Edgar Filing: TRI COUNTY FINANCIAL CORP /MD/

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2011

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to ________

Commission File Number 0-18279

Tri-County Financial Corporation

(Exact name of registrant as specified in its charter)

Maryland	52-1652138
(State of other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

3035 Leonardtown Road, Waldorf, Maryland	20601
(Address of principal executive offices)	(Zip Code)

(301) 645-5601

(Registrant's telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark 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 x 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. (Check one):

Large Accelerated Filer ¨	Accelerated Filer ¨
Non-accelerated Filer ¨	Smaller Reporting Company x
(Do not check if a smaller reporting company)

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

As of July 26, 2011, the registrant had 3,016,305 shares of common stock outstanding.

TRI-COUNTY FINANCIAL CORPORATION

FORM 10-Q

INDEX

	Page

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements (Unaudited)

Consolidated Balance Sheets – June 30, 2011 and December 31, 2010	3

Consolidated Statements of Income - Three and Six Months Ended June 30, 2011 and 2010	4

Consolidated Statements of Cash Flows - Six Months Ended June 30, 2011 and 2010	5

Notes to Consolidated Financial Statements	7

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3 – Quantitative and Qualitative Disclosures about Market Risk	37

Item 4 – Controls and Procedures	37

PART II - OTHER INFORMATION

Item 1 – Legal Proceedings	37

Item 1A – Risk Factors	37

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	38

Item 3 – Defaults Upon Senior Securities	38

Item 4 – [Removed and Reserved]	38

Item 5 – Other Information	38

Item 6 – Exhibits	38

SIGNATURES	39

PART I FINANCIAL STATEMENTS

ITEM I. FINANCIAL STATEMENTS

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS JUNE 30, 2011 AND DECEMBER 31, 2010

	June 30,			December 31,
	2011			2010
	(Unaudited)
Assets
Cash and due from banks	$	12,398,545		$	8,695,590
Federal funds sold		820,000			615,000
Interest-bearing deposits with banks		768,044			512,846
Securities available for sale (AFS), at fair value		29,324,105			34,946,225
Securities held to maturity (HTM), at amortized cost		106,780,655			126,988,316
Federal Home Loan Bank and Federal Reserve Bank stock - at cost		5,957,800			6,315,600
Loans receivable - net of allowance for loan losses of $7,099,659 and $7,669,147		692,247,025			654,449,936
Premises and equipment, net		13,493,936			12,132,141
Foreclosed real estate		10,546,881			10,469,302
Accrued interest receivable		3,012,870			2,784,396
Investment in bank owned life insurance		17,771,896			17,447,692
Other assets		12,653,040			10,579,058
Total Assets	$	905,774,797		$	885,936,102

Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing deposits	$	84,199,169		$	75,642,197
Interest-bearing deposits		669,732,661			648,940,129
Total deposits		753,931,830			724,582,326
Short-term borrowings		1,860,549			816,422
Long-term debt		60,600,557			70,624,044
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000			12,000,000
Accrued expenses and other liabilities		6,437,512			6,808,383
Total Liabilities		834,830,448			814,831,175

Stockholders' Equity
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540		15,540,000			15,540,000
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777		777,000			777,000
Common stock - par value $.01; authorized - 15,000,000 shares; issued 3,023,534 and 3,002,616 shares, respectively		30,235			30,026
Additional paid in capital		17,296,309			16,962,460
Retained earnings		37,496,035			37,892,557
Accumulated other comprehensive gain		443,745			411,188
Unearned ESOP shares		(638,975	)		(508,304	)
Total Stockholders’ Equity		70,944,349			71,104,927

Total Liabilities and Stockholders' Equity	$	905,774,797		$	885,936,102

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Interest and Dividend Income
Loans, including fees	$	9,012,635	$	8,728,673	$	17,873,206	$	17,487,459
Taxable interest and dividends on investment securities		889,515		1,160,439		1,859,352		2,363,013
Interest on deposits with banks		2,282		3,970		3,664		6,147
Total Interest and Dividend Income		9,904,432		9,893,082		19,736,222		19,856,619

Interest Expenses
Deposits		2,595,961		2,691,842		5,204,481		5,511,123
Short-term borrowings		10,022		6,025		24,455		16,879
Long-term debt		562,446		631,989		1,161,810		1,280,755
Total Interest Expenses		3,168,429		3,329,856		6,390,746		6,808,757

Net Interest Income		6,736,003		6,563,226		13,345,476		13,047,862
Provision for loan losses		890,861		804,430		2,896,691		1,662,804
Net Interest Income After Provision For Loan Losses		5,845,142		5,758,796		10,448,785		11,385,058

Noninterest Income
Loan appraisal, credit, and miscellaneous charges		193,633		83,388		351,731		253,800
Gain on sale of asset		-		22,500		-		22,500
Income from bank owned life insurance		164,509		106,168		324,204		210,914
Service charges		539,874		442,611		966,833		846,655
Gain on sale of loans held for sale		54,583		89,677		80,158		171,700
Total Noninterest Income		952,599		744,344		1,722,926		1,505,569

Noninterest Expenses
Salary and employee benefits		2,675,393		2,398,821		5,426,867		4,761,355
Occupancy expense		467,581		466,398		884,972		894,042
Advertising		115,341		101,853		234,037		178,602
Data processing expense		288,356		248,677		571,109		494,817
Professional fees		233,153		285,394		450,241		444,233
Depreciation of furniture, fixtures, and equipment		102,663		134,345		202,192		261,943
Telephone communications		44,207		42,109		86,231		82,228
Office supplies		37,109		33,690		75,900		79,436
FDIC insurance		330,022		394,659		656,341		746,765
Valuation allowance on foreclosed real estate		-		287,934		315,883		287,934
Other		629,473		505,753		1,130,749		906,687
Total Noninterest Expenses		4,923,298		4,899,633		10,034,522		9,138,042

Income before income taxes		1,874,443		1,603,507		2,137,189		3,752,585
Income tax expense		654,648		567,423		675,896		1,352,077
Net Income	$	1,219,795	$	1,036,084	$	1,461,293	$	2,400,508
Preferred stock dividends		211,732		211,732		423,465		423,465
Net Income Available to Common Shareholders	$	1,008,063	$	824,352	$	1,037,828	$	1,977,043

Per Common Share
Basic earnings	$	0.33	$	0.28	$	0.34	$	0.66
Diluted earnings	$	0.33	$	0.27	$	0.34	$	0.66
Cash dividends paid	$	0.40	$	0.40	$	0.40	$	0.40

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2011 AND 2010

	Six Months Ended June 30,
	2011			2010

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,461,293		$	2,400,508

Adjustments to reconcile net income to net cash provided by operating activities:

Provision for loan losses		2,896,691			1,662,804
Depreciation and amortization		434,471			511,453
Loans originated for resale		(2,992,200	)		(5,038,460	)
Proceeds from sale of loans originated for sale		3,051,520			4,891,118
Gain on sale of loans held for sale		(80,158	)		(171,700	)
Gain on sale of asset		-			(22,500	)
Net amortization of premium/discount on investment securities		85,186			(188,148	)
Increase in foreclosed real estate valuation allowance		315,883			287,934
Increase in cash surrender of bank owned life insurance		(324,204	)		(210,914	)
Deferred income tax benefit		259,178			(574,839	)
(Increase) decrease in accrued interest receivable		(228,474	)		43,343
Decrease in deferred loan fees		(456,619	)		(43,245	)
(Decrease) increase in accounts payable, accrued expenses, other liabilities		(370,871	)		127,453
Increase in other assets		(2,349,931	)		(822,209	)

Net cash provided by operating activities		1,701,765			2,852,598

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities available for sale		(60,648	)		(66,099	)
Proceeds from redemption or principal payments of investment securities available for sale		5,758,869			10,015,172
Purchase of investment securities held to maturity		(99,951	)		(26,526,103	)
Proceeds from maturities or principal payments of investment securities held to maturity		20,195,654			15,222,385
Net decrease of FHLB and Federal Reserve stock		357,800			-
Loans originated or acquired		(142,803,152	)		(125,936,531	)
Principal collected on loans		102,193,367			106,782,306
Purchase of premises and equipment		(1,796,266	)		(456,157	)
Proceeds from sale of assets		-			22,500

Net cash used in investing activities		(16,254,327	)		(20,942,527	)

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2011 AND 2010 (continued)

	Six Months Ended June 30,
	2011			2010

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits	$	29,349,504		$	43,259,919
Payments of long-term borrowings		(10,023,487	)		(5,022,565	)
Net increase (decrease) in short-term borrowings		1,044,127			(12,939,213	)
Exercise of stock options		303,578			31,858
Dividends Paid		(1,633,321	)		(1,619,654	)
Redemption of common stock		(224,625	)
Net change in unearned ESOP shares		(100,061	)		64,141

Net cash provided by financing activities		18,715,715			23,774,486

INCREASE IN CASH AND CASH EQUIVALENTS	$	4,163,153		$	5,684,557

CASH AND CASH EQUIVALENTS - JANUARY 1		9,823,436			11,247,967

CASH AND CASH EQUIVALENTS - JUNE 30	$	13,986,589		$	16,932,524

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the six months for:
Interest	$	6,516,129		$	7,034,142
Income taxes	$	929,500		$	2,699,000

Transfer from loans to foreclosed real estate	$	6,230,707		$	10,241,740
Issuance of common stock for payment of compensation	$	245,294		$	-

See notes to consolidated financial statements

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2011 AND 2010

BASIS OF PRESENTATION

General - The consolidated financial statements of Tri-County Financial Corporation (the “Company”) and its wholly owned subsidiary, Community Bank of Tri-County (the “Bank”), and the Bank’s wholly owned subsidiary Community Mortgage Corporation of Tri-County, included herein are unaudited. However, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2010 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2010 Annual Report. The results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2011 presentation.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2010 Annual Report.

NATURE OF BUSINESS

The Company provides a variety of financial services to individuals and businesses through its offices in Southern Maryland. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and consumer mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.

FAIR VALUE MEASUREMENTS

The Company adopted the Financial Accounting Standards Board’s (“FASB”) Accounting Standard’s Codification (“ASC”) Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities” which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:

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.

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly or quarterly valuation process.

There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the six months ended June 30, 2011 and 2010, respectively. Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities (“GSEs”), municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans Receivable

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At June 30, 2011, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, in the aggregate. Fair value is derived from secondary market quotations for similar instruments. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold, using the specific identification method.

Foreclosed Real Estate

Foreclosed real estate is adjusted for fair value upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis:

The table below presents the recorded amount of assets and liabilities, as of June 30, 2011 measured at fair value on a recurring basis.

			Fair Value Measurements
			At June 30, 2011
			Using:
	Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description of Asset
Securities available for sale:
Asset-backed securities issued by GSEs
Collateralized Mortgage Obligations (CMO)	$	22,289,847	$	-	$	22,289,847	$	-
Mortgage Backed Securities (MBS)		3,077,532		-		3,077,532		-
Corporate equity securities		37,433		-		37,433		-
Bond mutual funds		3,919,293		-		3,919,293		-
Total securities available for sale	$	29,324,105	$	-	$	29,324,105	$	-

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of June 30, 2011 are included in the table below:

			Fair Value Measurements
			At June 30, 2011
			Using:
	Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description of Asset
Loans with impairment:
Commercial real estate	$	1,955,651	$	-	$	1,955,651	$	-
Commercial loans		5,436,000		-		5,436,000		-
Total loans with impairment	$	7,391,651	$	-	$	7,391,651	$	-

Foreclosed Real Estate	$	10,546,881	$	-	$	10,546,881	$	-

INCOME TAXES

The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. It is the Company’s policy to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.

EARNINGS PER COMMON SHARE

Basic earnings per common share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as options and warrants. As of June 30, 2011 and 2010, there were 102,524 and 253,359 shares, respectively, excluded from the diluted net income per share computation because the exercise price of the stock options were greater than the market price, and thus were anti-dilutive. Basic and diluted earnings per share have been computed based on weighted-average common and common equivalent shares outstanding as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
Net Income	$	1,219,795		$	1,036,084		$	1,461,293		$	2,400,508
Less: dividends payable on preferred stock		(211,732	)		(211,732	)		(423,465	)		(423,465	)
Net income available to common shareholders	$	1,008,063		$	824,352		$	1,037,828		$	1,977,043

Average number of common shares outstanding		3,024,625			2,984,808			3,017,112			2,981,616
Effect of dilutive options		31,830			16,934			37,489			17,617
Average number of shares used to calculate diluted earnings per share		3,056,455			3,001,742			3,054,601			2,999,233

COMPREHENSIVE INCOME

Comprehensive income is net income adjusted for net unrealized holding gains or losses and other than temporary impairment for the period.

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Net Income	$	1,219,795	$	1,036,084	$	1,461,293	$	2,400,508
Other comprehensive income net of tax:
Net unrealized holding gains arising during period		130,007		108,162		32,557		206,617
Comprehensive income	$	1,349,802	$	1,144,246	$	1,493,850	$	2,607,125

STOCK-BASED COMPENSATION

The Company has stock option and incentive arrangements to attract and retain key personnel. In May 2005, the 2005 Equity Compensation Plan (the “Plan”) was approved by the shareholders, which authorizes the issuance of restricted stock, stock appreciation rights, stock units and stock options to the Board of Directors and key employees. Compensation expense for service based awards is recognized over the vesting period. Performance based awards are recognized based on a vesting, if applicable, and the probability of achieving the goals.

There was $65,522 in stock-based compensation expense for the six months ended June 30, 2011 compared to $9,309 recognized for the six months ended June 30, 2010. The fair value of the Company’s employee stock options granted is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.

The exercise price for options granted is set at the discretion of the committee administering the Plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is 10 years and the options vest at the discretion of the committee.

The Company has accrued the full amounts due under these plans, but currently it is not possible to identify the portion that will be paid out in the form of stock–based compensation because such payments are subject to the future election of the recipient as to whether to receive payment in the form of stock or cash.

A summary of the Company’s stock option plans as of June 30, 2011 and changes during the six months then ended is presented below:

				Weighted				Weighted-Average
				Average		Aggregate		Contractual Life
				Exercise		Intrinsic		Remaining In
	Shares			Price		Value		Years

Outstanding at January 1, 2011		299,237		$	16.86	$	524,392		2.0
Granted at fair value		-			-
Exercised		(18,215	)		8.53		169,589
Expired		-			-
Forfeited		(1 ,576	)		15.02
Outstanding at June 30, 2011		279,446		$	17.41	$	508,554		2.1
Exercisable at June 30, 2011		279,446		$	17.41	$	508,554		2.1

Aggregate intrinsic value of outstanding stock options and exercisable stock options was $508,554 at June 30, 2011. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $16.80 at June 30, 2011, and the exercise price multiplied by the number of options outstanding.

The Company has outstanding restricted stock and stock units granted in accordance with the Plan. The following table summarizes the unvested restricted stock awards and units outstanding at June 30, 2011:

	Restricted Stock					Restricted Stock Units
	Number of Shares			Weighted Average Grant Date Fair Value		Number of Shares		Weighted Average Grant Date Fair Value

Nonvested at January 1, 2011		2,720		$	11.90		3,739	$	16.10
Granted		6,500			16.10		3,106		16.89
Vested		(2,661	)		16.10		-		-

Nonvested at June 30, 2011		6,559		$	14.36		6,845	$	16.46

GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES

On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance, along with the $155,000 for Capital Trust II’s common securities, to purchase $5,155,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust II’s obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company.

On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7,000,000 of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7,217,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust I’s obligations with respect to the capital securities. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company.

PREFERRED STOCK

On December 19, 2008, the United States Department of the Treasury (“Treasury”), acting under the authority granted to it by the Troubled Asset Relief Program’s Capital Purchase Program purchased $15,540,000 of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) issued by the Company. The preferred stock has a perpetual life, has liquidation priority over the Company’s common shareholders, and is cumulative. The dividend rate is 5% for the first five years, rising to 9% thereafter. The Series A Preferred Stock may not be redeemed unless the Company has paid all dividends accumulated. As condition to the issuance of the Series A Preferred Stock the Company agreed to accept restrictions on the repurchase of its common stock, the payment of dividends and certain compensation practices.

At the same time the Company issued its Series A Preferred Stock, it issued to the Treasury a warrant to purchase Fixed Rate Cumulative Perpetual Preferred Stock, Series B Preferred Stock (“Series B Preferred Stock”) in the amount of 5% of the Series A Preferred Stock or 777 shares with a par value of $777,000. The warrant had an exercise price of $.01 per share. The Series B Preferred Stock has the same rights, preferences and privileges as the Series A Preferred Stock except, the Series B Preferred Stock has a dividend rate of 9%. This warrant was immediately exercised.

Under the terms of the Treasury purchase of preferred stock, the Company cannot repurchase common stock without Treasury’s consent until December 19, 2018 or until the preferred stock issued to the Treasury is redeemed. On November 12, 2010, after approval from the Treasury, the Company approved a repurchase program under which the Company may repurchase shares of common stock equaling up to 1% of the Company’s stockholders’ equity. The Company intends to repurchase shares from time to time, depending on market conditions.

The Company believes that it is in compliance with all terms of the Preferred Stock Purchase Agreement.

10.

SECURITIES

	June 30, 2011
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs:
Residential MBS	$	2,802,570	$	274,962	$	-	$	3,077,532
Residential CMOs		21,798,633		495,614		4,400		22,289,847
Corporate equity securities		37,310		123		-		37,433
Bond mutual funds		3,757,856		161,437		-		3,919,293
Total securities available for sale	$	28,396,369	$	932,136	$	4,400	$	29,324,105

Securities held to maturity (HTM)
Asset-backed securities issued by GSEs:
Residential MBS	$	30,604,268	$	510,547	$	19,010	$	31,095,805
Residential CMOs		64,753,847		1,338,472		3,623		66,088,696
Asset-backed securities issued by Other:
Residential MBS		-		-		-		-
Residential CMOs		10,572,139		65,950		1,318,443		9,319,646
Total debt securities held to maturity		105,930,254		1,914,969		1,341,076		106,504,147

U.S. Government obligations		850,401		-		-		850,401
Total securities held to maturity	$	106,780,655	$	1,914,969	$	1,341,076	$	107,354,548

	December 31, 2010
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs:
Residential MBS	$	3,246,588	$	257,627	$	-	$	3,504,215
Residential CMOs		27,081,220		503,511		-		27,584,731
Corporate equity securities		37,310		80		-		37,390
Bond mutual funds		3,697,208		122,681		-		3,819,889
Total securities available for sale	$	34,062,326	$	883,899	$	-	$	34,946,225

Securities held to maturity (HTM)
Asset-backed securities issued by GSEs:
Residential MBS	$	33,252,667	$	453,900	$	518,124	$	33,188,443
Residential CMOs		80,519,344		1,307,909		264,146		81,563,107
Asset-backed securities issued by Other:								-
Residential MBS		-		-		-		-
Residential CMOs		12,463,500		132,928		1,709,386		10,887,042
Total debt securities held to maturity		126,235,511		1,894,737		2,491,656		125,638,592

U.S. Government obligations		752,805		-		-		752,805
Total securities held to maturity	$	126,988,316	$	1,894,737	$	2,491,656	$	126,391,397

At June 30, 2011, certain other securities with a carrying value of $9.4 million were pledged to secure certain deposits. At June 30, 2011, securities with a carrying value of $18.3 million were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.

At June 30, 2011, the AFS and HTM asset-backed securities investment portfolio was $131,297,633, or 96%, of the Company’s total AFS and HTM portfolios. Ninety-four percent of the asset-backed securities portfolio was rated AAA by Standard & Poor’s. AFS asset-backed securities issued by GSEs have an average life of 2.41 years and average duration of 2.29 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs have an average life of 3.47 years and average duration of 3.23 years and are guaranteed by their issuer as to credit risk.

At June 30, 2011, the AFS investment portfolio had a fair value of $29,324,105 with unrealized losses of $4,400 on asset-backed securities with a fair value of $1,609,437. All unrealized losses were for less than 12 months.

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at June 30, 2011, were as follows:

	Less Than 12				More Than 12
	Months				Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Asset-backed securities issued by GSEs	$	8,721,906	$	10,784	$	7,798,926	$	11,849	$	16,520,832	$	22,633
Asset-backed securities issued by other		-		-		7,434,140		1,318,443		7,434,140		1,318,443
	$	8,721,906	$	10,784	$	15,233,066	$	1,330,292	$	23,954,972	$	1,341,076

The HTM investment portfolio had an estimated fair value of $107,354,548 at June 30, 2011, of which $23,954,972, or 22% of the securities, had some unrealized losses from their amortized cost. Of these securities, $16,520,832, or 69%, were mortgage-backed securities issued by GSEs and the remaining $7,434,140, or 31%, were asset-backed securities issued by others.

HTM securities issued by GSEs are guaranteed by the issuer. Total unrealized losses on the asset-backed securities issued by GSEs were $22,633, or 0.02%, of the amortized cost of $95,358,115. HTM asset-backed securities issued by GSEs with unrealized losses have an average life of 3.02 years and an average duration of 2.73 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

HTM asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches that absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $1,318,443, or 12.47%, of the amortized cost of $10,572,139. HTM asset-backed securities issued by others with unrealized losses have an average life of 2.95 years and an average duration of 2.17 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. We believe that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class.

Management has the ability and intent to hold the securities with unrealized losses classified as held to maturity until they mature, at which time the Company expects it will receive full value for the securities. Because our intention is not to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, management considers the unrealized losses in the held-to-maturity portfolio to be temporary, except for a single CMO issue, for which an other-than-temporary charge of $148,000 was recorded in 2009. At June 30, 2011, the single CMO issue had a par value of $1,048,000, a market fair value of $680,000 and a carrying value of $645,000.

There were no sales of AFS or HTM securities during the six months ended June 30, 2011 and June 30, 2010. Asset-backed securities are comprised of mortgage-backed securities as well as mortgage-derivative securities such as collateralized mortgage obligations and real estate mortgage investment conduits.

The table below presents the Standard & Poor’s credit rating of AFS and HTM asset-backed securities issued by GSEs and others at June 30, 2011 carrying value:

Credit Rating	Amount
AAA	$	122,861,201
AA+		-
A+		152,214
BBB+		-
BBB		722,254
BBB-		1,761,855
BB+		1,308,642
BB		446,743
B+		970,891
CCC+		3,073,833
Other		-
Total	$	131,297,633

11.

FORECLOSED REAL ESTATE

Foreclosed assets are presented net of an allowance for losses. An analysis of the allowance for losses on foreclosed assets is as follows.

	Six Months Ended June 30,
	2011			2010
Balance at beginning of year	$	10,469,302		$	922,934
Additions to underlying property		6,781,857			10,241,740
Disposals of underlying property		(6,388,395	)		-
Valuation allowance		(315,883	)		(287,934	)
Balance at end of period	$	10,546,881		$	10,876,740

Expenses applicable to foreclosed assets include the following.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Valuation allowance	$	-	$	287,934	$	315,883	$	287,934
Operating expenses		150,582		48,142		294,450		49,928
	$	150,582	$	336,076	$	610,333	$	337,862

12.

LOANS

Loans consist of the following:

	June 30, 2011		December 31, 2010

Commercial real estate	$	375,502,810	$	336,299,836
Residential first mortgages		149,807,743		136,048,577
Construction and land development		31,937,744		42,504,200
Home equity and second mortgage		24,133,071		24,379,664
Commercial loans		99,908,997		104,566,261
Consumer loans		1,123,217		1,273,080
Commercial equipment		17,412,667		17,983,648
		699,826,249		663,055,266
Less:
Deferred loan fees		479,565		936,183
Allowance for loan loss		7,099,659		7,669,147
		7,579,224		8,605,330

	$	692,247,025	$	654,449,936

At June 30, 2011, the Bank’s allowance for loan losses totaled $7,099,659 or 1.01%, of loan balances as compared to $7,669,147, or 1.16%, of loan balances at December 31, 2010. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, volume, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

The following table details activity in the allowance for loan losses and loan receivable balances for the six months ended June 30, 2011 and the year ended December 31, 2010. An allocation of the allowance to one category of loans does not prevent the Company’s ability to utilize the allowance to absorb losses in a different category. The loan receivables are disaggregated on the basis of the Company’s impairment methodology.

At June 30, 2011	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147
Charge-offs		(780,064	)		(49,004	)		(213,017	)		-			(2,377,194	)		(1,000	)		(48,004	)		(3,468,283	)
Recoveries		-			-			-			-			-			2,104			-			2,104
Provisions		936,190			204,470			(197,676	)		(987	)		1,940,193			(6,356	)		20,857			2,896,691
Balance at June 30,	$	3,470,109		$	359,539		$	855,932		$	96,532		$	2,115,038		$	26,957		$	175,552		$	7,099,659
Ending balance: individually evaluated for impairment	$	297,488		$	-		$	-		$	-		$	1,068,912		$	-		$	27,780		$	1,394,180
Ending balance: collectively evaluated for impairment	$	3,172,621		$	359,539		$	855,932		$	96,532		$	1,046,126		$	26,957		$	147,772		$	5,705,479
Loan receivables:
Ending balance	$	375,502,810		$	149,807,743		$	31,937,744		$	24,133,071		$	99,908,997		$	1,123,217		$	17,412,667		$	699,826,249
Ending balance: individually evaluated for impairment	$	29,327,021		$	4,027,547		$	7,353,446		$	580,470		$	21,361,108		$	147,665		$	472,981		$	63,270,238
Ending balance: collectively evaluated for impairment	$	346,175,789		$	145,780,196		$	24,584,298		$	23,552,601		$	78,547,889		$	975,552		$	16,939,686		$	636,556,011

At December 31, 2010	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	2,661,371		$	127,848		$	1,696,396		$	130,692		$	2,109,513		$	63,989		$	681,505		$	7,471,314
Charge-offs		(525,992	)		(62,999	)		(2,248,967	)		(70,999	)		(568,992	)		(10,000	)		(255,996	)		(3,743,945	)
Recoveries		-			-			1,041			-			-			7,290			-			8,331
Provisions		1,178,604			139,224			1,818,155			37,826			1,011,518			(29,070	)		(222,810	)		3,933,447
Balance at December 31,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147
Ending balance: individually evaluated for impairment	$	500,000		$	-		$	-		$	-		$	1,449,179		$	-		$	48,456		$	1,997,635
Ending balance: collectively evaluated for impairment	$	2,813,983		$	204,073		$	1,266,625		$	97,519		$	1,102,860		$	32,209		$	154,243		$	5,671,512
Loan receivables:
Ending balance	$	336,299,836		$	136,048,577		$	42,504,200		$	24,379,664		$	104,566,261		$	1,273,080		$	17,983,648		$	663,055,266
Ending balance: individually evaluated for impairment	$	20,800,730		$	3,664,442		$	12,221,463		$	319,112		$	19,991,537		$	701		$	319,770		$	57,317,755
Ending balance: collectively evaluated for impairment	$	315,499,106		$	132,384,135		$	30,282,737		$	24,060,552		$	84,574,724		$	1,272,379		$	17,663,878		$	605,737,511

Non-accrual and Past Due Loans

Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Consumer loans are typically charged-off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Non-accrual loans as of June 30, 2011 and December 31, 2010 were as follows:

	June 30, 2011				December 31, 2010
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	1,709,897		5	$	8,244,683		12
Residential first mortgages		1,266,167		4		1,746,786		6
Construction and land development		-		-		983,867		1
Home equity and second mortgage		308,465		7		232,644		5
Commercial loans		593,631		4		2,261,642		6
Consumer loans		-		-		701		1
Commercial equipment		334,015		5		48,456		1
	$	4,212,175		25	$	13,518,779		32

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $2,480,266 and $8,715,318 at June 30, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at June 30, 2011 and December 31, 2010 was $159,448 and $598,603, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $1,731,909 and $4,803,461 at June 30, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at June 30, 2011 and December 31, 2010 was $106,773 and $276,567, respectively.

An analysis of past due loans as of June 30, 2011 and December 31, 2010 were as follows:

June 30, 2011	Current		31-60 Days		61-90 Days		Greater than 90 Days		Total Past Due		Total Loan Receivables		Loans > 90 Days and Accruing

Commercial real estate	$	370,935,761	$	2,012,858	$	844,294	$	1,709,897	$	4,567,049	$	375,502,810	$	-
Residential first mortgages		147,365,599		682,913		493,064		1,266,167		2,442,144		149,807,743		-
Construction and land dev.		31,937,744		-		-		-		-		31,937,744		-
Home equity and second mtg.		23,565,323		237,727		21,556		308,465		567,748		24,133,071		-
Commercial loans		98,821,922		493,444		-		593,631		1,087,075		99,908,997		-
Consumer loans		1,074,360		47,586		1,271		-		48,857		1,123,217		-
Commercial equipment		16,819,544		235,006		24,102		334,015		593,123		17,412,667		-
Total	$	690,520,253	$	3,709,534	$	1,384,287	$	4,212,175	$	9,305,996	$	699,826,249	$	-

December 31, 2010

Commercial real estate	$	327,358,352	$	696,801	$	-	$	8,244,683	$	8,941,484	$	336,299,836	$	-
Residential first mortgages		134,142,088		159,703		-		1,746,786		1,906,489		136,048,577		-
Construction and land dev.		41,520,333		-		-		983,867		983,867		42,504,200		-
Home equity and second mtg.		23,947,389		199,631		-		232,644		432,275		24,379,664		-
Commercial loans		102,221,510		83,109		-		2,261,642		2,344,751		104,566,261		-
Consumer loans		1,268,738		3,141		500		701		4,342		1,273,080		-
Commercial equipment		17,935,192		-		-		48,456		48,456		17,983,648		-
Total	$	648,393,602	$	1,142,385	$	500	$	13,518,779	$	14,661,664	$	663,055,266	$	-

Credit Quality Indicators

A risk grading matrix is used to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received, and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $350,000 or greater are subject to being risk rated. Relationships that are comprised of only a few loans which are fully amortizing, secured by real estate and have not had a history of delinquency are exempt from the annual review. Loans are graded on a scale of 1 to 10.

Ratings 1 thru 6 - Pass

Ratings 1 thru 6 have asset risks ranging from excellent low risk to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention

These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the Lending Officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM classified loans are the first adversely classified assets on our Watch List. These relationships will be reviewed at least quarterly.

Rating 8 - Substandard

Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.

Rating 9 - Doubtful

Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and it will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.

Rating 10 - Loss

Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss”. There may be some future potential recovery; however it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be uncollectable.

Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an OAEM or higher risk rating due to a delinquent payment history.

Management regularly reviews credit quality indicators in assessing the overall quality of the Bank’s loan portfolio including the composition of the loan portfolio, net charge-offs, nonperforming loans, performance of troubled debt restructured loans and general economic conditions in the Southern Maryland market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans.

Credit quality indicators as of June 30, 2011 and December 31, 2010 were as follows:

Credit Risk Profile by Internally Assigned Grade

	Commercial Real Estate				Construction and Land Dev.
	6/30/2011		12/31/2010		6/30/2011		12/31/2010

Unrated	$	1,013,632	$	1,074,330	$	146,182	$	-
Pass		347,855,909		317,579,637		26,155,031		30,274,737
Special mention		1,239,854		3,628,052		-		1,585,035
Substandard		25,393,415		14,017,818		5,636,531		10,644,428
Doubtful		-		-		-		-
Loss		-		-		-		-
Total	$	375,502,810	$	336,299,836	$	31,937,744	$	42,504,200

	Commercial Loans				Commercial Equipment
	6/30/2011		12/31/2010		6/30/2011		12/31/2010

Unrated	$	3,868,260	$	50,035	$	142,408	$	169,492
Pass		76,603,985		84,946,678		17,086,835		17,765,700
Special mention		-		2,814,668		-		-
Substandard		19,436,752		12,852,635		183,424		-
Doubtful		-		3,793,470		-		48,456
Loss		-		108,775		-		-
Total	$	99,908,997	$	104,566,261	$	17,412,667	$	17,983,648

Credit Risk Profile Based on Payment Activity

	Residential First Mortgages				Home Equity and Second Mtg.				Consumer Loans
	6/30/2011		12/31/2010		6/30/2011		12/31/2010		6/30/2011		12/31/2010

Performing	$	148,541,576	$	134,301,791	$	23,824,606	$	24,147,019	$	1,123,217	$	1,272,379
Nonperforming		1,266,167		1,746,786		308,465		232,645		-		701
Total	$	149,807,743	$	136,048,577	$	24,133,071	$	24,379,664	$	1,123,217	$	1,273,080

Impaired Loans and Troubled Debt Restructures (TDRs)

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless such loans are the subject of a troubled debt restructuring agreement or are risk rated as OAEM or above or are part of a commercial relationship that requires grading.

Interest payments made on impaired loans are applied to principal unless collectability of the principal amount is reasonably assured. Interest recognized on impaired loans is on a cash basis. Impaired loans at June 30, 2011 and December 31, 2010 were as follows:

June 30, 2011	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Year to Date Interest Income Recognized

Commercial real estate	$	11,107,498	$	8,446,709	$	2,253,139	$	10,699,848	$	297,488	$	9,131,959	$	271,124
Construction and land dev.		1,716,915		1,716,915		-		1,716,915		-		1,716,915		41,300
Commercial loans		9,157,106		2,652,194		6,504,912		9,157,106		1,068,912		10,568,967		201,326
Commercial equipment		234,139		206,358		27,780		234,139		27,780		264,955		11,880
Total	$	22,215,658	$	13,022,176	$	8,785,831	$	21,808,008	$	1,394,180	$	21,682,796	$	525,630

December 31, 2010	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized

Commercial real estate	$	11,254,896	$	5,624,780	$	5,222,466	$	10,847,246	$	500,000	$	8,710,501	$	329,446
Residential first mortgages		928,847		928,847		-		928,847		-		924,163		52,516
Commercial loans		9,292,145		3,195,567		6,096,578		9,292,145		1,449,179		9,308,552		464,956
Commercial equipment		319,769		271,313		48,456		319,769		48,456		300,533		13,836
Total	$	21,795,657	$	10,020,507	$	11,367,500	$	21,388,007	$	1,997,635	$	19,243,749	$	860,754

At June 30, 2011 and December 31, 2010, impaired loans totaled $21,808,008 and $21,388,007, respectively. Impaired loans had specific allocations within the allowance for loan losses or have been reduced by charge-offs to recoverable values. Allocations of the allowance for loan losses relative to impaired loans at June 30, 2011 and December 31, 2010 were $1,394,180 and $1,997,635, respectively.

The Company considers all troubled debt restructured loans (TDRs) to be impaired and defines TDRs as loans whose terms have been modified to provide for a reduction of either interest or principal because of deterioration in the financial condition of the borrower. A loan extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not considered a TDR. Once an obligation has been classified as a TDR it continues to be considered a TDR until paid in full or until the loan returns to performing status and yields a market interest rate equal to the current interest rate for new debt with similar risk. TDRs are evaluated by management on a regular basis utilizing the Company’s risk grading matrix. TDRs are evaluated for impairment on a loan-by-loan basis in accordance with the Company’s impairment methodology. The Company does not participate in any specific government or Company-sponsored loan modification programs. All restructured loan agreements are individual contracts negotiated with a borrower.

TDRs as of June 30, 2011 and December 31, 2010 were as follows:

	June 30, 2011				December 31, 2010
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	9,663,852		11	$	6,847,618		6
Residential first mortgages		-		-		928,847		2
Construction and land development		1,716,915		1		-		-
Commercial loans		2,652,194		5		8,834,025		7
Commercial equipment		234,139		3		271,313		4
	$	14,267,100		20	$	16,881,803		19

At June 30, 2011, $13,758,236 or 96.4% of TDRs were performing according to the terms of their restructured agreements compared to $16,584,546 or 98.2% at December 31, 2010.

13.

NEW ACCOUNTING STANDARDS

ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. In July 2010, the Financial Accounting Standards board (“FASB”) issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans. A company is required to disaggregate new and existing disclosure based on how it develops its allowance for loan losses and how it manages credit exposures. Existing disclosures to be presented on a disaggregated basis include a roll-forward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans. Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of past due loans, information about troubled debt restructurings, and significant purchases and sales of loans during the reporting period by class. For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010. Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Company adopted the applicable required additional disclosures effective December 31, 2010, and adoption of these additional disclosures did not have a material effect on its financial position or results of operations.

ASU No. 2011-02; A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“TDR”). In April, 2011, FASB issued ASU No. 2011-02, intended to provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and are to be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. Early adoption is permitted. The Company intends to adopt the methodologies prescribed by this ASU by the date required. Given the recent date of this pronouncement, the Company is continuing to evaluate the impact of adoption of this ASU.

ASU No. 2011-05; Presentation of Comprehensive Income. In June, 2011, the FASB issued ASU No. 2011-05, requiring companies to present comprehensive income in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement. The guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity, which is our current presentation. This guidance does not change which items are reported in other comprehensive income or the requirement to report reclassifications of items from other comprehensive income to net income. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011 and will require retrospective application for all periods presented.

14.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of the Company.

	June 30, 2011				December 31, 2010
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Assets
Cash and cash equivalents	$	13,986,589	$	13,986,589	$	9,823,436	$	9,823,436
Investment securities and stock in FHLB and FRB		142,062,560		142,636,453		168,250,141		167,654,621
Loans receivable, net		692,247,025		714,419,000		654,449,936		662,813,000
Foreclosed real estate		10,546,881		10,546,881		10,469,302		10,469,302

Liabilities
Savings, NOW, and money market accounts		327,549,079		327,549,079		286,383,452		286,383,452
Time certificates		426,382,751		433,102,000		438,198,874		444,601,000
Long-term debt and other borrowed funds		62,461,106		63,689,000		71,440,466		69,517,422
Guaranteed preferred beneficial interest in junior subordinated securities		12,000,000		2,400,000		12,000,000		2,400,000

At June 30, 2011, the Company had outstanding loan commitments and standby letters of credit of $20.1 million and $22.6 million, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these instruments differs significantly from their carrying values.

Valuation Methodology

Cash and cash equivalents - For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Investment securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. FHLB and FRB stock are carried and valued at cost.

Loans receivable - For conforming residential first-mortgage loans, the market price for loans with similar coupons and maturities was used. For nonconforming loans with maturities similar to conforming loans, the coupon was adjusted for credit risk. Loans which did not have quoted market prices were priced using the discounted cash flow method. The discount rate used was the rate currently offered on similar products. Loans priced using the discounted cash flow method included residential construction loans, commercial real estate loans, and consumer loans. The estimated fair value of loans held for sale is based on the terms of the related sale commitments.

Foreclosed real estate - Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral.

Deposits - The fair value of checking accounts, saving accounts, and money market accounts was the amount payable on demand at the reporting date.

Time certificates - The fair value was determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

Long-term debt and other borrowed funds - These were valued using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar borrowings.

Guaranteed preferred beneficial interest in junior subordinated securities - These were valued using discounted cash flows. The discount rate was equal to the rate currently offered on similar borrowings.

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

The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2011 and December 31, 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

ITEM 2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including: discussions of Tri-County Financial Corporation’s (the “Company”) goals, strategies and expected outcomes; estimates of risks and future costs; and reports of the Company’s ability to achieve its financial and other goals. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. These forward-looking statements are subject to significant known and unknown risks and uncertainties because they are based upon future economic conditions, particularly interest rates, loan demand, competition within and without the banking industry, changes in laws and regulations applicable to the Company, changes in the size, composition and quality of the Company’s loan and investment portfolios, changes in accounting principles, and various other matters. Additional factors that may affect our results are discussed in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Form 10-K”). Because of these uncertainties, there can be no assurance that the actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The Company does not undertake – and specifically disclaims any obligation – to publicly release the result of any revisions that may be made to any forward-looking statement to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

GENERAL

The Company is a bank holding company organized in 1989 under the laws of the State of Maryland. It owns all the outstanding shares of capital stock of Community Bank of Tri-County (the “Bank”), a Maryland-chartered commercial bank. The Company engages in no significant activity other than holding the stock of the Bank, paying its subordinated debt and preferred stock obligations, and directing the business of the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries.

The Bank serves Southern Maryland through its main office and nine branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince Frederick, Lusby, and California, Maryland. The Bank broke ground in June 2011 for its operations center in Waldorf, Maryland and is near completion of the permit process to build its 10th branch in Dahlgren, Virginia. Both projects are scheduled for completions in the first quarter of 2012 The Bank is engaged in the commercial and retail banking business as authorized by the banking statutes of the State of Maryland and applicable Federal regulations. The Bank accepts deposits and uses these funds, along with funds generated from operations and borrowings from the Federal Home Loan Bank (the “FHLB”), to fund loan originations to individuals, associations, partnerships and corporations and to invest in securities. The Bank makes residential first and second mortgage loans, home equity lines of credit, commercial mortgage and equipment loans, commercial loans, including secured and unsecured loans, construction and consumer loans. The Bank is a member of the Federal Reserve and FHLB Systems. The Federal Deposit Insurance Corporation provides deposit insurance coverage up to applicable limits.

Since its conversion to a state chartered commercial bank in 1997, the Bank has sought to increase its commercial and commercial real estate lending as well as the level of transactional deposits. Management recognizes that the shift in composition of the Bank’s loan portfolio away from residential first mortgage lending has and will continue to increase its exposure to credit losses. The Bank continues to evaluate its allowance for loan losses and the associated provision to compensate for the increased risk. Any evaluation of the allowance for loan losses is inherently inexact and reflects management’s expectations as to future interest rates and economic conditions in the Southern Maryland area as well as individual borrowers’ circumstances. Management believes that its allowance for loan losses is adequate. For further information on the Bank’s allowance for loan losses see the discussion in the sections captioned “Financial Condition” and “Critical Accounting Policies” as well as the relevant discussions in the Form 10-K and Annual Report for the year ended December 31, 2010.

The Company’s results are influenced by local and national economic conditions. These conditions include the level of short-term interest rates such as the federal funds rate, the differences between short- and long-term interest rates, the value of real estate in our markets, the prospects for economic growth or decline, and the rates of anticipated and current inflation. Local conditions, including employment growth or declines, may have direct or indirect effects on our borrowers’ ability to meet their obligations.

As a result of the enactment of Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) banks are no longer prohibited from paying interest on demand deposits, including those from businesses, effective July 21, 2011. It is not clear what affect the elimination of this prohibition will have on the Bank’s interest expense, allocation of deposits, deposit pricing, loan pricing, net interest margin, ability to compete, ability to establish and maintain customer relationships, or profitability.

SELECTED FINANCIAL DATA

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010

Condensed Income Statement
Interest and dividend income	$	9,904,432	$	9,893,082	$	19,736,222	$	19,856,619
Interest expense		3,168,429		3,329,856		6,390,746		6,808,757
Net interest income		6,736,003		6,563,226		13,345,476		13,047,862
Provision for loan loss		890,861		804,430		2,896,691		1,662,804
Noninterest income		952,599		744,344		1,722,926		1,505,569
Noninterest expense		4,923,298		4,899,633		10,034,522		9,138,042
Income before income taxes		1,874,443		1,603,507		2,137,189		3,752,585
Income taxes		654,648		567,423		675,896		1,352,077
Net income		1,219,795		1,036,084		1,461,293		2,400,508
Net income available to common shareholders		1,008,063		824,352		1,037,828		1,977,043

Per Common Share
Basic earnings	$	0.33	$	0.28	$	0.34	$	0.66
Diluted earnings	$	0.33	$	0.27	$	0.34	$	0.66
Cash dividends paid	$	0.40	$	0.40	$	0.40	$	0.40
Book value	$	18.07	$	17.73	$	18.07	$	17.73

RESULTS OF OPERATIONS – SIX MONTHS ENDED JUNE 30, 2011

Net income for the six-month period ended June 30, 2011 totaled $1,461,293 ($0.34 basic and diluted earnings per common share), compared to $2,400,508 ($0.66 basic and diluted earnings per common share) for the same period in the prior year. Net income available to common shareholders for the six-month period ended June 30, 2011 totaled $1,037,828 compared to $1,977,043 for the same period in the prior year. The decrease of $939,215, or 39.13% for net income or 47.51% for net income available to common shareholders, was primarily attributable to first quarter 2011 increases in the provision for loan losses to reflect current appraisals or contracted sales amounts for nonperforming loans and expenses and provisions related to foreclosed real estate. Increases in the provision for loan losses of $1,233,887 and noninterest expense of $896,480 were partially offset by increases in net interest income of $297,614 and noninterest income of $217,357.

	Six Months Ended June 30,
	2011		2010		$ Change			% Change
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans	$	17,873,206	$	17,487,459	$	385,747			2.21	%
Taxable interest and dividends on securities		1,859,352		2,363,013		(503,661	)		(21.31	)%
Interest on deposits with banks		3,664		6,147		(2,483	)		(40.39	)%
Total interest and dividend income		19,736,222		19,856,619		(120,397	)		(0.61	)%

INTEREST EXPENSE:
Interest on deposits		5,204,481		5,511,123		(306,642	)		(5.56	)%
Interest on short-term borrowings		24,455		16,879		7,576			44.88	%
Interest on long-term debt		1,161,810		1,280,755		(118,945	)		(9.29	)%
Total interest expenses		6,390,746		6,808,757		(418,011	)		(6.14	)%

Net interest income		13,345,476		13,047,862		297,614			2.28	%

Provision for loan losses		2,896,691		1,662,804		1,233,887			74.21	%

Net interest income after provision for loan losses	$	10,448,785	$	11,385,058	$	(936,273	)		(8.22	)%

Net interest income increased $297,614 as a reduction in interest expense outpaced the decrease in interest and dividend income. Interest rate spread and net interest margin decreased to 3.13% and 3.30%, respectively, for the six months ended June 30, 2011 from 3.19% and 3.41%, respectively, for the comparable period in the prior year.

The decrease in interest and dividend income was attributable to a reduction in the average yield on interest-earning assets from 5.18% for the six months ended June 30, 2010 to 4.88% for the six months ended June 30, 2011, partially offset by increases of $43.1 million to the average balance of interest-earning assets. The $385,747 increase in loan interest income was due to additional interest earned of $1,154,858 as a result of larger average loan balances offset by a decrease of $769,111 due to a decrease in average yields. Average loan yields decreased from 5.72% for the six months ended June 30, 2010 to 5.47% for the six months ended June 30, 2011. The Company has limited the effect of the lower interest rate environment on loan rates through pricing. The $506,144 decrease in interest and dividend on securities and deposits was due to a reduction in average security and deposit yields of $515,200 partially offset by additional interest earned of $9,056 as a result of larger average balances. Securities and deposits average yields decreased from 3.06% for the six months ended June 30, 2010 to 2.40% for the six months ended June 30, 2011.

The decrease in interest expense was due to a reduction in the average cost of funds on interest-bearing liabilities from 2.00% for the six months ended June 30, 2010 to 1.75% for the six months ended June 30, 2011 primarily due to a decrease in interest rates paid on certificates of deposits, which declined from 2.32% for the six months ended June 30, 2010 to 1.96% for the six months ended June 30, 2011. Interest expense also decreased due to a reduction in debt offset by higher average balances of deposits. Total average outstanding debt decreased approximately $8.6 million from $74.8 million for the six months ended June 30, 2010 to $66.2 million for the six months ended June 30, 2011. The Company increased average customer deposits by $57.7 million from $594.9 million for the six months ended June 30, 2010 to $652.6 million for the six months ended June 30, 2011. The Company has been successful in increasing its core deposits and reducing the cost of funds in the low interest-rate environment over the last several years.

The Company’s provision for loan losses increased due to additional charge-offs taken against the allowance for specific nonperforming loans based on management’s estimate of realizable value. Net charge-offs increased $2,223,328 from $1,242,851 for the six months ended June 30, 2010 to $3,466,179 for the six months ended June 30, 2011. The Company’s delinquency rate has improved from 2.38% at June 30, 2010 to 1.33% at June 30, 2011, as problem loans were charged-off, transferred to foreclosed real estate or worked out. The Company’s allowance for loan losses decreased from 1.25% of loan balances at June 30, 2010 to 1.01% of loan balances at June 30, 2011. The decline in the ratio of allowance to loans was affected by the higher level of charge-offs during the period.

The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.

	Six Months Ended June 30,
	2011		2010		$ Change			% Change
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges	$	351,731	$	253,800	$	97,931			38.59	%
Gain on sale of asset		-		22,500		(22,500	)		(100.00	)%
Income from bank owned life insurance		324,204		210,914		113,290			53.71	%
Service charges		966,833		846,655		120,178			14.19	%
Gain on loans held for sale		80,158		171,700		(91,542	)		(53.32	)%
Total noninterest income	$	1,722,926	$	1,505,569	$	217,357			14.44	%

Noninterest income increased primarily due to growth in service charge income and loan fees due to the increased asset size of the Bank and increases in per item charges on certain transactions. Gains on loan sales declined to $80,158 on sales of $3.1 million for the six months ended June 30, 2011 compared to $171,700 on sales of $4.9 million for the same period in 2010. BOLI income has increased primarily due to an increase in the average investment compared to the prior year.

The following table shows the components of noninterest expense and the dollar percentage changes for the periods presented.

	Six Months Ended June 30,
	2011		2010		$ Change			% Change
NONINTEREST EXPENSE:
Salary and employee benefits	$	5,426,867	$	4,761,355	$	665,512			13.98	%
Occupancy		884,972		894,042		(9,070	)		(1.01	)%
Advertising		234,037		178,602		55,435			31.04	%
Data processing		571,109		494,817		76,292			15.42	%
Legal and professional fees		450,241		444,233		6,008			1.35	%
Depreciation of furniture, fixtures, and equipment		202,192		261,943		(59,751	)		(22.81	)%
Telephone communications		86,231		82,228		4,003			4.87	%
Office supplies		75,900		79,436		(3,536	)		(4.45	)%
FDIC Insurance		656,341		746,765		(90,424	)		(12.11	)%
Valuation allowance on foreclosed real estate		315,883		287,934		27,949			9.71	%
Other		1,130,749		906,687		224,062			24.71	%
Total noninterest expenses	$	10,034,522	$	9,138,042	$	896,480			9.81	%

The Company’s noninterest expense increased from the comparable period in the prior year due to increased costs associated with the asset growth of the Bank, the rising cost of regulatory compliance and costs associated with foreclosed real estate. Salary and employee benefits expense increased as the Bank added employees to support the Bank’s balance sheet growth. Advertising expense increased as a result of the timing of campaigns compared to the prior year. The increased cost of compliance has impacted salaries and benefits, data processing and professional fees. Other expenses increased primarily due to expenses incurred to maintain and carry foreclosed real estate, and included $294,450 in expenses for the six months ended June 30, 2011 compared with $49,928 for the same period in 2010.

The Company recorded income tax expense of $675,896 or 31.6%, of pretax earnings of $2,137,189 for the six months ended June 30, 2011 compared with $1,352,077 or 36.0%, of pretax earnings of $3,752,585 for the six months ended June 30, 2010. The lower effective tax rate was the result of a higher relative percentage of tax exempt income as a percentage of pretax income than the comparable period of the prior year.

RESULTS OF OPERATIONS – THREE MONTHS ENDED JUNE 30, 2011

Net income for the three-month period ended June 30, 2011 totaled $1,219,795 ($0.33 basic and diluted earnings per common share), compared to $1,036,084 ($0.28 basic and $0.27 diluted earnings per common share) for the same period in the prior year. Net income available to common shareholders for the three-month period ended June 30, 2011 totaled $1,008,063 compared to $824,352 for the same period in the prior year. The increase of $183,711, or 17.73%, for net income or 22.29% for net income available to common shareholders, was primarily due to growth in noninterest income and net interest income as a result of the Bank’s larger average asset size and lower cost of funds compared with the same period in 2010.

	Three Months Ended June 30,
	2011		2010		$ Change			% Change
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans	$	9,012,635	$	8,728,673	$	283,962			3.25	%
Taxable interest and dividends on securities		889,515		1,160,439		(270,924	)		(23.35	)%
Interest on deposits with banks		2,282		3,970		(1,688	)		(42.52	)%
Total interest and dividend income		9,904,432		9,893,082		11,350			0.11	%

INTEREST EXPENSE:
Interest on deposits		2,595,961		2,691,842		(95,881	)		(3.56	)%
Interest on short-term borrowings		10,022		6,025		3,997			66.34	%
Interest on long-term debt		562,446		631,989		(69,543	)		(11.00	)%
Total interest expenses		3,168,429		3,329,856		(161,427	)		(4.85	)%

Net interest income		6,736,003		6,563,226		172,777			2.63	%

Provision for loan losses		890,861		804,430		86,431			10.74	%

Net interest income after provision for loan losses	$	5,845,142	$	5,758,796	$	86,346			1.50	%

The Company’s cost of funds continues to be the key driver of positive interest margin growth in the second quarter of 2011. The year-to-date average cost of the Company’s interest bearing liabilities decreased 19 basis points from 1.94% at December 31, 2010 to 1.75% at June 30, 2011 and is 25 basis points lower than the comparable period in the prior year. The three month trend for the components of net interest income is consistent with the trends discussed in the results of operations – six months ended narrative.

The Company’s provision for loan losses increased in the second quarter primarily due to additional charge-offs taken against the allowance for specific nonperforming loans based on management’s estimate of realizable value. Additionally, the provision for loan losses was impacted by increasing average loan balances, economic conditions that affected the loss factors used to compute the allowance, the level of delinquencies and charge-offs. Second quarter 2011 net charge-offs were $1,072,979 compared to $155,592 for the second quarter of 2010. The Company’s allowance for loan losses decreased from 1.16% of loan balances at December 31, 2010 to 1.01% of loan balances at June 30, 2011.

The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.

	Three Months Ended June 30,
	2011		2010		$ Change			% Change
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges	$	193,633	$	83,388	$	110,245			132.21	%
Gain on sale of asset		-		22,500		(22,500	)		(100.00	)%
Income from bank owned life insurance		164,509		106,168		58,341			54.95	%
Service charges		539,874		442,611		97,263			21.97	%
Gain on loans held for sale		54,583		89,677		(35,094	)		(39.13	)%
Total noninterest income	$	952,599	$	744,344	$	208,255			27.98	%

Noninterest income increased primarily due to growth in service charge income and loan fees as a result of increased asset size of the Bank and increases in per item charges on certain transactions. Gains on loan sales declined to $54,583 on sales of $1.5 million for the six months ended June 30, 2011 compared to $89,677 on sales of $1.8 million for the same period in 2010. BOLI income has increased primarily due to an increase in the average investment compared to the prior year.

The following table shows the components of noninterest expense and the dollar percentage changes for the periods presented.

	Three Months Ended June 30,
	2011		2010		$ Change			% Change
NONINTEREST EXPENSE:
Salary and employee benefits	$	2,675,393	$	2,398,821	$	276,572			11.53	%
Occupancy		467,581		466,398		1,183			0.25	%
Advertising		115,341		101,853		13,488			13.24	%
Data processing		288,356		248,677		39,679			15.96	%
Legal and professional fees		233,153		285,394		(52,241	)		(18.30	)%
Depreciation of furniture, fixtures, and equipment		102,663		134,345		(31,682	)		(23.58	)%
Telephone communications		44,207		42,109		2,098			4.98	%
Office supplies		37,109		33,690		3,419			10.15	%
FDIC Insurance		330,022		394,659		(64,637	)		(16.38	)%
Valuation allowance on foreclosed real estate		-		287,934		(287,934	)		(100.00	)%
Other		629,473		505,753		123,720			24.46	%
Total noninterest expenses	$	4,923,298	$	4,899,633	$	23,665			0.48	%

For the three months ended June 30, 2011, noninterest expense increased as growth in salary and benefits were offset against a valuation allowance on foreclosed real estate taken in the comparable period in 2010 compared to no allowance taken in the three months ended June 30, 2011. Salary and employee benefits expense increased as the Bank added additional employees to support the Bank’s balance sheet growth and increased compliance needs. Legal and professional fees decreased as a result of the timing of planned consultant usage in 2011 compared to the prior year. The increased cost of compliance has impacted salaries and benefits, data processing and professional fees. Other expenses increased primarily due to expenses incurred to maintain and carry foreclosed real estate, and included $150,582 in expenses for the three months ended June 30, 2011 compared with $48,142 for the same period in 2010.

The Company recorded income tax expense of $654,648 or 34.9%, of pretax earnings of $1,874,443 for the three months ended June 30, 2011 compared with 567,423 or 35.4%, of pretax earnings of $1,603,507 for the three months ended June 30, 2010. The lower effective tax rate was the result of a higher relative percentage of tax exempt income as a percentage of pretax income than the comparable period of the prior year.

FINANCIAL CONDITION

	June 30, 2011			December 31, 2010			$ Change			% Change
Assets
Cash and due from banks	$	12,398,545		$	8,695,590		$	3,702,955			42.58	%
Federal Funds sold		820,000			615,000			205,000			33.33	%
Interest-bearing deposits with banks		768,044			512,846			255,198			49.76	%
Securities available for sale, at fair value		29,324,105			34,946,225			(5,622,120	)		(16.09	)%
Securities held to maturity, at amortized cost		106,780,655			126,988,316			(20,207,661	)		(15.91	)%
FHLB and FRB stock - at cost		5,957,800			6,315,600			(357,800	)		(5.67	)%
Loans receivable - net of allowance for loan losses of $7,099,659 and $7,669,147, respectively		692,247,025			654,449,936			37,797,089			5.78	%
Premises and equipment, net		13,493,936			12,132,141			1,361,795			11.22	%
Foreclosed real estate		10,546,881			10,469,302			77,579			0.74	%
Accrued interest receivable		3,012,870			2,784,396			228,474			8.21	%
Investment in bank owned life insurance		17,771,896			17,447,692			324,204			1.86	%
Other assets		12,653,040			10,579,058			2,073,982			19.60	%

Total Assets	$	905,774,797		$	885,936,102		$	19,838,695			2.24	%

Nonperforming loans (NPLs)	$	4,212,175		$	13,518,779			(9,306,604	)		(68.84	)%
Nonperforming assets (NPLs + OREO)		14,759,056			23,988,081			(9,229,025	)		(38.47	)%
Troubled debt restructures (TDRs)		14,267,100			16,881,803			(2,614,703	)		(15.49	)%
Allowance for loan losses to total loans		1.01	%		1.16	%
Past due loans (PDLs) to total loans (31 to 90 days)		0.73	%		0.17	%
Nonperforming loans (NPLs) to total loans (>90 days)		0.60	%		2.04	%
Total loan delinquency (PDLs + NPLs) to total loans		1.33	%		2.21	%
Allowance for loan losses to nonperforming loans		168.57	%		56.73	%
Nonperforming assets (NPLs + OREO) to total assets		1.63	%		2.71	%
Nonperforming assets + TDRs to total assets (a)		3.15	%		4.58	%

(a) Ratio was adjusted to remove duplication of loans that are both nonperforming and troubled debt restructures.

Details of the Bank’s loan portfolio are presented below:

	June 30, 2011		%			December 31, 2010		%

Commercial real estate	$	375,502,810		53.66	%	$	336,299,836		50.72	%
Residential first mortgages		149,807,743		21.41	%		136,048,577		20.52	%
Construction and land development		31,937,744		4.56	%		42,504,200		6.41	%
Home equity and second mortgage		24,133,071		3.45	%		24,379,664		3.68	%
Commercial loans		99,908,997		14.28	%		104,566,261		15.77	%
Consumer loans		1,123,217		0.16	%		1,273,080		0.19	%
Commercial equipment		17,412,667		2.49	%		17,983,648		2.71	%
		699,826,249		100.00	%		663,055,266		100.00	%
Less:
Deferred loan fees		479,565		0.07	%		936,183		0.14	%
Allowance for loan loss		7,099,659		1.01	%		7,669,147		1.16	%
		7,579,224					8,605,330

	$	692,247,025				$	654,449,936

Assets increased primarily due to second quarter growth in the loan portfolio, partially offset by decreases in securities as principal from maturing securities was used to retire long-term debt and fund loan growth. The Company increased its most liquid assets with increases to cash and due from banks, federal funds sold and interest-bearing deposits with banks. The securities AFS and HTM portfolios decreased due to the maturing of asset-backed securities issued by government-sponsored entities. The differences in allocations between the different cash and investment categories reflect operational needs.

Premises and equipment increased due to the purchase of a developed plot of land in Dahlgren, Virginia for construction of the Bank’s 10th branch which is expected to be completed during the first quarter of 2012. Other assets increased due to increases in prepaid expenses and other receivables.

Loan growth was primarily due to net new loans of $39,202,974 in commercial real estate and $13,759,166 in residential mortgages offset by decreases of $10,566,456 in construction and land development and $4,657,264 in commercial loans. The majority of commercial real estate loan growth has been for amortizing loans secured by owner occupied real estate. Construction and land development loans decreased from $62,509,558 at December 31, 2009 to $31,937,744 at June 30, 2011, as the Bank has deemphasized that type of lending in this economic environment.

Nonperforming loans as a percentage of total loans declined to 0.60% at June 30, 2011 compared to 2.04% at December 31, 2010. The Bank had 25 nonperforming loans representing 15 customer relationships at June 30, 2011. There were 32 nonperforming loans at December 31, 2010. Foreclosed real estate increased $77,579 as additions of $6,781,857 were offset by disposals of $6,388,395 and a valuation allowance of $315,883. During the second quarter, the Bank continued to foreclose on problem loans and transferred $5,433,750 to OREO. Foreclosed real estate carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs.

The current year decrease in nonperforming assets was due to a reduction in nonperforming loans of $9,306,604 partially offset by a net increase in foreclosed real estate of $77,579. At June 30, 2011, $13,758,236 or 96.4% of troubled debt restructured balances were performing according to the terms of their restructured agreements compared to $16,584,546 or 98.2% at December 31, 2010. Nonperforming assets and troubled debt restructures to total assets decreased from 4.58% at December 31, 2010 to 3.15% at June 30, 2011. Additionally, the Company’s total delinquency has improved from 4.16% and 2.21% at December 31, 2009 and 2010, respectively, to 1.33% at June 30, 2011.

The allowance for loan losses decreased $569,488 to $7,099,659 or 1.01% of loan balances at June 30, 2011 from $7,669,147 or 1.16% of loan balances at December 31, 2010. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to: the overall loss experience; current economic conditions; volume, growth and composition of the loan portfolio; financial condition of the borrowers; and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance. Management believes that the allowance is adequate. Additional loan information for prior years is presented in the Company’s Form 10-K for the year ended December 31, 2010.

Details of the Bank’s nonperforming loans are presented below:

	June 30, 2011				December 31, 2010
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	1,709,897		5	$	8,244,683		12
Residential first mortgages		1,266,167		4		1,746,786		6
Construction and land development		-		-		983,867		1
Home equity and second mortgage		308,465		7		232,644		5
Commercial loans		593,631		4		2,261,642		6
Consumer loans		-		-		701		1
Commercial equipment		334,015		5		48,456		1
	$	4,212,175		25	$	13,518,779		32

As of June 30, 2011, the largest dollar concentrations of nonperforming loans are $1,709,897 of commercial real estate loans, which have been impacted by economic conditions in our local market mainly due to higher vacancies in commercial office space. Nonperforming residential first mortgages are the results of specific customer issues with unemployment and other circumstances requiring the liquidation of family assets. The Company has eliminated nonperforming construction and land development loans from $9,504,414 at December 31, 2009 and $983,867 at December 31, 2010 as loans were foreclosed or projects were completed. The Company has reduced its holdings in construction and land development loans from $62,509,558, or 10.0% at December 31, 2009 to $31,937,744, or 4.562% at June 30, 2011. At June 30, 2011, the Bank has provided for a specific allowance of $507,780 on nonperforming loans of $1,731,909 and no allowance on $2,480,266 of nonperforming loans. Specific allowances are based on management’s evaluation of the underlying collateral and utilization of the Bank credit evaluation criteria.

Management continues to monitor these loans and is working to resolve these loans in a manner that will preserve the most value for the Company. Additional loan information is presented in this Quarterly Report on Form 10-Q under Note 12 and for prior years is presented in the Company’s Form 10-K for the year ended December 31, 2010.

	June 30, 2011		December 31, 2010		$ Change			% Change
Liabilities
Deposits
Non-interest-bearing deposits	$	84,199,169	$	75,642,197	$	8,556,972			11.31	%
Interest-bearing deposits		669,732,661		648,940,129		20,792,532			3.20	%
Total deposits		753,931,830		724,582,326		29,349,504			4.05	%
Short-term borrowings		1,860,549		816,422		1,044,127			127.89	%
Long-term debt		60,600,557		70,624,044		(10,023,487	)		(14.19	)%
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000		12,000,000		-			0.00	%
Accrued expenses and other liabilities		6,437,512		6,808,383		(370,871	)		(5.45	)%

Total Liabilities	$	834,830,448	$	814,831,175	$	19,999,273			2.45	%

Deposits increased $70,253,122, or 10.28%, from June 30, 2010. During the first six months of 2011, an increase of $41,165,627 for transaction accounts was partially offset by a decrease in certificates of deposit accounts of $11,816,123. The Bank’s transaction accounts increased from $286,383,452, or 39.52% of deposits, at December 31, 2010 to $327,549,079, or 43.45% of deposits, at June 30, 2011. Total debt decreased as liquidity available from retail deposits and maturing securities was utilized to pay debt.

	June 30, 2011			December 31, 2010			$ Change			% Change
Stockholders' Equity
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540	$	15,540,000		$	15,540,000		$	-			0.00	%
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777		777,000			777,000			-			0.00	%
Common stock - par value $.01; authorized - 15,000,000 shares; issued 3,023,534 and 3,002,616 shares, respectively		30,235			30,026			209			0.70	%
Additional paid in capital		17,296,309			16,962,460			333,849			1.97	%
Retained earnings		37,496,035			37,892,557			(396,522	)		(1.05	)%
Accumulated other comprehensive gain		443,745			411,188			32,557			7.92	%
Unearned ESOP shares		(638,975	)		(508,304	)		(130,671	)		25.71	%

Total Stockholders' Equity	$	70,944,349		$	71,104,927		$	(160,578	)		(0.23	)%

The decrease in stockholders’ equity was due to the payments of common stock dividends of $1,209,856 and preferred stock dividends of $423,465 and net stock related activities of $21,107 partially offset by net income of $1,461,293 and adjustments to other comprehensive income of $32,557 for the available for sale securities portfolio. Common stockholders' equity of $54,627,349 resulted in a book value of $18.07 per common share at June 30, 2011 compared with $18.25 per common share at December 31, 2010 and $17.73 per common share for the same period end in 2010.

LIQUIDITY AND CAPITAL RESOURCES

The Company has no significant business other than holding the stock of the Bank and does not currently have any material funding requirements, except for the payment of dividends on preferred and common stock, and the payment of interest on subordinated debentures.

The Company’s principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends.

The Bank’s principal sources of funds for investment and operations are net income, deposits, sales of loans, borrowings, principal and interest payments on loans, principal and interest received on investment securities and proceeds from the maturity and sale of investment securities. Its principal funding commitments are for the origination or purchase of loans, the purchase of securities and the payment of maturing deposits. Deposits are considered the primary source of funds supporting the Bank’s lending and investment activities. The Bank also uses borrowings from the FHLB of Atlanta to supplement deposits. The amount of FHLB advances available to the Bank is limited to the lower of 40% of Bank assets or the amount supportable by eligible collateral including FHLB stock, loans and securities. In addition, the Bank has established lines of credit with the Federal Reserve Bank and commercial banks.

For additional information regarding these arrangements, including collateral, refer to Note 10 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2010.

The Bank’s most liquid assets are cash, federal funds sold and interest-bearing deposits with banks. The levels of such assets are dependent on the Bank’s operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows.

Cash, federal funds sold, and interest-bearing deposits with banks as of June 30, 2011 totaled $13,986,589, an increase of $4,163,153, or 42.38%, from the December 31, 2010 total of $9,823,436. The increase in cash was primarily due to proceeds received from maturing investment securities and an increase in deposits partially offset by the excess of loan originations over principal payments collected and the pay down of debt. Proceeds from maturing investment securities and the increase in deposits were utilized to pay down $8,979,360 in long-term debt and short-term borrowings and increase overall cash balances.

During the first six months of 2011, all financing activities provided $18,715,715 in cash compared to $23,774,486 in cash provided for the same period in 2010. The decrease of cash flows from financing activities of $5,058,771 was primarily due to a smaller increase in customer deposits for the six months ended June 30, 2011 of $29,349,504 compared to an increase in deposits of $43,259,919 for the six months ended June 30, 2010. The decrease was partially offset by a reduction in the net amount of short-term borrowings and long-term debt repaid from $17,961,778 for the six months ended June 30, 2010 to $8,979,360 for the six months ended June 30, 2011.

Operating activities provided cash of $1,701,765 in the first six months of 2011 compared to $2,852,598 provided in the same period of 2010, a decrease in cash of $1,150,833. The decrease in cash was primarily due to decreases in net income of $939,215, a reduction in proceeds received from loan sales of $1,839,598, a total decrease in deferred loan fees of $413,374 and accrued liabilities of $498,324 and the use of additional cash for the increase in other assets of $1,527,722. The reduction in cash was partially offset by increases in cash due to an increase in the provision for loan losses of $1,233,887, a decrease in loans originated for resale of $2,046,260 and a net decrease in deferred income tax benefit of $834,017.

Investing activities used cash of $16,254,327 in the first six months of 2011 compared to $20,942,527 of cash used in the same period of 2010. The increase to cash of $4,688,200 was primarily due to an increase in net proceeds received from investment securities transactions from a $1,354,645 use of cash for the six months ended June 30, 2010 to $26,151,724 in net cash proceeds provided for the six months ended June 30, 2011. These amounts were offset by an increase in the excess of loan originations over principal payments collected from $19,154,225 for the six months ended June 30, 2010 to $40,609,785 for the six months ended June 30, 2011. Additional decreases to cash included $1,340,109 in additional purchases for premises compared with the same period in 2010.

REGULATORY MATTERS

The Bank is subject to Federal Reserve Board capital requirements as well as statutory capital requirements imposed under Maryland law. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. The Company’s and the Bank’s actual capital amounts and ratios at June 30, 2011 are presented in the following table.

	Actual				Required for Capital Adequacy Purposes				To be Considered Well Capitalized Under Prompt Corrective Action
At June 30, 2011	(in thousands)
Total Capital (to risk weighted assets)
The Company	$	89,673	12.27	%	$	58,453	8.00	%
The Bank	$	86,513	11.89	%	$	58,191	8.00	%	$	72,739	10.00	%

Tier 1 Capital (to risk weighted assets)
The Company	$	82,500	11.29	%	$	29,227	4.00	%
The Bank	$	79,340	10.91	%	$	29,096	4.00	%	$	43,644	6.00	%

Tier 1 Capital (to average assets)
The Company	$	82,500	9.44	%	$	34,953	4.00	%
The Bank	$	79,340	9.11	%	$	34,853	4.00	%	$	43,566	5.00	%

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are defined as those that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. The Company considers its determination of other than temporary impairment of securities, the allowance for loan losses, the valuation of foreclosed real estate and the valuation of deferred tax assets to be 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 the general practices of the United States banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to 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. When these sources are not available, management makes estimates based upon what it considers to be the best available information.

Other Than Temporary Impairment of Securities

The Company evaluates securities to determine whether a decline in their value is other than temporary. The term “other than temporary” means the prospects for a near term recovery of value are not favorable or there is limited market information supporting the fair value of the securities at an amount greater or equal to the carrying value of the investment. Management reviews the underlying reasons for the decline and criteria such as the credit quality of the issuer and the size and duration of the decline and the Company’s intent to sell the security or if it is more likely than not that the security will be required to be sold before recovery of its amortized cost. When a decline in value is deemed to be other than temporary, the value of the security is reduced and the credit portion of the impairment is charged to earnings and the non-credit portion is recorded as an adjustment to comprehensive income.

If management concludes an unrealized loss is temporary and our intention is to hold the investment until recovery of the amortized cost basis, which may be maturity, no charge to earnings is recorded.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that exist in the loan portfolio. The allowance is based on two principles of accounting: (1) Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450 “Contingencies,” which requires that losses be accrued when they are probable of occurring and are estimable and (2) FASB ASC 310 “Receivables,” which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, is determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows and values observable in the secondary markets.

The allowance for loan loss balance is an estimate based upon management’s evaluation of the loan portfolio. The allowance is comprised of a specific and a general component. The specific component consists of management’s evaluation of certain classified and non-accrual loans and their underlying collateral. Management assesses the ability of the borrower to repay the loan based upon all information available. Loans are examined to determine a specific allowance based upon the borrower’s payment history, economic conditions specific to the loan or borrower and other factors that would impact the borrower’s ability to repay the loan on its contractual basis. Depending on the assessment of the borrower’s ability to pay and the type, condition and value of collateral, management will establish an allowance amount specific to the loan.

Management utilizes a risk grading matrix to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships with an aggregate exposure to the Bank of $350,000 or greater are risk rated. Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history. Management annually engages a third party consulting firm to perform independent loan reviews of its commercial loan portfolio, and the results are reported to the Company’s Audit Committee.

In establishing the general component of the allowance, management analyzes non-classified and non-impaired loans in the portfolio including changes in the amount and type of loans. Management also examines the Bank’s historical loss experience (charge-offs and recoveries) within each loan category. The state of the local and national economy is also considered. Based upon these factors, the Bank’s loan portfolio is categorized and a loss factor is applied to each category. These loss factors may be higher or lower than the Bank’s actual recent average losses in any particular loan category, particularly in loan categories that are increasing or decreasing in size. Based upon these factors, the Bank will adjust the loan loss allowance by increasing or decreasing the provision for loan losses.

Management has significant discretion in making the judgments inherent in the determination of the allowance for loan losses, including in connection with the valuation of collateral, a borrower’s prospects of repayment and in establishing loss factors on the general component of the allowance. Changes in loss factors will have a direct impact on the amount of the provision and a corresponding effect on net income. Errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. An increase or decrease in the allowance could result in a charge or credit to income before income taxes that materially impacts earnings.

For additional information regarding the allowance for loan losses, refer to Notes 1 and 5 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2010.

Foreclosed Real Estate

The Company maintains a valuation allowance on its foreclosed real estate. As with the allowance for loan losses, the valuation allowance on foreclosed real estate is based on FASB ASC 450 “Contingencies”, as well as the accounting guidance on impairment of long-lived assets. These statements require that the Company establish a valuation allowance when it has determined that the carrying amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed asset is measured by the cash flows expected to be realized from its subsequent disposition. These cash flows are reduced for the costs of selling or otherwise disposing of the asset.

In estimating the cash flows from the sale of foreclosed real estate, management must make significant assumptions regarding the timing and amount of cash flows. For example, in cases where the real estate acquired is undeveloped land, management must gather the best available evidence regarding the market value of the property, including appraisals, cost estimates of development and broker opinions. Due to the highly subjective nature of this evidence, as well as the limited market, long time periods involved and substantial risks, cash flow estimates are highly subjective and subject to change. Errors regarding any aspect of the costs or proceeds of developing, selling or otherwise disposing of foreclosed real estate could result in the allowance being inadequate to reduce carrying costs to fair value and may require an additional provision for valuation allowances.

For additional information regarding foreclosed real estate, refer to Notes 1 and 7 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2010.

Deferred Tax Assets

The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FASB ASC 740 requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or the entire deferred tax asset will not be realized.

The Company periodically evaluates the ability of the Company to realize the value of its deferred tax assets. If the Company were to determine that it was not more likely than not that the Company would realize the full amount of the deferred tax assets, it would establish a valuation allowance to reduce the carrying value of the deferred tax asset to the amount it believes would be realized. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax-planning strategies that could be implemented to realize the net deferred tax assets.

Failure to achieve forecasted taxable income might affect the ultimate realization of the net deferred tax assets. Factors that may affect the Company’s ability to achieve sufficient forecasted taxable income include, but are not limited to, the following: increased competition, a decline in net interest margin, a loss of market share, decreased demand for financial services and national and regional economic conditions.

The Company’s provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of management judgment and are based on the best information available at the time. The Company operates within federal and state taxing jurisdictions and is subject to audit in these jurisdictions.

Any change in the current federal or state income tax rates can affect the carrying amount of deferred taxes. Any change would be recorded through earnings in the period the new tax rates were enacted.

For additional information regarding the deferred tax assets, refer to Note 11 in the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2010.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable as the Company is a smaller reporting company.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, (1) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal executive and financial officers as appropriate to allow timely decisions regarding required disclosure. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2011 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings – The Company is not involved in any pending legal proceedings. The Bank is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company.

Item 1A - Risk Factors - In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A- Risk Factors” in the Form 10-K, which could materially affect our business, financial condition or future results. The risks described in the Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

(a)

Not applicable

(b)

Not applicable

(c)

The following table presents information regarding the Company’s stock repurchases during the three months ended June 30, 2011.

(c)

Total Number

of Shares

(d)

Purchased

Maximum

(a)

as Part of

Number of Shares

Total

(b)

Publicly

that May Yet Be

Number of

Average

Announced Plans

Purchased Under

Price Paid

the Plans or

Period

Purchased

per Share

Programs

April 1-30, 2011

130,717

May 1-31, 2011

4,900

16.89

4,900

125,817

June 1-30, 2011

125,817

Total

4,900

16.89

4,900

125,817

(1) On September 25, 2008, the Company announced a repurchase program under which it would repurchase up to 5% of its outstanding common stock or approximately 147,435 shares. As part of the Company’s participation in the Capital Purchase Program of the U.S. Department of Treasury’s Troubled Asset Relief Program, prior to the earlier of (a) December 19, 2018 or (b) the date on which the Series A preferred stock and the Series B preferred stock has been redeemed in full or the Treasury has transferred all of the Series A preferred stock and the Series B preferred stock to non-affiliates, the Company, without the consent of the Treasury, cannot repurchase any shares of its common stock or other capital stock or equity securities or trust preferred securities. These repurchase restrictions do not apply in certain limited circumstances, including the repurchase of common stock in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice. In addition, during the period beginning on December 19, 2018 and ending on the date on which the Series A preferred stock and the Series B preferred stock have been redeemed in full or the Treasury has transferred all of the Series A preferred stock and the Series B preferred stock to non-affiliates, the Company cannot repurchase any shares of its common stock or other capital stock or equity securities or trust preferred securities without the consent of the Treasury. On November 12, 2010, after approval from the Treasury, the Company approved a repurchase program under which the Company may repurchase shares of common stock equaling up to 1% of the Company’s stockholders’ equity under the previously authorized plan described above. The Company intends to repurchase shares from time to time, depending on market conditions.

Item 3 - Default Upon Senior Securities - None

Item 4 - [Removed and Reserved]

Item 5 - Other Information - None

Item 6 - Exhibits

Exhibit 31	-	Rule 13a-14(a) Certifications
Exhibit 32	-	Section 1350 Certifications
Exhibit 101.0*	-	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements, tagged as blocks of text.

* Furnished, not filed.

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.

		TRI-COUNTY FINANCIAL CORPORATION

Date:	August 5, 2011	By:	/s/ Michael L. Middleton
			Michael L. Middleton
			President and Chief Executive Officer

Date:	August 5, 2011	By:	/s/ William J. Pasenelli
			William J. Pasenelli
			Executive Vice President and Chief Financial Officer