UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (d)


OF THE
SECURITIES EXCHANGE ACT OF 1934





For the
quarterly period ended March 31, 2009





Commission
file number: 000-51765








Bay
National Corporation


(Exact
name of registrant 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


(Registrant’s
telephone number, including area code)





Indicate
by checkmark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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




Indicate
by check mark whether the registrant has submitted electronically and posted
on  its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files).


Yes
              
              
              No




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.




Large
accelerated filer o                                                                                                          Accelerated
filer o





Non-accelerated
filer o (Do
not check if a smaller reporting
company)              Smaller
reporting company þ





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes ____No X__





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





At May 13, 2009, the issuer had
2,154,301 shares of Common Stock outstanding.














PART
I   -     FINANCIAL
INFORMATION





Item
1.                 Financial
Statements





BAY
NATIONAL CORPORATION





CONSOLIDATED BALANCE
SHEETS


As of
March 31, 2009 and December 31, 2008





March
      31,
              2009
            
            
            December
      31,
              2008ASSETS
            
            (Unaudited)Cash and due from
      banks
            
            $
            17,833,255
            
            
            $
            7,263,034Federal funds sold and other
      overnight investments
            
            
            19,661,640
            
            
            
            2,023,478Investment
      securities available for sale (AFS) - at fair value
            
            
            -
            
            
            
            -Other
      equity securities
            
            
            1,191,900
            
            
            
            1,239,600Loans
      held for sale
            
            
            3,138,341
            
            
            
            1,187,954Loans, net of unearned
      fees
            
            
            244,882,588
            
            
            
            247,162,767Total
      Loans
            
            
            248,020,929
            
            
            
            248,350,721Less: Allowance for credit
      losses
            
            
            (6,217,983
            )
            
            
            (5,675,035
            )Loans, net
            
            
            241,802,946
            
            
            
            242,675,686Other
      real estate owned, net
            
            
            3,285,741
            
            
            
            3,873,405Premises and equipment,
      net
            
            
            1,042,359
            
            
            
            1,151,246Investment
      in bank owned life insurance
            
            
            5,326,639
            
            
            
            5,268,529Income
      tax receivable
            
            
            3,533,530
            
            
            
            3,276,739Deferred
      tax asset
            
            
            2,469,000
            
            
            
            2,469,000Accrued
      interest receivable and other assets
            
            
            1,087,672
            
            
            
            1,347,271Total Assets
            
            $
            297,234,682
            
            
            $
            270,587,988LIABILITIESNon-interest-bearing
      deposits
            
            $
            50,872,793
            
            
            $
            49,945,354Interest-bearing
      deposits
            
            
            223,126,835
            
            
            
            194,682,678Total deposits
            
            
            273,999,628
            
            
            
            244,628,032Short-term
      borrowings
            
            
            49
            
            
            
            1,864,056Subordinated
      debt
            
            
            8,000,000
            
            
            
            8,000,000Accrued
      expenses and other liabilities
            
            
            1,104,658
            
            
            
            1,073,899Total
    Liabilities
            
            
            283,104,335
            
            
            
            255,565,987STOCKHOLDERS'
      EQUITYCommon stock - $.01 par value,
      authorized:9,000,000 shares authorized,
      2,153,101 and 2,153,101  issued
              and
      outstanding as of March 31, 2009 and December 31, 2008,
      respectively:
            
            
            21,531
            
            
            
            21,531Additional paid in
      capital
            
            
            17,947,247
            
            
            
            17,954,770Accumulated
    deficit
            
            
            (3,838,431
            )
            
            
            (2,954,300
            )Total Stockholders'
      Equity
            
            
            14,130,347
            
            
            
            15,022,001Total Liabilities and
      Stockholders' Equity
            
            $
            297,234,682
            
            
            $
            270,587,988







See
accompanying notes to consolidated financial statements.




2




BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
OPERATIONS


For the
three-month periods ended March 31, 2009 and 2008


(Unaudited)





Three
      Months Ended
                March
      312009
              
              
              2008INTEREST
      INCOME:Interest and fees on
      loans
              
              $
              3,171,539
              
              
              $
              4,308,083Interest
      on federal funds sold and other overnight investments
              
              
              16,662
              
              
              
              45,391Taxable
      interest and dividends on investment securities
              
              
              -
              
              
              
              11,988Total interest
    income
              
              
              3,188,201
              
              
              
              4,365,462INTEREST
      EXPENSE:Interest
      on deposits
              
              
              1,528,789
              
              
              
              1,618,193Interest
      on short-term borrowings
              
              
              2,191
              
              
              
              114,365Interest
      on subordinated debt
              
              
              148,497
              
              
              
              149,991Total
      interest expense
              
              
              1,679,477
              
              
              
              1,882,549Net
      interest income
              
              
              1,508,724
              
              
              
              2,482,913Provision
      for credit losses
              
              
              1,050,450
              
              
              
              2,467,700Net
      interest income after provision for credit losses
              
              
              458,274
              
              
              
              15,213NON-INTEREST
      INCOME:Service charges on deposit
      accounts
              
              
              88,417
              
              
              
              56,251Gain
      on sale of mortgage loans
              
              
              121,788
              
              
              
              79,644Increase
      in cash surrender value of bank owned life insurance
              
              
              58,110
              
              
              
              55,957Loss
      on sale of OREO Properties
              
              
              (80,226
              )
              
              
              -Loss
      on disposal of equipment
              
              
              (18,527
              )
              
              
              -Other income
              
              
              12,528
              
              
              
              16,501Total non-interest
      income
              
              
              182,090
              
              
              
              208,353NON-INTEREST
      EXPENSES:Salaries and employee
      benefits
              
              
              939,339
              
              
              
              1,558,957Occupancy
    expenses
              
              
              188,097
              
              
              
              186,711Furniture and equipment
      expenses
              
              
              126,863
              
              
              
              96,402Legal and professional
      fees
              
              
              236,796
              
              
              
              165,193Data processing and other
      outside services
              
              
              320,611
              
              
              
              253,600Advertising
      and marketing related expenses
              
              
              51,289
              
              
              
              148,876Provision
      for losses on other real estate owned
              
              
              40,000
              
              
              
              61,150Other expenses
              
              
              205,697
              
              
              
              207,851Total non-interest
      expenses
              
              
              2,108,692
              
              
              
              2,678,740(Loss)
      Income before income taxes
              
              
              (1,468,328
              )
              
              
              (2,455,174
              )Income
      tax (benefit) expense
              
              
              (584,197
              )
              
              
              (969,000
              )NET
      (LOSS) INCOME
              
              $
              (884,131
              )
              
              $
              (1,486,174
              )Per
      Share Data:Net (Loss) Income
      (basic)
              
              $
              (.41
              )
              
              $
              (.69
              )Net (Loss) Income
      (diluted)
              
              $
              (.41
              )
              
              $
              (.69
              )Weighted Average shares
      outstanding (basic)
              
              
              2,153,101
              
              
              
              2,139,845Effect
      of Dilution – Stock options and Restricted shares
              
              
              -
              
              
              
              -Weighted Average shares
      outstanding (diluted)
              
              
              2,153,101
              
              
              
              2,139,845





See
accompanying notes to consolidated financial statements.






3




BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY


For the
three months ended March 31, 2009 and 2008


(Unaudited)








Common
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              EquityBalances
      at January 1, 2009
            $
            21,531
            
            
            17,954,770
            
            
            (2,954,300)
            
            
            15,022,001Net
      Stock-based compensation recovery
            
            -
            
            
            (7,523)
            
            
            -
            
            
            (7,523)Net
      Loss
            
            -
            
            
            -
            
            
            (884,131)
            
            
            (884,131)Balances
      at March 31, 2009
            $
            21,531
            
            
            17,947,247
            
            
            (3,838,431)
            
            
            14,130,347Common
              Stock
            
            
            Additional
              Paid
      in
              Capital
            
            
            Retained
              Earnings
            
            
            Total
              Stockholders’
              EquityBalances
      at January 1, 2008
            $
            21,376
            
            $
            17,788,833
            
            $
            2,110,343
            
            $
            19,920,552Stock-based
      compensation expense
            
            -
            
            
            23,520
            
            
            -
            
            
            23,520Issuance
      of Common Stock
            
            33
            
            
            22,707
            
            
            -
            
            
            22,740Net
      Loss
            
            -
            
            
            -
            
            
            (1,486,174)
            
            
            (1,486,174)Balances
      at March 31, 2008
            $
            21,409
            
            $
            17,835,060
            
            $
            624,169
            
            $
            18,480,638








See
accompanying notes to consolidated financial statements.






4




BAY
NATIONAL CORPORATION





CONSOLIDATED STATEMENTS OF
CASH FLOWS


For the
three months ended March 31, 2009 and 2008


(Unaudited)





2009
            
            
            2008Cash
      Flows From Operating Activities:Net Loss
            
            
            
            $
            (884,131)
            
            $
            (1,486,174
            )Adjustments to reconcile net
      loss to net cash (used in) provided by operating
    activities:Depreciation
            
            
            
            
            81,963
            
            
            73,074Loss
      on disposal of equipment
            
            
            
            
            18,527
            
            
            -Accretion
      of investment discounts
            
            
            
            
            -
            
            
            (471
            )Provision for credit
      losses
            
            
            
            
            1,050,450
            
            
            2,467,700Provision
      for losses on other real estate owned
            
            
            
            
            40,000
            
            
            61,150Loss
      on sale of real estate acquired through foreclosure
            
            
            
            
            80,226Stock-based
      (recovery) compensation
            
            
            
            
            (7,523)
            
            
            23,520Increase
      in cash surrender of  bank owned life insurance
            
            
            
            
            (58,110)
            
            
            (55,957
            )Deferred
      income taxes
            
            
            
            
            -
            
            
            (977,000
            )(Increase)
      decrease in income taxes receivable
            
            
            
            
            (256,791)
            
            
            174,704Gain
      on sale of loans held for sale
            
            
            
            
            (121,788)
            
            
            (79,644
            )Origination
      of loans held for sale
            
            
            
            
            (17,999,139)
            
            
            (27,780,911
            )Proceeds
      from sale of loans
            
            
            
            
            16,170,540
            
            
            33,986,043Net
      decrease (increase) in accrued interest receivable and other
      assets
            
            
            
            
            259,599
            
            
            (8,010)Net decrease in accrued
      expenses and other liabilities
            
            
            
            
            30,758
            
            
            (174,741
            )Net
      cash (used in) provided by operating activities
            
            
            
            
            (1,595,419)
            
            
            6,223,283Cash
      Flows From Investing Activities:Maturities of investment
      securities available for sale
            
            
            
            
            -
            
            
            400,000Redemption
      of Federal Home Loan Bank of Atlanta Stock
            
            
            
            
            47,700
            
            
            557,900Net
      decrease (increase) in loans
            
            
            
            
            1,726,428
            
            
            (11,454,977
            )Proceeds
      from sale of real estate acquired through foreclosure
            
            
            
            
            569,458Expenditures
      for other real estate owned
            
            
            
            
            (55,770)
            
            
            (3,088
            )Proceeds
      (expenditures) for premises and equipment
            
            
            
            
            8,397
            
            
            (168,934
            )Net cash provided by (used in)
      investing activities
            
            
            
            
            2,296,213
            
            
            (10,669,099
            )Cash
      Flows From Financing Activities:Net increase in
      deposits
            
            
            
            
            29,371,596
            
            
            29,167,697Net
      decrease in short-term borrowings
            
            
            
            
            (1,864,007)
            
            
            (17,059,049
            )Net proceeds from issuance of
      common stock
            
            
            
            
            -
            
            
            22,740Net cash provided
      by  financing activities
            
            
            
            
            27,507,589
            
            
            12,131,388Net
      increase  in cash and cash equivalents
            
            
            
            
            28,208,383
            
            
            7,685,572Cash
      and cash equivalents at beginning of year
            
            
            
            
            9,286,512
            
            
            7,173,671Cash
      and cash equivalents at March 31,
            
            
            
            $
            37,494,895
            
            $
            14,859,243





Supplemental
      information:Interest
      paid
            
            
            
            $
            1,545,232
            
            $
            1,920,193Income
      taxes paid
            
            
            
            $
            -
            
            $
            -Amount
      transferred from loans to other real estate owned
            
            
            
            $
            46,250
            
            $
            883,310







See
accompanying notes to consolidated financial statements.







5


BAY
NATIONAL CORPORATION





NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


For the
Three Months Ended March 31, 2009 and 2008


(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, 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, 2008 have been
derived from audited financial statements. These consolidated financial
statements should be read in conjunction with the financial statements and
accompanying notes included in Bay National Corporation’s 2008 Annual Report on
Form 10-K. There have been no significant changes to the Company’s accounting
policies as disclosed in the 2008 Annual Report.





The
results shown in this interim report are not necessarily indicative of results
to be expected for the full year 2009 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 retained earnings.








Recent Accounting Pronouncements and
Developments





SFAS No.
160, “Noncontrolling Interests in Consolidated Financial
Statements.”  SFAS No. 160’s objective is to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements by establishing
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary.  SFAS 160 is
effective for fiscal years and interim periods within those fiscal years,
beginning on or after December 15, 2008.  The Company does not own a
noncontrolling interest in any subsidiary so the implementation of SFAS No. 160
did not have a material impact on the Company’s consolidated financial
statements.






6









SFAS No.
141R, “Business Combinations.”  This revises SFAS No. 141 and changes
multiple aspects of the accounting for business combinations. Under the guidance
in SFAS No. 141R, the acquisition method must be used, which requires the
acquirer to recognize most identifiable assets acquired, liabilities assumed,
and noncontrolling interests in the acquiree at their full fair value on the
acquisition date. Goodwill is to be recognized as the excess of the
consideration transferred plus the fair value of the noncontrolling interest
over the fair values of the identifiable net assets acquired. Subsequent changes
in the fair value of contingent consideration classified as a liability are to
be recognized in earnings, while contingent consideration classified as equity
is not to be remeasured. Costs such as transaction costs are to be excluded from
acquisition accounting, generally leading to recognizing expense and
additionally, restructuring costs that do not meet certain criteria at
acquisition date are to be subsequently recognized as post-acquisition costs.
SFAS No. 141R is effective for business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning
on or after December 15, 2008.  The Company has not entered into any
business combinations, so the adoption of this new standard does not have a
material impact on the Company’s consolidated financial statements.





SFAS No.
161, “Disclosures about Derivative Instruments and Hedging Activities, an
amendment of FASB Statement No. 133.”  SFAS No. 161 is intended to
enhance the current disclosure framework previously required for derivative
instruments and hedging activities under SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” to include how and why an entity
uses derivative instruments, how derivative instruments and related hedge items
are accounted for and their impact on an entity’s financial positions, result of
operations and cash flows.  This standard is effective for fiscal
years and interim periods beginning after November 15, 2008, with early adoption
encouraged.  The Company does not currently utilize derivative
instruments so the adoption of this new standard does not have a material impact
on its consolidated financial statements.





SFAS No.
163, “Accounting for Financial Guarantee Insurance Contracts-an interpretation
of FASB Statement No. 60.”  SFAS No. 163 clarifies how Statement of
Financial Accounting Standards No. 60, “Accounting and Reporting by Insurance
Enterprises,” applies to financial guarantee insurance contracts, including the
recognition and measurement of premium revenue and claim
liabilities.  SFAS No. 163 also requires expanded disclosure about
financial guarantee insurance contracts.  SFAS No. 163 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008.  The Company does not have any guarantee
contracts, and therefore, the adoption of this new standard does not have a
material impact on its consolidated financial statements.





FASB
Staff Position Emerging Issues Task Force 03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities (“FSP-EITF 03-6-1”).”  Under FSP-EITF 03-6-1, unvested
share-based payment awards that contain non-forfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are participating securities and
shall be included in the computation of earnings per share pursuant to the
two-class method.  FSP-EITF 03-6-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those years and requires retrospective
application.  The Company has not granted any share-based payment
awards with non-forfeitable rights to dividends or dividend equivalents and
therefore, the adoption of this new standard does not have a material impact on
its consolidated financial statements.






7





FASB
Staff Position (“FSP”) FAS 140-4 and FIN 46(R)-8, “Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities.”  These pronouncements increase disclosure
requirements for public companies and are effective for reporting periods
(interim and annual) that end after December 15, 2008.  The purpose of
this FSP is to promptly improve disclosures by public entities and enterprises
until the pending amendments to FASB Statement No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,”
and FASB Interpretation No. 46 (revised December 2003), “Consolidation of
Variable Interest Entities,” are finalized by the Board.  The FSP
amends Statement No. 140 to require public entities to provide additional
disclosures about transferors’ continuing involvement with transferred financial
assets.  It also amends Interpretation 46(R) to require public
enterprises, including sponsors that have a variable interest in a variable
interest entity, to provide additional disclosures about their involvement with
variable interest entities.  This pronouncement is related to
disclosures only and does not have an impact on our consolidated financial
statements.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115.” This Statement permits entities to choose to measure many financial
instruments and certain other items at fair value. Unrealized gains and losses
on items for which the fair value option has been elected will be reported in
earnings. The objective is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. This Statement is expected to expand the
use of fair value measurement, which is consistent with the FASB’s long-term
measurement objectives for accounting for financial instruments.  SFAS No.
159 is effective for fiscal years beginning after November 15, 2007. The Company
has not elected the fair value option for any financial assets or liabilities at
March 31, 2009.





Accounting
pronouncements issued but not yet effective.





In April
2009, the Financial Accounting Standards Board issued three final staff
positions intended to provided addition application guidance and enhance
disclosures regarding fair value measurements and impairments of securities. FSP
FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for
Asset or Liability Have Significantly Decreased and Identifying Transactions
That Are Not Orderly,” provides guidelines for making fair value measurements
more consistent with the principles presented in FASB Statement No. 157, “Fair
Value Measurements.” FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair
Value of Financial Instruments,” enhances consistency in financial reporting by
increasing the frequency of fair value disclosures. FSP FAS 115-2 and FAS 124-2,
“Recognition and Presentation of Other-Than-Temporary Impairments,” provides
additional guidance designed to create greater clarity and consistency in
accounting for and presenting impairment losses on securities.  Prior
to issuing the FSP, fair values for these assets and liabilities were only
disclosed annually.  The FSP now requires these disclosures on a
quarterly basis, providing qualitative and quantitative information about fair
value estimates for all those financial instruments not measured on the balance
sheet at fair value.  The FSPs are effective for interim reporting
periods ending after June 15, 2009, with early adoption permitted for periods
ending after March 15, 2009.  The Company will adopt the FSPs in the
second quarter of 2009.





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.






8





As of
March 31, 2009, the Bank has been categorized as “Adequately Capitalized” by the
OCC under the regulatory framework for prompt corrective action. As
previously noted, on February 6, 2009, the Bank voluntarily entered into a
Consent Order with the OCC.  Among other things, the Consent Order
requires that by April 30, 2009 the Bank maintain certain regulatory capital
ratios in excess of the minimum required under the risk-based capital adequacy
guidelines adopted by our regulators.  The Bank was not in compliance
with the minimum capital requirements at April 30, 2009 and our request for an
extension for compliance was denied.  As a result, we are required to
develop a contingency plan for the Bank.  As discussed in the
Company’s proxy statement for our annual meeting of stockholders to be held on
May 26, 2009, we are planning to issue a significant number of shares of the
Company’s common stock in a private placement to accredited investors that are
likely to result in a change in control of the Company.  We believe
that such issuance will satisfy the contingency plan
requirement.





3.
FAIR VALUE MEASUREMENTS





Effective
January 1, 2008, the Company adopted SFAS No. 157 (SFAS 157), “Fair Value Measurements.”
SFAS 157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS 157 applies whenever other standards require (or
permit) assets or liabilities to be measured at fair value but does not expand
the use of fair value in any new circumstances. In this standard, the FASB
clarifies the principle that fair value should be based on the assumptions
market participants would use when pricing the asset or liability. In support of
this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. The fair value hierarchy is as
follows:





Level 1
inputs – Unadjusted quoted prices in active markets for identical assets or
liabilities that the entity has the ability to access at the measurement
date.





Level 2
inputs - Inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly. These might include
quoted prices for similar assets and liabilities in active markets, and inputs
other than quoted prices that are observable for the asset or liability, such as
interest rates and yield curves that are observable at commonly quoted
intervals.





Level 3
inputs - Unobservable inputs for determining the fair values of assets or
liabilities that reflect an entity’s own assumptions about the assumptions that
market participants would use in pricing the assets or liabilities.





As of
March 31, 2009, the Company had no balance sheet categories that are required by
generally accepted accounting principles to be recorded at fair
value.





Loans
held for sale and loans held in the Company’s loan portfolio are valued at cost.
Any impairment of the value of these loans is reflected in the allowance for
credit losses.






9




Other
real estate owned (“OREO”) property is valued at the time of foreclosure and
transferred to OREO from loans. Generally, the value of OREO is based upon the
lower of cost or net realizable value as determined by third party real estate
appraisals less the cost of disposal.





On a
nonrecurring basis, the Company may be required to measure certain assets at
fair value in accordance with generally accepted accounting
principles.  These adjustments usually result from application of
lower-of-cost-or-market accounting or write-downs of specific
assets.  The following table includes the assets measured at fair
value on a nonrecurring basis as of March 31, 2009 (in
thousands):





Carrying
              Value
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3Impaired
      Loans
            $
            24,927
            
            $
            -
            
            $
            24,927
            
            $
            -Real
      estate acquired through foreclosure
            
            3,286
            
            
            -
            
            
            3,286
            
            
            -Total
      assets at fair value
            $
            28,213
            
            $
            -
            
            $
            28,213
            
            $
            -





4.      INCOME
TAXES





The
Company employs the liability method of accounting for income taxes as required
by Statement of Financial Accounting Standards (“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 basis 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.  The Company adopted the provisions of FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” in the
first quarter of 2007.  The Company utilizes statutory requirements
for its income tax accounting and avoids risks associated with potentially
problematic tax positions that may incur challenge upon audit, where an adverse
outcome is more likely than not.  Therefore, no provisions are made
for either uncertain tax positions nor accompanying potential tax penalties and
interest for underpayments of income taxes in the Company’s tax
reserves.





5.      EARNINGS
PER SHARE





Earnings per common share are
computed by dividing net income by the weighted average number of common shares
outstanding during the period. Diluted earnings per common share is computed by
dividing net income by the weighted average number of common shares outstanding
during the period, including any potential dilutive common shares outstanding,
such as options. The Company’s common stock options totaling 135,441 were not
considered in the computation of diluted earnings per share for the three months
ended March 31, 2009 or March 31, 2008 because the results would have been
anti-dilutive in both periods.





6.    STOCK-BASED
COMPENSATION





Effective
January 1, 2006, the Company adopted SFAS No. 123(R), Share-based Payment,and has
included the stock-based employee compensation cost in its income statements for
the three-month periods ended March 31, 2009 and 2008. Amounts recognized in
the financial statements with respect to stock-based compensation are as
follows:








10





Three
      Months Ended
              March
      312009
            
            
            2008Amounts
      (recovered) expensed against
              income,
      before tax benefit
            
            
            
            
            
            
            $
            (7,523)
            
            $
            23,520Amount
      of related income tax (expense)
              benefit
      recognized in income
            
            
            
            
            
            
            $
            (2,558)
            
            $
            8,123







The
recovery related to forfeitures of restricted stock units.  An
estimated forfeiture rate was not considered in the fair value calculation at
time of grant.





The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants during the year ended December 31,
2002:





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





No stock
options have been issued since 2002.





The Bay
National Corporation 2007 Stock Incentive Plan (the “Incentive Plan”) was
established effective May 22, 2007 and provides for the granting of incentive
stock options intended to comply with the requirements of Section 422 of the
Internal Revenue Code (“incentive stock options”), non-qualified stock options,
stock appreciation rights (“SARs”), restricted or unrestricted stock awards,
awards of phantom stock, performance awards, other stock-based awards, or any
combination of the foregoing (collectively “Awards”).  Awards are
available for grant to officers, employees and directors of the Company and its
affiliates, including the Bank, except that non-employee directors are not
eligible to receive awards of incentive stock options.




The
Incentive Plan authorizes the issuance of up to 200,000 shares of common stock
plus any shares that were available under the Company’s 2001 Stock Option Plan
(“Option Plan”) that terminated as of May 22, 2007 and shares subject to options
granted under the Option Plan that expire or terminate without having been fully
exercised.  The Incentive Plan has a term of ten years and is
administered by the Compensation Committee of the Board of Directors. The
Compensation Committee consists of at least three non-employee directors
appointed by the Board of Directors. In general, the options have an exercise
price equal to 100% of the fair market value of the common stock on the date of
the grant.





As of
March 31, 2009, twelve Awards had been granted under the Incentive
Plan.  Five of these Awards included an unrestricted stock grant of
550 shares to five employees in August 2007 based on their 2006
performance.  The Awards vested immediately upon issuance and the
closing stock price on the grant date was $15.46.  The remaining seven
Awards represent restricted stock awards and are discussed in more detail below
in the section entitled “Restricted Stock Units.”






11







The
following is a summary of changes in outstanding options for the three-month
periods ended March 31, 2009 and 2008:


Number
              ofShares
            
            
            Weighted
              Average
              Exercise
              PriceBalance,
      January 1, 2008
            
            
            138,741
            
            
            $
            6.99Granted
            
            
            -
            
            
            
            -Cancelled
            
            
            -
            
            
            
            -Exercised
            
            
            (3,300
            )
            
            $
            6.89Balance,
      March 31, 2008
            
            
            135,441
            
            
            $
            6.99Balance,
      January 1, 2009
            
            
            135,441
            
            
            $
            6.99Granted
            
            
            -
            
            
            
            -Cancelled
            
            
            -
            
            
            
            -Exercised
            
            
            -Balance,
      March 31, 2009
            
            
            135,441
            
            
            $
            6.99Weighted
      average fair value of options granted during 2002
            
            $
            2.77





The
following table summarizes information about options outstanding at March 31,
2009:





Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Price
            
            Number
            
            Weighted
              Average
              Remaining
              Contractual
      Life
              (in
      years)
            
            Weighted
              Average
              Exercise
              Price
            
            
            Number
            
            Weighted
              Average
              Exercise
              Price$6.89
            
            116,945
            
            1
            
            $6.89
            
            
            116,945
            
            $6.89$7.61
            
            18,496
            
            1
            
            $7.61
            
            
            18,496
            
            $7.61135,441
            
            
            
            $6.99
            
            
            135,441
            
            $6.99





Based
upon a closing stock price of $1.37 per share as of March 31, 2009, there was no
aggregate intrinsic value in options outstanding and
exercisable.








12





Restricted Stock
Units





The
following table summarizes the changes in outstanding shares under restricted
stock grants for the three-month periods ended March 31, 2009 and
2008.





Number
      of
              Shares
            
            
            Weighted
              Value
      at
              Issuance
      DateUnvested
      grants at January 1, 2009
            
            
            13,200
            
            
            $
            13.24Granted
            
            
            
            
            
            
            -Vested
            
            
            600
            
            
            
            10.25Cancelled
            
            
            9,600
            
            
            
            14.38Unvested
      grants at March 31, 2009
            
            
            3,000
            
            
            $
            10.17Unvested
      grants at January 1, 2008
            
            
            24,000
            
            
            $
            15.91Granted
            
            
            7,500
            
            
            
            10.25Vested
            
            
            -
            
            
            
            -Cancelled
            
            
            -
            
            
            
            -Unvested
      grants at March 31, 2008
            
            
            31,500
            
            
            $
            14.56





The
Company recovered $7,523 of compensation associated with the forfeiture of
restricted stock units for the three-month period ending March 31,
2009.






13






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 March 31, 2009 and December 31, 2008 and for the three-month
periods ended March 31, 2009 and 2008.





Overview





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





The
principal business of the Company is to make loans and other investments and to
accept time and demand deposits. The Company’s primary market areas are in the
Baltimore Metropolitan area, Baltimore-Washington corridor and on Maryland’s
Eastern Shore, although the Company’s business development efforts generate
business outside of these areas. The Company offers a broad range of banking
products, including a full line of business and personal savings and checking
accounts, money market demand accounts, certificates of deposit, and other
banking services. The Company funds a variety of loan types including commercial
and residential real estate loans, commercial term loans and lines of credit,
consumer loans, and letters of credit with an emphasis on meeting the borrowing
needs of small businesses. The Company’s target customers are small and
mid-sized businesses, business owners, professionals, nonprofit institutions and
high net worth individuals.





The
Company experienced a significant operating loss during the quarter ended March
31, 2009 resulting from difficulties in its portfolio of investor-owned
residential real estate loans, deteriorating economic conditions and
industry-wide problems in residential real estate lending.   As
such, management continues to emphasize prudent asset/liability management and
it has significantly tightened its underwriting standards for residential real
estate loans. Key measurements for the three-month period ended March 31, 2009
include the following:





·
            Total
      assets at March 31, 2009 increased to $297.2 million from $270.6 million
      as of December 31, 2008.





·
            Total
      loans outstanding decreased from $248.4 million as of December 31, 2008 to
      $248.0 million as of March 31,
2009.





·
            There
      was approximately $12.4 million in non-accrual loans as of March 31,
      2009.  In addition, the Company foreclosed on one residential
      real estate property related to investor-owned residential real estate
      during the quarter. This property was placed into other real estate owned
      at estimated net realizable value of approximately $46
      thousand.  As of March 31, 2009, eleven properties remained with
      a net realizable value of $3.3 million.  Also, the Company had
      troubled debt restructures totaling $3.4 million and no outstanding loans
      90 days or more past due and still accruing.   The Company
      continues to maintain appropriate reserves for credit
    losses.





·
            Four
      properties held in real estate acquired through foreclosure were sold
      during the three months ending March 31, 2009.  Net losses were
      realized on three of the four properties sold.  In aggregate,
      losses on the three properties totaled $82 thousand while a gain of $2
      thousand was realized on the fourth
property.








14





·
            Deposits
      at March 31, 2009 increased to $274.0 million from $244.6 million as of
      December 31, 2008.





·
            The
      net loss for the period ended March 31, 2009 was $884 thousand compared to
      net loss of $1.5 million for the same period in 2008. Included in the
      results of the period ending March 31, 2009 was an income tax benefit of
      $584 thousand compared to $969 thousand for the same period in
      2008.





·
            Net
      interest income, the Company’s main source of income, was $1.5 million
      during the three-month period ended March 31, 2009, compared to $2.5
      million for the same period in 2008.  Interest income declined
      by $1.2 million from $4.4 million in the first quarter of 2008 to $3.2
      million in the first quarter of 2009 while interest expense declined only
      $200 thousand from $1.9 million to $1.7 million for the same
      periods.





·
            Net
      charge-offs of loans totaled $507 thousand for the period ending March 31,
      2009 and were divided among commercial, one to four family residential
      construction loans and one-to-four family residential mortgages. Net
      charge-offs were $768 thousand for the period ending March 31,
      2008.





·
            Non-interest
      income decreased by $26 thousand or 12.6%, for the three-month period
      ended March 31, 2009, as compared to the same period in 2008 due
      principally to the losses realized on the sales of other real estate owned
      and on the disposal of fixed
assets.





·
            Non-interest
      expenses decreased by $570 thousand or 21.3%, for the three-month period
      ended March 31, 2009, as compared to the same period in 2008 due largely
      to cost savings from several staff reductions since the first quarter of
      2008.





·
            The
      Company’s common stock closed at $1.37 on March 31, 2009, which
      represented an 84% decline from its closing price of $8.55 on March 31,
      2008.





·
            During
      the first quarter of 2009, the Company closed its Columbia office and is
      presently negotiating with a prospective tenant for a sublease of this
      office.





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





In
addition, as previously reported, on February 6, 2009, the Bank voluntarily
entered into a Consent Order with the Office of the Comptroller of the Currency
(the “OCC”), its primary banking regulator ( the “Consent Order”), that requires
the Bank to take certain actions.




On
February 27, 2009, the FDIC announced a proposed rule outlining its plan to
implement an emergency special assessment of 20 basis points on all insured
depository institutions in order to restore the Deposit Insurance Fund to an
acceptable level.  The assessment, which would be payable on September 30,
2009, would be in addition to a planned increase in premiums and a change in the
way regular premiums are assessed which the FDIC also approved on February 27,
2009.  The special assessment may be reduced to 10 basis points if Congress
clears legislation that would expand the FDIC’s line of credit with the Treasury
to $100 billion.  In addition, the proposed rule provides that, after June
30, 2009, if the reserve ratio of the Deposit Insurance Fund is estimated to
fall to a level that the FDIC believes would adversely affect public confidence
or to a level which is close to or less than zero at the end of a calendar
quarter, then an additional emergency special assessment of up to 10 basis
points may be imposed on all insured depository
institutions.
 
 As
presently drafted the proposed rule, if approved, would  significantly
increase the Company's FDIC assessment and have a material effect on the
Company’s Consolidated Statement of Operations for the period in which the
assessment is imposed.


Results
of Operations





General





The
Company recorded a net loss of $884 thousand for the three-month period ended
March 31, 2009. This compares to net loss of $1.5 million for the same period in
2008. This is an improvement of $602 thousand, or 41% for the three-month
period. The improvement in year-over-year results is due primarily to a $1.4
million lower provision for credit losses and reduction of $620 thousand in
salary expense which were largely offset by $1.0 million reduction in net






15




interest
income and $385 thousand less in income tax benefit when comparing the first
three months of 2009 to the first three months of 2008.





The
Bank’s mortgage origination operations, located in Lutherville and Salisbury,
Maryland, originate conventional first and second lien residential mortgage
loans. The 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 officers.
For the three-month periods ended March 31, 2009 and 2008, net gains on the sale
of mortgage loans totaled $122 thousand and $80 thousand, respectively. Gains on
the sale of mortgage loans have increased for the three-month period ended March
31, 2009 as compared to the same period in 2008 due to a general increase in
home purchase and refinance activity in the Company’s markets.





In 2004,
the Company began purchasing 100% participations in mortgage loans originated by
a mortgage company in the Baltimore metropolitan area. The participations were
for loans for which a secondary market investor had committed to purchase. The
participations were typically held for a period of three to four weeks before
being sold to the secondary market investor.  The Bank terminated the
program in August 2008 due to deterioration in the national mortgage markets
and, as of March 31, 2009, the Company had no such loans outstanding under this
program, which were classified as held for sale.  The Company earned
$48 thousand from this program for the same period in 2008.





Management
expects the remainder of 2009 to continue to be challenging for earnings and
asset growth as a result of the weakened economy.   Future
results will be subject to the volatility of the provision for credit losses,
which is related to loan quality, loan growth, and the fluctuation of mortgage
loan production, all of which is sensitive to economic and interest rate
instability and other competitive pressures that arise in a worsening
economy.





Net
Interest Income





Net
interest income is the difference between income on earning assets and the cost
of funds supporting those assets. Earning assets are composed primarily of
loans, investments, and federal funds sold. Interest-bearing deposits, other
short-term borrowings and subordinated debt 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 $1.5 million for the three-month
period ended March 31, 2009 as compared to $2.5 million for the same period in
2008. This represents a decrease of 39% for the three-month period ended March
31, 2009, as compared to the same period in 2008.





Interest
income from loans and investments for the three-month period ended March 31,
2009 was $3.2 million, compared to $4.4 million for the period ended March 31,
2008.  The 27% decrease for the 2009 period over the same period in
2008 was primarily attributed to lost interest from $12.4 million of non-accrual
loans and the decline in residential construction loan
originations.   In addition, the average target federal funds
rate decreased from 3.24% for the first quarter of 2008 to a range of 0 to .25%
for the first quarter of 2009.  As a result, due to  the
substantial number of variable rate loans in our portfolio, which re-price based
on the federal funds rate, the yields on interest earning assets decreased from
6.97% for the three months ended March 31, 2008 to 4.96% for the three months
ended March 31, 2009.






16





The
percentage of average interest-earning assets represented by loans was 96.8% and
94.8% for the three-month periods ended March 31, 2009 and 2008, respectively.
The high percentage of loans to earning assets is consistent with management’s
strategy to maximize net interest income by maintaining a higher concentration
of loans, which typically earn higher yields than investment securities. For the
three-month period ended March 31, 2009, the average yield on the loan portfolio
decreased to 5.10% from 7.26% for the three-month period ended March 31, 2008,
primarily as a result of the decrease in the federal funds rate and the high
percentage of variable-rate loans in our loan portfolio noted
above.





The
average yield on the investment portfolio and other earning assets, such as
federal funds sold, was .80% for the three-month period ended March 31, 2009 as
compared to 1.75% for the same period in 2008. This decline in the average yield
was a direct result of a decrease in federal funds rate for the 2009
period.  The percentage of average interest-earning assets represented
by investments was 3.2% and 5.2% for the three-month periods ended March 31,
2009 and 2008, respectively.





Interest
expense from deposits and borrowings for the three-month period ended March 31,
2009 was $1.7 million compared to $1.9 million for the same period in 2008. The
11% decrease for the 2009 period is the result of the previously discussed
reduction in the target federal funds rate offset by an increase in the
percentage of deposits held in the form of Certificates of Deposit (“CDs”). CDs
are the Bank’s most expensive form of deposits. As of March 31, 2009, CDs
comprised 75.1% of average interest-bearing liabilities compared to 52.2% of
average interest-bearing liabilities as of March 31, 2008. Average rates paid on
all interest-bearing liabilities decreased from 3.73% for the three-month period
ended March 31, 2008 to 3.10% for the three-month period ended March 31,
2009.





As a
result of the factors discussed above, net interest margins decreased to 2.35%
for the three-month period ended March 31, 2009 from 3.96% for the same period
in 2008. Although management has been able to implement deposit rate decreases,
the yield on loans and investments decreased at a higher rate than the cost of
funds. Management has observed ongoing pressure to offer lower rates on loans as
the market for loans has become more competitive while demand remains
low.  In addition, the market is very competitive for deposits, which
has limited management’s ability to maintain margins through reductions in the
interest rates on deposit accounts.








17




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




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





Three Months Ended
      March 31, 2009Average
              Balance
            
            
            Interest
              and fees
            
            
            Yield/
              RateASSETSLoans
      and loans held for sale
            
            $
            252,313,117
            
            $
            3,171,539
            
            
            5.10
            %Investment
      securities
            
            
            1,253,933
            
            
            -
            
            
            -Federal
      funds sold and other overnight investments
            
            
            7,194,274
            
            
            16,662
            
            
            .94Total
      earning assets
            
            
            260,761,324
            
            
            3,188,201
            
            
            4.96
            %Less:
      Allowance for credit losses
            
            
            (5,420,516)Cash
      and due from banks
            
            
            12,788,727Other
      real estate owned
            
            
            3,722,432Premises
      and equipment, net
            
            
            1,116,696Investment
      in bank owned life insurance
            
            
            5,289,963Accrued
      interest receivable and other assets
            
            
            6,618,763Total
      assets
            
            $
            284,877,389LIABILITIES
      AND STOCKHOLDERS’ EQUITYInterest-bearing
      demand deposits
            
            $
            43,634,243
            
            
            34,137
            
            
            .32
            %Regular
      savings deposits
            
            
            1,183,684
            
            
            -
            
            
            .00Time
      deposits
            
            
            164,998,641
            
            
            1,494,652
            
            
            3.67Short-term
      borrowings
            
            
            1,880,675
            
            
            2,191
            
            
            .47Subordinated
      debt
            
            
            8,000,000
            
            
            148,497
            
            
            7.53Total
      interest-bearing liabilities
            
            
            219,697,243
            
            
            1,679,477
            
            
            3.10
            %Net
      interest income and spread
            
            
            
            
            $
            1,508,724
            
            
            1.86
            %Non-interest-bearing
      demand deposits
            
            
            49,363,701Accrued
      expenses and other liabilities
            
            
            986,814Stockholders’
      equity
            
            
            14,829,631Total
      liabilities and stockholders’ equity
            
            $
            284,877,389Interest
      and fee income/earning assets
            
            
            4.96
            %Interest
      expense/earning assets
            
            
            2.61Net
      interest margin
            
            
            2.35
            %Return
      on Average Assets (Annualized)
            
            
            (1.24)
            %Return
      on Average Equity (Annualized)
            
            
            (23.84)
            %Average
      Equity to Average Assets
            
            
            5.21
            %










18










Three Months Ended
      March 31, 2008Average
              Balance
            
            
            Interestand fees
            
            
            Yield/
              RateASSETSLoans
      and loans held for sale
            
            $
            238,645,097
            
            $
            4,308,083
            
            
            7.26
            %Investment
      securities
            
            
            1,423,112
            
            
            11,988
            
            
            3.39Federal
      funds sold and other overnight investments
            
            
            11,779,081
            
            
            45,391
            
            
            1.55Total
      earning assets
            
            
            251,847,290
            
            
            4,365,462
            
            
            6.97
            %Less:
      Allowance for credit losses
            
            
            (5,015,269
            )Cash
      and due from banks
            
            
            728,732Other
      real estate owned
            
            
            959,659Premises
      and equipment, net
            
            
            1,230,823Investment
      in bank owned life insurance
            
            
            5,060,880Accrued
      interest receivable and other assets
            
            
            3,529,583Total
      assets
            
            $
            258,341,698LIABILITIES
      AND STOCKHOLDERS’ EQUITYInterest-bearing
      demand deposits
            
            $
            72,426,639
            
            
            441,993
            
            
            2.45
            %Regular
      savings deposits
            
            
            1,905,918
            
            
            2,220
            
            
            .47Time
      deposits
            
            
            105,959,645
            
            
            1,173,980
            
            
            4.46Short-term
      borrowings
            
            
            14,539,853
            
            
            114,365
            
            
            3.16Subordinated
      debt
            
            
            8,000,000
            
            
            149,991
            
            
            7.54Total
      interest-bearing liabilities
            
            
            202,832,055
            
            
            1,882,549
            
            
            3.73
            %Net
      interest income and spread
            
            
            
            
            $
            2,482,913
            
            
            3.24
            %Non-interest-bearing
      demand deposits
            
            
            34,527,128Accrued
      expenses and other liabilities
            
            
            916,788Stockholders’
      equity
            
            
            20,065,727Total
      liabilities and stockholders’ equity
            
            $
            258,341,698Interest
      and fee income/earning assets
            
            
            6.97
            %Interest
      expense/earning assets
            
            
            3.01Net
      interest margin
            
            
            3.96
            %Return
      on Average Assets (Annualized)
            
            
            (2.31)
            %Return
      on Average Equity (Annualized)
            
            
            (29.79)
            %Average
      Equity to Average Assets
            
            
            7.77
            %







Provision
for Credit Losses





There
provisionfor
credit losses was $1.1 million for the three-month period ended March 31, 2009
compared to $2.5 million for the comparable period in 2008. The amount of the
provision for credit losses is reflective of the ongoing economic difficulties
that many businesses and households are experiencing.  The economy
continues to suffer the effects of further declines in the values of real
estate, which represents a substantial portion of the collateral for
non-performing loans.   The provision in the 2009 period was
lower than the provision taken in the 2008 period, however, due to the fact that
we began accounting for the effects of current economic conditions in our loan
loss provision during 2008 and therefore some of the risks related to the
economy are already reflected in the allowance for credit losses.








19




Non-Interest
Income





Non-interest
income consists primarily of gains on the sale of mortgage loans, deposit
account service charges, income on bank owned life insurance and cash management
fees. For the three-month period ended March 31, 2009, the Company realized
non-interest income of $182 thousand as compared to $208 thousand for the same
period in 2008. Gains on the sale of mortgage loans of $122 thousand comprised
66.9% of the total for the three-month period ended March 31, 2009. This
compares to gains on the sale of mortgage loans of $80 thousand or 38.2%, of
total non-interest income for the three-month period ended March 31, 2008. The
level of gains on the sale of mortgage loans increased for the three-month
period ended March 31, 2009 due to a general increase in home refinance activity
in the Company’s markets.





Service
charges on deposit accounts totaled $88 thousand for the three-month period
ended March 31, 2009 as compared to $56 thousand for the same period in 2008.
The increase of 57.2% is attributable to an increase in overdraft fees charged
on transaction accounts as well as an increase in analysis fees charged on
business checking accounts. Although overdraft fees increased, the Company
continues to maintain a very low level of average overdrafts. Analysis fees have
increased as a result of the previously discussed Federal Reserve actions, which
reduced the rates used to calculate credits available to customers to offset any
analysis fees they incurred.





Other
income reflected a loss of $6 thousand for the three-month period ended March
31, 2009, as compared to income of $17 thousand for the same period in 2008. The
decrease of 135.3% is attributable to the Company’s $19 thousand in losses on
the sales of fixed assets associated with the closing of its loan production
office in Columbia, Maryland and the relocation of its former mortgage loan
origination office from Towson, Maryland to the Company’s headquarters building
in Lutherville, Maryland.





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, risk management and employee benefit
services.   Bay National Bank has not entered into any such fee
arrangements, although the Bank does offer such services to customers through
referral relationships for which it is not compensated. . No assurance can be
given that any such fee arrangements will be obtained or
maintained.





Non-Interest
Expense





Non-interest
expense for the three-month period ended March 31, 2009 totaled $2.1 million.
This compares to non-interest expense for the comparable period in 2008 of $2.7
million. The decrease of $570 thousand, or 21.3%, is primarily attributable to a
decrease in salary and employee benefits as a result of a reduction in personnel
subsequent to March 31, 2008.  Salaries and benefits expense decreased
to $939 thousand for the three-month period ended March 31, 2009 from $1.6
million for the same period of 2008.  The decreases in salaries and
benefits of $619 thousand for the 2009 period related to three separate
reductions in personnel since March 31, 2008, including the closing of the loan
production office in Columbia, Maryland during the first quarter of
2009.





Occupancy
expenses for the first three months of 2009 remained essentially flat with the
year ago period.  Subsequent to March 31, 2009, the Company was
successful in negotiating for the sub-lease of its former Towson, Maryland
mortgage origination office and for space that became available in the Company’s
Lutherville, Maryland headquarters building as a result of the reductions in
personnel during 2008 and the first quarter of 2009.  The Company is
currently in negotiations with a prospective sub-tenant for the space in the
former loan production office in Columbia, Maryland.  Therefore, we
expect occupancy expenses to decrease during the remainder of 2009.






20




Furniture
and equipment expense increased by $30 thousand or 32% for the three months
ended March 31, 2009 as compared to the same period in 2008.  The
increase is primarily due to personal property taxes paid on a higher number of
foreclosed properties owned in the first quarter of 2009 compared to the first
quarter of 2008.





Legal and
professional fees increased $72 thousand, or 43%, for the three months ended
March 31, 2009 as compared to the same period in 2008. The increase was related
to legal fees and other costs incurred to help manage and workout loans in the
Company’s residential real estate portfolio and to assist with meeting the
requirements of the OCC Consent Order.





Data
processing and other outside services expense increased $67 thousand, or 26.4%,
for the three months ended March 31, 2009 as compared to the same period in
2008.  Most of the increase is due to the cost of outside professional
services firms providing additional personnel to assist the Company with
streamlining process flows, bridging gaps in the workforce caused by the
departure of several employees and with preparing materials required by the OCC
Consent Order.





Advertising
and marketing-related expenses decreased $98 thousand, or 65.5%, for the three
months ended March 31, 2009 as compared to the same period in 2008. The decrease
is a result of the combination of increased expenditures incurred in 2008 as the
Company expanded the business development staff and the opening of the office in
Columbia, Maryland and an effort to reduce overall costs for
2009.  With a focus on minimizing costs, the Company deemed
advertising a discretionary expenditure and has curtailed such expenditures
beginning in January 2009.





There was
a decrease of $21 thousand, or 35%, in the provision for losses on other real
estate owned for the three-month period ended March 31, 2009 compared to the
same period in 2008. The decrease is due to the fact management began accounting
for the effects of the current economic conditions in the Company’s other real
estate owned during 2008 and therefore, some of the risks related to the economy
were already reflected in the values of other real estate owned.





Other
expense decreased $2 thousand or 1% for the three months ended March 31, 2009 as
compared to the same period in 2008.





The
banking industry utilizes an “efficiency ratio” as a key measure of expense
management and overall operating efficiency. This ratio is computed by dividing
non-interest expense by the sum of net interest income, before provision for
credit losses, and non-interest income. The Company’s efficiency ratio was
124.7% for the three-month period ended March 31, 2009. This compares to 99.5%
for the same period in 2008. The increase in the efficiency ratio from the prior
year is primarily a result of the previously discussed decline in interest
revenue.





Income
Taxes





For the
three-month period ended March 31, 2009, the Company recorded an income tax
benefit of $584 thousand compared a benefit of $969 thousand recorded for the
same period in 2008.  The change is a direct result of the smaller
pre-tax loss recognized for the first three months of  2009 when
compared to the first three months of 2008.







21


Financial
Condition





Composition
of the Balance Sheet





As of
March 31, 2009, total assets were $297.2 million. This represents an increase of
$26.6 million, or 9.9%, since December 31, 2008. The change in total assets
includes increases of $17.6 million in Federal funds sold and other overnight
investments, $10.6 million in cash and due from banks, $257 thousand in income
tax receivable and $58 thousand in bank owned life insurance.  These
increases were partially offset by decreases of $873 thousand in loans net of
the allowance for credit losses, $588 thousand in other real estate owned, net
and $260 thousand in other non-earning assets.





As of
March 31, 2009, loans, excluding loans held for sale, totaled $244.9 million.
This represents a decrease of $2.3 million, or .92%, from a balance of $247.2
million as of December 31, 2008.





The
composition of the loan portfolio as of March 31, 2009 was approximately $120.4
million of commercial loans, $4.6 million of consumer loans, and $119.9 million
of real estate loans (excluding mortgage loans held for sale). The composition
of the loan portfolio as of December 31, 2008 was approximately $125.3 million
of commercial loans, $3.8 million of consumer loans, and $118.1 million of real
estate loans (excluding mortgage loans held for sale).Mortgage loans
held for sale were $3.1 million and $1.2 million as of March 31, 2009 and
December 31, 2008, respectively. The decrease in the loan portfolio is due to
management’s efforts to limit loan growth in order to increase capital levels,
liquidity and the Bank’s capital ratios.





The
Company has experienced ongoing weakness in its portfolio of investor
residential construction and reconstruction loans. The total portfolio as of
March 31, 2009 was approximately $30.6 million of which $8.9 million was
classified as non-accrual and an additional $2.9 million was 30 days or more
past due. Management is proactively and aggressively addressing the problems in
this portfolio by reviewing the specific credits more frequently, consulting
with legal counsel when necessary, working with borrowers for potential
restructure or working with potential investors to facilitate the sale of the
property. In addition, the Company has significantly tightened underwriting
standards for these types of loans and is currently originating very little of
this business.  Resolving these issues will take time as the
residential real estate market works through its downturn and housing
inventories return to normal levels; therefore, there can be no assurance that
management’s actions will result in decreases in the rate of non-accrual and
past due loans.





During
the three-month period ending March 31, 2009, the Company foreclosed on one
piece of residential real estate related to investor-owned residential real
estate. This property was placed into other real estate owned at estimated net
realizable value of approximately $46 thousand. The difference between the
related loan balances and the net realizable value, $181 thousand, was charged
off to the allowance for credit losses during the period. This foreclosure
combined with additional property sales, capitalized expenditures, and allowance
adjustments resulted in a net decrease in other real estate owned of $588
thousand between the December 31, 2008 net carrying value of $3.9 million and
the March 31, 2009 net carrying value of $3.3 million.





At March
31, 2009, the Company had cash and due from banks of $17.8 million as compared
to $7.3 million as of December 31, 2008. This increase is a result of
management’s increased focus on liquidity during the quarter.  See the
Liquidity section later
in this Management’s Discussion and Analysis for further
information.






22





Funds not
extended in loans are invested in cash and due from banks and various
investments including federal funds sold and other overnight investments,
Federal Reserve Bank stock, Federal Home Loan Bank stock and bank owned life
insurance. Excluding cash and due from banks, these investments totaled
approximately $26.2 million as of March 31, 2009 compared to approximately $8.5
million as of December 31, 2008. The increase is also a result of management’s
increased focus on liquidity during the quarter.





In
March 2009, the Board of Directors approved a new investment policy and
authorized management of the Company to invest in a more traditional securities
portfolio in order to provide ongoing liquidity, income and a ready source of
collateral that can be pledged in order to access other sources of
funds.  The cash balances at March 31, 2009 represent funds
potentially available for purchase of longer term, higher yielding investment
securities. No investments were acquired under the new policy prior to March 31,
2009.





Deposits
at March 31, 2009 were $274.0 million of which approximately $8.0 million, or
2.9%, was related to one customer. Deposits at December 31, 2008 were $244.6
million of which deposits for the same customer stood at approximately $5.3
million, or 2.2%, of total deposits. The deposits for this customer tend to
fluctuate significantly; as a result, management monitors these deposits on a
daily basis to ensure that liquidity levels are adequate to compensate for these
fluctuations.  The increase in total deposits from December 31, 2008
was primarily related to efforts to gather reasonably priced national market CDs
to fund current and anticipated maturities of brokered certificates of deposit.
National market certificates of deposit are discussed in more detail
below.





In 2006,
the Company began using brokered certificates of deposit through the Promontory
Financial Network. Through this deposit matching network and its certificate of
deposit account registry service (CDARS), the Company has the ability to offer
its customers access to FDIC-insured deposit products in aggregate amounts
exceeding current insurance limits. When the Company places funds through CDARS
on behalf of a customer, it was eligible to receive matching deposits through
the network. The Company also had the ability to raise deposits directly through
the network.  These deposits received through the CDARS program are
considered “Brokered Deposits” for bank regulatory purposes. As of March 31,
2009 and December 31, 2008, the Company had approximately $1.2 million and $3.1,
respectively of CDARS deposits all of which was placed on behalf of
customers.  As a result of falling below the “well-capitalized” status
for regulatory reporting purposes, the Company may still place customer deposits
with CDARS but it is no longer permitted to accept brokered deposits including
the match portion through the CDARS program.





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 deposit. As of March 31, 2009, the
Company had total outstanding certificates of deposit of $177.7 million of which
approximately $132.9 million 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) and
$1.1 million were originally acquired through Promontory Financial Network’s
CDARS program.  The national market certificates of deposit were
issued with an average yield of 3.25% and an average term of 8.8 months.
Included in the $132.9 million are national market certificates of deposit
totaling approximately $50.4 million that have been classified as “Brokered
Deposits” for bank regulatory purposes. These “Brokered Deposits” were issued
with an average yield of 3.98% and an average term of 7.0 months.  As
of December 31, 2008, the total certificates of deposit obtained through the
listing of certificate of deposit rates on the internet-based listing services
were approximately $94.9 million. Included in the $94.9 million were national
market certificates of deposit totaling $80.5 million that had been classified
as “Brokered Deposits” for bank regulatory purposes.






23




Core
deposits, which management categorizes as all deposits other than brokered
deposits and national market certificates of deposit, CDARS deposits and $5.0
million of the $8.0 million of deposits from the large customer described above,
stood at $136.1 million as of March 31, 2009.  Core deposits declined
by $11.3 million or 7.7%, from the total as of December 31, 2008 of $147.4
million.  Overall, the Company did not aggressively compete for new
local deposits during 2009, which is the primary reason for the decrease in core
deposits from 2008.  Core deposits are closely monitored by management
because such deposits are considered not only a relatively stable source of
funding but also reflective of the growth of commercial and consumer depository
relationships.





Borrowed
funds as of December 31, 2008, consisted of $1.9 million borrowed under Federal
Funds lines of credit. These borrowings are unsecured and subordinated to all
deposits.  As of March 31, 2009 there were no borrowed
funds.





Subordinated
debt consists of $8 million of fixed interest rate trust preferred securities
issued through a Delaware trust subsidiary, Bay National Capital Trust I (the
“Trust”). The Company formed the Trust on December 12, 2005, and the Trust
issued $8 million of trust preferred securities to investors at a fixed interest
rate of 7.20%. The trust preferred securities bear a maturity date of February
23, 2036, but may be redeemed at the Company’s option on any February 23, May
23, August 23 or November 23 on or after February 23, 2011, and require
quarterly distributions by the trust to the holder of the trust preferred
securities. The securities are subordinated to the prior payment of any other
indebtedness of the Company that, by its terms, is not similarly subordinated
securities. The trust preferred securities qualify as Tier 1 capital at the
holding company level, subject to regulatory guidelines that limit the amount
included to an aggregate of 25% of Tier 1 capital.  On January 6,
2009, the Company provided notice under the Indenture of its election to defer
the interest payment due on February 23, 2009.  On May 1, 2009, the
Company provided notice under the Indenture of its election to continue the
extension of its previous deferral and of its election to defer the interest
payment due on May 23, 2009.  As a result of the Company’s restriction
on paying dividends pursuant to the Consent Order and the written agreement
between the Parent and the Federal Reserve Bank of Richmond entered into on
April 28, 2009 (the “Reserve Bank Agreement”), which events we have previously
reported, we anticipate that we will continue to defer such interest payments
for the immediate future, in any case as long as the Consent Order and Reserve
Bank Agreement are in effect.





Allowance
for Credit Losses and Credit Risk Management





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






24




Determining
an appropriate level of allowance for credit losses involves a high degree of
judgment.  The Company’s allowance for credit losses provides for
probable losses based on evaluations of inherent risks in the loan
portfolio.  The allowance for credit losses is maintained at a level
considered by management to be adequate to absorb losses inherent in the loan
portfolio as of the date of the financial statements.  The Company has
developed appropriate policies and procedures for assessing the adequacy of the
allowance for credit losses that reflect management’s careful evaluation of
credit risk considering all available information.  Management uses
historical quantitative information to assess the adequacy of the allowance for
credit losses as well as qualitative information about the prevailing economic
and business environment, among other things. In developing this assessment,
management must rely on estimates and exercise judgment in assigning credit
risk.  Depending on changing circumstances, future assessments of
credit risk may yield materially different results from the estimates, which may
require an increase or decrease in the allowance for credit
losses.  The Company’s allowance consists of formula-based components
for business and consumer loans, an allowance for impaired loans and an
unallocated component.  In the first quarter of 2009, management
refined the methodologies for the formula-based components to align more
appropriately the allowance methodology with the current framework for analyzing
credit losses.  Formula-based allowance calculations for business and
consumer components permit the Company to address specifically the current
trends and events affecting the credit risk in the loan portfolio.





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





The
allowance for credit losses as of March 31, 2009 and December 31, 2008 was $6.2
million and $5.7 million, respectively. These amounts equated to 2.51% and 2.29%
of outstanding loans, including loans held for sale, as of March 31, 2009 and
December 31, 2008, respectively. Excluding loans held for sale, the allowance
for credit losses equated to 2.54% and 2.30% of outstanding loans as of March
31, 2009 and December 31, 2008, respectively. The increased percentage was
attributable to an additional provision for credit losses of $1.1 million
recorded in the first quarter of 2009 primarily due to the increased economic
difficulties that many businesses and households are
experiencing.  The economy continues to suffer the effects of further
declines in the value of real estate, which represents a substantial portion of
the collateral for non-performing loans. Management is working vigorously to
sell properties, increase collateral for non-performing loans, move collateral
into real estate owned, and taking appropriate charge-offs to reflect the gap
between collateral values and loan balances.





Bay
National Corporation 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
March 31, 2009, the Company had non-accrual loans totaling $12.4 million, the
largest portion of which ($8.3 million) were included in the investor
residential real estate construction and reconstruction loan portfolio. This is
a direct result of the slowdown in the real estate market, which has resulted in
an increase in loan extensions and delinquencies due to the inability of
borrowers to refinance or sell properties as quickly as
anticipated.  Total nonperforming loans represented 5% of total
outstanding loans, including loans held for sale, as of March 31,
2009.  $10.9 million of these loans are at least partially
collateralized by real estate. As of December 31, 2008, the Company had a total
of $13.5 million of non-accrual loans representing 5.4% of total outstanding
loans with $11.5 million at least partially collateralized by real
estate.  Management will continue to closely monitor these loans and
the overall level of delinquencies; however, management believes that the
allowance for credit losses is adequate for these loans.  Any losses
on these loans will be charged off as soon as the amount of loss is
determinable.






25




The
Company recorded $507 thousand of net charge-offs during the three-month period
ended March 31, 2009 compared to $768 thousand during the three-month period
ended March 31, 2008.





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, FHLB credit facilities,
scheduled amortization and prepayment of loans, funds provided by operations and
capital. The Company also has access to national markets for certificates of
deposit.  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 federal funds sold and other overnight investments. As of
March 31, 2009, the Company had $17.8 million in cash and due from banks, $19.7
million in federal funds sold and other overnight investments and $3.1 million
in loans expected to be sold within 60 days. As of December 31, 2008, the
Company had $7.3 million in cash and due from banks, $2.0 million in federal
funds sold and other overnight investments and $1.2 million in loans expected to
be sold within 60 days.




The
Company had approximately $21.5 million of borrowing capacity with the FHLB of
Atlanta as of December 31, 2008.  This facility was rescinded on February
13, 2009.  The Company took steps to restore this line of credit and it was
restored to $6.5 million on March 27, 2009. Subsequently, on April 9, 2009 the
available line capacity was reduced to $5.0 million.  On May 14, 2009, the
Company received notification that due to the weak operating results of the Bank
for the first quarter of 2009, the line has again been rescinded.  The
Company will continue to take appropriate steps to identify and arrange for
lines of credit from other sources.


The
increase in the overall level of liquid assets, other than loans expected to be
sold within 60 days, is the result of management’s decision to increase
liquidity and, when appropriate, to allow non-core time deposits to
mature.





As an
additional source of liquidity, management has also identified specific loans to
sell and has contacted several correspondent banks as potential purchasers of
such loans.  Some of those correspondents have expressed an interest
and have begun preliminary reviews of documentation provided by the
Company.  Since undertaking transactions of this nature could have an
adverse impact on the profitability of the Company (i.e., loss in interest
income on the participated loans) the sale of these assets are being
considered only as a contingent source of liquidity.






26





To
further aid in managing the Company’s liquidity, in a March 2009 meeting, the
Board approved the formation of an Investment Committee and the use of available
cash to establish an investment portfolio. The Investment Committee will meet to
review and discuss recommendations for the composition of the portfolio. By
limiting the maturity of securities and maintaining a conservative investment
posture, management can rely on the investment portfolio to help meet any
short-term funding needs.  Among the options available to the Company
is selling shares of common stock to raise capital and improve our liquidity
position.





Based on
the actions noted above, we believe that the Company has backup facilities in
place to meet a liquidity shortfall. Although the Company believes sufficient
liquidity exists, if economic conditions continue to deteriorate and consumer
confidence is not restored, this excess liquidity could be depleted, which would
then materially affect the Company’s ability to meet its operating needs and to
raise additional capital.








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 generally 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 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.






27








The
following table sets forth the amount of the Company's interest-earning assets
and interest-bearing liabilities as of March 31, 2009, which are expected to
mature or reprice in each of the time periods shown:





Maturity
      or repricing withinAmount
                
                
                Percent
      ofTotal
                
                
                0
      to 3
                  Months
                
                
                4
      to 12
                  Months
                
                
                
                1
      to 5
                  Years
                
                
                Over
      5
                  YearsInterest-earning
      assetsFederal
      funds sold and other
                  overnight
      investments
                
                $
                19,691,640
                
                
                
                7.33
                %
                
                $
                19,691,640
                
                
                $
                -
                
                
                
                $
                -
                
                
                $
                -Loans
      held for sale
                
                
                3,138,341
                
                
                
                1.17
                
                
                
                3,138,341
                
                
                
                -
                
                
                
                
                -
                
                
                
                -Loans
      – Variable rate
                
                
                133,207,193
                
                
                
                49.56
                
                
                
                133,207,193
                
                
                
                -
                
                
                
                
                -
                
                
                
                -Loans
      – Fixed rate
                
                
                111,572,427
                
                
                
                41.51
                
                
                
                18,343,561
                
                
                
                8,385,265
                
                
                
                
                70,947,827
                
                
                
                13,895,774Other  earning
      assets
                
                
                1,191,900
                
                
                
                .44
                
                
                
                -
                
                
                
                -
                
                
                
                
                -
                
                
                
                1,191,900Total
      interest-earning assets
                
                $
                268,801,501
                
                
                
                100.00
                %
                
                
                174,380,735
                
                
                $
                8,385,265
                
                
                
                
                70,947,847
                
                
                
                15,087,674Interest-bearing
      liabilitiesDeposits
      – Variable rate
                
                $
                45,555,418
                
                
                
                19.71
                %
                
                $
                45,555,418
                
                
                $
                -
                
                
                
                $
                -
                
                
                $
                -Deposits
      – Fixed rate
                
                
                177,571,417
                
                
                
                76.83
                
                
                
                19,956,131
                
                
                
                126,432,929
                
                
                
                
                31,182,357
                
                
                
                -Subordinated
      debt and short term borrowings
                
                
                8,000,048
                
                
                
                3.46
                
                
                
                48
                
                
                
                -
                
                
                
                
                -
                
                
                
                8,000,000Total
      interest-bearing liabilities
                
                $
                231,126,883
                
                
                
                100.00
                %
                
                $
                65,511,597
                
                
                $
                126,432,929
                
                
                
                $
                31,182,,356
                
                
                $
                8,000,000Periodic
      repricing differencesPeriodic
      gap
                
                
                
                
                
                
                
                
                
                $
                108,869,138
                
                
                $
                (118,047,664
                )
                
                
                $
                39,765,470
                
                
                $
                7,087,674Cumulative
      gap
                
                
                
                
                
                
                
                
                
                $
                108,869,138
                
                
                $
                (9,178,526
                )
                
                
                $
                30,586,944
                
                
                $
                37,674,618Ratio
      of rate sensitive assets to rate
                  sensitive
      liabilities
                
                
                
                
                
                
                
                
                
                
                266.18
                %
                
                
                6.63
                %
                
                
                
                227.53
                %
                
                
                188.60
                %





The
Company has 58.1% of its interest-earning assets and 19.7% of its
interest-bearing liabilities in variable rate balances. Interest-earning assets
exceed interest-bearing liabilities by $37.7 million. The majority of this gap
is concentrated in items maturing or repricing within 0 to 3 months. This gap is
generally reflective of the Company’s effort, over the past 15 months, to
maintain flexibility in the balance sheet in a declining interest rate
environment. As rates have continued to drop over the past 15 months, the
Company has elected not to extend the term on time deposits in an effort to
minimize interest costs for the short-term while rates are still
declining.  This analysis indicates that the Company 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 evaluates 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.




28




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





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





Outstanding
loan commitments and lines and letters of credit at March 31, 2009 and December
31, 2008 are as follows:





March
      31,
              2009
            
            
            December
      31,
              2008Loan
      commitments
            
            $
            9,090,186
            
            
            $
            14,981,584Unused
      lines of credit
            
            
            74,486,128
            
            
            
            84,495,398Letters
      of credit
            
            
            4,101,160
            
            
            
            2,924,671





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





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








Capital
Resources





The
Company had stockholders’ equity at March 31, 2009 of $14.1 million as compared
to $15.0 million at December 31, 2008. The decrease in capital is a result of
the operating loss incurred for the three months ended March 31,
2009.






29







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 is currently considered “adequately
capitalized” under these capital guidelines.  However, pursuant to the
Consent Order the Bank was required to reach and then maintain certain
regulatory capital ratios in excess of the minimum required under the risk-based
capital adequacy guidelines by April 30, 2009. The Bank has not met these
regulatory capital requirements under the Consent Order.





In
addition, the Reserve Bank Agreement prohibits the Parent from paying
dividends on any of its securities, and the Consent Order prohibits the Bank
from paying dividends to the Parent (which is the Parent’s main source of funds
to pay dividends on its securities), without the consent of our
regulators.








Reconciliation
of Non-GAAP Measures





Below is
a reconciliation of total deposits to core deposits as of March 31, 2009 and
December 31, 2008, respectively:





March
      31,
              2009
            
            
            December
      31,
              2008Total
      deposits
            
            $
            273,999,628
            
            
            $
            244,628,032National
      market certificates of deposit (includes CDARS deposits)
            
            
            (132,854,634
            )
            
            
            (94,920,000
            )Variable
      balance accounts (1 customer at March 31, 2008 and December 31,
      2008)
            
            
            (8,048,219
            )
            
            
            (5,312,000
            )Portion
      of variable balance accounts considered to be core
            
            
            3,000,000
            
            
            
            3,000,000Core
      deposits
            
            $
            136,096,775
            
            
            $
            147,396,032





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.






30





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 credit losses, see “Allowance
for Credit Losses and Credit Risk Management.”





The
Company accounts for income taxes under the asset/liability
method.  Deferred tax assets are recognized for the future
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as operating loss and tax credit
carry-forwards.  Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period indicated by the
enactment date.  A valuation allowance is established for deferred tax
assets when, in the judgment of management, it is more likely than not that such
deferred tax assets will not become realizable.  The judgment about
the level of future taxable income is dependent to a great extent on matters
that may, at least in part, be beyond the Company’s control.  It is at
least reasonably possible that management’s judgment about the need for a
valuation allowance for deferred tax assets could change in the near
term.






31




Item
3.  Quantitative and Qualitative Disclosures About Market
Risk.





Not applicable.





Item
4.    Controls and Procedures.





As of the
end of the period covered by this quarterly report on Form 10-Q, 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 as of March 31,
2009.  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 (“Exchange Act”) 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 control over financial reporting (as defined
in Rule 13a-15 under the Exchange Act) during the quarter ended March 31, 2009,
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





This
report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E
of the Exchange Act.  Forward-looking statements also may be included
in other statements that we make.  All statements that are not
descriptions of historical facts are forward-looking statements. Forward-looking
statements often use words such as “believe,” “expect,” “plan,” “may,” “will,”
“should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other
words of similar meaning. You can also identify them by the fact that they do
not relate strictly to historical or current facts.





The
statements presented herein with respect to, among other things, the Company’s
plans, objectives, expectations and intentions, including statements regarding
the Company’s expectations with respect to resolving issues in its loan
portfolio, market expansion, earnings, asset and loan growth, investment
strategies, future sources of income, decreased occupancy expenses, losses from
off-balance sheet transactions, liquidity including anticipated sources of
liquidity, the allowance for credit losses, interest rate sensitivity, dividend
payments, future market conditions, the funding of loan commitments and letters
of credit and financial and other goals, as well as statements with respect to
the future status of our loan portfolio are forward-looking. These statements
are based on the Company’s beliefs and assumptions, and on information available
to it as of the date of this filing, and involve risks and uncertainties. These
risks and uncertainties include, among others, those discussed in this report on
Form 10-Q; the Company’s dependence on key personnel; risks related to the
Bank’s choice of loan portfolio; continuing declines in the real estate market
in the Company’s markets and in the economy generally; risks related to the
Bank’s lending limit; risks of a competitive market; the impact of any new or
amended government regulations on operating results; and the effects of
developments in technology. For a more complete discussion of these risks and
uncertainties, see the discussion under the caption “Risk Factors” in Bay
National Corporation’s Form 10-K for the year ended December 31, 2008. The
Company’s actual results and the actual outcome of our expectations and
strategies could differ materially from those anticipated or estimated because
of these risks and uncertainties and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only as of the
date of this filing, and the Company undertakes no obligation to update the
forward-looking statements to reflect factual assumptions, circumstances or
events that have changed after the forward-looking statements are
made.






32




PART
II – OTHER INFORMATION





Item
1.        Legal
Proceedings.





None





Item
1A.     Risk Factors





There have been no material changes in
the risk factors from those disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2008.





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





None





Item
3.         Defaults Upon Senior
Securities.





Not applicable.





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





None





Item
5.         Other
Information.





As previously noted, on February 6,
2009, the Bank voluntarily entered into the Consent Order.  Among
other things, the Consent Order requires that by April 30, 2009 the Bank
maintain certain regulatory capital ratios in excess of the minimum required
under the risk-based capital adequacy guidelines adopted by our
regulators.  The Bank was not in compliance with the minimum capital
requirements at April 30, 2009 and our request for an extension for compliance
was denied.  As a result, we are required to develop a contingency
plan for the Bank.  As discussed in the Company’s proxy statement for
our annual meeting of stockholders to be held on May 26, 2009, we are planning
to issue a significant number of shares of the Company’s common stock in a
private placement to accredited investors that is likely to result in a change
in control of the Company.  We believe that such issuance will satisfy
the contingency plan requirement.





Item
6.                           Exhibits.





(a)
            Exhibits.10.18
            Stipulation
      and Consent to the Issuance of a Consent Order by the Office of the
      Comptroller of the Currency (incorporated by reference from Bay National
      Corporation’s Annual Report on Form 10-K for the year ended December 31,
      2008, filed with the Securities and Exchange Commission on March 31,
      2009)10.19
            Consent
      Order issued by the Office of the Comptroller of the Currency
      (incorporated by reference from Bay National Corporation’s Annual Report
      on Form 10-K for the year ended December 31, 2008, filed with the
      Securities and Exchange Commission on March 31, 2009)31.1
            Rule 13a-14(a)Certification of
      Chief Executive Officer31.2
            Rule 13a-14(a)Certification of
      Chief Financial Officer32
            Rule 13a-14(b)Certification of
      Chief Executive Officer and Chief Financial
  Officer








33





SIGNATURES





Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.








Bay
      National CorporationDate:
      May 14, 2009
            
            By:
            /s/
      Hugh W. MohlerHugh
      W. Mohler, President(Principal
      Executive Officer)Date:
      May 14, 2009
            
            By:
            /s/
      David E. BorowyDavid
      E, Borowy, Treasurer(Principal
      Accounting and Financial Officer)











34