**U.S. SECURITIES AND EXCHANGE COMMISSION**

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WASHINGTON, D.C. 20549

FORM 10-K

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Annual Report pursuant to Section 13 OR15(d) of the Securities Exchange Act of 1934 (Fee required)

For the fiscal year ended December 31,2006

Commission file number: 0-23090

|        |                                                    | Carrollton Bancorp |   |   |
|--------|---------------------------------------------------------|--------------------|--------|--------|
|   | (Exact Name of Registrant as Specified in  its Charter) |               |

 
|                                                                 |   |                                 |   | Maryland                                                   |   |   |   |   |   | 52 1660951 |
|-----------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------------------------------|--------|--------|--------|--------|--------|------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |   | 344 N. Charles  St.                                        |   |   |   |   |   |       |
|                                                            |   |                                 |   | Baltimore, MD                                              |   |   |   |   |   | 21201      |
|                                                            |   |                                 |   | (Address of principal executive offices)                   |   |   |   |   |   | (Zip Code) |
|                                                            |   |                                 |   | (410) 536 4600                                             |   |   |   |   |   |       |
|                                                            |   |                                 |   | (Registrant’s telephone number,  including area code) |   |   |   |   |   |       |

 

Securities registered pursuant to Section 12(b) ofthe Act:

None

Securities registered pursuantto Section 12(g) of the Act:

Common Stock,par value $1.00 per share

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(Title of class)

Indicate bycheck mark whether the registrant is a well-known seasoned issuer, as definedin Rule 405 of the Securities Act. Yes x   No o

Indicate bycheck mark whether the registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Act. Yes o   No x

Indicate bycheck mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained in this form, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K o.

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

Largeaccelerated filer o   Acceleratedfiler o   Non-acceleratedfiler x

Indicate bycheck mark if the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o   No x

The aggregatemarket value of the Common Stock, all of which has voting rights, held by non-affiliatesof the registrant on December 31,****2006****was approximately $39.4 million. This calculation is basedupon the last price known to the registrant at which its Common Stock was soldas of the last business day of the registrant’s most recently completed fourthfiscal quarter. As of December 31, 2006, the last known sale price was $17.16per share. For the purpose of this calculation, the term “affiliate” referes toall directors and executive officers of the registrant.

On March 9, 2007, 2,819,035 shares ofthe registrant’s common stock were issued and outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

The Company’sProxy Statement for Annual Meeting of Shareholders to be held on May 15, 2007,is incorporated by reference in this Form 10-K in Part III, Item10, Item 11, Item 12, Item 13, and Item 14.

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CARROLLTON BANCORP

**TABLE OF CONTENTS**
| PART I         |   |                                                                                             |   |   |   |
|---------------------|--------|--------------------------------------------------------------------------------------------------|--------|--------|--------|
| Item 1 —  |   | Business                                                                                         |   | 4      |   |
| Item 1A — |   | Risk Factors                                                                                     |   | 11     |   |
| Item 2 —  |   | Properties                                                                                       |   | 14     |   |
| Item 3 —  |   | Legal Proceedings                                                                                |   | 15     |   |
| Item 4 —  |   | Submission of  Matters to a Vote of Security Holders                                             |   | 15     |   |
| PART II        |   |                                                                                             |   |   |   |
| Item 5 —  |   | Market for  Registrant’s Common Equity and Related Shareholders Matters                     |   | 16     |   |
| Item 6 —  |   | Selected  Financial Data                                                                         |   | 18     |   |
| Item 7 —  |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations      |   | 19     |   |
| Item 7A — |   | Quantitative  and Qualitative Disclosures About Market Risk                                      |   | 33     |   |
| Item 8 —  |   | Financial  Statements and Supplementary Data                                                     |   | 34     |   |
| Item 9 —  |   | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure            |   | 60     |   |
| Item 9A — |   | Controls and  Procedures                                                                         |   | 60     |   |
| Item 9B — |   | Other Information                                                                                |   | 60     |   |
| PART III       |   |                                                                                             |   |   |   |
| Item 10 — |   | Directors,  Executive Officers, and Corporate Governance                                         |   | 60     |   |
| Item 11 — |   | Executive  Compensation                                                                          |   | 60     |   |
| Item 12 — |   | Security  Ownership of Certain Beneficial Owners and Management and  Related Stockholder Matters |   | 60     |   |
| Item 13 — |   | Certain  Relationships and Related Transactions and Director Independence                        |   | 60     |   |
| Item 14 — |   | Principal Accountant  Fees and Services                                                          |   | 60     |   |
| PART IV        |   |                                                                                             |   |   |   |
| Item 15 — |   | Exhibits and  Financial Statement Schedules                                                      |   | 61     |   |
| Signatures          |   |                                                                                             |   | 62     |   |

 

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2006 ANNUAL REPORT

**FORWARD-LOOKING STATEMENTS**

This AnnualReport on Form 10-K and certain information incorporated herein byreference contain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. All statements included orincorporated by reference in this Annual Report on Form 10-K, otherthan statements that are purely historical, are forward-lookingstatements. Statements that include the use of terminology such as “anticipates,”“expects,” “plans”, “believes,” “estimates” and similar expressions alsoidentify forward-looking statements. The forward-looking statementsare based on Carrollton Bancorp’s current intent, belief and expectations.Forward-looking statements in this Annual Report on Form 10-Kinclude, but are not limited to:

Part I.Item 3. Legal Proceedings:

Statement regarding the impact on the Companyof routine legal proceeding.

Part II.Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations:

Statements regarding loan growth in realestate development and construction and commercial loan portfolios in 2007.

Statement regarding 2007****certificateof deposit pricing strategy.

Statement regarding challenges facingmanagement in terms of interest rates, growth in net interest income andoverall management of the net interest margin.

Statements regarding volatility in mortgagerefinancing activity.

Part III.Item 7A. Quantitative and Qualitative Disclosures About Market Risk:

Statements regarding the Company’s ability tolimit exposure to interest rate risk.

Statements regarding factors that influencedemand for real estate loans.

Statements regarding future revenueimprovements.

Statements regarding the sufficiency of theCompany’s allowance for loan losses.

Part IV.Item 8. Note 3. Investments:

Statement regarding anticipated changes inthe fair value of securities in relation to market rates.

Thesestatements are not guarantees of future performance and are subject to certainrisks and uncertainties that are difficult to predict. Actual results maydiffer materially from these forward-looking statements because ofinterest rate fluctuations, a deterioration of economic conditions in theBaltimore/ Washington metropolitan area, a downturn in the real estate market,losses from impaired loans, an increase in nonperforming assets, potentialexposure to environmental laws, changes in federal and state bank laws andregulations, the highly competitive nature of the banking industry, a loss ofkey personnel, changes in accounting standards and other risks described in theCompany’s filings with the Securities and Exchange Commission. Existing andprospective investors are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date of thisReport. Carrollton Bancorp undertakes no obligation to update or revise theinformation contained in this Annual Report whether as a result of newinformation, future events or circumstances or otherwise. Past results of operationsmay not be indicative of future results.

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CARROLLTON BANCORP

 

PART I

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**ITEM 1: BUSINESS**

**General. **– Carrollton Bancorp(the “Company”), a bank holding company registered under the Bank HoldingCompany Act of 1956, as amended, was organized on January 11, 1990, and isheadquartered in Baltimore, Maryland. Carrollton Bank (the “Bank”) is acommercial bank and the principal subsidiary of the Company. The Bank waschartered by an act of the General Assembly of Maryland (Chapter 727) approved April10, 1900. The Bank is engaged in a general commercial and retail banking businessand, as of December 31, 2006,****had a total often branch locations in Maryland with two branch locations in Baltimore City;three branch locations in Anne Arundel County; four branches in BaltimoreCounty and one branch  in Harford County.The Company expects its fifth branch to open in Baltimore County in June 2007. TheBank’s wholly owned subsidiaries are Carrollton Mortgage Services, Inc. (“CMSI”),which is used primarily to originate and sell residential mortgage loans,Carrollton Financial Services, Inc. (“CFS”), which provides brokerage services,and Mulberry Street LLC (“MSLLC”) which is used to dispose of other real estateowned. Carrollton Community Development Corporation (“CCDC”) is a 96.4% ownedsubsidiary of the Bank which promotes, develops and improves the housing andeconomic conditions of people in Maryland, particularly the MetropolitanBaltimore area.

The Bank alsooperated a network of ATMs in Maryland, Virginia, and West Virginia andsponsors national retailers who accept ATM cards for purchases in variouselectronic networks. On September 22, 2005, Wal-Mart notified the Bank of itsintention to terminate the agreement for the Bank to provide ATM’s at Wal-Mart,Sam’s Club, and Wal-Mart Supercenters in Maryland, Virginia, and West Virginia.The effective date of the termination was January 22, 2006.

The Bank is anindependent, community bank that seeks to provide personal attention andprofessional financial services to its customers while offering virtually allof the banking services of larger competitors. Our customers are primarilyindividuals and small and medium-sized businesses. The Bank’s businessphilosophy includes offering informed and courteous service, local and timelydecision-making, flexible and reasonable operating procedures andconsistently applied credit policies.

The executiveoffices of the Company and the principal office of the Bank are located at 344North Charles Street, Baltimore, Maryland 21201, telephone number (410) 536-4600.The Company files quarterly and annual reports with the Securities and ExchangeCommission (“SEC”) on forms 10-Q and 10-K, respectively, proxymaterials on Schedule 14A and current reports on Form 8-K. The Companymakes available, free of charge, all of these reports, as well as any amendments,through the Company’s Internet site as soon as is reasonably practicable afterthey are filed electronically with the SEC. The address of that site is *http://www.carrolltonbank.com*. To accessthe SEC reports, click on *“InsiderTransactions — SEC Filings” — ”SEC Filings”*. The SEC also maintainsan internet site that contains reports, proxy materials and informationstatements at *http://sec.gov*. Inaddition, the Company will provide paper copies of filings free of charge uponwritten request.

**Description of Services. **– TheBank provides a broad range of consumer and commercial banking products andservices to individuals, businesses, professionals and governments. Theservices and products have been designed in such a manner as to appeal toconsumers and business principals.

The following is a partial listing of thetypes of services and products that the Bank offers:

·         Commercial loans forbusinesses, including those for working capital purposes, equipment purchasesand accounts receivable and inventory financing.

·         Commercial andresidential real estate loans for acquisition, refinancing and construction.

·         Consumer loans includingautomobile loans, home equity loans and lines of credit.

·         Loans guaranteed by theUnited States Small Business Administration.

·         Money market deposits,demand deposits, NOW accounts, savings accounts and certificates of deposit.

·         Internet banking,including electronic bill payment

·         Letters of credit andremittance services.

·         Credit and debit cardservices.

·         Merchant credit carddeposit servicing.

·         Brokerage services forstocks, bonds, mutual funds and annuities.

·         A 24-hour ATMnetwork.

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2006 ANNUAL REPORT

·         After-hoursdepository services.

·         Safe deposit boxes.

·         Point of Sale (POS)services.

·         Other services, such asdirect deposit, traveler’s checks and IRAs.

Customerservice hours for the Bank are competitive with other institutions in themarket area. The Bank also acts as a reseller of services purchased from thirdparty vendors for customers requiring services not offered directly by theBank.

**Lending Activities. **– TheBank makes various types of loans to borrowers based on, among other things, anevaluation of the borrowers’ net asset value, cash flow, security and abilityto repay. Loans to consumers include home mortgage loans, home equity lines ofcredit, home improvement loans, overdraft lines of credit, and installmentloans for automobiles, boats and recreational vehicles. The Bank also makesloans secured by deposit accounts and common stocks. The Bank’s commercial loanproduct line includes commercial mortgage loans, time and demand loans, linesand letters of credit, and acquisition, development and construction financing.The Notes to the Consolidated Financial Statements contained in Part II,Item 8 report the classification by type of loan for the whole portfolio.

First andsecond residential mortgage loans, made principally through the Bank’ssubsidiary, CMSI, enable customers to purchase or refinance residentialproperties. These loans are secured by liens on the residential property. Allfirst mortgage loans with a loan to value ratio greater then 80% have privatemortgage insurance coverage equal to or greater than the amount required underthe Federal National Mortgage Association guidelines. Residential loans areconsidered low risk based on the type of collateral (residential property) andthe underwriting standards used. The Bank experienced no losses and norecoveries on residential mortgage loans in 2006. The Bank experienced nolosses and recoveries of $14,874 in 2005. The Bank experienced losses of $746and recoveries of $8,087 in 2004. There were no residential mortgage loansdelinquent more than 90 days at December 31, 2006. There are no discernibledelinquency or loss trends relating to residential mortgage loans known tomanagement.

Home equitylines of credit are typically second mortgage loans (sometimes first mortgages)secured by the borrower’s primary residence structured as a revolving borrowingline with a maximum loan amount. Customers write checks to access the line.Generally, the Bank has a second lien on the property behind the first mortgagelien holder. The Bank has a number of different equity loan products that itoffers. Borrowers can choose between fixed rate loans or loans tied to theprime rate with margins ranging from 0% to 1.5%. The Bank will finance up to90% of the value of the home in combination with the first mortgage loanbalance, depending on the rate and program. Home equity loans carry a higherlevel of risk than first mortgage residential loans because of the second lienposition on the property, and because a higher loan to value ratio is used inthe underwriting of the loan. However, the overall risk of loss on home equityloans is also considered low due to the underlying values of the collateral.The Bank experienced no losses or recoveries on home equity loans during 2006.The Bank experienced losses on home equity loans during 2005 of $0 andrecoveries of $7,700. The Bank experienced losses on home equity loans during2004 of $7,000 and recoveries of $0. There were $0 of home equity loansdelinquent more than 90 days at December 31, 2006**.**There are no discernible delinquency or loss trends relating to home equityloans known to management.

Commercial andinvestment mortgage loans are first mortgage loans made to individuals or tobusinesses to finance acquisitions of plant or earning assets, such as rentalproperty. These loans are secured by a first mortgage lien on the commercialproperty, and may be further secured by other property or other assetsdepending on the value of the mortgaged property. In most instances, theseloans are guaranteed personally by the principals. The Bank typically looks forcash flow from the business at least equal to 115% coverage of the business debtservice, and for income-producing property to be self-supporting,generally, with a minimum debt service coverage ratio of 120% to 125%.Commercial mortgage loans carry more risk than residential real estate loans.Commercial mortgage loans tend to be larger in size, and the properties tend toexhibit more fluctuation in value. The repayment of the loan is primarilydependent on the success of the business itself, or the tenants in the case ofincome producing property. Economic cycles can affect the success of abusiness. The Bank experienced losses on commercial mortgage loans of $59,120during 2006 and $0 during 2005 and 2004, respectively. There were $252,295 ofcommercial mortgage loans past due more than 90 days at December 31, 2006.There are no known discernible delinquency or loss trends relating tocommercial mortgage loans.

Constructionand land development loans are loans to finance the acquisition and developmentof parcels of land and to construct residential housing or commercial property.The Bank typically will finance 70% to 80% of the discounted future value ofthese projects, or 80% of value or 90% of cost, whichever is less, on a single-familydetached home. The loan is collateralized by the project or real estate itself,and other assets or guarantees of the principals in most cases. Repayment tothe Bank is anticipated from the proceeds of sale of the final units, orpermanent mortgage financing on a residential construction loan for a singleborrower. These types of loans carry a higher degree of risk than a commercialmortgage loan. Interest rates, buyer preferences, and desired locations 

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CARROLLTON BANCORP

are all subject to change during the periodfrom the time of the loan commitment to final delivery of the final unit, allof which can change the economics of the project. In addition, real estatedevelopers to whom these loans are typically made are subject to the businessrisk of operating a business in a competitive environment. The Bank did notexperience any losses or recoveries on construction and land development loansduring 2006, 2005, or 2004. There were no construction and land developmentloans past due more than 90 days at December 31, 2006. There are no discernibledelinquency or loss trends relating to construction and land development loansknown to management.

Demand and timeloans and lines of credit are loans to businesses for relatively short periodsof time, usually not more than one year. These loans are made for any validbusiness purpose. These loans may be secured by assets of the borrower orguarantor, but may be unsecured based on the personal guarantee of theprincipal. If secured, loans may be made for up to 100% of the value of thecollateral. The businesses to which these loans are made are subject to normalbusiness risk, and cash flows of the business may be subject to economiccycles. In addition, the value of the collateral may fluctuate. If guaranteedby the principal, the net worth and assets of the principal may be dissipatedby demands of the business, or due to other factors. The Bank had no losses orrecoveries on demand and time loans in 2006.The Bank had losses of $123,578 andrecoveries of $130,904 on time demand and loans in 2005. The Bank had losses of$192,440 and recoveries of $67,111 on demand and time loans in 2004. There wereno demand and time and line of credit loans delinquent more than 90 days at December31, 2005. There are no discernible delinquency or loss trends relating todemand and time loans or lines of credit known to management.

Homeimprovement loans are loans made to borrowers to complete improvements to theirhomes including such projects as room additions, swimming pool installations ornew roofs. The Bank makes unsecured home improvement loans to a maximum amountof $15,000. Any loan above that limit is secured by a deed of trust. Borrowersare required to own their home, and to meet certain income and debt ratiorequirements. The Bank also reviews the credit history of all applicants.Because they are unsecured or secured by a deed of trust, these loans are morerisky than first mortgage residential lending. This risk is mitigated somewhatbased on the fact that the loans are used to improve the borrower’s home,typically a borrower’s most significant asset. In addition, the debt-to-incomeratio requirement helps determine the borrower’s current ability to repay theloan. The Bank had charge-offs of home improvement loans of $11,515, $0 and$10,020, in 2006, 2005 and 2004, respectively. There were recoveries of $608,$0, and $14,898, in 2006, 2005, and 2004, respectively. There were no homeimprovement loans delinquent more than 90 days at December 31, 2005.There are no discernible loss or delinquency trends relating to homeimprovement loans known to management.

The remainderof the consumer loan portfolio is comprised of installment loans forautomobiles, boats and recreational vehicles (“RV”), overdraft protectionlines, and loans secured by deposit accounts or stocks. The largest portion ofthis group is installment loans for automobiles and other vehicles. The Bankwill finance up to 90% of the cost of a new car purchase, or the maximum loanamount as determined by the National Automobile Dealers Association (NADA)publication for used cars. The Bank will finance up to 85% of the cost of a newboat or RV, or the maximum loan amount determined by the NADA Boat/RV Guide forused Boats and RVs. These loans are secured by the vehicle purchased. Borrowersmust meet certain income and debt ratio requirements, and a credit review isperformed on each applicant. These types of loans are subject to the risk thatthe value of the vehicle will decline faster than the amount due on the loan.However, the income-to-debt ratio requirement helps determine the borrower’scurrent ability to repay. The Bank had losses on automobile loans of $6,849 in2006 and no losses in 2005, or 2004, and recoveries of $1,251, $0, and $0, in2006, 2005 and 2004, respectively. There were no automobile or other vehicleloans past due more than 90 days at December 31, 2005. There are nodiscernible delinquency or loss trends relating to automobile or other vehicleloans known to management.

Overdraft linesand other personal loans are unsecured lending arrangements. These loans orlines of credit are made to allow customers to easily make purchases ofconsumer goods. If the lines are handled as agreed, they will typically beautomatically renewed each year. Because they are unsecured, these loans carrya higher level of risk than secured lending transactions. The Bank attempts to mitigatesignificant risk by establishing fairly low credit limits**.**Net charge-offs in 2006, 2005, and 2004 were $11,662, $1,927, and  $43,470, respectively. There were no overdraft loans and other personal loanspast due more than 90 days at December 31, 2006. There are nodiscernible delinquency or loss trends relating to overdraft lines and otherpersonal loans known to management.

Loans securedby savings accounts and stock and bond certificates are secured lendingarrangements. The Bank will advance funds for up to 95% of balances in savingsor certificate of deposit accounts. The Bank will advance funds up to 60% ofthe market value of actively traded stock certificates and bonds or 50% of themarket value of listed but not actively traded stocks and bonds. Loans securedby stocks and bonds are subject to margin calls to maintain the loan to valueratio. Collateral is not released until the loan is repaid, and the borrower isgenerally required to pay interest monthly. There were no losses on loans securedby savings accounts or stock and bond certificates during 2006, 2005, or 2004.Recoveries on loans secured by stocks and bonds were $0, $0, and $411 in 2006,2005, and 2004 respectively. There were no loans secured by savings accounts orstock and bond certificates past due more than 90 days at December 31, 2006.There are no discernible delinquency or loss trends relating to loans securedby savings accounts or stock and bond certificates known to management.

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2006 ANNUAL REPORT

The Bank is theprincipal originator of the loans it makes, at this time. In prior periods,residential mortgage loans and home equity loans and lines of credit werepredominantly purchased from a network of brokers or other types of originatorswith whom the Bank did business. The Bank has sold some loans in the secondarymarket and therefore derives a small amount of noninterest income from servicedloans. These income amounts are not significant to the amounts of noninterestincome derived from other sources.

CMSI originatesadjustable and fixed-rate residential mortgage loans at terms and conditionsand with documentation that permit their sale in the secondary mortgage market.CMSI’s practice is to immediately sell substantially all residential mortgageloans in the secondary market with servicing released.

CCDC wasestablished in 1995 for the purpose of promoting, developing, and improving thehousing and economic conditions of people in Maryland with particular emphasisin the Metropolitan Baltimore area. CCDC promotes through loans, investments,and other transactions, efforts to increase housing for low and moderate-incomeindividuals.

Mulberry StreetLLC was established in 2004 for the purpose of disposing of real estate owned.

**Investment Activities. **– TheCompany maintains a portfolio of investment securities to provide liquidity andincome. The current portfolio amounts to about 16% of total assets, and isinvested primarily in U.S. government agency securities, state and municipalbonds, corporate bonds, and mortgage-backed securities with maturitiesvarying from 2006 to 2031, as well as equity securities.

**Deposit Services. **– The Bankoffers a wide range of both personal and commercial types of deposit accountsand services as a means of gathering funds. Deposit accounts available includenoninterest-bearing demand checking, interest-bearing checking (NOWaccounts), savings, money market, certificates of deposit, and individualretirement accounts. Deposit accounts carry varying fee structures depending onthe level of services desired by the customer. Interest rates vary depending onthe balance in the account maintained by the customer. Commercial depositcustomers may also choose an overnight investment account which automaticallyinvests excess balances available in demand accounts on a daily basis inrepurchase agreements. The Bank’s customer base for deposits is primarilyretail in nature. The Bank also offers certificates of deposit over $100,000 toits retail and commercial customers. The Bank has used deposit brokers in thepast and may do so in the future to meet liquidity needs. The balance ofaccounts over $100,000 is not significant, and these accounts are offeredprincipally as accommodations to existing customers.

The Companyoffers Certificate of Deposit Registry Service (“CDARS”) deposits to itscustomers. This is a program which allows customers to deposit more than wouldnormally be covered by FDIC insurance. CDARS is a nationwide program thatallows participating banks to “swap” customer deposits so that no customer hasgreater than the insurable maximum in one bank, but the customer only dealswith his/her own bank.

In addition totraditional deposit services, the Bank offers telephone banking services,internet banking services and internet bill paying services to its customers.

**Brokerage Activities. **– CFSprovides full service brokerage services for stocks, bonds, mutual funds andannuities. For 2006, commission income totaled $647,000 and net income was$152,000.

**Market. **– The Companyconsiders its core markets to be the communities within the BaltimoreMetropolitan Statistical Area (“Baltimore MSA”), particularly Baltimore Cityand the counties of Baltimore, Anne Arundel and Harford. Lending activities aremore broad and include areas outside of the Baltimore MSA. CMSI operates inDelaware, Pennsylvania, Virginia and West Virginia in addition to its coreMaryland operations.

**Competition. **– The Bank facesstrong competition in all areas of its operations. This competition comes fromentities operating in Baltimore City, Baltimore County, Anne Arundel County,Harford County, and Carroll County, and includes branches of some of thelargest banks in Maryland. Its most direct competition for depositshistorically has come from other commercial banks, savings banks, savings and loanassociations and credit unions. The Bank also competes for deposits with moneymarket funds, mutual funds and corporate and government securities. The Bankcompetes with the same banking entities for loans, as well as mortgage bankingcompanies and other institutional lenders. The competition for loans variesfrom time to time depending on certain factors, including, among others, thegeneral availability of lendable funds and credit, general and local economicconditions, current interest rate levels, conditions in the mortgage market andother factors which are not readily predictable. Some of the Bank’s competitorshave greater assets and operating capacity than the Bank.

Current federallaw allows the acquisition of banks by bank holding companies nationwide.Further, federal and Maryland law permit interstate banking. Recent legislationhas broadened the extent to which financial services companies, such asinvestment banks and insurance companies, may control commercial banks. As aconsequence of these developments, competition in the Bank’s principal marketmay increase, and a further consolidation of financial institutions in Marylandmay occur.

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CARROLLTON BANCORP

**Asset Management. **– The Bankmakes available several types of loan services to its customers as describedabove, depending on customer needs. Recent emphasis has been made onoriginating short-term (one year or less), variable rate commercial loans andvariable rate home equity lines of credit, with the balance of its fundsinvested in consumer/installment loans and real estate loans, both commercialand residential. In addition, a portion of the Bank’s assets is invested inhigh-grade securities and other investments in order to provide income,liquidity and safety. Such investments include U.S. government agencysecurities, corporate bonds, mortgage-backed securities andcollateralized mortgage obligations, as well as advances of federal funds toother member banks of the Federal Reserve System. Subject to the effects oftaxes, the Bank also invests in tax-exempt state and municipal securities witha minimum rating of “A” by a recognized ratings agency. The Bank’s primarysource of funds is customer deposits. The risk of non-repayment (or deferredpayment) of loans is inherent in the business of commercial banking, regardlessof the type of loan or borrower. The Bank’s efforts to expand its loanportfolio to small and medium-sized businesses may result in the Bankundertaking certain lending risks which are somewhat different from thoseinvolved in loans made to larger businesses. The Bank’s management evaluatesall loan applications and seeks to minimize the exposure to credit risksthrough the use of thorough loan application, approval and monitoringprocedures. However, there can be no assurance that such proceduressignificantly reduce all risks.

**Employees. **– Asof December 31, 2006, the Bank and its subsidiaries had 138 full timeequivalent employees, 33 of whom were officers. Each officer generally hasresponsibility for one or more loan, banking, customer contact, operations, orsubsidiary functions. Non-officer employees are employed in a variety ofadministrative capacities. Management believes that it has a favorablerelationship with its employees.

**CRITICAL ACCOUNTING POLICIES**

The Company’sfinancial condition and results of operations are sensitive to accountingmeasurements and estimates of matters that are inherently uncertain. Whenapplying accounting policies in areas that are subjective in nature, managementmust use its best judgment to arrive at the carrying value of certain assets.One of the most critical accounting policies applied is related to thevaluation of the loan portfolio.

A variety ofestimates impact the carrying value of the loan portfolio including thecalculation of the allowance for loan losses, valuation of underlyingcollateral and the timing of loan charge-offs.

The allowancefor loan losses is one of the most difficult and subjective judgments. Theallowance is established and maintained at a level that management believes isadequate to cover losses resulting from the inability of borrowers to makerequired payments on loans. Estimates for loan losses are arrived at by analyzingrisks associated with specific loans and the loan portfolio. Current trends indelinquencies and charge-offs, the views of Bank regulators, changes in thesize and composition of the loan portfolio and peer comparisons are alsofactors. The analysis also requires consideration of the economic climate anddirection and change in the interest rate environment, which may impact aborrower’s ability to pay, legislation impacting the banking industry andeconomic conditions specific to the Bank’s service area. Because thecalculation of the allowance for loan losses relies on estimates and judgmentsrelating to inherently uncertain events, results may differ from our estimates.

Another critical accounting policy is relatedto securities. Securities are evaluated periodically to determine whether adecline in their value is other than temporary. The term “other than temporary”is not intended to indicate a permanent decline in value. Rather, it means thatthe prospects for near term recovery of value are not necessarily favorable, orthat there is a lack of evidence to support fair values equal to, or greaterthan, the carrying value of the investment. Management reviews criteria such asthe magnitude and duration of the decline, as well as the reasons for thedecline, to predict whether the loss in value is other than temporary. Once adecline in value is determined to be other than temporary, the value of thesecurity is reduced and a corresponding charge to earnings is recognized.

**SUPERVISION AND REGULATION**

**General. **– The Company andBank are extensively regulated under federal and state law. Generally, theselaws and regulations are intended to protect depositors, not stockholders. Thefollowing is a summary description of certain provisions of certain laws, whichaffect the regulation of banks and holding companies. The discussion isqualified in its entirety by reference to applicable laws and regulations.Changes in these laws and regulations may have a material effect on thebusiness and prospects of the Company and the Bank.

As a bankholding company, the Company is subject to the Bank Holding Company Act of1956, as amended (the “BHCA”). The BHCA is administered by the Board ofGovernors of the Federal Reserve System (the “Board of Governors”), and the Companyis required to file with the Board of Governors such reports and information asmay be required pursuant to the BHCA. The Board of Governors also may examinethe Company and any of its nonbank subsidiaries. The BCHA requires every bankholding company to obtain the prior approval of the Board of Governors before: (i)it or any of its subsidiaries (other than a bank) acquires substantially all ofthe assets of any bank; (ii) it acquires ownership or control of any votingshares of any bank if after such acquisition it would own or control, directlyor indirectly, more than five percent of the voting shares of such bank; or (iii) itmerges or consolidates with any other bank holding company.

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2006 ANNUAL REPORT

Under the BHCA,a bank holding company is generally prohibited from engaging in, or acquiringdirect or indirect control of more than five percent (5%) of the voting sharesof any company engaged in non-banking activities. A major exception to thisprohibition is for activities the Board of Governors finds, by order orregulation, to be so closely related to banking or managing or controllingbanks. Some of the activities that the Board of Governors has determined byregulation to be properly incident to the business of a bank holding companyare: making or servicing loans and certain types of leases; engaging in certaininvestment advisory and discount brokerage activities; performing certain dataprocessing services; acting in certain circumstances as a fiduciary or as aninvestment or financial advisor; ownership of certain types of savingsassociations; engaging in certain insurance activities; and making investmentsin certain corporations or projects designed primarily to promote communitywelfare.

**Federal and State Bank Regulation.**   TheBank is a Maryland state-chartered bank, with all the powers of acommercial bank, regulated and examined by the Office of the MarylandCommissioner of Financial Regulation (the “Commissioner’) and the FederalDeposit Insurance Corporation (“FDIC”). The Commissioner and the FDIC haveextensive enforcement authority over the institutions they regulate to prohibitor correct activities which violate law, regulations or written agreements withthe regulator, or which are deemed to constitute unsafe or unsound practices.Enforcement actions may include the appointment of a conservator or receiver,the issuance of a cease and desist order, the termination of deposit insurance,the imposition of civil money penalties on the institution, its directors,officers, employees and institution-affiliated parties, and theenforcement of any such mechanisms through restraining orders or other courtactions.

In its lendingactivities, the maximum legal rate of interest, fees and charges which afinancial institution may charge on a particular loan depends on a variety offactors such as the type of borrower, the purpose of the loan, the amount ofthe loan and the date the loan is made. Other laws tie the maximum amount,which may be loaned to any one customer and its related interests to capitallevels. The Bank is also subject to certain restrictions on extensions ofcredit to executive officers, directors, principal stockholders or any relatedinterest of such persons which generally require that such credit extensions bemade on substantially the same terms as are available to third persons dealingwith the Bank and not involve more than the normal risk of repayment.

The CommunityReinvestment Act (“CRA”) requires that in connection with the examination offinancial institutions within their jurisdictions, the FDIC evaluate the recordof the financial institutions in meeting the credit needs of their localcommunities, including low and moderate-income neighborhoods, consistentwith the safe and sound operation of these banks. The factors are alsoconsidered by all regulatory agencies in evaluating mergers, acquisitions andapplications to open a branch or facility. As of the date of its most recentexamination report, the Bank has a CRA rating of “Satisfactory.”

Under theFederal Deposit Insurance Corporation Improvement Act of 1991(“FDICIA”), eachfederal banking agency is required to prescribe, by regulation, non-capitalsafety and soundness standards for institutions under its authority. Thefederal banking agencies, including the FDIC, have adopted standards coveringinternal controls, information systems, internal audit systems, loandocumentation, credit underwriting, interest rate exposure, asset growth, andcompensation, fees and benefits. An institution that fails to meet thosestandards may be required by the agency to develop a plan acceptable to theagency, which specifies the steps that the institution will take to meet thestandards. Failure to submit or implement such a plan may subject theinstitution to regulatory sanctions. The Bank believes that it meetssubstantially all standards which have been adopted. FDICIA also imposed newcapital standards on insured depository institutions described under thecaption, “Capital Requirements.”

Beforeestablishing new branch offices, the Bank must meet certain minimum capitalstock and surplus requirements. Prior to establishment of the branch, the Bankmust obtain Commissioner and FDIC approval.

**Deposit Insurance.**   As an FDICinsured institution, deposits of the Bank are currently insured to a maximum of$100,000 per depositor through the Bank Insurance Fund (“BIF”).  For traditional and ROTH IRA’s, the federaldeposit insurance limit increased from $100,000 to $250,000. The FDIC isrequired to establish the semi-annual assessments for BIF-insured depositoryinstitutions at a rate determined to be appropriate to maintain or increase thereserve ratio of the respective deposit insurance funds at or above1.25 percent of estimated insured deposits or at such higher percentagethat the FDIC determines to be justified for that year by circumstances raisingsignificant risk of substantial future losses to the fund. The Bank currentlypays a *de minimus* semi-annualassessment.

**Limits on Dividends and Other Payment.**   Bothfederal and state laws impose restrictions on the ability of the Bank to paydividends. The Federal Reserve Board (“FRB”) has issued a policy statement,which provides that, as a general matter, insured banks may pay dividends onlyout of prior operating earnings. For a Maryland state-chartered bank,dividends may be paid out of undivided profits or, with the prior approval ofthe Commissioner, from surplus in excess of 100% of required capital stock. If,however, the surplus of a Maryland bank is less than 100% of its requiredcapital stock, cash dividends may not be paid in excess of 90% of the netearnings. In addition to these specific restrictions, bank regulatory agencies,in general, also have the ability to prohibit proposed dividends by a financialinstitution, which would otherwise be permitted under applicable regulations ifthe regulatory body determines that such distribution would constitute anunsafe or unsound practice.

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CARROLLTON BANCORP

**Capital Requirements.**   The FDICadopted certain risk-based capital guidelines to assist in the assessment ofthe capital adequacy of a banking organization’s operations for bothtransactions reported as assets on the balance sheet and transactions, such asletters of credit and recourse arrangements, which are recorded as off balancesheet items. Under these guidelines, nominal dollar amounts of assets andcredit equivalent amounts of off balance sheet items are multiplied by one ofseveral risk adjustment percentages, which range from 0% for assets with lowcredit risk, such as certain U.S. Treasury securities, to 100% for assets withrelatively high credit risk, such as business loans.

A bankingorganization’s risk-based capital ratios are obtained by dividing itsqualifying capital by its total risk adjusted assets. The regulators measurerisk-adjusted assets, which include off balance sheet items, against both totalqualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2capital) and Tier 1 capital. “Tier 1,” or core capital, includes common equity,perpetual preferred stock (excluding auction rate issues) and minority interestin equity accounts of consolidated subsidiaries, less goodwill and otherintangibles, subject to certain exceptions. “Tier 2,” or supplementary capital,includes, among other things, limited-life preferred stock, hybrid capitalinstruments, mandatory convertible securities, qualifying subordinated debt,and the allowance for loan losses, subject to certain limitations and lessrequired deductions. The inclusion of elements of Tier 2 capital is subject tocertain other requirements and limitations of the federal banking agencies.Banks subject to the risk-based capital guidelines are required to maintain aratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio tototal capital to risk-weighted assets of at least 8%. The appropriateregulatory authority may set higher capital requirements when particularcircumstances warrant.

In August 1995and May 1996, the federal banking agencies adopted final regulationsspecifying that the agencies will include, in their evaluations of a bank’scapital adequacy, an assessment of the bank’s interest rate risk (“IRR”)exposure. The standards for measuring the adequacy and effectiveness of abanking organization’s interest rate risk management include a measurement ofboard of director and senior management oversight, and a determination ofwhether a banking organization’s procedures for comprehensive risk managementare appropriate to the circumstances of the specific banking organization. TheBank has internal IRR models that are used to measure and monitor IRR.Additionally, the regulatory agencies have been assessing IRR on an informalbasis for several years. For these reasons the addition of IRR evaluation tothe agencies’ capital guidelines does not result in significant changes incapital requirements for the Bank.

Failure to meetapplicable capital guidelines could subject a banking organization to a varietyof enforcement actions, including limitations on its ability to pay dividends,the issuance by the applicable regulatory authority of a capital directive toincrease capital and, in the case of depository institutions, the terminationof deposit insurance by the FDIC, as well as to the measures described underthe caption, “Federal Deposit Insurance Corporation Improvement Act of 1991”below, as applicable to undercapitalized institutions. In addition, futurechanges in regulations or practices could further reduce the amount of capitalrecognized for purposes of capital adequacy. Such a change could affect theability of the Bank to grow and could restrict the amount of profits, if any,available for the payment of dividends to the stockholders.

**Federal Deposit Insurance Corporation Improvement Act of 1991.**   InDecember 1991, Congress enacted FDICIA, which substantially revised the bankregulatory and funding provisions of the Federal Deposit Insurance Act and madesignificant revisions to several other federal banking statutes. FDICIAprovides for, among other things, (i) publicly available annual financialcondition and management reports for financial institutions, including auditsby independent accountants, (ii) the establishment of uniform accountingstandards by federal banking agencies, (iii) the establishment of a “promptcorrective action” system of regulatory supervision and intervention, based oncapitalization levels, with more scrutiny and restrictions placed on depositoryinstitutions with lower levels of capital, (iv) additional grounds for theappointment of a conservator or receiver, and (v) restrictions orprohibitions on accepting brokered deposits, except for institutions whichsignificantly exceed minimum capital requirements. FDICIA also provides forincreased funding of the FDIC insurance funds and the implementation ofrisk-based premiums, described further under the caption “Deposit Insurance.”

A centralfeature of FDICIA is the requirement that the federal banking agencies take “promptcorrective action” with respect to depository institutions that do not meetminimum capital requirements. Pursuant to FDICIA, the federal bank regulatoryauthorities have adopted regulations setting forth a five-tiered system formeasuring the capital adequacy of the depository institutions that theysupervise. Under these regulations, a depository institution is classified inone of the following capital categories: “well capitalized,” “adequatelycapitalized,” “undercapitalized,” “significantly undercapitalized” and “criticallyundercapitalized.” An institution may be deemed by the regulators to be in acapitalization category that is lower than is indicated by its actual capitalposition if, among other things, it receives an unsatisfactory examinationrating with respect to asset quality, management, earnings or liquidity. TheBank is currently “well capitalized.”

FDICIAgenerally prohibits a depository institution from making any capitaldistribution (including payment of a cash dividend) if the depositoryinstitution would thereafter be undercapitalized. Undercapitalized depositoryinstitutions are subject to growth limitations and are required to submitcapital restoration plans. If a depository institution fails to submit anacceptable plan, it is treated as if it is significantly undercapitalized.Significantly undercapitalized depository institutions may be subject to anumber of other requirements and restrictions, 

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including orders to sell sufficient votingstock to become adequately capitalized, requirements to reduce total assets andstop accepting deposits from correspondent banks. Critically undercapitalizedinstitutions are subject to the appointment of a receiver or conservator;generally within 90 days of the date such institution is determined to becritically undercapitalized.

FDICIA providesthe federal banking agencies with significantly expanded powers to takeenforcement action against institutions, which fail to comply with capital orother standards. Such action may include the termination of deposit insuranceby the FDIC or the appointment of a receiver or conservator for theinstitution. FDICIA also limits the circumstances under which the FDIC ispermitted to provide financial assistance to an insured institution beforeappointment of a conservator or receiver.

**Financial Modernization.**   In November 1999,the Gramm-Leach-Bliley Act (“GLBA”) was signed into law. Effectivein part on March 11, 2000, GLBA revises the Bank Holding Company Act of1956 and repeals the affiliation provisions for the Glass-Steagall Act of1933, which, taken together, limited the securities, insurance and othernon-banking activities of any company that controls a FDIC insured institution.Under GLBA, bank holding companies can elect, subject to certainqualifications, to become a “financial holding company.” GLBA provides that afinancial holding company may engage in a full range of financial activities,including, insurance and securities sales and underwriting activities, and realestate development, with the expedited notice procedures.

Maryland law generally permits Maryland state-charteredbanks, including the Bank, to engage in the same activities, directly orthrough an affiliate, as national banks. GLBA permits certain qualifiednational banks to form financial subsidiaries, which have broad authority to engagein all financial activities except insurance underwriting, insuranceinvestments, real estate investment or development, or merchant banking. Thus,GLBA has the effect of broadening the permitted activities of Maryland state-charteredbanks.

**THE PATRIOT ACT**

The Uniting and Strengthening America byProviding Appropriate Tools Required to Intercept and Obstruct Terrorism Act of2001 (the “PATRIOT Act”) requires financial institutions to develop a customeridentification plan that includes procedures to:

·         Collect identifyinginformation about customers opening a deposit or loan account

·         Verify customer identity

·         Maintain records of theinformation used to verify the customer’s identity

·         Determine whether thecustomer appears on any list of suspected terrorists or terrorist organizations

Under theprovisions of the PATRIOT Act, the Bank is also required from time to time tosearch its customer data base for the names of known or suspected terrorists asprovided by the government.

Due to the extensive regulation of thecommercial banking business in the United States, the Company is particularlysusceptible to changes in federal and state legislation and regulations.

**GOVERNMENTAL MONETARY POLICIES AND ECONOMICCONTROLS**

The Company is affected by monetary policiesof regulatory agencies, including the Federal Reserve Board, which regulatesthe national money supply in order to mitigate recessionary and inflationarypressures. Among the techniques available to the Federal Reserve Board are:engaging in open market transactions in U.S. Government securities, changingthe discount rate on bank borrowings, changing reserve requirements againstbank deposits, prohibiting the payment of interest on demand deposits, andimposing conditions on time and savings deposits. These techniques are used invarying combinations to influence the overall growth of bank loans, investmentsand deposits. Their use may also affect interest rates charged on loans or paidon deposits. The effect of governmental policies on the earnings of the Companycannot be predicted. However, the Company’s earnings will be impacted bymovement in interest rates, as discussed in Part II Item 7a. “Quantitativeand Qualitative Disclosure About Market Risk.”

**ITEM 1A: RISK FACTORS**

The risks and uncertainties described beloware not the only ones that we face. Additional risks and uncertainties that weare unaware of, or that we currently deem immaterial, also may become importantfactors that affect us and our business. If any of these risks were to occur,our business, financial condition or results of operations could be materiallyand adversely affected. Also, consider the other information in this AnnualReport on Form 10-K, as well as the documents incorporated byreference.

***Competition may decrease our growth orprofits.***

We facesignificant competition for banking services in our primary market in which weoperate. Competition in the local banking industries may limit our ability toattract and retain customers. We may face competition now and in the futurefrom the following: other local and regional banking institutions, includinglarger commercial 

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banking organizations; savings banks; creditunions; other financial institutions; and non-bank financial services companiesserving the area.

In particular,our competitors may possess greater resources that may afford them amarketplace advantage by enabling them to maintain numerous banking locationsand mount extensive promotional and advertising campaigns. Additionally, banksand other financial institutions with larger capitalization and financialintermediaries not subject to bank regulatory restrictions have larger lendinglimits, which enable them to serve the credit needs of larger customers. Wealso face competition from out-of-state financial intermediaries that haveopened low-end production offices or that solicit deposits in their respectivemarket areas. If we are unable to attract and retain banking customers we maybe unable to continue our loan growth and level of deposits and our results ofoperations and financial condition may otherwise be negatively affected.

In the past, we have expanded our operationsinto non-banking activities such as insurance-related products andbrokerage services. We may have difficulty competing with more establishedproviders of these products and services due to the intense competition in manyof these industries. In addition, we may be unable to attract and retainnon-banking customers due to a lack of market and product knowledge or otherindustry specific matters or an inability to attract and retain qualified,experienced employees. Our failure to attract and retain customers with respectto these non-banking activities could negatively impact our future earnings.

***Changes in interest rates and other factorsbeyond our control may adversely affect our earnings and financial condition.***

Our main sourceof income from operations is net interest income, which is equal to thedifference between the interest income received on loans, investment securitiesand other interest-earning assets and the interest expense incurred inconnection with deposits, borrowings and other interest-bearingliabilities. As a result, our net interest income can be affected by changes inmarket interest rates. These rates are highly sensitive to many factors beyondour control, including general economic conditions, both domestic and foreign,and the monetary and fiscal policies of various governmental and regulatoryauthorities. We have adopted asset and liability management policies to try tominimize the potential adverse effects of changes in interest rates on our netinterest income, primarily by altering the mix and maturity of loans,investments and funding sources. However, even with these policies in place, wecannot provide assurance that changes in interest rates will not negativelyimpact our operating results.

An increase ininterest rates also could have a negative impact on our business by reducingthe ability of borrowers to repay their current loan obligations, which could notonly result in increased loan defaults, foreclosures and write-offs, but alsonecessitate further increases to our allowance for loan losses. Increases ininterest rates also may reduce the demand for loans and, as a result, theamount of loan and commitment fees. In addition, fluctuations in interest ratesmay result in disintermediation, which is the flow of funds away fromdepository institutions into direct investments that pay higher rates ofreturn, and may affect the value of our investment securities and otherinterest-earning assets.

We originate and sell mortgage loans. Changesin interest rates affect demand for our loan products and the revenue realizedon the sale of loans. A decrease in the volume of loans sold and lower gains onsales of mortgages can decrease our revenues and net income.

***Our allowance for loan losses may not beadequate to cover our actual loan losses, which could adversely affect ourearnings.***

If ourcustomers default on the repayment of their loans, our profitability could beadversely affected. A borrower’s default on its obligations under one or moreof our loans may result in lost principal and interest income and increasedoperating expenses as a result of the allocation of management time andresources to the collection and work-out of the loans. If collection effortsare unsuccessful or acceptable workout arrangements cannot be reached, we mayhave to write-off the loans in whole or in part. Although we may acquire anyreal estate or other assets that secure the defaulted loans through foreclosureor other similar remedies, the amount owed under the defaulted loans may exceedthe value of the assets acquired.

Our managementperiodically makes a determination of our allowance for loan losses based onavailable information, including the quality of our loan portfolio, economicconditions, and the value of the underlying collateral and the level of ournon-accruing loans. If our assumptions prove to be incorrect, our allowance maynot be sufficient and future additions to the allowance may be necessary whichwill result in an expense for the period. If, as a result of general economicconditions or an increase in nonperforming loans, management determines that anincrease in our allowance for loan losses is necessary, we may incur additionalexpenses.

In addition, asan integral part of their examination process, bank regulatory agenciesperiodically review our allowance for loan losses and the value we attribute toreal estate acquired through foreclosure or other similar remedies. Theseregulatory agencies may require us to adjust our determination of the value forthese items based on their judgement. These adjustments could negatively impactour results of operations or financial condition.

In the course of our business, we mayacquire, through foreclosure, properties securing loans that are in default.Particularly in commercial real estate lending, there is a risk that hazardoussubstances could be discovered on 

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these properties. In this event, we might berequired to remove these substances from the affected properties at our solecost and expense. The cost of this removal could substantially exceed the valueof the affected properties. We may not have adequate remedies against the priorowners or other responsible parties and could find it difficult or impossibleto sell the affected properties. The occurrence of one or more of these eventscould adversely affect our financial condition or operating results.

***Changes in local economic conditions couldadversely affect our business.***

Because weserve primarily individuals and smaller businesses, the ability of ourcustomers to repay their loans is impacted by the economic conditions in theseareas. As of December 31, 2006, approximately 78% of our loan portfolioconsisted of commercial loans, defined as commercial and industrial, municipal,multi-family, commercial real estate and construction loans. Thus, ourresults of operations, both in terms of the origination of new loans and thepotential default of existing loans, is heavily dependent upon the strength oflocal businesses.

We have traditionally obtained fundsprincipally through deposits and borrowings. As a general matter, deposits area cheaper source of funds than borrowings, because interest rates paid fordeposits are typically less than interest rates charged for borrowings. If, asa result of competitive pressures, market interest rates, general economicconditions or other events, the balance of our deposits decrease relative toour overall banking operations, we may have to rely more heavily on borrowingsas a source of funds in the future. Such an increased reliance on borrowingscould have a negative impact on our results of operations or financialcondition.

***Government regulation significantly affectsour business.***

Bank holdingcompanies and state and federally chartered banks operate in a highly regulatedenvironment and are subject to supervision and examination by federal and stateregulatory agencies. We are subject to the Bank Holding Company Act of 1956, asamended, and to regulation and supervision by the Federal Deposit InsuranceCorporation, or FDIC, and the Office of the Maryland Commissioner of FinancialRegulation.. The cost of compliance with regulatory requirements may adverselyaffect our results of operations or financial condition. Federal and state lawsand regulations govern numerous matters including: changes in the ownership orcontrol of banks and bank holding companies; maintenance of adequate capitaland the financial condition of a financial institution; permissible types,amounts and terms of extensions of credit and investments; permissiblenon-banking activities; the level of reserves against deposits; andrestrictions on dividend payments. Regulations affecting banks and financial servicescompanies undergo continuous change, and we cannot predict the ultimate effectof these changes, which could have a material adverse effect on ourprofitability or financial condition. Federal economic and monetary policy mayalso affect our ablitity to attract deposits and other funding sources, makeloans and investements, and achieve satisfactory interest spreads.

The FDIC, andstate banking authorities possess cease and desist powers to prevent or remedyunsafe or unsound practices or violations of law by banks subject to theirregulation, and the Federal Reserve Board possesses similar powers with respectto bank holding companies. These and other restrictions limit the manner inwhich we may conduct our business and obtain financing.

Furthermore,our banking business is affected not only by general economic conditions, butalso by the monetary policies of the FRB. Changes in monetary or legislativepolicies may affect the interest rates we must offer to attract deposits andthe interest rates we can charge on our loans, as well as the manner in whichwe offer deposits and make loans. These monetary policies have had, and areexpected to continue to have, significant effects on the operating results ofdepository institutions, including our Bank.

Under regulatory capital adequacy guidelinesand other regulatory requirements, we must meet guidelines that includequantitative measures of assets, liabilities, and certain off-balance sheetitems, subject to qualitative judgments by regulators about components, riskweightings and other factors. If we fail to meet these minimum capitalguidelines and other regulatory requirements, our financial condition would bematerially and adversely affected. Our failure to maintain the status of “wellcapitalized” under our regulatory framework could affect the confidence of ourcustomers in us, thus compromising our competitive position. In addition,failure to maintain the status of “well capitalized” under our regulatoryframework or “well managed” under regulatory examination procedures couldcompromise our status as a bank holding company and related eligibility for astreamlined review process for acquisition proposals.

***Technology failure could adversely affect ouroperations and profits.***

We rely heavily on communications andinformation systems to conduct our business. Any failure or interruptions orbreach in security of these systems could result in failures or disruptions inour customer relationship management, general ledger, deposits, servicing orloan origination systems. The occurrence of any failures or interruptions couldresult in a loss of customer business and have a material adverse effect on ourresults of operations and financial condition.

***Our ability to pay dividends is limited bylaw and contract.***

Our ability to pay dividends to ourshareholders largely depends on Carrollton Bancorp’s receipt of dividends fromCarrollton Bank. The amount of dividends that Carrollton Bank may pay toCarrollton Bancorp is limited by 

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federal laws and regulations. We also maydecide to limit the payment of dividends even when we have the legal ability topay them in order to maintain earnings for use in our business.

***The market price for our common stock may bevolatile.***

The marketprice for our common stock has fluctuated, ranging between $14.40 and $19.45per share during the last 12 months ended December 31, 2006. The overallmarket and the price of our common stock may continue to be volatile. There maybe a significant impact on the market share of our common stock due to, amongother things:

Variations in our anticipated or actualoperating results or the results of our competitors;

Changes in investors’ or analysts’perceptions of the risks and conditions of business;

The size of the public float of our common stock;

Regulatory developments;

The announcement of acquisitions or newbranch locations by us or our competitors;

Market conditions; and

General economic conditions.

Additionally, the average daily tradingvolume for our common stock is low and on various days throughout  the year, there is no activity on the stock. Therecan be no assurance that a more active or consistent trading market willdevelop. As a result, relatively small trades could have a significant impacton the price of our stock.

**ITEM 2: PROPERTIES**

The Company owned the following properties,which had a book value of $2.7 million at December 31, 2006:

| Location                                       | * * | *Description*                                                                            |
|------------------------------------------------|----------|------------------------------------------------------------------------------------------|
| 1740 East Joppa Road  Towson, MD 21234         |     | Full service  branch with drive thru, Electronic Banking offices and leased office space |
| 427 Crain Highway  Glen Burnie, MD 21061       |     | Full service branch with drive-thru                                                      |
| 531 South Conkling Street  Baltimore, MD 21224 |     | Full service branch with drive-thru                                                      |
| 344 N. Charles Street  Baltimore, MD 21201     |     | Full service branch with Executive offices,  Lending offices and Finance offices         |

 

The Company leased the following facilitiesat an aggregate annual rental of $937,160 as of December 31, 2006:

| Location                                                                         | * * | *Description*                          | * * | *Lease Expiration Date** |
|----------------------------------------------------------------------------------|----------|----------------------------------------|----------|--------------------------|
| 1066-70 Maiden Choice Lane  Arbutus, MD 21229                                    |     | Full service  branch                   |     | April 30,  2031     |
| 4738 Shelbourne Road  Baltimore, MD 21229                                        |     | Detached drive-thru                    |     | April 30, 2031      |
| Suites 101-103 & 120-122  1589 Sulphur Spring Road  Baltimore, MD 21227 |     | Administrative and operational offices |     | February 28, 2019   |
| 2637-A Old Annapolis Road  Hanover, MD 21076                                     |     | Full service branch                    |     | October 1, 2014     |
| Wilkens Beltway Plaza 4658  Wilkens Avenue  Baltimore, MD 21229                  |     | Limited-service branch                 |     | October 21, 2024    |
| 8157A Honeygo Boulevard  White Marsh, MD 21236                                   |     | Full service branch                    |     | December 31, 2017   |
| Northway Shopping Center  684 Old Mill Road  Millersville, MD 21108              |     | Full service branch                    |     | August 31, 2014     |
| 602 Hoagie Drive  Bel Air, MD 21014                                              |     | Full service branch                    |     | November 30, 2044   |

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| 10301 York Road  Cockeysville, MD 21030            |   | Full service branch expected to open in the  second quarter of 2007 |   | December 1, 2047 |
|----------------------------------------------------|--------|---------------------------------------------------------------------|--------|-----------------------|
| 2300 York Road  Timonium, MD 21093                 |   | Mortgage subsidiary offices                                         |   | January 14, 2010 |
| 208 Hickory Avenue  Bel Air, MD 21014              |   | Mortgage subsidiary offices                                         |   | March 31, 2010   |
| 8905 Harford Road  Baltimore, MD 21234             |   | Mortgage subsidiary offices                                         |   | June 30, 2007    |
| 1 Center Square, Suite 201  Hanover, PA 17331 |   | Mortgage subsidiary offices                                         |   | June 29, 2007    |

 

*             Expirationdate, assuming the Company exercises all extension options.

**ITEM 3: LEGAL PROCEEDINGS**

The Company is involved in various legalactions arising from normal business activities. In management’s opinion, theoutcome of these matters, individually or in the aggregate, will not have amaterial adverse impact on the results of operation or financial position ofthe Company.

**ITEM 4: SUBMISSION OF MATTERSTO A VOTE OF SECURITY-HOLDERS**

There were nomatters submitted to a vote of the stockholders during the quarter ended December 31,2006.

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PART II

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**ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITYAND RELATED STOCKHOLDER MATTERS**

**TRADING AND DIVIDENDS**

As of December 31,2006, there were 391 shareholders of record of the Company. The Company’sCommon Stock has traded on the National Association of Security Dealers’Automated Quotation System (“NASDAQ”) National Market Tier of The NASDAQ StockMarket under the symbol “CRRB.” Currently, there are two broker-dealerswho make a market in the Common Stock.

As a depositoryinstitution whose deposits are insured by the FDIC, the Bank may not paydividends or distribute any of its capital assets while it remains in defaulton any assessment due to the FDIC. The Bank currently is not in default underany of its obligations to the FDIC. As a commercial bank under the MarylandFinancial Institution Law, the Bank may declare cash dividends from undividedprofits or, with the prior approval of the Commissioner of FinancialRegulation, out of surplus in excess of 100% of its required capital stock, andafter providing for due or accrued expenses, losses, interest and taxes.

The Company andthe Bank, in declaring and paying dividends, are also limited insofar asminimum capital requirements of regulatory authorities must be maintained. TheCompany and the Bank currently comply with such capital requirements.

Dividendsdeclared per share on the Company’s common stock were $0.45 in 2006, $0.40 in2005, and $0.38 in 2004, representing a payout ratio of 48.98% in 2006,****45.97% in 2005, and****121.17% in2004. The dividend payout ratio is the result of dividing the amount ofdividends paid by net income.

The Companyimplemented a Dividend Reinvestment Plan that provides automatic reinvestmentof dividends in additional shares of Carrollton Bancorp common stock.

During 2006,the Company repurchased and retired 7,518 shares of common stock at an averageprice of $17.14. In 2005, the Company repurchased and retired 42,500 shares ofcommon stock at a price of $14.10 per share.

The following table sets forth the high andlow sales price and dividends per share of the Company’s Common Stock for theperiods indicated.

| *Period*    | * * | *Price Per Share* | * * | *Cash Dividends Paid  Per Share* | * * |
|-------------|----------|-----------------------------|----------|-------------------------------------------------|----------|
| * *    | * * | *2006*                      | * * | *2005*                                          | * * | *2006* | * * | *2005* | * * |
| * *    | * * | *Low*                       | * * | *High*                                          | * * | *Low* | * * | *High* | * * | * * | * * | * * | * * |
| 4th Quarter |     | $                           | 16.99    |                                            | $        | 19.45 |   | $ | 14.00 |   | $ | 15.00 |   | $ | 0.12 |   | $ | 0.10 |   |
| 3rd Quarter |     | 16.11                       |     | 18.00                                           |     | 13.95 |   | 16.29 |   | 0.11 |   | 0.10 |   |
| 2nd Quarter |     | 15.64                       |     | 18.80                                           |     | 14.25 |   | 17.00 |   | 0.11 |   | 0.10 |   |
| 1st Quarter |     | 14.40                       |     | 15.95                                           |     | 14.12 |   | 17.00 |   | 0.11 |   | 0.10 |   |
|        |     |                        |     |                                            |     |   |   |   |   | $ | 0.45 |   | $ | 0.40 |   |
|             |          |                             |          |                                                 |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31,2006, there were approximately 391 common shareholders of record holding anaggregate of 2,806,705 shares. The Company believes there to be in excess of558 beneficial owners of the Company’s Common Stock.

The ability of the Company to pay dividendsin the future will be dependent on the earnings, if any, financial conditionand business of the Company, as well as other relevant factors, such asregulatory requirements. No assurance can be given either that the Company’sfuture earnings, if any, will be sufficient to enable it to pay dividends, orthat if such earnings are sufficient, that the Company will not decide toretain such earnings for general working capital and other funding needs. Inaddition, the Company is highly dependent on dividends received from the Bankto enable it to pay dividends to shareholders. No assurance can be given thatthe Bank will continue to generate sufficient earnings to enable it to paydividends to the Company, or that it will continue to meet regulatory capitalrequirements which, if not met, could prohibit payment of dividends to theCompany.

16

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2006 ANNUAL REPORT

**STOCK PERFORMANCE TABLE**

The Company is required by the SEC to providea five-year comparison of the cumulative total Shareholder return on our CommonStock compared with that of a broad equity market index, and either a publishedindustry index or a constructed peer group index of the Company.

The following chart compares the cumulativeShareholder return on the Company’s Common Stock from December 31, 2001 toDecember 31, 2006 with the cumulative total of the NASDAQ Composite(U.S.), the NASDAQ Bank and SNL Mid-Atlantic Indices. The comparison assumes$100 was invested on December 31, 2001 in the Company’s Common Stock andin each of the foregoing indices. It also assumes reinvestment of anydividends.

The Company does not make, nor does itendorse, any predictions as to future stock performance.

**Total Return Performance**

| * *                    | * * | *Period Ending* | * * |
|-----------------------------|----------|----------------------|----------|
| *Index*                     | * * | *12/31/01*           | * * | *12/31/02* | * * | *12/31/03* | * * | *12/31/04* | * * | *12/31/05* | * * | *12/31/06* | * * |
| Carrollton Bancorp          |     |                 | 100.00   |   |   |   | 112.33 |   |   |   | 148.16 |   |   |   | 151.37 |   |   |   | 131.18 |   |   |   | 154.18 |   |   |
| NASDAQ Composite            |     |                 | 100.00   |   |   |   | 68.76 |   |   |   | 103.67 |   |   |   | 113.16 |   |   |   | 115.57 |   |   |   | 127.58 |   |   |
| SNL Mid-Atlantic Bank Index |     |                 | 100.00   |   |   |   | 76.91 |   |   |   | 109.35 |   |   |   | 115.82 |   |   |   | 117.87 |   |   |   | 141.46 |   |   |

 

The following table provides informationabout the Company’s outstanding options, warrants and rights under equitycompensation plans:

**EQUITY COMPENSATION PLAN**

| *Plan Category*                                        | * * | *Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights  (a)* | * * | *Weighted-average exercise  price of outstanding options,  warrants and rights  (b)* | * * | *Number of securities remaining  available for future issuance under  equity compensation plans  (excluding securities reflected  in column (a))  (c)* | * * |
|-------------------------------------------------------------|----------|---------------------------------------------------------------------------------------------------------------------------------------------------------|----------|--------------------------------------------------------------------------------------------------------------------|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Equity compensation plans approved by  security holders     |     |                                                                                                                                                    | 229,030  |                                                                                                               |     |                                                                                                                                                                                                                    | $        | 14.70 |   |   |   | 34,140 |   |   |
| Equity compensation plans not approved by  security holders |     |                                                                                                                                                    | —   |                                                                                                               |     |                                                                                                                                                                                                                    | —   |   |   |   | — |   |   |
| Total                                                       |     |                                                                                                                                                    | 229,030  |                                                                                                               |     |                                                                                                                                                                                                                    | $        | 14.70 |   |   |   | 34,140 |   |   |

 

17

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CARROLLTON BANCORP

**ITEM 6:**   SELECTEDFINANCIAL DATA

| * *                                                                                | * *   | *2006*      | * *    | *2005*      | * * | *2004*      | * * | *2003*      | * *    | *2002*      | * * |
|-----------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|----------|-------------|----------|-------------|-------------|-------------|----------|
| CONSOLIDATED INCOME STATEMENT DATA:                                                     |       |        |        |        |     |        |     |        |        |        |     |
| Interest income                                                                         |       | $           | 23,127,504  |        | $        | 19,071,379  |     | $           | 15,500,323  |        | $        | 15,935,691 |   | $ | 18,985,364 |   |
| Interest expense                                                                        |       | 8,737,450   |        | 7,375,083   |     | 5,321,622   |     | 6,639,734   |        | 8,692,320   |     |
| Net interest income                                                                     |       | 14,390,054  |        | 11,696,296  |     | 10,178,701  |     | 9,295,957   |        | 10,293,044  |     |
| Provision for loan losses                                                               |       | —      |        | —      |     | —      |     | 243,000     |        | 526,000     |     |
| Net interest income after provision for  loan losses                                    |       | 14,390,054  |        | 11,696,296  |     | 10,178,701  |     | 9,052,957   |        | 9,767,044   |     |
| Noninterest income                                                                      |       | 8,898,996   |        | 10,718,636  |     | 8,781,151   |     | 8,268,612   |        | 7,534,802   |     |
| Noninterest expenses                                                                    |       | 19,381,003  |        | 18,634,124  |     | 17,751,000  |     | 16,058,355  |        | 14,536,958  |     |
| Income before income taxes                                                              |       | 3,908,047   |        | 3,780,808   |     | 1,208,852   |     | 1,263,214   |        | 2,764,888   |     |
| Income taxes                                                                            |       | 1,323,268   |        | 1,322,371   |     | 320,488     |     | 338,500     |        | 847,630     |     |
| Net income                                                                              |       | $           | 2,584,779   |        | $        | 2,458,437   |     | $           | 888,364     |        | $        | 924,714 |   | $ | 1,917,258 |   |
| CONSOLIDATED BALANCE SHEET DATA,  AT YEAR END                                           |       |        |        |        |     |        |     |        |        |        |     |
| Assets                                                                                  |       | $           | 349,824,752 |        | $        | 360,467,146 |     | $           | 319,123,132 |        | $        | 302,409,975 |   | $ | 324,221,615 |   |
| Gross loans                                                                             |       | 260,001,314 |        | 247,943,073 |     | 219,726,294 |     | 199,296,561 |        | 205,220,126 |     |
| Deposits                                                                                |       | 277,903,801 |        | 271,626,503 |     | 225,846,145 |     | 207,056,100 |        | 230,264,108 |     |
| Shareholders’ equity                                                               |       | 34,711,378  |        | 34,640,165  |     | 34,215,280  |     | 34,124,882  |        | 33,691,079  |     |
| PER SHARE DATA:                                                                         | ** ** | ** **  |        |        |     |        |     |        |        |        |     |
| Number of shares of Common Stock  outstanding, at year-end                              |       | 2,806,705   |        | 2,809,698   |     | 2,834,823   |     | 2,828,078   |        | 2,821,757   |     |
| Net income:                                                                             |       |        |        |        |     |        |     |        |        |        |     |
| Basic                                                                                   |       | $           | 0.92        |        | $        | 0.87        |     | $           | 0.31        |        | $        | 0.33 |   | $ | 0.68 |   |
| Diluted                                                                                 |       | 0.90        |        | 0.87        |     | 0.31        |     | 0.32        |        | 0.68        |     |
| Cash dividends declared                                                                 |       | 0.45        |        | 0.40        |     | 0.38        |     | 0.36        |        | 0.34        |     |
| Book value, at year end                                                                 |       | 12.37       |        | 12.33       |     | 12.07       |     | 12.07       |        | 11.94       |     |
| Performance and capital ratios:                                                         |       |        |        |        |     |        |     |        |        |        |     |
| Return on average assets                                                                |       | 0.75%       |        | 0.72%       |     | 0.29%       |     | 0.29%       |        | 0.57%       |     |
| Return on average shareholders’ equity                                             |       | 7.55%       |        | 7.12%       |     | 2.61%       |     | 2.71%       |        | 5.70%       |     |
| Net interest margin (a)                                                                 |       | 4.57%       |        | 3.89%       |     | 3.81%       |     | 3.36%       |        | 3.47%       |     |
| Average shareholders’ equity to average  total assets                              |       | 9.91%       |        | 10.13%      |     | 11.11%      |     | 10.83%      |        | 9.99%       |     |
| Year-end capital to year-end  risk- weighted assets:                                    |       |        |        |        |     |        |     |        |        |        |     |
| Tier 1                                                                                  |       | 11.92%      |        | 11.63%      |     | 11.52%      |     | 13.75%      |        | 13.57%      |     |
| Total                                                                                   |       | 13.20%      |        | 13.51%      |     | 12.74%      |     | 15.51%      |        | 15.07%      |     |
| Year-end Tier 1 leverage ratio                                                          |       | 9.74%       |        | 8.96%       |     | 9.41%       |     | 10.35%      |        | 9.54%       |     |
| Cash dividends declared to net income                                                   |       | 48.98%      |        | 45.97%      |     | 121.17%     |     | 109.96%     |        | 50.80%      |     |
| ASSET QUALITY RATIOS:                                                                   |       |        |        |        |     |        |     |        |        |        |     |
| Allowance for  loan losses, at year-end to:                                             |       |        |        |        |     |        |     |        |        |        |     |
| Gross loans                                                                             |       | 1.20%       |        | 1.35%       |     | 1.59%       |     | 1.83%       |        | 1.74%       |     |
| Nonperforming, restructured and past-due  loans                                         |       | 54.93%      |        | 209.50%     |     | 132.05%     |     | 151.37%     |        | 111.68%     |     |
| Net charge-offs to average gross  loans                                                 |       | 0.08%       |        | 0.06%       |     | 0.08%       |     | 0.09%       |        | 0.13%       |     |
| Nonperforming assets as a percent of period-end  gross loans and foreclosed real estate |       | 2.19%       |        | 0.64%       |     | 1.20%       |     | 1.26%       |        | 1.67%       |     |

 

(a)     Netinterest margin is the ratio of net interest income, determined on a fullytaxable equivalent basis (a non-GAAP financial measure), to total averageinterest earning assets.

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2006 ANNUAL REPORT

**ITEM 7: MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND**RESULTS OF OPERATIONS

**FORWARD-LOOKING STATEMENTS**

This AnnualReport on Form 10-K and certain information incorporated herein byreference contain forward-looking statements within the meaning of Section27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. All statements included orincorporated by reference in this Annual Report on Form 10-K, other thanstatements that are purely historical, are forward-looking statements.Statements that include the use of terminology such as “anticipates,” “expects,”“intends,” “plans,” “believes,” “estimates” and similar expressions alsoidentify forward-looking statements. The forward-looking statementsare based on the Company’s current intent, belief and expectations. Forward-lookingstatements in this Annual Report on Form 10-K include, but are notlimited to statements of the Company’s plans, strategies, objectives,intentions, including, among other statements, statements involving the Company’sprojected loan and deposit growth, loan collateral values, collectability ofloans, anticipated changes in other operating income, payroll and branchingexpenses, branch, office and product expansion of the Company and itssubsidiary, and liquidity and capital levels.

Thesestatements are not guarantees of future performance and are subject to certainrisks and uncertainties that are difficult to predict. Actual results maydiffer materially from these forward-looking statements because ofinterest rate fluctuations, a deterioration of economic conditions in theBaltimore-Washington metropolitan area, a downturn in the real estatemarket, losses from impaired loans, an increase in nonperforming assets,potential exposure to environmental laws, changes in federal and state banklaws and regulations, the highly competitive nature of the banking industry, aloss of key personnel, changes in accounting standards and other risksdescribed in the Company’s filings with the Securities and Exchange Commission.Existing and prospective investors are cautioned not to place undue reliance onthese forward-looking statements, which speak only as of today’s date.The Company undertakes no obligation to update or revise the informationcontained in this Annual Report whether as a result of new information, futureevents or circumstances or otherwise. Past results of operations may not beindicative of future results. Readers should carefully review the risk factorsdescribed in other documents the Company files from time to time with theSecurities and Exchange Commission, including the Quarterly Reports on Form 10-Qto be filed by the Company in 2007**.**

**BUSINESS AND OVERVIEW**

The Company isa bank holding company headquartered in Baltimore, Maryland with one wholly-ownedsubsidiary, Carrollton Bank. The Bank has four subsidiaries, CMSI, CFS, andMSLLC which are wholly owned, and CCDC, which is 96.4% owned.

The Bank isengaged in a general commercial and retail banking business with ten branchlocations. CMSI is in the business of originating residential mortgage loansand has two branch locations. CFS provides brokerage services to customers andMSLLC manages and disposes of real estate acquired through foreclosures. CCDCpromotes, develops and improves the housing and economic conditions of peoplein Maryland.

The Banksponsors national retailers who accept ATM cards for purchases in variouselectronic networks. Effective January 22, 2006, the agreement withWal-Mart for the Bank to provide ATMs at Wal-Mart, Sam’s Club, andWal-Mart Supercenters in Maryland, Virginia and West Virginia was terminated.

During 2006,total assets decreased $10.6 million to $349.8 million due mainly to the areduction in cash and cash equivalents that was used to pay off $18.0 millionof Federal Home Loan Bank of Atlanta (FHLBA) advances. Partially offsettingthis decrease was an $8.4 million or 5% increase in commercial loans that werefunded primarily by the increase in deposits. The Company’s loans held for saleportfolio, which consists of residential mortgage loans originated by CMSI andheld for sale, usually within 30 days of origination, decreased 45.6% dueto the slow down in the residential housing market.

Net income forthe year ended December 31, 2006 totaled $2.6 million compared to $2.5million for the prior year, a 5% increase. The earnings were significantlyaffected by recording a before tax charge of approximately $1.8 million ($1.2million after tax) representing the loss from a check kiting scheme by one ofthe Bank’s commercial customers. The earnings also included a charge ofapproximately $2.3 million representing a prepayment penalty for restructuringa $35 million FHLBA advance at a fixed rate of 6.84% maturing February 2,2010. This charge was substantially offet by a gain of approximately $2.2million from the sale of equity securities. The earnings for the year ended December 31,2005 included security gains of $840,000 from the sale of equity securities, a$506,000 charge representing a penalty for the prepayment of a $5 million FHLBAadvance at 7.26% maturing May 24, 2010, and the write down and cost ofdisposal of ATMS totaling $563,000 related to the termination of the Wal-Martagreement. Wal-Mart terminated the agreement for Carrollton Bank to provideautomated teller machines (ATMs) at Wal-Mart, Sam’s Club and Wal-MartSupercenters in Maryland, Virginia and West Virginia. The Company is assetsensitive and as a result of the increasing interest rate environment of 2006and the increase in average interest earning assets of $15.1 million from2005 to 2006, net interest income increased 23% for 2006 compared to 2005.Noninterest income excluding the gains on the sales of securities of $2.2million in 2006 and $840,000 in 2005 decreased 32% compared to 2005. Thedecrease was due primarily  to the $3.0million decrease in ATM and Point of Sale revenue relating to the terminationof the Wal-Mart ATM agreement.

The Companyexpects to open its newest retail branch in Cockeysville, Maryland in thesecond quarter of 2007.

Based upon current earnings and encouragingprospects for future earnings, the Company paid dividends of $0.45 per share toshareholders during 2006.

19

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CARROLLTON BANCORP

**RESULTS OF OPERATIONS**

**SUMMARY**

The Companyreported net income for 2006 of $2.6 million or $0.90 per diluted share,representing a 5% increase from 2005 net income of $2.5 million**** or $0.87 per share.

The loanportfolio net of the Allowance for Loan Losses and****includingloans held for sale, increased 2.3%**** to $264.4 million, as a result of theCompany’s continuing efforts to align the loan portfolio to be in line withtypical commercial banks. Loans held for sale decreased 45.6% to $7.5 milliondue to the slow down in the residential housing market. Interest income onloans, including loans held for sale, increased 19.1%****dueto average loans, including loans held for sale, increasing $14.9 million andloans repricing to higher rates.

The depositportfolio increased 2.3% to $277.9 million, with the majority of thegrowth derived from money market accounts and certificates of deposit.  Partially affecting these increases weredecreases in noninterest bearing deposits and savings accounts. Interestexpense increased during 2006, due primarily to a $24.7 million increasein average interest-bearing deposits and the yield on interest-bearingdeposits increasing 96 basis points.

Noninterestincome decreased 17.0% in 2006 compared to 2005, due primarily to a $3.0 milliondecrease in ATM and Point of Sale revenue relating to the termination of theWal-Mart ATM agreement and partially offset by the $1.3 million increase in thegain on the sale of securities.

Noninterestexpense increased 4.0% in 2006 compared to 2005. The increase was due to the$1.8 million charge from the check kiting scheme by one of the Bank’scommercial customers and the $1.7 million increase in the prepayment penaltyfor restructuring a FHLBA advance partially offset by the elimination ofpersonnel, transaction fees, and other operating expenses as well as a writedown of $563,000 in 2005 related to the termination of the Wal-Mart ATMagreement.

The Companyreported net income for 2005 of $2.5 million or $0.87 per diluted share,representing a 177% increase from 2004 net income of $888,000, or $0.31 perdiluted share.

The loanportfolio, including loans held for sale, increased 14.1% during 2005 to$258.3 million, a result of the Company’s continuing efforts to re-alignthe loan portfolio to be more in line with typical commercial banks. Interestincome increased 23.9% due to loans increasing $31.9 million and loansrepricing to higher rates. The deposit portfolio increased 20.3% to$271.6 million, with the majority of the growth derived from noninterestbearing deposits, money market accounts and certificates of deposit. Interestexpense increased during 2005, due primarily to a $32.5 million increase ininterest-bearing deposits and the yield on interest bearing depositsincreasing 80 basis points.

Noninterest income increased 22.1% in 2005compared to 2004, due primarily to a 625% or $724,000 increase in gains onsales of securities, an increase of 41% or $788,000 in fees and commissionsearned by CMSI, a 3% or $133,000 increase in the Electronic Banking Division’srevenue, and a 14% or $134,000 increase in service charges.

**NET INTEREST INCOME**

Net interestincome, the amount by which interest income on interest-earning assetsexceeds interest expense on interest-bearing liabilities, is the mostsignificant component of the Company’s earnings. Net interest income is afunction of several factors, including changes in the volume and mix ofinterest-earning assets and funding sources, and market interest rates.While management policies influence these factors, external forces, includingcustomer needs and demands, competition, the economic policies of the federalgovernment and the monetary policies of the Federal Reserve Board, are alsoimportant.

The followingtable sets forth, for the periods indicated, information regarding the averagebalances of interest-earning assets and interest-bearingliabilities, the amount of interest income and interest expense and theresulting yields on average interest-earning assets and rates paid onaverage interest-bearing liabilities. Average balances are also providedfor noninterest-earning assets and noninterest-bearing liabilities.

20

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2006 ANNUAL REPORT

**AVERAGE BALANCES, INTEREST, AND YIELDS**

| * *                                                | * * | *2006*             | * *    | *2005*     | * * | *2004*     | * * |
|---------------------------------------------------------|----------|--------------------|-------------|------------|----------|------------|----------|
| * *                                                | * * | *Average  Balance* | * *    | *Interest* | * * | *Yield*    | * * | *Average  Balance* | * * | *Interest* | * * | *Yield* | * * | *Average  Balance* | * * | *Interest* | * * | *Yield* | * * |
| ASSETS                                                  |     |               |        |       |     |       |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold  and Federal Home Loan Bank deposit  |     | $                  | 7,839,525   |       | $        | 382,625    |     |   | 4.88 | % |   | $ | 19,067,206 |   | $ | 623,910 |   |   | 3.27 | % |   | $ | 8,606,166 |   | $ | 116,899 |   |   | 1.36 | % |   |
| Federal Home Loan  Bank stock                           |     | 1,742,153          |        | 99,046     |     |       | 5.69     |   |   | 2,643,019 |   | 109,616 |   |   | 4.15 |   |   | 2,261,207 |   | 80,737 |   |   | 3.57 |   |   |
| Investment  securities: (a)                        |     |               |        |       |     |       |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. government  agency                                 |     | 15,316,293         |        | 788,538    |     |       | 5.15     |   |   | 20,306,719 |   | 560,887 |   |   | 2.76 |   |   | 28,566,496 |   | 674,774 |   |   | 2.36 |   |   |
| State and municipal                                     |     | 8,734,211          |        | 544,815    |     |       | 6.24     |   |   | 4,027,933 |   | 264,620 |   |   | 6.57 |   |   | 4,549,377 |   | 287,890 |   |   | 6.33 |   |   |
| Mortgage-backed  securities                             |     | 21,554,754         |        | 1,170,089  |     |       | 5.43     |   |   | 11,089,402 |   | 611,055 |   |   | 5.51 |   |   | 8,747,456 |   | 479,546 |   |   | 5.48 |   |   |
| Corporate bonds                                         |     | 4,089,963          |        | 270,840    |     |       | 6.62     |   |   | 1,277,192 |   | 70,749 |   |   | 5.54 |   |   | 4,592,680 |   | 274,845 |   |   | 5.98 |   |   |
| Other                                                   |     | 1,154,060          |        | 49,212     |     |       | 4.26     |   |   | 1,877,280 |   | 135,232 |   |   | 7.20 |   |   | 3,732,303 |   | 175,442 |   |   | 4.70 |   |   |
|                                                    |     | 50,849,281         |        | 2,823,494  |     |       | 5.55     |   |   | 38,578,526 |   | 1,642,543 |   |   | 4.26 |   |   | 50,188,312 |   | 1,892,497 |   |   | 3.77 |   |   |
| Loans:                                                  |     |               |        |       |     |       |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand and time                                         |     | 73,339,911         |        | 5,862,743  |     |       | 7.99     |   |   | 67,134,231 |   | 3,554,951 |   |   | 5.30 |   |   | 49,920,788 |   | 2,783,558 |   |   | 5.58 |   |   |
| Residential  mortgage (b)                          |     | 72,131,409         |        | 3,926,413  |     |       | 5.44     |   |   | 74,654,896 |   | 4,613,621 |   |   | 6.18 |   |   | 68,431,096 |   | 4,090,660 |   |   | 5.98 |   |   |
| Commercial mortgage  and construction                   |     | 110,899,759        |        | 8,544,541  |     |       | 7.70     |   |   | 97,985,886 |   | 8,298,411 |   |   | 8.47 |   |   | 86,429,102 |   | 6,193,969 |   |   | 7.17 |   |   |
| Installment                                             |     | 1,504,253          |        | 80,978     |     |       | 5.38     |   |   | 1,813,896 |   | 154,258 |   |   | 8.50 |   |   | 2,414,072 |   | 209,275 |   |   | 8.67 |   |   |
| Lease financing                                         |     | 1,429,551          |        | 80,889     |     |       | 5.66     |   |   | 2,782,231 |   | 214,524 |   |   | 7.71 |   |   | 4,024,469 |   | 320,885 |   |   | 7.97 |   |   |
|                                                    |     | 259,304,883        |        | 20,044,135 |     |       | 7.73     |   |   | 244,371,140 |   | 16,835,765 |   |   | 6.89 |   |   | 211,219,527 |   | 13,598,347 |   |   | 6.44 |   |   |
| Total interest-earning  assets                          |     | 319,735,842        |        | 23,349,301 |     |       | 7.30     |   |   | 304,659,891 |   | 19,211,834 |   |   | 6.31 |   |   | 272,275,212 |   | 15,688,480 |   |   | 5.76 |   |   |
| Noninterest-bearing  cash                               |     | 14,651,700         |        |       |     |       |     |   |   | 26,624,448 |   |   |   |   |   |   |   | 21,682,244 |   |   |   |   |   |   |   |
| Premises and  equipment                                 |     | 5,432,452          |        |       |     |       |     |   |   | 5,694,687 |   |   |   |   |   |   |   | 4,959,453 |   |   |   |   |   |   |   |
| Other assets                                            |     | 7,993,335          |        |       |     |       |     |   |   | 4,034,529 |   |   |   |   |   |   |   | 7,858,307 |   |   |   |   |   |   |   |
| Allowance for loan  losses                              |     | (3,287,376         | )           |       |     |       |     |   |   | (3,472,722 | ) |   |   |   |   |   |   | (3,616,474 | ) |   |   |   |   |   |   |
| Unrealized gains on  available for sale securities, net |     | 1,065,683          |        |       |     |       |     |   |   | 3,412,785 |   |   |   |   |   |   |   | 3,174,905 |   |   |   |   |   |   |   |
|                                                    |     | $                  | 345,591,636 |       |     |       |     |   |   |   | $ | 340,953,618 |   |   |   |   |   |   |   | $ | 306,333,647 |   |   |   |   |   |   |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY              |     |               |        |       |     |       |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                             |     |               |        |       |     |       |     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings and NOW                                         |     | $                  | 62,309,713  |       | 147,770  |       |     | 0.24 | % |   | $ | 67,931,566 |   | 162,865 |   |   | 0.24 | % |   | $ | 71,404,510 |   | 180,741 |   |   | 0.25 | % |   |
| Money market                                            |     | 51,303,354         |        | 1,936,266  |     |       | 3.77     |   |   | 40,658,604 |   | 998,161 |   |   | 2.45 |   |   | 29,186,544 |   | 322,785 |   |   | 1.11 |   |   |
| Certificates of  deposit                                |     | 101,071,899        |        | 4,521,369  |     |       | 4.47     |   |   | 81,412,306 |   | 2,861,697 |   |   | 3.52 |   |   | 61,370,913 |   | 1,627,239 |   |   | 2.65 |   |   |
|                                                    |     | 214,684,966        |        | 6,605,404  |     |       | 3.08     |   |   | 190,002,476 |   | 4,022,723 |   |   | 2.12 |   |   | 161,961,967 |   | 2,130,765 |   |   | 1.32 |   |   |
| Borrowed funds                                          |     | 38,900,240         |        | 2,132,046  |     |       | 5.48     |   |   | 54,879,637 |   | 3,352,360 |   |   | 6.11 |   |   | 56,153,768 |   | 3,190,857 |   |   | 5.68 |   |   |
| Total interest-bearing  liabilities                     |     | 253,585,206        |        | 8,737,451  |     |       | 3.45     |   |   | 244,882,113 |   | 7,375,083 |   |   | 3.01 |   |   | 218,115,735 |   | 5,321,622 |   |   | 2.44 |   |   |
| Noninterest-bearing  deposits                           |     | 56,441,180         |        |       |     |       |     |   |   | 59,645,770 |   |   |   |   |   |   |   | 51,501,352 |   |   |   |   |   |   |   |
| Other liabilities                                       |     | 1,312,259          |        |       |     |       |     |   |   | 1,885,164 |   |   |   |   |   |   |   | 2,674,734 |   |   |   |   |   |   |   |
| Shareholders’ equity                               |     | 34,252,991         |        |       |     |       |     |   |   | 34,540,571 |   |   |   |   |   |   |   | 34,041,826 |   |   |   |   |   |   |   |
| Total liabilities  and shareholders’ equity        |     | $                  | 345,591,636 |       |     |       |     |   |   |   | $ | 340,953,618 |   |   |   |   |   |   |   | $ | 306,333,647 |   |   |   |   |   |   |   |
| Net interest  margin (c)                           |     | $                  | 319,735,842 |       | $        | 14,611,850 |     |   | 4.57 | % |   | $ | 304,659,891 |   | $ | 11,836,751 |   |   | 3.89 | % |   | $ | 272,275,212 |   | $ | 10,366,858 |   |   | 3.81 | % |   |

 

(a)         Interest on investments and loans ispresented on a fully taxable equivalent basis (a non-GAAP financial measure),using the federal income tax rates of 34% and, where applicable, the state rateof 7% (or a combined federal and state rate of 38.62%) to increase tax exemptinterest income to a taxable equivalent basis. This is a non-GAAP measure thatmanagement believes is useful when comparing annual results.

(b)        Loans held for sale are included inresidential mortgage loans.

(c)         Net interest margin is the ratio of netinterest income, determined on a fully taxable-equivalent basis, to totalaverage interest earning assets.

21

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CARROLLTON BANCORP

Net interestincome on a tax-equivalent basis increased to $14.6 million for the yearended December 31, 2006 compared to $11.8 million for 2005. Theincrease in tax-equivalent net interest income during 2006 was due to a$15.1 million increase in average interest-earning assets during 2006compared to 2005 and an increase in the yield on interest-earning assets of 99basis points.

The $14.9million or 6.1% increase in average loans outstanding is attributed to theCompany’s active business development efforts in its commercial loan portfolioand general economic conditions of the Company’s primary service market. Theyield on loans increased to 7.73% in 2006 compared to 6.89% for 2005 as loweryielding loans repriced during the year to higher rates. The yield oninvestment securities also increased to 5.55% in 2006 from 4.26% in 2005. Thenet impact was a $4.1 million or 21.5% increase in tax-equivalent interestincome for the year ended December 31, 2006 compared to 2005.

In 2005, netinterest income on a tax-equivalent basis increased to $11.8 million forthe year ended December 31, 2005 compared to $10.4 million for 2004.The increase in tax-equivalent net interest income during 2005 was almostentirely due to a $32.4 million increase in average earning assets during2005 compared to 2004. An increase in average loans outstanding of$33.2 million, or 15.7% and average federal funds sold of$10.5 million or 121.6% was partially offset by a decline in averageinvestment securities outstanding for the year of $11.6 million.

The increase inaverage loans outstanding is attributed to the Company’s active businessdevelopment efforts in its commercial loan portfolio and general economicconditions of the Company’s primary service market. Targeted short-terminterest rates, as established by the Federal Reserve Bank, increased during2005 resulting in the Company’s yield on earning assets increasing 55 basispoints to 6.31% for the year ended December 31, 2005 compared to 5.76% forthe same period in 2004. The yield on loans increased to 6.89% in 2005 comparedto 6.44% for 2004 as lower yielding loans repriced during the year to higherrates. The yield on investment securities also increased to 4.26% in 2005 from3.77% in 2004. The net impact was a $3.5 million or 22.4% increase intax-equivalent interest income for the year ended December 31, 2005compared to 2004.

Interestexpense increased $1.4 million to $8.7 million in 2006 from$7.4 million in 2005. Interest expense increased primarily due to a changein the deposit mix, with an increase in the amount of interest-bearingdeposits partially offet by a decrease in borrowings. In addition, the cost ofinterest-bearing deposits increased from 2.12% in 2005 to 3.08% in 2006.

Interestexpense on total interest-bearing liabilities increased$1.4 million, or 18.5%, for the year ended December 31, 2006. Theincrease in interest expense was due to an $8.7 million increase inaverage interest-bearing liabilities and the cost of interest-bearingliabilities increasing to 3.45% for the year ended December 31, 2006compared to 3.01% for the same period in 2005.

The following table and the relateddiscussions of interest income and interest expense provide further analysis ofthe changes in net interest income during 2005 and 2004:

| * *                                                           | * * | *2006 Compared to 2005*          | * *  | *2005 Compared to 2004*          | * * |
|--------------------------------------------------------------------|----------|-------------------------------------------------|-----------|-------------------------------------------------|----------|
| * *                                                           | * * | *Change Due to Variance In* | * *  | *Change Due to Variance In* | * * |
| * *                                                           | * * | *Rate(b)*                                       | * *  | *Volume(b)*                                     | * * | *Total* | * * | *Rates(b)* | * * | *Volume(b)* | * * | *Total* | * * |
| INTEREST INCOME                                                    |     |                                            |      |                                            |     |   |   |   |   |   |   |   |   |
| Federal funds sold and interest-bearing  deposits with other banks |     | $                                               | 126,216   |                                            | $        | (367,145 | ) | $ | (240,929 | ) | $ | 364,757 |   | $ | 142,254 |   | $ | 507,011 |   |
| Investment securities and FHLB stock                               |     | 682,785                                         |      | 485,348                                         |     | 1,168,133 |   | (55,017 | ) | (166,058 | ) | (221,075 | ) |
| Loans (a)                                                     |     | 2,181,328                                       |      | 1,028,935                                       |     | 3,210,263 |   | 1,099,671 |   | 2,137,747 |   | 3,237,418 |   |
| TOTAL INTEREST EARNED                                              |     | 2,990,329                                       |      | 1,147,138                                       |     | 4,137,467 |   | 1,409,411 |   | 2,113,943 |   | 3,523,354 |   |
| INTEREST EXPENSE                                                   |     |                                            |      |                                            |     |   |   |   |   |   |   |   |   |
| Deposits                                                           |     | 2,060,511                                       |      | 523,269                                         |     | 2,583,779 |   | 1,501,020 |   | 390,938 |   | 1,891,958 |   |
| Borrowings                                                         |     | (245,072                                        | )         | (976,341                                        | )        | (1,221,413 | ) | 216,307 |   | (54,804 | ) | 161,503 |   |
| TOTAL INTEREST EXPENSE                                             |     | 1,815,439                                       |      | (453,072                                        | )        | 1,362,367 |   | 1,717,327 |   | 336,134 |   | 2,053,461 |   |
| NET INTEREST INCOME                                                |     | $                                               | 1,174,890 |                                            | $        | 1,600,210 |   | $ | 2,775,100 |   | $ | (307,916 | ) | $ | 1,777,809 |   | $ | 1,469,893 |   |

 

(a)     Intereston investments and loans is presented on a fully taxable equivalent basis (anon-GAAP financial measure), using regular income tax rates.

(b)    Thechange in interest income and expense due to variance in both rate and volumehas been allocated to the change due to variance in rate.

22

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2006 ANNUAL REPORT

**PROVISION FOR LOAN LOSSES**

On a monthlybasis, management of the Company reviews all loan portfolios to determinetrends and monitor asset quality. For consumer loan portfolios, this reviewgenerally consists of reviewing delinquency levels on an aggregate basis withtimely follow-up on accounts that become delinquent. In commercial loanportfolios, delinquency information is monitored and periodic reviews ofbusiness and property leasing operations are performed on an individual loanbasis to determine potential collection and repayment problems.

The Companycontinues to experience strong asset quality in its loan portfolio with a lowdelinquency rate and a low charge off rate. The Company did not provide for anyloan losses for the years ended December 31, 2006 and 2005. Nonaccrual,restructured and delinquent loans over 90 days to total loans increased to2.19% at the end of 2006 compared to 0.64% in 2005. The ratio of net loanlosses to average loans increased in 2006 to 0.08 % compared to 0.06% for 2005.

The Company did not provide for any loanlosses for the years ended December 31, 2005 and 2004. Nonaccrual,restructured, and delinquent loans over 90 days to total loans improved to0.64% at the end of 2005 compared to 1.20% in 2004. The ratio of net loanlosses to average loans decreased in 2005 to 0.06% compared to 0.08% for 2004.

**NONINTEREST INCOME**

Noninterestincome decreased from $10.7 million during 2005 to $8.9  million in2006 due primarily to the $3.0 million decrease in ATM and Point of Sale revenuerelating to the termination of the Wal-Mart ATM agreement and partially offsetby the $1.3 million increase in the gain on the sale of securities. Thedecrease in net gains and fees on sales of mortgage loans corresponded to adecrease in the volume of mortgage loans sold during the year due to a slowdown in the residential housing market. In 2006, sales of available-for-salesecurities generated $2.2 million in gains compared to $840,000 in 2005.

Electronicbanking income is comprised of three sources: national point of sale (“POS”)sponsorships, ATM fees, and check card fees. Through December 31, 2005,the Company maintained ATMs in Wal-Mart stores in Maryland, Virginia andWest Virginia, as well as at its branches. Effective January 22, 2006, theagreement with Wal-Mart for the Bank to provide ATM services at its locationsin Maryland, Virginia and West Virginia was terminated. The fees from theATMs represent approximately 8% of total electronic banking revenue in2006. The Company sponsors merchants who accept ATM cards for purchases withinvarious networks (i.e. STAR, PULSE, and NYCE). This national POS sponsorshipincome represents approximately 78% of total electronic banking revenue. Feesfrom check cards comprise the remaining 14% of electronic banking revenue.

The Companyoffers a variety of financial planning and investment options to customers,through its subsidiary, CFS, and recognizes commission income as these servicesare provided.

Noninterestincome increased from $8.8 million during 2004 to $10.7 million in2005 due, in large part, to increases in gains and fees recognized on the saleof mortgage loans, net of costs, gains on security sales, increases inElectronic Banking division’s revenues and increases in fees charged fordeposit services. Specifically, net gains and fees on sales of mortgage loansincreased $788,000 or 41.1% from 2004 to 2005, gains on sales of securitiesincreased $724,000 or 625.2%, the Electronic Banking Division’s revenueincreased $133,000 or 2.7% and deposit service charges increased by $134,000 or14.2%. Brokerage commissions also increased $44,000 or 7.0%. The increase innet gains and fees on sales of mortgage loans corresponded to an increase inthe volume of mortgage loans sold during the year, from $129.7 million in2004 to $183.1 million in 2005. The Company believes that this increase inmortgage loan volume was primarily attributable to the market, in general, andexpanding the operations of the mortgage company in 2004. The gain on sale ofsecurities increased $724,000 due to the Company taking some profits on equityinvestments in 2005.

Electronicbanking income is comprised of three sources: national point of sale (“POS”)sponsorships, ATM fees, and check card fees. Through December 31, 2005,the Company maintained ATMs in Wal-Mart stores in Maryland, Virginia andWest Virginia, as well as at its branches. The fees from theseATMs represent approximately 39% of total electronic banking revenue in2005. The Company sponsors merchants who accept ATM cards for purchases withinvarious networks (i.e. STAR, PULSE, and NYCE). This national POS sponsorshipincome represents approximately 41% of total electronic banking revenue. Feesfrom check cards comprise the remaining 20% of electronic banking revenue. On September 22,2005, Wal-Mart notified the Bank of its intention to terminate the agreementfor the Company to provide ATM services at its locations in Maryland, Virginiaand West Virginia. The effective date of the termination was January 22,2006.

During 2004, the Company opened a mortgagesubsidiary CMSI,  Our mortgage-bankingbusiness is structured to provide a source of fee income largely from theprocess of originating residential mortgage loans for sale on the secondarymarket, as well as the origination of loans to be held in our loan portfolio. Mortgage-bankingproducts include Federal Housing Adminstration (“FHA”) and the federal VeteransAdministration (“VA”) loans, conventional and nonconforming first and second mortgages, andconstruction and permanent financing.

23

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CARROLLTON BANCORP

**NONINTEREST EXPENSES**

Noninterestexpense consists primarily of costs associated with personnel, occupancy andequipment, data processing, marketing and professional fees. The Company’snoninterest expense for the year ended December 31, 2006 totaled$19.4 million, representing an increase of $747,000, or 4.0%, as comparedto 2005. The increase was due to the $1.8 million charge from the check kitingscheme by one of the Bank’s commercial customers and the $1.7 million increasein the prepayment penalty for restructuring a FHLBA advance partially offset bythe elimination of personnel, transaction fees, other operating expenses aswell as a write down of $563,000 in 2005 related to the termination of theWal-Mart agreement.

During 2005 noninterestexpenses increased by $883,000, or  5.0%to $18.6 million compared to $17.8 million in 2004.

Salaries, thelargest component of noninterest expense increased $607,000 or 8.9% from 2004to 2005 due to merit increases and the opening of a new branch in the North BelAir area of Harford County and were partially offset by a decrease in theaverage number of fulltime equivalent employees from 165 in 2004 to 157 in2005. Employee benefits decreased by $532,000 due to freezing the definedbenefit pension plan effective December 31, 2004.

Occupancy costsincreased $247,000 or 15.4% from 2004 to 2005 due to the opening of the newbranch in Harford County and normal lease payment escalations and costs tomaintain business properties. Furniture and equipment expense decreased$379,000 or 23.8% due to the original cost of the ATM network being fullydepreciated in 2004.

In 2005, theCompany had non-recurring charges of $563,000 related to the terminationof the Wal-Mart agreement, and $506,000 representing a penalty for theprepayment of a $5.0 million FHLBA advance at 7.26% maturing May 24,2010. In 2004, there was a non-recurring charge of $497,000 related tothe write down of FHLMC stock.

Other noninterest expense increased $368,000or 6.9% from 2003 to 2004 due to increases in marketing expenses related toopening the new branch in Harford County, amortization of software acquired,increased data processing services due to growth in loans and deposits,increased loan expenses related to CMSI, and professional fees partially offsetby decreases in various other expenses.

**INCOME TAX PROVISION**

Income tax expense was $1.3 million in2006 and 2005 and $320,000 in 2004. The effective tax rate was 33.9% in 2006,35.0% in 2005 and 26.5% in 2004. The effective tax rates fluctuate from year toyear due to changes in the mix of tax-exempt loans and investments as apercentage of total loans and investments. During 2005, a lower percentage ofthe Company’s pre-tax income was exempt from taxes compared to 2004. During2006, the Company purchased additional tax exempt securities, which reduced theeffective tax rates.

**FINANCIAL CONDITION**

**SUMMARY**

Total assets of the Company decreased by 3.0%to $349.8 million at December 31, 2006 from $360.5 million at December 31,2005. Investment securities increased 15.7% to $55.1 million at December 31,2006. Gross loans, excluding loans held for sale, increased by 4.9% to$260.0 million at December 31, 2006 compared to $247.9 millionat the end of 2005. Interest-earning assets increased $2.4 millionto $327.1 million and were 93.5% of total assets at December 31,2006.

**INVESTMENT SECURITIES**

The investmentportfolio consists of investment securities held to maturity and securitiesavailable for sale. Investment securities held to maturity are those securitiesthat the Company has the positive intent and ability to hold to maturity andare carried at amortized cost. Securities available for sale are thosesecurities that the Company intends to hold for an indefinite period of timebut not necessarily until maturity. These securities are carried at fair valueand may be sold as part of an asset/liability management strategy, liquiditymanagement, interest rate risk management, regulatory capital management orother similar factors.

24

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2006 ANNUAL REPORT

The components of the investment portfoliowere as follows at December 31:

| * *                    | * * | *2006*     | * *   | *2005*     | * * | *2004*     | * * | *2003*     | * *   | *2002*     | * * |
|-----------------------------|----------|------------|------------|------------|----------|------------|----------|------------|------------|------------|----------|
| AVAILABLE FOR SALE          |     |       |       |       |     |       |     |       |       |       |     |
| U.S. Government agency      |     | $          | 9,363,760  |       | $        | 10,740,335 |     | $          | 19,913,790 |       | $        | 34,566,285 |   | $ | 44,866,333 |   |
| Mortgage-backed securities  |     | 12,725,553 |       | 8,490,125  |     | 8,447,886  |     | 9,628,267  |       | 17,008,728 |     |
| State and municipal bonds   |     | 5,724,959  |       | 3,689,859  |     | 4,137,433  |     | 5,197,716  |       | 5,446,260  |     |
| Corporate bonds             |     | 5,621,529  |       | 1,514,471  |     | 3,036,920  |     | 6,820,340  |       | 7,962,805  |     |
| Subtotal                    |     | 33,709,801 |       | 24,434,790 |     | 35,536,029 |     | 56,212,608 |       | 75,284,126 |     |
| Equity securities           |     | 2,224,846  |       | 4,660,213  |     | 6,952,463  |     | 6,246,349  |       | 3,502,021  |     |
| Total available for sale    |     | 35,934,647 |       | 29,095,003 |     | 42,488,492 |     | 62,458,957 |       | 78,786,147 |     |
| HELD TO MATURITY            |     |       |       |       |     |       |     |       |       |       |     |
| U.S. Government agency      |     | 6,456,069  |       | 5,000,000  |     | —     |     | —     |       | —     |     |
| Mortgage-backed securities  |     | 8,761,200  |       | 9,575,713  |     | —     |     | —     |       | —     |     |
| State and municipal bonds   |     | 3,912,704  |       | 3,912,692  |     | —     |     | —     |       | —     |     |
| Equity securities           |     | —     |       | —     |     | —     |     | 25,000     |       | 25,000     |     |
| Total held to maturity      |     | 19,129,973 |       | 18,488,405 |     | —     |     | 25,000     |       | 25,000     |     |
| Total investment securities |     | $          | 55,064,620 |       | $        | 47,583,408 |     | $          | 42,488,492 |       | $        | 62,483,957 |   | $ | 78,811,147 |   |

 

Note:Investments classified as available for sale are carried at fair value whereasinvestments classified as held to maturity are carried at amortized cost.

The following table shows the maturity of theinvestment portfolio at December 31, 2006:

| * *                   | * * | *Available for Sale* | * *   | *Held to Maturity* | * * |
|----------------------------|----------|--------------------------------|------------|------------------------------|----------|
| *Maturing*                 | * * | *Amortized  Cost*              | * *   | *Fair  Value*                | * * | *Yield* | * * | *Amortized  Cost* | * * | *Fair  Value* | * * | *Yield* | * * |
| Within one year            |     | $                              | 2,000,000  |                         | $        | 1,985,620 |   |   | 3.05 | % |   | $ | — |   | $ | — |   |   | — | % |   |
| Over one to five years     |     | 4,923,172                      |       | 4,924,303                    |     |   | 4.96 |   |   | — |   | — |   |   | — |   |   |
| Over five to ten years     |     | 3,928,823                      |       | 3,958,428                    |     |   | 4.91 |   |   | 8,414,510 |   | 8,324,424 |   |   | 4.93 |   |   |
| Over ten years             |     | 10,120,600                     |       | 10,115,897                   |     |   | 5.83 |   |   | 1,954,263 |   | 1,941,379 |   |   | 5.73 |   |   |
|                       |     | 20,972,595                     |       | 20,984,248                   |     |   |   |   |   | 10,368,773 |   | 10,265,803 |   |   |   |   |   |
| Mortgage-backed securities |     | 12,712,231                     |       | 12,725,553                   |     |   | 5.82 |   |   | 8,761,200 |   | 8,624,465 |   |   | 4.96 |   |   |
| Equity securities          |     | 1,140,856                      |       | 2,224,846                    |     |   | 2.40 |   |   | — |   | — |   |   | — |   |   |
|                       |     | $                              | 34,825,682 |                         | $        | 35,934,647 |   |   |   |   |   | $ | 19,129,973 |   | $ | 18,890,268 |   |   |   |   |   |

 

The investmentportfolio consists primarily of U. S. Government agency securities, mortgage-backedsecurities, corporate bonds, state and municipal obligations, and equitysecurities. The income from state and municipal obligations is exempt fromfederal income tax. Certain agency securities are exempt from state incometaxes. The Company uses its investment portfolio as a source of both liquidityand earnings.

Investment securities increased$7.5 million to $55.1 million at December 31, 2006 compared to$47.6 million at December 31, 2005. The increase was due to purchasesof mortgage backed securities and state and municipal bonds. In 2004, theCompany recognized a $497,000 other-than-temporary impairment of the Company’sinvestment in FMLMC preferred stock.

**LOANS**

The following table represents a breakdown ofloan balances at December 31:

| * *                          | * * | *2006*      | * *    | *2005*      | * * | *2004*      | * * | *2003*      | * *    | *2002*      | * * |
|-----------------------------------|----------|-------------|-------------|-------------|----------|-------------|----------|-------------|-------------|-------------|----------|
| Real Estate:                      |     |        |        |        |     |        |     |        |        |        |     |
| Residential                       |     | $           | 55,057,625  |        | $        | 53,148,211  |     | $           | 55,242,018  |        | $        | 57,586,028 |   | $ | 79,520,154 |   |
| Commercial                        |     | 120,397,988 |        | 97,909,115  |     | 94,858,597  |     | 82,856,038  |        | 78,500,418  |     |
| Construction and land development |     | 29,996,306  |        | 37,415,478  |     | 17,774,874  |     | 16,275,828  |        | 7,664,367   |     |
| Demand and time                   |     | 51,549,802  |        | 56,118,527  |     | 46,168,587  |     | 35,978,633  |        | 32,444,790  |     |
| Lease financing                   |     | 969,113     |        | 1,936,482   |     | 3,598,003   |     | 4,449,408   |        | 4,343,539   |     |
| Installment                       |     | 2,030,480   |        | 1,415,260   |     | 2,084,215   |     | 2,150,626   |        | 2,746,858   |     |
|                              |     | 260,001,314 |        | 247,943,073 |     | 219,726,294 |     | 199,296,561 |        | 205,220,126 |     |
| Allowance for loan losses         |     | 3,131,021   |        | 3,337,163   |     | 3,485,076   |     | 3,648,245   |        | 3,578,762   |     |
| Loans, net                        |     | $           | 256,870,293 |        | $        | 244,605,910 |     | $           | 216,241,218 |        | $        | 195,648,316 |   | $ | 201,641,364 |   |

 

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CARROLLTON BANCORP

Gross loans,excluding loans held for sale, increased $12.1 million or 4.9% from$247.9 million as of December 31, 2005 to $260.0 million as of December 31,2006. The increase was primarily in commercial lending including commercialconstruction and land development. Commercial loans amounted to$202.9 million at December 31, 2006 and were 78% of total loans.Consumer loans amounted to $57.1 million and were 22% of total loans.

The following table shows the contractualmaturities and interest rate sensitivities of the Company’s loans at December 31,2006. Some loans may include contractual installment payments that are notreflected in the table until final maturity. In addition, the Company’sexperience indicates that a significant number of loans will be extended orrepaid prior to contractual maturity. Consequently, the table is not intendedto be a forecast of future cash repayments.

| * *                          | * * | *Maturing*                                | * *   |
|-----------------------------------|----------|-------------------------------------------|------------|
| * *                          | * * | *In one year or less* | * *   | *After 1 through 5 years* | * * | *After 5 years* | * * | * * | * * |
| * *                          | * * | *Fixed*                                   | * *   | *Variable* | * * | *Fixed* | *_* | *Variable* | * * | *Fixed* | * * | *Variable* | * * | *Total* | * * |
| Real Estate:                      |     |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential                       |     | $                                         | 185,032    |   | $ | 741,011 |   | $ | 1,417,229 |   | $ | — |   | $ | 16,074,707 |   | $ | 36,639,646 |   | $ | 55,057,625 |   |
| Commercial                        |     | 13,387,834                                |       | 11,053,853 |   | 73,766,392 |   | 841,931 |   | 18,693,031 |   | 2,654,947 |   | 120,397,988 |   |
| Construction and land development |     | 10,882,428                                |       | 7,408,186 |   | 380,673 |   | 4,235,920 |   | 6,944,049 |   | 145,050 |   | 29,996,306 |   |
| Demand and time                   |     | 1,335,962                                 |       | 31,720,178 |   | 10,735,337 |   | 6,036,889 |   | 1,142,042 |   | 579,394 |   | 51,549,802 |   |
| Lease financing                   |     | 216,151                                   |       | — |   | 752,962 |   | — |   | — |   | — |   | 969,113 |   |
| Installment                       |     | 935,382                                   |       | 15,717 |   | 258,766 |   | 281,791 |   | 301,761 |   | 237,063 |   | 2,030,480 |   |
|                              |     | $                                         | 26,942,789 |   | $ | 50,938,945 |   | $ | 87,311,359 |   | $ | 11,396,531 |   | $ | 43,155,590 |   | $ | 40,256,100 |   | $ | 260,001,314 |   |

 

The following table provides informationconcerning nonperforming assets and past due loans at December 31, 2006:

| * *                                 | * * | *2006*    | * *  | *2005* | * * | *2004*    | * * | *2003*  | * *  | *2002*  | * * |
|------------------------------------------|----------|-----------|-----------|--------|----------|-----------|----------|---------|-----------|---------|----------|
| Nonaccrual loans (a)                |     | $         | 3,699,397 |   | $        | 1,413,925 |     | $       | 615,394   |    | $        | 712,116 |   | $ | 734,879 |   |
| Restructured loans                       |     | 180,686   |      | — |     | 455,864   |     | 661,974 |      | 568,969 |     |
| Foreclosed real estate                   |     | 1,383,163 |      | — |     | —    |     | 100,000 |      | 218,654 |     |
|                                     |     | $         | 5,263,246 |   | $        | 1,413,925 |     | $       | 1,071,258 |    | $        | 1,474,090 |   | $ | 1,522,502 |   |
| Accruing loans past-due 90 days or  more |     | $         | 436,599   |   | $        | 179,012   |     | $       | 1,567,919 |    | $        | 1,036,018 |   | $ | 1,900,663 |   |

 

(a) Loans are placed in nonaccrual statuswhen they are past-due 90 days as to either principal or interest or when,in the opinion of management, the collection of all interest and/or principalis in doubt. A loan remains in nonaccrual status until the loan is current asto payment of both principal and interest and the borrower demonstrated theability to pay and remain current. Management may grant a waiver fromnonaccrual status for a 90-day past-due loan that is both well secured andin the process of collection.

**ALLOWANCE FOR LOAN LOSSES**

An allowancefor loan losses is maintained to absorb losses in the existing loan portfolio.The allowance is a function of specific loan allowances, general loanallowances based on historical loan loss experience and current trends, andallowances based on general economic conditions that affect the collectibilityof the loan portfolio. These can include, but are not limited to exposure to anindustry experiencing problems, changes in the nature or volume of theportfolio and delinquency and nonaccrual trends. The portfolio review andcalculation of the allowance is performed by management on a continuing basis.

The specificallowance is based on regular analysis of the loan portfolio and is determinedby analysis of collateral value, cash flow and guarantor capacity, asapplicable. The specific allowance was $534,639, $77,744, and $143,374 as of December 31,2006, 2005 and 2004, respectively.

The generalallowance is calculated using internal loan grading results and appropriateallowance factors on approximately ten classes of loans. This process isreviewed on a regular basis. The allowance factors may be revised whenevernecessary to address current credit quality trends or risks associated with particularloan types. Historic trend analysis is utilized to obtain the factors to beapplied. The general allowance was $2,001,000, $2,319,000, and $2,559,000 as ofDecember 31, 2006, 2005 and 2004, respectively.

Allocation of aportion of the allowance does not preclude its availability to absorb losses inother categories. An unallocated reserve is maintained to recognize theimprecision in estimating and measuring loss when evaluating the allowance forindividual loans or pools of loans.

26

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2006 ANNUAL REPORT

During the yearsended December 31, 2002 through 2006, the unallocated portion of theallowance for loan losses has fluctuated with the specific and generalallowances so that the total allowance for loan losses would be at a level thatmanagement believes is the best estimate of probable future loan losses at thebalance sheet date. The specific allowance may fluctuate from period to periodif the balance of what management considers problem loans changes. The generalallowance will fluctuate with changes in the mix of the Company’s loanportfolio, economic conditions, or specific industry conditions. Therequirements of the Company’s federal regulators are a consideration indetermining the required total allowance. Due to the level of the unallocatedallowance, management did not make any provision for loan losses in 2006 and2005.

Managementbelieves that it has adequately assessed the risk of loss in the loanportfolios based on a subjective evaluation and has provided an allowance whichis appropriate based on that assessment. Because the allowance is an estimatebased on current conditions, any change in the economic conditions of theCompany’s market area or change within a borrower’s business could result in arevised evaluation, which could alter the Company’s earnings.

The following charts show the level of loanlosses recorded by the Company for the past five years, management’s allocationof the allowance for loan losses by type of loan as of the end of each year,and other statistical information. The allocation of the allowance reflectsmanagement’s analysis of economic risk potential by type of loan, and is notintended as a forecast of loan losses.

| * *                                               | * * | *Years ended December 31* | * *  |
|--------------------------------------------------------|----------|------------------------------------------|-----------|
| *Description*                                          | * * | *2006*                                   | * *  | *2005* | * * | *2004* | * * | *2003* | * * | *2002* | * * |
| Balance at beginning of year                           |     | $                                        | 3,337,163 |   | $ | 3,485,076 |   | $ | 3,648,245 |   | $ | 3,578,762 |   | $ | 3,338,807 |   |
| Charge-offs:                                           |     |                                     |      |   |   |   |   |   |   |   |   |
| Demand and time                                        |     | —                                   |      | 123,578 |   | 192,440 |   | 200,173 |   | 21,904 |   |
| Lease financing                                        |     | 154,747                                  |      | 168,823 |   | — |   | — |   | — |   |
| Real estate:                                           |     |                                     |      |   |   |   |   |   |   |   |   |
| Residential                                            |     | —                                   |      | — |   | 7,746 |   | 16,898 |   | 160,591 |   |
| Commercial                                             |     | 59,120                                   |      | — |   | — |   | — |   | 112,718 |   |
| Construction                                           |     | —                                   |      | — |   | — |   | — |   | — |   |
| Installment                                            |     | 41,967                                   |      | 22,640 |   | 76,936 |   | 47,957 |   | 85,393 |   |
|                                                   |     | 255,834                                  |      | 315,041 |   | 277,122 |   | 265,028 |   | 380,606 |   |
| Recoveries:                                            |     |                                     |      |   |   |   |   |   |   |   |   |
| Demand and time                                        |     | —                                   |      | 130,904 |   | 67,111 |   | 58,034 |   | 2,475 |   |
| Lease financing                                        |     | 16,530                                   |      | 3,980 |   | — |   | — |   | — |   |
| Real estate:                                           |     |                                     |      |   |   |   |   |   |   |   |   |
| Residential                                            |     | —                                   |      | 14,874 |   | 8,087 |   | — |   | 67,705 |   |
| Commercial                                             |     | 6,290                                    |      | — |   | — |   | — |   | — |   |
| Construction                                           |     | —                                   |      | — |   | — |   | — |   | — |   |
| Installment                                            |     | 26,872                                   |      | 17,370 |   | 38,755 |   | 33,477 |   | 24,381 |   |
|                                                   |     | 49,692                                   |      | 167,128 |   | 113,953 |   | 91,511 |   | 94,561 |   |
| Net charge-offs                                        |     | 206,142                                  |      | 147,913 |   | 163,169 |   | 173,517 |   | 286,045 |   |
| Provision charged to operations                        |     | —                                   |      | — |   | — |   | 243,000 |   | 526,000 |   |
| Balance at end of the year                             |     | $                                        | 3,131,021 |   | $ | 3,337,163 |   | $ | 3,485,076 |   | $ | 3,648,245 |   | $ | 3,578,762 |   |
| Ratio of net charge-offs to average loans  outstanding |     | 0.08%                                    |      | 0.06% |   | 0.08% |   | 0.09% |   | 0.13% |   |

 

A breakdown ofthe allowance for loan losses is provided in the table below; however,management does not believe that the allowance can be segregated by categorywith precision. The breakdown of the allowance is based primarily on thosefactors discussed previously in evaluating the allowance as a whole. Since allof those factors are subject to change, the breakdown is not necessarilyindicative of the category of actual or realized credit losses.

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CARROLLTON BANCORP

The following table presents the allocationof the allowance for loan losses among the various loan categories at December 31:

| *Portfolio*                         | * * | *2006*  | * *  | *2005*  | * * | *2004*    | * * | *2003*    | * *  | *2002*    | * * |
|-------------------------------------|----------|---------|-----------|---------|----------|-----------|----------|-----------|-----------|-----------|----------|
| Demand and time and lease financing |     | $       | 922,612   |    | $        | 474,059   |     | $         | 589,053   |      | $        | 1,226,447 |   | $ | 733,560 |   |
| Real estate:                        |     |    |      |    |     |      |     |      |      |      |     |
| Residential                         |     | 409,684 |      | 718,028 |     | 587,292   |     | 831,173   |      | 754,979   |     |
| Commercial                          |     | 923,453 |      | 679,002 |     | 1,034,546 |     | 1,041,834 |      | 876,243   |     |
| Construction and land development   |     | 230,072 |      | 382,204 |     | 342,114   |     | —    |      | —    |     |
| Installment                         |     | 49,399  |      | 143,318 |     | 149,271   |     | 133,865   |      | 94,162    |     |
| Unallocated                         |     | 595,801 |      | 940,552 |     | 782,800   |     | 414,926   |      | 1,119,818 |     |
|                                |     | $       | 3,131,021 |    | $        | 3,337,163 |     | $         | 3,485,076 |      | $        | 3,648,245 |   | $ | 3,578,762 |   |

 

The table below provides a percentagebreakdown of the loan portfolio by category to total loans at December 31:

| *Portfolio*                         | * * | *2006* | * * | *2005* | * * | *2004* | *_*    | *2003* | * * | *2002* | * * |
|-------------------------------------|----------|--------|----------|--------|----------|--------|--------|--------|----------|--------|----------|
| Demand and time and lease financing |     | 20.2   | %        | 23.4   | %        | 22.7   | %      | 20.2   | %        | 17.9   | %        |
| Real estate:                        |     |   |     |   |     |   |   |   |     |   |     |
| Residential                         |     | 21.2   |     | 21.4   |     | 25.1   |   | 28.9   |     | 38.8   |     |
| Commercial                          |     | 46.3   |     | 39.6   |     | 43.2   |   | 41.6   |     | 38.2   |     |
| Construction and land development   |     | 11.5   |     | 15.1   |     | 8.1    |   | 8.2    |     | 3.8    |     |
| Installment                         |     | 0.8    |     | 0.5    |     | 0.9    |   | 1.1    |     | 1.3    |     |
|                                |     | 100.0  | %        | 100.0  | %        | 100.0  | %      | 100.0  | %        | 100.0  | %        |

 

All loanreserves are subject to regulatory examinations and determinations as to theappropriateness of the methodology and adequacy on an annual basis.

At December 31, 2006, the allowance for loanlosses was $3.1 million, a 6.2% decrease from the end of 2005. The ratio of theallowance to total loans was 1.20% at December 31, 2006 and 1.35% at December 31,2005. The ratio of net loan losses to average loans outstanding for 2006 was0.08% compared to 0.06% for 2005. The ratio of nonaccrual loans, restructuredloans and loans delinquent more than 90 days to total loans increased to 2.19%at December 31, 2006 from 0.64% at the end of 2005. The ratio of realestate loans to total loans increased to 79.0% at the end of 2006 from 76.1% atthe end of 2005.

**FUNDING SOURCES**

**DEPOSITS**

The following table sets forth the averagedeposit balances and average rates paid on deposits during the years ended December 31:

| * *                     | * * | *2006*             | * *    | *2005*          | * * | *2004*             | * * |
|------------------------------|----------|--------------------|-------------|-----------------|----------|--------------------|----------|
| * *                     | * * | *Average  Balance* | * *    | *Average  Rate* | * * | *Average  Balance* | * * | *Average  Rate* | * * | *Average  Balance* | * * | *Average  Rate* | * * |
| Noninterest-bearing deposits |     | $                  | 56,441,180  |            |     | —             | %        |   | $ | 59,645,770 |   |   | — | % |   | $ | 51,501,352 |   |   | — | % |   |
| Interest-bearing deposits:   |     |               |        |            |     |               |     |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                 |     | 32,038,917         |        |            | 0.21     |               |     | 34,384,963 |   |   | 0.21 |   |   | 35,016,262 |   |   | 0.21 |   |   |
| Savings accounts             |     | 30,270,796         |        |            | 0.27     |               |     | 33,546,603 |   |   | 0.27 |   |   | 36,388,248 |   |   | 0.29 |   |   |
| Money market accounts        |     | 51,303,354         |        |            | 3.77     |               |     | 40,658,604 |   |   | 2.45 |   |   | 29,186,544 |   |   | 1.11 |   |   |
| Certificates of deposit      |     | 101,071,899        |        |            | 4.47     |               |     | 81,412,306 |   |   | 3.52 |   |   | 61,370,913 |   |   | 2.65 |   |   |
|                         |     | $                  | 271,126,146 |            |     | 2.44               |     |   | $ | 249,648,246 |   |   | 1.61 |   |   | $ | 213,463,319 |   |   | 1.00 |   |   |

 

The following table provides the maturitiesof certificates of deposit of the Company in amounts of $100,000 or more at December 31,2006:

| Maturing in:                    |   |      |       |
|---------------------------------|--------|-----------|------------|
| 3 months or less                |   | $         | 12,945,360 |   |
| Over 3 months through 6 months  |   | 4,514,815 |       |
| Over 6 months through 12 months |   | 7,588,860 |       |
| Over 12 months                  |   | 4,518,886 |       |
|                            |   | $         | 29,567,921 |   |

 

28

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2006 ANNUAL REPORT

Total depositsat December 31, 2006 increased by $6.3 million to $277.9 million from the endof 2005. Interest bearing accounts increased by $23.2 million and noninterest-bearingdeposits decreased by $16.9 million.

The Company began offering CDARS deposits toits customers during 2004. This program allows for customers that wish toinvest more than the amounts that would normally be covered by FDIC insurancewith the Bank. The program is a nationwide one that allows participating banksto “swap” customer deposits so that no customer has greater than the insurablemaximum in one bank, but the customer only deals with his/her own bank. As of December 31,2006, the Bank had approximately $9.2 million in CDARS deposits, a decrease of$12.2 million from December 31, 2005.

**BORROWED FUNDS**

Borrowed fundsconsist of securities sold under repurchase agreements, federal funds purchasedand borrowings from the FHLB and notes payable-U.S. Tresury. Securities soldunder repurchase agreements are securities sold to the Bank’s customers under acontinuing “roll-over” contract and mature in one business day. The underlyingsecurities sold are federal agency securities that are segregated from theCompany’s other investment securities. Federal funds purchased are unsecured,overnight borrowings from other financial institutions. Notes payable-U.S.Treasury are U.S. Treasury and Federal Treasury Tax and Loan deposits acceptedby the Bank from its customers to be remitted to the Federal Reserve on aperiodic basis.

Information with respect to borrowings is asfollows at and for the years ended December 31:

| * *                                                                 | * * | *Maturity Date*  | * * | *2006*     | * *   | *2005*     | * *  | *2004*     | * * |
|--------------------------------------------------------------------------|----------|-----------------------|----------|------------|------------|------------|-----------|------------|----------|
| Amount outstanding at year-end:                                          |     |                  |     |       |       |       |      |       |     |
| Federal Home Loan Bank                                                   |     | March 26, 2008   |     | $          | 5,000,000  |       | $         | 5,000,000  |     | $ | 5,000,000 |   |
| Federal Home Loan Bank                                                   |     | February 2, 2010 |     | —     |       | 35,000,000 |      | 35,000,000 |     |
| Federal Home Loan Bank                                                   |     | May 24, 2010     |     | —     |       | —     |      | 5,000,000  |     |
| Federal Home Loan Bank                                                   |     | Daily Rate Credit     |     | 17,000,000 |       | —     |      | —     |     |
|                                                                     |     |                  |     | $          | 22,000,000 |       | $         | 40,000,000 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | $          | 13,405,463 |       | $         | 9,280,348  |     | $ | 10,183,951 |   |
| Notes-payable — U.S. Treasury                                  |     |                  |     | —     |       | $          | 1,932,124 |       | $        | 1,984,714 |   |
| Weighted average interest rate at year-end:                              |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | 5.43%      |       | 6.67%      |      | 6.84%      |     |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 4.86%      |       | 3.59%      |      | 1.91%      |     |
| Notes payable — U.S. Treasury                                  |     |                  |     | —     |       | 4.17%      |      | 1.97%      |     |
| Maximum outstanding at any month-end:                                    |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | $          | 40,000,000 |       | $         | 45,000,000 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 13,405,463 |       | 11,742,108 |      | 13,540,231 |     |
| Notes payable — U.S. Treasury                                  |     |                  |     | 1,432,463  |       | 1,958,750  |      | 2,008,989  |     |
| Average balance outstanding during the  year:                            |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | $          | 24,603,287 |       | $         | 44,876,712 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 9,040,071  |       | 8,986,714  |      | 10,102,501 |     |
| Notes payable — U.S. Treasury                                  |     |                  |     | 185,067    |       | 1,016,211  |      | 1,051,267  |     |
| Weighted average interest rate during the  year:                         |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | 5.38%      |       | 6.84%      |      | 6.84%      |     |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 4.66%      |       | 2.66%      |      | 0.96%      |     |
| Notes  payable — U.S. Treasury                                 |     |                  |     | 4.18%      |       | 3.06%      |      | 1.10%      |     |

 

Debt retirementexpense of $2.3 million was incurred in 2006 due to the restructuring of a$35.0 million FHLBA advance that had a maturity date of February 2, 2010 and aninterest rate of 6.84%. Debt retirement expense of $505,839 was incurred in2005 due to the prepayment of a $5.0 million FHLB advance that had a maturitydate of May 24, 2010 and an interest rate of 7.26%.

The Company may borrow under availableunsecured federal funds lines of credit of $5 million and a secured federalfunds line of credit of $10 million with other institutions. There was nobalance outstanding under these lines at December 31, 2006 and 2005. Theselines bear interest at the current federal funds rate of the correspondentbank.

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CARROLLTON BANCORP

**CAPITAL**

Bank holdingcompanies and banks are required by the Federal Reserve and FDIC to maintainminimum levels of Tier 1 (or Core) and Tier 2 capital measured as a percentageof assets on a risk-weighted basis. Capital is primarily represented byshareholders’ equity, adjusted for the allowance for loan losses and certainissues of preferred stock, convertible securities, and subordinated debt,depending on the capital level being measured. Assets and certain off-balancesheet transactions are assigned to one of five different risk-weighting factorsfor purposes of determining the risk-adjusted asset base. The minimum levels ofTier 1 and Tier 2 capital to risk-adjusted assets are 4% and 8%, respectively,under the regulations.

In addition,the Federal Reserve and the FDIC require that bank holding companies and banksmaintain a minimum level of Tier 1 (or Core) capital to average total assetsexcluding intangibles for the current quarter. This measure is known as theleverage ratio. The current regulatory minimum for the leverage ratio forinstitutions to be considered adequately capitalized is 4%, but could berequired to be maintained at a higher level based on the regulator’s assessmentof an institution’s risk profile. The following chart shows the regulatorycapital levels for the Company and Bank at December 31, 2006 and 2005. TheCompany’s subsidiary bank also exceeded the FDIC required minimum capitallevels at those dates by a substantial margin. Based on the levels of capital,the Company and the Bank are well capitalized.

The following table shows the Company’s andthe Bank’s capital ratios as of December 31:

| * *            | * * | * *  | * * | *Carrollton Bancorp* | * * | *Carrollton Bank* | * * |
|---------------------|----------|-----------|----------|---------------------------|----------|------------------------|----------|
| * *            | * * | *Minimum* | *_*      | *2006*                    | * * | *2006*                 | * * |
| Leverage ratio      |     |      | 4        | %                         |     |                   | 9.74     | % |   |   | 9.30 | % |   |
| Risk-based capital: |     |      |     |                      |     |                   |     |   |   |   |   |   |   |
| Tier 1 (Core)       |     |      | 4        | %                         |     |                   | 11.92    | % |   |   | 11.48 | % |   |
| Total               |     |      | 8        | %                         |     |                   | 13.20    | % |   |   | 12.60 | % |   |

 

Total shareholders’ equity increased 0.2% to$34.7 million at December 31, 2006. Earnings of the Company of$2.6 million for the year ended December 31, 2006 and the proceedsand the tax benefit from the exercise of stock options of $52,000 were offsetby dividends of $1.3 million, repurchase of shares totaling $129,000, and thereduction in unrealized gains on available for sale securities of $1.2 milliondue to the realization of the $2.2 million gain on the sale of equitysecurities.

**LIQUIDITY AND CAPITAL EXPENDITURES**

**CAPITAL EXPENDITURES**

Capital expenditures were approximately$901,000 in 2006, $902,000 in 2005, and $1.9 million in 2004. Capitalexpenditures in 2006 were due to renovataions at a couple of branches andpartial construction of a new branch in Cockeysville expected to open in thesecond quarter of 2007. Capital expenditures in 2005 were due to renovations atseveral branches and normal business activity. The capital expenditures in 2004were principally due to the expenditures required to open the Company’s newbranch in January 2005.

Capital expenditures are projected to beapproximately $1.2 million for fiscal year 2007 for renovations at five of theCompany’s branch locations and the costs to complete construction of a newbranch.

**LIQUIDITY**

Liquiditydescribes the ability of the Company to meet financial obligations, includinglending commitments and contingencies that arise during the normal course ofbusiness. Liquidity is primarily needed to meet the borrowing and depositwithdrawal requirements of the customers of the Company, as well as to meetcurrent and planned expenditures.

The Company’sliquidity is derived primarily from its deposit base and equity capital.Liquidity is provided through the Company’s portfolios of cash and interest-bearingdeposits in other banks, federal funds sold, loans held for sale, unpledgedinvestment securities held to maturity due within one year, and unpledgedsecurities available for sale. Such assets totaled $43.8 million or 12.5%of total assets at December 31, 2006.

The borrowingrequirements of customers include commitments to extend credit and the unusedportion of lines of credit, which totaled $132.0 million at December 31, 2006.Of this total, management places a high probability of required funding withinone year on approximately $72.6 million. The amount remaining is unused homeequity lines and other consumer lines on which management places lowprobability of funding.

The Company also has established lines ofcredit totaling $80.0 million with the Federal Home Loan Bank of Atlanta (the “FHLB”)as an additional source of liquidity. At December 31, 2006, the Company had$22.0 million outstanding with the FHLB and had $50.1 million collateralavailable to borrow under the line of credit. Additionally, the Company hasavailable unsecured federal funds lines of credit of $5.0 million and a secured

30

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2006 ANNUAL REPORT

federal funds line of credit of $5.0 millionwith other institutions. There was no balance outstanding under these lines at December31, 2006. The lines bear interest at the current federal funds rate of thecorrespondent bank.

**MARKET RISK AND INTEREST RATE SENSITIVITY**

The Company’sinterest rate risk represents the level of exposure it has to fluctuations ininterest rates and is primarily measured as the change in earnings and the theoreticalmarket value of equity that results from changes in interest rates. TheAsset/Liability Management Committee of the Board of Directors (the “ALCO”)oversees the Company’s management of interest rate risk. The objective of themanagement of interest rate risk is to optimize net interest income duringvolatile as well as stable interest rate environments while maintaining abalance between the maturity and repricing characteristics of assets andliabilities that is consistent with the Company’s liquidity, asset and earningsgrowth, and capital adequacy goals.

Due to changesin interest rates, the level of income for a financial institution can beaffected by the repricing characteristics of its assets and liabilities. At December31, 2006, the Company is in an asset sensitive position. Managementcontinuously takes steps to reduce higher costing fixed rate fundinginstruments, while increasing assets that are more fluid in their repricing. Anasset sensitive position, theoretically, is favorable in a rising rateenvironment since more assets than liabilities will reprice in a given timeframe as interest rates rise. Management works to maintain a consistent spreadbetween yields on assets and costs of deposits and borrowings, regardless ofthe direction of interest rates.

In order topartially offset a reduction in interest income in a declining interest rateenvironment, on December 14, 2005, the Bank purchased a $10.0 millionnotional amount interest rate Floor with a minimum interest rate (strike rate)of 7.0% based on the US prime rate. The term of the Floor is five years. TheFloor will reduce the variability of cash flow from a pool of variable rateloans should the rate index of the loans fall below the predetermined strikerate of the hedge (7%).

The followingchart shows the static gap position for interest sensitive assets andliabilities of the Company as of December 31, 2005. The chart is as of apoint in time, and reflects only the contractual terms of the loan or depositaccounts in assigning assets and liabilities to the various repricing periodsexcept that deposit accounts with no contractual maturity, such as moneymarket, NOW and savings accounts, have been allocated evenly over a five-yearperiod. In addition, the maturities of investments shown in the gap table willdiffer from contractual maturities due to anticipated calls of certainsecurities based on current interest rates. While this chart indicates theopportunity to reprice assets and liabilities within certain time frames, it doesnot reflect the fact that interest rate changes occur in disproportionateincrements for various assets and liabilities.

Period from December 31, 2006 in whichassets and liabilities reprice:

| *(Dollars in thousands)*                              | *_*    | *0 to 90  days* | * * | *91 to 365  days* | * * | *1 to 2  years* | * * | *3 to 5  years* | * * | *> 5  years* | * * |
|-----------------------------------------------------------------|--------|---------------------------|----------|-----------------------------|----------|---------------------------|----------|---------------------------|----------|----------------------|----------|
| ASSETS:                                                         |   |                      |     |                        |     |                      |     |                      |     |                 |     |   |   |
| Short term investments                                          |   | $                         | 3,990    |                        |     | $                         | —   |                      |     | $                    | —   |   | $ | — |   | $ | — |   |
| Investment securities                                           |   | 9,329                     |     |                        | 5,374    |                      |     | 5,082                     |     | 15,403               |     | 19,876 |   |
| Loans held for sale                                             |   | 7,489                     |     |                        | —   |                      |     | —                    |     | —               |     | — |   |
| Loans:                                                          |   |                      |     |                        |     |                      |     |                      |     |                 |     |   |   |
| Residential real estate                                         |   | 30,682                    |     |                        | 1,915    |                      |     | 3,088                     |     | 6,105                |     | 13,268 |   |
| Commercial real estate                                          |   | 20,570                    |     |                        | 13,436   |                      |     | 22,983                    |     | 50,357               |     | 13,052 |   |
| Construction and land development                               |   | 16,545                    |     |                        | 6,178    |                      |     | 301                       |     | 79                   |     | 6,893 |   |
| Demand and time                                                 |   | 35,606                    |     |                        | 840      |                      |     | 738                       |     | 9,998                |     | 4,368 |   |
| Lease financing                                                 |   | 19                        |     |                        | 197      |                      |     | 325                       |     | 428                  |     | — |   |
| Installment                                                     |   | 487                       |     |                        | 38       |                      |     | 72                        |     | 212                  |     | 1,221 |   |
|                                                            |   | $                         | 124,717  |                        |     | $                         | 27,978   |                      |     | $                    | 32,589   |   | $ | 82,582 |   | $ | 58,678 |   |
| LIABILITIES:                                                    |   |                      |     |                        |     |                      |     |                      |     |                 |     |   |   |
| Deposits                                                        |   | $                         | 93,786   |                        |     | $                         | 53,327   |                      |     | $                    | 13,866   |   | $ | 7,665 |   | $ | 109,259 |   |
| Borrowings                                                      |   | 30,405                    |     |                        | —   |                      |     | 5,000                     |     | —               |     | — |   |
|                                                            |   | $                         | 124,191  |                        |     | $                         | 53,327   |                      |     | $                    | 18,866   |   | $ | 7,665 |   | $ | 109,259 |   |
| Gap position                                                    |   |                      |     |                        |     |                      |     |                      |     |                 |     |   |   |
| Period                                                          |   | $                         | (526     | )                           |     | $                         | (25,349  | )                         |     | $                    | 13,723   |   | $ | 74,917 |   | $ | (50,581 | ) |
| % of assets                                                     |   | (0.15                     | )%       |                        | (7.25    | )%                        |     | 3.92                      | %        | 21.42                | %        | (14.46 | )% |
| Cumulative                                                      |   | $                         | (526     | )                           |     | $                         | (24,823  | )                         |     | $                    | (11,100  | ) | $ | 63,817 |   | $ | 13,236 |   |
| % of assets                                                     |   | (0.15                     | )%       |                        | (7.10    | )%                        |     | (3.17                     | )%       | 18.24                | %        | 3.78 | % |
| Cumulative risk sensitive assets to risk  sensitive liabilities |   | 100.42                    | %        |                        | 52.46    | %                         |     | 172.74                    | %        | 1,077.39             | %        | 53.71 | % |

 

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CARROLLTON BANCORP

**INFLATION**

Inflation may be expected to have an impacton the Company’s operating costs and thus on net income. A prolonged period ofinflation could cause interest rates, wages, and other costs to increase andcould adversely affect the Company’s results of operations unless the feescharged by the Company could be increased correspondingly. However, the Companybelieves that the impact of inflation was not material for 2006, 2005, and2004.

**OFF-BALANCE SHEET ARRANGEMENTS**

The Companyenters into off-balance sheet arrangements in the normal course of business.These arrangements consist primarily of commitments to extend credit, lines ofcredit and letters of credit. In addition, the Company has certain operatinglease obligations.

Creditcommitments are agreements to lend to a customer as long as there is noviolation of any condition to the contract. Loan commitments generally haveinterest rates fixed at current market amounts, fixed expiration dates, and mayrequire payment of a fee. Lines of credit generally have variable interestrates. Such lines do not represent future cash requirements because it isunlikely that all customers will draw upon their lines in full at any time.Letters of credit are commitments issued to guarantee the performance of acustomer to a third party.

The Company’sexposure to credit loss in the event of nonperformance by the borrower is thecontract amount of the commitment. Loan commitments, lines of credit, andletters of credit are made on the same terms, including collateral, asoutstanding loans. The Company is not aware of any accounting loss it wouldincur by funding its commitments.

Outstanding loan commitments, unused lines ofcredit and letters of credit were as follows at December 31, 2006**:**

| Loan commitments       |   | $          | 40,463,996 |   |
|------------------------|--------|------------|------------|--------|
| Unused lines of credit |   | 91,563,387 |       |
| Letters of credit      |   | 2,223,755  |       |

 

**CONTRACTURAL OBLIGATIONS**

The Company enters into contracturalobligations in the normal course of business. Among these obligations are shortand long-term FHLB advances, operating leases related to branch andadministrative facilities, a long term contract with a data processing providerand purchase contracts related to construction of a new branch office. Paymentsrequired under these obligations are set forth in the table below as of December 31,2006.

| *Contractual Obligations (Dollars in thousands)*      | *_*    | *Total* | *_*    | *Less than  1 year* | * * | *One to  three  years* | * * | *Three to  five  years* | * * | *More than  five  years* | * * |
|---------------------------------------------------------------------------|--------|---------|--------|-------------------------------|----------|-----------------------------|----------|------------------------------|----------|-------------------------------|----------|
| Federal Home Loan Bank                                                    |   | $       | 22,000 |                          |     | $                           | 17,000   |                         |     | $                             | 5,000    |   |   | $ | — |   |   |   | $ | — |   |   |
| Federal fund purchased and securities sold  under agreement to repurchase |   | 13,405  |   |                          | 13,405   |                        |     | —                       |     |                          | —   |   |   |   | — |   |   |
| Operating lease obligations                                               |   | 8,451   |   |                          | 959      |                        |     | 1,534                        |     |                          | 1,258    |   |   |   | 4,700 |   |   |
| Purchase obligations(1)                                                   |   | 1,971   |   |                          | 987      |                        |     | 595                          |     |                          | 389      |   |   |   | — |   |   |
| Total                                                                     |   | $       | 45,827 |                          |     | $                           | 32,351   |                         |     | $                             | 7,129    |   |   | $ | 1,647 |   |   |   | $ | 4,700 |   |   |

 

(1)    Representspayments required under contract, based on average monthly charges for 2006 andassuming a growth rate of 3%, with the Company’s current data processingservice provider that expires in March 2011. Also includes estimated costto complete construction of a new branch.

**NEW ACCOUNTING PRONOUNCEMENTS**

In February 2006,FASB issued SFAS 155, “*Accounting forCertain Hybrid Financial Instruments*”, which permits, but does notrequire, fair value accounting for any hybrid financial instrument thatcontains an embedded derivative that would otherwise require bifurcation inaccordance with SFAS 133, “Accounting for Derivative Instruments and HedgingActivities”. The statement also subjects beneficial interests in securitizedfinancial assets to the requirements of SFAS 133. This statement is effectivefor all financial instruments acquired, issued, or subject to remeasurement forfiscal years beginning after September 15, 2006. The Company does notexpect that the adoption of this Statement will have a material impact on itsfinancial position, results of operations or cash flows.

In March 2006,the FASB issued SFAS No. 156, *“Accountingfor Servicing of Financial Assets, and an amendment of FASB Statement No. 140.”*The statement amends SFAS No. 140 by (1) requiring the separateaccounting for servicing assets and servicing liabilities, which arise from thesale of financial assets; (2) requiring all separately recognized servingassets and servicing liabilities to be initially measured at fair value, ifpracticable; and (3) permitting an entity to choose between an amortizationmethod or a fair value method for subsequent 

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2006 ANNUAL REPORT

measurement for each class of separatelyrecognized servicing assets and servicing liabilities. This statement iseffective for fiscal years beginning after September 15, 2006, with earlieradoption permitted. The Company does not expect that the adoption of thisStatement will have a material impact on its financial position, results ofoperations or cash flows.

In June 2006,the FASB issued FASB Interpretation No. 48 (“FIN 48”), *“Accounting for Uncertainty in Income Taxes*.”This interpretation applies to all tax positions accounted for in accordancewith SFAS No. 109, *“Accounting for IncomeTaxes.”*FIN 48 clarifies the application of SFAS No. 109 by definingthe criteria that an individual tax position must meet in order for theposition to be recognized within the financial statements and provides guidanceon measurement, de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition for tax positions.This interpretation is effective for fiscal years beginning after December 15,2006, with earlier adoption permitted. The Company has evaluated the impact ofthe adoption of this interpretation and has determined that it will not have amaterial impact on its financial position, results of operations or cash flows.

In September 2006,the FASB issued SFAS No. 157, *“Fair ValueMeasurements”.*This Statement defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements. It clarifies that fair value is the price that would be receivedto sell an asset or paid to transfer a liability in an orderly transactionbetween market participants in the market in which the reporting entitytransacts. This Statement does not require any new fair value measurements, butrather, it provides enhanced guidance to other pronouncements that require orpermit assets or liabilities to be measured at fair value. This Statement iseffective for fiscal years beginning after November 15, 2007, with earlieradoption permitted. The Company does not expect that the adoption of thisStatement will have a material impact on its financial position, results ofoperations or cash flows.

At its September 2006 meeting, the EmergingIssues Task Force (“EITF”) reached a final consensus on Issue 06-04, “*Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*.” The consensus stipulates that an agreement by anemployer to share a portion of the proceeds of a life insurance policy with anemployee during the postretirement period is a postretirement benefitarrangement required to be accounted for under SFAS No. 106 or AccountingPrinciples Board Opinion (“APB”) No. 12, “Omnibus Opinion - 1967.” Theconsensus concludes that the purchase of a split-dollar life insurance policydoes not constitute a settlement under SFAS No. 106 and, therefore, a liabilityfor the postretirement obligation must be recognized under SFAS No. 106 if thebenefit is offered under an arrangement that constitutes a plan or under APB No.12, if it is not part of a plan. Issue 06-04 is effective for annual orinterim reporting periods beginning after December 15, 2007. The Companydoes not have split-dollar life insurance policiesand the adoption of thisstatement will not have a material effect on its financial position, results ofoperations or cash flows.

**7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

For informationregarding the market risk of the Company’s financial instruments, see “MarketRisk and Interest Rate Sensitivity” in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations in Item 7.

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CARROLLTON BANCORP

**ITEM 8: FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA**

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board ofDirectors and ShareholdersCarrollton BancorpBaltimore, Maryland

We have auditedthe accompanying consolidated balance sheets of Carrollton Bancorp andSubsidiary as of December 31, 2006 and 2005, and the related consolidatedstatements of income, changes in shareholders’ equity, and cash flows for eachof the three years ended December 31, 2006. These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conductedour audits in accordance with standards of the Public Company AccountingOversight Board in the United States of America. Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform an audit of the Company’sinternal control over financial reporting. Our audits included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Carrollton Bancorp and Subsidiaryas of December 31, 2006 and 2005, and the results of their operations andtheir cash flows for each of the three years ended December 31, 2006, inconformity with accounting principles generally accepted in the United Statesof America.

As discussed in Note 1 to the financialstatements, effective January 1, 2006, the Bank adopted the provisions of Statementof Financial Accounting Standard No. 123R, *Share BasedPayment,*and effective December 31, 2006, Statement ofFinancial Accounting Standards, No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans — anamendment of FASB Statement No. 87, 88, 106, and 132(R).*

Rowles & Company, LLP, CertifiedPublic Accountants

Baltimore,MarylandFebruary 23, 2007

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2006 ANNUAL REPORT

**CONSOLIDATED BALANCE SHEETS**

| * *                                                                                                                          | * * | *December 31,* | * *    |
|-----------------------------------------------------------------------------------------------------------------------------------|----------|---------------------|-------------|
| * *                                                                                                                          | * * | *2006*              | * *    | *2005* | * * |
| ASSETS                                                                                                                            |     |                |        |   |   |
| Cash and due from banks                                                                                                           |     | $                   | 9,632,763   |   | $ | 27,235,233 |   |
| Federal funds sold and Federal Home Loan  Bank deposit                                                                            |     | 3,990,003           |        | 11,855,332 |   |
| Federal Home Loan Bank stock, at cost                                                                                             |     | 1,704,500           |        | 2,431,600 |   |
| Investment securities                                                                                                             |     |                |        |   |   |
| Available for sale                                                                                                                |     | 35,934,647          |        | 29,095,003 |   |
| Held to maturity                                                                                                                  |     | 19,129,973          |        | 18,488,405 |   |
| Loans held for sale                                                                                                               |     | 7,489,290           |        | 13,767,109 |   |
| Loans, less allowance for loan losses of  $3,131,021 and $3,337,163                                                               |     | 256,870,293         |        | 244,605,910 |   |
| Premises and equipment                                                                                                            |     | 5,599,988           |        | 5,433,628 |   |
| Accrued interest receivable                                                                                                       |     | 1,713,653           |        | 1,418,829 |   |
| Prepaid income taxes                                                                                                              |     | —              |        | 256,482 |   |
| Bank owned life insurance                                                                                                         |     | 4,279,830           |        | 4,123,544 |   |
| Other real estate owned                                                                                                           |     | 1,383,163           |        | — |   |
| Other assets                                                                                                                      |     | 2,096,649           |        | 1,756,071 |   |
|                                                                                                                              |     | $                   | 349,824,752 |   | $ | 360,467,146 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                         |     |                |        |   |   |
| Deposits                                                                                                                          |     |                |        |   |   |
| Noninterest-bearing                                                                                                               |     | $                   | 50,069,560  |   | $ | 67,010,985 |   |
| Interest-bearing                                                                                                                  |     | 227,834,241         |        | 204,615,518 |   |
| Total deposits                                                                                                                    |     | 277,903,801         |        | 271,626,503 |   |
| Federal funds purchased and securities sold  under agreements to repurchase                                                       |     | 13,405,463          |        | 9,280,348 |   |
| Notes payable — U.S. Treasury                                                                                           |     | —              |        | 1,932,124 |   |
| Advances from the Federal Home Loan Bank                                                                                          |     | 22,000,000          |        | 40,000,000 |   |
| Accrued interest payable                                                                                                          |     | 214,565             |        | 581,863 |   |
| Other liabilities                                                                                                                 |     | 1,589,545           |        | 2,406,143 |   |
|                                                                                                                              |     | 315,113,374         |        | 325,826,981 |   |
| Shareholders’ equity                                                                                                         |     |                |        |   |   |
| Common stock, par $1.00 per share;  authorized 10,000,000 shares; issued and outstanding 2,806,705 in 2006 and  2,809,698 in 2005 |     | 2,806,705           |        | 2,809,698 |   |
| Additional paid-in capital                                                                                                        |     | 18,372,351          |        | 18,425,528 |   |
| Retained earnings                                                                                                                 |     | 12,886,247          |        | 11,567,531 |   |
| Accumulated other comprehensive income                                                                                            |     | 646,075             |        | 1,837,408 |   |
|                                                                                                                              |     | 34,711,378          |        | 34,640,165 |   |
|                                                                                                                              |     | $                   | 349,824,752 |   | $ | 360,467,146 |   |

 

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

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CARROLLTON BANCORP

**CONSOLIDATED STATEMENTS OF INCOME**

| * *                                                  | * * | *Years Ended December 31,* | * *   |
|-----------------------------------------------------------|----------|-------------------------------------------|------------|
| * *                                                  | * * | *2006*                                    | * *   | *2005* | * * | *2004* | * * |
| INTEREST INCOME                                           |     |                                      |       |   |   |   |   |
| Interest and fees on loans                                |     | $                                         | 20,041,704 |   | $ | 16,826,955 |   | $ | 13,584,677 |   |
| Interest and dividends on securities                      |     |                                      |       |   |   |   |   |
| Taxable interest income                                   |     | 2,197,049                                 |       | 1,201,016 |   | 1,399,879 |   |
| Nontaxable interest income                                |     | 357,867                                   |       | 174,649 |   | 188,296 |   |
| Dividends                                                 |     | 148,259                                   |       | 244,849 |   | 210,572 |   |
| Interest on federal funds sold and other  interest income |     | 382,625                                   |       | 623,910 |   | 116,899 |   |
| Total interest income                                     |     | 23,127,504                                |       | 19,071,379 |   | 15,500,323 |   |
| INTEREST EXPENSE                                          |     |                                      |       |   |   |   |   |
| Deposits                                                  |     | 6,624,327                                 |       | 4,022,723 |   | 2,130,765 |   |
| Borrowings                                                |     | 2,113,123                                 |       | 3,352,360 |   | 3,190,857 |   |
| Total interest expense                                    |     | 8,737,450                                 |       | 7,375,083 |   | 5,321,622 |   |
| Net interest income                                       |     | 14,390,054                                |       | 11,696,296 |   | 10,178,701 |   |
| PROVISION FOR LOAN LOSSES                                 |     | —                                    |       | — |   | — |   |
| Net interest income after provision for  loan losses      |     | 14,390,054                                |       | 11,696,296 |   | 10,178,701 |   |
| NONINTEREST INCOME                                        |     |                                      |       |   |   |   |   |
| Service charges on deposit accounts                       |     | 1,121,271                                 |       | 1,082,568 |   | 948,386 |   |
| Brokerage commissions                                     |     | 647,301                                   |       | 667,510 |   | 623,923 |   |
| Electronic Banking fees                                   |     | 2,045,618                                 |       | 4,975,646 |   | 4,841,303 |   |
| Mortgage banking fees and gains                           |     | 2,465,814                                 |       | 2,705,785 |   | 1,917,883 |   |
| Other fees and commissions                                |     | 461,841                                   |       | 447,268 |   | 333,846 |   |
| Gains on security sales                                   |     | 2,157,151                                 |       | 839,859 |   | 115,810 |   |
| Total noninterest income                                  |     | 8,898,996                                 |       | 10,718,636 |   | 8,781,151 |   |
| NONINTEREST EXPENSES                                      |     |                                      |       |   |   |   |   |
| Salaries                                                  |     | 7,001,847                                 |       | 7,444,463 |   | 6,837,035 |   |
| Employee benefits                                         |     | 1,500,820                                 |       | 1,344,092 |   | 1,876,248 |   |
| Occupancy                                                 |     | 1,794,873                                 |       | 1,848,168 |   | 1,601,321 |   |
| Furniture and equipment                                   |     | 633,004                                   |       | 1,211,349 |   | 1,590,436 |   |
| Prepayment penalty                                        |     | 2,251,971                                 |       | 505,839 |   | — |   |
| Check kiting loss                                         |     | 1,833,733                                 |       | — |   | — |   |
| Write down of impaired securities                         |     | —                                    |       | — |   | 497,313 |   |
| (Recovery) Impairment of ATM network                      |     | (106,221                                  | )          | 563,400 |   | — |   |
| Other noninterest expenses                                |     | 4,470,976                                 |       | 5,716,813 |   | 5,348,647 |   |
| Total noninterest expenses                                |     | 19,381,003                                |       | 18,634,124 |   | 17,751,000 |   |
| Income before income taxes                                |     | 3,908,047                                 |       | 3,780,808 |   | 1,208,852 |   |
| INCOME TAXES                                              |     | 1,323,268                                 |       | 1,322,371 |   | 320,488 |   |
| NET INCOME                                                |     | $                                         | 2,584,779  |   | $ | 2,458,437 |   | $ | 888,364 |   |
| NET INCOME PER SHARE — BASIC                    |     | $                                         | 0.92       |   | $ | 0.87 |   | $ | 0.31 |   |
| NET INCOME PER  SHARE — DILUTED                 |     | $                                         | 0.90       |   | $ | 0.87 |   | $ | 0.31 |   |

 

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

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2006 ANNUAL REPORT

**CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY**

**YEARS ENDED DECEMBER 31, 2006, 2005 AND2004**

| * *                                                                               | * * | *Common Stock* | * *  | *Additional  Paid-In  Capital* | * * | *Retained  Earnings* | * * | *Accumulated  Other  Comprehensive  Income* | * * | *Comprehensive  Income* | * *   |
|----------------------------------------------------------------------------------------|----------|---------------------|-----------|--------------------------------|----------|----------------------|----------|---------------------------------------------|----------|-------------------------|------------|
| **BALANCE, DECEMBER 31, 2003**                                                         |     |                | $         | 2,828,078                      |     |                 | $        | 18,682,387                                  |     | $                       | 10,427,425 |   |   | $ | 2,186,992 |   |   |   |   |   |   |
| Net Income                                                                             |     |                | —    |                           |     | —               |     | 888,364                                     |     |                    | —     |   |   |   | $ | 888,364 |   |   |
| Changes in net unrealized gains (losses) on  available for sale securities, net of tax |     |                | —    |                           |     | —               |     | —                                      |     |                    | 179,661    |   |   |   | 179,661 |   |   |
| Comprehensive Income                                                                   |     |                |      |                           |     |                 |     |                                        |     |                    |       |   |   |   | $ | 1,068,025 |   |   |
| Stock options exercised, including tax  benefit of $21,293                             |     |                | 8,845     |                           |     | 122,616              |     | —                                      |     |                    | —     |   |   |   |   |   |   |
| Shares acquired and cancelled                                                          |     |                | (2,100    | )                              |     | (30,555              | )        | —                                      |     |                    | —     |   |   |   |   |   |   |
| Cash dividends, $0.38 per share                                                        |     |                | —    |                           |     | —               |     | (1,076,433                                  | )        |                    | —     |   |   |   |   |   |   |
| **BALANCE, DECEMBER 31, 2004**                                                    |     |                | 2,834,823 |                           |     | 18,774,448           |     | 10,239,356                                  |     |                    | 2,366,653  |   |   |   |   |   |   |
| Net Income                                                                             |     |                | —    |                           |     | —               |     | 2,458,437                                   |     |                    | —     |   |   |   | $ | 2,458,437 |   |   |
| Changes in net unrealized gains (losses) on  available for sale securities, net of tax |     |                | —    |                           |     | —               |     | —                                      |     |                    | (529,245   | ) |   |   | (529,245 | ) |   |
| Comprehensive income                                                                   |     |                |      |                           |     |                 |     |                                        |     |                    |       |   |   |   | $ | 1,929,192 |   |   |
| Shares acquired and cancelled                                                          |     |                | (42,500   | )                              |     | (556,750             | )        | —                                      |     |                    | —     |   |   |   |   |   |   |
| Stock options exercised including tax  benefit of $18,166                              |     |                | 17,375    |                           |     | 207,830              |     | —                                      |     |                    | —     |   |   |   |   |   |   |
| Cash dividends, $0.40 per share                                                        |     |                | —    |                           |     | —               |     | (1,130,262                                  | )        |                    | —     |   |   |   |   |   |   |
| **BALANCE, DECEMBER 31, 2005**                                                    |     |                | 2,809,698 |                           |     | 18,425,528           |     | 11,567,531                                  |     |                    | 1,837,408  |   |   |   |   |   |   |
| Net Income                                                                             |     |                | —    |                           |     | —               |     | 2,584,779                                   |     |                    |       |   |   |   | $ | 2,584,779 |   |   |
| Changes in net unrealized gains (losses) on  available for sale securities, net of tax |     |                | —    |                           |     | —               |     | —                                      |     |                    | (1,191,817 | ) |   |   | (1,191,817 | ) |   |
| Adjustment to initially apply SFAS 158, net  of tax effects of $306                    |     |                | —    |                           |     | —               |     | —                                      |     |                    | 484        |   |   |   | 484 |   |   |
| Comprehensive income                                                                   |     |                |      |                           |     |                 |     |                                        |     |                    |       |   |   |   | $ | 1,393,446 |   |   |
| Shares acquired and cancelled                                                          |     |                | (7,518    | )                              |     | (121,332             | )        | —                                      |     |                    | —     |   |   |   |   |   |   |
| Stock options exercised including tax  benefit of $7,014                               |     |                | 4,525     |                           |     | 54,708               |     | —                                      |     |                    | —     |   |   |   |   |   |   |
| Stock based compensation                                                               |     |                | —    |                           |     | 13,447               |     | —                                      |     |                    | —     |   |   |   |   |   |   |
| Cash dividends, $0.45 per share                                                        |     |                | —    |                           |     | —               |     | (1,266,063                                  | )        |                    | —     |   |   |   |   |   |   |
| **BALANCE,  DECEMBER 31, 2006**                                                   |     |                | $         | 2,806,705                      |     |                 | $        | 18,372,351                                  |     | $                       | 12,886,247 |   |   | $ | 646,075 |   |   |   |   |   |   |

 

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

37

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CARROLLTON BANCORP

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

| * *                                                                                   | * * | *Years Ended December 31,* | * *   |
|--------------------------------------------------------------------------------------------|----------|-------------------------------------------|------------|
| * *                                                                                   | * * | *2006*                                    | * *   | *2005* | * * | *2004* | * * |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                     |     |                                      |       |   |   |   |   |
| Net income                                                                                 |     | $                                         | 2,584,779  |   | $ | 2,458,437 |   | $ | 888,364 |   |
| ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH ROVIDED  BY (USED IN) OPERATING ACTIVITES: |     |                                      |       |   |   |   |   |
| Provision for  loan losses                                                                 |     | —                                    |       | — |   | — |   |
| Deprecation  and amortization                                                              |     | 763,749                                   |       | 937,570 |   | 1,255,340 |   |
| Deferred  income taxes                                                                     |     | 60,631                                    |       | 153,209 |   | (198,755 | ) |
| Amortization  of premiums and discounts                                                    |     | (57,411                                   | )          | 80,719 |   | 230,676 |   |
| Gains on disposal  of securities                                                           |     | (2,157,176                                | )          | (839,859 | ) | (115,810 | ) |
| (Recovery)  impairment of ATM network                                                      |     | (106,221                                  | )          | 563,400 |   | — |   |
| Write down of  impaired securities                                                         |     | —                                    |       | — |   | 497,313 |   |
| Loans held  for sale made, net of principal sold                                           |     | 6,277,819                                 |       | (3,547,380 | ) | (7,978,146 | ) |
| Gains on sale  and write-down of premises and equipment                                    |     | —                                    |       | (6,246 | ) | (18,941 | ) |
| (Gains)  losses on sale of foreclosed real estate                                          |     | —                                    |       | — |   | 11,548 |   |
| Write-down  of foreclosed real estate                                                      |     | —                                    |       | — |   | 8,077 |   |
| Stock based  compensation expense                                                          |     | 13,447                                    |       | — |   | — |   |
| (Increase) decrease  in:                                                                   |     |                                      |       |   |   |   |   |
| Accrued interest receivable                                                                |     | (294,824                                  | )          | (123,110 | ) | 125,835 |   |
| Prepaid income taxes                                                                       |     | 256,482                                   |       | (61,871 | ) | (160,701 | ) |
| Cash surrender value of bank owned life  insurance                                         |     | (156,286                                  | )          | (70,896 | ) | (52,949 | ) |
| Other assets                                                                               |     | 226,026                                   |       | 582,001 |   | (547,860 | ) |
| Increase  (decrease) in:                                                                   |     |                                      |       |   |   |   |   |
| Accrued interest payable                                                                   |     | (367,298                                  | )          | 88,684 |   | 42,124 |   |
| Deferred loan origination fees                                                             |     | (33,566                                   | )          | 144,907 |   | 134,343 |   |
| Other liabilities                                                                          |     | 1,288                                     |       | 622,669 |   | (315,427 | ) |
| Net cash provided by (used in) operating  activities                                       |     | 7,011,464                                 |       | 982,234 |   | (6,194,969 | ) |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                     |     |                                      |       |   |   |   |   |
| Proceeds from  sales of securities available for sale                                      |     | 2,766,852                                 |       | 2,461,757 |   | 2,518,491 |   |
| Proceeds from  maturities of securities available for sale                                 |     | 3,554,884                                 |       | 19,174,448 |   | 30,660,807 |   |
| Proceeds from  maturities of securities held to maturity                                   |     | 1,353,243                                 |       | 541,881 |   | 25,000 |   |
| Redemption  (purchase) of Federal Home Loan Bank stock, net                                |     | 727,100                                   |       | 191,300 |   | (372,900 | ) |
| Purchase of  securities available for sale                                                 |     | (15,030,741                               | )          | (8,354,638 | ) | (13,528,310 | ) |
| Purchase of  securities held to maturity                                                   |     | (1,952,570                                | )          | (19,021,466 | ) | — |   |
| Loans made,  net of principal collected                                                    |     | (12,230,817                               | )          | (28,509,599 | ) | (20,811,745 | ) |
| Purchase of  premises and equipment                                                        |     | (801,823                                  | )          | (902,943 | ) | (1,935,364 | ) |
| Proceeds from  sale of premises and equipment                                              |     | —                                    |       | 15,189 |   | 361,582 |   |
| Proceeds from  sale of foreclosed real estate                                              |     | —                                    |       | — |   | 164,876 |   |
| Net cash (used in) investing activities                                                    |     | (21,613,872                               | )          | (34,404,071 | ) | (2,917,563 | ) |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                     |     |                                      |       |   |   |   |   |
| Net increase  (decrease) in time deposits                                                  |     | 25,486,897                                |       | 20,085,651 |   | 7,124,050 |   |
| Net increase  (decrease) in other deposits                                                 |     | (19,209,599                               | )          | 25,694,707 |   | 11,665,996 |   |
| Payment of  Federal Home Loan Bank advance                                                 |     | (18,000,000                               | )          | (5,000,000 | ) | — |   |
| Net increase  (decrease) in other borrowed funds                                           |     | 2,192,991                                 |       | (956,193 | ) | (1,808,269 | ) |
| Common stock  repurchase and retirement                                                    |     | (128,850                                  | )          | (599,250 | ) | (32,655 | ) |
| Stock options  exercised                                                                   |     | 52,219                                    |       | 207,039 |   | 110,168 |   |
| Income tax  benefit from exercise of stock options                                         |     | 7,014                                     |       | 18,166 |   | 21,293 |   |
| Dividends  paid                                                                            |     | (1,266,063                                | )          | (1,130,262 | ) | (1,076,433 | ) |
| Net cash provided by (used in) financing  activities                                       |     | (10,865,391                               | )          | 38,319,858 |   | 16,004,150 |   |
| Net increase  (decrease) in cash and cash equivalents                                      |     | (25,467,799                               | )          | 4,898,021 |   | 6,891,618 |   |
| Cash and cash  equivalents at beginning of year                                            |     | 39,090,565                                |       | 34,192,544 |   | 27,300,926 |   |
| Cash and cash  equivalents at end of year                                                  |     | $                                         | 13,622,766 |   | $ | 39,090,565 |   | $ | 34,192,544 |   |
| SUPPLEMENTAL INFORMATION:                                                                  |     |                                      |       |   |   |   |   |
| Interest paid  on deposits and borrowings                                                  |     | $                                         | 9,104,758  |   | $ | 7,286,399 |   | $ | 5,279,498 |   |
| Income taxes  paid                                                                         |     | $                                         | 837,661    |   | $ | 1,525,204 |   | $ | 545,609 |   |
| NONCASH ACTIVITY:                                                                          |     |                                      |       |   |   |   |   |
| Transfer of loans to foreclosed real estate                                                |     | $                                         | 1,383,163  |   | $ | — |   | $ | 84,500 |   |

 

 

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

38

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2006 ANNUAL REPORT

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

The accounting and reporting policies ofCarrollton Bancorp and subsidiary (the “Company”) conform to U.S. generallyaccepted accounting principles. The following is a description of the moresignificant of these policies.

***Organization***

The Company wasformed January 11, 1990 and is a Maryland corporation chartered as a bankholding company. The Company holds all the issued and outstanding shares ofcommon stock of Carrollton Bank (the “Bank”). The Bank is a Maryland companythat engages in general commercial banking operations. Deposits in the Bank areinsured, subject to regulatory limitations, by the Federal Deposit InsuranceCorporation (the “FDIC”).

The Bank provides commercial and brokerageservices to individuals and small and medium-sized businesses. Servicesoffered by the Bank include a variety of loans and a broad spectrum ofcommercial and consumer financial services.

***Basis of Presentation***

The consolidated financial statements areprepared in conformity with U.S. generally accepted accounting principles andinclude all accounts of the Company and its wholly-owned subsidiary,Carrollton Bank. All significant intercompany accounts and transactions havebeen eliminated in the consolidated financial statements. Certain amounts forprior years have been reclassified to conform to the presentation for 2006.These reclassifications have no effect on stockholders’ equity or net income aspreviously reported.

***Use of Estimates***

The preparationof the financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and judgments thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

Materialestimates that are particularly susceptible to significant change in thenear-term relate to the determination of the allowance for loan losses (the “Allowance”),and other than temporary impairment of investment securities. In connectionwith the determination of the Allowance, management prepares fair value analysesand obtains independent appraisals as necessary. Management believes that theAllowance is sufficient to address the losses inherent in the current loanportfolio. While management uses available information to recognize losses onloans, future additions to the Allowance may be necessary based on changes ineconomic conditions. In addition, various regulatory agencies, as an integralpart of their examination processes, periodically review the Bank’s Allowance.Such agencies may require the Bank to recognize additions to the Allowancebased on their judgments about information available to them at the time oftheir examinations.

Securities are evaluated periodically todetermine whether a decline in their value is other than temporary. The term “otherthan temporary” is not intended to indicate a permanent decline in value.Rather, it means that the prospects for near term recovery of value are notnecessarily favorable, or that there is a lack of evidence to support fairvalues equal to, or greater than, the carrying value of the investment.Management reviews criteria such as the magnitude and duration of the decline,as well as the reasons for the decline, to predict whether the loss in value isother than temporary. Once a decline in value is determined to be other thantemporary, the value of the security is reduced and a corresponding charge toearnings is recognized.

***Cash and Cash Equivalents***

For purposes ofthe Consolidated Statements of Cash Flows, cash and cash equivalents includecash and due from banks, federal funds sold and interest-bearing depositswith banks.

Federal funds sold are carried at cost, whichapproximates fair value, and are generally sold for one-day periods.

***Federal Home Loan Bank Stock***

Federal Home Loan Bank stock is carried atcost, which approximates fair value.

***Investment Securities Available for Sale***

Securitiesavailable for sale are acquired as part of the Company’s asset/liabilitymanagement strategy and may be sold in response to changes in interest rates,loan demand, changes in prepayment risk and other factors. Securities availablefor sale are recorded at their fair value. Unrealized holding gains or losses,net of the related tax effect, are excluded from earnings and reported as anitem of other comprehensive income until realized. The carrying values ofsecurities available for sale are adjusted for premium amortization to theearlier of the maturity or expected call date and discount accretion to thematurity date. Realized gains and losses, using the specific identificationmethod, are included as a separate component of noninterest income. Relatedinterest and dividends are included in interest income. Declines in the fairvalue of individual available for sale securities below 

39

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CARROLLTON BANCORP

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***(Continued)*

their cost that are other than temporaryresult in write-downs of the individual securities to their fair value.Factors affecting the determination of whether an other-than-temporaryimpairment has occurred include a downgrading of the security by a ratingagency, a significant deterioration in the financial condition of the issuer,or that management would not have the intent and ability to hold a security fora period of time sufficient to allow for any anticipated recovery in fairvalue.

Equity securities represent the stock ofvarious financial institutions.

***Investment Securities Held to Maturity***

Investment securities held to maturity arethose securities which the Company has the ability and positive intent to holduntil maturity. Securities so classified at the time of purchase are recordedat cost. Carrying values of securities held to maturity are adjusted forpremium amortization to the earlier of the maturity or expected call date anddiscount accretion to the maturity date. Declines in the fair value ofindividual held to maturity securities below their cost, that are other thantemporary, result in write-downs of the individual securities to theirfair value. Factors affecting the determination of whether an other-than-temporaryimpairment has occurred include a downgrading of the security by the ratingagency, a significant deterioration in the financial condition of the issuer,or that management would not have the ability to hold a security for a periodof time sufficient to allow for any anticipated recovery in fair value.

***Loans Held for Sale***

Residential mortgage loans originated forsale are carried at the lower of cost or market, which may be indicated by thecommitted sale price, determined on an individual basis.

***Loans Receivable***

Loans arestated at the amount of unpaid principal adjusted for deferred origination feesand costs and the allowance for loan losses. Deferred origination fees andcosts are recognized as an adjustment of the related loan yield using the interestmethod. The Company determines the delinquency status of loans based oncontractual loan terms. Loans are generally placed in nonaccrual status whenthey are past-due 90 days as to either principal or interest or when, in theopinion of management, the collection of all interest and/or principal is indoubt. A loan remains in nonaccrual status until the loan is current as topayment of both principal and interest and the borrower demonstrates theability to pay and remain current. Management may grant a waiver fromnonaccrual status for a 90-day past-due loan that is both well securedand in the process of collection.

A loan isconsidered to be impaired when, based on current information and events, it isprobable that the Company will be unable to collect all amounts due accordingto the contractual terms of the loan agreement. A loan is not consideredimpaired during a period of delay in payment if the Company expects to collectall amounts due, including interest past-due. The Company generally considers aperiod of delay in payment to include delinquency up to 90 days.

In accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 114, *Accounting by Creditors for Impairment of a Loan*(“SFAS No. 114”), the Company measures impaired loans: (i) at the present valueof expected cash flows discounted at the loan’s effective interest rate; (ii) atthe observable market price; or (iii) at the fair value of the collateral ifthe loan is collateral dependent. If the measure of the impaired loan is lessthan the recorded investment in the loan, an impairment is recognized through avaluation allowance and corresponding provision for loan losses.

SFAS No. 114does not apply to larger groups of smaller-balance homogeneous loans suchas consumer installment loans. These loans are collectively evaluated forimpairment. The Company’s impaired loans are, therefore, comprised primarily ofcommercial loans, including commercial mortgage loans, and real estatedevelopment and construction loans. In addition, impaired loans are generallyloans which management has placed in nonaccrual status. The Company recognizesinterest income for impaired loans consistent with its method for nonaccrualloans. Specifically, interest payments received are normally applied toprincipal. An impaired loan is charged off when the loan, or a portion thereof,is considered uncollectible.

The Company provides for loan losses throughthe establishment of the Allowance by provisions charged against earnings. TheCompany’s objective is to ensure that the Allowance is adequate to coverprobable loan losses inherent in the loan portfolio at the date of each balancesheet. Management considers a number of factors in estimating the requiredlevel of the Allowance. These factors include: historical loss experience inthe loan portfolios; the levels and trends in past-due and nonaccrual loans;the status of nonaccrual loans and other loans identified as having thepotential for further deterioration; credit risk and industry concentrations; trendsin loan volume; the effects of any changes in lending policies and proceduresor underwriting standards; and, a continuing evaluation of the economicenvironment. The Company’s estimate of the required Allowance is subject torevision as these factors change and is sensitive to the effects of economicand market conditions on borrowers. Loan losses are charged against theAllowance when management believes the uncollectibility of the loan balance isconfirmed. Subsequent recoveries, if any, are credited to the Allowance.

40

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2006 ANNUAL REPORT

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***(Continued)*

***Other Real Estate Owned (OREO)***

OREO is comprised of properties acquired inpartial or total satisfaction of problem loans. The properties are recorded atthe lower of cost or estimated fair value less selling costs. Losses incurredat the time of acquisition of the property are charged to the allowance forloan losses. Subsequent write-downs are included in noninterest expensealong with operating income and expenses of such properties and gains or lossesrealized upon disposition.

***Premises and Equipment***

Premises andequipment are stated at cost less accumulated depreciation and amortization.Depreciation and amortization are charged to noninterest expenses. Depreciationgenerally is computed on the straight-line basis over the estimated usefullives of the assets, which generally range from three to ten years forfurniture and equipment, three to five years for computer software andhardware, and ten to forty years for buildings and leasehold improvements.Leasehold improvements are generally amortized over the terms of the relatedleases or the lives of the assets, whichever is shorter. The costs ofsignificant purchases, renewals and betterments are capitalized, while thecosts of ordinary maintenance and repairs are expensed as incurred and includedin noninterest expense.

Any gain or loss on the sale of an asset istreated as an adjustment to the basis of its replacement, if traded in, or asan income or expense item, if sold. Leases are accounted for as operatingleases since none meet the criteria for capitalization.

***Bank Owned Life Insurance***

The Company purchased insurance on the livesof certain groups of employees. The policies accumulate asset values to meetfuture liabilities. Increases in the cash surrender value are recorded innoninterest income in the Consolidated Statements of Income.

***Income Taxes***

The Company and its subsidiary file aconsolidated federal income tax return. Deferred income taxes are recognizedfor the tax consequences of temporary differences between financial statementcarrying amounts and the tax basis of assets and liabilities based on enactedtax rates expected to be in effect when such amounts are realized or settled.

***Intangible Assets***

A deposit intangibleasset of $1,847,700, relating to a branch acquisition, is being amortized usingthe straight-line method over 15 years. The remaining unamortized balance at December31, 2006 and 2005 was $431,110 and $554,284, respectively. Amortization expensewas $123,180 for 2006, 2005, and 2004, respectively.

The Companycapitalizes the value of loan servicing retained on loan sales, and amortizesthe value over the estimated life of the portfolio of loans serviced.

Intangible assets are included in “Other assets”on the Consolidated Balance Sheets. Management evaluates intangible assets forimpairment quarterly.

***Derivative Instruments and Hedging Activities***

The Companyaccounts for derivative instruments and hedging activities utilizing guidelinesestablished in FASB Statement No. 133 (“FASB No. 133”), *Accounting for Derivative Instruments and HedgingActivities*, as amended. The Company recognizes all derivatives aseither assets or liabilities on the balance sheet and measures thoseinstruments at fair value. Changes in fair value of derivatives designated andaccounted for as cash flow hedges, to the extent they are effective as hedges,are recorded in “Other Comprehensive Income,” net of deferred taxes. Any hedgeineffectiveness would be recognized in the income statement line itempertaining to the hedged item.

Managementperiodically reviews contracts from various functional areas of the Company toidentify potential derivatives embedded within selected contracts. Managementhas identified potential embedded derivatives in certain loan commitments forresidential mortgages where the Company has intent to sell to an outsideinvestor. Due to the short-term nature of these loan commitments and theminimal historical dollar amount of commitments outstanding, the correspondingimpact on the Company’s financial condition and results of operation has notbeen material.

The Company entered into an interest rateFloor transaction on December 14, 2005. The Floor has a notional amount of$10.0 million with a minimum interest rate of 7.00% based on US prime rate andwas initiated to hedge exposure to the variability in the future cash flowsderived from adjustable rate home equity loans in a declining interest rateenvironment. The Floor has a term of five years. This interest rate Floor isdesignated a cash flow hedge, as it is designed to reduce variation in overallchanges in cash flow below the above designated strike level associated withthe first Prime based interest payments received each period on its thenexisting loans. The interest rate of these loans will change whenever therepricing index changes, plus or minus a credit spread 

41

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CARROLLTON BANCORP

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***(Continued)*

(based on each loan’s underlying creditcharacteristics), until the maturity of the interest rate Floor. Should thePrime rate index fall below the strike level of the Floor prior to maturity,the Floor’s counterparty will pay the Bank the difference between the strikerate and the rate index multiplied by the notional value of the Floormultiplied by the number of days in the period divided by 360 days. The fairvalue of the Floor will be recorded as “Other assets” and changes in the fairvalue will be recorded as “Other Comprehensive Income” a component ofshareholders’ equity.

***Per Share Data***

Basic net income per share is determined bydividing net income by the weighted average number of common shares outstandinggiving retroactive effect to any stock dividends and splits declared. Dilutedearnings per share is determined by adjusting average shares of common stockoutstanding by the potentially dilutive effects of stock options outstanding.The dilutive effects of stock options are computed using the treasury stockmethod.

***Comprehensive Income***

Comprehensive income includes all changes inshareholders’ equity during a period, except those relating to investments byand distributions to shareholders. The Company’s comprehensive income consistsof net earnings, unrealized gains and losses on securities available for sale,changes in the fair value of the Floor and the adjustment from the adoption ofStatement of Financial Accounting Standards No. 158, “Employees Accounting forDefined Benefit Pension and Other Post Retirement Plans” (“SFAS No. 158”) andis presented in the statements of shareholders’ equity. Accumulated othercomprehensive income is displayed as a separate component of shareholders’equity.

***Stock-based Compensation***

On January 1, 2006, the Company adopted theprovisions of Financial Accounting Standards Board (“FASB”) Statement No. 123(R), *Share-Based Payment,*(“SFAS No. 123R”),which requires companies to recognize expense related to the fair value of ourstock-based compensation. Prior to January 1, 2006, the Company accounted forstock-based compensation under the recognition and measurement provisions ofAccounting Principle Board (“APB”) Opinion No. 25, Accounting for Stock Issuedto Employees (“APB No. 25”), and related Interpretations, as permitted by FASBStatement No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). Inaccordance with APB No. 25, no compensation cost was required to be recognizedfor options granted that had an exercise price equal to the market value of theunderlying common stock on the date of the grant.

The Company adopted SFAS No. 123R using themodified prospective transition method. Under this transition method,compensation cost recognized for the year ended December 31, 2006 includes:a)  compensation cost for all share-basedcompensation granted prior to, but not vested as of January 1, 2006, based onthe grant-date fair value estimated in accordance with the original provisionsof SFAS No. 123, and b) compensation cost for all share-based compensationgranted subsequent to January 1, 2006, based on the grant-date fair value estimatedin accordance with the provisions of SFAS No. 123R. Prior to January 1, 2006,no compensation expense was recognized for stock option grants, as all suchgrants had an exercise price equal to the fair market value on the date of thegrant.

In December 2005, the Company authorized thegrant of 42,000 options to officers and the immediate vesting of such options. Alloutstanding options to officers where the exercise price of the option exceededthe fair market value of the Company’s stock were also approved for acceleratedvesting. This resulted in 75,500 options becoming vested in 2005 that wouldhave otherwise vested in future years.

As a result of adopting SFAS 123R on January 1,2006, incremental stock-based compensation expense recognized was $13,447during 2006. As of December 31, 2006, there was $10,928 of unrecognizedcompensation expense related to nonvested stock options, which will berecognized over the remaining vesting period.

The following illustrates the effect on thenet income and earnings per share if the Company had applied the fair valuemethod of SFAS No. 123, “Accounting for Stock-Based Compensation,” priorto January 1, 2006:

| * *                                       | * * | *2005*   | * *  | *2004*   | * * |
|------------------------------------------------|----------|----------|-----------|----------|----------|
| Net Income:                                    |     |     |      |     |     |
| As reported                                    |     | $        | 2,458,437 |     | $        | 888,364 |   |
| Additional compensation                        |     | (162,222 | )         | (133,288 | )        |
| Income tax benefit on additional  compensation |     | 62,650   |      | 51,476   |     |
| Pro forma                                      |     | $        | 2,358,865 |     | $        | 806,552 |   |
| Basic Earnings Per Share:                      |     |     |      |     |     |
| As reported                                    |     | $        | 0.87      |     | $        | 0.31 |   |
| Pro forma                                      |     | 0.83     |      | 0.28     |     |
| Diluted Earnings Per Share:                    |     |     |      |     |     |
| As reported                                    |     | 0.87     |      | 0.31     |     |
| Pro forma                                      |     | 0.83     |      | 0.28     |     |

 

42

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2006 ANNUAL REPORT

**2. CASH AND DUE FROM BANKS**

The Bank is required by the Federal ReserveSystem to maintain certain reserve balances based principally on depositliabilities. At December 31, 2006 and 2005, the required reserve balanceswere $1.4 million and $323,000, respectively. The Company sells federal fundson an unsecured basis to its correspondent banks. Average balances sold were$6.7 million in 2006 and $12.9 million in 2005.

**3. INVESTMENT SECURITIES**

Investment securities are summarized asfollows:

| * *                   | * * | *Amortized  cost* | * *   | *Unrealized  gains* | * * | *Unrealized  losses* | * * | *Fair  value* | * * |
|----------------------------|----------|-------------------|------------|---------------------|----------|----------------------|----------|---------------|----------|
| December 31, 2006     |     |              |       |                |     |                 |     |          |     |   |   |
| AVAILABLE FOR SALE         |     |              |       |                |     |                 |     |          |     |   |   |
| U.S. government agency     |     | $                 | 9,642,252  |                | $        | 24,405               |     |          | $        | (28,897 | ) |   | $ | 9,637,760 |   |
| Mortgage-backed securities |     | 12,712,231        |       | 129,674             |     |                 | (116,352 | )             |     | 12,725,553 |   |
| State and municipal        |     | 5,691,067         |       | 42,133              |     |                 | (8,241   | )             |     | 5,724,959 |   |
| Corporate bonds            |     | 5,639,276         |       | —              |     |                 | (17,747  | )             |     | 5,621,529 |   |
|                       |     | 33,684,826        |       | 196,212             |     |                 | (171,237 | )             |     | 33,709,801 |   |
| Equity securities          |     | 1,140,856         |       | 1,090,934           |     |                 | (6,944   | )             |     | 2,224,846 |   |
|                       |     | $                 | 34,825,682 |                | $        | 1,287,146            |     |          | $        | (178,181 | ) |   | $ | 35,934,647 |   |
| HELD TO MATURITY           |     |              |       |                |     |                 |     |          |     |   |   |
| U.S. government agency     |     | $                 | 6,456,069  |                | $        | —               |     |          | $        | (89,979 | ) |   | $ | 6,366,090 |   |
| Mortgage-backed securities |     | 8,761,200         |       | —              |     |                 | (136,735 | )             |     | 8,624,465 |   |
| State and municipal        |     | 3,912,704         |       | 3,528               |     |                 | (16,519  | )             |     | 3,899,713 |   |
|                       |     | $                 | 19,129,973 |                | $        | 3,528                |     |          | $        | (243,233 | ) |   | $ | 18,890,268 |   |

 

| * *                   | * * | *Amortized  cost* | * *   | *Unrealized  gains* | * * | *Unrealized  losses* | * * | *Fair  value* | * * |
|----------------------------|----------|-------------------|------------|---------------------|----------|----------------------|----------|---------------|----------|
| December 31, 2005     |     |              |       |                |     |                 |     |          |     |   |   |
| AVAILABLE FOR SALE         |     |              |       |                |     |                 |     |          |     |   |   |
| U.S. government agency     |     | $                 | 10,786,412 |                | $        | 3,225                |     |          | $        | (49,302 | ) |   | $ | 10,740,335 |   |
| Mortgage-backed securities |     | 8,551,994         |       | 34,005              |     |                 | (95,874  | )             |     | 8,490,125 |   |
| State and municipal        |     | 3,613,458         |       | 76,401              |     |                 | —   |          |     | 3,689,859 |   |
| Corporate bonds            |     | 1,516,345         |       | —              |     |                 | (1,874   | )             |     | 1,514,471 |   |
|                       |     | 24,468,209        |       | 113,631             |     |                 | (147,050 | )             |     | 24,434,790 |   |
| Equity securities          |     | 1,633,298         |       | 3,030,815           |     |                 | (3,900   | )             |     | 4,660,213 |   |
|                       |     | $                 | 26,101,507 |                | $        | 3,144,446            |     |          | $        | (150,950 | ) |   | $ | 29,095,003 |   |
| HELD TO MATURITY           |     |              |       |                |     |                 |     |          |     |   |   |
| U.S. government agency     |     | $                 | 5,000,000  |                | $        | —               |     |          | $        | (64,050 | ) |   | $ | 4,935,950 |   |
| Mortgage-backed securities |     | 9,575,713         |       | 29,016              |     |                 | (98,260  | )             |     | 9,506,469 |   |
| State and municipal        |     | 3,912,692         |       | —              |     |                 | (49,832  | )             |     | 3,862,860 |   |
|                       |     | $                 | 18,488,405 |                | $        | 29,016               |     |          | $        | (212,142 | ) |   | $ | 18,305,279 |   |

 

Information related to unrealized losses inthe portfolio as of December 31, 2006 follows:

| * *                   | * * | *December 31, 2006*        | * *  |
|----------------------------|----------|--------------------------------------|-----------|
| * *                   | * * | *Less than 12 months* | * *  | *12 months or longer* | * * | *Total* | * * |
| * *                   | * * | *Fair  Value*                        | * *  | *Unrealized  Losses* | * * | *Fair  Value* | * * | *Unrealized  Losses* | * * | *Fair  Value* | * * | *Unrealized  Losses* | * * |
| U.S. government agency     |     | $                                    | 1,985,619 |   |   | $ | (14,380 | ) |   | $ | 10,533,310 |   |   | $ | (104,496 | ) |   | $ | 12,518,929 |   |   | $ | (118,876 | ) |   |
| Mortgage-backed securities |     | —                               |      |   | — |   |   | 15,167,237 |   |   | (253,087 | ) |   | 15,167,237 |   |   | (253,087 | ) |   |
| State and municipal        |     | —                               |      |   | — |   |   | 5,373,469 |   |   | (24,760 | ) |   | 5,373,469 |   |   | (24,760 | ) |   |
| Corporate bonds            |     | —                               |      |   | — |   |   | 5,016,250 |   |   | (17,748 | ) |   | 5,016,250 |   |   | (17,748 | ) |   |
| Equity securities          |     | —                               |      |   | — |   |   | 125,790 |   |   | (6,944 | ) |   | 125,790 |   |   | (6,944 | ) |   |
|                       |     | $                                    | 1,985,619 |   |   | $ | (14,380 | ) |   | $ | 36,216,056 |   |   | $ | (407,035 | ) |   | $ | 38,201,675 |   |   | $ | (421,415 | ) |   |

 

43

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CARROLLTON BANCORP

**3. INVESTMENT SECURITIES*(CONTINUED)***

Managementevaluates securities for other-than-temporary impairment at least on aquarterly basis, and more frequently when economic or market concerns warrantsuch evaluation. Consideration is given to (1) the length of time and theextent to which the fair value has been less than cost, (2) the financialcondition and near-term prospects of the issuer, and (3) the intent and abilityof the Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.

At December 31,2006, five marketable equity securities had unrealized losses of approximately$6,944 from the Company’s cost basis. At December 31, 2005, one marketableequity security had an unrealized loss with aggregate depreciation ofapproximately $3,900 from the Company’s cost basis. During 2004, the Companywrote down its FHLMC preferred stock securities by $497,313 to fair value toreflect what the Company considered to be an other-than-temporary impairment ofthose securities. No credit issues have been identified that cause managementto believe the decline in market value is other than temporary. In analyzingthe issuer’s financial condition, management considers industry analysisreports, financial performance and projected target prices of investmentanalysts within a one-year time frame. Unrealized losses on marketable equitysecurities that are in excess of 50% of cost, and that have been sustained formore than 24 months, are generally recognized by management as being other thantemporary and charged to earnings, unless evidence exists to support arealizable value equal to or greater than the Company’s carrying value of theinvestment.

All unrealizedlosses on U.S. government agency, mortgage-backed securities, state andmunicipal securities and corporate bonds as of December 31, 2006 are consideredto be temporary losses, because each security will be redeemed at face valueat, or prior to maturity. In most cases, the temporary impairment in value iscaused by market interest rate fluctuations.

Contractual maturities of debt securities at December 31,2006 and 2005 are shown below. Actual maturities may differ from contractualmaturities because borrowers have the right to call or prepay obligations withor without call or prepayment penalties.

| * *                   | * * | *December 31, 2006*  | * *   |
|----------------------------|----------|--------------------------------|------------|
| * *                   | * * | *Available for sale* | * *   | *Held to maturity* | * * |
| *Maturing*                 | * * | *Amortized  Cost*              | * *   | *Fair  Value* | * * | *Amortized  Cost* | * * | *Fair  Value* | * * |
| Within one year            |     | $                              | 2,000,000  |   | $ | 1,985,620 |   | $ | — |   | $ | — |   |
| Over one to five years     |     | 4,923,172                      |       | 4,924,303 |   | — |   | — |   |
| Over five to ten years     |     | 3,928,823                      |       | 3,958,428 |   | 8,414,510 |   | 8,324,424 |   |
| Over ten years             |     | 10,120,600                     |       | 10,115,898 |   | 1,954,263 |   | 1,941,379 |   |
| Mortgage-backed securities |     | 12,712,231                     |       | 12,725,553 |   | 8,761,200 |   | 8,624,465 |   |
|                       |     | $                              | 33,684,826 |   | $ | 33,709,802 |   | $ | 19,129,973 |   | $ | 18,890,268 |   |

 

| * *                   | * * | *December 31, 2005*  | * *   |
|----------------------------|----------|--------------------------------|------------|
| * *                   | * * | *Available for sale* | * *   | *Held to maturity* | * * |
| *Maturing*                 | * * | *Amortized  Cost*              | * *   | *Fair  Value* | * * | *Amortized  Cost* | * * | *Fair  Value* | * * |
| Within one year            |     | $                              | 250,000    |   | $ | 250,161 |   | $ | 250,000 |   | $ | 250,161 |   |
| Over one to five years     |     | 9,767,684                      |       | 9,744,231 |   | 9,767,684 |   | 9,744,231 |   |
| Over five to ten years     |     | 5,899,059                      |       | 5,950,273 |   | 5,899,059 |   | 5,950,273 |   |
| Mortgage-backed securities |     | 8,551,466                      |       | 8,490,125 |   | 8,551,466 |   | 8,490,125 |   |
|                       |     | $                              | 24,468,209 |   | $ | 24,434,790 |   | $ | 24,468,209 |   | $ | 24,434,790 |   |

 

At December 31,2006 and 2005, securities with an amortized cost of $17.9 million (fair valueof $17.9 million) and $32.8 million (fair value of $32.6 million),respectively, were pledged as collateral for government deposits, securitiessold under repurchase agreements, and advances from the Federal Home Loan Bank.

In 2006, 2005,and 2004, the Company realized gross gains on sales of securities of $2.2million, $839,859, and $115,810, respectively. During 2004, the Companyrecognized an other than temporary impairment of $497,313. There were norealized losses in 2006 or 2005. Income taxes (benefit) on net security gains(losses) were $730,413, $293,783, and $(147,336), in 2006, 2005 and 2004,respectively.

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2006 ANNUAL REPORT

**4. LOANS**

Major classifications of loans at December 31are as follows:

| * *                          | * * | *2006*      | * *    | *2005*      | * * |
|-----------------------------------|----------|-------------|-------------|-------------|----------|
| Real estate:                      |     |        |        |        |     |
| Residential                       |     | $           | 55,057,625  |        | $        | 53,148,211 |   |
| Commercial                        |     | 120,397,988 |        | 97,909,115  |     |
| Construction and land development |     | 29,996,306  |        | 37,415,478  |     |
| Demand and time                   |     | 51,549,802  |        | 56,118,527  |     |
| Lease financing                   |     | 969,113     |        | 1,936,482   |     |
| Installment                       |     | 2,030,480   |        | 1,415,260   |     |
|                              |     | 260,001,314 |        | 247,943,073 |     |
| Allowance for loan losses         |     | 3,131,021   |        | 3,337,163   |     |
| Loans, net                        |     | $           | 256,870,293 |        | $        | 244,605,910 |   |

 

The Bank makesloans to customers located in Maryland, Virginia, Pennsylvania and Delaware.Although the loan portfolio is diversified, its performance will be influencedby the regional economy.

The maturity and rate repricing distributionof the loan portfolio at December 31 is as follows:

| * *                              | * * | *2006*     | * *    | *2005*     | * * |
|---------------------------------------|----------|------------|-------------|------------|----------|
| Repricing or maturing within one year |     | $          | 77,881,735  |       | $        | 139,326,825 |   |
| Maturing over one to five years       |     | 98,707,890 |        | 91,219,788 |     |
| Maturing over five years              |     | 83,411,689 |        | 17,396,460 |     |
|                                  |     | $          | 260,001,314 |       | $        | 247,943,073 |   |

 

Loan balances have been adjusted by thefollowing deferred amounts as of December 31:

| * *                                          | * * | *2006*   | * * | *2005*   | * * |
|---------------------------------------------------|----------|----------|----------|----------|----------|
| Deferred origination costs and premiums           |     | $        | 538,554  |     | $        | 392,075 |   |
| Deferred origination fees and unearned  discounts |     | (854,549 | )        | (741,636 | )        |
| Net deferred  fees                                |     | $        | (315,995 | )        | $        | (349,561 | ) |

 

Transactions in the allowance for loan lossesfor the years ended December 31 were as follows:

| * *                        | * * | *2006*    | * *  | *2005*    | * * | *2004*    | * * |
|---------------------------------|----------|-----------|-----------|-----------|----------|-----------|----------|
| Beginning balance               |     | $         | 3,337,163 |      | $        | 3,485,076 |     | $ | 3,648,245 |   |
| Provision charged to operations |     | —    |      | —    |     | —    |     |
| Recoveries                      |     | 49,692    |      | 167,128   |     | 113,953   |     |
|                            |     | 3,386,855 |      | 3,652,204 |     | 3,762,198 |     |
| Loans charged off               |     | 255,834   |      | 315,041   |     | 277,122   |     |
| Ending balance                  |     | $         | 3,131,021 |      | $        | 3,337,163 |     | $ | 3,485,076 |   |

 

Nonperforming assets and loans past-due90 days or more but accruing interest were as follows at December 31:

| * *                                        | * * | *2006*    | * *  | *2005* | * * | *2004*    | * * |
|-------------------------------------------------|----------|-----------|-----------|--------|----------|-----------|----------|
| Nonaccrual loans                                |     | $         | 3,699,397 |   | $        | 1,413,925 |     | $ | 615,394 |   |
| Restructured loans                              |     | 180,686   |      | — |     | 455,864   |     |
| Foreclosed real estate                          |     | 1,383,163 |      | — |     | —    |     |
| Total nonperforming assets                      |     | $         | 5,263,246 |   | $        | 1,413,925 |     | $ | 1,071,258 |   |
| Accruing loans past-due 90 days or  more        |     | $         | 436,599   |   | $        | 179,012   |     | $ | 1,567,919 |   |
| Unrecorded interest on nonaccrual loans         |     | $         | 76,044    |   | $        | 111,413   |     | $ | 64,037 |   |
| Interest income recognized on nonaccrual  loans |     | $         | 300,650   |   | $        | 58,718    |     | $ | 32,318 |   |

 

At December 31,2006 and 2005, there were no impaired loans.

At December 31,2004, the Company had one impaired loan to the same borrower amounting to$455,864, which was classified as impaired because it had been restructured toaccept interest only payments for a period of 

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CARROLLTON BANCORP

**4. LOANS*(CONTINUED)***

time. The average balance of impaired loansamounted to $298,406 and $530,680 in 2005 and 2004, respectively. During 2005 and 2004, the Company received totalpayments on impaired loans of $601,323 and $341,857, respectively. Of theseamounts, $24,583 and $75,938, were recorded as interest income for 2005 and2004, respectively. The remainder was applied to reduce principal and recoveryof professional fees. There was no specific allowance for this loan since thefair value of the collateral securing the loan was considered adequate to coverall principal and interest due. The Company also continued to accrue intereston this loan due to the adequacy of the collateral value.

Loans with a balance of approximately $86.6 millionand $86.2 million were pledged as collateral to the Federal Home Loan Bank ofAtlanta as of December 31, 2006 and 2005, respectively. At December 31, 2006and 2005, the Company serviced loans for others totaling $1.1million and$1.6 million, respectively.

**5. CREDIT COMMITMENTS**

Outstanding loan commitments, unused lines ofcredit, and letters of credit were as follows as of December 31:

| * *                          | * * | *2006*     | * *   | *2005*     | * * | *2004*     | * * |
|-----------------------------------|----------|------------|------------|------------|----------|------------|----------|
| LOAN COMMITMENTS                  |     |       |       |       |     |       |     |
| Mortgage loans                    |     | $          | 4,122,697  |       | $        | 4,066,223  |     | $ | 8,899,836 |   |
| Construction and land development |     | 29,501,299 |       | 14,913,344 |     | 9,438,961  |     |
| Commercial loans                  |     | 6,840,000  |       | 7,058,000  |     | 13,812,780 |     |
|                              |     | $          | 40,463,996 |       | $        | 26,037,567 |     | $ | 32,151,577 |   |
| UNUSED LINES OF CREDIT            |     |       |       |       |     |       |     |
| Home equity lines                 |     | $          | 46,199,911 |       | $        | 52,194,528 |     | $ | 55,883,051 |   |
| Commercial lines                  |     | 44,279,428 |       | 26,095,802 |     | 25,467,308 |     |
| Unsecured consumer lines          |     | 1,084,048  |       | 1,410,270  |     | 1,405,075  |     |
|                              |     | $          | 91,563,387 |       | $        | 79,700,600 |     | $ | 82,755,434 |   |
| LETTERS OF CREDIT                 |     | $          | 2,223,755  |       | $        | 2,606,061  |     | $ | 2,910,330 |   |

 

Loancommitments and lines of credit are agreements to lend to a customer as long asthere is no violation of any condition to the contract. Loan commitmentsgenerally have interest rates fixed at current market amounts, fixed expirationdates, and may require payment of a fee. Lines of credit generally havevariable interest rates. Such lines do not represent future cash requirementsbecause it is unlikely that all customers will draw upon their lines in full atany time. Letters of credit are commitments issued to guarantee the performanceof a customer to a third party.

The Company’s exposure to credit loss in theevent of nonperformance by the borrower is the contract amount of thecommitment. Loan commitments, lines of credit, and letters of credit are madeon the same terms, including collateral, as outstanding loans. The Company isnot aware of any accounting loss it would incur by funding the abovecommitments.

**6. RELATED PARTY TRANSACTIONS**

The Company’s executive officers anddirectors, or other entities, to which they are related, enter into loantransactions with the Bank in the ordinary course of business. The terms ofthese transactions are similar to the terms provided to other borrowersentering into similar loan transactions and do not involve more than normalrisk of collectibility. During the years ended December 31, 2006, 2005 and2004, transactions in related party loans were as follows:

| * *          | * * | *2006*     | * *  | *2005*   | * * | *2004*     | * * |
|-------------------|----------|------------|-----------|----------|----------|------------|----------|
| Beginning balance |     | $          | 1,894,784 |     | $        | 1,820,717  |     | $ | 3,209,200 |   |
| Additions         |     | 7,918,876  |      | 179,452  |     | 1,040,580  |     |
| Repayments        |     | (1,837,046 | )         | (105,385 | )        | (2,429,063 | )        |
| Ending balance    |     | $          | 7,976,614 |     | $        | 1,894,784  |     | $ | 1,820,717 |   |

 

A director ofthe Company is a partner in a law firm that provides legal services to theCompany and the Bank. During the years ended December 31, 2006, 2005, and 2004,amounts paid to the law firm in connection with those services were $195,000,$220,000, and $249,000, respectively.

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2006 ANNUAL REPORT

**6. RELATED PARTY TRANSACTIONS*(CONTINUED)***

A director ofthe Company is President of an insurance brokerage through which the Companyand the Bank place various insurance policies. During the years ended December 31,2006, 2005, and 2004, amounts paid to the insurance brokerage for insurancepremiums were $282,000, $215,000, and $192,000, respectively.

A director ofthe Company is President of an electrical company through which the Company andthe Bank may contract for electrical services. No such services were performedin 2006, 2005 or 2004.

A director of the Company is the ExecutiveVice President for a commercial real estate services company, through which theCompany and the Bank contracted for appraisal and management services amountingto $356,000 in 2006, $169,000 in 2005, and $739,000 in 2004.

**7. PREMISES AND EQUIPMENT**

A summary of premises and equipment is asfollows as of December 31:

| * *                                  | * * | *2006*     | * *  | *2005*     | * * |
|-------------------------------------------|----------|------------|-----------|------------|----------|
| Land and improvements                     |     | $          | 909,544   |       | $        | 909,544 |   |
| Buildings                                 |     | 2,995,117  |      | 2,885,994  |     |
| Leasehold improvements                    |     | 3,523,947  |      | 3,137,550  |     |
| Equipment and fixtures                    |     | 4,521,052  |      | 5,341,396  |     |
|                                      |     | 11,949,660 |      | 12,274,484 |     |
| Accumulated depreciation and amortization |     | (6,349,672 | )         | (6,840,856 | )        |
|                                      |     | $          | 5,599,988 |       | $        | 5,433,628 |   |

 

Depreciationand amortization of premises and equipment was $611,658, $673,022, and $1.1million, for 2006, 2005, and 2004, respectively. Amortization of software was$108,364, $141,368, and $72,962 for 2006, 2005, and 2004, respectively.

On September 22, 2005, Wal-Martnotified the Bank of its intention to terminate the agreement for the Bank toprovide ATMs at Wal-Mart, Sam’s Club, and Wal-Mart supercenters inMaryland, Virginia and West Virginia. An impairment of $563,400 was recordedfor the write down and cost of disposal of the ATM network. The ATMs wereassets of the Electronic Banking division.

**8. DEPOSITS**

Major classifications of interest-bearingdeposits are as follows as of December 31:

| * *                                    | * * | *2006*     | * *    | *2005*     | * * |
|---------------------------------------------|----------|------------|-------------|------------|----------|
| NOW and Super NOW                           |     | $          | 33,112,772  |       | $        | 33,396,380 |   |
| Money market                                |     | 52,072,965 |        | 50,482,662 |     |
| Savings                                     |     | 27,608,013 |        | 31,182,882 |     |
| Certificates of deposit of $100,000 or more |     | 29,567,921 |        | 14,990,576 |     |
| Other time deposits                         |     | 85,472,570 |        | 74,563,018 |     |
|                                        |     | $          | 227,834,241 |       | $        | 204,615,518 |   |

 

Time deposits mature as follows:

| * *                          | * * | *December 31,* | * *    |
|-----------------------------------|----------|---------------------|-------------|
| * *                          | * * | *2006*              | * *    | *2005* | * * |
| Maturing within one year          |     | $                   | 92,053,740  |   | $ | 67,555,717 |   |
| Maturing over one to two years    |     | 13,479,273          |        | 12,087,661 |   |
| Maturing over two to three years  |     | 5,197,865           |        | 3,353,809 |   |
| Maturing over three to four years |     | 3,503,735           |        | 2,445,906 |   |
| Maturing over four to five years  |     | 805,878             |        | 4,110,501 |   |
|                              |     | $                   | 115,040,491 |   | $ | 89,553,594 |   |

 

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CARROLLTON BANCORP

**9. BORROWED FUNDS**

Borrowed fundsconsist of securities sold under repurchase agreements, federal fundspurchased, borrowings from the FHLB and notes payable-U.S. Treasury. Notespayable-U.S. Treasury are U.S. Treasury and Federal Treasury Tax and Loandeposits accepted by the Bank from its customers to be remitted to the FederalReserve on a periodic basis. Securities sold under repurchase agreements are securitiessold to the Bank’s customers under a continuing “roll-over” contract and maturein one business day. The underlying securities sold are federal agencysecurities that are segregated from the Company’s other investment securities.Federal funds purchased are unsecured, overnight borrowings from otherfinancial institutions.

Information with respect to borrowings is asfollows at and for the years ended December 31:

| * *                                                                 | * * | *Maturity Date*  | * * | *2006*     | * *   | *2005*     | * *  | *2004*     | * * |
|--------------------------------------------------------------------------|----------|-----------------------|----------|------------|------------|------------|-----------|------------|----------|
| Amount outstanding at year-end:                                          |     |                  |     |       |       |       |      |       |     |
| Federal Home Loan Bank                                                   |     | March 26, 2008   |     | $          | 5,000,000  |       | $         | 5,000,000  |     | $ | 5,000,000 |   |
| Federal Home Loan Bank                                                   |     | February 2, 2010 |     | —     |       | 35,000,000 |      | 35,000,000 |     |
| Federal Home Loan Bank                                                   |     | May 24, 2010     |     | —     |       | —     |      | 5,000,000  |     |
| Federal Home Loan Bank                                                   |     | Daily Rate Credit     |     | 17,000,000 |       | —     |      | —     |     |
| Federal Home Loan Bank                                                   |     |                  |     | $          | 22,000,000 |       | $         | 40,000,000 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | $          | 13,405,463 |       | $         | 9,280,348  |     | $ | 10,183,951 |   |
| Notes-payable — U.S. Treasury                                  |     |                  |     | —     |       | $          | 1,932,124 |       | $        | 1,984,714 |   |
| Weighted average interest rate at year-end:                              |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | 5.43       | %          | 6.67       | %         | 6.84       | %        |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 4.86       | %          | 3.59       | %         | 1.91       | %        |
| Notes payable — U.S. Treasury                                  |     |                  |     | —     |       | 4.17       | %         | 1.97       | %        |
| Maximum outstanding at any month-end:                                    |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | $          | 40,000,000 |       | $         | 45,000,000 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 13,405,463 |       | 11,742,108 |      | 13,540,231 |     |
| Notes payable — U.S. Treasury                                  |     |                  |     | 1,432,423  |       | 1,958,750  |      | 2,008,989  |     |
| Average balance outstanding during the  year:                            |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | $          | 24,603,287 |       | $         | 44,876,712 |     | $ | 45,000,000 |   |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 9,040,071  |       | 8,986,714  |      | 10,102,501 |     |
| Notes payable — U.S. Treasury                                  |     |                  |     | 185,067    |       | 1,016,211  |      | 1,051,267  |     |
| Weighted average interest rate during the  year:                         |     |                  |     |       |       |       |      |       |     |
| Advances from the FHLB                                                   |     |                  |     | 5.38       | %          | 6.84       | %         | 6.84       | %        |
| Federal funds purchased and securities sold  under repurchase agreements |     |                  |     | 4.66       | %          | 2.66       | %         | 0.96       | %        |
| Notes  payable — U.S. Treasury                                 |     |                  |     | 4.18       | %          | 3.06       | %         | 1.10       | %        |

 

Debt retirementexpense of $2.3 million was incurred in 2006 due to the restructuring of a$35.0 million FHLB advance that had a maturity date of February 2, 2010and an interest rate of  6.84%. Debtretirement expense of $505,839 was incurred in 2005 due to the prepayment of a$5.0 million FHLB advance that had a maturity date of May 24, 2010and an interest rate of 7.26%.

The Company has available unsecured federalfunds lines of credit of $5 million and a secured federal funds line of creditof $10 million with other institutions. There was no balance outstanding underthese lines at December 31, 2005 and 2004. These lines bear interest atthe current federal funds rate of the correspondent bank.

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2006 ANNUAL REPORT

**10. OTHER NONINTEREST EXPENSES**

Other noninterest expenses include thefollowing for the years ended December 31:

| * *                           | * * | *2006*  | * *  | *2005*    | * * | *2004*    | * * |
|------------------------------------|----------|---------|-----------|-----------|----------|-----------|----------|
| Data processing services           |     | $       | 815,056   |      | $        | 807,314   |     | $ | 719,445 |   |
| Professional services              |     | 521,231 |      | 226,965   |     | 187,784   |     |
| Employee-related expenses          |     | 384,128 |      | 345,203   |     | 306,678   |     |
| Marketing                          |     | 303,903 |      | 355,921   |     | 287,343   |     |
| Directors’ fees               |     | 238,850 |      | 173,050   |     | 165,950   |     |
| Carrier service                    |     | 210,703 |      | 496,714   |     | 479,131   |     |
| Liability insurance                |     | 205,516 |      | 214,579   |     | 216,890   |     |
| Printing, stationary, and supplies |     | 202,541 |      | 257,865   |     | 282,914   |     |
| Loan expenses                      |     | 195,844 |      | 354,864   |     | 215,570   |     |
| Postage and freight                |     | 164,606 |      | 167,681   |     | 228,030   |     |
| Telephone                          |     | 162,808 |      | 189,990   |     | 195,867   |     |
| Deposit premium amortization       |     | 123,180 |      | 123,180   |     | 123,180   |     |
| Shareholder expense                |     | 111,768 |      | 111,273   |     | 91,283    |     |
| Software amortization              |     | 108,364 |      | 141,368   |     | 72,962    |     |
| Coin/Currency service              |     | 103,480 |      | 84,429    |     | 80,201    |     |
| ATM services                       |     | 77,704  |      | 1,057,794 |     | 1,134,848 |     |
| Bank account charges               |     | 51,643  |      | 80,592    |     | 88,134    |     |
| Other                              |     | 383,430 |      | 528,031   |     | 472,437   |     |
|                               |     | $       | 4,364,755 |      | $        | 5,716,813 |     | $ | 5,348,647 |   |

 

**11. STOCK OPTIONS**

The Companyadopted a stock option incentive plan in 1998, which provides for the grantingof common stock options to directors and key employees. In 2004, theshareholders approved increasing the number of shares available for grant underthe Plan from 210,000 shares to 300,000 shares. These stock option awardscontain a serial feature whereby one third of the options granted vest and canbe exercised after each year. Option prices are equal to the estimated fairmarket value of the common stock at the date of the grant. Options expire tenyears after the date of grant or upon employee termination if not exercised.

Information with respect to optionsoutstanding is as follows for the years ended December 31:

| * *                               | * * | *2006*   | * * | *2005*                         | * * | *2004*          | * * |
|----------------------------------------|----------|----------|----------|--------------------------------|----------|-----------------|----------|
| * *                               | * * | *Shares* | * * | *Option Price Range* | * * | *Shares*        | * * | *Option Price Range* | * * | *Shares* | * * | *Option Price Range* | * * |
| Outstanding  at beginning of year      |     | 227,130  |     |                           |     |            |     | 193,470 |   |   |   |   |   | 174,785 |   |   |   |   |   |
| Granted                                |     | 12,430   |     |                           | $        | 15.35 to $17.16 |     |   | 53,930 |   |   | $ | 14.45 to $14.85 |   |   | 32,430 |   |   | $ | 16.02 to $16.22 |   |   |
| Exercised                              |     | (4,525   | )        |                           | $        | 10.94 to $15.36 |     |   | (17,375 | ) |   | $ | 9.71 to $14.50 |   |   | (8,845 | ) |   | $ | 9.71 to $15.42 |   |   |
| Expired/Canceled                       |     | (6,005   | )        |                           | $        | 10.94 to $16.02 |     |   | (2,895 | ) |   | $ | 12.67 to $15.48 |   |   | (4,900 | ) |   | $ | 10.94 to $18.10 |   |   |
| Outstanding  at end of year            |     | 229,030  |     |                           | $        | 9.71 to $18.10  |     |   | 227,130 |   |   | $ | 9.71 to $18.10 |   |   | 193,470 |   |   | $ | 9.71 to $18.10 |   |   |
| Exercisable  at December 31       |     | 209,670  |     |                           |     |            |     | 213,550 |   |   |   |   |   | 143,919 |   |   |   |   |   |
| Aggregate  intrinsic value at year end |     | $        | 558,473  |                           |     |            |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                        |          |          |          |                                |          |                 |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

On December 15,2005, the Board of Directors authorized the grant of 42,000 options to officersand the immediate vesting of such options. All outstanding options to officerswhere the exercise price of the option exceeded the fair market value of theCompany’s stock were also approved for accelerated vesting. This resulted in75,500 options becoming vested in 2005 that would have otherwise vested infuture years.

As a result ofadopting SFAS 123R on January 1, 2006, incremental stock-basedcompensation expense recognized was $13,447 during 2006. As ofDecember 31, 2006, there was $10,928 of unrecognized compensation expenserelated to nonvested stock options, which will be recognized over the remainingvesting period. The total intrinsic value of options excised during the yearended December 31, 2006 and 2005 was approximately $18,000 and $47,000,respectively.

49

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CARROLLTON BANCORP

**11. STOCK OPTIONS*(CONTINUED)***

A summary of information about stock optionsoutstanding is as follows at December 31, 2006:

| *Weighted  Average  Exercise  Price* | * * | *Shares*   | * * | *Weighted  Average  Remaining  Life  (Years)* | * * | *Shares  Underlying  Options  Currently  Exercisable* |
|--------------------------------------|----------|------------|----------|-----------------------------------------------|----------|-------------------------------------------------------|
|                                 | $        |  9.71 |     |                                          |     | 2,940                                                 |   |   |   | 4.33 |   |   |   | 2,940 |   |
|                                 | 10.54    |       |     |                                          | 630      |                                                  |   |   | 4.16 |   |   |   | 630 |   |
|                                 | 10.94    |       |     |                                          | 19,950   |                                                  |   |   | 4.42 |   |   |   | 19,950 |   |
|                                 | 12.11    |       |     |                                          | 4,620    |                                                  |   |   | 5.33 |   |   |   | 4,620 |   |
|                                 | 12.14    |       |     |                                          | 630      |                                                  |   |   | 5.16 |   |   |   | 630 |   |
|                                 | 12.67    |       |     |                                          | 21,000   |                                                  |   |   | 5.58 |   |   |   | 21,000 |   |
|                                 | 13.45    |       |     |                                          | 14,700   |                                                  |   |   | 3.58 |   |   |   | 14,700 |   |
|                                 | 13.45    |       |     |                                          | 3,150    |                                                  |   |   | 3.33 |   |   |   | 3,150 |   |
|                                 | 14.45    |       |     |                                          | 6,930    |                                                  |   |   | 8.29 |   |   |   | 2,310 |   |
|                                 | 14.50    |       |     |                                          | 5,670    |                                                  |   |   | 6.33 |   |   |   | 5,670 |   |
|                                 | 14.50    |       |     |                                          | 39,500   |                                                  |   |   | 8.96 |   |   |   | 39,500 |   |
|                                 | 14.85    |       |     |                                          | 5,000    |                                                  |   |   | 8.43 |   |   |   | 5,000 |   |
|                                 | 15.35    |       |     |                                          | 500      |                                                  |   |   | 9.15 |   |   |   | — |   |
|                                 | 15.36    |       |     |                                          | 2,930    |                                                  |   |   | 2.33 |   |   |   | 2,930 |   |
|                                 | 15.42    |       |     |                                          | 26,670   |                                                  |   |   | 2.35 |   |   |   | 26,670 |   |
|                                 | 16.02    |       |     |                                          | 24,000   |                                                  |   |   | 7.58 |   |   |   | 24,000 |   |
|                                 | 16.22    |       |     |                                          | 6,930    |                                                  |   |   | 7.33 |   |   |   | 4,620 |   |
|                                 | 16.31    |       |     |                                          | 6,930    |                                                  |   |   | 9.29 |   |   |   | — |   |
|                                 | 16.70    |       |     |                                          | 3,150    |                                                  |   |   | 1.16 |   |   |   | 3,150 |   |
|                                 | 17.16    |       |     |                                          | 5,000    |                                                  |   |   | 10.0 |   |   |   | — |   |
|                                 | 17.75    |       |     |                                          | 3,000    |                                                  |   |   | 6.92 |   |   |   | 3,000 |   |
|                                 | 17.79    |       |     |                                          | 22,050   |                                                  |   |   | 1.35 |   |   |   | 22,050 |   |
|                                 | 18.10    |       |     |                                          | 3,150    |                                                  |   |   | 1.33 |   |   |   | 3,150 |   |
|                                 | 14.70    |       |     |                                          | 229,030  |                                                  |   |   | 5.41 |   |   |   | 209,670 |   |

 

As of December 31,2006, the weighted average exercise price of shares underlying options currentlyexercisable is $14.58 per share.

The value of eachoption is estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions used for grantsduring the years ended December 31, 2006, 2005 and 2004:

| * *            | * * | *2006*          | * * | *2005*          | * * | *2004*   | * * |
|---------------------|----------|-----------------|----------|-----------------|----------|----------|----------|
| Dividend yield      |     | 2.67%           |     | 2.67%           |     | 2.25%    |     |
| Expected volatility |     | 24.76%          |     | 26.94%          |     | 18.15%   |     |
| Risk free rate      |     | 4.91% to  4.99% |     | 3.96% to  4.47% |     | 4.43%    |     |
| Estimated  life     |     | 10 years        |     | 10 years        |     | 10 years |     |

 

The dividend yield is based on estimatedfuture dividend yields. The risk-free rate for periods within the contracturalterm of the share option is based on the U.S. Treasury  yield curve in effect at the time of thegrant. Expected volatilities are generally based on historical volatilitites.

**12. NET INCOME PER SHARE**

The calculation of net income per commonshare as restated giving retroactive effect to any stock dividends and splitsis as follows for the years ended December 31:

| * *                                           | * * | *2006*    | * *  | *2005*    | * * | *2004*    | * * |
|----------------------------------------------------|----------|-----------|-----------|-----------|----------|-----------|----------|
| Weighted average common shares outstanding         |     | 2,812,289 |      | 2,827,747 |     | 2,831,880 |     |
| Stock option adjustment                            |     | 58,953    |      | 14,140    |     | 28,366    |     |
| Weighted average common shares outstanding-diluted |     | 2,871,242 |      | 2,841,887 |     | 2,860,246 |     |
| Net income (applicable to common stock)            |     | $         | 2,584,779 |      | $        | 2,458,437 |     | $ | 888,364 |   |
| Basic net income per share                         |     | $         | 0.92      |      | $        | 0.87      |     | $ | 0.31 |   |
| Diluted net income per share                       |     | $         | 0.90      |      | $        | 0.87      |     | $ | 0.31 |   |

 

50

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2006 ANNUAL REPORT

**13. COMPREHENSIVE INCOME**

Comprehensive income is defined as net incomeplus transactions and other occurrences which are the result of nonownerchanges in equity. For the Company, nonowner equity changes are comprised ofunrealized gains or losses on available for sale securities, changes in thefair value of the derivative interest rate floor transaction and the adjustmentfor the adoption of SFAS 158 related to the funded status of the definedbenefit plan. These items, net of taxes, will be accumulated with net income indetermining comprehensive income. Presented below is a reconcilement of netincome to comprehensive income for the years ended December 31:

| * *                                             | * * | *2006*     | * *  | *2005*   | * * | *2004*    | * * |
|------------------------------------------------------|----------|------------|-----------|----------|----------|-----------|----------|
| Net Income                                           |     | $          | 2,584,779 |     | $        | 2,458,437 |     | $ | 888,364 |   |
| Other comprehensive income:                          |     |       |      |     |     |      |     |
| Unrealized holding gains (losses) during  the period |     | 215,449    |      | (22,384  | )        | (88,800   | )        |
| Add: Security impairment write down                  |     | —     |      | —   |     | 497,313   |     |
| Adoption of SFAS 158                                 |     | 790        |      | —   |     | —    |     |
| Less: Adjustment for security gains                  |     | (2,157,151 | )         | (839,859 | )        | (115,810  | )        |
| Other comprehensive income before tax                |     | (1,940,912 | )         | (862,243 | )        | 292,703   |     |
| Income taxes on comprehensive income                 |     | 749,579    |      | 332,998  |     | (113,042  | )        |
| Other comprehensive income after tax                 |     | (1,191,333 | )         | (529,245 | )        | 179,661   |     |
| Comprehensive  income                                |     | $          | 1,393,446 |     | $        | 1,929,192 |     | $ | 1,068,025 |   |

 

**14. CAPITAL STANDARDS**

The Company andthe Bank are subject to various regulatory capital requirements administered bythe federal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory and possibly additional discretionary action takenby regulators that, if undertaken, could have a direct material effect on theCompany’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of assets, liabilities,and certain off-balance sheet items as calculated under regulatory accountingprocedures. The Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings andother factors.

Quantitative measures established byregulation to ensure capital adequacy require the Bank to maintain minimumamounts and ratios (set forth in the table below) of total and Tier 1 capital(as defined) to risk-weighted assets (as defined), and of Tier 1 capital toaverage assets (as defined). Management believes, as of December 31, 2006,that the Bank meets all capital adequacy requirements to which it is subject.As of December 31, 2006, the most recent notification from the FederalReserve Bank and the FDIC categorized the Company and the Bank as “wellcapitalized” under the regulatory framework for prompt corrective action. Thereare no conditions or events since that notification that management believeswould change the Company’s or the Bank’s category.

| * *                                  | * *   | *Actual*   | * *   | *Minimum Capital Adequacy* | * *   | *To Be Well Capitalized* | * *   |
|-------------------------------------------|------------|------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| * *                                  | * *   | *Amount*   | * *   | *Ratio*                              | * *   | *Amount*                                | * *   | *Ratio* | * * | *Amount* | * * | *Ratio* | * * |
| **DECEMBER 31, 2006**                | ** ** | ** ** | ** ** | ** **                           | ** ** | ** **                              | ** ** |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Total Capital (to risk-weighted  assets)  |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | $          | 37,253,000 |                                 | 13.20%     |                                    | $          | 22,573,000 |   |   | 8.0% | ** ** |   | $ | 28,217,000 |   | 10.0% |   |
| Carrollton Bank                           |       | 35,313,000 |       | 12.60%                               |       | 22,428,000                              |       |   | 8.0% | ** ** |   | 28,035,000 |   | 10.0% |   |
| Tier 1 Capital (to risk-weighted  assets) |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | 33,634,000 |       | 11.92%                               |       | $                                       | 11,287,000 |   |   | 4.0% | ** ** |   | 16,930,000 |   | 6.0% |   |
| Carrollton Bank                           |       | 32,182,000 |       | 11.48%                               |       | 11,214,000                              |       |   | 4.0% | ** ** |   | 16,821,000 |   | 6.0% |   |
| Tier 1 Capital (to average assets)        |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | 33,634,000 |       | 9.74%                                |       | $                                       | 13,824,000 |   |   | 4.0% | ** ** |   | 17,280,000 |   | 5.0% |   |
| Carrollton Bank                           |       | 32,182,000 |       | 9.30%                                |       | 13,849,000                              |       |   | 4.0% | ** ** |   | 17,311,000 |   | 5.0% |   |
| **DECEMBER 31,  2005**               | ** ** | ** ** | ** ** | ** **                           | ** ** | ** **                              | ** ** |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Total Capital (to risk-weighted  assets)  |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | $          | 37,447,000 |                                 | 13.51%     |                                    | $          | 22,176,000 |   |   | 8.0% | ** ** |   | $ | 27,720,000 |   | 10.0% |   |
| Carrollton Bank                           |       | 34,338,000 |       | 12.52%                               |       | 21,945,000                              |       |   | 8.0% | ** ** |   | 27,432,000 |   | 10.0% |   |
| Tier 1 Capital (to risk-weighted  assets) |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | 32,250,000 |       | 11.63%                               |       | 11,088,000                              |       |   | 4.0% | ** ** |   | 16,632,000 |   | 6.0% |   |
| Carrollton Bank                           |       | 31,001,000 |       | 11.30%                               |       | 10,973,000                              |       |   | 4.0% | ** ** |   | 16,459,000 |   | 6.0% |   |
| Tier 1 Capital (to average assets)        |       |       |       |                                 |       |                                    |       |   |   | ** ** |   |   |   |   |   |
| Consolidated                              |       | 32,250,000 |       | 8.96%                                |       | 14,937,000                              |       |   | 4.0% | ** ** |   | 17,996,000 |   | 5.0% |   |
| Carrollton Bank                           |       | 31,001,000 |       | 8.72%                                |       | 14,223,000                              |       |   | 4.0% | ** ** |   | 17,779,000 |   | 5.0% |   |

 

51

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CARROLLTON BANCORP

**15. RETIREMENT PLANS**

In the yearended December 31, 2006, the Company adopted Statement of FinancialAccounting Standards No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans” (“SFAS 158”), which requires therecognition of the funded status of defined benefit postretirement plans andrelated disclosures. While it does not impact net income, this resulted in aone-time adjustment to accumulated other comprehensive income in shareholders’equity of $484 (net of tax) for the Pension Plan. The Company’s 2005 and 2004disclosures have not been changed as SFAS 158 prohibits retrospectiveapplication.

Effective December 31,2004, the Company froze the Defined Benefit Pension Plan. Participant benefitsstopped accruing as of the date of the freeze. No new participants entered thePlan after December 31, 2004.

The following table sets forth the financialstatus of the Plan as of and for the years ended December 31:

| * *                                                                  | * * | *2006*    | * *  | *2005*    | * * | *2004*     | * * |
|---------------------------------------------------------------------------|----------|-----------|-----------|-----------|----------|------------|----------|
| CHANGE IN BENEFIT OBLIGATION:                                             |     |      |      |      |     |       |     |
| Benefit obligation at beginning of year                                   |     | $         | 7,944,785 |      | $        | 7,739,006  |     | $ | 8,820,583 |   |
| Service cost                                                              |     | —    |      | —    |     | 528,407    |     |
| Interest cost                                                             |     | 469,361   |      | 477,203   |     | 545,710    |     |
| Actuarial gain                                                            |     | 230,830   |      | 61,831    |     | 69,083     |     |
| Benefits paid                                                             |     | (354,637  | )         | (333,255  | )        | (331,542   | )        |
| Adjustment for special event —  curtailment                     |     | —    |      | —    |     | (1,893,235 | )        |
| Benefit obligation at end of year                                         |     | 8,290,339 |      | 7,944,785 |     | 7,739,006  |     |
| CHANGE IN PLAN ASSETS:                                                    |     |      |      |      |     |       |     |
| Fair value of plan assets at beginning of  year                           |     | 7,952,987 |      | 7,730,718 |     | 7,399,746  |     |
| Actual return on plan assets                                              |     | 767,957   |      | 591,608   |     | 271,153    |     |
| Employer contribution                                                     |     | —    |      | —    |     | 450,000    |     |
| Benefits paid and administrative expenses                                 |     | (429,815  | )         | (369,339  | )        | (390,181   | )        |
| Fair value of plan assets at end of year                                  |     | 8,291,129 |      | 7,952,987 |     | 7,730,718  |     |
| Funded status                                                             |     |      |      |      |     |       |     |
| Status of plan overfunded (underfunded)                                   |     | 790       |      | 8,202     |     | (8,288     | )        |
| Unrecognized net actuarial (gain) loss                                    |     | 256,285   |      | 45,450    |     | (15,901    | )        |
| Prepaid (accrued) benefit cost before the  adoption of SFAS 158           |     | $         | 257,075   |      | $        | 53,652     |     | $ | (24,189 | ) |
| Amounts Recognized in the Consolidated  Balance Sheets:                   |     |      |      |      |     |       |     |
| Prepaid benefit cost                                                      |     | $         | 257,075   |      | $        | 53,652     |     | $ | (24,189 | ) |
| Net amount recognized                                                     |     | $         | 257,075   |      | $        | 53,652     |     | $ | (24,189 | ) |
| After the adoption of SFAS 158:                                           |     |      |      |      |     |       |     |
| Other assets                                                              |     | $         | 790       |      | $        | —     |     | $ | — |   |
| Net amount recognized                                                     |     | $         | 790       |      | $        | —     |     | $ | — |   |
| Amounts recognized in accumulated other comprehensive  income consist of: |     |      |      |      |     |       |     |
| Net loss                                                                  |     | $         | 256,285   |      | $        | —     |     | $ | — |   |
| Net amount  recognized (before tax effect)                                |     | $         | 256,285   |      | $        | —     |     | $ | — |   |

 

The incremental effect of applying FASBStatement No. 158 on individual items in the consolidated balance sheet asof December 31, 2006 is as follows:

| * *                                                         | * * | *Before Application  of Statement 158* | * * | *Adjustments* | * * | *After Application  of Statement 158* | * * |
|------------------------------------------------------------------|----------|-------------------------------------------------------|----------|---------------|----------|------------------------------------------------------|----------|
| * *                                                         | * * | *Debit*                                               | * * | *Credit*      | * * | *Debit*                                              | * * | *Credit* | * * |
| Other assets, excluding prepaid pension  cost and deferred taxes |     |                                                  | $        | 1,338,781     |     |                                                 |     | $ | — |   |   | $ | — |   | $ | 1,338,781 |   |
| Prepaid pension costs                                            |     |                                                  | 257,075  |          |     |                                                 | —   |   |   | (256,285 | ) | 790 |   |
| Deferred taxes                                                   |     |                                                  | 599,770  |          |     |                                                 | 157,308  |   |   | — |   | 757,078 |   |
| Total other assets                                               |     |                                                  | $        | 2,195,626     |     |                                                 |     | $ | 157,308 |   |   | $ | (256,285 | ) | $ | 2,096,649 |   |
| Total assets                                                     |     |                                                  | $        | 349,923,729   |     |                                                 |     | $ | 157,308 |   |   | $ | (256,285 | ) | $ | 349,824,752 |   |
| Accumulated other comprehensive loss                             |     |                                                  | $        | (745,052      | )        |                                                 |     | $ | 98,977 |   |   | $ | — |   | $ | (646,075 | ) |
| Total stockholders’ equity                                  |     |                                                  | $        | (34,810,355   | )        |                                                 |     | $ | 98,977 |   |   | $ | — |   | $ | (34,711,378 | ) |

 

52

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2006 ANNUAL REPORT

**15. RETIREMENT PLANS*(****Continued)*

| * *                                                                                                              | * * | *2006*    | * *  | *2005*    | * * | *2004*    | * * |
|-----------------------------------------------------------------------------------------------------------------------|----------|-----------|-----------|-----------|----------|-----------|----------|
| ASSUMPTIONS USED IN MEASURING THE PROJECTED  BENEFIT OBLIGATION WERE AS FOLLOWS FOR THE YEARS ENDED DECEMBER 31: |     |      |      |      |     |      |     |
| Discount rates                                                                                                        |     | 5.82      | %         | 6.25      | %        | 6.25      | %        |
| Rates of increase in compensation levels                                                                              |     | N/A       |      | N/A       |     | 4.25      | %        |
| Long-term rate of return on assets                                                                                    |     | 8.00      | %         | 8.00      | %        | 8.00      | %        |
| NET PERIODIC PENSION EXPENSE INCLUDES THE  FOLLOWING COMPONENTS:                                                      |     |      |      |      |     |      |     |
| Service cost                                                                                                          |     | $         | —    |      | $        | —    |     | $ | 528,407 |   |
| Interest cost                                                                                                         |     | 469,361   |      | 477,203   |     | 545,710   |     |
| Expected return on plan assets                                                                                        |     | (622,784  | )         | (555,044  | )        | (558,384  | )        |
| Net amortization and deferral                                                                                         |     | —    |      | —    |     | 148,670   |     |
| Net periodic pension expense (benefit)                                                                                |     | $         | (153,423  | )         | $        | (77,841   | )        | $ | 664,403 |   |
| ACCUMULATED BENEFIT OBLIGATION AT YEAR END                                                                            |     | $         | 8,290,339 |      | $        | 7,944,785 |     | $ | 7,739,006 |   |
| ALLOCATION OF ASSETS                                                                                                  |     |      |      |      |     |      |     |
| Equity securities                                                                                                     |     | $         | 4,361,023 |      | $        | 4,102,673 |     | $ | 3,715,646 |   |
| Fixed income-guaranteed fund                                                                                          |     | 3,930,106 |      | 3,850,314 |     | 4,015,072 |     |
|                                                                                                                  |     | $         | 8,291,129 |      | $        | 7,952,987 |     | $ | 7,730,718 |   |

 

There are nonet transaction obligation (asset), prior service cost (credit) and estimated netloss (gain) for the Plan that are expected to be amortized from accumulatedother comprehensive income into net periodic benefit cost over the next fiscalyear.

Benefits expected to be paid from the Planare as follows:

| *Year*    | * * | *Amount*  | * * |
|-----------|----------|-----------|----------|
| 2007      |     | $         | 340,417  |   |
| 2008      |     | 363,113   |     |
| 2009      |     | 362,976   |     |
| 2010      |     | 390,677   |     |
| 2011      |     | 406,123   |     |
| 2012-2016 |     | 2,524,509 |     |
|           |          |           |          |  |

 

The Plan’sinvestment strategy is predicated on its investment objectives and the risk andreturn expectations of asset classes appropriate for the Plan. Investment objectiveshave been established by considering the Plan’s liquidity needs and timehorizon and the fiduciary standards under ERISA. The asset allocation strategyis developed to meet the Plan’s long term needs in a manner designed to controlvolatility and to reflect the Company’s risk tolerance.

In determiningthe long-term rate of return on pension plan assets assumption, the targetasset allocation is first reviewed. An expected long-term rate of return isassumed for each asset class, and an underlying inflation rate assumption isalso made. The effects of asset diversification and periodic fund rebalancingare also considered.

The Company has a contributory thrift planqualifying under Section 401(K) of the Internal Revenue Code.Employees with one year of service are eligible for participation in the Plan.In conjunction with the curtailment of the pension plan, the Company expandedthe thrift plan to make it a Safe Harbor Plan. Once an employee has been at theCompany for one year, the Company then contributes 3% of the employee’s salaryquarterly to the Plan for the employee’s benefit. The Company also matches 50%of the employee 401(K) contribution up to 6% of employee compensation.Contributions to this Plan, included in employee benefit expenses, were$319,453, $292,080, and $92,485, for 2006, 2005, and 2004 , respectively.

**16. CONTINGENCIES**

The Company is involved in various legalactions arising from normal business activities. Management believes that theultimate liability or risk of loss resulting from these actions will notmaterially affect the Company’s financial position or results of operations.

53

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CARROLLTON BANCORP

**17. INCOME TAXES**

The components of income tax expense are asfollows for the years ended December 31:

| * * | * * | *2006*    | * *  | *2005*    | * * | *2004*    | * * |
|----------|----------|-----------|-----------|-----------|----------|-----------|----------|
| CURRENT  |     |      |      |      |     |      |     |
| Federal  |     | $         | 1,082,628 |      | $        | 989,907   |     | $ | 428,205 |   |
| State    |     | 180,009   |      | 179,255   |     | 91,038    |     |
|     |     | 1,262,637 |      | 1,169,162 |     | 519,243   |     |
| DEFERRED |     | 60,631    |      | 153,209   |     | (198,755  | )        |
|     |     | $         | 1,323,268 |      | $        | 1,322,371 |     | $ | 320,488 |   |

 

The components of the deferred tax benefitswere as follows for the years ended December 31:

| * *                        | * * | *2006*  | * * | *2005*   | * * | *2004*   | * * |
|---------------------------------|----------|---------|----------|----------|----------|----------|----------|
| Provision for loan losses       |     | $       | 79,612   |     | $        | 57,124   |     | $ | 62,425 |   |
| Deferred loan origination costs |     | (20,427 | )        | (4,812   | )        | 6,794    |     |
| Deferred compensation plan      |     | 16,466  |     | (227     | )        | 3,128    |     |
| Depreciation                    |     | 522     |     | (120,334 | )        | 7,004    |     |
| Discount accretion              |     | 5,178   |     | (666     | )        | (2,140   | )        |
| Retirement benefits             |     | (20,720 | )        | 30,062   |     | (83,904  | )        |
| Impairment loss provisions      |     | —  |     | 192,062  |     | (192,062 | )        |
|                            |     | $       | 60,631   |     | $        | 153,209  |     | $ | (198,755 | ) |

 

The components of the net deferred taxliability were as follows for the years ended December 31:

| * *                                                      | * * | *2006*    | * * | *2005*    | * * | *2004*    | * * |
|---------------------------------------------------------------|----------|-----------|----------|-----------|----------|-----------|----------|
| DEFERRED TAX ASSETS                                           |     |      |     |      |     |      |     |
| Allowance for loan losses                                     |     | $         | 974,066  |      | $        | 1,053,678 |     | $ | 1,110,802 |   |
| Deferred compensation plan                                    |     | 190,426   |     | 206,892   |     | 206,665   |     |
| Depreciation                                                  |     | 27,000    |     | 27,522    |     | —    |     |
| Accrued retirement benefits                                   |     | —    |     | —    |     | 9,342     |     |
|                                                          |     | 1,191,492 |     | 1,288,092 |     | 1,326,809 |     |
| DEFERRED TAX LIABILITIES                                      |     |      |     |      |     |      |     |
| Prepaid retirement benefits                                   |     | —    |     | 20,720    |     | —    |     |
|                                                          |     | 106,645   |     | 127,072   |     | 131,884   |     |
| Unrealized gains on available for sale  investment securities |     | 317,406   |     | 1,156,088 |     | 1,297,024 |     |
| Depreciation                                                  |     | —    |     | —    |     | 92,812    |     |
| Discount accretion                                            |     | 8,344     |     | 3,166     |     | 3,832     |     |
| FHLB Stock dividends                                          |     | 2,019     |     | 2,019     |     | 2,019     |     |
|                                                          |     | 434,414   |     | 1,309,065 |     | 1,527,571 |     |
| NET DEFERRED TAX ASSET (LIABILITY)                            |     | $         | 757,078  |      | $        | (20,973   | )        | $ | (200,762 | ) |

 

The differences between the federal income taxrate of 34 percent and the effective tax rate for the Company arereconciled as follows:

| * *                                               | *_*    | *2006* | * * | *2005* | * * | *2004* | * * |
|--------------------------------------------------------|--------|--------|----------|--------|----------|--------|----------|
| Statutory federal income tax rate                      |   |   | 34.0     | %      |     |   | 34.0     | % |   |   | 34.0 | % |   |
| Increase (Decrease) resulting from:                    |   |   |     |   |     |   |     |   |   |   |   |   |   |
| Tax-exempt income                                      |   |   | (4.5     | )      |     |   | (3.4     | ) |   |   | (10.2 | ) |   |
| State income taxes, net of federal income  tax benefit |   |   | 3.8      |   |     |   | 4.0      |   |   |   | 1.9 |   |   |
| Nondeductible expense                                  |   |   | 0.6      |   |     |   | 0.4      |   |   |   | 0.8 |   |   |
|                                                   |   |   | 33.9     | %      |     |   | 35.0     | % |   |   | 26.5 | % |   |

 

54

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2006 ANNUAL REPORT

**18. LEASE COMMITMENTS**

The Companyleases various branch and general office facilities to conduct its operations.The leases have remaining terms which range from a period of 1 year to20 years. Most leases contain renewal options which are generallyexercisable at increased rates. Some of the leases provide for increases in therental rates at specified times during the lease terms, prior to the expirationdates.

The leasesgenerally provide for payment of property taxes, insurance, and maintenancecosts by the Company. The total rental expense for all real property leasesamounted to $937,160, $947,957, and $779,709, for 2006, 2005, and 2004,respectively.

Lease obligations will require minimum rentpayments as follows:

| *Period*        | * * | *Minimum rentals* | * *  |
|-----------------|----------|------------------------|-----------|
| 2007            |     |                   | $         | 959,293 |   |   |
| 2008            |     |                   | 810,397   |   |   |
| 2009            |     |                   | 723,251   |   |   |
| 2010            |     |                   | 710,115   |   |   |
| 2011            |     |                   | 547,557   |   |   |
| Remaining years |     |                   | 4,700,487 |   |   |
|            |     |                   | $         | 8,451,100 |   |   |

 

**19. PARENT COMPANY FINANCIAL INFORMATION**

The balance sheets as of December 31,2006 and 2005 and statements of income and cash flows for Carrollton Bancorp(Parent Only) for 2006, 2005, and 2004, are presented below:

**BALANCE SHEETS**

| * *                                  | * * | *December 31,* | * *   |
|-------------------------------------------|----------|---------------------|------------|
| * *                                  | * * | *2006*              | * *   | *2005* | * * |
| ASSETS                                    |     |                |       |   |   |
| Cash                                      |     | $                   | 6,293      |   | $ | 22,094 |   |
| Interest-bearing deposits in  subsidiary  |     | 956,518             |       | 217,679 |   |
| Investment in subsidiary                  |     | 32,593,361          |       | 31,536,069 |   |
| Investment securities available for sale  |     | 2,224,846           |       | 4,660,213 |   |
| Other assets                              |     | 28,270              |       | 25,813 |   |
|                                      |     | $                   | 35,809,288 |   | $ | 36,461,868 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY |     |                |       |   |   |
| Liabilities                               |     | 1,097,910           |       | $ | 1,821,703 |   |
| Shareholders’ Equity                 |     |                |       |   |   |
| Common Stock                              |     | 2,806,705           |       | 2,809,698 |   |
| Additional Paid-in Capital                |     | 18,372,351          |       | 18,425,528 |   |
| Retained earnings                         |     | 12,886,247          |       | 11,567,531 |   |
| Accumulated other comprehensive income    |     | 646,075             |       | 1,837,408 |   |
|                                      |     | 34,711,378          |       | 34,640,165 |   |
|                                      |     | $                   | 35,809,288 |   | $ | 36,461,868 |   |

 

55

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CARROLLTON BANCORP

**19. PARENT COMPANY FINANCIAL INFORMATION*(****Continued)*

**STATEMENTS OF INCOME**

| * *                                                                          | * * | *Years ended December 31,* | * *  |
|-----------------------------------------------------------------------------------|----------|-------------------------------------------|-----------|
| * *                                                                          | * * | *2006*                                    | * *  | *2005* | * * | *2004* | * * |
| INCOME                                                                            |     |                                      |      |   |   |   |   |
| Dividends from subsidiary                                                         |     | $                                         | 258,840   |   | $ | 608,827 |   | $ | 588,273 |   |
| Interest and dividends                                                            |     | 73,720                                    |      | 138,592 |   | 132,490 |   |
| Security gains                                                                    |     | 2,157,151                                 |      | 766,772 |   | — |   |
|                                                                              |     | 2,489,711                                 |      | 1,514,191 |   | 720,763 |   |
| EXPENSES                                                                          |     | 161,751                                   |      | 163,639 |   | 105,403 |   |
| Income before income taxes and equity in  undistributed  net income of subsidiary |     | 2,327,960                                 |      | 1,350,552 |   | 615,360 |   |
| Income tax expense (benefit)                                                      |     | 785,790                                   |      | 249,895 |   | (21,691 | ) |
|                                                                              |     | 1,542,170                                 |      | 1,100,657 |   | 637,051 |   |
| Equity in undistributed net income of  subsidiary                                 |     | 1,042,609                                 |      | 1,357,780 |   | 251,313 |   |
| Net Income                                                                        |     | $                                         | 2,584,779 |   | $ | 2,458,437 |   | $ | 888,364 |   |

 

**STATEMENTS OF CASH FLOWS**

| * *                                                                           | * * | *Years ended December 31,* | * *  |
|------------------------------------------------------------------------------------|----------|-------------------------------------------|-----------|
| * *                                                                           | *_*      | *2006*                                    | * *  | *2005* | * * | *2004* | * * |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |     |                                      |      |   |   |   |   |
| Net income                                                                         |     | $                                         | 2,584,779 |   | $ | 2,458,437 |   | $ | 888,364 |   |
| ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING  ACTIVITIES: |     |                                      |      |   |   |   |   |
| Equity in undistributed net income of  subsidiary                                  |     | (1,042,609                                | )         | (1,357,780 | ) | (251,313 | ) |
| Gains on disposal of securities                                                    |     | (2,157,151                                | )         | (766,772 | ) | — |   |
| Stock based compensation expense                                                   |     | 13,447                                    |      | — |   | — |   |
| Decrease (increase) in other assets                                                |     | (2,457                                    | )         | (74 | ) | 662 |   |
| Increase (decrease) in other liabilities                                           |     | 13,126                                    |      | 309,958 |   | (99,454 | ) |
| Net cash (used in) provided by operating  activities                               |     | (590,865)                                 |      | 661,935 |   | 559,552 |   |
| Cash Flows from Investing Activities:                                              |     |                                      |      |   |   |   |   |
| Purchase of securities available for sale                                          |     | 117,259                                   |      | — |   | (100,000 | ) |
| Proceeds from sales of securities available  for sale                              |     | 2,766,852                                 |      | 1,016,133 |   | — |   |
| Net cash provided by (used in) investing  activities                               |     | 2,649,593                                 |      | 1,016,133 |   | (100,000 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |     |                                      |      |   |   |   |   |
| Dividends paid                                                                     |     | (1,266,063                                | )         | (1,130,262 | ) | (1,076,433 | ) |
| Common stock repurchase and retirement                                             |     | (128,850                                  | )         | (599,250 | ) | (32,655 | ) |
| Stock options exercised                                                            |     | 52,219                                    |      | 207,039 |   | 110,168 |   |
| Income tax benefit from exercise of stock  options                                 |     | 7,014                                     |      | 18,166 |   | 21,293 |   |
| Net cash used in financing activities                                              |     | (1,335,690                                | )         | (1,522,473 | ) | (998,920 | ) |
| Net increase (decrease) in cash                                                    |     | 723,038                                   |      | 155,595 |   | (539,368 | ) |
| Cash and cash equivalents at beginning of  year                                    |     | 239,773                                   |      | 84,178 |   | 623,546 |   |
| Cash and cash equivalents at end of year                                           |     | $                                         | 962,811   |   | $ | 239,773 |   | $ | 84,178 |   |
| Noncash Activities:                                                                |     |                                      |      |   |   |   |   |
| Income taxes paid, net of cash received  from subsidiaries                         |     | $                                         | 769,473   |   | $ | 36,615 |   | $ | 53,475 |   |

 

56

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2006 ANNUAL REPORT

**20. FAIR VALUE OF FINANCIAL INSTRUMENTS**

The following methods and assumptions wereused to estimate the fair value of each class of financial instrument.

***Cash and cash equivalents***

The carrying amount of cash and due frombanks is a reasonable estimate of fair value.

***Federal funds sold and Federal Home Loan Bankdeposit***

The carrying amount of federal funds sold andFederal Home Loan Bank deposit is a reasonable estimate of fair value.

***Investment Securities***

The fair values of securities held tomaturity and securities available for sale are based upon quoted market pricesor dealer quotes.

***Loans held for sale***

The fair value of residential mortgage loansoriginated for sale is estimated by discounting future cash flows using currentrates for which similar loans would be made to borrowers with similar credithistories.

***Loans, net***

The fair value of loans receivable isestimated by discounting future cash flows using current rates for whichsimilar loans would be made to borrowers with similar credit histories.

***Deposit liabilities***

The fair value of demand deposits and savingsaccounts is the amount payable on demand. The fair value of fixed maturitycertificates of deposit is estimated using the rates currently offered fordeposits of similar remaining maturities.

***Federal funds purchased and securities soldunder agreements to repurchase***

The carrying amount of federal fundspurchased and securities sold under agreements to repurchase is a reasonableestimate of fair value.

***Advances from the FHLB***

The fair value of long-term FHLB advances isestimated by discounting the value of contractual cash flows using ratescurrently offered for advances with similar terms and remaining maturities.

***Commitments to extend credit, standby lettersof credit and financial guarantees written***

The Company charges fees for commitments toextend credit. Interest rates on loans for which these commitments are extendedare normally committed for periods of less than one month. Fees charged onstandby letters of credit and other financial guarantees are deemed to beimmaterial and these guarantees are expected to be settled at face amount orexpire unused. It is impractical to assign any fair value to these commitments.

| * *                                                                    | * * | *December 31, 2006* | * *   | *December 31, 2005* | * * |
|-----------------------------------------------------------------------------|----------|-------------------------------|------------|-------------------------------|----------|
| * *                                                                    | * * | *Carrying  amount*            | * *   | *Fair  value*                 | * * | *Carrying  amount* | * * | *Fair  value* | * * |
| FINANCIAL ASSETS                                                            |     |                          |       |                          |     |   |   |   |   |
| Cash and cash equivalents                                                   |     | $                             | 13,622,766 |                          | $        | 13,622,766 |   | $ | 39,090,565 |   | $ | 39,090,565 |   |
| Investment securities (total)                                               |     | 55,064,620                    |       | 54,824,915                    |     | 47,583,408 |   | 47,400,282 |   |
| Federal Home Loan Bank stock                                                |     | 1,704,500                     |       | 1,704,500                     |     | 2,431,600 |   | 2,431,600 |   |
| Loans held for sale                                                         |     | 7,489,290                     |       | 7,524,363                     |     | 13,767,109 |   | 13,798,773 |   |
| Loans, net                                                                  |     | 256,870,293                   |       | 258,073,223                   |     | 244,605,910 |   | 245,175,511 |   |
| FINANCIAL LIABILITIES                                                       |     |                          |       |                          |     |   |   |   |   |
| Noninterest-bearing deposits                                                |     | 50,069,560                    |       | 50,069,560                    |     | 67,010,985 |   | 67,010,985 |   |
| Interest-bearing deposits                                                   |     | 227,834,241                   |       | 227,711,750                   |     | 204,615,518 |   | 204,132,515 |   |
| Federal funds purchased and securities sold  under agreements to repurchase |     | 13,405,463                    |       | 13,405,463                    |     | 9,280,348 |   | 9,280,348 |   |
| Notes payable — U.S. Treasury                                     |     | —                        |       | —                        |     | 1,932,124 |   | 1,932,124 |   |
| Advances from  the Federal Home Loan Bank                                   |     | 22,000,000                    |       | 21,995,650                    |     | 40,000,000 |   | 42,069,827 |   |
|                                                                             |          |                               |            |                               |          |  |  |  |  |  |  |  |  |

 

57

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CARROLLTON BANCORP

**21. SEGMENT INFORMATION**

The Company hasreportable segments that are strategic business units offering complimentaryproducts and services to the core business of banking. The accounting policiesof the segments are the same as those described in the summary of significantaccounting policies. The Company provides the accounting for all segments andcharges a management fee for this service to the other segments. The Companyhas also lent money to various segments with terms similar to those offeredthird parties.

TheCommercial/Retail Bank segment provides full service retail and businessbanking services, including lending and deposit services, investment activitiesand other customary services associated with a bank.

The ElectronicBanking segment provides national point of sale transaction originations, homebanking, and debit card transaction processing.

The Brokeragesegment provides full service brokerage services for stocks, bonds, mutualfunds and annuities.

The MortgageUnit segment provides residential mortgage lending products and services.

Segment information for the Company for 2006is as follows:

| * *                                                                | * * | *Commercial/  Retail Bank* | * *    | *Electronic  Banking* | * * | *Brokerage* | * * | *Mortgage  Unit* | * * | *Segment  Totals* | * * | *Eliminations* | * * | *Consolidated* | * * |
|-------------------------------------------------------------------------|----------|---------------------------------|-------------|-----------------------|----------|-------------|----------|------------------|----------|-------------------|----------|----------------|----------|----------------|----------|
| Interest income                                                         |     | $                               | 22,680,213  |                  | $        | —      |     |             | $        | —            |     |           | $        | 1,222,566      |     | $ | 23,902,779 |   | $ | (775,275 | ) | $ | 23,127,504 |   |
| Interest expense                                                        |     | (9,512,725                      | )           | —                |     |        | —   |             |     | —            |     | (9,512,725     | )        | 775,275        |     | 8,737,450 |   |
| Net interest income                                                     |     | 13,167,488                      |        | —                |     |        | —   |             |     | 1,222,566         |     | 14,390,054     |     | —         |     | 14,390,054 |   |
| Provision for loan  losses                                              |     | —                          |        | —                |     |        | —   |             |     | —            |     | —         |     | —         |     | — |   |
| Noninterest income                                                      |     | 3,779,786                       |        | 2,013,943             |     |        | 647,301  |             |     | 2,457,966         |     | 8,898,996      |     | —         |     | 8,898,996 |   |
| Intersegment income                                                     |     | 793,360                         |        | 23,285                |     |        | 1,398    |             |     | (724,140          | )        | 93,903         |     | (93,903        | )        | — |   |
| Noninterest expenses                                                    |     | (16,102,581                     | )           | (701,085              | )        |        | (402,917 | )                |     | (2,268,323        | )        | (19,474,906    | )        | 93,903         |     | 19,381,003 |   |
| Income before  income taxes                                             |     | 1,638,053                       |        | 1,336,143             |     |        | 245,782  |             |     | 688,069           |     | 3,908,047      |     | —         |     | 3,908,047 |   |
| Income taxes                                                            |     | (441,553                        | )           | (516,018              | )        |        | (93,441  | )                |     | (272,276          | )        | (1,323,268     | )        | —         |     | (1,323,268 | ) |
| Net income                                                              |     | $                               | 1,196,520   |                  | $        | 820,125     |     |             | $        | 152,341           |     |           | $        | 415,793        |     | $ | 2,584,779 |   | $ | — |   | $ | 2,584,779 |   |
| Segment assets                                                          |     | $                               | 348,578,067 |                  | $        | 15,848      |     |             | $        | 26,702            |     |           | $        | 17,736,965     |     | $ | 366,357,582 |   | $ | (16,532,830 | ) | $ | 349,824,752 |   |
| Expenditures  for segment purchases of premises, equipment and software |     | $                               | 885,945     |                  | $        | —      |     |             | $        | —            |     |           | $        | 15,456         |     | $ | 901,401 |   | $ | — |   | $ | 901,401 |   |

 

A reconciliation of total segment assets toconsolidated total assets follows as of December 31, 2006:

| Total segment assets                          |   | $           | 366,357,582 |   |
|-----------------------------------------------|--------|-------------|-------------|--------|
| Elimination of intersegment loans             |   | (14,934,950 | )           |
| Elimination of intersegment deposit  accounts |   | (1,597,880  | )           |
|                                          |   | $           | 349,824,752 |   |

 

Segment information for the Company for 2005is as follows:

| * *                                                                | * * | *Commercial/  Retail Bank* | * *    | *Electronic  Banking* | * * | *Brokerage* | * * | *Mortgage  Unit* | * * | *Segment  Totals* | * * | *Eliminations* | * * | *Consolidated* | * * |
|-------------------------------------------------------------------------|----------|---------------------------------|-------------|-----------------------|----------|-------------|----------|------------------|----------|-------------------|----------|----------------|----------|----------------|----------|
| Interest income                                                         |     | $                               | 17,177,300  |                  | $        | —      |     |             | $        | —            |     |           | $        | 1,366,403      |     | $ | 18,543,703 |   | $ | 527,676 |   | $ | 19,071,379 |   |
| Interest expense                                                        |     | (6,741,963                      | )           | (105,444              | )        |        | —   |             |     | —            |     | (6,847,407     | )        | (527,676       | )        | (7,375,083 | ) |
| Net interest income                                                     |     | 10,435,337                      |        | (105,444              | )        |        | —   |             |     | 1,366,403         |     | 11,696,296     |     | —         |     | 11,696,296 |   |
| Provision for loan  losses                                              |     | —                          |        | —                |     |        | —   |             |     | —            |     | —         |     | —         |     | — |   |
| Noninterest income                                                      |     | 2,466,304                       |        | 4,871,076             |     |        | 667,510  |             |     | 2,713,746         |     | 10,718,636     |     | —         |     | 10,718,636 |   |
| Intersegment income                                                     |     | 598,180                         |        | —                |     |        | 2,906    |             |     | (512,785          | )        | 88,301         |     | (88,301        | )        | — |   |
| Noninterest expenses                                                    |     | (11,919,891                     | )           | (3,727,831            | )        |        | (412,222 | )                |     | (2,662,481        | )        | (18,722,425    | )        | 88,301         |     | (18,634,124 | ) |
| Income before  income taxes                                             |     | 1,579,930                       |        | 1,037,801             |     |        | 258,194  |             |     | 904,883           |     | 3,780,808      |     | —         |     | 3,780,808 |   |
| Income taxes                                                            |     | (472,393                        | )           | (400,798              | )        |        | (99,714  | )                |     | (349,466          | )        | (1,322,371     | )        | —         |     | (1,322,371 | ) |
| Net income                                                              |     | $                               | 1,107,537   |                  | $        | 637,003     |     |             | $        | 158,480           |     |           | $        | 555,417        |     | $ | 2,458,437 |   | $ | — |   | $ | 2,458,437 |   |
| Segment assets                                                          |     | $                               | 358,760,082 |                  | $        | 3,691,629   |     |             | $        | 82,512            |     |           | $        | 23,749,243     |     | $ | 386,283,466 |   | $ | (25,816,320 | ) | $ | 360,467,146 |   |
| Expenditures  for segment purchases of premises, equipment and software |     | $                               | 655,832     |                  | $        | 211,910     |     |             | $        | —            |     |           | $        | 35,201         |     | $ | 902,943 |   | $ | — |   | $ | 902,943 |   |

 

58

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2006 ANNUAL REPORT

A reconciliation of total segment assets toconsolidated total assets follows as of December 31, 2005:

| Total segment assets                          |   | $           | 386,283,466 |   |
|-----------------------------------------------|--------|-------------|-------------|--------|
| Elimination of intersegment loans             |   | (25,065,528 | )           |
| Elimination of intersegment deposit  accounts |   | (750,792    | )           |
|                                          |   | $           | 360,467,146 |   |

 

**22. CONSOLIDATED QUARTERLY RESULTSOF OPERATIONS (UNAUDITED)**

| * *                               | * * | *Year Ended December 31, 2006* | * *  |
|----------------------------------------|----------|----------------------------------------------------|-----------|
| * *                               | * * | *First Quarter*                               | * *  | *Second Quarter* | * * | *Third Quarter* | * * | *Fourth Quarter* | * * |
| Interest income                        |     |                                               | $         | 5,566706 |   |   |   | $ | 5,652,219 |   |   |   | $ | 5,855,415 |   |   |   | $ | 6,053,164 |   |   |
| Interest expense                       |     |                                               | 2,082,985 |   |   |   | 2,052,221 |   |   |   | 2,237,219 |   |   |   | 2,365,025 |   |   |
| Net interest income                    |     |                                               | 3,483,721 |   |   |   | 3,599,998 |   |   |   | 3,618,196 |   |   |   | 3,688,139 |   |   |
| Gains on security sales                |     |                                               | 2,157,176 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other noninterest income               |     |                                               | 1,783,075 |   |   |   | 1,986,531 |   |   |   | 1,555,033 |   |   |   | 1,417,182 |   |   |
| Noninterest expenses                   |     |                                               | 6,088,968 |   |   |   | 5,558,716 |   |   |   | 3,859,040 |   |   |   | 3,874,280 |   |   |
| Income before income taxes             |     |                                               | 1,335,004 |   |   |   | 27,813 |   |   |   | 1,314,189 |   |   |   | 1,231,041 |   |   |
| Income taxes                           |     |                                               | 467,146   |   |   |   | (30,557 | ) |   |   | 459,078 |   |   |   | 427,601 |   |   |
| Net income                             |     |                                               | $         | 867,858 |   |   |   | $ | 58,370 |   |   |   | $ | 855,111 |   |   |   | $ | 803,440 |   |   |
| Net income per share — basic |     |                                               | $         | 0.31 |   |   |   | $ | 0.02 |   |   |   | $ | 0.30 |   |   |   | $ | 0.29 |   |   |
| Cash dividends per share               |     |                                               | $         | 0.11 |   |   |   | $ | 0.11 |   |   |   | $ | 0.11 |   |   |   | $ | 0.12 |   |   |
| Market prices: high                    |     |                                               | $         | 15.95 |   |   |   | $ | 18.80 |   |   |   | $ | 18.00 |   |   |   | $ | 19.45 |   |   |
| low                                    |     |                                               | $         | 14.40 |   |   |   | $ | 15.64 |   |   |   | $ | 16.11 |   |   |   | $ | 16.99 |   |   |

 

| * *                               | * * | *Year Ended December 31, 2005* | * *   |
|----------------------------------------|----------|----------------------------------------------------|------------|
| * *                               | * * | *First Quarter*                               | * *   | *Second Quarter* | * * | *Third Quarter* | * * | *Fourth Quarter* | * * |
| Interest income                        |     |                                               | $          | 4,275,029 |   |   |   | $ | 4,512,073 |   |   |   | $ | 4,957,555 |   |   |   | $ | 5,326,722 |   |   |
| Interest expense                       |     |                                               | (1,555,268 | ) |   |   | (1,766,890 | ) |   |   | (1,937,526 | ) |   |   | (2,115,399 | ) |   |
| Net interest income                    |     |                                               | 2,719,761  |   |   |   | 2,745,183 |   |   |   | 3,020,029 |   |   |   | 3,211,323 |   |   |
| Gains on security sales                |     |                                               | 73,087     |   |   |   | — |   |   |   | 766,772 |   |   |   | — |   |   |
| Other noninterest income               |     |                                               | 2,255,502  |   |   |   | 2,649,218 |   |   |   | 2,615,235 |   |   |   | 2,358,822 |   |   |
| Noninterest expenses                   |     |                                               | (4,367,243 | ) |   |   | (4,435,408 | ) |   |   | (4,736,498 | ) |   |   | (5,094,975 | ) |   |
| Income before income taxes             |     |                                               | 681,107    |   |   |   | 958,993 |   |   |   | 1,665,538 |   |   |   | 475,170 |   |   |
| Income taxes                           |     |                                               | (268,511   | ) |   |   | (324,661 | ) |   |   | (629,609 | ) |   |   | (99,590 | ) |   |
| Net income                             |     |                                               | $          | 412,596 |   |   |   | $ | 634,332 |   |   |   | $ | 1,035,929 |   |   |   | $ | 375,580 |   |   |
| Net income per share — basic |     |                                               | $          | 0.15 |   |   |   | $ | 0.22 |   |   |   | $ | 0.37 |   |   |   | $ | 0.13 |   |   |
| Cash dividends per share               |     |                                               | $          | 0.10 |   |   |   | $ | 0.10 |   |   |   | $ | 0.10 |   |   |   | $ | 0.10 |   |   |
| Market prices: high                    |     |                                               | $          | 17.00 |   |   |   | $ | 17.00 |   |   |   | $ | 16.29 |   |   |   | $ | 15.00 |   |   |
| low                                    |     |                                               | $          | 14.12 |   |   |   | $ | 14.25 |   |   |   | $ | 13.95 |   |   |   | $ | 14.00 |   |   |

 

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CARROLLTON BANCORP

**ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND**FINANCIAL DISCLOSURE

There have been no changes in ordisagreements with accountants, on accounting and financial disclosure during2006.

**ITEM 9A: CONTROLS AND PROCEDURES**

The Company’s principal executive officer andprincipal financial officer have concluded that the Company’s disclosurecontrols and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934) are effective based on the evaluation of thesecontrols and procedures by the Company’s management, including our principalexecutive and principal financial officers, as of December 31, 2006. Therewere no changes in the Company’s internal controls over financial reportingthat occurred during the fourth fiscal quarter of 2006 that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**ITEM 9B: OTHER INFORMATION**

None.

**PART III**

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**ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

The information required by this Item isincorporated by reference into this Item 10 the information appearing under thecaptions “Election of Directors,” “Executive Officers” and “Section 16(a) BeneficialOwnership Reporting Compliance” in the Company’s definitive Proxy Statement forthe Annual Meeting of Shareholders to be held on May 15, 2007.

**ITEM 11: EXECUTIVE COMPENSATION**

The information required by this Item isincorporated by reference to the information appearing under the captions “ExecutiveCompensation,” “Long-Term Incentive Plan,” and “Retirement Plans” in theCompany’s definitive Proxy Statement for the Annual Meeting of Shareholders tobe held on May 15, 2007

**ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

The information required by this Item isincorporated by reference to the information appearing under the caption “SecurityOwnership of Certain Beneficial Owners and Management” in the Company’sdefinitive Proxy Statement for the Annual Meeting of Shareholders to be held onMay 15, 2007.

**ITEM 13: CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE**

The information required by this Item ishereby incorporated by reference to the information appearing under the caption“Certain Relationships and Related Transactions” in the Company’s definitiveProxy Statement for the Annual meeting of Shareholders to be held on May 15,2007.

**ITEM 14: PRINCIPAL ACCOUNTANT FEESAND SERVICES**

The information required by this Item ishereby incorporated by reference to the information appearing under the caption“Audit Fees and Services” in the Company’s definitive Proxy Statement for theAnnual meeting of Shareholders to be held on May 15, 2007.

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2006 ANNUAL REPORT

**PART IV**

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**ITEM 15: EXHIBITS AND FINANCIALSTATEMENT SCHEDULES**

1.         FinancialStatements

Carrollton Bancorp and Subsidiaries:

Report of Independent Registered PublicAccounting Firm

Consolidated Balance Sheets as of December 31,2006 and 2005

Consolidated Statements of Income for theyears ended December 31, 2006, 2005, and 2004

Consolidated Statements of Changes inShareholders’ Equity for the years ended December 31, 2006, 2005, and 2004

Consolidated Statements of Cash Flows for theyears ended December 31, 2006, 2005, and 2004

Notes to Consolidated Financial Statements

2.         FinancialStatement Schedules

None

3.         Exhibits

| Exhibit  Number   | * * | *Description*                                                                                                                          |
|-------------------|----------|----------------------------------------------------------------------------------------------------------------------------------------|
|   3(i)  |     | Articles of Incorporation of Carrollton  Bancorp*                                                                                      |
|   3(ii) |     | By-Laws of Carrollton Bancorp*                                                                                                         |
| 10.1              |     | Lease dated January 24, 1989 by and  between Hill Management Services, Inc. and The Carrollton Bank of  Baltimore.*          |
| 10.2              |     | Lease dated July 21, 1989 by and  between Hill Management Services, Inc. and The Carrollton Bank of  Baltimore.*             |
| 10.4              |     | Lease dated August 3, 1976 between  Amcap, Inc. and The Carrollton Bank of Baltimore.*                                       |
| 10.7              |     | Lease dated July 19, 1988 by and  between Northway Limited Partnership and The Carrollton Bank of Baltimore.*                     |
| 10.8              |     | Lease dated August 11, 1994 by and  between KIMCO and Carrollton Bank.**                                                          |
| 10.9              |     | Lease dated October 11, 1994 by and  between Ridgeview Associates Limited Partnership and Carrollton Bank.**                      |
| 10.10             |     | Employment agreement with Robert A.  Altieri***                                                                                        |
| 10.11             |     | Employment agreement with Gary M. Jewell***                                                                                            |
| 10.12             |     | Lease dated January 15, 2004 by and  between Turf Village Offices and Carrollton Bank (2300 York Road,  Suite 114, 115, 116) |
| 10.13             |     | Lease dated June 17, 2004 by and  between Turf Village Offices and Carrollton Bank (2300 York Road,  Suite 211)              |
| 10.14             |     | Lease dated February 15, 2005 by and  between Turf Village Offices and Carrollton Bank (2300 York Road, Suites  213,214,215,216)  |
| 10.15             |     | Lease dated February 18, 2005 by and  between Broadway 205 Associates, LLP and Carrollton Mortgage  Services, Inc.           |
| 10.16             |     | Lease dated October 26, 2005 by and  between Arthur Lea Stabler and Helen H. Stabler and Carrollton Bank                          |
| 10.17             |     | Lease dated June 11, 2004 by and  between Mario J. Orlando and Matthew J. Salafia and Carrollton Mortgage  Services, Inc.    |
| 10.18             |     | Lease dated November 4, 2003 by and  between Hickory Crossing, LLC and Carrollton Bank                                            |
| 10.19             |     | Lease dated October 31, 1997 between  The Avenue at White Marsh, LLC and Carrollton Bank                                          |
| 10.20             |     | Lease dated January 13, 2006 by and  between Scotts Corner LLLP and Carrollton Bank                                               |
| 10.21             |     | Lease dated April 27, 2006 by and  between Arbutus Shopping Center Limited Partnership and Carrollton Bank                        |
| 21.1              |     | Subsidiaries of Carrollton Bancorp                                                                                                     |
| 23.1              |     | Consent of Independent Registered Public  Accounting Firm by Exchange Act Rule 13-a-14(a)                                         |
| 31.1              |     | Certification by the Principal Executive  Officer required by Exchange Act Rule 13-a-14(a)                                        |
| 31.2              |     | Certification by Principal Financial  Officer required by Exchange Act Rule 13-a-14(a)                                            |
| 32.1              |     | Certification by the Principal Executive  Officer                                                                                      |
| 32.2              |     | Certification by the Principal Financial  Officer                                                                                      |

 

*             Incorporated by reference from Registration Statementdated January 12, 1990 on SEC Form S-4 (1933 Act File No.: 33-33027).

**       Incorporated by reference from Annual Report on Form 10-KSBfor the fiscal year ended December 31, 1994 (1934 Act File No.: 0-23090).

***                              Incorporated by reference from QuarterlyReport on Form 10-Q for the quarter ended September 30, 2004(1934 Act File No.: 000-23090)

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CARROLLTON BANCORP

**SIGNATURES**

Pursuant to the requirement of Section 13or 15(d) of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

**CARROLLTON BANCORP**(Registrant)
| March 1, 2007 |   | By:                                    |   | /s/ Robert A.  Altieri |   |   |
|--------------------|--------|----------------------------------------|--------|------------------------|--------|--------|
|               |   | Robert A.  Altieri                     |   |                   |
|               |   | President and  Chief Executive Officer |   |                   |

 

Pursuant to the requirements of SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated.
| March 1, 2007 |   | By:                                    |   | /s/ Robert A.  Altieri |   |   |
|--------------------|--------|----------------------------------------|--------|------------------------|--------|--------|
|               |   | Robert A.  Altieri                     |   |                   |
|               |   | President and  Chief Executive Officer |   |                   |

 

**PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER**
| March 1, 2007 |   | By:                                               |   | /s/ James M. Uveges       |   |   |
|--------------------|--------|---------------------------------------------------|--------|---------------------------|--------|--------|
|               |   | James M. Uveges                                   |   |                      |
|               |   | (Principal financial and accounting officer)      |   |                      |
|               |   | Senior Vice President and Chief Financial Officer |   |                      |
|               |   | *Board of Directors*                              |   |                      |
| March 1, 2007 |   | By:                                               |   | /s/ Robert  J. Aumiller   |   |   |
|               |   | Robert J. Aumiller                                |   |                      |
|               |   | Director                                          |   |                      |
| March 1, 2007 |   | By:                                               |   | /s/ Steven  K. Breeden    |   |   |
|               |   | Steven K. Breeden                                 |   |                      |
|               |   | Director                                          |   |                      |
| March 1, 2007 |   | By:                                               |   | /s/ Albert  R. Counselman |   |   |
|               |   | Albert R. Counselman                              |   |                      |
|               |   | Chairman of the Board                             |   |                      |
| March 1, 2007 |   | By:                                               |   | /s/ Harold  I. Hackerman  |   |   |
|               |   | Harold I. Hackerman                               |   |                      |
|               |   | Director                                          |   |                      |
| March 1, 2007 |   | By:                                               |   | /s/ William  L. Hermann   |   |   |
|               |   | William L. Hermann                                |   |                      |
|               |   | Director                                          |   |                      |

 

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2006 ANNUAL REPORT

 
| March 1, 2007 |   | By:                         |   | /s/ David P. Hessler            |   |   |
|--------------------|--------|-----------------------------|--------|---------------------------------|--------|--------|
|               |   | David P. Hessler            |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ Howard S. Klein             |   |   |
|               |   | Howard S. Klein             |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ Ben F. Mason                |   |   |
|               |   | Ben F. Mason                |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ Charles E. Moore, Jr.  |   |   |
|               |   | Charles E. Moore, Jr.  |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ John Paul Rogers            |   |   |
|               |   | John Paul Rogers            |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ William C. Rogers, Jr. |   |   |
|               |   | William C. Rogers, Jr. |   |                            |
|               |   | Director                    |   |                            |
| March 1, 2007 |   | By:                         |   | /s/ Francis X. Ryan             |   |   |
|               |   | Francis X. Ryan             |   |                            |
|               |   | Director                    |   |                            |

 

63

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CARROLLTON BANCORP

**EXHIBIT INDEX**
| Exhibit  Number | * * | *Description*                                                                                                                    | * * | *Sequentially  Numbered Page* |
|-----------------|----------|----------------------------------------------------------------------------------------------------------------------------------|----------|-------------------------------|
|   3(i)     |     | Articles of  Incorporation of Carrollton Bancorp                                                                                 |     |                          | * |   |
|   3(ii)    |     | By-Laws  of Carrollton Bancorp                                                                                                   |     |                          | * |   |
| 10.1            |     | Lease dated  January 24, 1989 by and between Hill Management Services, Inc. and The  Carrollton Bank of Baltimore.               |     |                          | * |   |
| 10.2            |     | Lease dated  July 21, 1989 by and between Hill Management Services, Inc. and The  Carrollton Bank of Baltimore.                  |     |                          | * |   |
| 10.4            |     | Lease dated  August 3, 1976 between Amcap, Inc. and The Carrollton Bank of Baltimore.                                       |     |                          | * |   |
| 10.7            |     | Lease dated  July 19, 1988 by and between Northway Limited Partnership and The Carrollton  Bank of Baltimore.                    |     |                          | * |   |
| 10.8            |     | Lease dated  August 11, 1994 by and between KIMCO and Carrollton Bank.                                                      |     |                          | ** |   |
| 10.9            |     | Lease dated  October 11, 1994 by and between Ridgeview Associates Limited Partnership and  Carrollton Bank.                      |     |                          | ** |   |
| 10.10           |     | Employment  agreement with Robert A. Altieri                                                                                     |     |                          | *** |   |
| 10.11           |     | Employment  agreement with Gary M. Jewell                                                                                        |     |                          | *** |   |
| 10.12           |     | Lease dated  January 15, 2004 by and between Turf Village Offices and Carrollton Bank  (2300 York Road, Suite 114, 115, 116)     |     |                          |   |   |
| 10.13           |     | Lease dated  June 17, 2004 by and between Turf Village Offices and Carrollton Bank (2300  York Road, Suite 211)             |     |                          |   |   |
| 10.14           |     | Lease dated  February 15, 2005 by and between Turf Village Offices and Carrollton Bank  (2300 York Road, Suites 213,214,215,216) |     |                          |   |   |
| 10.15           |     | Lease dated  February 18, 2005 by and between Broadway 205 Associates, LLP and  Carrollton Mortgage Services, Inc.     |     |                          |   |   |
| 10.16           |     | Lease dated  October 26, 2005 by and between Arthur Lea Stabler and Helen H. Stabler and  Carrollton Bank                        |     |                          |   |   |
| 10.17           |     | Lease dated June  11, 2004 by and between Mario J. Orlando and Matthew J. Salafia and  Carrollton Mortgage Services, Inc.   |     |                          |   |   |
| 10.18           |     | Lease dated  November 4, 2003 by and between Hickory Crossing, LLC and Carrollton Bank                                           |     |                          |   |   |
| 10.19           |     | Lease dated  October 31, 1997 between The Avenue at White Marsh, LLC and Carrollton Bank                                         |     |                          |   |   |
| 10.20           |     | Lease dated  January 13, 2006 by and between Scotts Corner LLLP and Carrollton Bank                                         |     |                          |   |   |
| 10.21           |     | Lease dated  April 27, 2006 by and between Arbutus Shopping Center Limited  Partnership and Carrollton Bank                 |     |                          |   |   |
| 21.1            |     | Subsidiaries  of Carrollton Bancorp                                                                                              |     |                          |   |   |
| 23.1            |     | Consent of  Independent Registered Public Accounting Firm required by Exchange Act  Rule 13-a-14(a)                         |     |                          |   |   |
| 31.1            |     | Certification  by the Principal Executive Officer required by Exchange Act Rule 13a-14(a)                                   |     |                          |   |   |
| 31.2            |     | Certification  by the Principal Financial Officer required by Exchange Act Rule 13a-14(a)                                   |     |                          |   |   |
| 32.1            |     | Certification  by the Principal Executive Officer                                                                                |     |                          |   |   |
| 32.2            |     | Certification  by Principal Financial Officer                                                                                    |     |                          |   |   |

 

****             **Incorporated by reference fromRegistration Statement dated January 12, 1990 on SEC Form S-4(1933 Act File No.: 33-33027).*

*****        **Incorporated by reference fromAnnual Report on Form 10-KSB for the fiscal year ended December 31,1994 (1934 Act File No.: 0-23090).*

******   **Incorporated by reference fromQuarterly Report on Form 10-Q for the quarter ended September 30,2004 (1934 Act File No.: 000-23090)*

64

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