Income before income tax benefit               |  |      | 2,036 |   |      |   | 1,565 |      |  |   | 1,174 |  
|Income tax benefit                             |  |      | (137  | ) |      |   | (109  | )    |  |   | (53   | )
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Net income                                     |  | $    | 2,173 |   |      | $ | 1,674 |      |  | $ | 1,227 |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  



43



---

Statements of Cash Flows



|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|Years Ended December 31,                                          |  | 2004 |        |   | 2003 |   |        | 2002 | 
|Cash flows from operating activities                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net income                                                        |  | $    | 2,173  |   |      | $ | 1,674  |      |  | $ | 1,227  |  
|Due from subsidiaries                                             |  |      | (2     | ) |      |   | 13     |      |  |   | (13    | )
|Tax benefit received                                              |  |      | (15    | ) |      |   | (7     | )    |  |   | 70     |  
|Undistributed net income of subsidiary                            |  |      | (2,440 | ) |      |   | (1,886 | )    |  |   | (1,330 | )
|Net Increase in other assets and liabilities                      |  |      | 31     |   |      |   | (99    | )    |  |   |       |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash used for operations                                      |  |      | (253   | ) |      |   | (305   | )    |  |   | (46    | )
|                                                                  |  |      |       
|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                                                    |  |      |       |   |      |   |       |      |  |   | (30    | )
|Dividends received from Bank                                      |  |      | 205    |   |      |   | 145    |      |  |   | 25     |  
|Proceeds from stock options exercised and restricted stock issued |  |      | 81     |   |      |   | 39     |      |  |   | 63     |  
|Options expensed                                                  |  |      | 18     |   |      |   |       |      |  |   |       |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                         |  |      | 304    |   |      |   | 309    |      |  |   | 58     |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash                                   |  |      | 51     |   |      |   | 4      |      |  |   | 12     |  
|Cash and equivalents at beginning of year                         |  |      | 17     |   |      |   | 13     |      |  |   | 1      |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Cash and equivalents at end of year                               |  | $    | 68     |   |      | $ | 17     |      |  | $ | 13     |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  



44