UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549








FORM
      10-QSB








QUARTERLY
      REPORT UNDER SECTION 13 OR 15 (d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934








For
      the
      quarterly period ended September 30, 2005.





Commission
      file number: 333-87781







**Bay
      National Corporation**


(Exact
      name of small business issuer as specified in its charter)





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





2328
      West Joppa Road, Lutherville, MD 21093


Address
      of principal executive offices





(410)
      494-2580


Issuer’s
      telephone number





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days.





Yes
            X
            
            No





State
      the
      number of shares outstanding of each of the issuer’s classes of common equity,
      as of the latest practicable date:





At
      November 11, 2005, the issuer had 1,924,436 shares of Common Stock
      outstanding.





Transitional
      Small Business Disclosure Format (Check One):  Yes  No X





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








**PART
      I -**  **FINANCIAL
      INFORMATION**





**Item
      1.****Financial
      Statements**





**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      BALANCE SHEETS


As
      of
      September 30, 2005 and December 31, 2004





September
                30,
              2005
            
            
            December
                31,
              2004ASSETS
            
            
            
            
            (Unaudited)Cash
                and due from banks
            
            
            
            $
            1,663,245
            
            $
            1,403,424Federal
                funds sold and other overnight investments
            
            
            
            
            11,847,688
            
            
            16,708,528Investment
                securities available for sale (AFS) - at fair value
            
            
            
            
            1,541,231
            
            
            1,544,496Other
                equity securities
            
            
            
            
            906,940
            
            
            556,090Loans
                held for sale
            
            
            
            
            19,096,277
            
            
            9,613,162Loans,
                net of unearned fees
            
            
            
            
            167,657,004
            
            
            141,413,437Total
                loans
            
            
            
            
            186,753,281
            
            
            151,026,599Less:
                Allowance for credit losses
            
            
            
            
            (2,350,000
            )
            
            (1,810,000
            )Loans,
                net
            
            
            
            
            184,403,281
            
            
            149,216,599Premises
                and equipment, net
            
            
            
            
            759,786
            
            
            593,583Accrued
                interest receivable and other assets
            
            
            
            
            1,310,985
            
            
            740,754Total
                Assets
            
            
            
            $
            202,433,156
            
            $
            170,763,474LIABILITIESNon-interest-bearing
                deposits
            
            
            
            $
            24,910,101
            
            $
            20,638,596Interest-bearing
                deposits
            
            
            
            
            155,442,869
            
            
            133,288,446Total
                deposits
            
            
            
            
            180,352,970
            
            
            153,927,042Short-term
                borrowings
            
            
            
            
            3,710,000
            
            
            1,381,000Note
                payable
            
            
            
            
            2,100,000
            
            
            1,250,000Accrued
                expenses and other liabilities
            
            
            
            
            1,182,181
            
            
            786,668Total
                Liabilities
            
            
            
            
            187,345,151
            
            
            157,344,710STOCKHOLDERS'
                EQUITYCommon
                stock - $.01 par value, authorized:9,000,000
                shares authorized, 1,924,436 and 1,917,710 issuedand
                outstanding as of September 30, 2005 and December 31, 2004,
                respectively
            
            
            
            
            19,244
            
            
            19,177Additional
                paid in capital
            
            
            
            
            17,451,201
            
            
            17,400,284Accumulated
                deficit
            
            
            
            
            (2,382,440
            )
            
            (4,000,697
            )Total
                Stockholders' Equity
            
            
            
            
            15,088,005
            
            
            13,418,764Total
                Liabilities and Stockholders' Equity
            
            
            
            $
            202,433,156
            
            $
            170,763,474





See
      accompanying notes to consolidated financial statements.




2


**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF OPERATIONS


For
      the
      three and nine-month periods ended September 30, 2005 and 2004


(Unaudited)





Three
                Months Ending
              September
                30
            
            
            Nine
                Months Ending
              September
                302005
            
            
            2004
            
            
            2005
            
            
            2004INTEREST
                INCOME:Interest
                and fees on loans
            $
            3,532,663
            
            $
            1,947,348
            
            $
            8,772,889
            
            $
            5,186,493Interest
                on federal funds sold and other overnight investments
            
            48,617
            
            
            46,725
            
            
            160,401
            
            
            99,224Taxable
                interest and dividends on investmentsecurities
            
            16,555
            
            
            7,035
            
            
            53,923
            
            
            26,820Total
                interest income
            
            3,597,835
            
            
            2,001,108
            
            
            8,987,213
            
            
            5,312,537INTEREST
                EXPENSE:Interest
                on deposits
            
            1,110,071
            
            
            649,532
            
            
            2,774,317
            
            
            1,725,216Interest
                on short-term borrowings
            
            45,309
            
            
            6,178
            
            
            90,859
            
            
            12,618Interest
                on note payable
            
            26,278
            
            
            -
            
            
            61,801
            
            
            -Total
                interest expense
            
            1,181,658
            
            
            655,710
            
            
            2,926,977
            
            
            1,737,834Net
                interest income
            
            2,416,177
            
            
            1,345,398
            
            
            6,060,236
            
            
            3,574,703Provision
                for credit losses
            
            297,000
            
            
            136,500
            
            
            532,500
            
            
            350,221Net
                interest income after provision forcredit
                losses
            
            2,119,177
            
            
            1,208,898
            
            
            5,527,736
            
            
            3,224,482NON-INTEREST
                INCOME:Service
                charges on deposit accounts
            
            58,267
            
            
            66,447
            
            
            152,209
            
            
            178,025Gain
                on sale of mortgage loans
            
            160,592
            
            
            50,576
            
            
            352,745
            
            
            181,697Other
                income
            
            12,158
            
            
            15,579
            
            
            35,095
            
            
            41,703Total
                non-interest income
            
            231,017
            
            
            132,602
            
            
            540,049
            
            
            401,425NON-INTEREST
                EXPENSES:Salaries
                and employee benefits
            
            1,002,607
            
            
            621,937
            
            
            2,630,500
            
            
            1,805,823Occupancy
                expenses
            
            102,119
            
            
            80,930
            
            
            297,002
            
            
            223,945Furniture
                and equipment expenses
            
            69,782
            
            
            62,912
            
            
            221,664
            
            
            185,482Legal
                and professional fees
            
            30,000
            
            
            49,087
            
            
            102,712
            
            
            122,335Data
                processing and other outside services
            
            165,953
            
            
            133,391
            
            
            517,788
            
            
            416,051Advertising
                and marketing related expenses
            
            102,340
            
            
            55,687
            
            
            254,975
            
            
            140,661Other
                expenses
            
            126,748
            
            
            93,184
            
            
            424,887
            
            
            252,855Total
                non-interest expenses
            
            1,599,549
            
            
            1,097,128
            
            
            4,449,528
            
            
            3,147,152Income
                before income taxes
            
            750,645
            
            
            244,372
            
            
            1,618,257
            
            
            478,755Income
                tax expense
            
            -
            
            
            -
            
            
            -
            
            
            -NET
                INCOME
            $
            750,645
            
            $
            244,372
            
            $
            1,618,257
            
            $
            478,755Per
                Share Data:Cash
                Dividends Paid
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Net
                Income (basic)
            $
            .39
            
            $
            .13
            
            $
            .84
            
            $
            .26Net
                Income (diluted)
            $
            .37
            
            $
            .13
            
            $
            .81
            
            $
            .25Weighted
                Average shares outstanding (basic)
            
            1,924,436
            
            
            1,872,058
            
            
            1,921,954
            
            
            1,865,849Effect
                of Dilution - Stock options and Warrants
            
            80,192
            
            
            60,799
            
            
            75,231
            
            
            60,416Weighted
                Average shares outstanding (diluted)
            
            2,004,628
            
            
            1,932,857
            
            
            1,997,185
            
            
            1,926,265





See
      accompanying notes to consolidated financial statements.





3


**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


For
      the
      nine-months ended September 30, 2005 and 2004


(Unaudited)




Common
              Stock
            
            
            Additional
              Paid
                in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              EquityBalances
                at December 31, 2004
            $
            19,177
            
            $
            17,400,284
            
            $
            (4,000,697
            )
            $
            13,418,764Issuance
                of Common Stock
            
            67
            
            
            50,917
            
            
            -
            
            
            50,984Net
                Income
            
            -
            
            
            -
            
            
            1,618,257
            
            
            1,618,257Balances
                at September 30, 2005
            $
            19,244
            
            $
            17,451,201
            
            $
            (2,382,440
            )
            $
            15,088,005Common
              Stock
            
            
            Additional
              Paid
                in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              EquityBalances
                at December 31, 2003
            $
            18,627
            
            $
            16,850,834
            
            $
            (4,802,961
            )
            $
            12,066,500Issuance
                of Common Stock
            
            413
            
            
            412,087
            
            
            -
            
            
            412,500Net
                Income
            
            -
            
            
            -
            
            
            478,755
            
            
            478,755Balances
                at September 30, 2004
            $
            19,040
            
            $
            17,262,921
            
            $
            (4,324,206
            )
            $
            12,957,755








See
      accompanying notes to consolidated financial statements.


4




**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF CASH FLOWS


For
      the
      nine-months ended September 30, 2005 and 2004


(Unaudited)





2005
            
            
            2004Cash
                Flows From Operating ActivitiesNet
                income
            $
            1,618,257
            
            $
            478,755Adjustments
                to reconcile net income to net cash usedby
                operating activities:Depreciation
            
            137,119
            
            
            146,386Accretion
                of investment discounts
            
            (32,237
            )
            
            (12,250
            )Provision
                for credit losses
            
            532,500
            
            
            350,221Gain
                on sale of loans held for sale
            
            (352,745
            )
            
            (181,697
            )Origination
                of loans held for sale
            
            (144,459,618
            )
            
            (72,407,201
            )Proceeds
                from sale of loans
            
            135,329,248
            
            
            66,431,935Net
                increase in accrued interest receivable and other assets
            
            (570,231
            )
            
            (156,272
            )Net
                increase in accrued expenses and other liabilities
            
            395,513
            
            
            134,441Net
                cash used in operating activities
            
            (7,402,194
            )
            
            (5,215,682
            )Cash
                Flows From Investing ActivitiesPurchases
                of investment securities - AFS
            
            (4,614,498
            )
            
            (4,635,883
            )Maturities
                of investment securities - AFS
            
            4,650,000
            
            
            4,650,000Purchase
                of Federal Reserve Bank stock
            
            (139,650
            )
            
            -Purchase
                of Federal Home Loan Bank of Atlanta stock
            
            (211,200
            )
            
            (56,600
            )Loan
                disbursements in excess of principal payments
            
            (26,236,067
            )
            
            (27,439,466
            )Capital
                expenditures
            
            (303,322
            )
            
            (139,964
            )Net
                cash used in investing activities
            
            (26,854,737
            )
            
            (27,621,913
            )Cash
                Flows From Financing ActivitiesNet
                increase in deposits
            
            26,425,928
            
            
            33,753,944Net
                increase in short-term borrowings
            
            2,329,000
            
            
            328,000Proceeds
                from notes payable
            
            850,000
            
            
            500,000Net
                proceeds from stock issuance
            
            50,984
            
            
            412,500Net
                cash provided by financing activities
            
            29,655,912
            
            
            34,994,444Net
                (decrease) increase in cash and cash equivalents
            
            (4,601,019
            )
            
            2,156,849Cash
                and cash equivalents at beginning of period
            
            18,111,952
            
            
            18,060,105Cash
                and cash equivalents at end of period
            $
            13,510,933
            
            $
            20,216,954Cash
                paid for:Interest
            $
            2,777,209
            
            $
            1,678,360Income
                taxes
            $
            -
            
            $
            -




See
      accompanying notes to consolidated financial statements.


5




**BAY
      NATIONAL CORPORATION**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


For
      The
      Three and Nine Months Ended September 30, 2005 and 2004


(Unaudited)





**1.**  **GENERAL**





*Organization*





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





*Basis
      of Presentation*





The
      accompanying consolidated financial statements include the activity of Bay
      National Corporation and its wholly owned subsidiary, Bay National Bank. All
      significant intercompany transactions and balances have been eliminated in
      consolidation.





The
      foregoing consolidated financial statements are unaudited; however, in the
      opinion of management, all adjustments (comprising only normal recurring
      accruals) necessary for a fair presentation of the results of the interim
      periods have been included. The balances as of December 31, 2004 have been
      derived from audited financial statements. These statements should be read
      in
      conjunction with the financial statements and accompanying notes included in
      Bay
      National Corporation’s 2004 Annual Report on Form 10-KSB. There have been no
      significant changes to the Company’s Accounting Policies as disclosed in the
      2004 Annual Report. The results shown in this interim report are not necessarily
      indicative of results to be expected for the full year 2005 or any other interim
      period.





The
      accounting and reporting policies of the Company conform to accounting
      principles generally accepted in the United States of
      America and to
      general practices in the banking industry.





*Reclassifications*





Certain
      reclassifications have been made to amounts previously reported to conform
      to
      the current presentation. These reclassifications had no effect on previously
      reported results of operations or accumulated deficit.





**2.**  **REGULATORY
      MATTERS**





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





6


Quantitative
      measures established by regulation to ensure capital adequacy require the Bank
      to maintain minimum amounts and ratios. Management believes, as of September
      30,
      2005, that the Bank meets all capital adequacy requirements to which it is
      subject.





As
      of
      September 30, 2005, the Bank has been categorized as “Well Capitalized” by the
      OCC under the regulatory framework for prompt corrective action. To be
      categorized as well capitalized, the Bank must maintain minimum total
      risk-based, Tier I risk-based, and Tier I leverage ratios.





**3.**  **INCOME
      TAXES**





The
      Company uses the liability method of accounting for income taxes as required
      by
      SFAS No. 109, “Accounting for Income Taxes.” Under the liability method,
      deferred-tax assets and liabilities are determined based on differences between
      the financial statement carrying amounts and the tax bases of existing assets
      and liabilities (i.e., temporary differences) and are measured at the enacted
      rates that will be in effect when these differences reverse. Deferred income
      taxes will be recognized when it is deemed more likely than not that the
      benefits of such deferred income taxes will be realized; accordingly, no
      deferred income taxes or income tax benefits have been recorded by the
      Company.





**4.**  **EARNINGS
      PER SHARE**





Earnings
      per common share are computed by dividing net income by the weighted average
      number of common shares outstanding during the period. Diluted earnings per
      common share is computed by dividing net income by the weighted average number
      of common shares outstanding during the period, including any potential dilutive
      common shares outstanding, such as options and warrants.




**5.**  **STOCK-BASED
      COMPENSATION**





The
      Company has adopted the disclosure-only provisions of Statement of Financial
      Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS
      No. 123) and Statement of Financial Accounting Standards No. 148, “Accounting
      for Stock-Based Compensation - Transition and Disclosure” (SFAS No. 148), and
      applies Accounting Principles Board Opinion No. 25 and related interpretations
      in accounting for its stock option plan. No compensation expenses related to
      the
      Company’s stock option plan were recorded during the three-month and nine-month
      periods ended September 30, 2005 and 2004.


7


The
      following table illustrates the effect on net income and earnings per share
      if
      the Company had applied the fair value recognition provisions of SFAS No. 123
      and SFAS No. 148 to stock-based employee compensation for the three-month and
      nine-month periods ended September 30:





Three
                Months Ending
              September
                30
            
            
            Nine
                Months Ending
              September
                302005
            
            
            2004
            
            
            2005
            
            
            2004Net
                income, as reported
            $
            750,645
            
            $
            244,372
            
            $
            1,618,257
            
            $
            478,755Less
                pro forma stock-based compensation
              expense
                determined under the fair value
              method
            
            (1,404
            )
            
            (1,404
            )
            
            (75,882
            )
            
            (73,076
            )Pro
                forma net income
            $
            749,241
            
            $
            242,968
            
            $
            1,542,375
            
            $
            405,679Net
                income per share:Basic
                - as reported
            $
            .39
            
            $
            .13
            
            $
            .84
            
            $
            .26Diluted
                - as reported
            $
            .37
            
            $
            .13
            
            $
            .81
            
            $
            .25Basic
                - pro forma
            $
            .39
            
            $
            .13
            
            $
            .80
            
            $
            .22Diluted
                - pro forma
            $
            .37
            
            $
            .13
            
            $
            .77
            
            $
            .21





8


**Item
      2.**  **Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations**





This
      discussion and analysis provides an overview of the financial condition and
      results of operations of Bay National Corporation (the “Parent”) and its
      national bank subsidiary, Bay National Bank (the “Bank”), collectively (the
“Company”), as of September 30, 2005 and December 31, 2004 and for the
      three-month and nine-month periods ended September 30, 2005 and
      2004.





**General**





On
      May
      12, 2000, the Parent became a bank holding company by purchasing all of the
      common stock of the Bank. The Bank opened its first office on May 12, 2000
      and
      its second office on May 26, 2000.





The
      Bank
      serves the business communities of North Baltimore and Salisbury,
      Maryland.





**Overview**





Strong
      asset growth continued for the three-month period ended September 30, 2005,
      while operating results continued to improve significantly over prior year
      results. Key measurements for the three-month and nine-month periods ended
      September 30, 2005 include the following:





·
            Total
                assets at September 30, 2005 increased to $202.4 million as compared
                to
                $170.8 million as of December 31, 2004.





·
            Net
                loans outstanding increased from $149.2 million as of December 31,
                2004 to
                $184.4 million as of September 30,
                2005.





·
            There
                were no nonperforming loans at September 30, 2005. Appropriate reserves
                for loan losses continue to be
                maintained.





·
            Deposits
                at September 30, 2005 were $180.4 million, an increase from $153.9
                million
                as of December 31, 2004.





·
            The
                Company realized net income of $750,645 and $1,618,257 for the three-month
                and nine-month periods ended September 30, 2005, respectively. This
                represents increases of 207.2% and 238.0% over net income of $244,372
                and
                $478,755 for the three-month and nine month periods ended September
                30,
                2004, respectively.





·
            Net
                interest income, the Company’s main source of income, was $2.4 million and
                $6.1 million during the three-month and nine-month periods ended
                September
                30, 2005 compared to $1.3 million and $3.6 million for the same periods
                in
                2004. This represents an increase of 79.6% and 69.5% for the three-months
                and nine-months ended September 30, 2005, respectively, as compared
                to the
                same periods in 2004.





·
            There
                were recoveries on prior charge-offs of $7,500 for the nine-month
                period
                ended September 30, 2005. Loan charge-offs were $6,221 for the nine-month
                period ended September 30, 2004.





9


·
            Non-interest
                income increased by $98,415, or 74.2%, and by $138,624, or 34.5%,
                for the
                three-month and nine-month periods September 30, 2005, respectively,
                as
                compared to the same periods in 2004.





·
            Non-interest
                expenses increased by $502,421 and $1,302,376, or 45.8% and 41.4%,
                for the
                three-month and nine-month periods ended September 30, 2005, respectively,
                as compared to the same periods ended September 30, 2004.





·
            The
                market price of common shares ended the quarter at $19.00, up 43.4%
                from
                the closing price of $13.25 on December 31,
                2004.





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





**Results
      of Operations**





*Overview*





The
      Company recorded net income of $750,645 and $1,618,257 for the three-month
      and
      nine-month periods ended September 30, 2005, respectively. This compares to
      net
      income of $244,372 and $478,755 for the same periods in 2004. This is an
      improvement of $506,273, or 207.2%, for the three-month period and $1,139,502,
      or 238.0%, for the nine-month period. This significant improvement in results
      for the periods is due to the continued year over year growth of the loan
      portfolio, improvement in net interest margins, and prudent management of
      operating expenses.





Bay
      National Bank’s mortgage origination operations, located in Lutherville and
      Salisbury, Maryland, originate conventional first and second lien residential
      mortgage loans. Bay National Bank sells most of its first and second lien
      residential mortgage loans in the secondary market and typically recognizes
      a
      gain on the sale of these loans after the payment of commissions to the loan
      origination officer. Since its inception in February 2001, the Salisbury
      mortgage division has been a significant contributor to operating results.
      The
      Lutherville mortgage operation was initiated in February 2005 and began to
      contribute to the Company’s overall profitability during the second half of
      2005. For the three-month periods ended September 30, 2005 and 2004, gains
      on
      the sale of mortgage loans totaled $160,592 and $50,576, respectively. For
      the
      nine-month periods ended September 30, 2005 and 2004, gains on the sale of
      mortgage loans totaled $352,745 and $181,697, respectively.





The
      level
      of gains on the sale of mortgage loans has increased from 2004 due to the
      addition of the Lutherville origination operation, which focuses on construction
      and rehabilitation loans that will be modified to permanent financing upon
      completion of the project. The permanent financing is then sold in the secondary
      market. We believe that this type of residential lending is less sensitive
      to
      the fluctuation of interest rates.





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




10


The
      primary risk to the Company is that the secondary market investor may decline
      to
      purchase the loans due to documentary deficiencies or errors. The Company
      attempts to manage this risk by conducting a thorough review of the
      documentation prior to purchasing the participation. If the secondary market
      investor declines to purchase the loan, the Company could attempt to sell the
      loan to other investors or hold the loan in its loan portfolio. As of September
      30, 2005, the Company held $17.1 million of these loans which were classified
      as
      held for sale. The Company earned $262,621 and $496,004 of interest on this
      program for the three-month and nine-month periods ended September 30, 2005,
      respectively. This compares to $115,774 and $186,407 for the same periods in
      2004.





Management
      expects continued strength in operating results over the remainder of 2005;
      however, actual results will be subject to the volatility of the provision
      for
      credit losses, which is related to loan growth, the continued success of the
      new
      Lutherville mortgage lending programs, and the volatility of existing mortgage
      loan production, which is sensitive to economic and interest rate
      fluctuations.





*Net
      Interest Income*





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





As
      previously stated, net interest income was $2.4 million and $6.1 million during
      the three-month and nine-month periods ended September 30, 2005 as compared
      to
      $1.3 million and $3.6 million for the same periods in 2004. This represents
      increases of 79.6% and 69.5% for the three-months and nine-months ended
      September 30, 2005 as compared to the same periods in 2004.





Interest
      income from loans and investments for the three-month and nine-month periods
      ended September 30, 2005 was $3.6 million and $9.0 million, respectively,
      compared to $2.0 million and $5.3 million, respectively, for the three-month
      and
      nine-month periods ended September 30, 2004. The 79.8% and 69.2% increases
      for
      the three and nine-month periods over the same periods in 2004 were directly
      related to the 28.3% increase in average interest-earning assets for the
      nine-months ended September 30, 2005 as compared to the same period in 2004.
      The
      increase in average interest-earning assets was also aided by a significant
      increase in average yields due to eight .25% increases in the target federal
      funds rate since September 30, 2004. The yields on these assets increased from
      5.14% for the nine-months ended September 30, 2004 to 6.78% for the nine-months
      ended September 30, 2005.





The
      percentage of average interest-earning assets represented by loans was 92.1%
      and
      87.1% for the nine-month periods ended September 30, 2005 and 2004,
      respectively. For the nine-month period ended September 30, 2005, the average
      yield on the loan portfolio increased to 7.18% from 5.76% for the nine-month
      period ended September 30, 2004. This increase is primarily due to the
      difference in the target federal funds rate in effect for the
      periods.  The
      Federal Reserve has increased its target for the federal funds rate from 1.75%
      as of September 30, 2004 to 3.75% as of September 30, 2005. As can be seen
      by
      the yields discussed above, these increases had a significant effect on the
      Company’s operating results. Yields on earning assets in future periods should
      continue to improve following any future increases in the target federal funds
      rate.





11


The
      average yield on the investment portfolio and other earning assets, such as
      federal funds sold, was 2.05% for the nine-month period ended September 30,
      2005
      as compared to .95% for the same period in 2004. The improvement in the average
      yield was a direct result of the Federal Reserve actions discussed above, as
      well as an increase in the holdings of Federal Reserve and Federal Home Loan
      bank stocks, which pay dividend yields greater than the prevailing federal
      funds
      rates. The percentage of average interest-earning assets represented by
      investments was 7.9% and 12.9% for the nine-month periods ended September 30,
      2005 and 2004, respectively.





Interest
      expense from deposits and borrowings for the three-month and nine-month periods
      ended September 30, 2005 was $1,181,658 and $2,926,977, respectively. This
      compares to $655,710 and $1,737,834 for the comparable periods in 2004. The
      80.2% and 68.4% increases over the three-month and nine-month periods in 2004
      are a result of a 27.9% increase  in
      average interest-bearing liabilities for the nine-month period ended September
      30, 2005 as compared to the same period in 2004. The increase in interest
      expense was also related to the increase in average rates paid. Average rates
      paid on these liabilities increased from 2.12% for the nine-month period ended
      September 30, 2004 to 2.79% for the nine-month period ended September 30, 2005.
      The increase in rates paid is directly attributable to the Federal Reserve
      actions discussed above. Although market rates of interest have increased
      significantly since September 30, 2004, management has been able to carefully
      implement deposit rate increases, which has allowed for significantly improved
      margins. Management expects that pressure to increase rates paid on deposits
      will increase if the target for the federal funds rate continues to
      rise.





12


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





No
      tax
      equivalent adjustments were made and no income was exempt from federal income
      taxes. All average balances are monthly average balances. We do not believe
      that
      the monthly averages differ materially from what the daily averages would have
      been. The amortization of loan fees is included in computing interest income;
      however, such fees are not material.





**Nine****Months Ended September 30, 2005****Average**
              **Balance**
            
            
            **Interest**
              **and
                fees**
            
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            162,883,257
            
            $
            8,772,889
            
            
            7.18
            %Investment
                securities
            
            
            2,325,834
            
            
            53,923
            
            
            3.09Federal
                funds sold and other overnight investments
            
            
            11,643,564
            
            
            160,401
            
            
            1.84Total
                earning assets
            
            
            176,852,655
            
            
            8,987,213
            
            
            6.78
            %Less:
                Allowance for credit losses
            
            
            (1,959,675
            )Cash
                and due from banks
            
            
            1,316,501Premises
                and equipment, net
            
            
            683,184Accrued
                interest receivable and other assets
            
            
            793,880Total
                assets
            
            $
            177,686,545LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            55,137,766
            
            
            695,691
            
            
            1.68
            %Regular
                savings deposits
            
            
            5,460,498
            
            
            26,457
            
            
            .65Time
                deposits
            
            
            74,127,589
            
            
            2,052,169
            
            
            3.69Short-term
                borrowings
            
            
            3,960,879
            
            
            90,859
            
            
            3.06Note
                payable
            
            
            1,337,363
            
            
            61,801
            
            
            6.16Total
                interest-bearing liabilities
            
            
            140,024,095
            
            
            2,926,977
            
            
            2.79
            %Net
                interest income and spread
            
            
            
            
            $
            6,060,236
            
            
            3.99
            %Non-interest-bearing
                demand deposits
            
            
            22,888,519Accrued
                expenses and other liabilities
            
            
            767,178Stockholders’
                equity
            
            
            14,006,753Total
                liabilities and stockholders’ equity
            
            $
            177,686,545Interest
                income/earning assets
            
            
            6.78
            %Interest
                expense/earning assets
            
            
            2.21Net
                interest margin
            
            
            4.57
            %Return
                on Average Assets (Annualized)
            
            
            1.21
            %Return
                on Average Equity (Annualized)
            
            
            15.40
            %Average
                Equity to Average Assets
            
            
            7.88
            %





13





**Nine****Months Ended September 30, 2004****Average**
              **Balance**
            
            
            **Interest**
              **and****fees**
            
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            120,097,860
            
            $
            5,186,493
            
            
            5.76
            %Investment
                securities
            
            
            2,022,488
            
            
            26,820
            
            
            1.77Federal
                funds sold and other overnight investments
            
            
            15,729,612
            
            
            99,224
            
            
            .84Total
                earning assets
            
            
            137,849,960
            
            
            5,312,537
            
            
            5.14
            %Less:
                Allowance for credit losses
            
            
            (1,406,395
            )Cash
                and due from banks
            
            
            859,704Premises
                and equipment, net
            
            
            650,349Accrued
                interest receivable and other assets
            
            
            556,700Total
                assets
            
            $
            138,510,318LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            44,806,717
            
            
            359,507
            
            
            1.07
            %Regular
                savings deposits
            
            
            4,015,492
            
            
            19,556
            
            
            .65Time
                deposits
            
            
            59,201,495
            
            
            1,346,153
            
            
            3.03Short-term
                borrowings
            
            
            1,456,369
            
            
            12,618
            
            
            1.16Total
                interest-bearing liabilities
            
            
            109,480,073
            
            
            1,737,834
            
            
            2.12
            %Net
                interest income and spread
            
            
            
            
            $
            3,574,703
            
            
            3.02
            %Non-interest-bearing
                demand deposits
            
            
            16,306,404Accrued
                expenses and other liabilities
            
            
            463,110Stockholders’
                equity
            
            
            12,260,731Total
                liabilities and stockholders’ equity
            
            $
            138,510,318Interest
                income/earning assets
            
            
            5.14
            %Interest
                expense/earning assets
            
            
            1.68Net
                interest margin
            
            
            3.46
            %Return
                on Average Assets (Annualized)
            
            
            .46
            %Return
                on Average Equity (Annualized)
            
            
            5.21
            %Average
                Equity to Average Assets
            
            
            8.85
            %





*Provision
      for Credit Losses*





The
      provision for credit losses was $297,000 and $532,500 for the three-month and
      nine-month periods ended September 30, 2005, respectively, as compared to
      $136,500 and $350,221 for the three-month and nine-month periods ended September
      30, 2004. The provisions for each period were reflective of the growth in loan
      balances outstanding in all segments of the portfolio. The provisions for the
      three-month and nine-month periods ended September 30, 2005 were higher than
      the
      same periods in the prior year due to the fact that the Company began to
      establish a reserve against loans held for sale to reflect the additional risk
      associated with loans originated through a third party mortgage company. For
      additional information regarding the methodology used to determine the provision
      for credit losses, see the Management Discussion and Analysis section entitled
      “Allowance for Credit Losses and Credit Risk Management.”





*Non-Interest
      Income*





Non-interest
      income consists primarily of gains on the sale of mortgage loans, deposit
      account service charges, and cash management fees. For the three-month period
      ended September 30, 2005, the Company realized non-interest income in the amount
      of $231,017 as compared to




14


$132,602
      for the three-month period ended September 30, 2004. Gains on the sale of
      mortgage loans of $160,592 comprised 69.5% of the total for the three-month
      period ended September 30, 2005. This compares to gains on the sale of mortgage
      loans of $50,576, or 38.1% of total non-interest income, for the three-month
      period ended September 30, 2004.





For
      the
      nine-month period ended September 30, 2005, the Company realized non-interest
      income in the amount of $540,049 as compared to $401,425 for the nine-month
      period ended September 30, 2004. Gains on the sale of mortgage loans of $352,745
      comprised 65.3% of the total for the nine-month period ended September 30,
      2005.
      This compares to gains on the sale of mortgage loans of $181,697, or 45.3%
      of
      total non-interest income, for the nine-month period ended September 30,
      2004.





The
      level
      of gains on the sale of mortgage loans has increased in the three-months and
      nine-months ended September 30, 2005 because the Company added additional
      residential construction and mortgage capabilities with the opening of the
      Lutherville mortgage operation in February 2005. This was achieved through
      the
      hiring of a team of eight individuals, including originators, processors and
      servicers who have extensive experience in the industry and the Company’s market
      area. It is expected that these additional capabilities will increase future
      levels of gains on the sale of mortgage loans, while also providing interest
      income on construction loans.





Service
      charges on deposit accounts totaled $58,267 and $152,209 for the three-month
      and
      nine-month periods ended September 30, 2005, as compared to $66,447 and $178,025
      for the three-month and nine-month periods ended September 30, 2004. The
      decreases of 12.3% and 14.5% for the periods, as compared to the same periods
      in
      2004, can be directly attributed to a decline in analysis fees charged on
      commercial deposit accounts. This decline occurred as the rate used for the
      calculation of analysis credits increased in conjunction with the increase
      in
      the target federal funds rate discussed earlier. Analysis credits are fee
      reductions provided based upon the analysis credit rate and the average balance
      of the account subject to analysis fees.





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





*Non-Interest
      Expense*





Non-interest
      expense for the three-month and nine-month periods ended September 30, 2005
      totaled $1,599,549 and $4,449,528, respectively. This compares to non-interest
      expense for the comparable periods in 2004 of $1,097,128 and $3,147,152,
      respectively. The increases of $502,421, or 45.8%, and $1,302,376, or 41.4%,
      for
      the three-month and nine-month periods, respectively, primarily resulted from
      an
      increase in salaries and benefits of $380,670, or 61.2%, and $824,677, or 45.7%,
      for the same periods. The increases in salaries and benefits related to staffing
      growth, including the addition of an eight-person mortgage lending operation
      in
      February 2005, as well as the addition of commercial account portfolio managers
      and other operational support personnel. These additions were made to continue
      to expand the Bank’s market presence, as well as to manage the growth of the
      loan and deposit portfolios and support increased operational volume.





Occupancy
      expenses increased by $21,189 and $73,057 for the three-months and nine-months
      ended September 30, 2005, respectively, as compared to the same periods in
      2004.
      The 26.2% and 32.6% increases for the periods, as compared to the same periods
      in 2004, were due in part to scheduled rent increases as well as the acquisition
      of new space obtained to facilitate the expansion of the Company’s corporate
      offices and to accommodate the new Lutherville mortgage lending group.





15


The
      $32,562, or 24.4%, and $101,737, or 24.5%, increases in data processing and
      other outside services for the three-months and nine-months ended September
      30,
      2005, respectively, as compared to the same period in 2004 is the result of
      increased data and item processing costs and other costs paid to external
      service providers. The costs include one-time expenses of approximately $45,000
      incurred in conjunction with the Bank’s planned change of core processors that
      occurred in May 2005, approximately $24,000 of recruiting fees paid to hire
      additional staff, and approximately $8,000 of systems support costs incurred
      to
      facilitate network infrastructure changes required for a bank processing system
      upgrade. The remaining increase is due to the costs associated with purchasing
      additional hardware and software to support increased staffing, as well as
      the
      fact that systems and item processing costs are volume-driven based upon the
      number of customer accounts and related transaction volume. As a result, these
      costs increase with the growth of the Company.





Advertising
      and marketing-related expenses increased $46,653, or 83.8%, and $114,314, or
      81.3%, for the three-months and nine-months ended September 30, 2005,
      respectively, as compared to the same periods in 2004. The increases were
      related to an increase in the number of marketing events conducted and the
      number of business development professionals on staff as well as increases
      of
      $30,000 and $50,000 in funds set aside for charitable contributions to The
      Baltimore Community Foundation account established by the Bank for the
      three-month and nine-month periods, respectively.





The
      increases of $33,564, or 36.0%, and $172,032, or 68.0%, in other expenses for
      the three-month and nine-month periods ended September 30, 2005, respectively,
      includes increases in director fees of approximately $12,000 and $52,000,
      respectively, related to the director compensation plan adopted in the second
      half of 2004 and an increase in regulatory fees related to the growth of the
      Bank. The remaining increase in non-interest expense relates to various costs
      associated with the increased size and complexity of the Company.





The
      banking industry utilizes the “efficiency ratio” as a key measure of expense
      management and overall operating efficiency. This ratio is computed by dividing
      non-interest expense by the sum of net interest income before the loan loss
      provision and non-interest income. The Company’s efficiency ratio was 60.42% and
      67.41% for the three-month and nine-month periods ended September 30, 2005,
      respectively. This compares to 74.23% and 79.15% for the same periods in 2004.
      The improved ratios from the prior year were driven by strong revenue growth
      and
      prudent management of the Company’s cost structure.





As
      previously discussed, non-interest expense for the three-month and nine-month
      periods ended September 30, 2005 increased by 45.8% and 41.4%, respectively.
      The
      rate of increase in non-interest expenses, including non-recurring expenses,
      is
      substantially less than the 79.6% and 69.5% increases in net interest income
      for
      the three-month and nine-month periods ended September 30, 2005, respectively,
      as compared to the same periods in 2004. Management believes this indicates
      that
      the Company is continuing to effectively leverage its cost structure to generate
      profitable growth. While management expects that the ongoing growth of the
      Company’s customer base will continue to require additional staffing in order to
      appropriately service customers and manage the business effectively, management
      believes that additional growth in the customer base can continue to be
      accomplished without proportionate increases in these costs.





16


*Income
      Taxes*





When
      the
      realization of deferred income taxes is deemed to be more likely than not,
      the
      recordation of previously unrecorded net deferred income tax assets will have
      a
      positive effect on the earnings in the period when such determination is made.
      As of December 31, 2004, the Company had net deferred tax assets of
      approximately $1.4 million that were eliminated through a valuation allowance.
      Subsequent to the recordation of deferred taxes, the Company will begin to
      record income tax expense at the statutory rate. Since inception, the Company
      has not recorded any income tax expense or benefit. Recognizing income tax
      expense in future periods will have a detrimental effect on reported
      earnings.





**Financial
      Condition**





*Composition
      of the Balance Sheet*





As
      of
      September 30, 2005, total assets were $202,433,156. This represents growth
      of
      $31,669,682, or 18.5%, since December 31, 2004. The growth in total assets
      included increases of $259,821 in cash and due from banks, $350,850 in other
      equity securities, $35,186,682 in loans net of the allowance for credit losses
      and $736,434 in other non-earning assets. These increases were offset by
      decreases of $4,860,840 in federal funds sold and other overnight investments
      and $3,265 in investment securities available for sale.





During
      the second quarter of 2004, the Company introduced a new loan program for
      conventional first lien and second lien residential mortgage loans. Under this
      program, the Company purchases a 100% participation in mortgage loans originated
      by a mortgage company in the Baltimore metropolitan area. These participations
      are for loans that a secondary market investor has committed to purchase. The
      participations are typically held for a period of three to four weeks before
      being sold to the secondary market investor. The Company earns interest on
      these
      loans at a rate indexed to the prime rate. As of September 30, 2005, the Company
      held $17.1 million of these loans which were classified as held for sale, a
      significant increase from the $8.0 million held as of December 31,
      2004.





As
      of
      September 30, 2005, loans, excluding
      loans held for sale, totaled $167,657,004. This represents an increase of
      $26,243,567, or 18.6%, from a balance of $141,413,437 as of December 31, 2004.
      Approximately $23 million of this growth is a result of residential construction
      and rehabilitation lending generated by the Lutherville residential lending
      group established in February 2005. Loan growth excluding Lutherville
      residential construction and rehabilitation loans was
      impacted by significant pay downs and payoffs. A total of approximately $34.6
      million in loans that were outstanding as of December 31, 2004 were paid off
      during the first nine months of 2005. This activity combined with normal
      fluctuations in revolving credit balances and installment payments on amortizing
      loans offset most of the approximately $51.2 million in new loans funded during
      that same period. The Company continues to emphasize prudent growth through
      the
      identification of new market segments, hiring of experienced commercial lenders,
      and the development and use of referral sources including accountants, lawyers
      and existing customers, as well as members of the Board of Directors and the
      Baltimore and Salisbury Advisory Boards.





The
      composition of the loan portfolio as of September 30, 2005 was approximately
      $74.3 million of commercial loans, $2.1 million of consumer loans, and $91.3
      million of real estate loans (excluding mortgage loans held for sale). The
      composition of the loan portfolio as of December 31, 2004 was approximately
      $73.8 million of commercial loans, $2.2 million of consumer loans, and $65.4
      million of real estate loans (excluding mortgage loans held for sale). Mortgage
      loans held for sale were $19.1 million and $9.6 million as of September 30,
      2005
      and December 31, 2004, respectively.





17


Funds
      not
      extended in loans are invested in cash and due from banks and various
      investments including federal funds sold and other overnight investments, U.S.
      Treasury securities, Federal Reserve Bank stock and Federal Home Loan Bank
      stock. These investments totaled approximately $16.0 million as of September
      30,
      2005 compared to approximately $20.2 million as of December 31, 2004. At
      September 30, 2005, the Company had federal funds sold and other overnight
      investments totaling $11,847,688 as compared to $16,708,528 as of December
      31,
      2004. The Company held $452,340 of Federal Reserve Bank stock as of September
      30, 2005 and $312,690 as of December 31, 2004. The Company also held Federal
      Home Loan Bank of Atlanta stock of $454,600 and $243,400 as of September 30,
      2005 and December 31, 2004, respectively, and United States Treasury bills
      with
      a maturity value of $1,550,000 as of both September 30, 2005 and December 31,
      2004. The Treasury securities are used to collateralize repurchase agreements,
      which are classified as short-term borrowings under which $1,210,000 and
      $1,381,000 were outstanding as of September 30, 2005 and December 31, 2004,
      respectively. Management has made a decision to maintain an appropriate level
      of
      liquidity in the investment portfolio in order to ensure that funds are readily
      available to fund the growth of the loan portfolio and to meet the needs of
      deposit customers.





The
      increase in total assets was funded with operating earnings and an increase
      in
      deposits of $26,425,928, or 17.2%, since December 31, 2004. Short-term
      borrowings increased by $2,329,000.





Deposits
      at September 30, 2005 were $180,352,970, of which approximately $15.4 million,
      or 8.6%, were related to two customers in one industry and a third customer
      in
      another industry. Deposits at December 31, 2004 were $153,927,042, of which
      deposits for these same customers stood at approximately $16.6 million, or
      10.8%, of total deposits. The deposits for these customers tend to fluctuate
      significantly; as a result, management monitors these deposits on a daily basis
      to ensure that liquidity levels are adequate to compensate for these
      fluctuations. Management was able to manage the rate of deposit growth to
      closely match loan growth by actively managing the level of certificates of
      deposit obtained by listing rates on the internet.




The
      market in which the Company operates is very competitive; therefore, the rates
      of interest paid on deposits are affected by rates paid by other depository
      institutions. Management closely monitors rates offered by other institutions
      and seeks to be competitive within the market. The Company has chosen to
      selectively compete for large certificates of deposits. The Company will choose
      to pursue such deposits when expected loan growth provides for adequate spreads
      to support the cost of those funds. As of September 30, 2005, the Company had
      outstanding certificates of deposit of approximately $34.2 million that were
      obtained through the listing of certificate of deposit rates on two
      Internet-based listing services (such deposits are sometimes referred to herein
      as national market certificates of deposit). These certificates of deposit
      were
      issued with an average yield of 3.97% and an average term of 27.8 months.
      Included in the $34.2 million of Internet-originated certificates of deposit
      is
      one certificate of deposit in the amount of $96,626 that has been classified
      as
      a “Brokered Deposit” for bank regulatory purposes. This “Brokered Deposit” was
      issued with a yield of 2.75% and matures in October 2006. As of December 31,
      2004, the total certificates of deposit obtained through the listing of
      certificate of deposit rates on the Internet-based listing services were
      approximately $28.9 million, of which $394,666 were classified as “Brokered
      Deposits.” The Company has never paid broker fees for deposits. Additionally,
      the Company has not accepted any new “Brokered Deposits” since August
      2002.





Core
      deposits, which management categorizes as all deposits other than national
      market certificates of deposit and all but $5.0 million of deposits from the
      three large customers described above (which management considers to be a stable
      deposit amount from these customers based upon historical trends), stood at
      $135,682,965 as of September 30, 2005, up




18


19.6%
      from $113,412,507 as of December 31, 2004. Core deposits are closely monitored
      by management because they consider such deposits not only a relatively stable
      source of funding but also reflective of the growth of commercial and consumer
      depository relationships.





Short-term
      borrowings consist of repurchase agreements collateralized by pledges of U.S.
      Government Treasury Securities, based upon their market values, equal to 100%
      of
      the principal and accrued interest of its short-term borrowings. The outstanding
      balance of repurchase agreements decreased from $1,381,000 at December 31,
      2004
      to $1,210,000 at September 30, 2005 due to decreases in the balance of available
      funds for customers participating in this program . In
      addition, short-term borrowings include $2.5 million borrowed from the Federal
      Home Loan Bank of Atlanta with approximately $16.2 million remaining in
      borrowing capacity.




Note
      payable consists of $2.1 million borrowed under a $5 million, three-year
      unsecured non-revolving credit facility executed on September 28, 2004 with
      another financial institution. Borrowings under the credit facility are used
      to
      provide regulatory capital to the Bank. The loan bears interest at the prime
      rate.





Total
      stockholders’ equity at September 30, 2005 was $15,088,005 as compared to
      $13,418,764 at December 31, 2004. The increase in stockholders’ equity is a
      result of the positive operating results for the nine-months ended September
      30,
      2005 and $50,984 received upon the issuance of shares of common stock upon
      the
      exercise of options.





Management
      believes that the Company will need additional capital, in excess of the $2.9
      million still available under the credit facility, to support projected asset
      growth over the next 12 months. Management and the Capital Committee of the
      Board of Directors are currently evaluating available alternatives. Any
      additional capital, if available at all, may be on terms which are not as
      favorable to the Company as that desired by management and may result in
      dilution to the Company’s shareholders. If adequate capital is not available,
      the Company may be required to curtail its expected growth strategy.





*Allowance
      for Credit Losses and Credit Risk Management*





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





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





19


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





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





The
      allowance for credit losses as of September 30, 2005 and December 31, 2004
      was
      $2,350,000 and $1,810,000, respectively. The amount equates to 1.26% and 1.20%
      of outstanding loans as of September 30, 2005 and December 31, 2004,
      respectively. The increased percentage was directly related to an increase
      in
      the mix of loans with a higher risk factor based on management’s current loan
      grading system, which is discussed above. No additional information has
      indicated that the overall level of reserves is inappropriate. The Company
      has
      no exposure to foreign countries or foreign borrowers. Management believes
      that
      the allowance for credit losses is adequate for each period
      presented.





As
      of
      September 30, 2005, the Company had no loans more than 90 days past due and
      no
      loans classified as non-accrual loans. The Company had $7,500 of recoveries
      on
      past loan charge-offs during the nine-months ended September 30, 2005. The
      Company had loan charge-offs of $6,221 during the nine-months ended September
      30, 2004.





*Liquidity*





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





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





The
      Company's most liquid assets are cash and assets that can be readily converted
      into cash, including investment securities maturing within one year. As of
      September 30, 2005, the Company had $1,663,245 in cash and due from banks,
      $11,847,688 in federal funds sold and other overnight investments, $1,541,231
      in
      three-month U.S. Treasury Securities, and $19,096,277 in loans expected to
      be
      sold within 60 days. As of December 31, 2004, the Company had $1,403,424 in
      cash
      and due from banks, $16,708,528 in federal funds sold and other overnight
      investments, $1,544,496 in three-month U.S. Treasury Securities, and $9,613,162
      in loans expected to be sold within 60 days.





20


The
      stability in the overall level of liquid assets is the result of an ongoing
      effort by management to maintain adequate liquidity to fund loan growth and
      declines in deposit levels. Growth in the Company’s loan portfolio, without
      corresponding growth in deposits, would reduce liquidity, as would reductions
      in
      the level of customer deposits.





The
      Company has commitments for a total of $7.0 million of borrowing availability
      under unsecured Federal funds lines of credit with three separate financial
      institutions. The Company also has approximately $16.2 million of borrowing
      capacity with the Federal Home Loan Bank of Atlanta as of September 30, 2005
      and
      $2.9 million of borrowing capacity under its three-year note payable. These
      credit facilities can be used in conjunction with the normal deposit strategies,
      which include pricing changes to increase deposits as necessary. From time
      to
      time, the Company may sell or participate out loans to create additional
      liquidity as required.





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





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





*Interest
      Rate Sensitivity*





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




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





21


The
      following table sets forth the amount of the Company's interest-earning assets
      and interest-bearing liabilities as of September 30, 2005, which are expected
      to
      mature or reprice in each of the time periods shown:





**Maturity
                or repricing within****Amount**
            
            **Percent
                of**
              **Total**
            
            
            **0
                to 3**
              **Months**
            
            **4
                to 12**
              **Months**
            
            
            **1
                to 5******
              **Years**
            
            **Over
                5**
              **Years**Interest-earning
                assetsFederal
                funds sold and other overnight investments
            $
            11,847,688
            
            5.89%
            
            $
            11,847,688
            $
            -
            
            $
            -
            $
            -Loans
                held for sale
            
            19,096,277
            
            9.50%
            
            
            19,096,277
            
            -
            
            
            -
            
            -Loans
                - Variable rate
            
            110,292,053
            
            54.86%
            
            
            110,292,053
            
            -
            
            
            -
            
            -Loans
                - Fixed rate
            
            57,364,951
            
            28.53%
            
            
            2,864,244
            
            23,788,169
            
            
            29,586,307
            
            1,126,231Other
                earning assets
            
            2,448,171
            
            1.22%
            
            
            1,541,231
            
            -
            
            
            -
            
            906,940Total
                interest-earning assets
            $
            201,049,140
            
            100.00%
            
            $
            145,641,493
            $
            23,788,169
            
            $
            29,586,307
            $
            2,033,171Interest-bearing
                liabilitiesDeposits
                - Variable rate
            $
            66,931,193
            
            41.51%
            
            $
            66,931,193
            $
            -
            
            $
            -
            $
            -Deposits
                - Fixed rate
            
            88,511,676
            
            54.89%
            
            
            12,734,395
            
            31,253,091
            
            
            44,524,190
            
            -Short-term
                borrowings - Variable rate
            
            3,710,000
            
            2.30%
            
            
            3,710,000
            
            -
            
            
            -
            
            -Note
                Payable
            
            2,100,000
            
            1.30%
            
            
            2,100,000
            
            -
            
            
            -
            
            -Total
                interest-bearing liabilities
            $
            161,252,869
            
            100.00%
            
            $
            85,475,588
            $
            31,253,091
            
            $
            44,524,190
            $
            -Periodic
                repricing differencesPeriodic
                gap
            
            
            
            
            
            
            60,165,905
            
            (7,464,922
            )
            
            (14,937,883
            )
            2,033,171Cumulative
                gap
            
            
            
            
            
            
            60,165,905
            
            52,700,983
            
            
            37,763,100
            
            39,796,271Ratio
                of rate sensitive assets to rate
              sensitive
                liabilities
            
            
            
            
            
            
            170.39%
            
            76.11%
            
            
            66.45%
            
            N/A




The
      Company has 71.47% of its interest-earning assets and 45.11% of its
      interest-bearing liabilities in variable rate balances. Interest-earning assets
      exceed interest-bearing liabilities by $39,796,271. The majority of this gap
      is
      concentrated in items maturing or repricing within 5 years. This gap is
      generally reflective of the Company’s emphasis on originating variable rate
      loans and the demand in the market for higher yielding fixed rate deposits.
      This
      analysis indicates that the Company generally will benefit from increasing
      market rates of interest. However, since all interest rates and yields do not
      adjust at the same pace, the gap is only a general indicator of interest rate
      sensitivity. The analysis of the Company's interest-earning assets and
      interest-bearing liabilities presents only a static view of the timing of
      maturities and repricing opportunities, without taking into consideration the
      fact that changes in interest rates do not affect all assets and liabilities
      equally. Net interest income may be affected by other significant factors in
      a
      given interest rate environment, including changes in the volume and mix of
      interest-earning assets and interest-bearing liabilities.





Management
      constantly monitors and manages the structure of the Company's balance sheet,
      seeks to control interest rate exposure, and evaluate pricing strategies.
      Strategies to better match maturities of interest-earning assets and
      interest-bearing liabilities include structuring loans with rate floors and
      ceilings on variable-rate notes and providing for repricing opportunities on
      fixed rate notes. Management believes that a lending strategy focusing on
      variable-rate loans and short-term fixed rate loans will best facilitate the
      goal of minimizing interest rate risk. However, management will
      opportunistically enter into longer term fixed-rate loans and/or investments
      when, in management’s judgment, rates adequately compensate the Company for the
      interest rate risk. The Company's current investment concentration in federal
      funds sold and other overnight




22


investments
      provides the most flexibility and control over rate sensitivity since it
      generally can be restructured more quickly than the loan portfolio. On the
      liability side, deposit products can be restructured so as to offer incentives
      to attain the maturity distribution desired although competitive factors
      sometimes make control over deposit maturity difficult.





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





*Off-Balance
      Sheet Arrangements*





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





Outstanding
      loan commitments and lines and letters of credit as of September 30, 2005 and
      December 31, 2004 are as follows:





**September
                30,**
              **2005**
            
            **December
                31,**
              **2004**Loan
                commitments
            $
            22,514,982
            $
            9,867,893Unused
                lines of credit
            
            43,250,442
            
            40,423,986Letters
                of credit
            
            3,685,563
            
            1,578,379





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





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





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





The
      increase in the overall level of loan commitments and unused lines of credit
      as
      of September 30, 2005 as compared to loan commitments and unused lines of credit
      as of December 31, 2004, is consistent with the overall increase in outstanding
      loans.





23





*Capital
      Resources*





The
      Company had stockholders’ equity at September 30, 2005 of $15,088,005 as
      compared to $13,418,764 at December 31, 2004. The increase in capital is
      a
      result of the positive operating results for the nine-months ended September
      30,
      2005, and $50,984
      received upon the issuance of shares of common stock upon the exercise of
      options. Management believes that the Company will need additional capital, in excess of the $2.9 million still available under the
      credit facility, to support projected asset growth over the next 12 months.
      Management and the Capital Committee of the Board of Directors are currently
      evaluating available alternatives. Any additional capital, if available at
      all,
      may be on terms which are not favorable to the Company as that desired by
      management and may result in dilution to the Company’s shareholders. If adequate
      capital is not available, the Company may be required to curtail significantly
      its expected growth strategy.





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





Banking
      regulations also limit the amount of dividends that may be paid without prior
      approval of the Bank's regulatory agencies. Regulatory approval is required
      to
      pay dividends that exceed the Bank’s net profits for the current year plus its
      retained net profits for the preceding two years. The Bank could not have paid
      dividends to the Company without approval from bank regulatory agencies at
      September 30, 2005.





**Reconciliation
      of Non-GAAP Measures**





Below
      is
      a reconciliation of total deposits to core deposits as of September 30, 2005
      and
      December 31, 2004, respectively:





**September
                30,**
              **2005**
            
            
            **December
                31,**
              **2004**Total
                deposits
            
            
            $
            180,352,970
            
            $
            153,927,042National
                market certificates of deposit
            
            
            
            (34,248,440
            )
            
            (28,908,592
            )Variable
                balance accounts (3 customers)
            
            
            
            (15,421,565
            )
            
            (16,605,943
            )Portion
                of variable balance accounts considered to be core
            
            
            
            5,000,000
            
            
            5,000,000Core
                deposits
            
            
            $
            135,682,965
            
            $
            113,412,507





**Application
      of Critical Accounting Policies**





The
      Company’s consolidated financial statements are prepared in accordance with
      accounting principles generally accepted in the United States of America and
      follow general practices within the industries in which it operates. Application
      of these principles requires management to make estimates, assumptions and
      judgments that affect the amounts reported in the consolidated financial
      statements and accompanying notes. These estimates, assumptions and judgments
      are based on information available as of the date of the financial statements;
      accordingly, as this information changes, the financial statements could reflect
      different estimates, assumptions and judgments. Certain policies inherently
      have
      a greater reliance on the use of estimates, assumptions and judgments and as
      such, have a greater possibility of producing results that could be materially
      different than originally reported. Estimates, assumptions and judgments are
      necessary when assets and liabilities are required to be recorded at fair value,
      when a decline in the value of an asset not carried on the financial statements
      at fair value warrants an impairment write-down or valuation reserve to be
      established, or when an asset or liability must




24


be
      recorded contingent upon a future event. Carrying assets and liabilities at
      fair
      value inherently results in more financial statement volatility. The fair values
      and the information used to record valuation adjustments for certain assets
      and
      liabilities are based either on quoted market prices or are provided by other
      third-party sources, when available.





Based
      on
      the valuation techniques used and the sensitivity of financial statement amounts
      to the methods, assumptions and estimates underlying those amounts, management
      has identified the determination of the allowance for credit losses as the
      accounting area that requires the most subjective or complex judgments, and
      as
      such could be most subject to revision as new information becomes available.





Management
      has significant discretion in making the judgments inherent in the determination
      of the provision and allowance for credit losses. The establishment of allowance
      factors is a continuing exercise and allowance factors may change over time,
      resulting in an increase or decrease in the amount of the provision or allowance
      based upon the same volume and classification of loans. Changes in allowance
      factors or in management’s interpretation of those factors will have a direct
      impact on the amount of the provision and a corresponding effect on income
      and
      assets. Also, errors in management’s perception and assessment of the allowance
      factors could result in the allowance not being adequate to cover losses in
      the
      portfolio, and may result in additional provisions or charge-offs, which would
      adversely affect income and capital.





For
      additional information regarding the allowance for loan and lease losses, see
      the “Allowance for Credit Losses and Credit Risk Management” section of this
      financial review.





25


**Item
      3.**  **Controls
      and Procedures**





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





In
      addition, there were no changes in Bay National Corporation’s internal controls
      over financial reporting (as defined in Rule 13a-15 or Rule 15d-15 under the
      Securities Act of 1934, as amended) during the quarter ended September 30,
      2005,
      that have materially affected, or are reasonably likely to materially affect,
      Bay National Corporation’s internal control over financial
      reporting.





*Information
      Regarding Forward-Looking Statements*





In
      addition to the historical information contained in Part I of this Quarterly
      Report on Form 10-QSB, the discussion in Part I of this Quarterly Report on
      Form
      10-QSB contains certain forward-looking statements. Forward-looking statements
      often use words such as “believe,” “expect,” “plan,” “may,” “will,” “should,”
“project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of
      similar meaning. You can also identify them by the fact that they do not relate
      strictly to historical or current facts.





The
      statements presented herein with respect to, among other things, Bay National
      Corporation’s plans, objectives, expectations and intentions, including
      statements regarding profitability, liquidity, allowance for loan losses,
      interest rate sensitivity, market risk and financial and other goals are forward
      looking. These statements are based on Bay National Corporation’s beliefs and
      assumptions, and on information available to Bay National Corporation as of
      the
      date of this filing, and involve risks and uncertainties. These risks and
      uncertainties include, among others, those discussed in this Quarterly Report
      on
      Form 10-QSB; Bay National Corporation’s limited operating history; dependence on
      key personnel; risks related to Bay National Bank’s choice of loan portfolio;
      risks related to Bay National Bank’s lending limit; risks of a competitive
      market; impact of government regulation on operating results; and effect of
      developments in technology. For a more complete discussion of these risks and
      uncertainties, see the discussion under the caption “Factors Affecting Future
      Results” in Bay National Corporation’s Form 10-KSB for the year ended December
      31, 2004. Bay National Corporation’s and Bay National Bank’s actual results and
      the actual outcome of our expectations and strategies could differ materially
      from those anticipated or estimated because of these risks and uncertainties
      and
      you should not put undue reliance on any forward-looking statements. All
      forward-looking statements speak only as of the date of this filing, and Bay
      National Corporation undertakes no obligation to update the forward-looking
      statements to reflect factual assumptions, circumstances or events that have
      changed after the forward-looking statements are made.





26


**PART
      II - OTHER INFORMATION**





Item
      1.Legal
      Proceedings.





None





Item
      2.Unregistered
      Sales of Equity Securities and Use of Proceeds.





(a)  None





(b)  None





(c)  None





Item
      3.Defaults
      Upon Senior Securities.





Not
      applicable.





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





None





Item
      5.  Other
      Information.





None





27


Item
                6.
            Exhibits.(a)
            Exhibits.31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002.31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002.32
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                Section
                906 of the Sarbanes-Oxley Act of 2002.








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**SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.








Bay
                National CorporationDate:
                November 11, 2005
            
            By:
            /s/
                Hugh W. MohlerHugh
                W. Mohler, President(Principal
                Executive Officer)Date:
                November 11, 2005
            
            By:
            /s/
                Mark A. SemanieMark
                A. Semanie, Treasurer(Principal
                Accounting and Financial Officer)







29