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 June 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
      August
      11, 2005, the issuer had 1,924,436 shares of Common Stock
      outstanding.




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





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




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





**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      BALANCE SHEETS


As
      of
      June 30, 2005 and December 31, 2004





June
                30,
              2005
            
            December
                31,
              2004ASSETS
            
            (Unaudited)Cash
                and due from banks
            
            $
            1,179,685
            
            $
            1,403,424Federal
                funds sold and other overnight investments
            
            
            9,051,954
            
            
            16,708,528Investment
                securities available for sale (AFS) - at fair value
            
            
            1,542,436
            
            
            1,544,496Other
                equity securities
            
            
            794,440
            
            
            556,090Loans
                held for sale
            
            
            16,862,174
            
            
            9,613,162Loans,
                net of unearned fees
            
            
            157,422,710
            
            
            141,413,437Total
                loans
            
            
            174,284,884
            
            
            151,026,599Less:
                Allowance for credit losses
            
            
            (2,053,000
            )
            
            (1,810,000
            )Loans,
                net
            
            
            172,231,884
            
            
            149,216,599Premises
                and equipment, net
            
            
            799,509
            
            
            593,583Accrued
                interest receivable and other assets
            
            
            1,030,493
            
            
            740,754Total
                Assets
            
            $
            186,630,401
            
            $
            170,763,474LIABILITIESNon-interest-bearing
                deposits
            
            $
            23,449,676
            
            $
            20,638,596Interest-bearing
                deposits
            
            
            145,018,555
            
            
            133,288,446Total
                deposits
            
            
            168,468,231
            
            
            153,927,042Short-term
                borrowings
            
            
            1,498,000
            
            
            1,381,000Note
                Payable
            
            
            1,500,000
            
            
            1,250,000Accrued
                expenses and other liabilities
            
            
            826,810
            
            
            786,668Total
                Liabilities
            
            
            172,293,041
            
            
            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 June 30, 2005 and December 31, 2004,
                respectively
            
            
            19,244
            
            
            19,177Additional
                paid in capital
            
            
            17,451,201
            
            
            17,400,284Accumulated
                deficit
            
            
            (3,133,085
            )
            
            (4,000,697
            )Total
                Stockholders' Equity
            
            
            14,337,360
            
            
            13,418,764Total
                Liabilities and Stockholders' Equity
            
            $
            186,630,401
            
            $
            170,763,474




See
        accompanying notes to consolidated financial statements.


2




**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF OPERATIONS


For
      the
      three and six-month periods ended June 30, 2005 and 2004


(Unaudited)





Three
                Months Ending
              June
                30
            
            Six
                Months Ending
              June
                302005
            
            2004
            
            2005
            
            2004INTEREST
                INCOME:Interest
                and fees on loans
            
            $
            2,776,966
            
            $
            1,708,501
            
            $
            5,240,226
            
            $
            3,239,145Interest
                on federal funds sold and other overnight investments
            
            
            45,306
            
            
            26,557
            
            
            111,784
            
            
            52,499Taxable
                interest and dividends on investmentsecurities
            
            
            25,762
            
            
            14,890
            
            
            37,368
            
            
            19,785Total
                interest income
            
            
            2,848,034
            
            
            1,749,948
            
            
            5,389,378
            
            
            3,311,429INTEREST
                EXPENSE:Interest
                on deposits
            
            
            873,777
            
            
            567,247
            
            
            1,664,246
            
            
            1,075,684Interest
                on short-term borrowings
            
            
            37,434
            
            
            3,532
            
            
            45,550
            
            
            6,440Interest
                on note payable
            
            
            18,527
            
            
            -
            
            
            35,523
            
            
            -Total
                interest expense
            
            
            929,738
            
            
            570,779
            
            
            1,745,319
            
            
            1,082,124Net
                interest income
            
            
            1,918,296
            
            
            1,179,169
            
            
            3,644,059
            
            
            2,229,305Provision
                for credit losses
            
            
            203,500
            
            
            104,000
            
            
            235,500
            
            
            213,721Net
                interest income after provision forcredit
                losses
            
            
            1,714,796
            
            
            1,075,169
            
            
            3,408,559
            
            
            2,015,584NON-INTEREST
                INCOME:Service
                charges on deposit accounts
            
            
            44,703
            
            
            57,123
            
            
            93,942
            
            
            111,578Gain
                on sale of mortgage loans
            
            
            104,147
            
            
            74,172
            
            
            145,751
            
            
            131,121Other
                income
            
            
            11,551
            
            
            12,201
            
            
            22,937
            
            
            26,124Total
                non-interest income
            
            
            160,401
            
            
            143,496
            
            
            262,630
            
            
            268,823NON-INTEREST
                EXPENSES:Salaries
                and employee benefits
            
            
            832,896
            
            
            589,209
            
            
            1,581,491
            
            
            1,183,886Occupancy
                expenses
            
            
            100,709
            
            
            73,194
            
            
            194,883
            
            
            143,015Furniture
                and equipment expenses
            
            
            74,791
            
            
            68,467
            
            
            151,882
            
            
            122,570Legal
                and professional fees
            
            
            32,712
            
            
            27,000
            
            
            72,712
            
            
            50,748Data
                processing and other outside services
            
            
            143,010
            
            
            151,989
            
            
            351,835
            
            
            282,660Advertising
                and marketing related expenses
            
            
            90,850
            
            
            41,476
            
            
            152,635
            
            
            84,974Other
                expenses
            
            
            162,107
            
            
            94,023
            
            
            298,139
            
            
            182,171Total
                non-interest expenses
            
            
            1,437,075
            
            
            1,045,358
            
            
            2,803,577
            
            
            2,050,024Income
                before income taxes
            
            
            438,122
            
            
            173,307
            
            
            867,612
            
            
            234,383Income
                tax expense
            
            
            -
            
            
            -
            
            
            -
            
            
            -NET
                INCOME
            
            $
            438,122
            
            $
            173,307
            
            $
            867,612
            
            $
            234,383Per
                Share Data:Cash
                Dividends Paid
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Net
                Income (basic)
            
            $
            .23
            
            $
            .09
            
            $
            .45
            
            $
            .13Net
                Income (diluted)
            
            $
            .22
            
            $
            .09
            
            $
            .44
            
            $
            .12Weighted
                Average shares outstanding (basic)
            
            
            1,921,649
            
            
            1,862,710
            
            
            1,920,693
            
            
            1,862,710Effect
                of Dilution - Stock options and Warrants
            
            
            76,269
            
            
            71,040
            
            
            72,020
            
            
            62,272Weighted
                Average shares outstanding (diluted)
            
            
            1,997,918
            
            
            1,933,750
            
            
            1,992,713
            
            
            1,924,982





See
      accompanying notes to consolidated financial statements.


3




**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


For
      the
      six-months ended June 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
            
            
            -
            
            
            -
            
            
            867,612
            
            
            867,612Balances
                at June 30, 2005
            
            $
            19,244
            
            $
            17,451,201
            
            $
            (3,133,085
            )
            $
            14,337,360Common
                Stock
            
            
            Additional
              Paid
                in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              EquityBalances
                at December 31, 2003
            
            $
            18,627
            
            $
            16,850,834
            
            $
            (4,802,961
            )
            $
            12,066,500Net
                Income
            
            
            -
            
            
            -
            
            
            234,383
            
            
            234,383Balances
                at June 30, 2004
            
            $
            18,627
            
            $
            16,850,834
            
            $
            (4,568,578
            )
            $
            12,300,883




See
      accompanying notes to consolidated financial statements.





4


**BAY
      NATIONAL CORPORATION**





CONSOLIDATED
      STATEMENTS OF CASH FLOWS


For
      the
      six-months ended June 30, 2005 and 2004


(Unaudited)





2005
            
            2004Cash
                Flows From Operating ActivitiesNet
                income
            
            $
            867,612
            
            $
            234,383Adjustments
                to reconcile net income to net cash usedby
                operating activities:Depreciation
            
            
            86,509
            
            
            94,683Accretion
                of investment discounts
            
            
            (19,872
            )
            
            (7,192
            )Provision
                for credit losses
            
            
            235,500
            
            
            213,721Gain
                on sale of loans held for sale
            
            
            (145,751
            )
            
            (131,121
            )Origination
                of loans held for sale
            
            
            (77,927,607
            )
            
            (48,737,479
            )Proceeds
                from sale of loans
            
            
            70,824,346
            
            
            34,109,507Net
                increase in accrued interest receivable and other assets
            
            
            (289,739
            )
            
            (238,115
            )Net
                increase (decrease) in accrued expenses and other
                liabilities
            
            
            40,142
            
            
            (26,763
            )Net
                cash used by operating activities
            
            
            (6,328,860
            )
            
            (14,488,376
            )Cash
                Flows From Investing ActivitiesPurchases
                of investment securities - AFS
            
            
            (3,078,068
            )
            
            (2,992,365
            )Maturities
                of investment securities - AFS
            
            
            3,100,000
            
            
            3,000,000Purchase
                of Federal Reserve Bank stock
            
            
            (139,650
            )
            
            -Purchase
                of Federal Home Loan Bank of Atlanta stock
            
            
            (98,700
            )
            
            (51,200
            )Loan
                disbursements in excess of principal payments
            
            
            (16,001,773
            )
            
            (16,537,184
            )Capital
                expenditures
            
            
            (292,435
            )
            
            (108,341
            )Net
                cash used by investing activities
            
            
            (16,510,626
            )
            
            (16,689,090
            )Cash
                Flows From Financing ActivitiesNet
                increase in deposits
            
            
            14,541,189
            
            
            19,855,526Net
                increase in short-term borrowings
            
            
            117,000
            
            
            328,000Proceeds
                from notes payable
            
            
            250,000Net
                proceeds from stock issuance
            
            
            50,984
            
            
            -Net
                cash provided by financing activities
            
            
            14,959,173
            
            
            20,183,526Net
                decrease in cash and cash equivalents
            
            
            (7,880,313
            )
            
            (10,993,940
            )Cash
                and cash equivalents at beginning of period
            
            
            18,111,952
            
            
            18,060,105Cash
                and cash equivalents at end of period
            
            $
            10,231,639
            
            $
            7,066,165Cash
                paid for:Interest
            
            $
            1,705,524
            
            $
            1,054,894Income
                taxes
            
            $
            -
            
            $
            -




See
      accompanying notes to consolidated financial statements.


5


**BAY
      NATIONAL CORPORATION**





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


For
      The
      Three and Six Months Ended June 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 June 30,
      2005, that the Bank meets all capital adequacy requirements to which it is
      subject.





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




**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 six-month
      periods ended June 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
      six-month periods ended June 30:





Three
                Months Ending
              June
                30
            
            Six
                Months Ending
              June
                302005
            
            2004
            
            2005
            
            2004Net
                income, as reported
            
            $
            438,122
            
            $
            173,307
            
            $
            867,612
            
            $
            234,383Less
                pro forma stock-based compensation expense determined under the fair
                value
                method
            
            
            (57,467
            )
            
            (56,063
            )
            
            (74,478
            )
            
            (71,672
            )Pro
                forma net income
            
            $
            380,655
            
            $
            117,244
            
            $
            793,134
            
            $
            162,711Net
                income per share:Basic
                - as reported
            
            $
            .23
            
            $
            .09
            
            $
            .45
            
            $
            .13Diluted
                - as reported
            
            $
            .22
            
            $
            .09
            
            $
            .44
            
            $
            .12Basic
                - pro forma
            
            $
            .20
            
            $
            .06
            
            $
            .41
            
            $
            .09Diluted
                - pro forma
            
            $
            .19
            
            $
            .06
            
            $
            .40
            
            $
            .08





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 June 30, 2005 and December 31, 2004 and for the three-month
      and six-month periods ended June 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**





After
      a
      slow first quarter, strong asset growth resumed for the three-month period
      ended
      June 30, 2005, while operating results continued a strong trend of improvement
      over prior year results. Key measurements for the three-month and six-month
      periods ended June 30, 2005 include the following:





·
            Total
                assets at June 30, 2005 increased to $186.6 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
                $172.2 million as of June 30, 2005.





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





·
            Deposits
                at June 30, 2005 were $168.5 million, an increase from $153.9 million
                as
                of December 31, 2004.





·
            The
                Company realized net income of $438,122 and $867,612 for the three-month
                and six-month periods ended June 30, 2005, respectively. This represents
                increases of 152.8% and 270.2% over net income of $173,307 and $234,383
                for the three-month and six month periods ended June 30, 2004,
                respectively.





·
            Net
                interest income, the Company’s main source of income, was $1.9 million and
                $3.6 million during the three-month and six-month periods ended June
                30,
                2005 compared to $1.2 million and $2.2 million for the same periods
                in
                2004. This represents an increase of 62.7% and 63.5% for the three-months
                and six-months ended June 30, 2005, respectively, as compared to
                the same
                periods in 2004.





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





·
            Non-interest
                income increased by $16,905, or 11.8%, for the three-month period
                and
                declined by $6,193, or 2.3%, for the six-month period ended June
                30, 2005,
                as compared to the same period in 2004.





9




·
            Non-interest
                expenses increased by $391,717 and $753,553, or 37.5% and 36.8%,
                for the
                three-month and six-month periods ended June 30, 2005, respectively,
                as
                compared to the same periods ended June 30, 2004.





·
            The
                market price of common shares ended the quarter at $17.25, up 30.2%
                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 $438,122 and $867,612 for the three-month and
      six-month periods ended June 30, 2005. This compares to net income of $173,307
      and $234,383 for the same periods in 2004. This is an improvement of $264,815,
      or 152.8%, for the three-month period and $633,229, or 270.2%, for the six-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 is expected
      to
      contribute to the Company’s overall profitability during the second half of
      2005. For the three-month periods ended June 30, 2005 and 2004, gains on the
      sale of mortgage loans totaled $104,147 and $74,172, respectively. For the
      six-month periods ended June 30, 2005 and 2004, gains on the sale of mortgage
      loans totaled $145,751 and $131,121, 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 will then be sold in the
      secondary market. This type of residential lending is expected to be 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.





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 June 30, 2005, the Company held $14.1 million of these loans
      which were classified as held for sale. The Company earned $233,383 of interest
      on this program for the six-month period ended June 30, 2005. This compares
      to
      $70,633 for the same period in 2004.




10




Management
      expects continued improvement 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 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 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 $1.9 million and $3.6 million during
      the three-month and six-month periods ended June 30, 2005 as compared to $1.2
      million and $2.2 million for the same periods in 2004. This represents increases
      of 62.7% and 63.5% for the three-months and six-months ended June 30, 2005
      as
      compared to the same periods in 2004.





Interest
      income from loans and investments for the three-month and six-month periods
      ended June 30, 2005 was $2.8 million and $5.4 million, respectively, compared
      to
      $1.7 million and $3.3 million, respectively, for the three-month and six-month
      periods ended June 30, 2004. The 62.8% increases for the three and six-month
      periods over the same periods in 2004 were directly related to the 29.3%
      increase in average interest-earning assets for the six-months ended June 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 nine .25% increases in the target federal funds rate since June
      30, 2004. The yields on these assets increased from 5.05% for the six-months
      ended June 30, 2004 to 6.36% for the six-months ended June 30,
      2005.





The
      percentage of average interest-earning assets represented by loans was 91.2%
      and
      86.9% for the six-month period ended June 30, 2005 and 2004, respectively.
      For
      the six-month period ended June 30, 2005, the average yield on the loan
      portfolio increased to 6.78% from 5.69% for the six-month period ended June
      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 1.00%
      as of June 30, 2004 to 3.25% as of June 30, 2005. As can be seen by the yields
      discussed above, these increases have begun to have 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.





The
      average yield on the investment portfolio and other earning assets, such as
      federal funds sold, was 2.00% for the six-month period ended June 30, 2005
      as
      compared to .84% 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 8.8% and 13.1% for the six-month periods ended June 30, 2005
      and
      2004, respectively.


11




Interest
      expense from deposits and borrowings for the three-month and six-month periods
      ended June 30, 2005 was $929,738 and $1,745,319, respectively. This compares
      to
      $570,779 and $1,082,124 for the comparable periods in 2004. The 62.9% and 61.3%
      increases over the three-month and six-month periods in 2004 are a result of
      a
      28.3% increase  in
      average interest-bearing liabilities for the six-month period ended June 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 2.08% for the six-month period ended June
      30,
      2004 to 2.62% for the six-month period ended June 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
      June
      30, 2004, management has been able to minimize 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.





**Six
                Months Ended June 30, 2005****Average**
              **Balance**
            
            **Interest**
              **and
                fees**
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            154,633,131
            
            $
            5,240,226
            
            
            6.78
            %Investment
                securities
            
            
            2,234,294
            
            
            37,368
            
            
            3.34Federal
                funds sold and other overnight investments
            
            
            12,705,699
            
            
            111,784
            
            
            1.76Total
                earning assets
            
            
            169,573,124
            
            
            5,389,378
            
            
            6.36
            %Less:
                Allowance for credit losses
            
            
            (1,855,576
            )Cash
                and due from banks
            
            
            1,224,630Premises
                and equipment, net
            
            
            632,884Accrued
                interest receivable and other assets
            
            
            822,330Total
                assets
            
            $
            170,397,392LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            54,599,691
            
            
            423,803
            
            
            1.55
            %Regular
                savings deposits
            
            
            5,472,360
            
            
            17,600
            
            
            .64Time
                deposits
            
            
            68,808,025
            
            
            1,222,843
            
            
            3.55Short-term
                borrowings
            
            
            3,312,326
            
            
            45,550
            
            
            2.75Note
                payable
            
            
            1,251,381
            
            
            35,523
            
            
            5.68Total
                interest-bearing liabilities
            
            
            133,443,783
            
            
            1,745,319
            
            
            2.62
            %Net
                interest income and spread
            
            
            
            
            $
            3,644,059
            
            
            3.74
            %Non-interest-bearing
                demand deposits
            
            
            22,486,472Accrued
                expenses and other liabilities
            
            
            667,377Stockholders’
                equity
            
            
            13,799,760Total
                liabilities and stockholders’ equity
            
            $
            170,397,392Interest
                income/earning assets
            
            
            6.36
            %Interest
                expense/earning assets
            
            
            2.06Net
                interest margin
            
            
            4.30
            %Return
                on Average Assets (Annualized)
            
            
            1.02
            %Return
                on Average Equity (Annualized)
            
            
            12.57
            %Average
                Equity to Average Assets
            
            
            8.10
            %





13




**Six****Months Ended June 30, 2004****Average**
              **Balance**
            
            **Interest**
              **and
                fees**
            
            **Yield/**
              **Rate**ASSETSLoans
                and loans held for sale
            
            $
            113,905,280
            
            $
            3,239,145
            
            
            5.69
            %Investment
                securities
            
            
            1,991,440
            
            
            19,785
            
            
            1.99Federal
                funds sold and other overnight investments
            
            
            15,227,504
            
            
            52,499
            
            
            .69Total
                earning assets
            
            
            131,124,224
            
            
            3,311,429
            
            
            5.05
            %Less:
                Allowance for credit losses
            
            
            (1,354,026
            )Cash
                and due from banks
            
            
            804,855Premises
                and equipment, net
            
            
            654,798Accrued
                interest receivable and other assets
            
            
            518,384Total
                assets
            
            $
            131,748,235LIABILITIES
                AND STOCKHOLDERS’ EQUITYInterest-bearing
                demand deposits
            
            $
            42,164,785
            
            
            218,923
            
            
            1.04
            %Regular
                savings deposits
            
            
            3,700,434
            
            
            11,984
            
            
            .65Time
                deposits
            
            
            56,924,186
            
            
            844,777
            
            
            2.97Short-term
                borrowings
            
            
            1,340,357
            
            
            6,440
            
            
            .96Total
                interest-bearing liabilities
            
            
            104,129,762
            
            
            1,082,124
            
            
            2.08
            %Net
                interest income and spread
            
            
            
            
            $
            2,229,305
            
            
            2.97
            %Non-interest-bearing
                demand deposits
            
            
            15,018,908Accrued
                expenses and other liabilities
            
            
            435,452Stockholders’
                equity
            
            
            12,164,113Total
                liabilities and stockholders’ equity
            
            $
            131,748,235Interest
                income/earning assets
            
            
            5.05
            %Interest
                expense/earning assets
            
            
            1.65Net
                interest margin
            
            
            3.40
            %Return
                on Average Assets (Annualized)
            
            
            .36
            %Return
                on Average Equity (Annualized)
            
            
            3.85
            %Average
                Equity to Average Assets
            
            
            9.23
            %





*Provision
      for Credit Losses*





The
      provision for credit losses was $203,500 and $235,500 for the three-month and
      six-month periods ended June 30, 2005, respectively, as compared to $104,000
      and
      $213,721 for the three-month and six-month periods ended June 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 six-month periods ended June 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 June 30, 2005, the Company realized non-interest income in the amount
      of
      $160,401 as compared to $143,496 for the three-month period ended June 30,
      2004.
      Gains on the sale of mortgage loans of $104,147 comprised 64.9% of the total
      for
      the three-month period ended June 30, 2005. This compares to gains on the sale
      of mortgage loans of $74,172, or 51.7%, of total non-interest income, for the
      three-month period ended June 30, 2004.




14




For
      the
      six-month period ended June 30, 2005, the Company realized non-interest income
      in the amount of $262,630 as compared to $268,823 for the six-month period
      ended
      June 30, 2004. Gains on the sale of mortgage loans of $145,751 comprised 55.5%
      of the total for the six-month period ended June 30, 2005. This compares to
      gains on the sale of mortgage loans of $131,121, or 48.8% of total non-interest
      income, for the six-month period ended June 30, 2004.





The
      level
      of gains on the sale of mortgage loans has increased in the three-months and
      six-months ended June 30, 2005 because the Company added additional residential
      construction and mortgage capabilities through the addition of the Lutherville
      mortgage operation in February 2005. 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. This capability
      was
      added through the hiring of a team of eight individuals, including originators,
      processors and servicers from another financial institution. These individuals
      have extensive experience in the industry and the Company’s market area.





Service
      charges on deposit accounts totaled $44,703 and $93,942 for the three-month
      and
      six-month periods ended June 30, 2005, as compared to $57,123 and $111,578
      for
      the three-month and six-month periods ended June 30, 2004. The decreases of
      21.7% and 15.8% 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 six-month periods ended June 30, 2005 totaled
      $1,437,075 and $2,803,577, respectively. This compares to non-interest expense
      for the comparable periods in 2004 of $1,045,358 and $2,050,024, respectively.
      The increases of $391,717, or 37.5%, and $753,553, or 36.8%, for the three-month
      and six-month periods, respectively, primarily resulted from an increase in
      salaries and benefits of $243,687, or 41.4%, and $397,605, or 33.6%, 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 four commercial account portfolio managers
      and
      other operational support personnel. These additions were made to continue
      to
      expand the marketing efforts of the Bank, as well as to manage the growth of
      the
      loan and deposit portfolios and support increased operational volume.





Occupancy
      expenses increased by $27,515 and $51,868 for the three-months and six-months
      ended June 30, 2005, respectively, as compared to the same periods in 2004.
      The
      37.6% and 36.3% 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
      $69,175, or 24.5%, increase in data processing and other outside services for
      the six-months ended June 30, 2005 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, $13,000 of recruiting fees paid to hire
      an
      additional corporate finance and compliance staff person, 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 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. The decrease of
      $8,979, or 5.9%, for the three-months ended June 30, 2005 was due to the fact
      that the three-months ended June 30, 2004 included $15,000 of fees paid for
      recruiting services. No such fees were incurred in the most recent quarter.





Advertising
      and marketing-related expenses increased $49,374, or 119.0%, and $67,661, or
      79.6%, for the three-months and six-months ended June 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 a $20,000 increase in
      contributions to The Baltimore Community Foundation account established by
      the
      Bank.





The
      increases of $68,084, or 72.4%, and $115,968, or 63.7%, in other expenses for
      the three-month and six-month periods ended June 30, 2005, respectively,
      includes director fees of approximately $21,000 and $42,000, 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.





As
      previously discussed, non-interest expense for the three-month and six-month
      periods ended June 30, 2005 increased by 37.5% and 36.8%, respectively. The
      rate
      of increase in non-interest expenses, including non-recurring expenses, is
      substantially less than the 62.7% and 63.5% increases in net interest income
      for
      the three-month and six-month periods ended June 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.





*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.


16




**Financial
      Condition**





*Composition
      of the Balance Sheet*





As
      of
      June 30, 2005, total assets were $186,630,401. This represents growth of
      $15,866,927, or 9.3%, since December 31, 2004. The growth in total assets
      included increases of $238,350 in other equity securities, $23,015,285 in loans
      net of the allowance for credit losses and $495,665 in other non-earning assets.
      These increases were offset by decreases of $223,739 in cash and due from banks,
      $7,656,574 in federal funds sold and other overnight investments and $2,060
      in
      investment securities available for sale.





During
      the second quarter of 2004, the Company introduced a new loan program for
      conventional first and second 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 June 30, 2005, the Company
      held
      $14.1 million of these loans which were classified as held for sale, a
      significant increase from the $9.6 million held as of December 31,
      2004.





As
      of
      June 30, 2005, loans, excluding
      loans held for sale, totaled $157,422,710. The increase of $16,009,273, or
      11.3%, from a balance of $141,413,437 as of December 31, 2004, is a
      slow
      down from the growth trend established in prior periods. The majority of this
      growth occurred in the three-month period ended June 30, 2005, following modest
      first quarter growth that was impacted by significant pay downs and payoffs.
      A
      total of approximately $11.8 million in loans that were outstanding as of
      December 31, 2004 were paid off during the first quarter of 2005. This activity
      combined with normal fluctuations in revolving credit balances and installment
      payments on amortizing loans offset most of the approximately $14.8 million
      in
      new loans funded during that same quarter. Management did not believe that
      the
      first quarter loan growth was an indicator of any ongoing trend that would
      result in further moderation of growth, and strong growth in the second quarter
      has confirmed that belief. The Company continues to emphasize prudent growth
      through the hiring of experienced commercial lenders, and the development and
      use of referral sources including accountants, lawyers and existing customers,
      as well as members of the Board of Directors and the Baltimore and Salisbury
      Advisory Boards.





The
      composition of the loan portfolio as of June 30, 2005 was approximately $73.6
      million of commercial loans, $1.8 million of consumer loans, and $82.0 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 $16.9 million and $9.6 million as of June 30, 2005 and December 31,
      2004, respectively.





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 $12.6 million as of June 30,
      2005
      compared to approximately $20.2 million as of December 31, 2004. At June 30,
      2005, the Company had federal funds sold and other overnight investments
      totaling $9,051,954 as compared to $16,708,528 as of December 31, 2004. The
      Company held $452,340 of Federal Reserve Bank stock as of June 30, 2005 and
      $312,690 as of December 31, 2004. The Company also held Federal Home Loan Bank
      of Atlanta stock of $342,100 and $243,400 as of June 30, 2005 and December
      31,
      2004, respectively, and United States Treasury bills with a maturity value
      of
      $1,550,000 as of both June 30, 2005 and December 31, 2004. The Treasury
      securities are used to collateralize repurchase agreements, which are classified
      as short-term borrowings under which $1,498,000 and $1,381,000 were outstanding
      as of June 30, 2005 and December 31, 2004, respectively.




17




The
      increase in total assets was funded with operating earnings and an increase
      in
      deposits of $14,541,189, or 9.4%, since December 31, 2004. Short-term borrowings
      increased by $117,000. 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.





Deposits
      at June 30, 2005 were $168,468,231, of which approximately $11.8 million, or
      7.0%, 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 June 30, 2005, the Company had
      outstanding certificates of deposit of approximately $31.8 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 3.80% and an average term of 29.5 months.
      Included in the $31.8 million of Internet-originated certificates of deposit
      is
      $195,968 that has been classified as “Brokered Deposits” for bank regulatory
      purposes. These “Brokered Deposits” were issued in average amounts of
      approximately $97,984 with an average yield of 2.79% and an average term of
      45
      months. 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
      $129,888,763 as of June 30, 2005, up 14.5% 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 short-term borrowings increased from $1,381,000 at December 31,
      2004
      to $1,498,000 at June 30, 2005 due to increases in the balance of available
      funds for customers participating in this program .





Note
      payable consists of $1,500,000 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.




18




Total
      stockholders’ equity at June 30, 2005 was $14,337,360 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 six-months ended June 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 $3.5
      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 significantly 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.





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.




19




The
      allowance for credit losses as of June 30, 2005 and December 31, 2004 was
      $2,053,000 and $1,810,000, respectively. The amount equates to 1.18% and 1.20%
      of outstanding loans as of June 30, 2005 and December 31, 2004, respectively.
      This percentage has remained fairly consistent because 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
      June 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 six-months ended June 30, 2005. The Company had
      loan
      charge-offs of $6,221 during the six-months ended June 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
      June
      30, 2005, the Company had $1,179,685 in cash and due from banks, $9,051,954
      in
      federal funds sold and other overnight investments, $1,542,436 in three-month
      U.S. Treasury Securities, and $16,862,174 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.





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 $17 million of borrowing
      capacity with the Federal Home Loan Bank of Atlanta as of June 30, 2005 and
      $3.5
      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.





20




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.





The
      following table sets forth the amount of the Company's interest-earning assets
      and interest-bearing liabilities as of June 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
              
              $
              9,051,954
              
              
              4.88
              %
              $
              9,051,954
              
              $
              -
              
              $
              -
              
              $
              -Loans
                  held for sale
              
              
              16,862,174
              
              
              9.08
              %
              
              16,862,174
              
              
              -
              
              
              -
              
              
              -Loans
                  - Variable rate
              
              
              107,541,536
              
              
              57.92
              %
              
              107,541,536
              
              
              -
              
              
              -
              
              
              -Loans
                  - Fixed rate
              
              
              49,881,174
              
              
              26.86
              %
              
              2,918,998
              
              
              15,350,517
              
              
              30,022,236
              
              
              1,589,423Other
                  earning assets
              
              
              2,336,876
              
              
              1.26
              %
              
              1,542,436
              
              
              -
              
              
              -
              
              
              794,440Total
                  interest-earning assets
              
              $
              185,673,714
              
              
              100.00
              %
              $
              137,917,098
              
              $
              15,350,517
              
              $
              30,022,236
              
              $
              2,383,863Interest-bearing
                  liabilitiesDeposits
                  - Variable rate
              
              $
              61,001,300
              
              
              41.21
              %
              $
              61,001,300
              
              $
              -
              
              $
              -
              
              $
              -Deposits
                  - Fixed rate
              
              
              84,017,255
              
              
              56.76
              %
              
              16,269,915
              
              
              25,358,135
              
              
              42,389,205
              
              
              -Short-term
                  borrowings - Variable rate
              
              
              1,498,000
              
              
              1.01
              %
              
              1,498,000
              
              
              -
              
              
              -
              
              
              -Note
                  Payable
              
              
              1,500,000
              
              
              1.02
              %
              
              1,500,000
              
              
              -
              
              
              -
              
              
              -Total
                  interest-bearing liabilities
              
              $
              148,016,555
              
              
              100.00
              %
              $
              80,269,215
              
              $
              25,358,135
              
              $
              42,389,205
              
              $
              -Periodic
                  repricing differencesPeriodic
                  gap
              
              
              
              
              
              
              
              $
              57,647,883
              
              $
              (10,007,618
              )
              $
              (12,366,969
              )
              $
              2,383,863Cumulative
                  gap
              
              
              
              
              
              
              
              $
              57,647,883
              
              $
              47,640,265
              
              $
              35,273,296
              
              $
              37,657,159Ratio
                  of rate sensitive assets to rate sensitive liabilities
              
              
              
              
              
              
              
              
              171.82
              %
              
              60.53
              %
              
              70.83
              %
              
              N/A
 21




The
      Company has 71.88% of its interest-earning assets and 43.24% of its
      interest-bearing liabilities in variable rate balances. Interest-earning assets
      exceed interest-bearing liabilities by $37,657,159. 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 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 June 30, 2005 and
      December 31, 2004 are as follows:





**June
                30,**
              **2005**
            
            **December
                31, 2004**Loan
                commitments
            
            $
            14,583,165
            
            $
            9,867,893Unused
                lines of credit
            
            
            46,459,812
            
            
            40,423,986Letters
                of credit
            
            
            1,416,002
            
            
            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.





22




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
      modest increase in the overall level of loan commitments and unused lines of
      credit as of June 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.





*Capital
      Resources*





The
      Company had stockholders’ equity at June 30, 2005 of $14,337,360 as compared to
      $13,418,764 at December 31, 2004. The increase in capital is
      a
      result of the positive operating results for the six-months ended June 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 $3.5 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 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
      June
      30, 2005.





23


**Reconciliation
      of Non-GAAP Measures**





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





**June
                30,**
              **2005**
            
            **December
                31,**
              **2004**Total
                deposits
            
            $
            168,468,231
            
            $
            153,927,042National
                market certificates of deposit
            
            
            (31,762,774
            )
            
            (28,908,592
            )Variable
                balance accounts (3 customers)
            
            
            (11,816,694
            )
            
            (16,605,943
            )Portion
                of variable balance accounts considered to be core
            
            
            5,000,000
            
            
            5,000,000Core
                deposits
            
            $
            129,888,763
            
            $
            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 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.





24


**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 June 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. Our actual results and the actual
      outcome of our expectations and strategies could be different from those
      anticipated or estimated.





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.





Bay
      National Corporation’s actual results could differ materially from those
      discussed herein and you should not put undue reliance on any forward-looking
      statements. All forward-looking statements speak only as of the date of this
      filing, and Bay National Corporation undertakes no obligation to make any
      revisions to the forward-looking statements to reflect events or circumstances
      after the date of this filing or to reflect the occurrence of unanticipated
      events.


25


**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.





At
      the
      Company’s Annual Meeting of Stockholders held May 24, 2005, the following
      directors were elected to serve a three-year term expiring upon the date of
      the
      Company’s 2008 Annual Meeting or until their respective successors are duly
      elected and qualified.





Votes
                CastFor
            Withheld
            TotalCarroll
                A. Bodie
            1,483,653
            2,500
            1,486,153Charles
                E. Bounds
            1,483,153
            3,000
            1,486,153Gary
                T. Gill
            1,480,653
            5,500
            1,486,153John
                R. Lerch
            1,483,653
            2,500
            1,486,153James
                P. O’Conor
            1,483,653
            2,500
            1,486,153Carl
                A.J. Wright
            1,483,653
            2,500
            1,486,153





Names
      of
      other directors continuing in office:





Donald
                G. McClure, Jr.Hugh
                W. MohlerRobert
                L. MooreH.
                Victor Rieger, Jr.William
                B. RinnierEdwin
                A. Rommel IIIHenry
                H. StansburyKenneth
                H. TroutEugene
                M. Waldron, Jr.





26





At
      the
      Company’s Annual Meeting of Stockholders held May 24, 2005, the selection of
      Stegman & Company to serve as independent auditors for the 2005 fiscal year
      was ratified by the following vote:





Votes
                CastFor
            Against
            Abstain
            Total1,485,653
            500
            0
            1,486,153





There
      were no broker nonvotes on these matters.





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.











28


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




29