**United
      States**


**Securities
      and Exchange Commission**


**Washington,
      D.C. 20549**





**Form
      10-KSB**





**(Mark
      One)**





**[X]**
            **ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**





**For
      the fiscal year ended December 31, 2005**





**[
                ]**
            **TRANSITION
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**





**For
      the transition period from**       **to**





**Commission
      File Number 000-51765**








Bay
      National Corporation


(Name
      of
      small business issuer in its charter)





Maryland
            52-2176710(State
                or other jurisdiction of
            (I.R.S.
                Employerincorporation
                or organization)
            Identification
                No.)





2328
      West Joppa Road, Lutherville, Maryland 21093


(Address
      of principal executive offices) (Zip
      Code)





Issuer's
      telephone number: 410-494-2580





Securities
      registered under Section 12(b) of the Exchange Act: None





Securities
      registered under Section 12(g) of the Exchange Act: Common stock, par value
      $0.01 per share





Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act. [ ]





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days.  Yes X No
      __








Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant's knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB. [x]




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the
      Exchange Act):   Yes  __  No X




The
      issuer's revenues for its most recent fiscal year were $13,733,299.





The
      aggregate market value of the common equity held by non-affiliates was
      $28,121,276 as of March 23, 2006, based on a sales price of $20.25 per share
      of
      Common Stock, which is the sales price at which shares of Common Stock were
      last
      sold in over the counter trading on March 15, 2006.




The
      number of shares outstanding of the issuer's Common Stock was 1,927,894 as
      of
      March 23, 2006.


**DOCUMENTS
        INCORPORATED BY REFERENCE**
  Portions
        of the Proxy Statement for the 2006 Annual Meeting of Stockholders of Bay
        National Corporation, to be filed with the Securities and Exchange Commission
        no
        later than 120 days after the close of the fiscal year, are incorporated
        by
        reference in Part III of this Annual Report on Form
        10-KSB.


Transitional
      Small Business Disclosure Format (check
      one): Yes  __  No X







2


**PART
      I**





Item
      1.
      Description of Business





**BUSINESS
      OF BAY NATIONAL CORPORATION AND BAY NATIONAL BANK**





**General**





Bay
      National Corporation was incorporated under the laws of the State of Maryland
      on
      June 3, 1999, primarily to serve as a bank holding company for a proposed
      federally chartered commercial bank to be named Bay National Bank.





Bay
      National Bank commenced operations on May 12, 2000 with its main office in
      Lutherville, Maryland and a branch office in Salisbury, Maryland. Bay National
      Bank accepts checking and savings deposits and offers a wide range of commercial
      and industrial, real estate, consumer and residential mortgage
      loans.





On
      December 12, 2005, Bay National Corporation consummated the sale of a trust
      preferred securities offering in which it issued $8,248,000 of subordinated
      debt
      securities due 2036 to Bay National Capital Trust I, a Delaware statutory trust
      (the “Trust”) and an unconsolidated subsidiary formed by Bay National
      Corporation, and the Trust simultaneously issued $8,000,000 of trust preferred
      securities. The Trust also issued $248,000 of its common securities to Bay
      National Corporation. No underwriting commissions were paid in connection with
      the issuances. All of the securities were issued in a private placement exempt
      from registration under 4(2) of the Securities Act of 1933, as amended and/or
      Regulation D promulgated thereunder.





**Marketing
      Focus**





Bay
      National Bank was formed by a group of individuals active in business,
      professional, banking, financial and charitable activities in the Baltimore,
      Maryland metropolitan area and the Eastern Shore of Maryland. These individuals
      believed that the banking needs of certain segments of these communities were
      not being served adequately by existing banks. Specifically, as a result of
      bank
      mergers in the 1990’s, many banks in the Baltimore metropolitan area and the
      Eastern Shore of Maryland became local branches of large regional and national
      banks. Although size gave the larger banks some advantages in competing for
      business from large corporations, including economies of scale and higher
      lending limits, the organizers believed that these “megabanks” were focused on a
      mass market approach which de-emphasized personal contact and service. The
      organizers also believed that the centralization of decision-making power at
      these large institutions had resulted in a lack of customer service. At many
      of
      these institutions, determinations were made at the "home office" by individuals
      who lacked personal contact with customers as well as an understanding of the
      customers' needs and scope of the relationship with the institution.





Bay
      National Bank’s management believes that this trend is ongoing, and continues to
      be particularly frustrating to owners of small and mid-sized businesses,
      business professionals and high net worth individuals who traditionally have
      been accustomed to dealing directly with a bank executive who had an
      understanding of their banking needs with the ability to deliver a prompt
      response.





Bay
      National Bank targets its commercial banking services to small and mid-sized
      businesses and targets its retail banking services to the owners of these
      businesses and their employees, to business professionals and high net worth
      individuals.





Bay
      National Bank seeks to distinguish itself by





·
            Developing
                personal relationships with its customers.





3


·
            Customizing
                its products to fit the needs of its customers instead of adopting
                a "one
                size fits all" mentality.





·
            Streamlining
                the decision making process.





·
            Offering
                its customers additional complementary services, such as insurance
                and
                investment advice, through relationships with strategic partners.





Bay
      National Bank’s offices are not organized in the traditional retail branch
      structure, which is transaction and "bank teller" oriented. Instead, Bay
      National Bank emphasizes a "sit-down" model where customers can choose to be
      greeted by a personal banker and taken to a private desk. Customers also have
      the option to conduct their transactions using a more traditional teller
      counter. Management believes that this approach makes service more
      individualized and enhances the banker's understanding of the customer's needs.
      Furthermore, Bay National Bank’s branch locations do not focus on capturing
      every customer within the surrounding area. Instead, they are strategically
      located in areas convenient to Bay National Bank’s target customer
      base.





**Market
      Area and Facilities**





Bay
      National Bank’s headquarters and Baltimore branch office are located at 2328
      West Joppa Road, Lutherville, Maryland 21093. Bay National Bank serves the
      Baltimore metropolitan area from that location, with its primary service area
      being Towson, Lutherville-Timonium, Cockeysville, Hunt Valley, Ruxton and Roland
      Park. Bay National Bank’s Salisbury, Maryland branch office is located at 109
      Poplar Hill Avenue, Salisbury, Maryland 21801, from which it serves Maryland’s
      Eastern Shore.





**Products
      and Services**





Loan
      Portfolio .





Bay
      National Bank offers a full range of loans, including commercial and industrial
      loans, real estate loans, consumer loans and residential mortgage and home
      equity loans. Commercial business and commercial real estate loans for
      owner-occupied properties are Bay National Bank's primary loan products,
      accounting for approximately 64% of the loan portfolio as of December 31, 2005.





Generally,
      Bay National Bank is subject to a lending limit to any one borrower of 15%
      of
      Bay National Bank’s unimpaired capital and surplus. However, management is able
      to originate loans and to participate with other lenders in loans that exceed
      Bay National Bank's lending limits.





The
      following is a description of the types of loans Bay National Bank has targeted
      in building its loan portfolio:





·
            Commercial
                and industrial loans for business purposes including working capital,
                equipment purchases, lines of credit and government contract financing.
                Asset-based lending, accounts receivable financing and lease financing
                are
                also available. As of December 31, 2005, these loans represented
                approximately 38% of Bay National Bank’s loan portfolio. In general, Bay
                National Bank targets small and mid-sized businesses in its market
                area
                with credit needs in the range of up to
                $5,000,000.





·
            Commercial
                real estate loans, including mortgage loans on non-residential properties,
                and land development and construction loan financing, primarily for
                owner-occupied premisesas
                well as first and second mortgage loans on commercially owned residential
                investment properties. As of December 31, 2005, these loans represented
                approximately 26% of Bay National Bank’s loan
                portfolio.





4


·
            Mortgage
                loans and residential construction loans secured by residential property,
                including first and second mortgage loans on owner occupied and investment
                properties (1 to 4 family and multi-family) owned by individuals,
                and home
                equity loans secured by single-family owner-occupied residences.
                As of
                December 31, 2005, these loans represented approximately 35% of Bay
                National Bank’s loan portfolio. A large portion of these loans,
                approximately 9% of Bay National Bank’s total loan portfolio, are
                residential real estate loans held for sale. Like its consumer loans,
                Bay
                National Bank’s residential real estate loans are targeted to business
                owners and their employees, business professionals and high net worth
                individuals.





·
            Consumer
                loans including automobile and personal loans. In addition, Bay National
                Bank offers personal lines of credit. As of December 31, 2005, these
                loans
                represented approximately 1% of Bay National Bank’s loan portfolio. Bay
                National Bank’s consumer loans are targeted to business owners and their
                employees, business professionals and high net worth individuals.





Bay
      National Bank originates some of its Eastern Shore residential mortgage loans
      through BNB Mortgage, LLC, a Maryland limited liability company, which is a
      joint venture between Bay National Bank and an Ocean City, Maryland real estate
      agent. Bay National Bank is responsible for all of the operations of BNB
      Mortgage, LLC. Bay National Bank’s share of net income from this entity amounted
      to $12,916 and $24,603 for the years ended December 31, 2005 and 2004,
      respectively. All loans originated by BNB Mortgage, LLC are immediately sold
      to
      Bay National Bank. These loans are then sold to third party investors in the
      same fashion as other conventional first and second residential mortgage loans
      originated by Bay National Bank.





Bay
      National Bank’s conventional first and second residential mortgage loans adhere
      to standards developed by FNMA/FHLMC. Management requires private mortgage
      insurance for loans in excess of 80% of a property's value. Bay National Bank
      sells most of its first and second residential mortgage loans in the secondary
      market. Therefore, management sells those loans that have a lower degree of
      risk, and a lower yield, relative to the other types of loans that Bay National
      Bank makes. Since these loans are typically sold, Bay National Bank offers
      these
      loans as well as certain residential construction loans to a broader array
      of
      individuals than its home equity loans and other consumer loan products. As
      of
      December 31, 2005, mortgage loans held for sale totaled
      $17,509,064.





Deposits .





Bay
      National Bank offers a wide range of interest-bearing and non-interest-bearing
      accounts, including commercial and retail checking accounts, money market
      accounts, individual retirement accounts, interest-bearing statement savings
      accounts and certificates of deposit with fixed and variable rates and a range
      of maturity date options.





Other
      Banking and Financial Services .





Bay
      National Bank offers commercial customers cash management services such as
      sweep
      accounts, account reconciliation, lockbox services and wire transfers of funds.
      Additionally, Bay National Bank makes available telephone banking, ATM/debit
      cards, safe keeping boxes, after-hours deposit services, travelers checks,
      direct deposit of payroll and automatic drafts for various accounts. These
      services are provided either directly by Bay National Bank or through
      correspondent banking relationships. Bay National Bank does not have its own
      network of ATM machines. In general, Bay National Bank waives fees on a
      predetermined number of ATM transactions per month, thereby allowing its
      customers to use any ATM machine.





In
      addition, Bay National Bank's customers are able to access information about
      their accounts and view information about Bay National Bank's services and
      products on Bay National Bank's website, which is located at
      http://www.baynational.com. Bay National Bank’s website also permits customers
      to make transfers of funds among accounts, pay bills and send e-mail to Bay
      National Bank personnel.




5


Bay
      National Bank offers, through strategic partners, investment advisory, risk
      management and employee benefit services. Through these affiliations, banking
      clients can receive a full range of financial services, including investment
      advice, personal and business insurance products and employee benefit products
      such as pension and 401(k) plan administration. To the extent permitted by
      applicable regulations, the strategic partners may share fees and commissions
      with Bay National Bank. As of December 31, 2005, Bay National Bank had not
      entered in to any such fee arrangements. When sufficient volume is developed
      in
      any of these lines of business, Bay National Bank may provide these services
      if
      permitted by applicable regulations.





**Competition**





In
      both
      the Baltimore metropolitan area and on Maryland's Eastern Shore, Bay National
      Bank faces strong competition from large banks headquartered within and outside
      of Maryland. Bay National Bank also competes with other community banks, savings
      and loan associations, credit unions, mortgage companies, finance companies
      and
      others providing financial services. In addition, insurance companies,
      securities brokers and other non-bank entities or their affiliates may provide
      services, which historically have been considered banking in nature.





Many
      of
      Bay National Bank’s competitors can finance extensive advertising campaigns,
      maintain extensive branch networks and technology investments, and offer
      services, which Bay National Bank cannot offer or chooses not to offer. Also,
      larger institutions have substantially higher lending limits than Bay National
      Bank. Some of Bay National Bank’s competitors have other advantages, such as tax
      exemption in the case of credit unions, and lesser regulation in the case of
      mortgage companies and finance companies.





**Employees**





As
      of
      March 22, 2006, Bay National Bank employed fifty-six individuals. Forty-five
      people operate from Bay National Bank’s headquarters, banking office, and
      mortgage operations in Lutherville, Maryland and eleven people from the
      Salisbury, Maryland banking office. Bay National Corporation has no
      employees.





**SUPERVISION
      AND REGULATION**





**General**





Bay
      National Corporation and Bay National Bank are subject to extensive regulation
      under state and federal banking laws and regulations. These laws impose specific
      requirements and restrictions on virtually all aspects of operations and
      generally are intended to protect depositors, not stockholders. The following
      discussion is only a summary and readers should refer to particular statutory
      and regulatory provisions for more detailed information. In addition, management
      cannot predict the nature or the extent of the effect on business and earnings
      that new federal or state legislation may have in the future.





**Bay
      National Corporation**





*Federal
      Bank Holding Company Regulation.* Bay
      National Corporation is a bank holding company registered under the Bank Holding
      Company Act of 1956, as amended, and is subject to supervision by the Federal
      Reserve Board. As a bank holding company, Bay National Corporation is required
      to file with the Federal Reserve Board an annual report and such other
      additional information as the Federal Reserve Board may require by statute.
      The
      Federal Reserve Board may also examine Bay National Corporation and each of
      its
      subsidiaries.





The
      Federal Reserve Board must approve, among other things, the acquisition by
      a
      bank holding company of control of more than five percent (5%) of the voting
      shares, or substantially all the assets, of any bank or bank holding company
      or
      the merger or consolidation by a bank holding company with another bank holding
      company. Under the Riegle-Neal Interstate Banking and Branching Efficiency
      Act
      of 1994, the restrictions on interstate acquisitions of banks by bank holding
      companies were repealed as of September 29, 1995. The effect of the repeal
      of
      these restrictions is that, subject to certain time and deposit base
      requirements, Bay National Corporation may acquire a bank located in Maryland
      or
      any other state, and a bank holding company located outside of Maryland can
      acquire any Maryland-based bank holding company or bank.





6


Unless
      it
      chooses to become a financial holding company, as further described below,
      a
      bank holding company is prohibited from acquiring control of any voting shares
      of any company which is not a bank or bank holding company and from engaging
      directly or indirectly in any activity other than banking, or managing or
      controlling banks or furnishing services for its authorized subsidiaries. There
      are limited exceptions. A bank holding company may, for example, engage in
      activities which the Federal Reserve Board has determined by order or regulation
      to be so closely related to banking or managing or controlling banks as to
      be
      "properly incident thereto." In making such a determination, the Federal Reserve
      Board is required to consider whether the performance of such activities can
      reasonably be expected to produce benefits to the public, such as convenience,
      increased competition or gains in efficiency, which outweigh possible adverse
      effects, such as undue concentration of resources, decreased or unfair
      competition, conflicts of interest or unsound banking practices. The Federal
      Reserve Board is also empowered to differentiate between activities commenced
      de
      novo and activities commenced by the acquisition, in whole or in part, of a
      going concern. Some of the activities that the Federal Reserve Board has
      determined by regulation to be closely related to banking include servicing
      loans, performing certain data processing services, acting as a fiduciary,
      investment or financial advisor, and making investments in corporations or
      projects designed primarily to promote community welfare.




Subsidiary
      banks of a bank holding company are subject to certain restrictions imposed
      by
      statute on any extensions of credit to the bank holding company or any of its
      subsidiaries, or investments in their stock or other securities, and on taking
      such stock or securities as collateral for loans to any borrower. Further,
      a
      bank holding company and any subsidiary bank are prohibited from engaging in
      certain tie-in arrangements in connection with the extension of credit. In
      1997,
      the Federal Reserve Board adopted amendments to its Regulation Y, creating
      exceptions to the Bank Holding Company Act's anti-tying prohibitions that give
      bank subsidiaries of holding companies greater flexibility in packaging products
      and services with their affiliates.





In
      accordance with Federal Reserve Board policy, Bay National Corporation is
      expected to act as a source of financial strength to Bay National Bank and
      to
      commit resources to support Bay National Bank in circumstances in which Bay
      National Corporation might not otherwise do so. The Federal Reserve Board may
      require a bank holding company to terminate any activity or relinquish control
      of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon
      the
      Federal Reserve's determination that such activity or control constitutes a
      serious risk to the financial soundness or stability of any subsidiary
      depository institution of the bank holding company. Further, federal bank
      regulatory authorities have additional discretion to require a bank holding
      company to divest itself of any bank or non-bank subsidiary if the agency
      determines that divestiture may aid the depository institution's financial
      condition.





On
      November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley
      Act
      (“GLBA”). Effective March 11, 2000, pursuant to authority granted under the
      GLBA, a bank holding company may elect to become a financial holding company
      and
      thereby engage in a broader range of financial and other activities than are
      permissible for traditional bank holding companies. In order to qualify for
      the
      election, all of the depository institution subsidiaries of the bank holding
      company must be well capitalized and well managed, as defined by regulation,
      and
      all of its depository institution subsidiaries must have achieved a rating
      of
      satisfactory or better with respect to meeting community credit needs.





Pursuant
      to the GLBA, financial holding companies will be permitted to engage in
      activities that are "financial in nature" or incidental or complementary
      thereto, as determined by the Federal Reserve Board. The GLBA identifies several
      activities as "financial in nature," including, among others, insurance
      underwriting and agency, investment advisory services, merchant banking and
      underwriting, and dealing or making a market in securities. Being designated
      a
      financial holding company will allow insurance companies, securities brokers
      and
      other types of financial companies to affiliate with and/or acquire depository
      institutions.





7


As
      a bank
      holding company with consolidated assets of more than $150,000,000, Bay National
      Corporation also is subject to certain risk-based capital guidelines imposed
      on
      bank holding companies by the Federal Reserve Board to insure the holding
      company’s capital adequacy.





The
      status of Bay National Corporation as a registered bank holding company under
      the Bank Holding Company Act does not exempt it from certain federal and state
      laws and regulations applicable to corporations generally, including, without
      limitation, certain provisions of the federal securities laws.





*State
      Bank Holding Company Regulation.* Bay
      National Corporation is a Maryland-chartered bank holding company and is subject
      to various restrictions on its activities as set forth in Maryland law, in
      addition to those restrictions set forth in federal law.





Under
      Maryland law, a bank holding company that desires to acquire a Maryland
      state-chartered bank or trust company, a federally chartered bank with its
      main
      office in Maryland, or a bank holding company that has its principal place
      of
      business in Maryland, must file an application with the Maryland Commissioner
      of
      Financial Regulation (the "Commissioner"). In approving the application, the
      Commissioner must consider whether the acquisition may be detrimental to the
      safety and soundness of the entity being acquired or whether the acquisition
      may
      result in an undue concentration of resources or a substantial reduction in
      competition in Maryland. The Commissioner may not approve an acquisition if,
      on
      consummation of the transaction, the acquiring company, together with all its
      insured depository institution affiliates, would control 30% or more of the
      total amount of deposits of insured depository institutions in Maryland. The
      Commissioner has authority to adopt by regulation a procedure to waive this
      requirement for good cause. In a transaction for which the Commissioner's
      approval is not required due to an exemption under Maryland law, or for which
      federal law authorizes the transaction without application to the Commissioner,
      the parties to the acquisition must provide written notice to the Commissioner
      at least 15 days before the effective date of the acquisition.





**Bay
      National Bank**





*General.* Bay
      National Bank, as a national banking association whose accounts are insured
      by
      the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation
      ("FDIC") up to the maximum legal limits, is subject to regulation, supervision
      and regular examinations by the Office of the Comptroller of the Currency
      ("OCC"). Bay National Bank is a member of the Federal Reserve System and, as
      such, is subject to certain regulations issued by the Federal Reserve Board.
      Bay
      National Bank also is subject to applicable banking provisions of Maryland
      law
      insofar as they do not conflict with or are not preempted by federal law. The
      regulations of these various agencies govern most aspects of Bay National Bank's
      business, including setting required reserves against deposits, loans,
      investments, mergers and acquisitions, borrowing, dividends, and location and
      number of branch offices.





The
      GLBA
      authorizes expanded activities for national banks, but requires (with the
      exception of underwriting municipal revenue bonds and other state and local
      obligations) that any expanded activities be conducted in a new entity called
      a
“financial subsidiary” that is a subsidiary of the bank rather than the bank
      itself. A financial subsidiary may engage in any activities in which a financial
      holding company or a financial holding company’s non-bank subsidiaries can
      engage, except that a financial subsidiary may not underwrite most insurance,
      engage in real estate development or conduct merchant banking activities. A
      financial subsidiary may be established through acquisition or *de
      novo* .





In
      order
      for a national bank to operate a financial subsidiary, it must be well
      capitalized and well managed, have a satisfactory or better rating with respect
      to meeting community credit needs and the aggregate assets of all of the bank’s
      financial subsidiaries may not exceed 45% of the total assets of the bank,
      subject to certain exceptions. Existing authority of the OCC and the FDIC to
      review subsidiary activities are preserved.





8


Banking
      is a business which depends on interest rate differentials. In general, the
      differences between the interest paid by a bank on its deposits and its other
      borrowings and the interest received by a bank on loans extended to its
      customers and securities held in its investment portfolio constitute the major
      portion of a bank's earnings. Thus, the earnings and growth of Bay National
      Bank
      will be subject to the influence of economic conditions generally, both domestic
      and foreign, and also on the monetary and fiscal policies of the United States
      and its agencies, particularly the Federal Reserve Board, which regulates the
      supply of money.





*Branching
      and Interstate Banking.* Beginning
      on June 1, 1997, the federal banking agencies were authorized to approve
      interstate bank merger transactions without regard to whether such a transaction
      is prohibited by the law of any state, unless the home state of one of the
      banks
      has opted out of the interstate bank merger provisions of the Riegle-Neal
      Interstate Banking and Branching Efficiency Act of 1994. Furthermore, under
      the
      Riegle-Neal Act, interstate acquisitions of branches are permitted if the law
      of
      the state in which the branch is located permits such acquisitions. The
      Riegle-Neal Act also authorizes the OCC and FDIC to approve interstate branching
      de novo by national and non-member banks, respectively, but only in states
      which
      specifically allow for such branching.





The
      District of Columbia, Maryland, Delaware and Pennsylvania have all enacted
      laws
      which permit interstate acquisitions of banks and bank branches and permit
      out-of-state banks to establish de novo branches.





*Capital
      Adequacy Guidelines.* The
      Federal Reserve Board, the OCC and the FDIC have all adopted risk-based capital
      adequacy guidelines by which they assess the adequacy of capital in examining
      and supervising banks and bank holding companies and in analyzing bank
      regulatory applications. Risk-based capital requirements determine the adequacy
      of capital based on the risk inherent in various classes of assets and
      off-balance sheet items.





Since
      December 31, 1992, national banks have been expected to meet a minimum ratio
      of
      total qualifying capital (the sum of core capital (Tier 1) and supplementary
      capital (Tier 2)) to risk-weighted assets (a "Total Risk-Based Capital Ratio")
      of 8%. At least half of this amount (4%) should be in the form of core capital.
      These requirements apply to Bay National Bank.





Tier
      1
      capital for national banks generally consists of the sum of common stockholders'
      equity and perpetual preferred stock (subject in the case of the latter to
      limitations on the kind and amount of such stock which may be included as Tier
      1
      capital), less goodwill, without adjustment in accordance with Statement of
      Financial Accounting Standards No. 115. Tier 2 capital consists of the
      following: hybrid capital instruments, perpetual preferred stock which is not
      otherwise eligible to be included as Tier 1 capital, term subordinated debt
      and
      intermediate-term preferred stock, and, subject to limitations, general
      allowances for loan losses. Assets are adjusted under the risk-based guidelines
      to take into account different risk characteristics, with the categories ranging
      from 0% (requiring no risk-based capital) for assets such as cash, to 100%
      for
      the bulk of assets which are typically held by a bank holding company, including
      certain multi-family residential and commercial real estate loans, commercial
      business loans and consumer loans. Residential first mortgage loans on
      one-to-four-family residential real estate and certain seasoned multi-family
      residential real estate loans, which are not 90 days or more past-due or
      non-performing and which have been made in accordance with prudent underwriting
      standards, are assigned a 50% level in the risk-weighing system, as are certain
      privately issued mortgage-backed securities representing indirect ownership
      of
      such loans. Off-balance sheet items also are adjusted to take into account
      certain risk characteristics.





In
      addition to the risk-based capital requirements, the OCC has established a
      minimum 3% Leverage Capital Ratio (Tier 1 capital to total adjusted assets)
      requirement for the most highly-rated national banks, with an additional cushion
      of at least 100 to 200 basis points for all other national banks, which
      effectively increases the minimum Leverage Capital Ratio for such other banks
      to
      4%-5% or more. Under the OCC's regulations, highest-rated banks are those that
      the OCC determines are not anticipating or experiencing significant growth
      and
      have well diversified risk, including no undue interest rate risk exposure,
      excellent asset quality, high liquidity, good earnings and, in general, those
      which are considered a strong banking organization. A national bank that has
      less than the minimum Leverage Capital Ratio requirement must submit, to the
      applicable district office for review and approval, a reasonable plan describing
      the means and timing by which the bank will achieve its minimum Leverage Capital
      Ratio requirement. A national bank which fails to file such a plan is deemed
      to
      be operating in an unsafe and unsound manner and could be subject to a
      cease-and-desist order.





9


The
      OCC's
      regulations also provide that any insured depository institution with a Leverage
      Capital Ratio less than 2% is deemed to be operating in an unsafe or unsound
      condition. Operating in an unsafe or unsound manner could lead the FDIC to
      terminate deposit insurance. However, such an institution will not be subject
      to
      an enforcement proceeding solely on account of its capital ratios if it has
      entered into and is in compliance with a written agreement with the OCC to
      increase its Leverage Capital Ratio to such level as the OCC deems appropriate
      and to take such other action as may be necessary for the institution to be
      operated in a safe and sound manner. The capital regulations also provide,
      among
      other things, for the issuance by the OCC or its designee(s) of a capital
      directive, which is a final order issued to a bank that fails to maintain
      minimum capital or to restore its capital to the minimum capital requirement
      within a specified time period. Such directive is enforceable in the same manner
      as a final cease-and-desist order.





*Prompt
      Corrective Action.* Each
      federal banking agency is required to implement a system of prompt corrective
      action for institutions which it regulates. Under applicable regulations, a
      bank
      will be deemed to be: (i) "well capitalized" if it has a Total Risk-Based
      Capital Ratio of 10% or more, a Tier 1 Risk-Based Capital Ratio of 6% or more,
      a
      Leverage Capital Ratio of 5% or more and is not subject to any written capital
      order or directive; (ii) "adequately capitalized" if it has a Total Risk-Based
      Capital Ratio of 8% or more, a Tier 1 Risk-Based Capital Ratio of 4% or more
      and
      a Leverage Capital Ratio of 4% or more (3% under certain circumstances); (iii)
      "undercapitalized" if it has a Total Risk-Based Capital Ratio that is less
      than
      8%, a Tier 1 Risk-Based Capital Ratio that is less than 4% or a Leverage Capital
      Ratio that is less than 4% (3.3% under certain circumstances); (iv)
      "significantly undercapitalized" if it has a Total Risk-Based Capital Ratio
      that
      is less than 6%, a Tier 1 Risk-Based Capital Ratio that is less than 3% or
      a
      Leverage Capital Ratio that is less than 3%; and (v) "critically
      undercapitalized" if it has a ratio of tangible equity to total assets that
      is
      equal to or less than 2%. Bay National Bank is "well capitalized" as of December
      31, 2005.




An
      institution generally must file a written capital restoration plan which meets
      specified requirements with an appropriate federal banking agency within 45
      days
      of the date the institution receives notice or is deemed to have notice that
      it
      is undercapitalized, significantly undercapitalized or critically
      undercapitalized. The federal banking agency must provide the institution with
      written notice of approval or disapproval within 60 days after receiving the
      capital restoration plan, subject to extensions by the applicable agency.





An
      institution which is required to submit a capital restoration plan must
      concurrently submit a performance guaranty by each company that controls the
      institution. Such guaranty is limited to the lesser of (i) an amount equal
      to 5%
      of the institution's total assets at the time the institution was notified
      or
      deemed to have notice that it was undercapitalized or (ii) the amount necessary
      at such time to restore the relevant capital measures of the institution to
      the
      levels required for the institution to be classified as adequately capitalized.
      Such a guaranty expires after the federal banking agency notifies the
      institution that it has remained adequately capitalized for each of four
      consecutive calendar quarters. An institution which fails to submit a written
      capital restoration plan within the requisite period, including any required
      performance guaranty, or fails in any material respect to implement a capital
      restoration plan, is subject to the restrictions in Section 38 of the Federal
      Deposit Insurance Act which are applicable to significantly undercapitalized
      institutions.





A
      critically undercapitalized institution will be placed in conservatorship or
      receivership within 90 days unless the FDIC formally determines that forbearance
      from such action would better protect the deposit insurance fund. Unless the
      FDIC or another appropriate federal banking regulatory agency makes specific
      further findings and certifies that the institution is viable and is not
      expected to fail, an institution that remains critically undercapitalized on
      average during the four calendar quarters after the date it becomes critically
      undercapitalized must be placed in receivership.





10


Immediately
      upon becoming undercapitalized, an institution becomes subject to statutory
      provisions which (i) restrict payment of capital distributions and management
      fees; (ii) require that the appropriate federal banking agency monitor the
      condition of the institution and its efforts to restore its capital; (iii)
      require submission of a capital restoration plan; (iv) restrict the growth
      of
      the institution's assets; and (v) require prior approval of certain expansion
      proposals. The appropriate federal banking agency for an undercapitalized
      institution also may take any number of discretionary supervisory actions if
      the
      agency determines that any of these actions is necessary to resolve the problems
      of the institution at the least possible long-term cost to the deposit insurance
      fund, subject, in certain cases, to specified procedures. These discretionary
      supervisory actions include requiring the institution to raise additional
      capital, restricting transactions with affiliates, requiring divestiture of
      the
      institution or the sale of the institution to a willing purchaser, and any
      other
      supervisory action that the agency deems appropriate. Significantly
      undercapitalized and critically undercapitalized institutions are subject to
      these and additional mandatory and permissive supervisory actions.





*Regulatory
      Enforcement Authority.* The
      Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA")
      included substantial enhancement to the enforcement powers available to federal
      banking regulators. This enforcement authority included, among other things,
      the
      ability to assess civil money penalties, to issue cease-and-desist or removal
      orders and to initiate injunctive actions against banking organizations and
      institution-affiliated parties, as defined in FIRREA. In general, these
      enforcement actions may be initiated for violations of laws and regulations
      and
      unsafe or unsound practices. Other actions or inactions may provide the basis
      for enforcement action, including misleading or untimely reports filed with
      regulatory authorities. FIRREA significantly increased the amount of and grounds
      for civil money penalties and requires, except under certain circumstances,
      public disclosure of final enforcement actions by the federal banking agencies.





*Deposit
      insurance.* The FDIC
      has adopted a risk-based deposit insurance assessment system. The FDIC assigns
      an institution to one of three capital categories based on the institution's
      financial information, as of the reporting period ending seven months before
      the
      assessment period, consisting of (i) well capitalized, (ii) adequately
      capitalized or (iii) undercapitalized, and one of three supervisory
      subcategories within each capital group. The supervisory subgroup to which
      an
      institution is assigned is based on a supervisory evaluation provided to the
      FDIC by the institution's primary federal regulator and information that the
      FDIC determines to be relevant to the institution's financial condition and
      the
      risk posed to the deposit insurance funds. An institution's assessment rate
      depends on the capital category and supervisory subcategory to which it is
      assigned. Assessment rates for BIF deposits currently range from 0 basis points
      to 27 basis points. Bay National Bank is currently assigned to a capital and
      supervisory subcategory that has an assessment rate of 0. The FDIC is authorized
      to raise the assessment rates in certain circumstances, including to maintain
      or
      achieve the designated reserve ratio of 1.25%, which requirement the BIF
      currently meets. The FDIC has exercised its authority to raise rates in the
      past
      and may raise insurance premiums in the future. If such action is taken by
      the
      FDIC, it could have an adverse effect on the earnings of Bay National Bank.





Under
      the
      Federal Deposit Insurance Act, insurance of deposits may be terminated by the
      FDIC upon a finding that the institution has engaged in unsafe or unsound
      practices, is in an unsafe or unsound condition to continue operations or has
      violated any applicable law, regulation, rule, order or condition imposed by
      the
      FDIC.





*Transactions
      with Affiliates and Insiders.* Bay
      National Bank is subject to the provisions of Section 23A of the Federal Reserve
      Act, which place limits on the amount of loans or extensions of credit to
      affiliates, investments in or certain other transactions with affiliates and
      on
      the amount of advances to third parties collateralized by the securities or
      obligations of affiliates. Section 23A limits the aggregate amount of
      transactions with any individual affiliate to ten percent (10%) of the capital
      and surplus of Bay National Bank and also limits the aggregate amount of
      transactions with all affiliates to twenty percent (20%) of capital and surplus.
      Loans and certain other extensions of credit to affiliates are required to
      be
      secured by collateral in an amount and of a type described in Section 23A,
      and
      the purchase of low quality assets from affiliates is generally prohibited.





11


Bay
      National Bank also is subject to the provisions of Section 23B of the Federal
      Reserve Act which, among other things, prohibit an institution from engaging
      in
      certain transactions with certain affiliates unless the transactions are on
      terms substantially the same, or at least as favorable to such institution
      and/or its subsidiaries, as those prevailing at the time for comparable
      transactions with non-affiliated entities. In the absence of comparable
      transactions, such transactions may only occur under terms and circumstances,
      including credit standards that in good faith would be offered to or would
      apply
      to non-affiliated companies.





Bay
      National Bank also is subject to the restrictions contained in Section 22(h)
      of
      the Federal Reserve Act and the Federal Reserve Board's Regulation O thereunder
      on loans to executive officers, directors and principal stockholders. Under
      Section 22(h), loans to a director, an executive officer or a greater-than-10%
      stockholder of a bank as well as certain affiliated interests of any of the
      foregoing may not exceed, together with all other outstanding loans to such
      person and affiliated interests, the loans-to-one-borrower limit applicable
      to
      national banks (generally 15% of the institution's unimpaired capital and
      surplus), and all loans to all such persons in the aggregate may not exceed
      the
      institution's unimpaired capital and unimpaired surplus. Regulation O also
      prohibits the making of loans in an amount greater than $25,000 or 5% of capital
      and surplus but in any event not over $500,000, to directors, executive officers
      and greater-than-10% stockholders of a bank, and their respective affiliates,
      unless such loans are approved in advance by a majority of the Board of
      Directors of the bank with any "interested" director not participating in the
      voting. Further, Regulation O requires that loans to directors, executive
      officers and principal stockholders be made on terms substantially the same
      as
      those that are offered in comparable transactions to other persons. Regulation
      O
      also prohibits a depository institution from paying overdrafts over $1,000
      of
      any of its executive officers or directors unless they are paid pursuant to
      written pre-authorized extension of credit or transfer of funds plans.





*Loans
      to One Borrower.* As
      a
      national bank, Bay National Bank is subject to the statutory and regulatory
      limits on the extension of credit to one borrower. Generally, the maximum amount
      of total outstanding loans that a national bank may have to any one borrower
      at
      any one time is 15% of the bank's unimpaired capital and surplus. A national
      bank may lend an additional 10% on top of the 15% if the amount that exceeds
      15%
      of the bank's unimpaired capital and surplus is fully secured by readily
      marketable collateral.





*Liquidity.* Bay
      National Bank is subject to the reserve requirements of Federal Reserve Board
      Regulation D, which applies to all depository institutions. Specifically, as
      of
      December 22, 2005, amounts in transaction accounts above $7,800,000 and up
      to
      $48,300,000 must have reserves held against them in the ratio of three percent
      of the amount. Amounts above $48,300,000 require reserves of $1,215,000 plus
      10
      percent of the amount in excess of $48,300,000. Bay National Bank is in
      compliance with the applicable liquidity requirements.





*Community
      Reinvestment Act.* The
      Community Reinvestment Act ("CRA") requires that, in connection with
      examinations of financial institutions within their respective jurisdictions,
      the Federal Reserve Board, the FDIC, the OCC or the Office of Thrift Supervision
      shall evaluate the record of the financial institutions in meeting the credit
      needs of their local communities, including low and moderate income
      neighborhoods, consistent with the safe and sound operation of those
      institutions. The CRA does not establish specific lending requirements or
      programs for financial institutions nor does it limit an institution's
      discretion to develop the types of products and services that it believes are
      best suited to its particular community, consistent with the CRA. An
      institution's CRA activities are considered in, among other things, evaluating
      mergers, acquisitions and applications to open a branch or facility as well
      as
      determining whether the institution will be permitted to exercise certain of
      the
      powers allowed by the GLBA. The CRA also requires all institutions to make
      public disclosure of their CRA ratings. Bay National Bank received a
“satisfactory” rating in its latest CRA examination in May 2003.





12


*USA
      PATRIOT Act.* On
      October 26, 2001, the President signed into law comprehensive anti-terrorism
      legislation known as the USA PATRIOT Act of 2001 (the “USA Patriot Act”). Title
      III of the USA Patriot Act substantially broadened the scope of U.S. anti-money
      laundering laws and regulations by imposing significant new compliance and
      due
      diligence obligations, creating new crimes and penalties and expanding the
      extra-territorial jurisdiction of the United States. The U.S. Treasury
      Department (“Treasury”) has issued a number of implementing regulations that
      apply to various requirements of the USA Patriot Act to financial institutions
      such as Bay National Bank. Those regulations impose new obligations on financial
      institutions to maintain appropriate policies, procedures and controls to
      detect, prevent and report money laundering and terrorist financing. Treasury
      may issue additional regulations that will further clarify the USA Patriot
      Act’s
      requirements.




Failure
      of a financial institution to comply with the USA Patriot Act’s requirements
      could have serious legal and reputational consequences for the institution.
      The
      Company has adopted appropriate policies, procedures and controls to address
      compliance with the requirements of the USA Patriot Act under the existing
      regulations and will continue to revise and update its policies, procedures
      and
      controls to reflect changes required by the USA Patriot Act and Treasury’s
      regulations.





**FORWARD
      LOOKING STATEMENTS**





Some
      of
      the matters discussed in this annual report including under the captions
“Business of Bay National Corporation and Bay National Bank,” and “Management’s
      Discussion And Analysis Of Financial Condition And Results Of Operations”
include forward-looking statements. These forward-looking statements include
      statements regarding profitability, liquidity, allowance for loan losses,
      interest rate sensitivity, market risk and financial and other goals.
      Forward-looking statements often use words such as “believe,” “expect,” “plan,”
“may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,”
“intend”, or other words of similar meaning. You can also identify them by the
      fact that they do not relate strictly to historical or current
      facts.  When
      you
      read a forward-looking statement, you should keep in mind the risk factors
      described below and any other information contained in this annual report which
      identifies a risk or uncertainty. Bay National Corporation’s actual results and
      the actual outcome of Bay National Corporation’s expectations and strategies
      could be different from that described in this annual report because of these
      risks and uncertainties and you should not put undue reliance on any
      forward-looking statements. All forward-looking statements speak only as of
      the
      date of this filing, and Bay National Corporation undertakes no obligation
      to
      make any revisions to the forward-looking statements to reflect events or
      circumstances after the date of this filing or to reflect the occurrence of
      unanticipated events.





**RISK
      FACTORS**





You
      should carefully consider the following risks, along with the other information
      contained in this annual report. The risks and uncertainties described below
      are
      not the only ones that may affect Bay National Corporation. Additional risks
      and
      uncertainties may also adversely affect our business and operations including
      those discussed in Item 6 - Management’s Discussion and Analysis of Financial
      Condition and Results of Operations. If any of the following events actually
      occur, our business and financial results could be materially adversely
      affected.




Bay
      National Corporation and Bay National Bank depend heavily on one key employee,
      Mr. Hugh W. Mohler, and business would suffer if something were to happen to
      Mr.
      Mohler . **** Mr.
      Mohler is the Chairman, President and Chief Executive Officer of Bay National
      Bank. If he were to leave for any reason, Bay National Corporation’s and Bay
      National Bank’s business would suffer because he has banking experience and
      relationships with clients and potential clients that would not be easy to
      replace. In addition, because Bay National Bank’s business is relationship
      driven, the loss of an employee who has primary contact with one or more of
      Bay
      National Bank’s clients could cause Bay National Bank to lose those clients'
      business, possibly resulting in a decline in revenues.





13


If
      our
      allowance for credit losses is not sufficient to cover actual loan losses,
      our
      earnings could decrease. We make
      various assumptions and judgments about the collectibility of our loan
      portfolio, including the creditworthiness of our borrowers and the value of
      collateral for the repayment of many of our loans. In determining the amount
      of
      the allowance for credit losses, we review, among other things, our loans and
      our loss and delinquency experience, and we evaluate economic conditions. If
      our
      assumptions are incorrect, our allowance for credit losses may not be sufficient
      to cover losses inherent in our loan portfolio, resulting in additions to our
      allowance.





We
      are
      particularly susceptible to this risk because we are a relatively new bank
      and
      have experienced significant growth over the past few years. In general, loans
      do not begin to show signs of credit deterioration or default until they have
      been outstanding for some period of time, a process referred to as “seasoning.”
As a result, a portfolio of older loans will usually behave more predictably
      than a newer portfolio. Because a large portion of our loan portfolio is
      relatively new, the current level of delinquencies and defaults may not be
      representative of the level that will prevail when the portfolio becomes more
      seasoned, which may be higher than current levels. If delinquencies and defaults
      increase, we may be required to increase our provision for loan losses.





Material
      additions to our allowance would materially decrease our net income. In
      addition, bank regulators periodically review our allowance for credit losses
      and may require us to increase our provision for loan losses or recognize
      further loan charge-offs. Any increase in our allowance for credit losses or
      loan charge-offs may have a material adverse effect on our results of operations
      and financial condition.




Bay
      National Bank’s lending strategy involves risks resulting from the choice of
      loan portfolio .
      Bay
      National Bank's loan strategy emphasizes commercial business loans and
      commercial real estate loans. At December 31, 2005, such loans accounted for
      approximately 64% of the loan portfolio. Commercial business and commercial
      real
      estate loans generally carry a higher degree of credit risk than do residential
      mortgage loans because of several factors including larger loan balances,
      dependence on the successful operation of a business or a project for repayment,
      or loan terms with a balloon payment rather than full amortization over the
      loan
      term.





Bay
      National Bank’s lending limit may limit its growth and the growth of Bay
      National Corporation .
      Bay
      National Bank is limited in the amount it can loan to a single borrower by
      the
      amount of its capital. Specifically, under current law, Bay National Bank may
      lend up to 15% of its unimpaired capital and surplus to any one borrower. Bay
      National Bank’s lending limit is significantly less than that of many of its
      competitors and may discourage potential borrowers who have credit needs in
      excess of Bay National Bank’s lending limit from conducting business with Bay
      National Bank.





Bay
      National Bank faces substantial competition which could adversely affect its
      ability to attract depositors and borrowers .
      Bay
      National Bank operates in a competitive market for financial services and faces
      intense competition from other institutions both in making loans and in
      attracting deposits. Many of these institutions have been in business for many
      years, are significantly larger, have established customer bases, have greater
      financial resources and lending limits than Bay National Bank, and are able
      to
      offer certain services that Bay National Bank is not able to offer. If Bay
      National Bank cannot attract deposits and make loans at a sufficient level,
      its
      operating results will suffer, as will its opportunities for growth.





Government
      regulation could restrict Bay National Corporation’s or Bay National Bank’s
      growth or cause Bay National Corporation or Bay National Bank to incur higher
      costs .
      Bay
      National Corporation and Bay National Bank operate in a highly regulated
      environment and are subject to examination, supervision and comprehensive
      regulation by several federal and state regulatory agencies. Banking
      regulations, designed primarily for the safety of depositors, may limit the
      growth of Bay National Bank and the return to investors by restricting
      activities such as the payment of dividends; mergers with, or acquisitions
      by,
      other institutions; investments; loans and interest rates; interest rates paid
      on deposits; and the creation of branch offices. Laws and regulations could
      change at any time, and changes could adversely affect Bay National
      Corporation’s and Bay National Bank’s business. In addition, the cost of
      compliance with regulatory requirements could adversely affect Bay National
      Corporation’s and Bay National Bank’s ability to operate profitably.





14


Bay
      National Bank's ability to compete may suffer if it cannot take advantage of
      technology to provide banking services or if its customers fail to embrace
      that
      technology .
      Bay
      National Bank’s business strategy relies less on customers' access to a large
      branch network and more on access to technology and personal relationships.
      Further, the market for financial services is increasingly affected by advances
      in technology, including developments in telecommunications, data processing,
      computers, automation, Internet-based banking and, tele-banking. Bay National
      Bank’s ability to compete successfully may depend on the extent to which Bay
      National Bank can take advantage of technological changes and the extent to
      which Bay National Bank’s customers embrace technology to complete their banking
      transactions.





Because
      we currently serve limited market areas, we could be more adversely affected
      by
      an economic downturn in our market areas than our larger competitors which
      are
      more geographically diverse. Currently, our primary market area is limited to the Baltimore metropolitan
      area
      and Maryland’s Eastern Shore. If either of these areas suffer an economic
      downturn, our business and financial condition may be severely affected. Our
      larger competitors serve a more geographically diverse market area, parts of
      which may not be affected by the same economic conditions that exist in our
      primary market areas.





If
      economic conditions deteriorate, our results of operations and financial
      condition could be adversely affected as borrowers’ ability to repay loans
      declines and the value of the collateral securing our loans
      decreases. Our
      financial results may be adversely affected by changes in prevailing economic
      conditions, including decreases in real estate values, changes in interest
      rates
      which may cause a decrease in interest rate spreads, adverse employment
      conditions, the monetary and fiscal policies of the federal government and
      other
      significant external events. Because a significant portion of our loan portfolio
      is comprised of real estate related loans, decreases in real estate values
      could
      adversely affect the value of property used as collateral. Adverse changes
      in
      the economy also may have a negative effect on the ability of our borrowers
      to
      make timely repayments of their loans, which would have an adverse impact on
      our
      earnings.





Our
      profitability depends on interest rates and changes in monetary policy may
      impact us. Our
      results of operations depend to a large extent on our “net interest income,”
which is the difference between the interest expense incurred in connection
      with
      our interest-bearing liabilities, such as interest on deposit accounts, and
      the
      interest income received from our interest-earning assets, such as loans.
      Interest rates, because they are influenced by, among other things, expectations
      about future events, including the level of economic activity, federal monetary
      and fiscal policy and geo-political stability, are not predictable or
      controllable. In addition, competitive factors heavily influence the interest
      rates we can earn on our loan and investment portfolios and the interest rates
      we pay on our deposits. Community banks are often at a competitive disadvantage
      in managing their cost of funds compared to the large regional, super-regional
      or national banks that have access to the national and international capital
      markets. These factors influence our ability to maintain a stable interest
      margin.





The
      costs of being a public company are proportionately higher for small companies
      like us due to the requirement of the Sarbanes-Oxley Act .
      The
      Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated
      by
      the Securities and Exchange Commission have increased the scope, complexity,
      and
      cost of corporate governance, reporting, and disclosure practices. These
      regulations are applicable to our company. We expect to experience increasing
      compliance costs, including costs related to internal controls, as a result
      of
      the Sarbanes-Oxley Act. These necessary costs are proportionately higher for
      a
      company of our size and will affect our profitability more than that of some
      of
      our larger competitors.





15








Item
      2.
      Description of Property





Baltimore





Our
      Baltimore offices are located at 2328 West Joppa Road, Lutherville, Maryland
      21093. Currently, we lease space in the basement (1,429 square feet), the first
      floor (4,067 square feet) and the third floor (6,206 square feet) of this
      building. The basement space and 947 square feet of the first floor space are
      currently used for the Lutherville residential mortgage operation, 2,355 square
      feet of the first floor space is used for the Lutherville branch office, 765
      square feet of the first floor is sublet and the third floor space is used
      for
      Bay National Corporation and Bay National Bank’s administrative offices. The
      current lease expires on February 28, 2010, and we have the right to extend
      the
      lease for one five-year term to February 28, 2015.





As
      of
      December 31, 2005, Bay National Corporation was paying rent of $339,096 per
      year, or $28,258 per month for all of the leased space in the building. For
      the
      March 2006 to February 2007 lease year, Bay National Corporation will pay annual
      rent of $349,268, or $29,106 per month. For each lease year thereafter,
      including any lease years during any renewal term, the yearly base rent will
      increase by three percent. The rent includes Bay National Corporation’s share of
      taxes and building operating costs.





Beginning
      November 15, 2004, Bay National Corporation sublet approximately 765 square
      feet
      of the space on the first floor for a term through December 31, 2006 at a
      monthly rent for the first year of $1,893, which amount increases at the rate
      of
      three percent per year. Upon the termination of the sublease on December 31,
      2006, management expects that it will convert this space for use by Bay National
      Corporation and Bay National Bank in order to accommodate current and future
      growth.





The
      Landlord, Joppa Green II Limited Partnership, LLLP, is beneficially owned by
      the
      MacKenzie Companies. Gary T. Gill, who has been a director of Bay National
      Corporation and Bay National Bank since January 2003, is the president and
      chief
      executive officer of the MacKenzie Companies. See “Item 12 - Certain
      Relationships and Related Transactions.”





Salisbury





On
      September 16, 1999, Bay National Corporation entered into a lease agreement
      for
      Bay National Bank's Salisbury, Maryland branch office, which is located at
      109
      Poplar Hill Avenue, Salisbury Maryland 21801 in a two-story building containing
      approximately 2,500 square feet of office space. This lease, which became
      effective as of September 1, 1999, was for a term of five years with Bay
      National Corporation having the option to extend the term for three five-year
      renewal terms.





Bay
      National Corporation exercised its option to extend this lease which will now
      terminate on August 31, 2009, unless extended. During the new lease term, Bay
      National Corporation is paying monthly rent of approximately $2,292, plus all
      real estate taxes and utilities. Pursuant to this lease, Bay National
      Corporation has a right of first refusal to purchase the building in the event
      the landlord receives a bona fide offer to sell. This property is owned by
      John
      R. Lerch, who has been a director of Bay National Corporation and Bay National
      Bank since their formation. See “Item 12 - Certain Relationships and Related
      Transactions.”





On
      September 1, 2002, Bay National Corporation entered into a lease agreement
      for
      Bay National Bank's Salisbury, Maryland mortgage division office, which is
      located at 318 East Main Street, Salisbury Maryland 21801. The leased space
      consists of two office suites totaling approximately 420 square feet. This
      lease, which became effective as of January 1, 2003, was for a term of one
      year
      with Bay National Corporation having the option to extend the term for one
      additional one-year renewal term. Bay National Corporation renewed the lease
      for
      an additional one year term effective as of January 1, 2004. During the initial
      lease term and the renewal term, Bay National Corporation paid monthly rent
      of
      $700. The lease expired on December 31, 2004 and reverted to a monthly rental
      arrangement. On January 1, 2005, Bay National Corporation obtained an additional
      200 square feet in the same building. The total space of 620 square feet was
      rented on a month to month basis at a cost of $1,000 per month through November
      2005 at which time the additional 200 square feet was returned to the landlord.
      The remaining 420 square feet is currently rented on a month to month basis
      at a
      cost of $700 per month. The landlord is responsible for all real estate taxes
      and utilities.





16


Item
      3.
      Legal Proceedings





There
      are
      no pending legal proceedings to which Bay National Corporation or Bay National
      Bank is a party or to which any of their properties are subject, nor are there
      proceedings known to Bay National Corporation to be contemplated by any
      governmental authority. There are no material proceedings known to Bay National
      Corporation, pending or contemplated, in which any director, officer or
      affiliate or any principal security holder of Bay National Corporation is a
      party adverse to Bay National Corporation or Bay National Bank or has a material
      interest adverse to Bay National Corporation or Bay National Bank.





Item
      4.
      Submission of Matters to a Vote of Security Holders





No
      matter
      was submitted during the fourth quarter of the year ended December 31, 2005
      to a
      vote of security holders of Bay National Corporation.


17





**PART
      II**





Item
      5.
      Market for Common Equity and Related Stockholder Matters





As
      of
      March 22 , 2006, the number of holders of record of Bay National Corporation’s
      common stock was approximately 399. Bay National Corporation’s common stock is
      traded on the Over the Counter Bulletin Board (“OTCBB”)  under
      the
      symbol "BANI.OB."





Bay
      National Corporation completed an initial public offering (“IPO”) of its common
      stock on April 30, 2000. Stock prices subsequent to the IPO are based upon
      limited trading on the OTCBB. The following table reflects the high and low
      sales information as reported on the OTCBB for the periods presented. Quotations
      reflect inter-dealer prices, without retail mark-up, mark-down, or commission
      and may not represent actual transactions.





2005
              Bid
                Price Range
            
            
            2004
              Bid
                Price RangeQuarter
            
            Low
            
            
            High
            
            
            Low
            
            
            High1st
            $
            13.20
            
            $
            15.25
            
            $
            10.10
            
            $
            14.002nd
            
            14.50
            
            
            19.75
            
            
            11.75
            
            
            14.003rd
            
            17.25
            
            
            21.00
            
            
            10.00
            
            
            12.504th
            
            18.80
            
            
            23.00
            
            
            10.50
            
            
            13.25





To
      date,
      Bay National Corporation has not declared or paid any dividends on its common
      stock. Management anticipates that Bay National Corporation will retain all
      earnings, if any, in order to provide more funds to operate and expand Bay
      National Corporation’s business and, therefore, Bay National Corporation has no
      plans to pay any cash dividends at least until its profitability exceeds the
      level necessary to support capital growth in excess of regulatory capital needs.
      If Bay National Corporation decides to pay dividends in the future, its ability
      to do so will depend on the ability of Bay National Bank to pay dividends to
      Bay
      National Corporation. In addition, management would consider a number of other
      factors before deciding to pay dividends, including Bay National Corporation’s
      earnings prospects, financial condition and cash needs.





The
      amount of dividends that may be paid by Bay National Bank to Bay National
      Corporation depends on Bay National Bank's earnings and capital position and
      is
      limited by statute, regulations and regulatory policies. As a national bank,
      Bay
      National Bank may not pay dividends from its permanent capital. All cash
      dividends must be paid out of undivided profits then on hand, after deducting
      expenses, including provisions for loan losses and bad debts. In addition,
      a
      national bank is prohibited from declaring a cash dividend on its shares of
      common stock until its surplus equals its stated capital, unless there has
      been
      transferred to surplus no less than one-tenth of the bank's net profits for
      the
      preceding two consecutive half-year periods (in the case of an annual dividend).
      The approval of the OCC is required if the total of all cash dividends declared
      by a national bank in any calendar year exceeds the total of its net profits
      for
      that year combined with its retained net profits for the preceding two years,
      less any required transfers to surplus. In addition, Bay National Bank may
      not
      pay a dividend if, after paying the dividend, it would be “undercapitalized” as
      defined in the applicable regulations.





Recent
      Sales of Unregistered Securities





From
      July
      13, 2004 to November 12, 2004, Bay National Corporation issued 55,000 shares
      of
      its common stock, $0.01 par value per share, at a purchase price of $10.00
      per
      share, and received aggregate proceeds of $550,000. The shares were issued
      upon
      the exercise of outstanding warrants.





On
      September 10, 1999, Bay National Corporation issued warrants to purchase 56,250
      shares of its common stock, $0.01 par value per share, to investors in its
      organizational offering. The warrants became exercisable on April 30, 2001
      and
      expired on November 16, 2004. 1,250 of the warrants were not exercised prior
      to
      their expiration.





There
      were no underwriting discounts or commissions paid with respect to the issuance
      of the common stock upon exercise of the warrants. Bay National Corporation
      believes that the issuance of the shares of common stock upon exercise of the
      warrants was exempt from the registration requirements of the Securities Act
      of
      1933 by virtue of Section 4(2) of the Securities Act of 1933 and Rule 506
      promulgated thereunder. The transaction was not conducted by any form of general
      solicitation or general advertising and, in connection with the transaction,
      Bay
      National Corporation is taking reasonable care to assure that the purchasers
      of
      the common stock upon exercise of the warrants are not underwriters within
      the
      meaning of Section 2(11) of the Securities Act by, among other things, placing
      appropriate restrictive legends on the share certificates.





18


SELECTED
      FINANCIAL DATA


AS
      OF
      DECEMBER 31, 2005, 2004, 2003, 2002 and 2001


(dollars
      in thousands, except per share data)





**2005**
            
            
            **2004**
            
            
            **2003**
            
            
            ******2002**
            
            
            ******2001**Total
                assets
            $
            209,966
            
            $
            170,763
            
            $
            122,328
            
            $
            84,609
            
            $
            47,026Cash
                and due from banks
            
            1,461
            
            
            1,403
            
            
            573
            
            
            363
            
            
            3,065Federal
                funds sold and other overnight investments
            
            6,033
            
            
            16,709
            
            
            17,487
            
            
            11,753
            
            
            6,488Investment
                securities available for sale
            
            1,540
            
            
            1,544
            
            
            1,548
            
            
            948
            
            
            -Federal
                Reserve Bank stock
            
            452
            
            
            313
            
            
            313
            
            
            276
            
            
            276Federal
                Home Loan Bank stock
            
            342
            
            
            243
            
            
            168
            
            
            80
            
            
            -Loans,
                net
            
            196,590
            
            
            149,217
            
            
            101,049
            
            
            70,045
            
            
            36,097Deposits
            
            182,573
            
            
            153,927
            
            
            108,531
            
            
            76,079
            
            
            38,139Short-term
                borrowings
            
            1,444
            
            
            1,381
            
            
            1,222
            
            
            507
            
            
            -Note
                payable
            
            -
            
            
            1,250
            
            
            -
            
            
            -
            
            
            -Subordinated
                debt
            
            8,000
            
            
            -
            
            
            -
            
            
            -
            
            
            -Stockholders’
                equity
            
            16,214
            
            
            13,419
            
            
            12,067
            
            
            7,610
            
            
            8,602Common
                shares outstanding
            
            1,924,436
            
            
            1,917,710
            
            
            1,862,710
            
            
            1,242,020
            
            
            1,242,020Book
                value per share
            $
            8.43
            
            $
            7.00
            
            $
            6.48
            
            $
            6.13
            
            $
            6.93Ratio
                of interest earning assets to interest bearing
              liabilities
            
            126.38
            %
            
            124.95
            %
            
            127.61
            %
            
            127.68
            %
            
            134.86
            %Stockholders’
                equity as a percentage of assets
            
            7.72
            %
            
            7.86
            %
            
            9.86
            %
            
            8.99
            %
            
            18.29
            %





SELECTED
      FINANCIAL RATIOS


FOR
      THE
      YEARS ENDED DECEMBER 31, 2005, 2004, 2003, 2002 and 2001





**Weighted
                average yield/rate on:**
            
            **2005**
            
            **2004**
            
            
            **2003**
            
            
            ******2002**
            
            
            ******2001**Loans
                and loans held for sale
            
            7.46
            %
            5.89
            %
            
            5.98
            %
            
            6.52
            %
            
            7.38
            %Investments
                and interest bearing cash balances
            
            2.27
            %
            1.11
            %
            
            .80
            %
            
            1.36
            %
            
            3.79
            %Deposits
                and short-term borrowings
            
            2.96
            %
            2.17
            %
            
            2.26
            %
            
            2.84
            %
            
            3.70
            %Net
                interest spread
            
            4.12
            %
            3.14
            %
            
            2.81
            %
            
            2.80
            %
            
            2.31
            %Net
                interest margin
            
            4.74
            %
            3.60
            %
            
            3.29
            %
            
            3.43
            %
            
            3.58
            %





SELECTED
      OPERATIONAL DATA


FOR
      THE
      YEARS ENDED DECEMBER 31, 2005, 2004, 2003, 2002 and 2001


(dollars
      in thousands, except per share data)





**2005**
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Interest
                income
            $
            12,983
            $
            7,624
            
            $
            5,520
            
            $
            3,486
            
            $
            1,882Interest
                expense
            
            4,294
            
            2,464
            
            
            1,937
            
            
            1,367
            
            
            760Net
                interest income
            
            8,689
            
            5,160
            
            
            3,583
            
            
            2,119
            
            
            1,122Provision
                for credit losses
            
            1,179
            
            560
            
            
            415
            
            
            405
            
            
            377Net
                interest income after provision for credit losses
            
            7,510
            
            4,600
            
            
            3,168
            
            
            1,714
            
            
            745Non-interest
                income
            
            750
            
            539
            
            
            626
            
            
            479
            
            
            187Non-interest
                expenses
            
            6,171
            
            4,337
            
            
            3,786
            
            
            3,185
            
            
            2,548Income
                (loss) before income taxes
            
            2,089
            
            802
            
            
            8
            
            
            (992
            )
            
            (1,616
            )Income
                tax benefit
            
            655
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                income (loss)
            **$**
            2,744
            $
            802
            
            $
            8
            
            $
            (992
            )
            $
            (1,616
            )PER
                COMMON SHAREBasic
                net income (loss) per share
            $
            1.43
            $
            .43
            
            $
            .00
            
            $
            (.80
            )
            $
            (1.30
            )Diluted
                net income (loss) per share
            $
            1.37
            $
            .41
            
            $
            .00
            
            $
            (.80
            )
            $
            (1.30
            )Average
                shares outstanding (Basic)
            
            1,922,580
            
            1,877,929
            
            
            1,660,348
            
            
            1,242,020
            
            
            1,242,020Average
                shares outstanding (Diluted)
            
            2,002,225
            
            1,936,693
            
            
            1,682,905
            
            
            1,242,020
            
            
            1,242,020


19





Item
      6.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations





The
      following discussion of Bay National Corporation’s financial condition and
      results of operations should be read in conjunction with Bay National
      Corporation’s consolidated financial statements, the notes thereto and the other
      information included in this annual report.





This
      discussion and analysis provides an overview of the financial condition and
      results of operations of Bay National Corporation ("Parent") and its national
      bank subsidiary, Bay National Bank ("Bank"), (collectively the "Company"),
      as of
      December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004,
      and
      2003.





**General**





The
      Parent was incorporated on June 3, 1999 under the laws of the State of Maryland
      to operate as a bank holding company of the Bank. The Bank commenced operations
      on May 12, 2000.





The
      principal business of the Company is to make loans and other investments and
      to
      accept time and demand deposits. The Company’s primary market areas are in the
      areas North of Baltimore and the areas surrounding Salisbury, Maryland, although
      the Company’s business development efforts generate business outside of these
      areas. The Company 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 Company
      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
      with an emphasis on meeting the borrowing needs of small businesses. The
      Company’s target customers are small closely held businesses, business owners,
      professionals and high net worth individuals.





**Overview**





The
      Company continued a pattern of strong growth during the year ended December
      31,
      2005. This growth has resulted in improved operating results as compared to
      prior years. Key measurements for the year ended December 31, 2005 include
      the
      following:





·
            Total
                assets at December 31, 2005 increased by 23.0% to $210.0 million
                as
                compared to $170.8 million as of December 31, 2004.





·
            Net
                loans outstanding increased by 31.7% from $149.2 million as of December
                31, 2004 to $196.6 million as of December 31,
                2005.





·
            At
                December 31, 2005, the Company had a borrower with nonperforming
                loans for
                which a $500,000 provision was established in the fourth quarter.
                We
                believe an appropriate allowance for credit losses continues to be
                maintained.





·
            Deposits
                at December 31, 2005 were $182.6 million, an increase of $28.6 million
                or
                18.6% from December 31, 2004.





·
            On
                December 12, 2005, the Company participated in a private placement
                of $8
                million of fixed interest rate trust preferred securities through
                a newly
                formed Delaware trust subsidiary, Bay National Capital Trust I. The
                Company used $2.2 million of the proceeds of the offering to repay
                in full
                the amount outstanding under its credit facility with another financial
                institution. The remaining proceeds will be used for general corporate
                purposes, including but not limited to supporting continued asset
                growth.





20


·
            The
                Company realized net income of $2,744,330 for the year ended December
                31,
                2005. This compares to net income of $802,264 and $7,581 for the
                years
                ended December 31, 2004 and 2003, respectively. Included in the results
                of
                the year ended December 31, 2005 was an income tax benefit of $655,000
                as
                we recognized our previously unrecorded net deferred income tax
                asset.





·
            Net
                interest income, the Company’s main source of income, was $8.7 million for
                the year ended December 31, 2005 compared to $5.2 million and $3.6
                million
                for the years ended December 31, 2004 and 2003, respectively. This
                represents increases of 68.4% and 142.5% over the two prior years.





·
            Net
                loan recoveries were $11,134 for the year ended December 31, 2005.
                Net
                charge-offs since the inception of the Bank in 2000 were
                $4,961.





·
            Non-interest
                income for the year ended December 31, 2005 increased by $211,746
                or 39.3%
                as compared to the year ended December 31, 2004, primarily as a result
                of
                the addition of the Lutherville residential mortgage origination
                operation.





·
            Non-interest
                expenses increased by $1,834,615 or 42.3% for the year ended December
                31,
                2005, as compared to the year ended December 31, 2004.





·
            The
                market price of common shares ended the year at $21.00, up 58.5%
                from the
                closing price of $13.25 on December 31,
                2004.





A
      detailed discussion of the factors leading to these changes can be found in
      the
      discussion below.





**Results
      of Operations**





OVERVIEW





The
      Company recorded net income of $2,744,330 for the year ended December 31, 2005.
      This compares to $802,264 reported for the year ended December 31, 2004, an
      improvement of $1,942,066. The Company reported its first annual profit of
      $7,581 for the year ended December 31, 2003. This significant improvement in
      results for the periods is due to the continued strong growth of the loan
      portfolio, as well as significant improvement in margins resulting from a rising
      interest rate environment.





Bay
      National Bank’s mortgage origination operations, located in Lutherville and
      Salisbury, Maryland, originate conventional first and second residential
      mortgage loans. Bay National Bank sells most of its first and second residential
      mortgage loans in the secondary market and typically recognizes a gain on the
      sale of these loans after the payment of commissions to the loan origination
      officer. Since its inception in February 2001, the Salisbury mortgage division
      has been a significant contributor to operating results. The Lutherville
      mortgage operation was initiated in February 2005 and began to contribute to
      the
      Company’s overall profitability during the second half of 2005. For the years
      ended December 31, 2005, 2004 and 2003, gains on the sale of mortgage loans
      totaled $512,047, $244,716 and $370,326, respectively.





The
      level
      of gains on the sale of mortgage loans has increased in 2005 due to the addition
      of the Lutherville origination operation, which focuses on construction and
      rehabilitation loans that will be modified to permanent financing upon
      completion of the project. The permanent financing is then sold in the secondary
      market. We believe that this type of residential lending is less sensitive
      to
      the fluctuation of interest rates.





During
      the second quarter of 2004, the Company introduced a new loan program for
      conventional first lien and second lien residential mortgage loans. Under this
      program, the Company purchases a 100% participation in mortgage loans originated
      by a mortgage company in the Baltimore metropolitan area. These participations
      are for loans which a secondary market investor has committed to purchase.
      The
      participations are typically held for a period of three to four weeks before
      being sold to the secondary market investor. This holding period represents
      the
      amount of time taken by the secondary market investor to review the loan files
      for completeness and accuracy. During this holding period, the Company earns
      interest on these loans at a rate indexed to the prime rate.





21


The
      primary risk to the Company from this program is that the secondary market
      investor may decline to purchase the loans due to documentary deficiencies
      or
      errors. The Company attempts to manage this risk by conducting a thorough review
      of the documentation prior to purchasing the participation. If the secondary
      market investor declines to purchase the loan, the Company could attempt to
      sell
      the loan to other investors or hold the loan in its loan portfolio. As of
      December 31, 2005, the Company held $15.5 million of these loans which were
      classified as held for sale. The Company expects that all of these loans will
      be
      purchased by the secondary market investor. The Company earned $751,803 of
      interest on this program during 2005 and $287,835 during 2004.





Management
      expects continued improvement in operating results as asset levels continue
      to
      grow. However, actual results will be subject to the volatility of the provision
      for credit losses, which is related to loan growth, the impact of interest
      rate
      changes, which can reduce margins, the continued success of the new Lutherville
      mortgage lending programs, and the volatility of existing mortgage loan
      production, which is sensitive to economic and interest rate
      fluctuations.





NET
      INTEREST INCOME / MARGINS





Net
      interest income is the difference between income on earning assets and the
      cost
      of funds supporting those assets. Earning assets are composed primarily of
      loans, investments, and federal funds sold. Interest-bearing deposits and other
      borrowings make up the cost of funds. Non-interest bearing deposits and capital
      are also funding sources. Changes in the volume and mix of earning assets and
      funding sources along with changes in associated interest rates determine
      changes in net interest income.





Interest
      income from loans and investments for the year ended December 31, 2005 was
      $12,982,706, compared to $7,623,564 and $5,520,068 for the years ended December
      31, 2004 and 2003, respectively. The 70.3% increase over 2004, and the 135.2%
      increase over 2003, is directly related to the 27.8% increase in average
      interest earning assets from 2004, and the 68.7% increase in average interest
      earning assets from 2003. The change in interest income was also impacted by
      changes in average yields due to a rising interest rate environment in 2005
      and
      2004. The yields on these assets rose from 5.07 %
      for the
      year ended December 31, 2003 to 5.31% for the year ended December 31, 2004
      and
      to 7.08% for the year ended December 31, 2005.





The
      percentage of average interest-earning assets represented by loans was 92.5%,
      88.0% and 82.5% for the years ended December 31, 2005, 2004, and 2003,
      respectively. For the year ended December 31, 2005, the average yield on the
      loan portfolio was 7.46%, as compared to 5.89% for the year ended December
      31,
      2004 and 5.98% for the year ended December 31, 2003. Loan yields have primarily
      increased as a result of thirteen 0.25% increases in the target federal funds
      rate, from 1.00% at June 25, 2003 to 4.25% effective December 13, 2005. As
      can
      be seen by the yields discussed above, these increases had a significant impact
      on the Company’s operating results. The timing and amount of the impact on loan
      yields of changes to the federal funds rates varies from period to period as
      a
      result of differences in the mix of fixed rate loans to variable rate loans
      at
      any point in time.





The
      average yield on the investment portfolio and other earning assets such as
      federal funds sold was 2.27% for the year ended December 31, 2005 as compared
      to
      1.11% and 0.80% for the years ended December 31, 2004 and 2003, respectively.
      The fluctuations in the average yields were a direct result of the Federal
      Reserve actions discussed above as well as an increase in the holdings of
      Federal Reserve and Federal Home Loan Bank of Atlanta stocks, which pay dividend
      yields greater than the prevailing federal funds rate. The percentage of average
      interest-earning assets represented by investments was 7.5%, 12.0% and 17.5%
      for
      the years ended December 31, 2005, 2004, and 2003, respectively.





22


Interest
      expense from deposits and borrowings for the year ended December 31, 2005 was
      $4,294,146 compared to $2,464,209 and $1,936,726 for the years ended December
      31, 2004 and 2003, respectively. The 74.3% increase over 2004 and the 121.7%
      increase over 2003 are directly related to the 27.5% increase in average
      interest-bearing liabilities from 2004 and the 69.2% increase in average
      interest-bearing liabilities from 2003. Interest expense was also impacted
      by
      changes in average rates paid due to the fluctuating interest rate environment.
      The average rates paid on these liabilities changed from 2.26% for the year
      ended December 31, 2003 to 2.17% for the year ended December 31, 2004 to 2.96%
      for the year ended December 31, 2005. Average rates paid increased during 2005
      as a result of the rising interest rate environment during this period. Even
      though interest rates rose in 2004, management was able to delay raising rates,
      which is why average rates declined between 2003 and 2004. Management has
      observed pressure to increase rates paid on deposits as the target for the
      federal funds rate has risen. Management expects that this pressure will
      continue if rates continue to rise.





The
      following tables set forth, for the periods indicated, information regarding
      the
      average balances of interest-earning assets and interest-bearing liabilities,
      the amount of interest income and interest expense, and the resulting yields
      on
      average interest-earning assets and rates paid on average interest-bearing
      liabilities. Average balances are also provided for non-interest-earning assets
      and non-interest-bearing liabilities.





No
      tax
      equivalent adjustments were made and no income was exempt from federal income
      taxes. All average balances are daily average balances. The amortization of
      loan
      fees is included in computing interest income, however, such fees are not
      material.





23





**Year
                Ended December 31, 2005****Average**
              **Balance**
            
            
            **Interest**
              **and
                fees**
            
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            169,811,066
            
            $
            12,671,707
            
            
            7.46
            %Investment
                securities
            
            
            2,343,007
            
            
            86,267
            
            
            3.68Federal
                funds sold and other overnight investments
            
            
            11,340,021
            
            
            224,732
            
            
            1.98Total
                Earning Assets
            
            
            183,494,094
            
            
            12,982,706
            
            
            7.08
            %Less:
                Allowance for credit losses
            
            
            (2,064,604
            )Cash
                and due from banks
            
            
            1,328,362Premises
                and equipment, net
            
            
            708,549Accrued
                interest receivable and other assets
            
            
            900,832Total
                Assets
            
            $
            184,367,233LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            56,170,562
            
            
            1,064,126
            
            
            1.89
            %Regular
                savings deposits
            
            
            5,643,798
            
            
            36,572
            
            
            .65Time
                deposits
            
            
            77,785,133
            
            
            2,957,821
            
            
            3.80Short-term
                borrowings
            
            
            3,630,729
            
            
            115,810
            
            
            3.19Note
                payable
            
            
            1,426,027
            
            
            91,709
            
            
            6.43Subordinated
                debt
            
            
            438,356
            
            
            28,108
            
            
            7.20Total
                interest-bearing liabilities
            
            
            145,094,605
            
            
            4,294,146
            
            
            2.96
            %Net
                interest income and spread
            
            
            
            
            $
            8,688,560
            
            
            4.12
            %Non-interest-bearing
                demand deposits
            
            
            24,032,958Accrued
                expenses and other liabilities
            
            
            884,689Stockholders’
                equity
            
            
            14,354,981Total
                Liabilities and Stockholders’ Equity
            
            $
            184,367,233Interest
                and fee income/earning assets
            
            
            7.08
            %Interest
                expense/earning assets
            
            
            2.34Net
                interest margin
            
            
            4.74
            %Return
                on Average Assets
            
            
            1.49
            %Return
                on Average Equity
            
            
            19.12
            %Average
                Equity to Average Assets
            
            
            7.79
            %








24





**Year
                Ended December 31, 2004****Average**
              **Balance**
            
            
            **Interest**
              **and
                fees**
            
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            126,212,414
            
            $
            7,431,368
            
            
            5.89
            %Investment
                securities
            
            
            2,038,432
            
            
            45,173
            
            
            2.22Federal
                funds sold and other overnight investments
            
            
            15,232,288
            
            
            147,023
            
            
            0.97Total
                Earning Assets
            
            
            143,483,134
            
            
            7,623,564
            
            
            5.31
            %Less:
                Allowance for credit losses
            
            
            (1,473,985
            )Cash
                and due from banks
            
            
            909,590Premises
                and equipment, net
            
            
            641,550Accrued
                interest receivable and other assets
            
            
            534,261Total
                Assets
            
            $
            144,094,550LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            46,627,122
            
            
            509,308
            
            
            1.09
            %Regular
                savings deposits
            
            
            4,363,244
            
            
            28,396
            
            
            0.65Time
                deposits
            
            
            61,184,843
            
            
            1,901,183
            
            
            3.11Short-term
                borrowings
            
            
            1,475,148
            
            
            19,020
            
            
            1.29Note
                payable
            
            
            129,098
            
            
            6,302
            
            
            4.88Subordinated
                debt
            
            
            -
            
            
            -
            
            
            -Total
                interest-bearing liabilities
            
            
            113,779,445
            
            
            2,464,209
            
            
            2.17
            %Net
                interest income and spread
            
            
            
            
            $
            5,159,355
            
            
            3.14
            %Non-interest-bearing
                demand deposits
            
            
            17,391,401Accrued
                expenses and other liabilities
            
            
            515,639Stockholders’
                equity
            
            
            12,408,055Total
                Liabilities and Stockholders’ Equity
            
            $
            144,094,550Interest
                and fee income/earning assets
            
            
            5.31
            %Interest
                expense/earning assets
            
            
            1.71Net
                interest margin
            
            
            3.60
            %Return
                on Average Assets
            
            
            0.56
            %Return
                on Average Equity
            
            
            6.47
            %Average
                Equity to Average Assets
            
            
            8.61
            %





25





**Year
                Ended December 31, 2003****Average**
              **Balance**
            
            
            **Interest**
              **and
                fees**
            
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            89,721,871
            
            $
            5,367,997
            
            
            5.98
            %Investment
                securities
            
            
            1,833,052
            
            
            37,317
            
            
            2.04Federal
                funds sold and other overnight investments
            
            
            17,238,474
            
            
            114,754
            
            
            0.67Total
                Earning Assets
            
            
            108,793,397
            
            
            5,520,068
            
            
            5.07
            %Less:
                Allowance for credit losses
            
            
            (1,090,526
            )Cash
                and due from banks
            
            
            903,675Premises
                and equipment, net
            
            
            689,080Accrued
                interest receivable and other assets
            
            
            396,583Total
                Assets
            
            $
            109,692,209LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            33,884,963
            
            
            381,985
            
            
            1.13
            %Regular
                savings deposits
            
            
            2,997,371
            
            
            20,532
            
            
            0.69Time
                deposits
            
            
            47,675,682
            
            
            1,522,525
            
            
            3.19Short-term
                borrowings
            
            
            1,172,658
            
            
            11,684
            
            
            1.00Subordinated
                debt
            
            
            -
            
            
            -
            
            
            -Total
                interest-bearing liabilities
            
            
            85,730,674
            
            
            1,936,726
            
            
            2.26
            %Net
                interest income and spread
            
            
            
            
            $
            3,583,342
            
            
            2.81
            %Non-interest-bearing
                demand deposits
            
            
            13,158,325Accrued
                expenses and other liabilities
            
            
            386,732Stockholders’
                equity
            
            
            10,416,478Total
                Liabilities and Stockholders’ Equity
            
            $
            109,692,209Interest
                and fee income/earning assets
            
            
            5.07
            %Interest
                expense/earning assets
            
            
            1.78Net
                interest margin
            
            
            3.29
            %Return
                on Average Assets
            
            
            -
            %Return
                on Average Equity
            
            
            -
            %Average
                Equity to Average Assets
            
            
            9.50
            %





26


RATE/VOLUME
      ANALYSIS





A
      rate/volume analysis, which demonstrates changes in taxable-equivalent interest
      income and expense for significant assets and liabilities, appears below. The
      calculation of rate, volume and rate/volume variances is based on a procedure
      established for bank holding companies by the Securities and Exchange
      Commission. Rate, volume and rate/volume variances presented for each component
      may not total to the variances presented on totals of interest income and
      interest expense because of shifts from year to year in the relative mix of
      interest-earning assets and interest-bearing liabilities.





Year
                ended December 31,2005
                vs. 2004
              Due
                to variances inTotal
            
            
            Rates
            
            
            Volumes
            
            
            Rate/
                VolumeInterest
                earned on:Loans
                and loans held for sale
            $
            5,240,339
            
            $
            1,986,904
            
            $
            2,567,082
            
            $
            686,353Investment
                Securities
            
            41,094
            
            
            29,880
            
            
            6,749
            
            
            4,465Federal
                funds sold and other overnight investments
            
            77,709
            
            
            154,844
            
            
            (37,568
            )
            
            (39,567
            )Total
                interest income
            
            5,359,142
            
            
            2,171,628
            
            
            2,536,263
            
            
            651,251Interest
                paid on:Interest-bearing
                demand deposits
            
            554,818
            
            
            374,022
            
            
            104,243
            
            
            76,553Regular
                savings deposits
            
            8,176
            
            
            (122
            )
            
            8,334
            
            
            (36
            )Time
                deposits
            
            1,056,638
            
            
            425,403
            
            
            515,817
            
            
            115,418Short-term
                borrowings
            
            96,790
            
            
            28,033
            
            
            27,793
            
            
            40,964Note
                payable
            
            85,407
            
            
            2,001
            
            
            63,310
            
            
            20,096Subordinated
                debt
            
            28,108
            
            
            -
            
            
            -
            
            
            28,108Total
                interest expense
            
            1,829,937
            
            
            829,337
            
            
            719,497
            
            
            281,103Net
                interest earned
            $
            3,529,205
            
            $
            1,342,291
            
            $
            1,816,766
            
            $
            370,148








Year
                ended December 31,2004
                vs. 2003
              Due
                to variances inTotal
            
            
            Rates
            
            
            Volumes
            
            
            Rate/
                VolumeInterest
                earned on:Loans
                and loans held for sale
            $
            2,063,371
            
            $
            (85,187
            )
            $
            2,183,204
            
            $
            (34,646
            )Investment
                Securities
            
            7,856
            
            
            3,305
            
            
            4,181
            
            
            370Federal
                funds sold and other overnight investments
            
            32,269
            
            
            51,633
            
            
            (13,355
            )
            
            (6,009
            )Total
                interest income
            
            2,103,496
            
            
            (30,249
            )
            
            2,174,030
            
            
            (40,285
            )Interest
                paid on:Interest-bearing
                demand deposits
            
            127,323
            
            
            (11,860
            )
            
            143,642
            
            
            (4,459
            )Regular
                savings deposits
            
            7,864
            
            
            (1,025
            )
            
            9,356
            
            
            (467
            )Time
                deposits
            
            378,658
            
            
            (41,109
            )
            
            431,416
            
            
            (11,649
            )Short-term
                borrowings
            
            7,336
            
            
            3,436
            
            
            3,014
            
            
            886Note
                payable
            
            6,302
            
            
            -
            
            
            -
            
            
            6,302Subordinated
                Debt
            
            -
            
            
            -
            
            
            -
            
            
            -Total
                interest expense
            
            527,483
            
            
            (50,558
            )
            
            587,428
            
            
            (9,387
            )Net
                interest earned
            $
            1,576,013
            
            $
            20,309
            
            $
            1,586,602
            
            $
            (30,898
            )








PROVISION
      FOR CREDIT LOSSES





The
      provision for credit losses was $1,178,866 for the year ended December 31,
      2005,
      as compared to $559,596 for the year ended December 31, 2004, and $415,000
      for
      the year ended December 31, 2003. The provisions for each year were the direct
      result of growth in loan balances outstanding in all segments of the portfolio.
      In addition, the provision for 2005 was higher than the prior years due to
      the
      fact that the Company established a reserve of approximately $88,000 against
      loans held for sale to reflect the additional risk associated with loans
      originated through a third party mortgage company and an additional $500,000
      provision was established in the fourth quarter of 2005 as a result of the
      downgrading of one credit. For additional information regarding the methodology
      used to determine the provision for credit losses see the Management Discussion
      and Analysis section entitled “Allowance for Credit Losses and Credit Risk
      Management.”





27


NON-INTEREST
      INCOME





Non-interest
      income consists primarily of gains on the sale of mortgage loans, deposit
      account service charges and cash management fees. For the year ended December
      31, 2005, the Company realized non-interest income in the amount of $750,593
      as
      compared to $538,847 and $625,263 for the years ended December 31, 2004 and
      2003, respectively.





Gains
      on
      the sale of mortgage loans of $512,047 represented 68.22% of non-interest income
      for the year ended December 31, 2005. This compares to gains on the sale of
      mortgage loans of $244,716 or 45.42% of total non-interest income for the year
      ended December 31, 2004 and $370,326 or 59.23% of total non-interest income
      for
      the year ended December 31, 2003. The level of gains on the sale of mortgage
      loans has increased because the Company added additional residential
      construction and mortgage capabilities with the opening of the Lutherville
      mortgage operation in February 2005. This was achieved through the hiring of
      a
      team of eight individuals, including originators, processors and servicers
      who
      have extensive experience in the industry and the Company’s market area. It is
      expected that these additional capabilities will increase future levels of
      gains
      on the sale of mortgage loans, while also providing interest and fee income
      on
      construction loans. However, additional increases in interest rates, or a slow
      down in the housing market, could impact the Company’s ability to generate
      non-interest income associated with mortgage loan production.





Service
      charges on deposit accounts totaled $188,276 for the year ended December 31,
      2005, as compared to $237,980 and $212,787 for the years ended December 31,
      2004
      and 2003, respectively. The decreases of 20.9% over 2004 and 11.5% over 2003
      can
      be directly attributed to a decline in analysis fees charged on commercial
      deposit accounts. This decline occurred as the rate used for the calculation
      of
      analysis credits increased in conjunction with the increase in the target
      federal funds rate discussed earlier. Analysis credits are fee reductions
      provided based upon the analysis credit rate and the average balance of the
      account subject to analysis fees.





The
      Company will continue to seek ways to expand its sources of non-interest income.
      In the future, the Company may enter into fee arrangements with strategic
      partners that offer investment advisory services, risk management and employee
      benefit services. No assurance can be given that such fee arrangements will
      be
      obtained or maintained.





NON-INTEREST
      EXPENSE





The
      components of non-interest expense were as follows:





**Years
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Salaries
                and employee benefits
            $
            3,627,630
            $
            2,442,774
            $
            2,115,351Occupancy
                expenses
            
            420,866
            
            312,550
            
            259,719Furniture
                and equipment expenses
            
            304,132
            
            255,547
            
            215,254Legal
                and professional fees
            
            154,476
            
            175,757
            
            158,406Data
                processing and other outside services
            
            655,726
            
            582,396
            
            536,433Advertising
                and marketing related expenses
            
            445,482
            
            212,237
            
            210,289Other
                expenses
            
            562,645
            
            355,081
            
            290,572Total
                non-interest expenses
            $
            6,170,957
            $
            4,336,342
            $
            3,786,024





28


2005
      compared to 2004





Non-interest
      expense for the year ended December 31, 200 5
      totaled
      $6,170,957 compared to $4,336,342 for the year ended December 31, 2004. The
      increase of $1,834,615, or 42.3%, was primarily due to increases in salaries
      and
      employee benefit expenses, occupancy expenses, data processing and other outside
      services, advertising and marketing related expenses, furniture and equipment
      expenses and other expenses.





Salaries
      and benefits increased by $1,184,856 or 48.5% as a result of staffing growth
      related to the addition of the Lutherville mortgage operation as well as
      staffing to increase marketing efforts, manage the growth of the loan and
      deposit portfolios and support increased operational volume. Occupancy expenses
      increased by $108,316, or 34.7%, due in part to scheduled rent increases and
      increased rental expenses associated with new space obtained to facilitate
      the
      expansion of the Company’s corporate offices and to accommodate the new
      Lutherville mortgage lending group.





The
      $73,330, or 12.6%, increase in data processing and other outside services
      resulted from increased data and item processing costs paid to external service
      providers. The costs include one-time expenses of approximately $45,000 incurred
      in conjunction with the Bank’s planned change of core processors that occurred
      in May 2005, approximately $24,000 of recruiting fees paid to hire additional
      staff, and approximately $8,000 of systems support costs incurred to facilitate
      network infrastructure changes required for a bank processing system upgrade.
      The costs associated with purchasing additional hardware and software to support
      increased staffing were offset by savings on the new core processing contract,
      which provides for lower unit costs on a volume driven pricing structure.





The
      $48,585, or 19.0%, increase in furniture and equipment expenses is related
      to
      increased costs associated with expanded staffing and facilities. Advertising
      and marketing related expenses increased $233,245, or 109.9%, which was related
      to an increase in the number of marketing events conducted and the number of
      business development professionals as well as a total of $125,000 increase
      in
      funds set aside for charitable contributions to the Baltimore Community
      Foundation Donor Advised Fund and the Community
      Foundation of the Eastern Shore Donor
      Advised Fund established by the Bank. The increase of $186,283, or 35.1%, in
      all
      other expenses relates to various costs associated with the increased size
      and
      complexity of the Company.





The
      banking industry utilizes the “efficiency ratio” as a key measure of expense
      management and overall operating efficiency. This ratio is computed by dividing
      non-interest expense by the sum of net interest income before the loan loss
      provision and non-interest income. The Company’s efficiency ratio was 65.4% for
      the year ended December 31, 2005 compared to 76.1% for the year ending December
      31, 2004. The improved ratio from the prior year was driven by strong revenue
      growth and prudent management of the Company’s cost structure.





The
      rate
      of increase in non-interest expenses is substantially less than the 68.4%
      increase in net interest income for the year ended December 31, 2005 as compared
      to the year ended December 31, 2004. Management believes this indicates that
      the
      Company is continuing to effectively leverage its cost structure to generate
      profitable growth. While management expects that the ongoing growth of the
      Company's customer base will continue to require additional staffing in order
      to
      appropriately service customers and manage the business effectively, management
      believes that additional growth in the customer base can continue to be
      accomplished without proportionate increases in these costs.





29


Substantially
      all of the occupancy costs are paid to directors of Bay National Corporation
      or
      entities controlled by directors of Bay National Corporation. Management
      believes that the terms of these leases are at least as favorable as could
      be
      obtained from independent third parties. However, management has not conducted
      a
      recent market analysis to confirm this fact. For a discussion of the terms
      of
      the leases with these persons, see “Item 12 - Certain Relationships and Related
      Transactions.”





2004
      compared to 2003





Non-interest
      expense for the year ended December 31, 2004 totaled $4,336,342 compared to
      $3,786,024 for the
      year ended December 31, 2003. The increase of $550,318, or 14.54%, was primarily
      due to increases in salaries and employee benefit expenses, occupancy expenses,
      data processing and other outside services, furniture and equipment expenses
      and
      other expenses.





Salaries
      and benefits increased by $327,423 or 15.48% as a result of staffing growth
      initiated to increase marketing efforts, manage the growth of the loan and
      deposit portfolios and support increased operational volume. Occupancy expenses
      increased by $52,831, or 20.34% due in part to scheduled rent increases as
      well
      as a reduction in sublease income of approximately $10,900 due to expansion
      of
      the Company’s corporate office into previously sublet space and $20,400 of
      rental expenses associated with new space obtained to facilitate the expansion
      of the Company’s corporate offices. The $45,963, or 8.57%, increase in data
      processing and other outside services resulted from increased data and item
      processing costs paid to external service providers. These costs are
      volume-driven based upon the number of customer accounts and related transaction
      volume. As a result, these costs increase with the growth of the Company. The
      $40,293, or 18.72%, increase in furniture and equipment expenses is related
      to
      increased costs associated with expanded staffing and facilities. The increase
      of $83,808, or 12.71%, in all other expenses relates to various costs associated
      with the increased size and complexity of the Company.





The
      Company’s efficiency ratio was 76.10% for the year ended December 31, 2004
      compared to 89.96% for the year ending December 31, 2003. The improved ratio
      from the prior year was driven by strong revenue growth and prudent management
      of the Company’s cost structure.





INCOME
      TAXES




For
      the
      year ended December 31, 2005, the Company will be required to pay income taxes
      for the first time in its brief history. The Company incurred a current income
      tax liability of $428,000 for the year ended December 31, 2005.





For
      financial reporting purposes, taxable income for the years ended December 31,
      2004 and 2003 was offset by the Company’s net operating loss carryforwards
      available in those years. The 2005 liability was offset by the recognition
      of a
      deferred tax asset of $1,083,000, resulting in a net tax benefit of $655,000
      for
      the year ended December 31, 2005.





The
      use
      of the net operating loss carryforward and the recognition of net deferred
      income tax assets had a positive effect on 2005 earnings. In subsequent periods,
      the Company will begin to record income tax expense at the statutory rate.
      Prior
      to 2005, the Company had not recorded any income tax expense or benefit.
      Recognizing income tax expense in future periods will have a detrimental effect
      on reported earnings.





At
      December 31, 2005, the Company continues to have approximately $886,000 of
      Maryland net operating loss carryforwards (a possible net tax benefit on
      $62,000) for the unconsolidated state tax return for Bay National Corporation.
      Unless Bay National Corporation generates income from its own operations (i.e.,
      unrelated to Bay National Bank), these operating loss carryforwards will expire
      in 2019 and 2020.











30


**Financial
      Condition**





COMPOSITION
      OF THE BALANCE SHEET





Total
      assets of the Company were $ 209,966,335
      as of December 31, 2005, compared to total assets of $170,763,474 as of December
      31, 2004. This represents growth of approximately $39.2 million, or 23%, since
      December 31, 2004. The growth in assets was funded by growth in deposits,
      earnings and issuance of $8.0 million in subordinated debt. Deposits at December
      31, 2005 were $182,573,086 as compared to deposits of $153,927,042 at December
      31, 2004. Deposit growth resulted from the marketing efforts of officers and
      directors of the Bank and the use of two Internet based listing services for
      certificates of deposit. Management has set the interest rates paid on deposits
      to be competitive in the market and has continued to increase marketing
      activities throughout the year.





As
      of
      December 31, 2005, loans including
      loans held for sale (net of a $3,000,000 allowance for credit losses), totaled $196,589,961. This represents an increase of $47,373,362, or 31.7%, from
      December 31, 2004. The composition of the loan portfolio as of December 31,
      2005
      was approximately $75.6 million of commercial loans (excluding real estate
      loans), $2.9 million of consumer loans and $103.6 million of real estate loans
      excluding $17,509,064 of mortgage loans held for sale. The
      composition of the loan portfolio as of December 31, 2004 was approximately
      $73.8 million of commercial loans (excluding real estate loans), $2.2 million
      of
      consumer loans and $65.4 million of real estate loans excluding $9,613,162 of mortgage loans held for sale. Growth in the loan portfolio is
      a
      direct result of the addition of the Lutherville mortgage group as well as
      the
      marketing efforts of bank employees, members of the Board of Directors and
      the
      Baltimore and Salisbury Advisory Boards. The mix of loans shifted to a higher
      concentration in real estate as a result of the Lutherville mortgage group’s
      production and the strength of the overall real estate market. -





The
      Company continues to emphasize prudent growth through the hiring of experienced
      commercial lenders and the development and use of referral sources including
      accountants, lawyers and existing customers, as well as members of the Board
      of
      Directors and the Baltimore and Salisbury Advisory Boards.





Funds
      not
      extended in loans are held in cash and due from banks, and various investments
      including federal funds sold and other overnight investments, United States
      Treasury securities, Federal Reserve Bank stock and Federal Home Loan Bank
      stock. These investments totaled $9,828,447 as of December 31, 2005 compared
      to
      $20,212,538 as of December 31, 2004. Other than the investments in Federal
      Reserve Bank stock and Federal Home Loan Bank stock, totaling $794,440 and
      $556,090 at December 31, 2005 and 2004, respectively, all investments have
      maturities of 90 days or less. The Treasury securities are used to collateralize
      repurchase agreements which are classified as short-term borrowings under which
      $916,158 and $1,381,000 were outstanding as of December 31, 2005 and December
      31, 2004, respectively. Management has made a decision to maintain liquidity
      in
      the investment portfolio in order to ensure that funds are readily available
      to
      fund the growth of the loan portfolio.





As
      of
      December 31, 2004, the Company had borrowed $1,250,000 under a $5 million,
      three-year unsecured non-revolving credit facility executed on September 28,
      2004 with another financial institution. Borrowings under the credit facility were
      used
      to provide regulatory capital to the Bank. The loan bore interest at the prime
      rate as offered by the financial institution. On December 12, 2005, the Company
      used $2.2 million of proceeds from the private placement of $8 million of fixed
      interest rate trust preferred securities to repay in full the amount outstanding
      under its credit facility with this financial institution. The trust preferred
      securities bear interest at a rate of 7.2% and mature on February 23, 2036.
      These securities are redeemable at the Company’s option at par beginning on
      February 23, 2011. The remaining proceeds will be used for general corporate
      purposes including supporting asset growth.





Total
      capital at December 31, 2005 was $16,214,078 as compared to $13,418,764 at
      December 31, 2004. The
      increase in capital is primarily a result of the positive operating results
      for
      the year ended December 31, 2005.





31


COMPOSITION
      OF LOAN PORTFOLIO





Because
      yields on loans typically exceed the yields on investments, the Company’s
      business strategy is to continue to increase the overall level of loans, as
      well
      as maintain a relatively high percentage of loans to total earning assets.
      Increasing loans and loans as a percentage of total earning assets will maximize
      the net interest margin. As of December 31, 2005 and 2004, loans represented
      95.98% and 89.19% of total earning assets, respectively.





The
      following table sets forth the composition of the principal balances of the
      Company's loan portfolio as of December 31, 2005, 2004, 2003, 2002, and 2001,
      respectively.





**2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Real
                Estate - Home Equity Line of Credit
            $
            21,067,964
            
            $
            24,548,506
            
            $
            16,078,166
            
            $
            9,960,943
            
            $
            5,641,198Real
                Estate - Construction
            
            25,719,603
            
            
            12,968,251
            
            
            8,101,017
            
            
            3,700,389
            
            
            2,230,067Real
                Estate - Mortgage
            
            56,757,096
            
            
            27,854,130
            
            
            13,687,709
            
            
            7,816,997
            
            
            2,448,595Loans
                Held for Sale
            
            17,509,064
            
            
            9,613,162
            
            
            923,825
            
            
            2,818,500
            
            
            682,000Commercial
            
            75,626,825
            
            
            73,836,994
            
            
            61,868,002
            
            
            42,566,165
            
            
            23,488,566Consumer
            
            2,909,409
            
            
            2,205,556
            
            
            1,657,081
            
            
            4,033,767
            
            
            2,053,629Total
                Loans
            $
            199,589,961
            
            $
            151,026,599
            
            $
            102,315,800
            
            $
            70,896,761
            
            $
            36,544,055





The
      following table sets forth the percentages
      of loans in each category for the Company's loan portfolio as of December 31,
      2005, 2004, 2003, 2002, and 2001, respectively.





**2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Real
                Estate - Home Equity Line of Credit
            
            10.55
            %
            
            16.25
            %
            
            15.71
            %
            
            14.05
            %
            
            15.44
            %Real
                Estate - Construction
            
            12.89
            
            
            8.59
            
            
            7.92
            
            
            5.22
            
            
            6.10Real
                Estate - Mortgage
            
            28.44
            
            
            18.44
            
            
            13.38
            
            
            11.03
            
            
            6.70Loans
                Held for Sale
            
            8.77
            
            
            6.37
            
            
            .90
            
            
            3.97
            
            
            1.87Commercial
            
            37.89
            
            
            48.89
            
            
            60.47
            
            
            60.04
            
            
            64.27Consumer
            
            1.46
            
            
            1.46
            
            
            1.62
            
            
            5.69
            
            
            5.62Total
                Loans
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %





The
      following table sets forth the maturity distribution for the Company's loan
      portfolio at December 31, 2005. Some of the loans may be renewed or repaid
      prior
      to maturity. Therefore, the following table should not be used as a forecast
      of
      future cash flows.





**Within
                one****year**
            
            
            **One
                to****three
                years**
            
            
            **Three
                to****five
                years**
            
            
            **Over
                five****years**Real
                Estate - Home Equity Line of
              Credit
            $
            21,067,964
            
            $
            -
            
            $
            -
            
            $
            -Real
                Estate - Construction
            
            22,692,415
            
            
            3,027,188
            
            
            -
            
            
            -Real
                Estate - Mortgage
            
            44,345,737
            
            
            5,434,758
            
            
            6,161,436
            
            
            815,165Loans
                Held for Sale
            
            17,509,064
            
            
            -
            
            
            -
            
            
            -Commercial
            
            62,423,877
            
            
            8,406,625
            
            
            4,619,805
            
            
            176,518Consumer
            
            2,796,489
            
            
            101,441
            
            
            11,479
            
            
            -Total
            $
            170,835,546
            
            $
            16,970,012
            
            $
            10,792,720
            
            $
            991,683Fixed
                interest rate
            $
            37,968,824
            
            $
            16,970,012
            
            $
            10,792,720
            
            $
            991,683Variable
                interest rate
            
            115,357,658
            
            
            -
            
            
            -
            
            
            -Loans
                Held for Sale
            
            17,509,064
            
            
            -
            
            
            -
            
            
            -Total
            $
            170,835,546
            
            $
            16,970,012
            
            $
            10,792,720
            
            $
            991,683





32


The
      scheduled repayments as shown above are reported in the maturity category in
      which the payment is due, except for the adjustable rate loans, which are
      reported in the period of repricing.





The
      Company's loan portfolio composition as of December 31, 2005 reflects a 57.80%
      concentration in variable rate loans. Loans held for sale total $17,509,064
      or
      10.25% of the Company's loan portfolio. Fixed rate loans total $66,723,239
      or
      33.43% of the Company's loan portfolio. Interest rates on variable rate loans
      adjust to the current interest rate environment, whereas fixed rates do not
      allow this flexibility. Loans held for sale are expected to be sold in three
      months or less and as a result are not materially impacted by interest rate
      fluctuations. If interest rates were to increase in the future, the interest
      earned on the variable rate loans would improve, and, if rates were to fall,
      the
      interest earned would decline. See "Liquidity and Interest Rate
      Sensitivity."





The
      officers and directors of the Company ha d
      outstanding loans from the Bank of $8,059,647 at December 31, 2005 and
      $5,828,095 at December 31, 2004. All loans made to officers and directors are
      made on substantially the same terms, including interest rates and collateral,
      as those prevailing at the time for comparable transactions with unaffiliated
      third parties and do not involve more than the normal risk of repayment or
      present other unfavorable features.





ALLOWANCE
      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
      Company charges the provision for credit losses to earnings to maintain the
      total allowance for credit losses at a level considered by management to
      represent its best estimate of the losses known and inherent in the portfolio
      that are both probable and reasonable to estimate, based on, among other
      factors, prior loss experience, volume and type of lending conducted, estimated
      value of any underlying collateral, economic conditions (particularly as such
      conditions relate to the Company’s market area), regulatory guidance, peer
      statistics, management’s judgment, past due loans in the loan portfolio, loan
      charge off experience and concentrations of risk (if any). The Company charges
      losses on loans against the allowance when it is believed that collection of
      loan principal is unlikely. Recoveries on loans previously charged off are
      added
      back to the allowance.





Management
      uses a loan grading system where all loans are graded based on management's
      evaluation of the risk associated with each loan. A factor, based on the loan
      grading, is applied to the loan balance to reserve for potential losses. In
      addition, management judgmentally establishes an additional nonspecific reserve.
      The nonspecific portion of the allowance reflects management's estimate of
      probable inherent but undetected losses within the portfolio due to
      uncertainties in economic conditions, delays in obtaining information, including
      unfavorable information about a borrower's financial condition, the difficulty
      in identifying triggering events that correlate perfectly to subsequent loss
      rates and risk factors that have not yet manifested themselves in loss
      allocation factors.





The
      reserve factors used are based on management’s judgment as to appropriate
      reserve percentages for various categories of loans, and adjusts those values
      based on the following: historical losses in each category, historical and
      current delinquency in each category, underwriting standards in each category,
      comparison of losses and delinquencies to peer group performance and an
      assessment of the likely impact of economic and other external conditions on
      the
      performance of each category.





A
      test of
      the adequacy of the allowance for credit losses is performed and reported to
      the
      Board of Directors on a monthly basis. Management uses the information available
      to make a determination with respect to the allowance for credit losses,
      recognizing that the determination is inherently subjective and that future
      adjustments may be necessary depending upon, among other factors, a change
      in
      economic conditions of specific borrowers or generally in the economy and new
      information that becomes available. However, there are no assurances that the
      allowance for credit losses will be sufficient to absorb losses on nonperforming
      assets or that the allowance will be sufficient to cover losses on nonperforming
      assets in the future.





33


The
      allowance for credit losses as of December 31, 2005 and December 31, 2004 was
      $3,000,000 and $1,810,000, respectively. The amount equates to 1.50% and 1.20%
      of outstanding loans, including loans held for sale, as of December 31, 2005
      and
      2004, respectively. The increased percentage was due to the fact that the
      Company established a reserve of approximately $88,000 against loans held for
      sale to reflect the additional risk associated with loans originated through
      a
      third party mortgage company and an additional $500,000 provision established
      in
      the fourth quarter of 2005 as a result of the downgrading of one credit. Bay
      National Corporation has no exposure to foreign countries or foreign borrowers.
      Management believes that the allowance for loan losses is adequate for each
      period presented.





The
      following table represents an analysis of the activity in the allowance for
      credit losses for the periods presented:




**2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001**Balance
                at beginning of year
            $
            1,810,000
            $
            1,266,500
            $
            851,500
            $
            447,000
            $
            70,000Provision
                for credit losses
            
            1,178,866
            
            559,596
            
            415,000
            
            404,500
            
            377,000Loan
                charge-offsCommercial
            
            -
            
            (15,222
            )
            -
            
            -
            
            -Consumer
            
            -
            
            (2,134
            )
            -
            
            -
            
            -Loan
                recoveriesCommercial
            
            11,134
            
            1,260
            
            -
            
            -
            
            -Net
                recoveries (charge-offs)
            
            11,134
            
            (16,096
            )
            -
            
            -
            
            -Balance
                at end of year
            $
            3,000,000
            $
            1,810,000
            $
            1,266,500
            $
            851,500
            $
            447,000





The
      following table presents the allocation of the allowance for credit losses,
      reflecting use of the methodology presented above for the periods
      presented:





**Amount****2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Real
                Estate - Home Equity Line of Credit
            $
            106,986
            
            $
            122,918
            
            $
            80,370
            
            $
            52,720
            
            $
            30,987Real
                Estate - Construction
            
            347,092
            
            
            150,346
            
            
            86,252
            
            
            33,961
            
            
            23,551Real
                Estate - Mortgage
            
            306,577
            
            
            179,798
            
            
            133,109
            
            
            84,548
            
            
            27,069Loans
                Held for Sale
            
            87,545
            
            
            48,066
            
            
            -
            
            
            -
            
            
            -Commercial
            
            2,046,219
            
            
            1,279,472
            
            
            954,623
            
            
            626,699
            
            
            244,308Consumer
            
            10,275
            
            
            11,032
            
            
            10,324
            
            
            26,256
            
            
            8,811Unallocated
            
            95,306
            
            
            18,368
            
            
            1,822
            
            
            27,316
            
            
            112,274Total
                Allowance
            $
            3,000,000
            
            $
            1,810,000
            
            $
            1,266,500
            
            $
            851,500
            
            $
            447,000





The
      unallocated portion of the allowance for credit losses increased in 2005. This
      occurred because the Company calculates an overall reserve level while the
      underlying portfolio experienced a moderate shift in the mix of loans by risk
      grade. The shift in the mix of loans by risk grade is a normal result of the
      addition of new loans, the decrease in balances of more mature loans and the
      ongoing reassessment of all loans.





The
      following table sets forth the percentages
      of loans in each category for the Company's loan portfolio as of December 31,
      2005, 2004, 2003, 2002, and 2001, respectively.





**2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Real
                Estate - Home Equity Line of Credit
            
            10.55
            %
            
            16.25
            %
            
            15.71
            %
            
            14.05
            %
            
            15.44
            %Real
                Estate - Construction
            
            12.89
            
            
            8.59
            
            
            7.92
            
            
            5.22
            
            
            6.10Real
                Estate - Mortgage
            
            28.44
            
            
            18.44
            
            
            13.38
            
            
            11.03
            
            
            6.70Loans
                Held for Sale
            
            8.77
            
            
            6.37
            
            
            .90
            
            
            3.97
            
            
            1.87Commercial
            
            37.89
            
            
            48.89
            
            
            60.47
            
            
            60.04
            
            
            64.27Consumer
            
            1.46
            
            
            1.46
            
            
            1.62
            
            
            5.69
            
            
            5.62Total
                Loans
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %
            
            100.00
            %





34


NONPERFORMING
      LOANS AND OTHER DELINQUENT ASSETS





Management
      performs reviews of all delinquent loans. Management will generally classify
      loans as non-accrual when collection of full principal and interest under the
      original terms of the loan is not expected or payment of principal or interest
      has become 90 days past due. Classifying a loan as non-accrual results in the
      Company no longer accruing interest on such loan and reversing any interest
      previously accrued but not collected. A non-accrual loan may be restored to
      accrual status when delinquent principal and interest payments are brought
      current and future monthly principal and interest payments are expected to
      be
      collected. The Company will recognize interest on non-accrual loans only when
      received. As of December 31, 2005 and 2004, the Company did not have any
      non-accrual loans.





Any
      property acquired by the Company as a result of foreclosure on a mortgage loan
      will be classified as "real estate owned" and will be recorded at the lower
      of
      the unpaid principal balance or fair value at the date of acquisition and
      subsequently carried at the lower of cost or net realizable value. Any required
      write-down of the loan to its net realizable value will be charged against
      the
      allowance for credit losses. Upon foreclosure, the Company generally will
      require an appraisal of the property and, thereafter, appraisals of the property
      on at least an annual basis with external inspections on at least a quarterly
      basis. As of December 31, 2005 ,
      and
      December 31, 2004, the
      Company held no real estate acquired as a result of foreclosure.





The
      Company applies the provisions of Statements of Financial Accounting Standards
      No. 114 ("SFAS No. 114"), "Accounting by Creditors for Impairment of a Loan,"
      as
      amended by Statements of Financial Accounting Standards No. 118 ("SFAS No.
      118"), "Accounting by Creditors for Impairment of a Loan-Income Recognition
      and
      Disclosure." SFAS No. 114 and SFAS No. 118 require that impaired loans, which
      consist of all modified loans and other loans for which collection of all
      contractual principal and interest is not probable, be measured based on the
      present value of expected future cash flows discounted at the loan's effective
      interest rate, or at the loan's observable market price or the fair value of
      the
      collateral if the loan is collateral dependent. If the measure of the impaired
      loan is less than the recorded investment in the loan, an impairment is
      recognized through a valuation allowance and corresponding provision for credit
      losses. The Company considers consumer loans as homogenous loans and thus does
      not apply the SFAS No. 114 impairment test to these loans. Impaired loans will
      be written off when collection of the loan is doubtful.





The
      Company had no impaired loans as of December
      31, 2004, 2003, 2002 and 2001, respectively. As of December 31, 2005, the
      Company, based on information obtained subsequent to year-end, deemed loans
      to
      one borrower, with a net principal balance of $1,708,874, as impaired due to
      the
      obligor’s financial difficulties. Accordingly, a $500,000
      provision against the allowance for credit losses was established in the fourth
      quarter of 2005 for the downgrading of this credit. A loan to this borrower,
      with a net principal balance of $1,238,041, was classified as non-accrual as
      of
      January 1, 2006, the amount of accrued interest being considered immaterial.
      The
      Company has subsequently received approximately $537,000 that was applied
      against this loan and full payment on a related loan, resulting in a net
      principal balance of $700,237. Collection of the remainder is uncertain.
      Management believes that the allowance for credit losses is adequate.





INVESTMENT
      PORTFOLIO





The
      Company has chosen to invest its available funds primarily in federal funds
      sold
      and other overnight investments. As a result, investment securities as of
      December 31, 2005, consisted of $452,340
      of Federal Reserve Bank stock, $342,100 of Federal Home Loan Bank stock and
      $1,540,386 of U.S. Treasury securities which mature within three months.
      Investment securities for the year ended December 31, 2004, consisted of
      $312,690 of Federal Reserve Bank stock, $243,400 of Federal Home Loan Bank
      stock
      and $1,544,496 of U.S. Treasury securities which matured within three months.
      Investment securities for the year ended December 31, 2003 consisted of $312,690
      of Federal Reserve Bank stock, $168,400 of Federal Home Loan Bank stock and
      $1,547,798 of U.S. Treasury securities which matured within three months.





Management
      has made the decision to maintain its available funds in highly liquid assets
      because it wishes to ensure that funds are readily available to fund the growth
      of the loan portfolio. Management believes that this strategy will allow the
      Company to maximize interest margins while maintaining appropriate levels of
      liquidity to fund loan growth.





35


SOURCES
      OF FUNDS





General





Deposits,
      short-term borrowings in the form of repurchase agreements, short-term
      borrowings under secured and unsecured lines of credit, borrowings under the
      subordinated debt, scheduled amortization and prepayment of loans, funds
      provided by operations and capital are the current sources of funds utilized
      by
      the Company for lending and investment activities, and other general business
      purposes.





Deposits





The
      Company offers a variety of deposit products having a range of interest rates
      and terms. The Company's deposits consist of checking accounts, savings
      accounts, money market accounts and certificates of deposit.





The
      following table sets forth the composition of the Company's deposits as of
      December 31, 2005 and December 31, 2004:




**2005**
            
            **2004**Demand
                Deposits
            $
            61,057,678
            
            33.44
            %
            
            $
            52,121,451
            
            
            33.86
            %Savings
            
            9,215,092
            
            5.05
            
            
            
            5,255,422
            
            
            3.41Money
                Market and sweep
            
            19,411,421
            
            10.63
            
            
            
            28,304,367
            
            
            18.39Certificates
                of deposit
            
            92,888,895
            
            50.88
            
            
            
            68,245,802
            
            
            44.34Total
                deposits
            $
            182,573,086
            
            100.00
            %
            
            $
            153,927,042
            
            
            100.00
            %





The
      mix
      of deposits has remained relatively steady from year to year. The decrease
      in
      the percentage of deposits represented by money market and sweep accounts is
      due
      primarily to a decrease in balances held for one large customer, as well as
      movement of funds to certificates of deposit as depositors seek higher yields.





Of
      the
      total deposits at December 31, 2005, $12.0 million, or 6.56%, were related
      to
      two customers in one industry and a third customer in another industry as
      compared to $16.6 million, or 10.79%, at December 31, 2004. The deposits for
      these customers tend to fluctuate significantly; as a result, management
      monitors these deposits on a daily basis to ensure that liquidity levels are
      adequate to compensate for these fluctuations.





The
      following table sets forth the maturity distribution for the Company's deposits
      at December 31, 2005. Some of the deposits may be renewed or withdrawn prior
      to
      maturity. Therefore, the following table should not be used as a forecast of
      future cash flows.





**Within
                one**
              **year**
            
            
            **One
                to****three**
              **years**
            
            
            **Three
                to**
              **five
                years**
            
            
            **Over
                five**
              **years**Demand
                deposits
            $
            61,057,678
            
            $
            -
            
            $
            -
            
            $
            -Savings
            
            9,215,092
            
            
            -
            
            
            -
            
            
            -Money
                Market and sweep
            
            19,411,421
            
            
            -
            
            
            -
            
            
            -Certificates
                of deposit
            
            49,419,719
            
            
            26,427,778
            
            
            17,041,398
            
            
            -Total
            $
            139,103,910
            
            $
            26,427,778
            
            $
            17,041,398
            
            $
            -





36


Certificates
      of deposit in amounts of $100,000 or more, and their remaining maturities at
      December 31, 2005, are as follows:





Three
                months or less
            $
            4,374,777Over
                three months through six months
            
            11,163,966Over
                six months through twelve months
            
            6,400,569Over
                twelve months
            
            15,072,324Total
            $
            37,011,636





The
      market in which the Company operates is very competitive and the rates of
      interest paid on deposits are affected by rates paid by other depository
      institutions. Management closely monitors rates offered by other institutions
      and seeks to be competitive within the market. The Company has chosen to
      selectively compete for large certificates of deposits. The Company will choose
      to pursue such deposits when expected loan growth provides for adequate spreads
      to support the cost of those funds. As of December 31, 2005, the Company had
      outstanding certificates of deposit of approximately $33.8 million that were
      obtained through the listing of certificate of deposit rates on two
      Internet-based listing services. These certificates of deposit were issued
      with
      an average yield of 4.10% and an average term of 28 months. Included in the
      $33.8 million of Internet-originated certificates of deposit is one certificate
      of deposit in the amount of $97,296 that has been classified as a “Brokered
      Deposit” for bank regulatory purposes. This “Brokered Deposit” was issued with a
      yield of 2.75% and matures in October 2006. As of December 31, 2004, the total
      certificates of deposit obtained through the listing of certificate of deposit
      rates on the Internet-based listing services was approximately $29 million,
      of
      which $394,666 were classified as “Brokered Deposits.” The Company has never
      paid broker fees for deposits and has not accepted any new “Brokered Deposits”
since August 2002.





Core
      deposits, which management categorizes as all deposits other than national
      market certificates of deposit and all but $5.0 million of deposits from the
      three large customers described above (which management considers to be a stable
      deposit amount from these customers based upon historical trends), stood at
      $141,825,926 as of December 31, 2005, up 25.05% from $113,412,507 as of December
      31, 2004. Core deposits are closely monitored by management because they
      consider such deposits not only a relatively stable source of funding but also
      reflective of the growth of commercial and consumer depository relationships.





Borrowings.





On
      September 28, 2004, the Company entered into a five million, three year
      unsecured non-revolving credit facility with Drovers Bank of York, Pennsylvania,
      a division of Fulton Bank. The loan paid interest at the prime rate as offered
      by Drovers Bank. The credit facility was scheduled to expire on September 28,
      2007, at which time all outstanding amounts under the credit facility, including
      accrued but unpaid interest, would have become due and payable. The Company
      had
      the option to repay interest and principal under the credit facility at any
      time
      without premium or penalty.





In
      December 2005, the Company used $2.2 million of the proceeds from the private
      placement of $8 million of fixed interest rate trust preferred securities to
      repay in full the amount outstanding under its credit facility with Drovers
      Bank
      as further described below.





On
      December 12, 2005, the Company participated in a private placement of $8 million
      of fixed interest rate trust preferred securities (the “Trust Preferred
      Securities”), through a newly formed Delaware trust subsidiary, Bay National
      Capital Trust I (the “Trust”). The Trust was formed for the purpose of issuing
      the Trust Preferred Securities and all of its common securities are owned by
      the
      Company. The Company purchased the common securities from the Trust for
      $248,000. In accordance with provisions of FIN46, the financial position and
      results of operations are not included in the Company’s consolidated financial
      position and results of operations.





37


The
      Trust
      used the proceeds of the sale of the Trust Preferred Securities and common
      securities to purchase from the Company the aggregate principal amount of
      $8,248,000 of the Company’s Fixed Rate Junior Subordinated Debt Securities Due
      2036 (the “Debt Securities”). Like the Trust Preferred Securities, the Debt
      Securities bear interest at the fixed annual rate of 7.20% until maturity.
      The
      interest expense on Trust Preferred Securities was $28,108 in 2005. The Debt
      Securities mature on February 23, 2036, but may be redeemed at the Company’s
      option at any time on any February 23, May 23, August 23 or November 23 on
      or
      after February 23, 2011, or at any time upon certain events, such as a change
      in
      the regulatory capital treatment of Debt Securities, the Trust being deemed
      to
      be an “investment company” under the Investment Company Act of 1940, as amended,
      or the occurrence of certain adverse tax events. Except upon the occurrence
      of
      the events described above, which require a redemption premium for redemptions
      prior to February 23, 2011, the Company may redeem the Debt Securities at their
      aggregate principal amount, plus accrued interest, if any.





The
      Parent is required to retain $1,000,000 of the proceeds from the Debt Securities
      for general corporate purposes (which may include making interest payments
      on
      the Debt Securities) until the earlier of (i) the date on which the retained
      funds are reduced to zero, or (ii) the date on which Bay National Bank (or
      any
      successor) meets the statutory requirements to pay dividends of at least
      $148,464 for each of two consecutive quarters with positive retained earnings
      remaining after any such dividend payment.





The
      Debt
      Securities are subordinated to the prior payment of other indebtedness of the
      Company that, by its terms, are not similarly subordinated. Although the Debt
      Securities are recorded as a liability on the Company’s balance sheet, for
      regulatory purposes, the Debt Securities are being treated as Tier 1 or Tier
      2
      capital under regulatory capital guidelines issued by the Federal Reserve
      Board.





Short-term
      borrowings as of December 31, 2005 consist of advances under unsecured Federal
      Funds lines of credit of $528,000 and repurchase agreements collateralized
      by
      pledges of U.S. Government Treasury Securities, based upon their market values,
      equal to 100% of the principal and accrued interest of the repurchase
      agreements. The outstanding balance of repurchase agreements decreased from
      $1,381,000 at December 31, 2004 to $916,158 at December 31, 2005, due to
      decreases in the balance of available funds for customers participating in
      this
      program.





As
      of
      December 31, 2005, the Company maintained commitments for a total of $9.0
      million of borrowing availability under unsecured Federal Funds lines of credit
      with three separate financial institutions. The Company also had approximately
      $21.0 million of borrowing capacity with the Federal Home Loan Bank of Atlanta
      as of December 31, 2005.





INTEREST
      RATE SENSITIVITY





The
      primary objective of asset/liability management is to ensure the steady growth
      of the Company’s primary earnings component, net interest income. Net interest
      income can fluctuate with significant interest rate movements. To minimize
      the
      risk associated with these rate swings, management works to structure the
      Company’s balance sheet so that the ability exists to adjust pricing on
      interest-earning assets and interest-bearing liabilities in roughly equivalent
      amounts at approximately the same time intervals. Imbalances in these repricing
      opportunities at any point in time constitute interest rate
      sensitivity.




The
      measurement of the Company’s interest rate sensitivity, or "gap," is one of the
      principal techniques used in asset/liability management. The interest sensitive
      gap is the dollar difference between assets and liabilities which are subject
      to
      interest rate pricing within a given time period, including both floating rate
      or adjustable rate instruments, and instruments which are approaching
      maturity.





38


The
      following table sets forth the amount of the Company's interest-earning assets
      and interest-bearing liabilities as of December 31, 2005, which are expected
      to
      mature or reprice in each of the time periods shown:


**Maturity
                  or repricing within****Amount**
              
              **Percent
                  of****Total**
              
              
              **0
                  to 3****Months**
              
              **4
                  to 12****Months**
              
              
              **1
                  to 5****Years**
              
              **Over
                  5****Years**Interest-earning
                  assetsFederal
                  funds sold and other overnight investments
              $
              6,032,952
              
              2.90
              %
              $
              6,032,952
              $
              -
              
              $
              -
              $
              -Loans
                  held for sale
              
              17,509,064
              
              8.42
              
              
              17,509,064
              
              -
              
              
              -
              
              -Investment
                  securities available for sale
              
              1,540,386
              
              0.74
              
              
              1,540,386
              
              -
              
              
              -
              
              -Loans
                  - Variable rate
              
              115,357,658
              
              55.47
              
              
              115,357,658
              
              -
              
              
              -
              
              -Loans
                  - Fixed rate
              
              66,723,239
              
              32.09
              
              
              3,978,062
              
              33,990,762
              
              
              27,762,732
              
              991,683Other
                  earning assets
              
              794,440
              
              0.38
              
              
              -
              
              -
              
              
              -
              
              794,440Total
                  interest-earning assets
              $
              207,957,739
              
              100.00
              %
              $
              144,418,122
              $
              33,990,762
              
              $
              27,762,732
              $
              1,786,123Interest-bearing
                  liabilitiesDeposits
                  - Variable rate
              $
              62,215,434
              
              37.81
              %
              $
              62,215,434
              $
              -
              
              $
              -
              $
              -Deposits
                  - Fixed rate
              
              92,888,895
              
              56.45
              
              
              8,127,549
              
              41,192,170
              
              
              43,569,176
              
              -Short-term
                  borrowings
              
              9,444,158
              
              5.74
              
              
              1,444,158
              
              -
              
              
              -
              
              8,000,000Total
                  interest-bearing liabilities
              $
              164,548,486
              
              100.00
              %
              $
              71,787,141
              $
              41,192,170
              
              $
              43,569,176
              $
              8,000,000Periodic
                  repricing differencesPeriodic
                  gap
              
              
              
              
              
              $
              72,630,981
              $
              (7,201,408
              )
              $
              (15,806,444
              )     $
              (6,213,877
              )Cumulative
                  gap
              
              
              
              
              
              $
              72,630,981
              $
              65,429,573
              
              $
              49,623,129
              $
              43,409,252Ratio
                  of rate sensitive assets to rate sensitive liabilities
              
              
              
              
              
              
              201.18
              %
              82.52
              %
              
              63.72
              %
              22.33
              %




The
      Company has 66.79% of its interest-earning assets and 38.69% of its
      interest-bearing liabilities in variable rate balances. The excess of
      interest-earning assets over interest-bearing liabilities of $65,429,573 in
      the
      categories of items maturing or repricing within 12 months comprises the
      majority of the overall gap. This gap is generally reflective of the Company’s
      emphasis on originating variable rate loans and the demand in the market for
      higher yielding fixed rate deposits. This analysis indicates that the Company
      generally will benefit from rising market rates of interest. However, since
      all
      interest rates and yields do not adjust at the same pace, the gap is only a
      general indicator of interest rate sensitivity. The analysis of the Company's
      interest-earning assets and interest-bearing liabilities presents only a static
      view of the timing of maturities and repricing opportunities, without taking
      into consideration the fact that changes in interest rates do not affect all
      assets and liabilities equally. Net interest income may be affected by other
      significant factors in a given interest rate environment, including changes
      in
      the volume and mix of interest-earning assets and interest-bearing
      liabilities.





Management
      constantly monitors and manages the structure of the Company's balance sheet,
      seeks to control interest rate exposure and evaluate pricing strategies.
      Strategies to better match maturities of interest-earning assets and
      interest-bearing liabilities include structuring loans with rate floors and
      ceilings on variable rate notes and by providing for repricing opportunities
      on
      fixed rate notes. Management believes that a lending strategy focusing on
      variable rate loans and short-term fixed rate loans will best facilitate the
      goal of minimizing interest rate risk. However, management will
      opportunistically enter into longer term fixed rate loans and/or investments
      when, in management’s judgment, rates adequately compensate the Company for the
      interest rate risk. The Company's current investment concentration in federal
      funds sold and other overnight investments provides the most flexibility and
      control over rate sensitivity since it generally can be restructured more
      quickly than the loan portfolio. On the liability side, deposit products can
      be
      restructured so as to offer incentives to attain the maturity distribution
      desired although competitive factors sometimes make control over deposit
      maturity difficult.





39


In
      theory, maintaining a nominal level of interest rate sensitivity can diminish
      interest rate risk. In practice, this is made difficult by a number of factors,
      including cyclical variation in loan demand, different impacts on interest
      sensitive assets and liabilities when interest rates change and the availability
      of funding sources. Management generally attempts to maintain a balance between
      rate-sensitive assets and liabilities as the exposure period is lengthened
      to
      minimize the overall interest rate risk to the Company.





LIQUIDITY





The
      Company’s overall asset/liability strategy takes into account the need to
      maintain adequate liquidity to fund asset growth and deposit runoff. Management
      monitors the liquidity position daily.





The
      Company’s primary sources of funds are deposits, short-term borrowings in the
      form of repurchase agreements, borrowings under the Federal funds and Federal
      Home Loan Bank credit facilities, scheduled amortization and prepayment of
      loans, funds provided by operations and capital. While scheduled principal
      repayments on loans are a relatively predictable source of funds, deposit flows
      and loan prepayments are greatly influenced by market interest rates, economic
      conditions, and rates offered by our competition.





The
      Company's most liquid assets are cash and assets that can be readily converted
      into cash, including investment securities maturing within one year. As of
      December 31, 2005, the Company had $1,460,669 in cash and due from banks,
      $6,032,952 in federal funds sold and other overnight investments and $1,540,386
      in three-month U.S. Treasury Securities. As of December 31, 2004, the Company
      had $1,403,424 in cash and due from banks, $16,708,528 in federal funds sold
      and
      other overnight investments and $1,544,496 in three-month U.S. Treasury
      Securities.





The
      decline in the overall level of liquid assets is the result of an ongoing effort
      by management to maximize net interest margins by utilizing liquidity to fund
      loans. This is made possible by preserving available liquidity in the Federal
      funds and Federal Home Loan Bank credit facilities. Growth in the Company’s loan
      portfolio, without corresponding growth in deposits, would reduce liquidity,
      as
      would reductions in the level of customer deposits.





During
      2005, the Company maintained commitments for a total of $9.0 million of
      borrowing availability under unsecured Federal funds lines of credit with three
      separate financial institutions. The Company also has approximately $21 million
      of borrowing capacity with the Federal Home Loan Bank of Atlanta as of December
      31, 2005. These credit facilities can be used in conjunction with the normal
      deposit strategies, which include pricing changes to increase deposits as
      necessary. From time to time, the Company may sell or participate out loans
      to
      create additional liquidity as required.





The
      Company has sufficient liquidity to meet its loan commitments as well as
      fluctuations in deposits. The Company will seek to retain maturing certificates
      of deposit, when necessary, by offering competitive rates.





Management
      is not aware of any known trends, events or uncertainties that will have or
      are
      reasonably likely to have a material effect on our liquidity, capital or
      operations, nor are we aware of any current recommendation by regulatory
      authorities, which if implemented, would have a material effect on liquidity,
      capital or operations.




40


CONTRACTUAL
      OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE SHEET
      ARRANGEMENTS





The
      Company is a party to financial instruments with off-balance sheet risk in
      the
      normal course of business. These financial instruments primarily include
      commitments to extend credit, lines of credit and standby letters of credit.
      The
      Company uses these financial instruments to meet the financing needs of its
      customers. These financial instruments involve, to varying degrees, elements
      of
      credit, interest rate and liquidity risk. In addition, the Company also has
      operating lease obligations and purchase commitments.





Outstanding
      loan commitments and lines and letters of credit at December 31 of 2005 and
      2004
      are as follows:





**2005**
            
            **2004**Loan
                commitments
            $
            21,577,585
            $
            9,867,893Unused
                lines of credit
            
            41,317,927
            
            40,423,986Letters
                of credit
            
            2,754,383
            
            1,578,379





Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      violation of any condition established in the contract. Commitments generally
      have interest rates fixed at current market amounts, fixed expiration dates
      or
      other termination clauses and may require payment of a fee. Unused lines of
      credit represent the unused portion of lines of credit previously extended
      and
      available to the customer as long as there is no violation of any contractual
      condition. These lines generally have variable interest rates. Since many of
      the
      commitments are expected to expire without being drawn upon, and since it is
      unlikely that customers will draw upon their line of credit in full at any
      time,
      the total commitment amount or line of credit amount does not necessarily
      represent future cash requirements. The Company is not aware of any loss it
      would incur by funding its commitments or lines of credit.





Standby
      letters of credit are conditional commitments issued to guarantee the
      performance of a customer to a third party. The Company’s exposure to credit
      loss in the event of nonperformance by the customer is the contract amount
      of
      the commitment.





In
      general, loan commitments, lines of credit and letters of credit are made on
      the
      same terms, including with respect to collateral, as outstanding loans. Each
      customer’s credit-worthiness and the collateral required are evaluated on a
      case-by-case basis.





The
      increase in the overall level of loan commitments and unused lines of credit
      as
      of December 31, 2005 as compared to loan commitments and unused lines of credit
      as of December 31, 2004, is a direct result of the same marketing activities
      that resulted in the 32.2% increase in outstanding loans.





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





41


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








**Within
                one****year**
            
            
            **One
                to****three
                years**
            
            
            **Three
                to**
              **five
                years**
            
            
            **Over
                five****years**Deposits
                without a
              stated
                maturity(a)
            $
            89,689,099
            
            $
            -
            
            $
            -
            
            $
            -Certificates
                of deposit(a)
            
            49,776,317
            
            
            26,427,778
            
            
            17,041,398
            
            
            -Other
                borrowings
            
            1,444,158
            
            
            -
            
            
            -
            
            
            8,000,000Operating
                leases
            
            375,073
            
            
            781,740
            
            
            461,745
            
            
            -Purchase
                obligations
            
            313,732
            
            
            362,166
            
            
            301,805
            
            
            -Total
            $
            141,598,379
            
            $
            27,571,684
            
            $
            17,804,948
            
            $
            8,000,000





(a)
            Includes
                accrued interest payable.





The
      Company's operating lease obligations represent short and long-term lease and
      rental payments for facilities. Purchase obligations represent estimated
      obligations under agreements to purchase goods or services that are enforceable
      and legally binding on the Company. The purchase obligation amounts presented
      above primarily relate to estimated obligations under data and item processing
      contracts and accounts payable for goods and services received through December
      31, 2005.





CAPITAL
      RESOURCES





The
      Company had stockholders’ equity at December 31, 2005 of $16,214,078 as compared
      to $13,418,764 at December 31, 2004. The
      increase in capital is a result of the positive operating results. The Company
      has declared no cash dividends since its inception.





Banking
      regulatory authorities have implemented strict capital guidelines directly
      related to the credit risk associated with an institution’s assets. Banks and
      bank holding companies are required to maintain capital levels based on their
      "risk adjusted” assets so that categories of assets with higher "defined” credit
      risks will require more capital support than assets with lower risks. The Bank
      has exceeded its capital adequacy requirements to date.





Banking
      regulations also limit the amount of dividends that may be paid without prior
      approval of the Bank's regulatory agencies. Regulatory approval is required
      to
      pay dividends that exceed the Bank’s net profits for the current year plus its
      retained net profits for the preceding two years. The Bank could not have paid
      dividends to the Company without approval from bank regulatory agencies at
      December 31, 2005.








42


The
      tables below present the Bank's capital position relative to its various minimum
      regulatory capital requirements as of December 31, 2005, and 2004. For a
      discussion of these capital requirements, see "Item 1 Description of Business
      -
      Supervision and Regulation - Bay National Bank - Capital Adequacy
      Guidelines."





**December
                31, 2005****Actual**
            
            
            **For
                Capital**
              **Adequacy
                Purpose**
            
            
            **To
                Be Well**
              **Capitalized
                Under**
              **Prompt
                Corrective**
              **Action
                Provisions****Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**Total
                Capital (to Risk Weighted Assets):
            $
            21,668,568
            
            10.21
            %
            $
            16,675,000
            
            8.00
            %
            $
            20,843,000
            
            10.00
            %Tier
                I Capital (to Risk Weighted Assets):
            
            18,668,568
            
            8.96
            %
            
            8,337,000
            
            4.00
            %
            
            12,506,000
            
            6.00
            %Tier
                I Capital (to Average Assets):
            
            18,668,568
            
            9.15
            %
            
            6,124,000
            
            3.00
            %
            
            10,206,000
            
            5.00
            %








**December
                31, 2004****Actual**
            
            
            **For
                Capital**
              **Adequacy
                Purpose**
            
            
            **To
                Be Well**
              **Capitalized
                Under**
              **Prompt
                Corrective**
              **Action
                Provisions****Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**Total
                Capital (to Risk Weighted Assets):
            $
            16,242,797
            
            10.32
            %
            $
            12,592,000
            
            8.00
            %
            $
            15,740,000
            
            10.00
            %Tier
                I Capital (to Risk Weighted Assets):
            
            14,432,797
            
            9.17
            %
            
            6,296,000
            
            4.00
            %
            
            9,444,000
            
            6.00
            %Tier
                I Capital (to Average Assets):
            
            14,432,797
            
            8.98
            %
            
            4,821,000
            
            3.00
            %
            
            8,034,000
            
            5.00
            %





**Impact
      of Inflation and Changing Prices**





The
      consolidated financial statements and notes thereto presented herein have been
      prepared in accordance with accounting principles generally
      accepted in the United States of America ,
      which
      require the measurement of financial position and operating results in terms
      of
      historical dollars without considering the change in the relative purchasing
      power of money over time and due to inflation. The impact of inflation is
      reflected in the increased cost of the Company's operations. Unlike most
      industrial companies, nearly all the assets of the Company are monetary in
      nature. As a result, interest rates have a greater impact on the Company's
      performance than do the effects of general levels of inflation. Interest rates
      do not necessarily move in the same direction or to the same extent as the
      price
      of goods and services.





**Reconciliation
      of Non-GAAP Measures**





Below
      is
      a reconciliation of total deposits to core deposits as of December 31, 2005
      and
      December 31, 2004, respectively:





**December
                31,**
              **2005**
            
            
            **December
                31,**
              **2004**Total
                deposits
            
            
            $
            182,573,086
            
            $
            153,927,042National
                market certificates of deposit
            
            
            
            (33,765,135
            )
            
            (28,908,592
            )Variable
                balance accounts (3 customers in 2005 and 2004)
            
            
            
            (11,982,025
            )
            
            (16,605,943
            )Portion
                of variable balance accounts considered to be core
            
            
            
            5,000,000
            
            
            5,000,000Core
                deposits
            
            
            $
            141,825,926
            
            $
            113,412,507





43








**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 could 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 based either on
      quoted market prices or are provided by other third-party sources, when
      available.





The
      most
      significant accounting policies followed by the Company are presented in Note
      1
      to the consolidated financial statements. 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 as 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 best estimate of losses
      known and inherent in the loan portfolio that are both probable and reasonable
      to estimate, based on, among other factors: prior loss experience of the Company
      and peer institutions; current economic conditions; review of the ongoing
      financial conditions of borrowers; and the views of the Company’s regulators and
      the firm that conducts an annual independent loan review. Determining the amount
      of the allowance for credit losses is considered a critical accounting estimate
      because it requires significant estimates, assumptions and judgments. The loan
      portfolio also represents the largest asset type on the consolidated balance
      sheets.





The
      Company uses a loan grading system where loans are graded based on management's
      evaluation of the risk associated with each loan. A factor, based on the loan
      grading, is applied to the loan balance to reserve for losses. In addition,
      management judgmentally establishes an additional nonspecific reserve. The
      nonspecific portion of the allowance reflects management's estimate of probable
      inherent but undetected losses within the portfolio due to uncertainties in
      economic conditions, delays in obtaining information, including unfavorable
      information about a borrower's financial condition, the difficulty in
      identifying triggering events that correlate perfectly to subsequent loss rates
      and risk factors that have not yet manifested themselves in loss allocation
      factors.





Management
      has significant discretion in making the judgments inherent in the determination
      of the provision and allowance for credit losses, including the valuation of
      collateral and the financial condition of the borrower, and in establishing
      allowance percentages and risk ratings. The establishment of allowance factors
      is a continuing exercise and allowance factors may change over time, resulting
      in an increase or decrease in the amount of the provision or allowance based
      upon the same volume and classification of loans.





Changes
      in allowance factors or in management’s interpretation of those factors will
      have a direct impact on the amount of the provision and a corresponding effect
      on income and assets. Also, errors in management’s perception and assessment of
      the allowance factors could result in the allowance not being adequate to cover
      losses in the portfolio and may result in additional provisions or charge-offs,
      which would adversely affect income and capital. For additional information
      regarding the allowance for loan and lease losses, see the “Provision for Credit
      Losses and Credit Risk Management” section of this financial
      review.





44


**Recent
      Accounting Pronouncements And Developments**







In
      December 2004, the FASB revised SFAS 123, “Accounting for Stock-Based
      Compensation.” SFAS 123R establishes accounting requirements for share-based
      compensation to employees and carries forward prior guidance on accounting
      for
      awards to non-employees. The provisions of this statement will become effective
      January 1, 2006 for non-accelerated filers for all equity awards vesting after
      the effective date. SFAS 123R requires an entity to recognize compensation
      expense based on an estimate of the number of awards expected to actually vest,
      exclusive of awards expected to be forfeited. At December 31, 2005, the total
      value of options outstanding and vesting after January 1, 2006 is expected
      to be
      approximately $119,000, with $87,000 (before the consideration of income taxes,
      if any) vesting in the year ending December 31, 2006.







Note
      1 to
      the consolidated financial statements discusses SFAS 123R and other new
      accounting policies adopted by the Company during 2005 and the expected impact
      of accounting policies, recently issued or proposed, but not yet required to
      be
      adopted. To the extent the adoption of new accounting standards materially
      affects the Company's financial condition, results of operations or liquidity,
      the impacts are discussed in the applicable section(s) of this financial review
      and notes to the consolidated financial statements.





**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 and fosters a strong internal
      control environment. Through its Executive, Asset/Liability and Audit
      Committees, 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 actively manages
      risk at the line of business level, supplemented with corporate-level oversight
      through the Asset/Liability Committee, the internal audit process and quality
      control functions and other risk management groups within the Company. This
      risk
      management structure is designed to uncover risk issues through a systematic
      process, enabling timely and appropriate action to avoid and mitigate risk.
      The
      risk management process establishes risk limits and other measurement systems,
      with a focus on risk reduction strategies and capital allocation practices.


45


Item
      7.
      Financial Statements





The
      following consolidated financial statements are filed with this
      report:





Report
      of
      Independent Registered Public Accounting Firm





Consolidated
      Balance Sheets - December 31, 2005 and 2004





Consolidated
                Statements of Operations - For the years ended December 31, 2005,
                2004 and
                2003





Consolidated
      Statements of Changes in Stockholders’ Equity - For the years ended December 31,
      2005, 2004 and 2003





Consolidated
                Statements of Cash Flows - For the years ended December 31, 2005,
                2004 and
                2003




Notes
      to
      Consolidated Financial Statements








46


**Report
      of Independent Registered Public Accounting Firm**








Board
      of
      Directors and Stockholders


Bay
      National Corporation





We
      have
      audited the accompanying consolidated balance sheets of Bay National Corporation
      and subsidiary (the “Company”) as of December 31, 2005 and 2004, and the related
      consolidated statements of operations, changes in stockholders’ equity, and cash
      flows for each of the three years in the period ended December 31, 2005. These
      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 Bay National Corporation
      and
      subsidiary as of December 31, 2005 and 2004, and the results of their operations
      and their cash flows for each of the three years in the period ended December
      31, 2005, in conformity with accounting principles generally accepted in the
      United States of
      America.





/s/
      Stegman & Company


Baltimore,
      Maryland


January
      17, 2006


47


**BAY
      NATIONAL CORPORATION**


CONSOLIDATED
      BALANCE SHEETS


December
      31, 2005 and 2004





2005
            
            2004ASSETSCash
                and due from banks
            
            $
            1,460,669
            
            $
            1,403,424Federal
                funds sold and other overnight investments
            
            
            6,032,952
            
            
            16,708,528Investment
                securities available for sale (AFS) - at fair value
            
            
            1,540,386
            
            
            1,544,496Other
                equity securities
            
            
            794,440
            
            
            556,090Loans
                held for sale
            
            
            17,509,064
            
            
            9,613,162Loans,
                net of unearned fees
            
            
            182,080,897
            
            
            141,413,437Total
                Loans
            
            
            199,589,961
            
            
            151,026,599Less:
                Allowance for credit losses
            
            
            (3,000,000
            )
            
            (1,810,000
            )Loans,
                net
            
            
            196,589,961
            
            
            149,216,599Premises
                and equipment, net
            
            
            746,826
            
            
            593,583Accrued
                interest receivable and other assets
            
            
            2,801,101
            
            
            740,754Total
                Assets
            
            $
            209,966,335
            
            $
            170,763,474LIABILITIESNon-interest-bearing
                deposits
            
            $
            27,468,757
            
            $
            20,638,596Interest-bearing
                deposits
            
            
            155,104,329
            
            
            133,288,446Total
                deposits
            
            
            182,573,086
            
            
            153,927,042Short-term
                borrowings
            
            
            1,444,158
            
            
            1,381,000Note
                payable
            
            
            -
            
            
            1,250,000Subordinated
                debt
            
            
            8,000,000
            
            
            -Accrued
                expenses and other liabilities
            
            
            1,735,013
            
            
            786,668Total
                Liabilities
            
            
            193,752,257
            
            
            157,344,710STOCKHOLDERS'
                EQUITYCommon
                stock - $.01 par value, authorized:9,000,000
                shares authorized, 1,924,436 and 1,917,710 issued and outstanding
                as of
                December 31, 2005 and 2004, respectively:
            
            
            19,244
            
            
            19,177Additional
                paid in capital
            
            
            17,451,201
            
            
            17,400,284Accumulated
                deficit
            
            
            (1,256,367
            )
            
            (4,000,697
            )Total
                Stockholders' Equity
            
            
            16,214,078
            
            
            13,418,764Total
                Liabilities and Stockholders' Equity
            
            $
            209,966,335
            
            $
            170,763,474


See
        accompanying notes to consolidated financial statements.


48


**BAY
        NATIONAL CORPORATION**


CONSOLIDATED
      STATEMENTS OF OPERATIONS


For
      the
      years ended December 31, 2005, 2004 and 200 3





2005
            
            2004
            
            2003INTEREST
                INCOME:Interest
                and fees on loans
            
            $
            12,671,707
            
            $
            7,431,368
            
            $
            5,367,997Interest
                on federal funds sold and other overnight
              investments
            
            
            224,732
            
            
            147,023
            
            
            114,754Taxable
                interest and dividends on investment securities
            
            
            86,267
            
            
            45,173
            
            
            37,317Total
                interest income
            
            
            12,982,706
            
            
            7,623,564
            
            
            5,520,068INTEREST
                EXPENSE:Interest
                on deposits
            
            
            4,058,519
            
            
            2,438,887
            
            
            1,925,042Interest
                on short-term borrowings
            
            
            115,810
            
            
            19,020
            
            
            11,684Interest
                on note payable
            
            
            91,709
            
            
            6,302
            
            
            -Interest
                on subordinated debt
            
            
            28,108
            
            
            -
            
            
            -Total
                interest expense
            
            
            4,294,146
            
            
            2,464,209
            
            
            1,936,726Net
                interest income
            
            
            8,688,560
            
            
            5,159,355
            
            
            3,583,342Provision
                for credit losses
            
            
            1,178,866
            
            
            559,596
            
            
            415,000Net
                interest income after provision for credit losses
            
            
            7,509,694
            
            
            4,599,759
            
            
            3,168,342NON-INTEREST
                INCOME:Service
                charges on deposit accounts
            
            
            188,276
            
            
            237,980
            
            
            212,787Gain
                on sale of mortgage loans
            
            
            512,047
            
            
            244,716
            
            
            370,326Other
                income
            
            
            50,270
            
            
            56,151
            
            
            42,150Total
                non-interest income
            
            
            750,593
            
            
            538,847
            
            
            625,263NON-INTEREST
                EXPENSE:Salaries
                and employee benefits
            
            
            3,627,630
            
            
            2,442,774
            
            
            2,115,351Occupancy
                expenses
            
            
            420,866
            
            
            312,550
            
            
            259,719Furniture
                and equipment expenses
            
            
            304,132
            
            
            255,547
            
            
            215,254Legal
                and professional fees
            
            
            154,476
            
            
            175,757
            
            
            158,406Data
                processing and other outside services
            
            
            655,726
            
            
            582,396
            
            
            536,433Advertising
                and marketing related expenses
            
            
            445,482
            
            
            212,237
            
            
            210,289Other
                expenses
            
            
            562,645
            
            
            355,081
            
            
            290,572Total
                non-interest expenses
            
            
            6,170,957
            
            
            4,336,342
            
            
            3,786,024Income
                before income taxes
            
            
            2,089,330
            
            
            802,264
            
            
            7,581Income
                tax benefit
            
            
            655,000
            
            
            -
            
            
            -Net
                Income
            
            $
            2,744,330
            
            $
            802,264
            
            $
            7,581Per
                Share Data:Net
                Income (Basic)
            
            $
            1.43
            
            $
            .43
            
            $
            .00Net
                Income (Diluted)
            
            $
            1.37
            
            $
            .41
            
            $
            .00Average
                Shares Outstanding (Basic)
            
            
            1,922,580
            
            
            1,877,929
            
            
            1,660,348Effect
                of dilution - Stock options and Warrants
            
            
            79,645
            
            
            58,764
            
            
            22,557Average
                Shares Outstanding (Diluted)
            
            
            2,002,225
            
            
            1,936,693
            
            
            1,682,905





See
      accompanying notes to consolidated financial statements.


49


**BAY
      NATIONAL CORPORATION**


CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


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





Common
                Stock
            
            Additional
                Paid in Capital
            
            Accumulated
              Deficit
            
            TotalBalances
                at December 31, 2002
            
            $
            12,420
            
            $
            12,407,780
            
            $
            (4,810,542
            )
            $
            7,609,658Issuance
                of Common Stock
            
            
            6,207
            
            
            4,443,054
            
            
            -
            
            
            4,449,261Net
                Income
            
            
            -
            
            
            -
            
            
            7,581
            
            
            7,581Balances
                at December 31, 2003
            
            
            18,627
            
            
            16,850,834
            
            
            (4,802,961
            )
            
            12,066,500Issuance
                of Common Stock
            
            
            550
            
            
            549,450
            
            
            -
            
            
            550,000Net
                Income
            
            
            -
            
            
            -
            
            
            802,264
            
            
            802,264Balances
                at December 31, 2004
            
            
            19,177
            
            
            17,400,284
            
            
            (4,000,697
            )
            
            13,418,764Issuance
                of Common Stock
            
            
            67
            
            
            50,917
            
            
            -
            
            
            50,984Net
                Income
            
            
            -
            
            
            -
            
            
            2,744,330
            
            
            2,744,330Balances
                at December 31, 2005
            
            $
            19,244
            
            $
            17,451,201
            
            $
            (1,256,367
            )
            $
            16,214,078


See
        accompanying notes to consolidated financial statements. ****





50


**BAY
      NATIONAL CORPORATION**


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


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





2005
            
            2004
            
            2003Cash
                Flows From Operating Activities:Net
                Income
            
            $
            2,744,330
            
            $
            802,264
            
            $
            7,581Adjustments
                to reconcile net income to net cash provided (used) by operating
                activities:Depreciation
            
            
            193,196
            
            
            204,204
            
            
            189,858Loss
                on disposal of equipment
            
            
            203
            
            
            17,018
            
            
            -Accretion
                of investment discounts
            
            
            (46,539
            )
            
            (19,251
            )
            
            (14,804
            )Provision
                for credit losses
            
            
            1,178,866
            
            
            559,596
            
            
            415,000Deferred
                income taxes
            
            
            (1,083,000
            )
            
            -
            
            
            -Gain
                on sale of loans held for sale
            
            
            (512,047
            )
            
            (244,716
            )
            
            (370,326
            )Origination
                of loans held for sale
            
            
            (217,744,320
            )
            
            (108,988,138
            )
            
            (35,629,285
            )Proceeds
                from sale of loans
            
            
            210,360,465
            
            
            100,543,517
            
            
            37,894,286Net
                increase in accrued interest receivable and other assets
            
            
            (977,347
            )
            
            (188,403
            )
            
            (117,569
            )Net
                increase in accrued expenses and other liabilities
            
            
            948,345
            
            
            277,813
            
            
            95,061Net
                cash (used) provided by operating activities
            
            
            (4,937,848
            )
            
            (7,036,096
            )
            
            2,469,802Cash
                Flows From Investing Activities:Purchases
                of investment securities
            
            
            (6,149,351
            )
            
            (6,177,447
            )
            
            (6,284,633
            )Maturities
                of investment securities
            
            
            6,200,000
            
            
            6,200,000
            
            
            5,700,000Purchase
                of Federal Reserve Bank stock
            
            
            (139,650
            )
            
            -
            
            
            (36,750
            )Purchase
                of Federal Home Loan Bank of Atlantastock
            
            
            (98,700
            )
            
            (75,000
            )
            
            (88,500
            )Loan
                disbursements in excess of principal payments
            
            
            (40,656,326
            )
            
            (40,037,558
            )
            
            (33,313,714
            )Expenditures
                for premises and equipment
            
            
            (346,642
            )
            
            (177,193
            )
            
            (118,267
            )Net
                cash used by investing activities
            
            
            (41,190,669
            )
            
            (40,267,198
            )
            
            (34,141,864
            )Cash
                Flows From Financing Activities:Net
                increase in deposits
            
            
            28,646,044
            
            
            45,396,141
            
            
            32,452,170Net
                increase in short-term borrowings
            
            
            63,158
            
            
            159,000
            
            
            715,000Net
                payoff (proceeds) from notes payable
            
            
            (1,250,000
            )
            
            1,250,000
            
            
            -Proceeds
                from subordinated debt
            
            
            8,000,000
            
            
            -
            
            
            -Net
                proceeds from issuance of common stock
            
            
            50,984
            
            
            550,000
            
            
            4,449,261Net
                cash provided by financing activities
            
            
            35,510,186
            
            
            47,355,141
            
            
            37,616,431Net
                (decrease) increase in cash and cash equivalents
            
            
            (10,618,331
            )
            
            51,847
            
            
            5,944,369Cash
                and cash equivalents at beginning of year
            
            
            18,111,952
            
            
            18,060,105
            
            
            12,115,736Cash
                and cash equivalents at end of year
            
            $
            7,493,621
            
            $
            18,111,952
            
            $
            18,060,105Cash
                paid for:Interest
            
            $
            4,128,414
            
            $
            2,366,155
            
            $
            1,926,169Income
                taxes
            
            $
            -
            
            $
            -
            
            $
            -




See
      accompanying notes to consolidated financial statements.  51
  **BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**1.**
            **SUMMARY
                OF SIGNIFICANT ACCOUNTING
                POLICIES**





The
      consolidated financial statements include the accounts of Bay National
      Corporation and its subsidiary, Bay National Bank (the “Bank”), collectively
      (the “Company”). All significant intercompany balances and transactions have been eliminated in
      consolidation. The investment in subsidiary is recorded on the parent's books
      on
      the basis of its equity in the net assets. The accounting and reporting policies
      of the Company conform to accounting principles generally accepted in the United
      States of
      America and to
      general practices in the banking industry.





Certain
      reclassifications have been made to amounts previously reported to conform
      to
      the classifications made in 2005.





**Nature
      of Business**





Bay
      National Corporation was incorporated on June 3, 1999 under the laws of the
      State of Maryland to operate as a bank holding company of a national bank with
      the name Bay National Bank. On May 12, 2000, the Company purchased all the
      shares of common stock issued by the Bank. The Company's operations through
      that
      date were limited to taking the necessary actions to organize and capitalize
      the
      Company and the Bank. The Bank commenced operations on May 12, 2000 after
      successfully meeting the conditions of the Office of the Comptroller of the
      Currency (the "OCC") to receive its charter authorizing it to commence
      operations as a national bank, obtaining the approval of the Federal Deposit
      Insurance Corporation to insure its deposit accounts and meeting certain other
      regulatory requirements.





The
      principal business of the Company is to make loans and other investments and
      to
      accept time and demand deposits. The Company’s primary market areas are
      Baltimore and Salisbury, Maryland, although the Company’s business development
      efforts generate business outside of these areas. The Company 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 Company 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 Company’s
      customers are primarily individuals and small businesses.





**Use
      of Estimates**





The
      preparation of financial statements in conformity with accounting principles generally
      accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities and disclosure of contingent assets and liabilities
      at
      the date of the financial statements and the reported amounts of revenues and
      expenses during the reporting period. Actual results could differ from those
      estimates.





**Cash
      and Cash Equivalents**





The
      Company has included cash and due from banks, and federal funds sold and other
      overnight investments as cash and cash equivalents for the purpose of reporting
      cash flows.





52


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003




**Investments
      Available-for-Sale and Other Equity Securities** ****





Marketable
      equity securities and debt securities, not classified as held-to-maturity or
      trading, are classified as available-for-sale. Securities available-for-sale
      are
      acquired as part of the Company's asset/liability management strategy and may
      be
      sold in response to changes in interest rates, loan demand, changes in
      prepayment risk and other factors. Securities available-for-sale are carried
      at
      fair value, with unrealized gains or losses based on the difference between
      amortized cost and fair value reported as accumulated other comprehensive
      income, a separate component of stockholders' equity, net of deferred tax.
      Realized gains and losses, using the specific identification method, are
      included as a separate component of non-interest income. Related interest and
      dividends are included in interest income. Declines in the fair value of
      individual available-for-sale 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 a rating
      agency, a significant deterioration in the financial condition of the issuer,
      or
      the fact that management would not have the intent and ability to hold a
      security for a period of time sufficient to allow for any anticipated recovery
      in fair value.





Other
      equity securities represented by Federal Reserve Bank and Federal Home Loan
      Bank
      of Atlanta stock are considered restricted as to marketability.





**Loans
      Held for Sale**





The
      Company engages in sales of residential mortgage loans originated by the Bank
      and by a third party. Loans held for sale are carried at the lower of aggregate
      cost or fair value. Fair value is derived from secondary market quotations
      for
      similar instruments. Gains and losses on sales of the loan originated by the
      Bank are recorded as a component of non-interest income in the accompanying
      consolidated statements of operations. No gains or losses are realized on the
      sale of loans originated by third parties. The
      Company's current practice is to sell loans on a servicing released basis,
      and,
      therefore, it has no intangible asset recorded for the value of such servicing
      at either December 31, 2005 or December 31, 2004. The Company earns interest
      on
      the outstanding balances of all loans that are held for sale.





**Loans**





Loans
      are
      stated at the principal amount outstanding net
      of
      any deferred fees and costs. Interest
      income on loans is accrued at the contractual rate on the principal amount
      outstanding. It is the Company's policy to discontinue the accrual of interest
      when circumstances indicate that collection is doubtful. Fees charged and costs
      capitalized for originating certain loans are amortized on the interest method
      over the term of the loan.





Loans
      are
      considered impaired when, based on current information, it is improbable that
      the Company will collect all principal and interest payments according to
      contractual terms. Generally, loans are considered impaired once principal
      and
      interest payments are 90 days 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, consumer installment loans and commercial leases, 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 Company 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 Company 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 if the collateral is not sufficient,
      payments received are accounted for as a reduction in principal.





53


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**Allowance
      for Credit Losses**





The
      allowance for credit losses is established through a provision for credit losses
      charged to expense. Loans are charged against the allowance for credit losses
      when management believes that the collectibility of the principal is unlikely.
      The allowance, based on evaluations of the collectibility of loans, is an amount
      that management believes will be adequate to absorb possible losses on existing
      loans that may become uncollectible. The evaluations take into consideration
      such factors as changes in the nature and volume of the loan portfolio, overall
      portfolio quality, review of specific problem loans and current economic
      conditions and trends that may affect the borrowers' ability to
      pay.





The
      allowance for credit losses represents 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 Company uses a loan grading system where loans are graded based on
      management's evaluation of the risk associated with each loan. A factor, based
      on the loan grading, is applied to the loan balance to reserve for losses.
      In
      addition, management judgmentally establishes an additional nonspecific reserve.
      The nonspecific portion of the allowance reflects management's estimate of
      probable inherent, but undetected, losses within the portfolio due to
      uncertainties in economic conditions, delays in obtaining information, including
      unfavorable information about a borrower's financial condition, the difficulty
      in identifying triggering events that correlate perfectly to subsequent loss
      rates and risk factors that have not yet manifested themselves in loss
      allocation factors. The
      adequacy of the allowance is determined through careful and continuous
      evaluation of the credit portfolio and involves consideration of a number of
      factors to establish a prudent level. Determination of the allowance is
      inherently subjective and requires significant estimates, including estimated
      losses on pools of homogeneous loans based on historical loss experience and
      consideration of current economic trends, which may be susceptible to
      significant change.





While
      management believes it has established the allowance for credit losses in
      accordance with generally accepted accounting principles and has taken into
      account the views of its regulators and the current economic environment, there
      can be no assurance that in the future the Company's regulators or the economic
      environment will not require further increases in the allowance.





**Rate
      Lock Commitments**





The
      Company enters into commitments to originate residential mortgage loans with
      interest rates determined prior to funding. Such rate lock commitments on
      mortgage loans to be sold in the secondary market are considered to be
      derivatives. The period of time between issuance of a loan commitment and
      closing and sale of the loan generally range from 15 to 90 days. The Company
      protects itself from changes in interest rates through the use of best efforts
      forward delivery commitments, whereby the Company commits to sell a loan at
      the
      time the borrower commits to an interest rate with the intent that the buyer
      has
      assumed interest rate risk on the loan. As a result, the Company is not exposed
      to losses nor will it realize gains related to its rate lock commitments due
      to
      changes in interest rates.





54


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003




**Premises
      and Equipment**





Premises
      and equipment are stated at cost less accumulated depreciation and amortization
      computed using the straight-line method. Premises and equipment are depreciated
      over the useful lives of the assets, except for leasehold improvements which
      are
      amortized over the terms of the respective leases or the estimated useful lives
      of the improvements, whichever is shorter. Useful lives range from: five to
      ten
      years for furniture, fixtures and equipment; and three to five years for
      software, hardware and data handling equipment. 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.





Long-lived
      depreciable assets are evaluated periodically for impairment when events or
      changes in circumstances indicate the carrying amount may not be recoverable.
      Impairment exists when the expected undiscounted future cash flows of a
      long-lived asset are less than its carrying value. In that event, the Company
      recognizes a loss for the difference between the carrying amount and the
      estimated fair value of the asset based on a quoted market price, if applicable,
      or a discounted cash flow analysis.





**Transfers
      of Financial Assets**





Transfers
      of financial assets are accounted for as sales, when control over the assets
      has
      been surrendered. Control over transferred assets is deemed to be surrendered
      when: (1) the assets have been isolated from the Company; (2) the transferee
      obtains the right (free of conditions that constrain it from taking advantage
      of
      that right) to pledge or exchange the transferred assets; and (3) the Company
      does not maintain effective control over the transferred assets through an
      agreement to repurchase them before their maturity.





55


**BAY
      NATIONAL CORPORATION**


Notes
      to Consolidated Financial
      Statements


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


**Stock-Based
      Compensation**





The
      Company has adopted the disclosure-only provisions of Statement of Financial
      Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS
      No. 123), and applies Accounting Principles Board Opinion No. 25 and related
      interpretations in accounting for its stock option plan. Compensation expense
      for stock option awards is disclosed as a pro forma income adjustment, ratably
      recognized over the vesting period, based on the fair value of the stock on
      the
      date of grant under SFAS No. 123 and SFAS No. 148 “Accounting for Stock-Based
      Compensation - Transition and Disclosure.”





The
      fair
      value of each option grant is estimated on the date of grant using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions used for grants during the year ended December 31:





**2002**Dividend
                yield
            
            
            
            
            -Expected
                volatility
            
            
            
            
            20.00
            %Risk-free
                interest rate
            
            
            
            
            4.17
            %Expected
                lives (in years)
            
            
            
            
            8





No
      compensation expenses related to the Company’s stock option plan was recorded
      during the years ended December 31, 2005, 2004 and 2003. The following table
      illustrates the pro-forma effect on net income (loss) and earnings per share
      if
      the Company had applied the fair value recognition provisions of SFAS No. 123
      to
      stock-based employee compensation for the years ending December 31:


**2005**
              
              
              **2004**
              
              
              **2003**Net
                  income as reported
              
              $
              2,744,330
              
              $
              802,264
              
              $
              7,581Less
                  pro forma stock-based compensation expense determined under the
                  fair value
                  method, net of related tax effects
              
              
              (102,382
              )
              
              (92,474
              )
              
              (84,163
              )Pro
                  forma net income (loss)
              
              $
              2,641,948
              
              $
              709,790
              
              $
              (76,582
              )Net
                  income (loss) per share:Basic
                  - as reported
              
              $
              1.43
              
              $
              .43
              
              $
              (.00
              )Diluted
                  - as reported
              
              $
              1.37
              
              $
              .41
              
              $
              (.00
              )Basic
                  - pro forma
              
              $
              1.37
              
              $
              .38
              
              $
              (.05
              )Diluted
                  - pro forma
              
              $
              1.32
              
              $
              .37
              
              $
              (.05
              )


**Advertising
      Costs**





Advertising
      costs are generally expensed as incurred.





**Income
      Taxes**





The
      Company uses the liability method of accounting for income taxes. Under the
      liability method, deferred-tax assets and liabilities are determined based
      on
      differences between the financial statement carrying amounts and the tax bases
      of existing assets and liabilities (i.e., temporary differences) and are
      measured at the enacted rates in effect when these differences reverse.





56


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**Earnings
      Per Share**





Earnings
      per common share are computed by dividing net income by the weighted average
      number of common shares outstanding during the period. Diluted net income per
      common share is computed by dividing net income by the weighted average number
      of common shares outstanding during the period, including any potential dilutive
      common shares outstanding such as options and warrants. For the year ended
      December 31, 2003 there were 56,250 shares excluded from the diluted net income
      per share computation because the exercise price exceeded the average market
      price and therefore, their effect would be anti-dilutive.





**New
      Accounting Standards**




In
      December 2003, the American Institute of Certified Public Accountants issued
      Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt
      Securities Acquired in a Transfer.” SOP 03-3 requires acquired loans, including
      debt securities, to be recorded at the amount of the purchaser's initial
      investment and prohibits carrying over valuation allowances from the seller
      for
      those individually-evaluated loans that have evidence of deterioration in credit
      quality since origination, and it is probable all contractual cash flows on
      the
      loan will be unable to be collected. SOP 03-3 also requires the excess of all
      undiscounted cash flows expected to be collected at acquisition over the
      purchaser's initial investment to be recognized as interest income on a
      level-yield basis over the life of the loan. Subsequent increases in cash flows
      expected to be collected are recognized prospectively through an adjustment
      of
      the loan's yield over its remaining life, while subsequent decreases are
      recognized as impairment. Loans carried at fair value, mortgage loans held
      for
      sale, and loans to borrowers in good standing under revolving credit agreements
      are excluded from the scope of SOP 03-3. The guidance is effective for loans
      acquired in fiscal years beginning after December 15, 2004 and is not expected
      to have a material impact on financial condition, results of operations, or
      liquidity.





In
      December 2004, the FASB issued SFAS 153, “Exchanges
      of Nonmonetary Assets, an amendment of APB Opinion No. 29,” Accounting for
      Nonmonetary Transactions. This statement amends the principle that exchanges
      of
      nonmonetary assets should be measured based on the fair value of the assets
      exchanged and more broadly provides for exceptions regarding exchanges of
      nonmonetary assets that do not have commercial substance. This Statement is
      effective for nonmonetary asset exchanges occurring in fiscal periods beginning
      after June 15, 2005. The adoption of this standard is not expected to have
      a
      material impact on financial condition, results of operations, or
      liquidity.







In
      December 2004, the FASB revised SFAS 123, “Accounting for Stock-Based
      Compensation.” SFAS 123R establishes accounting requirements for share-based
      compensation to employees and carries forward prior guidance on accounting
      for
      awards to non-employees. The provisions of this statement will become effective
      January 1, 2006 for non-accelerated filers for all equity awards vesting after
      the effective date. SFAS 123R requires an entity to recognize compensation
      expense based on an estimate of the number of awards expected to actually vest,
      exclusive of awards expected to be forfeited. At December 31, 2005, the total
      value of options outstanding and vesting after January 1, 2006 is expected
      to be
      approximately $119,000, with $87,000 (before the consideration of income taxes,
      if any) vesting in the year ending December 31, 2006.




57


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


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





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





58


**BAY
      NATIONAL CORPORATION**


Notes
      to Consolidated Financial
      Statements


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


**2.**
            **INVESTMENT
                SECURITIES**





**Investments
      available-for-sale**





The
      amortized cost and estimated fair values of investments available-for-sale
      at
      December 31, 2005 are as follows:





**Amortized
                Cost**
            
            
            **Gross
                Unrealized Gains**
            
            
            **Gross
                Unrealized Losses**
            
            
            **Estimated
                Fair Value**U.S.
                Treasury securities
            $
            1,540,386
            
            $
            -
            
            $
            -
            
            $
            1,540,386Total
                investments available-for-sale
            $
            1,540,386
            
            $
            -
            
            $
            -
            
            $
            1,540,386





The
      amortized cost and estimated fair values of investments available-for-sale
      at
      December 31, 2005 by contractual maturity are shown below.





**Amortized
                Cost**
            
            
            **Estimated
                Fair Value**Due
                in one year or less
            
            
            
            
            
            
            $
            1,540,386
            
            $
            1,540,386Total
                investments available-for-sale
            
            
            
            
            
            
            $
            1,540,386
            
            $
            1,540,386





The
      amortized cost and estimated fair values of investments available-for-sale
      at
      December 31, 2004 were as follows:





**Amortized
                Cost**
            
            
            **Gross
                Unrealized Gains**
            
            
            **Gross
                Unrealized Losses**
            
            
            **Estimated
                Fair Value**U.S.
                Treasury securities
            $
            1,544,496
            
            $
            -
            
            $
            -
            
            $
            1,544,496Total
                investments available-for-sale
            $
            1,544,496
            
            $
            -
            
            $
            -
            
            $
            1,544,496





The
      amortized cost and estimated fair values of investments available-for-sale
      at
      December 31, 2004 by contractual maturity are shown below.





**Amortized
                Cost**
            
            
            **Estimated
                Fair Value**Due
                in one year or less
            
            
            
            
            
            
            $
            1,544,496
            
            $
            1,544,496Total
                investments available-for-sale
            
            
            
            
            
            
            $
            1,544,496
            
            $
            1,544,496





There
      were no sales of investments available-for-sale during 2005, 2004 or
      2003.





At
      December 31, 2005 and 2004, investments available-for-sale with a carrying
      value
      of $916,158 and $1,381,000, respectively, were pledged as collateral for certain
      short-term borrowings.





59


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**Other
      equity securities**





At
      December 31, the
      Company’s investment in other equity securities consisted of :





**2005**
            
            
            **2004**Federal
                Reserve Bank stock
            
            
            
            
            
            
            $
            452,340
            
            $
            312,690Federal
                Home Loan Bank stock
            
            
            
            
            
            
            
            342,100
            
            
            243,400Total
                investments in other equity securities
            
            
            
            
            
            
            $
            794,440
            
            $
            556,090





**3.**  ****  **LOANS
      AND ALLOWANCE FOR CREDIT LOSSES**





Major
      loan categories at December 31 are presented below:




**2005**
            
            
            **2004**Real
                Estate - Home Equity Line of Credit
            $
            21,067,964
            
            $
            24,548,506Real
                Estate - Construction
            
            25,719,603
            
            
            12,968,251Real
                Estate - Mortgage
            
            56,757,096
            
            
            27,854,130Loans
                Held for Sale
            
            17,509,064
            
            
            9,613,162Commercial
            
            75,626,825
            
            
            73,836,994Consumer
            
            2,909,409
            
            
            2,205,556Total
                Loans
            
            199,589,961
            
            
            151,026,599Less:
                Allowance for credit losses
            
            (3,000,000
            )
            
            (1,810,000
            )Net
                Loans
            $
            196,589,961
            
            $
            149,216,599





Activity
      in the allowance for credit losses for the year ended December
      31, 2005, 2004and 2003
      is shown below:





**2005**
            
            **2004**
            
            **2003**Balance
                at beginning of year
            $
            1,810,000
            $
            1,266,500
            $
            851,500Provision
                for credit losses
            
            1,178,866
            
            559,596
            
            415,000Loan
                charge-offsCommercial
            
            -
            
            (15,222
            )
            -Consumer
            
            -
            
            (2,134
            )
            -Loan
                recoveriesCommercial
            
            11,134
            
            1,260
            
            -Net
                recoveries (charge-offs)
            
            11,134
            
            (16,096
            )
            -Balance
                at end of year
            $
            3,000,000
            $
            1,810,000
            $
            1,266,500





As
      of
      December 31, 2003, there was one
      non-accrual loan of $4,087, and as of December 31, 2005, loans to one borrower,
      with a net principal balance of $1,708,874, were considered impaired under
      SFAS
      No. 114 for which a $500,000 reserve was established in the fourth quarter
      of
      2005.





60


**BAY
      NATIONAL CORPORATION**


Notes
      to Consolidated Financial
      Statements


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


**4.**  **PREMISES
      AND EQUIPMENT**





Premises
      and equipment at December 31 include the following:





**2005**
            
            
            **2004**Furniture
                and equipment
            $
            520,944
            
            $
            404,269Computer
                hardware and software
            
            602,550
            
            
            511,369Leasehold
                improvements
            
            475,943
            
            
            338,1571,599,437
            
            
            1,253,795Less
                accumulated depreciation
            
            (852,611
            )
            
            (660,212
            )Net
                premises and equipment
            $
            746,826
            
            $
            593,583





The
      Company rents office space in three locations under two non-cancelable lease
      arrangements and one monthly rental agreement accounted for as operating leases.
      The initial lease periods are from one to five years and provide for one or
      more
      one to five-year renewal options. The lease for the Baltimore location provides
      for percentage annual rent escalations. The lease for the Salisbury location
      requires that the lessee pay certain operating expenses applicable to the leased
      space.





Rent
      expense applicable to operating leases, for the periods ended December 31,
      was
      as follows:





**2005**
            
            **2004**
            
            **2003**Minimum
                rentals
            $
            330,406
            $
            241,097
            $
            202,720Less:
                Sublease rentals
            
            (23,657
            )
            (12,930
            )
            (23,843
            )Net
                rent expense
            $
            306,749
            $
            228,167
            $
            178,877





At
      December 31, 2005, future minimum lease payments under non-cancelable operating
      leases having an initial term in excess of one year are as follows:





Years
                ending December 31:2006
            $
            375,0732007
            
            385,5002008
            
            396,2402009
            
            398,1362010
            
            63,609Total
                minimum lease payments
            $
            1,618,558




Total
      minimum future rental payments have not been reduced by $23,450 of sublease
      rentals expected to be received in 2006 under a non-cancelable sublease expiring
      in December 2006.





61


**BAY
      NATIONAL CORPORATION**


Notes
      to Consolidated Financial
      Statements


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


**5.**   **DEPOSITS**





Certificates
      of deposit in amounts of $100,000 or more and their remaining maturities at
      December 31 are as follows:





**2005**
            
            **2004**Three
                months or less
            $
            4,374,777
            $
            4,285,752Over
                three months through six months
            
            11,163,966
            
            3,553,729Over
                six months through twelve months
            
            6,400,569
            
            3,351,703Over
                twelve months
            
            15,072,324
            
            10,745,359Total
            $
            37,011,636
            $
            21,936,543








Interest
      expense on deposits, for the years ended December 31, is as
      follows:





**2005**
            
            **2004**
            
            **2003**Interest-bearing
                transaction
            $
            525,691
            $
            293,076
            $
            206,695Savings
                and money market
            
            575,007
            
            244,628
            
            195,822Time,
                $100,000 or more
            
            980,590
            
            531,287
            
            444,882Other
                time
            
            1,977,231
            
            1,369,896
            
            1,077,643Total
                interest on deposits
            $
            4,058,519
            $
            2,438,887
            $
            1,925,042





**6.**  **BORROWINGS**





Information
      relating to short-term borrowings, as of December 31, 2005 and 2004, is as
      follows:





**Securities
                under agreement to repurchase****2005**
            
            
            **2004****Amount**
            
            
            **Rate**
            
            
            **Amount**
            
            
            **Rate**As
                of year end
            $
            916,158
            
            
            3.10
            %
            $
            1,381,000
            
            
            2.00
            %Average
                for the year
            $
            1,392,674
            
            
            2.72
            %
            $
            1,475,148
            
            
            1.24
            %Maximum
                month end balance
            $
            1,550,000
            
            
            
            
            $
            1,550,000





**Federal
                funds purchased****2005**
            
            
            **2004****Amount**
            
            
            **Rate**
            
            
            **Amount**
            
            
            **Rate**As
                of year end
            $
            528,000
            
            
            4.35
            %
            $
            -
            
            
            -
            %Average
                for the year
            $
            230,384
            
            
            2.61
            %
            $
            -
            
            
            -
            %Maximum
                month end balance
            $
            528,000
            
            
            
            
            $
            -





62


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


The
      Company pledges U.S. Government Treasury Securities, based upon their market
      values, as collateral for 100% of the principal and accrued interest of its
      short-term borrowings.





In
      the
      first quarter of 2004, the Company maintained commitments for a total of $9
      million of borrowing availability under unsecured federal funds lines of credit
      with three separate financial institutions. The Company also has approximately
      $21 million of borrowing capacity with the Federal Home Loan Bank of Atlanta
      as
      of December 31, 2005. These borrowing facilities will be used, as necessary,
      to
      supplement short-term liquidity needs.





Information
      relating to note payable as of December 31, 2005 and 2004 is as
      follows:





**2005**
            
            
            **2004****Amount**
            
            
            **Rate**
            
            
            **Amount**
            
            
            **Rate**As
                of year end
            $
            -
            
            
            -
            %
            $
            1,250,000
            
            
            5.25
            %Average
                for the year
            $
            1,426,027
            
            
            6.43
            %
            $
            129,098
            
            
            4.88
            %Maximum
                month end balance
            $
            2,100,000
            
            
            
            
            $
            1,250,000





In
      2004,
      n ote
      payable consisted of $1,250,000 borrowed under a $5 million, three-year
      unsecured non-revolving credit facility executed on September 28, 2004 with
      another financial institution. The loan paid interest at the prime rate. As
      of
      December 12, 2005, the credit facility terminated. The Company funded the
      repayment with proceeds from the issuance by its wholly owned subsidiary, Bay
      National Capital Trust I, of $8.0 million of 30-year fixed rate trust preferred
      securities. See discussion below.





Information
      relating to subordinated debt as of December 31, 2005 and 2004 is as
      follows:





**2005**
            
            
            **2004****Amount**
            
            
            **Rate**
            
            
            **Amount**
            
            
            **Rate**As
                of year end
            $
            8,000,000
            
            
            7.20
            %
            $
            -
            
            
            -
            %Average
                for the year
            $
            438,356
            
            
            7.20
            %
            $
            -
            
            
            -
            %Maximum
                month end balance
            $
            8,000,000
            
            
            
            
            $
            -





On
      December 12, 2005, the Company participated in a private placement of $8 million
      of fixed interest rate trust preferred securities (the “Trust Preferred
      Securities”), through a newly formed Delaware trust subsidiary, Bay National
      Capital Trust I (the “Trust”). The Trust was formed for the purpose of issuing
      the Trust Preferred Securities and all of its common securities are owned by
      the
      Company. The Company purchased the common securities from the Trust for
      $248,000. In accordance with provisions of FIN46, the financial position and
      results of operations are not included in the Company’s consolidated financial
      position and results of operations.





The
      Trust
      used the proceeds of the sale of the Trust Preferred Securities and common
      securities to purchase from the Company the aggregate principal amount of
      $8,248,000 of the Company’s Fixed Rate Junior Subordinated Debt Securities Due
      2036 (the “Debt Securities”). Like the Trust Preferred Securities, the Debt
      Securities bear interest at the fixed annual rate of 7.20% until maturity.
      The
      interest expense on Trust Preferred Securities was $28,108 in 2005. The Debt
      Securities mature on February 23, 2036, but may be redeemed at the Company’s
      option at any time on any February 23, May 23, August 23 or November 23 on
      or
      after February 23, 2011, or at any time upon certain events, such as a change
      in
      the regulatory capital treatment of Debt Securities, the Trust being deemed
      to
      be an “investment company” under the Investment Company Act of 1940, as amended,
      or the occurrence of certain adverse tax events. Except upon the occurrence
      of
      the events described above, which require a redemption premium for redemptions
      prior to February 23, 2011, the Company may redeem the Debt Securities at their
      aggregate principal amount, plus accrued interest, if any.





63


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


The
      Parent is required to retain $1,000,000 of the proceeds from the Debt Securities
      for general corporate purposes (which may include making interest payments
      on
      the Debt Securities) until the earlier of (i) the date on which the retained
      funds are reduced to zero, or (ii) the date on which Bay National Bank (or
      any
      successor) meets the statutory requirements to pay dividends of at least
      $148,464 for each of two consecutive quarters with positive retained earnings
      remaining after any such dividend payment.





The
      Debt
      Securities are subordinated to the prior payment of other indebtedness of the
      Company that, by its terms, is not similarly subordinated. Although the Debt
      Securities are recorded as a liability on the Company’s balance sheet, for
      regulatory purposes, the Debt Securities are being treated as Tier 1 or Tier
      2
      capital under regulatory capital guidelines issued by the Federal Reserve
      Board.





**7.**  **ISSUANCE
      OF COMMON STOCK**





On
      October 31, 2002, Bay National Corporation commenced a private offering, to
      accredited investors only, of an aggregate of 550,000 shares of its common
      stock, which was subsequently increased to 620,690 shares of its common stock.
      The purchase price per share was $7.25 for an aggregate purchase price of
      $4,500,002. The private offering terminated on April 30, 2003 with all shares
      issued. Net proceeds after offering costs were $4,449,261.





On
      August
      31, 1999, the Board of Directors of the Company authorized the issuance on
      September 10, 1999, to each stockholder of record of the Company on August
      31,
      1999, a warrant to purchase one share of common stock at $10 per share for
      every
      two shares that the stockholder purchased in the organizational offering. As
      a
      result, the Company issued warrants to purchase 56,250 shares. The warrants
      were
      issued in recognition of the financial and organizational risk undertaken by
      the
      purchasers in the organizational offering. The warrants became exercisable
      on
      April 30, 2001 and were exercisable in whole or in part until November 16,
      2004.
      During the second half of 2004, 55,000 of these warrants were exercised
      resulting in the issuance of 55,000 shares of common stock and the receipt
      of
      $550,000 of additional capital.





**8.**  **STOCK
      OPTIONS**





The
      Company’s 2001 Stock Option Plan (“Option Plan”) provides for the granting of
      incentive and non-qualifying stock options to the Company’s directors and to
      selected employees on a periodic basis at the discretion of the Board of
      Directors. The Option Plan authorizes the issuance of up to 200,000 shares
      of
      common stock, has a term of ten years, and is administered by the Compensation
      Committee of the Board of Directors. The Compensation Committee consists of
      at
      least three non-employee directors appointed by the Board of Directors. In
      general, the options have an exercise price, which may not be less than 100%
      of
      the fair market value on the date of the grant, must be exercised within eight
      years and vest over a period of six years.





64


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


The
      following is a summary of changes in shares under options for the years ended
      December 31, 2005, 2004 and 2003:





**Number
                of Shares**
            
            **Weighted
                Average Exercise Price**Balance,
                January 1, 2003
            
            148,825
            
            $
                7.67Granted
            
            -
            
            -Cancelled
            
            (919
            )
            7.58Exercised
            
            -
            
            -Balance,
                December 31, 2003
            
            147,906
            
            7.67Granted
            
            -
            
            -Cancelled
            
            (414
            )
            7.58Exercised
            
            -
            
            -Balance,
                December 31, 2004
            
            147,492
            
            7.67Granted
            
            -
            
            -Cancelled
            
            -
            
            -Exercised
            
            (6,726
            )
            7.58Balance,
                December 31, 2005
            
            140,766
            
            $
                7.67Weighted
                average fair value of options granted during 2002
            $
            3.05





The
      following table summarizes information about options outstanding at December
      31,
      2005:





**Options
                Outstanding**
            
            
            **Options
                Exercisable****Range
                of Exercise Price**
            
            **Number**
            
            **Weighted
                Average Remaining Contractual Life**
              **(in
                years)**
            
            **Weighted
                Average Exercise Price**
            
            
            **Number**
            
            **Weighted
                Average Exercise Price**$7.58
            
            123,951
            
            4
            
            $7.58
            
            
            98,782
            
            $7.58$8.37
            
            16,815
            
            5
            
            $8.37
            
            
            4,204
            
            $8.37140,766
            
            
            
            $7.67
            
            
            102,986
            
            $7.67








**9.**   **RETIREMENT
      PLAN**





The
      Company has a 401(k) profit sharing plan covering substantially all full-time
      employees. The plan requires the Company to match 25% of employee contributions
      of up to 3% of compensation as defined under the plan. The Company has also
      elected to make a safe harbor contribution to the plan on behalf of all eligible
      employees, as defined under the plan. The safe harbor contribution is equal
      to
      3% of compensation as defined under the plan. The plan permits additional
      contributions at the discretion of management. Expenses under this plan totaled
      $120,368, $77,180 and $67,388 for the years ended December 31, 2005, 2004
      and 2003, respectively.





65


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**10.**  **INCOME
      TAXES**





Federal
      and state income tax expense (benefit) consists of the following for the periods
      ended December 31:





**2005**
            
            
            **2004**
            
            **2003**Current
                federal income tax
            $
            307,000
            
            $
            -
            $
            -Current
                state income tax
            
            121,000
            
            
            -
            
            -Deferred
                federal income tax expense (benefit)
            
            (887,000
            )
            
            -
            
            -Deferred
                state income tax expense (benefit)
            
            (196,000
            )
            
            -
            
            -Total
                income tax expense (benefit)
            $
            (655,000
            )
            $
            -
            $
            -





The
      following table is a summary of the tax effect of temporary differences that
      give rise to a significant portion of deferred tax assets:





Deferred
                tax assets:
            
            **2005**
            
            **2004**Net
                operating loss carryforwards
            $
            62,000
            $
            955,000Contributions
            
            47,000
            
            18,000Deferred
                loan fees, net
            
            105,000
            
            -Allowance
                for credit losses
            
            979,000
            
            525,000Total
                deferred tax assets
            
            1,193,000
            
            1,498,000Less
                valuation allowance
            
            (62,000
            )
            (1,381,000
            )Deferred
                tax assets, net of valuation allowance
            
            1,131,000
            
            117,000Deferred
                tax liabilities:Depreciation
                and amortization
            
            (48,000
            )
            (114,000
            )Deferred
                loan costs, net
            
            -
            
            (3,000
            )Netdeferred
                tax assets (liabilities)
            $
            1,083,000
            $
            -





For
      the
      year ended December 31, 2005, the Company will have a tax liability for the
      first time in its brief history. The Company recorded an income tax liability
      of
      $428,000 for the year ended December 31, 2005. Taxable income for the years
      ended December 31, 2004 and 2003 were offset by the Company’s net operating loss
      carryforwards available in those years. The 2005 liability was offset by the
      recognition of a deferred tax asset of $1,083,000, resulting in a net tax
      benefit of $655,000 for the year ended December 31, 2005. At December 31, 2004,
      the Company had a net operating loss carryforward of approximately $2.5 million,
      which was fully utilized in 2005, except for approximately $886,000 of state
      net
      operating loss carryforwards for the unconsolidated state tax return of Bay
      National Corporation.





The
      use
      of the net operating loss carryforward and the recognition of net deferred
      income tax assets had a positive effect on 2005 earnings. In subsequent periods,
      the Company will begin to record income tax expense at the statutory rate.
      Prior
      to 2005, the Company had not recorded any income tax expense or benefit.
      Recognizing income tax expense in future periods will have a detrimental effect
      on future reported earnings.





66


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


Reported
      income tax benefit differed from the amounts computed by applying the U.S.
      federal statutory income tax rate of 34% to income before income taxes as
      follows:





**2005**
            
            
            **2004**
            
            
            **2003**Federal
                income tax expense computed at the statutory rate
            $
            710,372
            
            $
            272,770
            
            $
            2,578State
                income tax benefit, net
            
            (49,500
            )
            
            -
            
            
            -Nondeductible
                expenses
            
            13,536
            
            
            9.365
            
            
            11,044Adjustment
                to valuation allowance
            
            (1,329,408
            )
            
            (282,135
            )
            
            (13,622
            )Federal
                income tax (benefit) expense, as reported
            $
            (655,000
            )
            $
            -
            
            $
            -








**11.**  **RELATED
      PARTY TRANSACTIONS**





Certain
      directors and executive officers have loan transactions with the Company. Such
      loans were made in the ordinary course of business on substantially the same
      terms, including interest rates and collateral, as those prevailing at the
      time
      for comparable transactions with outsiders. The following schedule summarizes
      changes in amounts of loans outstanding, both direct and indirect, to these
      persons during 2005  and
      2004.





**2005**
            
            **2004**Balance
                at beginning of period
            $
            5,828,095
            $
            4,672,104Additions
            
            12,546,714
            
            12,385,135Repayments
            
            (10,315,162
            )
            (11,229,144
            )Balance
                at December 31
            $
            8,059,647
            $
            5,828,095





An
      individual, who is a director of the Company, owns an office building which
      is
      leased to the Company. The lease term commenced September 1, 1999 for a term
      of
      five years and contains renewal options for three additional five-year terms.
      Rent expense under this agreement was $27,500 for the year ended December 31,
      2005, $25,004 for the year ended December 31, 2004 and $23,756 for the year
      ended December 31, 2003. Management believes that the terms of the foregoing
      lease are no more and no less favorable to the Company than those which could
      have been received from unaffiliated parties.





An
      individual, who became a director of the Company in 2003, is an executive
      officer for the Company which owns an office building in which the Company
      had
      leased space under two separate operating leases. The leases were effectively
      combined during 2004 and extended to February 28, 2010. Bay National Corporation
      has the right to extend the leases for one additional five year term, to
      February 28, 2015. Rent expense under these leases was $286,406, $202,945,
      and
      $170,099 for the periods ended December 31, 2005, 2004 and 2003, respectively.
      Management believes that the terms of the foregoing leases are no more and
      no
      less favorable to the Company than those which could have been received from
      unaffiliated parties.





67


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**12.**  **FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK**





The
      Company is a party to financial instruments with off-balance sheet risk in
      the
      normal course of business. These financial instruments may include commitments
      to extend credit, standby letters of credit and purchase commitments. The
      Company uses these financial instruments to meet the financing needs of its
      customers. Financial instruments involve, to varying degrees, elements of
      credit, interest rate and liquidity risk. These do not represent unusual risks
      and management does not anticipate any losses which would have a material effect
      on the accompanying financial statements.





Outstanding
      loan commitments and lines and letters of credit at December 31 are as
      follows:





**2005**
            
            **2004**Loan
                commitments
            $
            21,577,585
            $
            9,867,893Unused
                lines of credit
            
            41,317,927
            
            40,423,986Standby
                letters of credit
            
            2,754,383
            
            1,578,379





Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      violation of any condition established in the contract. The Company generally
      requires collateral to support financial instruments with credit risk on the
      same basis as it does for on-balance sheet instruments. The collateral is based
      on management's credit evaluation of the counter party. Commitments generally
      have fixed expiration dates or other termination clauses and may require payment
      of a fee. Since many of the commitments are expected to expire without being
      drawn upon, the total commitment amount does not necessarily represent future
      cash requirements. Each customer's credit-worthiness is evaluated on a
      case-by-case basis.





Standby
      letters of credit are conditional commitments issued to guarantee the
      performance of a customer to a third party. The credit risk involved in issuing
      letters of credit is essentially the same as that involved in extending loan
      facilities to customers.





**13.**  **REGULATORY
      MATTERS**





As
      of
      December 31, 2005 , the
      Company was required to maintain a weekly average of $1,004,000 of
      non-interest-bearing deposits with the Federal Reserve Bank. As of December
      31,
      2004 , the
      Company was required to maintain a weekly average of $958,000 of
      non-interest-bearing deposits with the Federal Reserve Bank. The average weekly
      balance maintained with the Federal Reserve Bank for the weekly period ended
      December 31, 2005 was $1,073,000. The average weekly balance maintained with
      the
      Federal Reserve Bank for the weekly period ended December 31, 2004 was
      $1,511,000. The actual balances maintained with the Federal Reserve Bank at
      December 31, 2005 and 2004 were $1,024,914 and $1,217,580,
      respectively.





The
      Company and the Bank are subject to various regulatory capital requirements
      administered by federal banking agencies. Failure to meet minimum capital
      requirements can initiate certain mandatory and possibly additional
      discretionary actions by regulators that, if undertaken, could have a direct
      material effect on the Company’s and the Bank's financial statements. Under
      capital adequacy guidelines and the regulatory framework for prompt corrective
      action, the Bank must meet specific capital guidelines that involve quantitative
      measures of the Bank's assets, liabilities and certain off-balance sheet items
      as calculated under regulatory accounting practices. The Bank's capital amounts
      and classification are also subject to qualitative judgments by the regulators
      about components, risk weightings and other factors.





68


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


Quantitative
      measures established by regulation to ensure capital adequacy require the Bank
      to maintain amounts and ratios (set forth in the table below) of total and
      Tier
      I capital (as defined in the regulations) to risk-weighted assets (as defined)
      and Tier I capital (as defined) to average assets (as defined). Management
      believes, as of December 31, 2005, that the Bank met all capital adequacy
      requirements to which it is subject.





The
      Bank
      has been categorized as “well capitalized” by the OCC under the regulatory
      framework for prompt corrective action. To be categorized as well capitalized,
      the Bank must maintain minimum total risk-based, Tier I risk-based and Tier
      I
      leverage ratios. There are no conditions or events that management believes
      would prevent the Bank from continuing to be categorized as well
      capitalized.





69


**BAY
      NATIONAL CORPORATION**


Notes
      to Consolidated Financial
      Statements


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


The
      Bank’s actual capital amounts and ratios as of December 31, 2005 and
      2004
      are presented in the
      following table:





**December
                31, 2005****Actual**
            
            
            **For
                Capital**
              **Adequacy
                Purpose**
            
            
            **To
                Be Well**
              **Capitalized
                Under**
              **Prompt
                Corrective**
              **Action
                Provisions****Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**Total
                Capital (to Risk Weighted Assets):
            $
            21,668,568
            
            10.21
            %
            $
            16,675,000
            
            8.00
            %
            $
            20,843,000
            
            10.00
            %Tier
                I Capital (to Risk Weighted Assets):
            
            18,668,568
            
            8.96
            %
            
            8,337,000
            
            4.00
            %
            
            12,506,000
            
            6.00
            %Tier
                I Capital (to Average Assets):
            
            18,668,568
            
            9.15
            %
            
            6,124,000
            
            3.00
            %
            
            10,206,000
            
            5.00
            %








**December
                31, 2004****Actual**
            
            
            **For
                Capital**
              **Adequacy
                Purpose**
            
            
            **To
                Be Well**
              **Capitalized
                Under**
              **Prompt
                Corrective**
              **Action
                Provisions****Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**
            
            
            **Amount**
            
            **Ratio**Total
                Capital (to Risk Weighted Assets):
            $
            16,242,797
            
            10.32
            %
            $
            12,592,000
            
            8.00
            %
            $
            15,740,000
            
            10.00
            %Tier
                I Capital (to Risk Weighted Assets):
            
            14,432,797
            
            9.17
            %
            
            6,296,000
            
            4.00
            %
            
            9,444,000
            
            6.00
            %Tier
                I Capital (to Average Assets):
            
            14,432,797
            
            8.98
            %
            
            4,821,000
            
            3.00
            %
            
            8,034,000
            
            5.00
            %





Banking
      regulations also limit the amount of dividends that may be paid without prior
      approval of the Bank's regulatory agencies. Regulatory approval is required
      to
      pay dividends which exceed the Bank’s net profits for the current year, plus its
      retained net profits for the preceding two years. The Bank could not have paid
      dividends to the Company without approval from bank regulatory agencies at
      December 31, 2005.





**14.**  **FAIR
      VALUE OF FINANCIAL INSTRUMENTS**





The
      Company discloses fair value information about financial instruments, for which
      it is practicable to estimate the value, whether or not such financial
      instruments are recognized on the balance sheet. Financial instruments have
      been
      defined broadly to encompass 99.3% of the Company's assets and 99.7% of its
      liabilities. Fair value is the amount at which a financial instrument could
      be
      exchanged in a current transaction between willing parties, other than in a
      forced sale or liquidation, and is best evidenced by a quoted market price,
      if
      one exists.





Quoted
      market prices, where available, are shown as estimates of fair market values.
      Because no quoted market prices are available for a significant part of the
      Company's financial instruments, the fair values of such instruments have been
      derived based on the amount and timing of future cash flows and estimated
      discount rates.





70


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


Present
      value techniques used in estimating the fair value of many of the Company's
      financial instruments are significantly affected by the assumptions used. In
      that regard, the derived fair value estimates cannot be substantiated by
      comparison to independent markets and, in many cases, could not be realized
      in
      immediate cash settlement of the instrument. Additionally, the accompanying
      estimates of fair values are only representative of the fair values of the
      individual financial assets and liabilities and should not be considered an
      indication of the fair value of the Company.





The
      estimated fair values of the Company's financial instruments at December 31
      are
      as follows:





2005
              2004Estimated
              
              EstimatedCarrying
              Fair
              Carrying
              Fair*(In
                  thousands)*
              Amount
              Value
              Amount
              ValueFinancial
                  AssetsCash
                  and temporary investments(1)
              $
              7,493,621
              
              $
              7,493,621
              
              $
              18,111,952
              
              $
              18,111,952Investments
                  available-for-sale
              1,540,386
              
              1,540,386
              
              1,544,496
              
              1,544,496Other
                  equity securities
              794,440
              
              794,440
              
              556,090
              
              556,090Loans,
                  net of allowances(2)
              196,589,961
              
              196,403,633
              
              149,216,599
              
              149,265,832Accrued
                  interest receivable and other assets(3)
              1,199,924
              
              1,199,924
              
              591,844
              
              591,844Financial
                  LiabilitiesDeposits
              $
              182,573,086
              
              $
              182,710,244
              
              $
              153,927,042
              
              $
              153,676,261Short-term
                  borrowings
              1,444,158
              
              1,444,158
              
              1,381,000
              
              1,381,000Note
                  payable
              -
              
              -
              
              1,250,000
              
              1,250,000Subordinated
                  debt
              8,000,000
              
              8,090,097
              
              -
              
              -Accrued
                  interest payable and other liabilities(3)
              361,506
              
              361,506
              
              222,602
              
              222,602




(1)
            Temporary
                investments include federal funds sold and overnight
                investments.


(2)
            Loans,
                net of allowances, include loans held for
                sale.


(3)
            Only
                financial instruments as defined in Statement of Financial Accounting
                Standards No. 107, “Disclosure about Fair Value of Financial Instruments,”
                are included in other assets and other
                liabilities.





The
      following methods and assumptions were used to estimate the fair value of each
      category of financial instruments for which it is practicable to estimate that
      value:





**Cash
      and due from banks, federal funds sold and overnight
      investments.** The
      carrying amount approximated the fair value.





**Loans
      held for sale.** The fair
      value of residential mortgage loans held for sale was derived from secondary
      market quotations for similar instruments.





**Investment
      Securities.** The fair
      value for U.S. Treasury securities was based upon quoted market
      bids.





71


**BAY
          NATIONAL CORPORATION**
 Notes
          to Consolidated Financial
          Statements
 For
          the years ended December 31, 2005, 2004 and
          2003


**Other
      equity securities.** The fair
      value of Federal Reserve Bank and Federal Home Loan Bank of Atlanta stock is
      not
      readily determinable since these stocks are restricted as to
      marketability.





**Loans.** The fair
      value was estimated by computing the discounted value of estimated cash flows,
      adjusted for potential credit losses, for pools of loans having similar
      characteristics. The discount rate was based upon the current loan origination
      rate for a similar loan. Non-performing loans have an assumed interest rate
      of
      0%.





**Accrued
      interest receivable.** The
      carrying amount approximated the fair value of accrued interest, considering
      the
      short-term nature of the receivable and its expected collection.





**Other
      assets.** The
      carrying amount approximated the fair value.





**Deposit
      liabilities.** The fair
      value of demand, money market savings and regular savings deposits, which have
      no stated maturity, were considered equal to their carrying amount, representing
      the amount payable on demand. These estimated fair values do not include the
      intangible value of core deposit relationships, which comprise a significant
      portion of the Bank’s deposit base. Management believes that the Bank’s core
      deposit relationships provide a relatively stable, low-cost funding source
      that
      has a substantial intangible value separate from the value of the deposit
      balances.





The
      fair
      value of time deposits was based upon the discounted value of contractual cash
      flows at current rates for deposits of similar remaining maturity.





**Short-term
      borrowings.** The
      carrying amount approximated the fair value of repurchase agreements due to
      their variable interest rates.





**Note
      payable.** The
      carrying amount approximated the fair value of the note payable due to their
      variable interest rates.





**Subordinated
      Debt.**  Carrying
      values were discounted using a cash flow approach based on market rates as
      of
      December 31, 2005.





**Other
      liabilities.** The
      carrying amount approximated the fair value of accrued interest payable, accrued
      dividends and premiums payable, considering their short-term nature and expected
      payment.





**Off-balance
      sheet instruments.** The
      Company charges fees for commitments to extend credit. Interest rates on loans,
      for which these commitments are extended, are normally committed for periods
      of
      less than one month. Fees charged on standby letters of credit and other
      financial guarantees are deemed to be immaterial and **** these
      guarantees are expected to be settled at face amount or expire unused. It is
      impractical to assign any fair value to these commitments.




72


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003


**15.**  **PARENT
      COMPANY FINANCIAL INFORMATION**





Condensed
      financial information for Bay National Corporation (Parent Only) is as
      follows:





CONDENSED
      BALANCE SHEETS


December
      31, 2005 and 2004




2005
            
            2004ASSETSCash
                and cash equivalents
            
            
            $
            5,212
            
            $
            104,769Due
                from subsidiary
            
            
            
            5,432,231
            
            
            137,500Investment
                in subsidiary
            
            
            
            18,916,568
            
            
            14,432,797Other
                assets
            
            
            
            134,894
            
            
            -Total
                Assets
            
            
            $
            24,488,905
            
            $
            14,675,066LIABILITIESAccrued
                expenses and other liabilities
            
            
            $
            26,827
            
            $
            6,302Note
                payable
            
            
            
            -
            
            
            1,250,000Subordinated
                debt
            
            
            
            8,248,000
            
            
            -Total
                Liabilities
            
            
            
            8,274,827
            
            
            1,256,302STOCKHOLDERS'
                EQUITYCommon
                stock - $.01 par value, authorized:9,000,000
                shares authorized, 1,924,436 and 1,917,710 issued and outstanding
                as of
                December 31, 2005 and 2004, respectively:
            
            
            
            19,244
            
            
            19,177Additional
                paid in capital
            
            
            
            17,451,201
            
            
            17,400,284Accumulated
                Deficit
            
            
            
            (1,256,367
            )
            
            (4,000,697
            )Total
                Stockholders' Equity
            
            
            
            16,214,078
            
            
            13,418,764Total
                Liabilities and Stockholders' Equity
            
            
            $
            24,488,905
            
            $
            14,675,066













73


**BAY
        NATIONAL CORPORATION**
 Notes
        to Consolidated Financial
        Statements
 For
        the years ended December 31, 2005, 2004 and
        2003





CONDENSED
      STATEMENTS OF OPERATIONS


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





2005
            
            
            2004
            
            
            2003Interest
                and dividends on investment securities
            $
            1,376
            
            $
            2,231
            
            $
            5,146Interest
                expense
            
            119,817
            
            
            6,302
            
            
            -Net
                interest income (expense)
            
            (118,441
            )
            
            (4,071
            )
            
            5,146Non-interest
                expense
            
            -
            
            
            1,335
            
            
            3,219Income
                (loss) before income taxes and equity in undistributed losses of
                subsidiary
            
            (118,441
            )
            
            (5,406
            )
            
            1,927Income
                tax expense (benefit)
            
            (257,000
            )
            
            -
            
            
            -Income
                (loss) before equity in undistributed income (losses) of
                subsidiary
            
            138,559
            
            
            (5,406
            )
            
            1,927Equity
                in undistributed income of subsidiary
            
            2,605,771
            
            
            807,670
            
            
            5,654Net
                Income
            $
            2,744,330
            
            $
            802,264
            
            $
            7,581





CONDENSED
      STATEMENTS OF CASH FLOWS


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





2005
            
            
            2004
            
            
            2003Cash
                Flows From Operating ActivitiesNet
                Income
            $
            2,744,330
            
            $
            802,264
            
            $
            7,581Adjustments
                to reconcile net income (loss) to net cash(used)
                provided by operating activities:Equity
                in undistributed (income) loss of subsidiary
            
            (2,605,771
            )
            
            (807,670
            )
            
            (5,654
            )Net
                decrease (increase) in other assets
            
            (5,429,625
            )
            
            812,686
            
            
            (699,450
            )Net
                increase (decrease) in other liabilities
            
            20,525
            
            
            6,302
            
            
            (250,292
            )Net
                cash (used) provided by operating activities
            
            (5,270,541
            )
            
            813,582
            
            
            (947,815
            )Cash
                Flows From Investing ActivitiesInvestment
                in subsidiary
            
            (1,878,000
            )
            
            (3,162,500
            )
            
            (3,500,000
            )Net
                cash used by investing activities
            
            (1,878,000
            )
            
            (3,162,500
            )
            
            (3,500,000
            )Cash
                Flows From Financing ActivitiesNet
                proceeds (payoff) from note payable
            
            (1,250,000
            )
            
            1,250,000
            
            
            -Proceeds
                from issuance of preferred stock
            
            8,248,000
            
            
            -
            
            
            -Issuance
                of common stock
            
            50,984
            
            
            550,000
            
            
            4,449,261Net
                cash provided by financing activities
            
            7,048,984
            
            
            1,800,000
            
            
            4,449,261Net
                (decrease) increase in cash and cash equivalents
            
            (99,557
            )
            
            (548,918
            )
            
            1,446Cash
                and cash equivalents at beginning of year
            
            104,769
            
            
            653,687
            
            
            652,241Cash
                and cash equivalents at end of year
            $
            5,212
            
            $
            104,769
            
            $
            653,687





74




Item
      8.
      Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure





There
      has
      been no occurrence requiring a response to this Item.





Item
      8A.
      Controls and Procedures





As
      of the
      end of the period covered by this annual report on Form 10-KSB, Bay National
      Corporation’s Chief Executive Officer and Chief Financial Officer evaluated the
      effectiveness of Bay National Corporation’s disclosure controls and procedures.
      Based upon that evaluation, Bay National Corporation’s Chief Executive Officer
      and Chief Financial Officer concluded that Bay National Corporation’s disclosure
      controls and procedures are effective. Disclosure controls and procedures are
      controls and other procedures that are designed to ensure that information
      required to be disclosed by Bay National Corporation in the reports that it
      files or submits under the Securities Exchange Act of 1934, as amended, is
      recorded, processed, summarized and reported within the time periods specified
      in the Securities and Exchange Commission’s rules and forms.





In
      addition, there were no changes in Bay National Corporation’s internal controls
      over financial reporting (as defined in Rule 13a-15 or Rule 15d-15 under the
      Securities Act of 1934, as amended) during the quarter ended December 31, 2005,
      that have materially affected, or are reasonably likely to materially affect,
      Bay National Corporation’s internal control over financial
      reporting.





Item
      8B.
      Other Information





On
      December 12, 2005, the Compensation Committee of the Board of Directors of
      Bay
      National Bank increased, effective January 1, 2006, Hugh Mohler’s annual base
      compensation from $200,000 to $250,000 and Mark Semanie’s annual base
      compensation from $165,000 to $180,000.





On
      December 12, 2005, the Compensation Committee of the Board of Directors of
      Bay
      National Bank authorized a $75,000 discretionary bonus to Mr. Mohler, and a
      $60,000 discretionary bonus to Mr. Semanie. These bonuses were paid on January
      20, 2006.








75





**PART
      III**





Item
      9.
      Directors, Executive Officers, Promoters and Control Persons; Compliance with
      Section 16(a) of the Exchange Act





**Directors,
      Executive Officers, Promoters and Control Persons**





The
      directors of Bay National Corporation, their ages, the years in which their
      terms expire and the year in which they became directors are as
      follows:





Name
            Age
            Term
                to Expire
            Director
                SinceHugh
                W. Mohler
            60
            2006
                Annual Meeting
            June
                1999Charles
                E. Bounds
            87
            2008
                Annual Meeting
            June
                1999Gary
                T. Gill
            53
            2008
                Annual Meeting
            January
                2003R.
                Michael Gill
            55
            2006
                Annual Meeting
            March
                2006John
                R. Lerch
            61
            2008
                Annual Meeting
            June
                1999Donald
                G. McClure, Jr.
            62
            2006
                Annual Meeting
            April
                2000Robert
                L. Moore
            52
            2006
                Annual Meeting
            February
                2001James
                P. O’Conor
            77
            2008
                Annual Meeting
            July
                2004H.
                Victor Rieger, Jr.
            68
            2006
                Annual Meeting
            June
                1999William
                B. Rinnier
            64
            2007
                Annual Meeting
            August
                1999Edwin
                A. Rommel, III
            56
            2007
                Annual Meeting
            June
                1999Henry
                H. Stansbury
            66
            2007
                Annual Meeting
            June
                1999Kenneth
                H. Trout
            57
            2007
                Annual Meeting
            October
                1999Eugene
                M. Waldron, Jr.
            62
            2007
                Annual Meeting
            June
                1999Carl
                A.J. Wright
            51
            2008
                Annual Meeting
            March
                2003





(1)
            All
                of the directors with terms to expire in 2006 have been nominated
                to serve
                on the Board of Directors for an additional three (3) year term .
                Elections for these directors will take place at the 2006 Annual
                Meeting
                of Stockholders to be held on May 23,
                2006.


76


Biographical
      information concerning the directors is set forth below.





**Hugh
      W. Mohler** serves
      as chairman, president, and chief executive officer. He has been a director
      of
      Bay National Corporation since June 1999 and a director of Bay National Bank
      since April 2000. Mr. Mohler has 36 years experience in the financial services
      industry, holding positions in executive management, commercial lending and
      business development. From 1977 to 1999, Mr. Mohler was affiliated with
      Mercantile Bankshares Corporation, which is headquartered in Baltimore,
      Maryland, most recently serving as executive vice president with responsibility
      for 20 community banks in a three-state area. For 17 years, from 1977 to 1994,
      he was president of Mercantile’s Salisbury, Maryland-based affiliate, Peninsula
      Bank, the largest financial institution on Maryland’s Eastern Shore. Earlier he
      was a vice president in commercial lending at First National Bank of
      Maryland.





A
      native
      of Baltimore, Mr. Mohler earned his undergraduate degree in economics from
      Loyola College of Maryland and his master of business administration degree
      from
      the University of Baltimore. He is a past president of the board of trustees
      of
      Associated Catholic Charities, Inc. in the Roman Catholic Archdiocese of
      Baltimore. In the past, Mr. Mohler has served as a trustee of Loyola Blakefield,
      Goucher College and the Independent College Fund of Maryland. Mr. Mohler serves
      on the Board of Sponsors of the Sellinger School of Business at Loyola College
      of Maryland and the Board of Governors of The Maryland Club. In 2004, he was
      appointed by Governor Robert L. Ehrlich, Jr. to the Maryland Economic
      Development Commission. He also serves on the President’s Advisory Council of
      Villa Julie College ,
      is a
      member of the finance committee for the Maryland Jesuit Province, and is
      President of the Baltimore Chapter of Legatus International.





Mr.
      Mohler’s prior civic experiences include serving as chairman of the Greater
      Salisbury Committee, chairman of the Salisbury School, and chairman of the
      Governor’s Lower Shore Economic Task Force. He also served on the boards of
      Peninsula Regional Medical Center, Maryland Chamber of Commerce,
      Salisbury-Wicomico Economic Development Committee and the Somerset County
      Economic Development Committee. Mr. Mohler also served as president of the
      Maryland Bankers Association and on several committees of the American Bankers
      Association.





**Charles
      E. Bounds** has
      been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Mr. Bounds is a retired executive who served
      from 1944 to 1969 as director of purchases and inventory for Symington Wayne
      Corporation, an international conglomerate headquartered in Salisbury, Maryland,
      which operated businesses in the United States and seven foreign countries.
      From
      1969 to 1999, he was a vice president-investments for Morgan Stanley Dean
      Witter, working in the Salisbury, Maryland office of the investment banking
      firm.





A
      native
      of Salisbury, Maryland, Mr. Bounds is past chairman of the Salvation Army Boys
      Club in Salisbury, Maryland, and headed the Salisbury, Maryland Salvation Army
      administrative board. He has also chaired fund raising efforts for the Boy
      Scouts of America, Delmarva District. Mr. Bounds was an original member of
      the
      Ward Foundation, which is a Salisbury, Maryland based non-profit organization,
      which operates The Ward Museum of Wildfowl Art. Mr. Bounds is an alumnus of
      Beacom College.





**Gary
      T. Gill** has
      been
      a director of Bay National Corporation and Bay National Bank since January
      2003.
      Mr. Gill is president and chief executive officer of the MacKenzie Companies,
      a
      Baltimore-based full-service commercial real estate firm comprising Mackenzie
      Commercial Real Estate Services, LLC, Mackenzie Management Corporation,
      MacKenzie Services Corporation and MacKenzie Contracting Company, LLC. Mr.
      Gill
      joined MacKenzie in 1977 and has served in his capacity as president since
      1985.
      Mr. Gill serves also as executive vice president of MacKenzie Properties, Inc.,
      the managing partner of over 35 partnerships of income-producing commercial
      properties.





77


A
      native
      of Towson, Maryland, Mr. Gill received his Bachelor of Arts degree in Business
      Administration in 1974 from Towson University. Mr. Gill currently serves on
      the
      Baltimore County Economic Advisory Board, Towson University Stadium Committee,
      US *Lacrosse* Foundation Board, and chairs the Towson University Board of Visitors.





**R.
      Michael Gill** ,
      has
      been a director of Bay National Corporation and Bay National Bank since March
      2006. Mr. Gill is chairman of Curtis Engine, a Baltimore-based locally owned
      and
      operated provider of power solutions equipment and he has served in that
      capacity since January 2006. In 2003, Mr. Gill formed Hoyt Capital, an
      investment firm that provides capital and business advising to start-up and
      existing enterprises. For sixteen years, beginning in 1984, he served as CEO
      of
      AMERICOM, a provider of cellular products and services. In 2000, AMERICOM was
      acquired by Solectron, a leader in the electronics manufacturing
      sector.





Mr.
      Gill
      is an alumnus of Towson University where he received an honorary Doctor of
      Humane Letters degree in 1996. In May 2005, he received Towson University’s
      Distinguished Alumnus Award. Prior to transferring to Towson University, Mr.
      Gill attended Clemson University, which recently named him to its President’s
      Advisory Board. He also serves on the board of Corporate Printing Solutions.
      In
      2004, Governor Robert L. Ehrlich, Jr. appointed Mr. Gill to a five-year term
      on
      the Board of Regents of the University System of Maryland, a public system
      of
      higher education comprised of 11 degree-granting and two research
      institutions.





**John
      R. Lerch** has
      been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Since January 1999, Mr. Lerch has been
      self-employed as a private investor trading as the Chesapeake Venture Group.
      From 1973 to January 1999, Mr. Lerch was president of Chesapeake Insurance-The
      Harris Riggin Agency, an independent insurance agency based in Salisbury,
      Maryland. Mr. Lerch began his business career in the securities industry,
      serving as a stockbroker at firms in Washington, D.C. and Salisbury, Maryland.
      Mr. Lerch is a past director of the Independent Insurance Agents of Maryland.





Mr.
      Lerch
      is an alumnus of Dickinson College of Carlisle, Pennsylvania. He served as
      an
      officer in the U.S. Army and holds a Bronze Star from his service in Vietnam.
      He
      is a director of Barr International, Inc., a regional medium and heavy truck
      sales and service organization. He is a past director of Peninsula Bank, a
      subsidiary of Baltimore-based Mercantile Bankshares Corporation. He is a past
      director and vice-chairman of the Greater Salisbury Committee, past trustee
      of
      the Peninsula Regional Medical Center in Salisbury, past president of
      Salisbury-Wicomico Economic Development Corporation and past president and
      campaign chairman of the United Way of the Lower Eastern Shore. He also has
      served as a director for the Mid-Delmarva Family YMCA and was a former chairman
      and a current trustee for The Ward Foundation.





**Donald
      G. McClure, Jr.** has
      been
      a director of Bay National Corporation and Bay National Bank since April 2000.
      Mr. McClure is a principal in the McClure Group, Inc, a Baltimore-based private
      equity investment firm originated in 1979. He is the former Chairman and
      Co-Chief Executive of Americom Wireless Services, Inc., which merged with a
      Fortune 200 company in 2000. McClure Group holdings include operations based
      in
      Texas, Florida, Colorado as well as Maryland.





78


Mr.
      McClure is the immediate past Chairman of the board of trustees of Loyola
      Blakefield and serves on several private company boards as well as devoting
      substantial time to various civic, charitable and educational organizations
      here
      and in other states.





**Robert
      L. Moore** has
      been
      a director of Bay National Corporation since February 2001 and Bay National
      Bank
      since June 2001. Mr. Moore is a certified public accountant. He received his
      CPA
      designation twenty- seven years ago, and is the owner and founder of the
      Salisbury, Maryland accounting firm of Moore & Company, P.A. His
      professional concentration is income tax and estate tax planning and all facets
      of business consulting.





Mr.
      Moore
      received his Bachelor of Science degree from the University of Virginia in
      1976.
      Currently, he serves as Chairman of the Trustees of the Wicomico County Pension
      System, a board member of Salisbury-Wicomico Economic Development Corporation,
      a
      board member of the Greater Salisbury Committee, and a member of the Salisbury
      Area Chamber of Commerce, and member of the Finance Committee of Trinity United
      Methodist Church.





Mr.
      Moore
      is a past president of the Eastern Shore Chapter of the Maryland Association
      of
      CPAs. In addition, Mr. Moore served on the Board of Directors of the Bank of
      Fruitland, Maple Shade Residential Homes, Inc., and the Holly Foundation. He
      was
      also a member of the Executive Committee and Board of Directors of the Green
      Hill Yacht & Country Club and a member and officer of the Salisbury
      Jaycees.





**James
      P. O’Conor** has
      been
      a director of Bay National Corporation and Bay National Bank since July 2004.
      Mr. O’Conor is the general partner of O’Conor Enterprises, a real estate
      investment and consulting company, and he has served in that capacity since
      2002. Mr. O’Conor co-founded the Maryland real estate brokerage firm of O’Conor
& Flynn in 1961. In 1984, that firm merged with another large Maryland real
      estate brokerage firm, creating O’Conor, Piper & Flynn. Mr. O’Conor served
      as its Chairman and CEO. In 1998, O’Conor, Piper & Flynn was sold to NRT. At
      the time of the sale, O’Conor, Piper & Flynn was the sixth largest
      residential real estate brokerage company in the United States.





Mr.
      O’Conor currently serves on the Board of Directors of the Baltimore Symphony
      Orchestra, the Maryland Hospital Association, Loyola College, Signal 13
      Foundation, and Towson University and is Chairman of the Jefferson School.





**H.
      Victor Rieger, Jr.** has been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Mr. Rieger retired from Signet Banking
      Corporation, successor to Union Trust Company of Maryland, in December 1997
      after nearly four decades of service. Mr. Rieger served in numerous capacities
      for Signet, including regional executive vice president of international banking
      and as part of Signet's Maryland commercial banking group. Mr. Rieger has
      extensive experience in commercial relationship banking, credit administration
      and loan policy.





An
      alumnus of Johns Hopkins University, Mr. Rieger is a graduate of the Stonier
      School of Banking at Rutgers University. He is past president and a current
      trustee of Family and Children's Services of Central Maryland, past treasurer
      and board member of the National Flag Day Foundation and a past vice-president
      and director of the Baltimore Junior Association of Commerce. He is a former
      member of the loan committee for the Minority Small Business Investment Company
      and a past advisory board member of the U.S. Small Business Administration.
      Mr.
      Rieger also is past president of the Chesapeake Chapter of Robert Morris
      Associates.





79


**William
      B. Rinnier** has
      been
      a director of Bay National Corporation since August 1999 and a director of
      Bay
      National Bank since April 2000. Mr. Rinnier is the owner and president of
      Rinnier Development Company, a Salisbury, Maryland based real estate development
      company, which specializes in the development and sale or management of resort
      condominiums, multi-family apartments, and commercial and industrial buildings.
      He joined Rinnier Development Company nearly three decades ago after his
      honorable discharge from the U.S. Navy.





A
      native
      of Salisbury, Maryland, Mr. Rinnier earned a degree in aerospace engineering
      from the Georgia Institute of Technology and attended the Graduate School of
      Business at the University of Virginia. He is a board member of the Greater
      Salisbury Committee and is past president of the Salisbury-Wicomico Economic
      Development Corporation and the Coastal Board of Realtors.





**Edwin
      A. Rommel III** has
      been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Mr. Rommel is a certified public accountant
      that, since 1974, has been a partner in the Salisbury, Maryland, accounting
      firm
      of Twilley, Rommel & Stephens, P.A. Mr. Rommel has been certified as a
      valuation analyst and accredited in business evaluation by the American
      Institute of Certified Public Accountants.





A
      Baltimore native, Mr. Rommel earned his undergraduate degree from Loyola College
      of Maryland. Mr. Rommel is a past Chairman of the Maryland Association of
      Certified Public Accountants, and is a member of the governing board of the
      American Institute of Certified Public Accountants. Mr. Rommel is a current
      director of the Greater Salisbury Committee and past president of the Salisbury
      Area Chamber of Commerce. He serves as a director of the Maryland Association
      of
      Certified Public Accountants and an officer of its Eastern Shore Chapter. Mr.
      Rommel is past president of the St. Francis de Sales Board of Trustees and
      past
      member of the Wicomico County Democratic Central Committee.





**Henry
      H. Stansbury** has
      been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Since 1975, Mr. Stansbury has been the chief
      executive officer of Agency Services, Inc., an independently owned premium
      finance company. Since 1989, Mr. Stansbury is the Chairman of the Board of
      Directors of Agency Insurance Company of Maryland, Inc., a privately owned
      multi-line property/casualty insurance company. Mr. Stansbury is a past
      president of the Maryland Association of Premium Finance Companies and is a
      past
      president of the National Association of Premium Finance Companies.





Mr.
      Stansbury is a vice president and trustee of the Maryland Historical Society.
      He
      served as director and chairman of the museum committee for the Lacrosse Hall
      of
      Fame at the Johns Hopkins University and as trustee of the St. Paul's School
      for
      Boys and The Ward Museum of Wildfowl Art. He is also past president of
      ReVisions, Inc., a nonprofit organization that serves the mentally ill. Mr.
      Stansbury is a graduate of Leadership Maryland and a director of Leadership
      Baltimore County. He is the author of two books; *LLOYD
      J. TYLER: FOLK ARTIST AND*  *DECOY
      MAKER* and *IRA
      HUDSON AND FAMILY, CHINCOTEAGUE CARVERS.* He
      is
      also a contributing writer for *Decoy
      Magazine* .
      Mr.
      Stansbury is an alumnus of the University of Maryland and holds a master of
      business administration degree from George Washington University.





**Kenneth
      H. Trout** has
      been
      a director of Bay National Corporation since October 1999 and a director of
      Bay
      National Bank since April 2000. Since January 1999, Mr. Trout has served as
      the
      president and chief executive officer of Rosemore, Inc., a Baltimore-based
      privately held investment company primarily engaged in the business of oil
      and
      gas exploration and production. He also serves as a director of Rosemore
      Holdings, Inc., Rosemore Calvert, Inc., Tema Oil and Gas Company and Gateway
      Gathering and Marketing Company, which are all subsidiaries of Rosemore, Inc.
      He
      is also a director of KCI Technologies, Inc. From 1970 to November 1997, Mr.
      Trout was employed by Signet Banking Corporation. During his last five years
      of
      tenure with Signet, he served as senior executive vice president-commercial
      banking and as president and chief executive officer of Signet Bank-Maryland.
      Mr. Trout was retired from December 1997 to December 1998.





80


A
      Bridgeton, New Jersey native, Mr. Trout received his undergraduate degree in
      economics and business administration from Methodist College in North Carolina.
      He is a member of the Board of Trustees of The College of Notre Dame of
      Maryland.





**Eugene
      M. Waldron, Jr.** has
      been
      a director of Bay National Corporation since June 1999 and a director of Bay
      National Bank since April 2000. Mr. Waldron is a Chartered Financial Analyst
      and
      since September 1998 has been a senior vice president in the Washington, D.C.,
      office of Capital Guardian Trust Company, an employee-owned firm based in Los
      Angeles dedicated to institutional investment management. From March 1994 to
      August 1998, Mr. Waldron was employed by Loomis, Sayles & Company, an
      investment management firm. Mr. Waldron's more than three decades of investment
      experience include employment at CS First Boston Asset Management, Fidelity
      Management Trust Company, T. Rowe Price Associates and Ferris, Baker, Watts
      & Company.





An
      alumnus of Mt. St. Mary's University, Emmitsburg, Maryland, Mr. Waldron earned
      his master of business administration degree at the Bernard M. Baruch College
      of
      the City University of New York. A native of Annapolis, Maryland, he is a member
      of the Mt. St. Mary's Endowment Committee.




**Carl
      A.J. Wright** has been
      a director of Bay National Corporation and Bay National Bank since March
      2003.  Mr. Wright is the CEO of Stephen James Associates, an executive
      search and staffing firm specializing in accounting, finance, human resources
      and banking.  He has served in that capacity since January 2006.  From
      1998 to May 2005, Mr. Wright was a senior vice president of Spherion (formerly
      Interim Financial Solutions), an executive search and staffing firm specializing
      in finance, human resources and information systems.  From 1980 until 1998,
      Mr. Wright was President and CEO of A.J. Burton Group. Mr. Wright served in
      the
      auditing and tax departments of Ernst & Young from 1976 to 1980. Along with
      his corporate responsibilities, he is an involved community member and active
      in
      professional, civic and political organizations.




Mr.
      Wright is an alumnus of Loyola College and Loyola Blakefield and has served
      on
      boards and committees of both institutions. He is past president of the
      Baltimore Junior Association of Commerce and serves on Maryland Governor Robert
      Ehrlich’s Strategic and Finance Committees. He was appointed as the chairman of
      the Maryland Stadium Authority in 2003. In addition, he is an active supporter
      of the Catholic Charities and Maryland Business for Responsive Government.





Other
      than Gary T. Gill and R. Michael Gill who are brothers, and Mr. Mohler and
      Mr.
      Waldron who are first cousins, there are no family relationships between any
      director or executive officer and any other director or executive officer of
      Bay
      National Corporation.





The
      one
      executive officer and significant employee of Bay National Corporation and
      Bay
      National Bank that does not serve on the Board of Directors of Bay National
      Corporation is Mark A. Semanie. Mr. Semanie, **** age
      42,
      serves as Executive Vice President and Chief Financial Officer, Treasurer and
      Secretary of Bay National Corporation and Executive Vice President and Chief
      Financial Officer, Chief Compliance Officer, Treasurer and Secretary of Bay
      National Bank. Mr. Semanie is a Certified Public Accountant. Mr. Semanie worked
      in the insurance industry for over seven years. From July 1996 to October 2000,
      he served as Executive Vice President and Chief Financial Officer for Agency
      Holding Company of Maryland, Inc., parent company of Baltimore-based Agency
      Services, Inc., an insurance premium finance company, and Agency Insurance
      Company of Maryland, Inc., a multi-line property/casualty insurance company.
      From March 1993 to July 1996, he was associated with USF&G Corporation where
      he served in various capacities, including Manager of SEC and External
      Reporting. From August 1985 to March 1993, Mr. Semanie worked in the Boston
      and
      Baltimore offices of the international accounting firm of KPMG LLP. He last
      served as a Senior Manager in the Audit practice with the firm. His background
      includes experience in financial planning and reporting, backroom operations,
      human resources and regulatory compliance.





81


A
      native
      of Connecticut, Mr. Semanie earned a Bachelor of Science degree in accounting
      from Bentley College. He currently serves on the Board of Directors of Agency
      Insurance Company of Maryland, Inc. He is a member of the American Institute
      of
      Certified Public Accountants, the Maryland Association of Certified Public
      Accountants, the American Institute of Chartered Property Casualty Underwriters,
      and Financial Executives International.





Bay
      National Corporation’s charter and bylaws provide that Bay National Corporation
      shall have at least three (3) directors, and that the number of directors may
      be
      increased or decreased by the Board of Directors. As of March 22, 2006, the
      number of directors has been fixed at 15 with all positions filled. Pursuant
      to
      Bay National Corporation’s charter and bylaws, the Board of Directors is divided
      into three classes, with each class serving a three-year term, and the term
      of
      one class expiring each year. A director may only be removed by the affirmative
      vote of at least 80% of the votes entitled to be cast on the matter and only
      for
      cause.





Bay
      National Corporation's officers are appointed by the Board of Directors and
      hold
      office at the will of the board or as otherwise provided in an employment
      agreement between an officer and Bay National Corporation.





As
      Bay
      National Corporation is the sole stockholder of Bay National Bank, each director
      of Bay National Bank is elected by the Board of Directors of Bay National
      Corporation. Directors of Bay National Bank serve for a term of one year and
      are
      elected each year at Bay National Bank's annual meeting of stockholders. Bay
      National Bank's officers are appointed by its Board of Directors and hold office
      at the will of the board.





Bay
      National Corporation has established advisory boards of directors for its two
      locations. These are comprised of professionals and business persons, who
      provide advice to Bay National Corporation’s and Bay National Bank’s Board of
      Directors and who promote the interests of Bay National Corporation and Bay
      National Bank. An advisory board of directors is not required by any Maryland
      or
      federal law or regulation and advisory directors are not subject to regulatory
      approval or supervision. The advisory directors do not have the power to vote
      on
      any matter considered by the Board of Directors and they serve at the pleasure
      of the board.


82





**Audit
      Committee Matters**





Bay
      National Corporation has a standing Audit Committee. The Audit Committee
      currently has five members: William B. Rinnier, Chairman, James P. O’Conor,
      Henry H. Stansbury Edwin A. Rommel III and Kenneth H. Trout. As of the date
      of
      this report, each of the members of the Audit Committee is “independent” under
      rules promulgated by the Securities and Exchange Commission. The Audit
      Committee’s functions and responsibilities are described in a written
      charter.





Pursuant
      to Securities and Exchange Commission regulations, Bay National Corporation
      is
      required to disclose in this annual report whether one or more members of the
      audit committee are “audit committee financial experts” and the names of those
      members. If Bay National Corporation does not have an audit committee financial
      expert on the audit committee, it is required to explain why that is the case.





The
      Securities and Exchange Commission has defined an “audit committee financial
      expert” as a person who has the following attributes:




·
            An
                understanding of generally accepted accounting principles and financial
                statements;




·
            The
                ability to assess the general application of such principles in connection
                with the accounting for estimates, accruals and
                reserves;




·
            Experience
                preparing, auditing, analyzing or evaluating financial statements
                that
                present a breadth and level of complexity of accounting issues that
                are
                generally comparable to the breadth and complexity of issues that
                can
                reasonably be expected to be raised by the financial statements,
                or
                experience actively supervising one or more persons engaged in such
                activities;




·
            An
                understanding of internal controls and procedures for financial reporting;
                and




·
            An
                understanding of audit committee
                functions.




Bay
      National Corporation’s Board of Directors determined that Edwin
      A.
      Rommel meets
      the
      definition of an “audit committee financial expert.” The
      Board
      of Directors has also determined that Mr. Rommel is independent as that term
      is
      used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act
      of
      1934, as amended.


83





**Compliance
      with Section 16(a) of the Exchange Act**





The
      Company did not have a class of equity securities registered pursuant to the
      Securities Exchange Act of 1934, as amended (the “Exchange Act”), at any time
      during the Company’s fiscal year ended December 31, 2005. Accordingly, there was
      no requirement upon the Company’s officers, directors and 10% or greater
      shareholders to file any reports required pursuant to Section 16(a) of the
      Exchange Act with respect to the fiscal year ended December 31,
      2005.





On
      January 27, 2006, the Company registered its common stock under Section 12(g)
      of
      the Exchange Act. Accordingly, the Company’s officers, directors, and 10% or
      greater shareholders are now required to file reports pursuant to Section 16(a)
      of the Exchange Act.





**Code
      of Ethics**





Bay
      National Corporation’s Board of Directors has adopted a code of ethics that
      applies to its principal executive officer, principal accounting officer or
      controller and persons performing similar functions. That Code of Ethics for
      Senior Financial Officers has been posted on Bay National Bank’s internet
      website at www.baynational.com .
      A copy
      of the Code of Ethics for Senior Financial Officers is also included as an
      exhibit to this annual report.


The
        remaining information required by this Item 9 is incorporated by reference
        to the information appearing under the captions “Board Meetings and Committees -
        Nominating Committee” in the Proxy Statement for the 2006 Annual Meeting of
        Stockholders of Bay National Corporation.


Item
      10.
      Executive Compensation





**Director
      Compensation**





Except
      for discretionary grants of options to purchase shares of common stock as
      described below and discretionary payments based on special circumstances,
      the
      directors of Bay National Corporation and Bay National Bank were not compensated
      for their attendance at regularly scheduled or special board meetings or for
      other services prior to July 2004.





In
      July
      2004, Bay National Bank began paying directors who are not officers or employees
      of Bay National Corporation or Bay National Bank (e.g., all directors other
      than
      Mr. Mohler) (“Qualified Directors”) $200 for each attended regularly scheduled
      meeting and each special meeting of the Board of Directors of Bay National
      Bank,
      and $150 for each attended regularly scheduled meeting and each special meeting
      of a committee of the Board of Directors of Bay National Bank. In addition,
      the
      chair of the Executive Committee and the chair of the Audit Committee of the
      Board of Directors of Bay National Bank received an additional $100 for each
      attended regularly scheduled meeting and each special meeting. During 2004,
      Bay
      National Bank paid (or accrued the payment of) $23,250 for these meeting
      fees.





On
      January 25, 2005, the Board of Directors of Bay National Corporation and Bay
      National Bank adopted a formal Director Compensation Policy. The Director
      Compensation Policy provides for compensation for attendance at meetings and
      reimbursement of expenses in substantially the same manner as that paid from
      July 2004 to December 2004 except that directors of Bay National Bank will
      receive $300 for attended meetings of the Board of Directors instead of $200.
      The Director Compensation Policy also provides that the Board of Directors
      or
      the compensation committee of the Board of Directors of Bay National Bank may
      authorize discretionary payments to Qualified Directors as a result of
      outstanding service by the Qualified Director. Furthermore, the Director
      Compensation Policy provides that the policy may be changed from time to time.
      During 2005, Bay National Bank accrued $80,650 for these meeting fees which
      were
      subsequently paid in February 2006.





84


Included
      in the accrued fees was a special payment of $30,000 to Mr. H. Victor Rieger,
      Jr., a director of Bay National Corporation and Bay National Bank, in
      recognition of Mr. Rieger’s outstanding service as a key member of Bay National
      Bank’s Executive Committee. Since 2001, Bay National Bank has made annual
      special payments to Mr. Rieger in recognition of his outstanding
      service.





During
      2005, all Qualified Directors of Bay National Bank were also entitled to
      reimbursement for their reasonable travel costs related to their attendance
      at
      board and committee meetings, and all directors of Bay National Corporation
      and
      Bay National Bank are reimbursed for reasonable expenses incurred on behalf
      of
      Bay National Corporation and Bay National Bank. **** During
      2005, Bay National Corporation and Bay National Bank did not reimburse any
      travel costs or expenses.





Bay
      National Corporation does not pay cash remuneration to its directors. It is
      expected that unless and until Bay National Corporation becomes actively
      involved in additional businesses other than owning all the capital stock of
      Bay
      National Bank, no separate cash compensation will be paid to the directors
      of
      Bay National Corporation in addition to that paid to them by Bay National Bank
      in their capacities as directors of Bay National Bank. However, Bay National
      Corporation may determine in the future that such separate cash compensation
      is
      appropriate.





In
      November 2001, Bay National Corporation granted each of its then directors
      options to purchase 3,000 shares of its common stock at $7.58 per share, the
      then fair market value. A total of 39,000 options were issued. The options
      vest
      in four (4) equal installments with the first 25% installment vesting on the
      third anniversary of the individual director’s appointment to Bay National
      Corporation’s Board of Directors. The remaining 25% installments vest on the
      fourth, fifth, and sixth anniversary of the individual director’s appointment to
      the Board of Directors. As of March 23, 2006 options to purchase 6,000 shares
      had been exercised. Options to purchase 31,500 shares were exercisable as of,
      or
      within 60 days, of March 23, 2006. The options expire on November 19, 2009.





85





**Executive
      Compensation**





**Summary
      Compensation Table**





The
      following table sets forth the compensation paid by Bay National Corporation
      and
      Bay National Bank to the Chief Executive Officer of Bay National Corporation
      and
      Bay National Bank and to any other executive officer of Bay National Corporation
      and Bay National Bank who received compensation in excess of $100,000 during
      2005.





**Summary
                Compensation Table**Long
                Term CompensationAnnual
                Compensation
            Awards
            PayoutsName
                and Principal Position
            Year
            Salary
                ($)
            Bonus
                ($)
            Other
                Annual Compensation ($)
            Restricted
                Stock Award(s) ($)
            Securities
                Underlying Options/
              SARs
                (#)
            LTIP
                Payouts ($)
            All
                Other Compensation ($)Hugh
                W. Mohler
              President
                and Chief Executive Officer (1)
            2005
            $
                200,000
            $50,000
            -
            -
            -
            -
            $
                9,6622004
            $
                170,308
            $
                30,000
            $
                7,500
            -
            -
            -
            $
                7,6542003
            $
                164,000
            -
            -
            -
            -
            -
            $
                6,798Mark
                A. Semanie
              Executive
                Vice President and CFO (2)
            2005
            $
                165,000
            $
                40,000
            -
            -
            -
            -
            $
                8,2702004
            $
                155,192
            $
                30,000
            -
            -
            -
            -
            $
                7,5192003
            $
                135,000
            $
                30,000
            -
            -
            -
            -
            $
                6,838





(1)     
      Other compensation includes $9,000, $7,003 and $6,150 of contributions to the
      Company’s 401(k) retirement plan for 2005, 2004 and 2003, respectively, and
      $662, $651 and $648 of term life insurance premiums paid by the Bank on Mr.
      Mohler’s behalf for 2005, 2004 and 2003, respectively. Other annual compensation
      for 2004 includes $7,500 which represents the difference between the fair market
      value of 5,000 shares of common stock purchased upon the exercise of warrants
      and the $10 per share exercise price of the warrants. The aggregate market
      value
      of the stock purchased was $57,500 as of the exercise date of September 16,
      2004, based on a sales price of $11.50 per share of Common Stock, which is
      the
      sales price at which shares of Common Stock were last sold in over the counter
      trading on August 31, 2004. The summary of Mr. Mohler’s 2005 compensation does
      not include a bonus of $75,000 approved by the Compensation Committee of the
      Board of Directors on December 12, 2005 and paid on January 20,
      2006.





(2)  Other
      compensation includes $7,388, $6,651 and $5,962 of contributions to the
      Company’s 401(k) retirement plan for 2005, 2004 and 2003, respectively, and
      $882, $868 and $864 of term life insurance premiums paid by the Bank on Mr.
      Semanie’s behalf for 2005, 2004 and 2003, respectively. The summary of Mr.
      Semanie’s 2005 compensation does not include a bonus of $60,000 approved by the
      Compensation Committee of the Board of Directors on December 12, 2005 and paid
      on January 20, 2006.





86





**Aggregate
      Options Table**





The
      following table sets forth information on the aggregate number of shares of
      common stock underlying unexercised options held as of December 31, 2005 by
      Mr.
      Mohler and Mr. Semanie and the aggregate dollar value of in-the-money
      unexercised options held as of December 31, 2005 by Mr. Mohler and Mr.
      Semanie.


Name
            Number
                of Securities Underlying
              Unexercised
                Options at
              December
                31, 2005
            Value
                of Unexercised in-the-Money
              Options
                at
              December
                31, 2005Exercisable
            Unexercisable
            
            
            Exercisable
            UnexercisableHugh
                W. Mohler
            27,945
            9,310
            
            
            $
                375,022
            $
                124,940Mark
                A. Semanie
            13,972
            4,658
            
            
            187,504
            62,510





The
      exercise price of these options is $7.58
      per
      share. The market value of the common stock was $21.00 per share, which is
      the
      sales price at which shares of common stock were last sold in over the counter
      trading on December 31, 2005.





**Employment
      Arrangements**





Bay
      National Bank has entered into a written employment agreement with Mr. Mohler
      dated September 14, 1999, which became effective upon the opening of Bay
      National Bank on May 12, 2000. Under this agreement, Mr. Mohler serves as the
      president of Bay National Bank at an initial annual base salary of $154,000,
      subject to annual review. The Compensation Committee of the Board of Directors
      of the Bank provided Mr. Mohler with base salary increases of $10,000 beginning
      with the 2002 calendar year, $36,000 beginning with the 2005 calendar year,
      and
      $50,000 beginning with the 2006 calendar year. Accordingly, Mr. Mohler’s current
      base salary is $250,000. Also,
      the
      Compensation Committee of the Board of Directors of the Bank approved
      discretionary bonuses to Mr. Mohler of $30,000, $50,000 and $75,000 in December
      2003, 2004 and 2005, respectively (the agreement is silent with respect to
      the
      payment of bonuses to Mr. Mohler). These bonuses were paid in January 2004,
      2005
      and 2006, respectively.





The
      agreement had an initial term of three years, automatically renewable for
      one-year terms unless written notice is provided by either party 90 days before
      expiration of a term. Written notice was not provided by either party 90 days
      before the expiration of the term which was set to expire on September 13,
      2005
      and, accordingly the new term is set to expire on September 13, 2006. It is
      anticipated that the term set to expire in September 2006 will automatically
      renew to September 2007.





Bay
      National Bank may terminate the employment agreement without cause upon 30
      days'
      prior written notice and may terminate the employment agreement for cause at
      any
      time without prior notice. Mr. Mohler may terminate his employment agreement
      at
      any time upon 30 days' prior written notice. In the event Mr. Mohler is
      terminated without cause, he will continue to receive salary payments for the
      earlier of six months from the date of termination or until he has found
      comparable employment. Mr. Mohler is required to use his best efforts to obtain
      comparable employment. In the event Bay National Bank elects to terminate the
      employment agreement at the expiration of a term, Bay National Bank must pay
      Mr.
      Mohler his then base salary for three months.





Pursuant
      to the agreement, if Mr. Mohler is employed by Bay National Bank on the date
      of
      a “change of control,” he is entitled to a payment of 290% of his “base amount”
(as that term is defined in Section 280G(b)(3) of the Internal Revenue Code)
      from Bay National Bank. In general, the employment agreement defines “change of
      control” as: (i) the acquisition by any person of beneficial ownership of forty
      percent (40%) or more of the outstanding shares of common stock of Bay National
      Bank or Bay National Corporation; (ii) the election of a majority of the members
      of the Board of Directors who were not approved or nominated by then incumbent
      board; or (iii) the approval by the stockholders of Bay National Bank or Bay
      National Corporation of: (a) a reorganization, merger or consolidation of Bay
      National Bank or Bay National Corporation, subject to certain exceptions; (b)
      a
      liquidation or dissolution of Bay National Bank or Bay National Corporation;
      or
      (c) the sale or other disposition of all or substantially all of the assets
      of
      Bay National Bank or Bay National Corporation.





87


If
        the
        change of control severance payment were required to be paid in 2006, Mr.
        Mohler
        would receive approximately $725,000.





In
      the
      employment agreement, Mr. Mohler agrees that for a period of six (6) months
      after employment with Bay National Bank or any affiliate, he will not, directly
      or indirectly, own, operate or otherwise be associated with, any financial
      institution which is located in the Bank's market area. Mr. Mohler also agrees
      that for a period of one (1) year after employment with Bay National Bank or
      any
      affiliate, he will not (i) solicit any person or entity which at the time of
      his
      termination was, or within one (1) year prior thereto had been, a customer
      of
      Bay National Bank or any of its affiliates or (ii) solicit the employment of
      any
      person who was employed by Bay National Bank or any of its affiliates on a
      full
      or part time basis at the time of his termination of employment, unless such
      person (a) was involuntarily discharged by Bay National Bank or the affiliate
      or
      (b) voluntarily terminated his relationship with Bay National Bank or the
      affiliate prior to Mr. Mohler's termination of employment.





Bay
      National Bank has purchased "key man" life insurance on Mr. Mohler.





Bay
      National Bank has agreed to employ Mr. Semanie on an at will basis at a rate
      of
      pay of $180,000 as of January 1, 2006. Mr. Semanie is also eligible for
      incentive bonuses at the discretion of the Compensation Committee of the Board
      of Directors, and is entitled to all benefits available to full time employees
      of Bay National Bank. Mr. Semanie is not a party to a written agreement with
      Bay
      National Bank.





The
      Compensation Committee of the Board of Directors of the Bank approved
      discretionary bonuses to Mr. Semanie of $30,000 in December 2002 and 2003,
      $40,000 in December 2004, and $60,000 in December 2005. These bonuses were
      paid
      in the subsequent calendar year.





In
      November 2001, Mr. Mohler was granted options to purchase 37,261 shares of
      Bay
      National Corporation common stock, and Mr. Semanie was granted options to
      purchase 18,630 shares of Bay National Corporation common stock. The options
      vest in four (4) equal installments with the first 25% installment vesting
      on
      the third anniversary of the officer’s date of employment with Bay National
      Bank. The remaining 25% installments vest on the fourth, fifth and sixth
      anniversary of the individual officer’s date of employment with Bay National
      Bank. A total of 51,233 of these options to purchase shares were exercisable
      as
      of, or within 60 days of, March 23, 2006. The options expire on November 19,
      2009. They are exercisable at $7.58 per share. None have been
      exercised.




88





Item
      11.
      Security Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters





**Securities
      Authorized For Issuance Under Equity Compensation Plans**





The
      following table sets forth certain information as of December 31, 2005,
      with respect to compensation plans under which equity securities of Bay National
      Corporation are authorized for issuance.





**Equity
                Compensation Plan Information**Plan
                category
            
            Number
                of securities to be issued upon exercise of outstanding options and
                warrants
              (a)
            
            
            Weighted-average
                exercise price of outstanding options and warrants
              (b)
            
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a)
              (c)4Equity
                compensation plans approved by security holders
            
            140,766
            
            
            $
                7.67
            
            
            52,508Equity
                compensation plans not approved by security holders
            
            -Total
            
            140,766
            
            
            $
                7.67
            
            
            52,508





89


**Security
      Ownership**





The
      following table sets forth the beneficial ownership of Bay National
      Corporation's common stock as of March
      23,
      2006 by its directors, executive officers named in the Summary Compensation
      Table in Item 10 above, directors and officers as a group and persons believed
      by management to beneficially own more than five percent (5%) of the common
      stock. The table includes warrants and options beneficially owned by these
      persons. Unless otherwise noted below, management believes that each person
      named in the table has the sole voting and sole investment power with respect
      to
      each of the shares of common stock reported as beneficially owned by such
      person.





**Name
                and Address**
              **of
                Beneficial Owner (13)**
            **Number
                of Shares (13****)**
            **Percentage**
              **of
                Class**Charles
                E. Bounds(1)
              1707
                Upper Millstone Lane
              Salisbury,
                Maryland 21801
            7,880
            .39%Gary
                T. Gill
              6
                Brierleigh Court
              Lutherville,
                Maryland 21093
            5,949
            .30%R.
                Michael Gill
              707
                President Street, Apt. 1606
              Baltimore,
                Maryland 21202
            1,380
            .07%John
                R. Lerch(2)
              618
                Indian Lane
              Salisbury,
                Maryland 21801
            45,000
            2.24%Donald
                G. McClure, Jr.(3)
              24
                Dockside Lane
              Key
                Largo, Florida 33037
            17,000
            .85%Hugh
                W. Mohler(4)
              23
                Buchanan Road
              Baltimore,
                Maryland 21212
            94,061
            4.68%Robert
                L. Moore(5)
              10
                79th#403
              Ocean
                City, Maryland 21842
            9,844
            .49%James
                P. O’Conor
              2
                Fieldspring Court
              Lutherville,
                Maryland 21093
            5,000
            .25%H.
                Victor Rieger, Jr.(6)
              1015
                Ivy Hill Road
              Cockeysville,
                Maryland 21030
            29,000
            1.44%




90


William
                B. Rinnier(7)
              616
                Manor Drive
              Salisbury,
                Maryland 21801
            13,500
            .67%Edwin
                A. Rommel, III(8)
              5281
                Silver Run Lane
              Salisbury,
                Maryland 21801
            34,500
            1.72%Mark
                A. Semanie (9)
              1200
                Corinthian Court
              Bel
                Air, Maryland 21014
            15,653
            .78%Henry
                H. Stansbury(10)
              6200
                Foxhall Farm Road
              Catonsville,
                Maryland 21228
            36,800
            1.83%Kenneth
                H. Trout (11)
              804
                Hillstead Drive
              Lutherville,
                Maryland 21093
            89,482
            4.45%Eugene
                M. Waldron, Jr.(12)
              5309
                Woodlawn Avenue
              Chevy
                Chase, Maryland 20815
            40,000
            1.99%Carl
                A.J. Wright
              8609
                Marburg Manor Drive
              Lutherville,
                Maryland 21093
            14,000
            .70%All
                directors and executive officers as a group: Sixteen persons
            459,049
            22.82%NexTier,
                Inc.
              P.O.
                Box 1550
              Butler,
                Pennsylvania 16003
            163,624
            8.13%





(1)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005.





(2)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005. Includes 9,000 shares held by LFI partnership, of which
      Mr. Lerch is a general partner; and 4,000 shares held by Mr. Lerch’s spouse.





(3)  Includes
      2,250 shares issuable upon the exercise of options that were exercisable
      starting in April 2005 and 750 shares issuable upon the exercise of options
      that
      are exercisable within 60 days of the date of this annual report. Includes
      10,000 shares held in trust for the benefit of Mr. McClure’s children for which
      Mr. McClure is a co-trustee.





91


(4)  Includes
      40,261 shares issuable upon the exercise of options that were fully exercisable
      starting in May 2006. Includes 1,000 shares held by Mr. Mohler’s spouse.





(5)  Includes
      2,250 shares issuable upon the exercise of options that were exercisable
      starting in starting in February 2006.





(6)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005. Includes 1,000 shares held by Mr. Rieger’s spouse.





(7)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in August 2005. Includes 3,000 shares held by Mr. Rinnier’s
      spouse.





(8)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005.





(9)  Includes
      13,972 shares issuable upon the exercise of options that were exercisable
      starting in October 2005.





(10)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005. Includes 12,500 shares held by Mr. Stansbury’s spouse.





(11)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in October 2005. Includes 84,482 shares held by Rosemore, Inc. Mr.
      Trout disclaims beneficial ownership as to the shares held by Rosemore,
      Inc.





(12)  Includes
      3,000 shares issuable upon the exercise of options that were fully exercisable
      starting in June 2005.





(13)  All
      of the named individuals, other than Mr. Semanie, are directors of Bay National
      Corporation. Mr. Mohler is a director and executive officer of Bay National
      Corporation.





The
      number of shares beneficially owned includes shares of common stock subject
      to
      options held by the named persons that are exercisable as of, or within 60
      days
      of, this report. Such shares are deemed outstanding for the purpose of computing
      the percentage ownership of the person holding the options or warrants, but
      are
      not deemed outstanding for the purpose of computing the percentage ownership
      of
      any other person.





Item
      12.
      Certain Relationships and Related Transactions





Prior
      to
      Bay National Corporation’s initial public offering, the organizers of Bay
      National Corporation and Bay National Bank and certain other investors purchased
      an aggregate of 112,500 shares of Bay National Corporation’s common stock at a
      purchase price of $10.00 per share. The primary purpose of this “organizational
      offering” was to provide Bay National Corporation and Bay National Bank with the
      capital necessary to fund some of the initial organizational and prepaid
      operating expenses.





In
      recognition of the financial and organizational risk undertaken by the
      purchasers in the organizational offering, on September 10, 1999, the purchasers
      in the organizational offering received, for no additional consideration, a
      warrant to purchase one share of common stock at $10.00 per share for every
      two
      shares that they purchased in the organizational offering. As a result, Bay
      National Corporation issued warrants to purchase an aggregate of 56,250 shares
      of common stock to the purchasers in the organizational offering.





92


The
      warrants became exercisable on April 30, 2001 and were exercisable in whole
      or
      in part until November 16, 2004. Prior to expiration on November 16, 2004,
      55,000 of the warrants were exercised. The remaining 1,250 warrants expired.
      Bay
      National Corporation received an aggregate of $550,000 from the exercise of
      the
      warrants.





Lucy
      Mohler, the spouse of Hugh W. Mohler, serves as Bay National Corporation’s and
      Bay National Bank’s Vice President of Marketing and Investor Relations. Ms.
      Mohler earned an aggregate compensation of $72,308 plus benefits valued at
      $3,239 during 2004 and aggregate compensation of $75,000 plus benefits valued
      at
      $3,373 during 2005 from Bay National Bank.





E.
      Matthew Waldron, III and C. Bradford Wright, the sons of directors Eugene M.
      Waldron and Carl A.J. Wright, respectively, became employees of Bay National
      Bank during 2004. Neither of them earned aggregate compensation in excess of
      $60,000 during 2004 or 2005.





Director
      John R. Lerch owns a 100% interest in the property being leased for Bay National
      Bank's Salisbury, Maryland branch office. This lease, which became effective
      as
      of September 1, 1999, was for a term of five years with Bay National Corporation
      having the option to extend the term for three five-year renewal terms. During
      the initial lease term, Bay National Corporation paid monthly rent of
      approximately $1,980, plus all real estate taxes and utilities. Bay National
      Corporation exercised its option to extend this lease and it will now terminate
      on August 31, 2009, unless extended. During the new lease term, Bay National
      Corporation will pay monthly rent of approximately $2,292, plus all real estate
      taxes and utilities. Pursuant to this lease, Bay National Corporation has a
      right of first refusal to purchase the building in the event the landlord
      receives a bona fide offer to sell. Bay National Corporation paid Mr. Lerch
      $25,004 during 2004 and $27,500 during 2004 or 2005.





At
      the
      time of entering into the lease in 1999, Bay National Corporation believed
      that
      the lease rate was at fair market value, based, in part, on an evaluation of
      the
      lease terms by William E. Martin of ERA Martin Associates, a Salisbury-based
      real estate brokerage firm. Bay National Corporation engaged Mr. Martin to
      review the lease terms for the purpose of determining whether the terms were
      consistent with the lease terms for similar properties in the downtown Salisbury
      area. Although Bay National Corporation did not have an independent third party
      reevaluate the lease terms in connection with the renewal, management believes
      that the terms of the lease are at least as favorable as could be obtained
      from
      an independent third party.




Director
      Gary T. Gill is president and chief executive officer of the MacKenzie
      Companies, which owns the property being leased for Bay National Bank's
      Lutherville, Maryland corporate and branch offices. Bay National Corporation
      is
      a party to two leases with this landlord dated July 16, 1999.  These leases
      were amended during February and October 2004 to add additional space and
      extended in October 2004 to February 28, 2010.  The leases were further
      amended in January and March 2005 to add additional space.  Bay National
      Corporation has the right to extend the leases for one additional five year
      term, to February 28, 2015.  The various amendments effectively combined
      both leases.




As
      of
      December 31, 2005, Bay National Corporation was leasing 4,067 square feet on
      the
      first floor of the building , 6,206 square feet on the third floor of the
      building, and 1,429 square feet in the basement of the building and was paying
      $28,258 in monthly rent, which includes Bay National Corporation’s share of
      taxes and building operating costs. Bay National Corporation paid the landlord
      $202,945 during 2004 and $286,406 during 2005.





93





The
      leases were originally entered into well in advance of Mr. Gill’s appointment to
      the Board of Directors in January 2003. Although Bay National Corporation did
      not have an independent third party reevaluate the lease terms in connection
      with the renewal, or evaluate the terms of the lease of additional space,
      management believes that the terms of the lease are at least as favorable as
      could be obtained from an independent third party.





Some
      of
      Bay National Bank’s directors and officers and the business and professional
      organizations with which they are associated have banking transactions with
      Bay
      National Bank in the ordinary course of business. It is Bay National Bank’s
      policy that any loans and loan commitments will be made in accordance with
      applicable laws and on substantially the same terms, including interest rates
      and collateral, as those prevailing at the time for comparable transactions
      with
      other persons of comparable credit standing. Loans to directors and officers
      must comply with Bay National Bank's lending policies and statutory lending
      limits; therefore, directors with a personal interest in any loan application
      will be excluded from considering any such loan application.





The
      officers and directors of Bay National Corporation and Bay National Bank have
      loans due to Bay National Bank in the amount of $8,059,647 at December 31,
      2005
      and $5,828,095 at December 31, 2004. All loans were made on substantially the
      same terms, including interest rates and collateral, as those prevailing at
      the
      time for comparable transactions with unaffiliated third parties and do not
      involve more than the normal risk of repayment or present other unfavorable
      features.


94





Item
      13.
      Exhibits





The
      following exhibits are filed with or incorporated by reference into this report.





No.
            Description
                of Exhibit3.1*
            Articles
                of Incorporation of Bay National Corporation3.2*
            Bylaws
                of Bay National Corporation4.1*
            Rights
                of Holders of Common Stock (as contained in Exhibit
                3.1)4.2*
            Form
                of Common Stock Certificate4.3
            Indenture
                dated as of December 12, 2005 between Bay National Corporation and
                Wilmington Trust Company, as Trustee.4.4
            Amended
                and Restated Declaration of Trust dated as of December 12, 2005 between
                Wilmington Trust Company, as the Trustees of Bay National Capital
                Trust I,
                Bay National Corporation, as Sponsor, and Hugh W. Mohler, Mark A.
                Semanie
                and Warren F. Boutilier, as the Administrators.4.5
            Guarantee
                Agreement dated as of December 12, 2005 between Bay National Corporation
                and Wilmington Trust Company.10.1#*
            Employment
                Agreement between Bay National Bank and Hugh W. Mohler dated September
                14,
                199910.2#*
            Terms
                of December 2005 Amendment to Employment Agreement between Bay National
                Bank and Hugh W. Mohler10.3
            Terms
                of December 2006 Amendment to Employment Agreement between Bay National
                Bank and Hugh W. Mohler10.4
            Terms
                of Employment Arrangement between Bay National Bank and Mark A.
                Semanie10.5**
            Bay
                National Corporation Stock Option Plan10.6**
            Form
                of Incentive Stock Option Agreement for Stock Option
                Plan10.7#
            Bay
                National Corporation and Bay National Bank Director Compensation
                Policy10.8*
            Office
                Lease Agreement dated July 16, 1999 between Bay National Corporation
                and
                Joppa Green II Limited Partnership10.9*
            Office
                Lease Agreement dated July 16, 1999 between Bay National Corporation
                and
                Joppa Green II Limited Partnership10.10##
            Amendment
                to Lease Agreement dated February 12, 2004 between Bay National
                Corporation and Joppa Green II Limited Partnership10.11##
            Amendment
                to Lease Agreement dated October 5, 2004 between Bay National Corporation
                and Joppa Green II Limited Partnership10.12##
            Amendment
                to Lease Agreement dated January 3, 2005 between Bay National Corporation
                and Joppa Green II Limited Partnership10.13##
            Amendment
                to Lease Agreement dated March 7, 2005 between Bay National Corporation
                and Joppa Green II Limited Partnership10.14*
            Lease
                Agreement dated September 16, 1999 between Bay National Corporation
                and
                John R. Lerch and Thomas C. Thompson14@
            Code
                of Ethics for Senior Financial Officers21.1
            Subsidiaries
                of Bay National Corporation23.1
            Consent
                of Stegman & Company31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200231.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200232
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                Section
                906 of the Sarbanes-Oxley Act of
                2002.





The
      exhibits which are denominated with an asterisk (*) were previously filed by
      Bay
      National Corporation as a part of, and are hereby incorporated by reference
      from, Bay National Corporation’s Registration Statement on Form SB-2, as
      amended, under the Securities Act of 1933, Registration Number
      333-87781.





The
      exhibit which are denominated by two asterisks (**) were previously filed by
      Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Registration Statement on Form S-8, as amended, under
      the Securities Act of 1933, Registration Number 333-69428.





The
      exhibit which is denominated by the at sign (@) was previously filed by Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Annual Report on Form 10-KSB, as amended, filed on
      March 30, 2004.





The
      exhibit which is denominated by the number sign (#) was previously filed by
      Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Current Report on Form 8-K filed on January 26,
      2005.





The
      exhibit which is denominated by two number signs (##) was previously filed
      by
      Bay National Corporation as a part of, and is hereby incorporated by reference
      from, Bay National Corporation’s Current Report on Form 8-K filed on March 11,
      2005.





The
      exhibits which are denominated by the number sign followed by the asterisk
      (#*)
      were previously filed by Bay National Corporation as a part of, and are hereby
      incorporated by reference from, Bay National Corporation’s Annual Report on From
      10-KSB filed on March 29, 2005.








Note:
      Exhibits 10.1 through 10.7 relate to management contracts or compensatory plans
      or arrangements.





95


Item
      14.
      Principal Accountant Fees and Services.





Audit
      and
      Non-Audit Fees




The
      following table presents fees for professional audit services rendered by
      Stegman & Company for the audit of Bay National Corporation’s annual
      consolidated financial statements for the years ended December 31, 2005 and
      December 31, 2004 and fees billed for other services rendered by Stegman &
Company during those periods.




Years
                Ended December 312005
            
            
            2004Audit
                Fees (1)
            
            
            
            $
            45,490
            
            $
            37,669Audit
                Related Fees (2)
            
            
            
            
            -
            
            
            -Tax
                Fees (3)
            
            
            
            
            5,550
            
            
            4,000All
                Other Fees (4)
            
            
            
            
            -
            
            
            -Total
            
            
            
            $
            51,040
            
            $
            41,669








(1) Audit
      Fees consist of fees billed for professional services rendered for the audit
      of
      the Company’s consolidated annual financial statements and review of the interim
      consolidated financial statements included in quarterly reports and services
      that are normally provided by Stegman & Company in connection with statutory
      and regulatory filings or engagements.





(2)
      Audit-Related Fees would normally consist of fees billed for assurance and
      related services that are reasonably related to the performance of the audit
      or
      review of the Company’s consolidated financial statements and are not reported
      under “Audit Fees.”





(3)
      Tax
      Fees consist of fees billed for professional services rendered for federal
      and
      state tax compliance, tax advice and tax planning.





(4)
      All
      Other Fees would normally consist of fees for services other than the services
      reported above.





Policy
      on
      Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent
      Auditor




Before
      the accountant is engaged by Bay National Corporation or Bay National Bank
      to
      render any audit or non-audit services, the engagement is approved by Bay
      National Corporation’s audit committee.


96


**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




BAY
                NATIONAL CORPORATIONDate:
                March 28, 2006
            By:
            /s/
                Hugh W. MohlerHugh
                W. Mohler, President





In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.











**Name**
            **Position**
            **Date**/s/
                Hugh W. Mohler
              Hugh
                W. Mohler
            Director
                and President (Principal Executive Officer)
            March
                28, 2006/s/
                Mark A. Semanie
              Mark
                A. Semanie
            Executive
                Vice President and CFO
              (Principal
                Accounting and Financial Officer)
            March
                28, 2006/s/
                Charles E. Bounds
              Charles
                E. Bounds
            Director
            March
                28, 2006/s/
                Gary T. Gill
              Gary
                T. Gill
            Director
            March
                28, 2006/s/
                R. Michael Gill
              R.
                Michael Gill
            Director
            March
                28, 2006/s/
                John R. Lerch
              John
                R. Lerch
            Director
            March
                28, 2006/s/
                Donald G. McClure, Jr.
              Donald
                G. McClure, Jr.
            Director
            March
                28, 2006/s/
                Robert L. Moore
              Robert
                L. Moore
            Director
            March
                28, 2006/s/
                James P. O’Conor
              James
                P. O’Conor
            Director
            March
                28, 2006/s/
                H. Victor Rieger, Jr.
              H.
                Victor Rieger, Jr.
            Director
            March
                28, 2006




97


/s/
                William B. Rinnier
              William
                B. Rinnier
            Director
            March
                28, 2006/s/
                Edwin A. Rommel
              Edwin
                A. Rommel, III
            Director
            March
                28, 2006/s/
                Henry H. Stansbury
              Henry
                H. Stansbury
            Director
            March
                28, 2006/s/
                Kenneth H. Trout
              Kenneth
                H. Trout
            Director
            March
                28, 2006/s/
                Eugene M. Waldron, Jr.
              Eugene
                M. Waldron, Jr.
            Director
            March
                28, 2006/s/
                Carl A. J. Wright
              Carl
                A.J. Wright
            Director
            March
                28, 2006





98


EXHIBIT
      INDEX








No.
            Description
                of Exhibit3.1*
            Articles
                of Incorporation of Bay National Corporation3.2*
            Bylaws
                of Bay National Corporation4.1*
            Rights
                of Holders of Common Stock (as contained in Exhibit
                3.1)4.2*
            Form
                of Common Stock Certificate4.3
            Indenture
                dated as of December 12, 2005 between Bay National Corporation and
                Wilmington Trust Company, as Trustee.4.4
            Amended
                and Restated Declaration of Trust dated as of December 12, 2005 between
                Wilmington Trust Company, as the Trustees of Bay National Capital
                Trust I,
                Bay National Corporation, as Sponsor, and Hugh W. Mohler, Mark A.
                Semanie
                and Warren F. Boutilier, as the Administrators.4.5
            Guarantee
                Agreement dated as of December 12, 2005 between Bay National Corporation
                and Wilmington Trust Company.10.1#*
            Employment
                Agreement between Bay National Bank and Hugh W. Mohler dated September
                14,
                199910.2#*
            Terms
                of December 2005 Amendment to Employment Agreement between Bay National
                Bank and Hugh W. Mohler10.3
            Terms
                of December 2006 Amendment to Employment Agreement between Bay National
                Bank and Hugh W. Mohler10.4
            Terms
                of Employment Arrangement between Bay National Bank and Mark A.
                Semanie10.5**
            Bay
                National Corporation Stock Option Plan10.6**
            Form
                of Incentive Stock Option Agreement for Stock Option
                Plan10.7#
            Bay
                National Corporation and Bay National Bank Director Compensation
                Policy10.8*
            Office
                Lease Agreement dated July 16, 1999 between Bay National Corporation
                and
                Joppa Green II Limited Partnership10.9*
            Office
                Lease Agreement dated July 16, 1999 between Bay National Corporation
                and
                Joppa Green II Limited Partnership10.10##
            Amendment
                to Lease Agreement dated February 12, 2004 between Bay National
                Corporation and Joppa Green II Limited Partnership10.11##
            Amendment
                to Lease Agreement dated October 5, 2004 between Bay National Corporation
                and Joppa Green II Limited Partnership10.12##
            Amendment
                to Lease Agreement dated January 3, 2005 between Bay National Corporation
                and Joppa Green II Limited Partnership10.13##
            Amendment
                to Lease Agreement dated March 7, 2005 between Bay National Corporation
                and Joppa Green II Limited Partnership10.14*
            Lease
                Agreement dated September 16, 1999 between Bay National Corporation
                and
                John R. Lerch and Thomas C. Thompson14@
            Code
                of Ethics for Senior Financial Officers21.1
            Subsidiaries
                of Bay National Corporation23.1
            Consent
                of Stegman & Company31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200231.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200232
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                Section
                906 of the Sarbanes-Oxley Act of
                2002.






99





The
      exhibits which are denominated with an asterisk (*) were previously filed by
      Bay
      National Corporation as a part of, and are hereby incorporated by reference
      from, Bay National Corporation’s Registration Statement on Form SB-2, as
      amended, under the Securities Act of 1933, Registration Number
      333-87781.





The
      exhibit which are denominated by two asterisks (**) were previously filed by
      Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Registration Statement on Form S-8, as amended, under
      the Securities Act of 1933, Registration Number 333-69428.





The
      exhibit which is denominated by the at sign (@) was previously filed by Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Annual Report on Form 10-KSB, as amended, filed on
      March 30, 2004.





The
      exhibit which is denominated by the number sign (#) was previously filed by
      Bay
      National Corporation as a part of, and is hereby incorporated by reference
      from,
      Bay National Corporation’s Current Report on Form 8-K filed on January 26,
      2005.





The
      exhibit which is denominated by two number signs (##) was previously filed
      by
      Bay National Corporation as a part of, and is hereby incorporated by reference
      from, Bay National Corporation’s Current Report on Form 8-K filed on March 11,
      2005.





The
      exhibits which are denominated by the number sign followed by the asterisk
      (#*)
      were previously filed by Bay National Corporation as a part of, and are hereby
      incorporated by reference from, Bay National Corporation’s Annual Report on From
      10-KSB filed on March 29, 2005.








Note:
      Exhibits 10.1 through 10.7 relate to management contracts or compensatory plans
      or arrangements.




100