ANNAPOLIS BANCORP INC - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - ANNAPOLIS BANCORP INC	dex321.htm
EX-31.1 - EXHIBIT 31.1 - ANNAPOLIS BANCORP INC	dex311.htm
EX-31.2 - EXHIBIT 31.2 - ANNAPOLIS BANCORP INC	dex312.htm
EX-32.2 - EXHIBIT 32.2 - ANNAPOLIS BANCORP INC	dex322.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 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 0-22961

ANNAPOLIS BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland

52-1595772

(State or other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

1000 Bestgate Road, Annapolis, Maryland 21401

(Address of principal executive offices)

(410) 224-4455

(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) 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 0

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 (§232.405 of this chapter) during the preceding 12 months (or for a shorter period that the registrant was required to submit and post such files). YES 0 NO 0

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

Large accelerated filer 0 Accelerated filer 0 Non-accelerated filer 0 Smaller Reporting Company x

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

YES 0 NO x

At April 30, 2011, the Registrant had 3,951,977 shares of common stock outstanding.

TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION	PAGE

Item 1 – Financial Statements
Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010		1
Consolidated Statements of Operations for the Three Month Periods Ended March 31, 2011 and 2010 (unaudited)		2
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Three Month Periods Ended March 31, 2011 and 2010 (unaudited)		3
Consolidated Statements of Cash Flows for the Three Month Periods Ended March 31, 2011 and 2010 (unaudited)		4-5
Notes to Consolidated Financial Statements (unaudited)		6-23
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.		23-37
Item 3 – Quantitative and Qualitative Disclosures About Market Risk		37
Item 4 – Controls and Procedures		38

PART II - OTHER INFORMATION

Item 1 – Legal Proceedings		38

Item 1A – Risk Factors		38

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

Item 3 – Defaults Upon Senior Securities		38

Item 4 – Reserved		38

Item 5 – Other Information		38

Item 6 – Exhibits		39

SIGNATURES		40
CERTIFICATIONS		41-47

This Quarterly Report on Form 10-Q contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements appear in a number of places in this Report and include all statements regarding the intent, belief or current expectations of Annapolis Bancorp, Inc. (the “Company”), its directors or its officers with respect to, among other things: (i) the Company’s financing plans; (ii) trends affecting the Company’s financial condition or results of operations; (iii) the Company’s growth strategy; and (iv) the declaration and payment of dividends. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, including but not limited to: changes in interest rates, deposit flows, cost of funds and demand for financial services; general economic conditions; legislative and regulatory changes; changes in tax policies, rates and regulations of federal, state and local tax authorities; and changes in accounting principles, policies and guidelines. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors discussed herein and those factors discussed in the Company’s filings with the Securities and Exchange Commission. The Company undertakes no obligation to publicly release the results of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

as of March 31, 2011 and December 31, 2010

(in thousands)


	(Unaudited) March 31, 2011		(Audited) December 31, 2010
Assets
Cash and due from banks		$2,094		$7,854
Interest bearing balances with banks		13,612		16,856
Federal funds sold and other overnight investments		17,405		11,984
Investment securities available for sale, at fair value		89,060		96,295
Federal Reserve and Federal Home Loan Bank Stock		3,035		3,035
Loans held for sale		464		1,379
Loans, less allowance for credit losses of $6,892 and $6,853		277,716		271,684
Premises and equipment, net		8,722		8,787
Accrued interest receivable		1,450		1,567
Deferred income taxes		3,129		2,929
Investment in bank owned life insurance		5,483		5,442
Real estate owned		1,608		1,608
Other assets		2,330		2,720

Total assets		$426,108		$432,140


Liabilities and Stockholders’ Equity
Deposits
Noninterest bearing		$45,759		$45,514
Interest bearing		290,414		295,400
Securities sold under agreements to repurchase		12,717		14,558
Long-term borrowings		35,000		35,000
Guaranteed preferred beneficial interests in junior subordinated debentures		5,000		5,000
Accrued interest payable and other liabilities		2,211		1,894

Total liabilities		391,101		397,366


Stockholders’ Equity
Preferred stock, par value $0.01 per share; authorized 5,000,000 shares; Series A, $1,000 per share liquidation preference, shares issued and outstanding 8,152 shares at March 31, 2011 and at December 31, 2010, net of discount of $69 and $89		8,083		8,063
Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 3,946,832 shares at March 31, 2011 and 3,922,006 at December 31, 2010		39		39
Warrants		234		234
Paid in capital		11,697		11,643
Retained earnings		14,886		14,499
Accumulated other comprehensive income		68		296

Total stockholders’ equity		35,007		34,774

Total liabilities and stockholders’ equity		$426,108		$432,140

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

for the Three Month Periods Ended March 31, 2011 and 2010

(unaudited)

(in thousands, except Shares and Per Share data)


	For the Three Months Ended March 31,
	2011		2010
Interest and dividend income
Loans, including fees		$4,191		$4,120
Interest bearing deposits with banks		4		6
Federal funds sold and other overnight investments		7		6
Mortgage-backed securities		348		585
U. S. Treasury securities and obligations of other U. S. Government agencies		329		607
State and municipal securities		11		11
Equity securities		20		14

Total interest and dividend income		4,910		5,349

Interest expense
Certificates of deposit, $100,000 or more		135		211
Other deposits		459		753
Securities sold under agreements to repurchase		17		21
Interest on long-term borrowings		321		345

Total interest expense		932		1,330

Net interest income		3,978		4,019
Provision for credit losses		557		236

Net interest income after provision for credit losses		3,421		3,783

Noninterest income
Service charges and fees on deposits		300		267
Mortgage banking fees		2		22
Other fee income		29		104
Loss on sale of securities		-		(55)
Gain on sale of loans		68		42
Gain on sale of real estate owned and repossessed assets		-		32
Loss on disposal of fixed assets		(31)		-

Total noninterest income		368		412

Noninterest expense
Personnel		1,761		1,784
Occupancy and equipment		421		417
Data processing		208		208
Legal and professional fees		79		146
Marketing		109		101
FDIC insurance		146		150
Other operating expenses		319		407

Total noninterest expense		3,043		3,213

Income before income taxes		746		982
Income tax expense		237		365

Net income		509		617
Preferred stock dividend and discount accretion		122		120

Net income available to common shareholders		$387		$497

Basic earnings per common share		$0.10		$0.13

Basic weighted average shares		3,938,070		3,890,619

Diluted earnings per common share		$0.09		$0.13

Diluted weighted average shares		4,280,370		3,963,139

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

and Comprehensive Income

for the Three Month Periods Ended March 31, 2011 and 2010

(unaudited)

(dollars in thousands)


	Preferred Stock		Common Stock		Warrants		Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income		Total		Comprehensive Income


Balances, January 1, 2011		$8,063		$39		$234		$11,643		$14,499		$296		$34,774
Net income		-		-		-		-		509		-		509		$509
Stock options exercised and restricted stock issued		-		-		-		14		-		-		14		-
Preferred stock dividend declared and discount accretion		20		-		-		-		(122)		-		(102)		-
Stock-based compensation		-		-		-		38		-		-		38		-
Employee stock purchase plan		-		-		-		2		-		-		2		-
Unrealized loss on investment securities net of taxes of $149		-		-		-		-		-		(228)		(228)		(228)

Balances, March 31, 2011		$8,083		$39		$234		$11,697		$14,886		$68		$35,007		$281


	Preferred Stock		Common Stock		Warrants		Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income/(Loss)		Total		Comprehensive Income


Balances, January 1, 2010		$7,985		$39		$234		$11,501		$13,367		($494)		$32,632
Net income		-		-		-		-		617		-		617		$617
Stock options exercised and restricted stock issued		-		-		-		43		-		-		43		-
Preferred stock dividend declared and discount accretion		19		-		-		-		(120)		-		(101)		-
Stock-based compensation		-		-		-		46		-		-		46		-
Employee stock purchase plan		-		-		-		2		-		-		2		-
Reclassification adjustment for securities losses net of taxes of $20 included in net income		-		-		-		-		-		35		35		35
Unrealized gain on investment securities net of taxes of $483		-		-		-		-		-		737		737		737

Balances, March 31, 2010		$8,004		$39		$234		$11,592		$13,864		$278		$34,011		$1,389

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

for the Three Month Periods Ended March 31, 2011 and 2010

(unaudited)

(in thousands)


	For the Three Months Ended March 31,
	2011		2010
Cash flows from operating activities
Net income		$509		$617
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		145		155
Amortization of premiums and accretions of discounts, net		85		97
Provision for credit losses		557		236
Origination of loans held for sale		(5,215)		(5,682)
Proceeds from sale of loans held for sale		6,198		7,619
Stock based compensation		38		46
Deferred income taxes		(51)		47
Earnings on life insurance policies		(41)		(38)
Loss on sale of securities, available for sale		-		55
Gain on sale of loans held for sale		(68)		(42)
Gain on sale of real estate owned and repossessed assets		-		(32)
Loss on disposal of fixed assets		31		-
Decrease (increase) in:
Accrued interest receivable		117		294
Prepaid FDIC insurance		132		140
Other assets		255		(183)
Increase (decrease) in:
Accrued interest payable		(3)		3
Accrued income taxes, net of taxes refundable		103		317
Deferred loan origination fees		(43)		(62)
Other liabilities		217		266

Net cash provided by operating activities		2,966		3,853

Cash flows from investing activities
Proceeds from sales and maturities of securities available for sale		9,781		25,691
Purchase of securities available for sale		(3,008)		(11,577)
Net increase in federal funds sold		(5,421)		(12,262)
Net decrease in interest bearing certificates of deposit		3,244		1,822
Net (increase) decrease in loans receivable		(6,546)		1,598
Proceeds from sales of real estate owned		-		945
Proceeds from sales of repossessed assets		-		19
Purchase of premises and equipment, net of disposals		(108)		(24)

Net cash (used in) provided by investing activities		(2,058)		6,212

Cash flows from financing activities
Net increase (decrease) in:
Time deposits		170		(7,305)
Other deposits		(4,911)		1,877
Securities sold under agreements to repurchase		(1,841)		(1,496)
Repayment of long-term borrowing		-		(5,000)
Proceeds from stock options exercised		14		43
Proceeds from issuance of common stock		2		3
Payment of preferred stock dividend		(102)		(102)

Net cash used in financing activities		(6,668)		(11,980)

Net decrease in cash		(5,760)		(1,915)
Cash and cash equivalents, beginning of period		7,854		5,936

Cash and cash equivalents, end of period		$2,094		$4,021

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (continued)

for the Three Month Periods Ended March 31, 2011 and 2010

(unaudited)

(in thousands)


	For the Three Months Ended March 31,
	2011		2010

Supplemental cash flow information
Interest paid, including interest credited to accounts		$1,037		$1,328
Income taxes paid		$225		$205

Non-cash investing activities
Transfers from loans to real estate owned		$-		$282
Transfers from loans to other assets		$-		$64

Annapolis Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

for the Three Month Periods Ended March 31, 2011 and 2010

(unaudited)

Note A – Basis of Presentation

The accompanying unaudited consolidated financial statements of Annapolis Bancorp, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required for complete financial statements. In the opinion of management, all adjustments and reclassifications that are normal and recurring in nature and are considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011 or any other period. These unaudited consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended December 31, 2010, which includes the consolidated financial statements and footnotes. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2011.

Note B – Business

The Company was incorporated on May 26, 1988, under the laws of the State of Maryland, to serve as a bank holding company for BankAnnapolis (formerly known as Annapolis National Bank) (the “Bank”). Effective November 1, 2000, the Bank changed its charter from a national charter to a state charter and joined the State of Maryland and the Federal Reserve banking systems. Also effective November 1, 2000, the Bank changed its name from Annapolis National Bank to BankAnnapolis. The bank holding company changed its name from Annapolis National Bancorp, Inc. to Annapolis Bancorp, Inc. effective June 1, 2001. The Company (as a bank holding company) and the Bank are subject to governmental supervision, regulation, and control.

The Bank currently conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals from its headquarters in Annapolis, its six other branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Anne’s County, Maryland. The Bank recently announced that it will close its Market House branch on May 27, 2011. Deposits of the branch will be moved to the Bank’s Bestgate office.

The Bank has built its reputation on exemplary customer service and outreach to the communities surrounding each of the Bank’s locations. The Bank is committed to offering products and services that focus on relationship banking and provide an alternative to the large multi-regional financial institutions that are so pervasive in the markets the Bank serves. The Bank has selected its newest location, Annapolis Towne Centre, based on demographics and business development opportunities. The Bank attracts most of its customer deposits from Anne Arundel County, Maryland, and to a lesser extent, Queen Anne’s County, Maryland. The Bank’s lending operations are centered in Anne Arundel County, but extend throughout Central Maryland.

Note C – Stock Based Compensation

Stock based-compensation expense recognized in the three month periods ended March 31, 2011 and 2010 was $38,000 and $46,000, respectively. Stock-based compensation expense recognized in the consolidated statements of income for the first quarter of 2011 and 2010 reflects estimated forfeitures.

During the first quarter of 2011 and 2010, there were no options granted to employees or directors of the Company or Bank.

Stock option activity for the three months ended March 31, 2011 and 2010 was as follows:


	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value

Outstanding at January 1, 2011		124,270		$6.06
Grants		-		-
Exercised		(5,333)		2.64
Forfeitures		-		-
Expired		(22,374)		2.64

Outstanding as of March 31, 2011		96,563		$7.05


Exercisable at March 31, 2011		94,204		$6.99		2.8		$-


Outstanding at January 1, 2010		183,819		$5.05
Grants		-		-
Exercised		(17,776)		2.42
Forfeitures		-		-

Outstanding as of March 31, 2010		166,043		$5.33


Exercisable at March 31, 2010		152,850		$5.01		2.8		$-

The aggregate intrinsic value in the table above represents the total pre-tax value of the exercisable in-the-money options (that is, the difference between the closing stock price on the last trading day in the first three months of 2011 and 2010, and the exercise price of the options multiplied by the number of shares) on March 31, 2011 and March 31, 2010. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised was $9,386 for the three months ended March 31, 2011, and $19,200 for the three months ended March 31, 2010. No options vested during the three month periods ending March 31, 2011 and 2010. As of March 31, 2011, $4,798 of total unrecognized costs related to options is expected to be recognized over a weighted average period of 0.8 years.

During the first quarter of 2011, an employee of the Bank was awarded 5,000 restricted shares at a market value of $4.45 per share. One-half of the restricted shares vest on each of the employee’s first two anniversaries of employment with the Bank, with the shares being fully vested on February 28, 2013. During the first quarter of 2010, an employee of the Bank was awarded 3,000 restricted shares at a market value of $3.75 per share. One-third of the restricted shares vest on each of the employee’s first three anniversaries of employment with the Bank, with the shares being fully vested on March 15, 2013.

During the first quarter of 2011, non-employee directors of the Bank were awarded a total of 12,782 shares of restricted stock at a market value of $4.30 per share in lieu of an annual retainer. These shares vest on January 27, 2012. During the first quarter of 2010, non-employee directors of the Bank were awarded a total of 15,384 shares of restricted stock at a market value of $3.90 per share in lieu of an annual retainer. These shares vested on January 28, 2011. Non-compensation related expense of $13,750 and $15,000 was recognized for each of the three month periods ended March 31, 2011 and 2010, respectively, relating to the shares issued to non-employee directors.

As of March 31, 2011, 5,000 restricted shares of the 67,282 shares outstanding have vested. The remaining 62,282 shares will vest over a weighted average period of 2.3 years.

Restricted stock activity for the three months ended March 31, 2011 and 2010 was as follows:



	Shares		Weighted Average Grant Price
Outstanding at January 1, 2011		68,384		$3.66
Grants		17,782		4.34
Issued		18,884		3.77
Forfeitures		-		-

Outstanding as of March 31, 2011		67,282		$3.84


Outstanding at January 1, 2010		98,005		$3.69
Grants		18,384		3.88
Issued		23,005		2.50
Forfeitures		-		-

Outstanding as of March 31, 2010		93,384		$4.02

As of March 31, 2011, $170,000 of total unrecognized costs related to unvested restricted shares and restricted share units is expected to be recognized over a weighted average period of 2.3 years. As of March 31, 2010, $261,000 of total unrecognized costs related to unvested restricted shares and restricted share units was expected to be recognized over a weighted average period of 1.4 years.

Note D – Earnings Per Share

Information regarding earnings per share is summarized as follows:

Computation of Earnings Per Share

(in thousands, except Earnings Per Share)


	For the Three Months Ended March 31,
	2011		2010
Net income available to common shareholders		$387		$497
Weighted average common shares outstanding		3,938		3,891
Basic Earnings Per Common Share		$0.10		$0.13

Net income available to common shareholders		$387		$497
Weighted average common shares outstanding		3,938		3,891
Effect of potential dilutive common shares		342		72
Total weighted average diluted common shares outstanding		4,280		3,963
Diluted Earnings Per Common Share		$0.09		$0.13

Basic earnings per share are calculated using the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share are calculated using the weighted-average number of shares of common stock plus dilutive potential shares of common stock outstanding during the period. Potential common shares consist of stock options and restricted stock, restricted share units and warrants. For each of the three months ended March 31, 2011 and 2010, 58,969 and 385,036 shares of common stock, respectively, attributable to outstanding stock options, restricted stock, restricted share units and warrants were excluded from the calculations of diluted earnings per common share because their effect was anti-dilutive.

Note E – Investment Securities

Investment securities are summarized as follows:


	Amortized		Unrealized		Unrealized		Estimated Fair
(dollars in thousands)	Cost		Gains		Losses		Value
March 31, 2011
Available for sale
U.S. Government agency		$49,977		$196		$738		$49,435
State and municipal		1,078		16		-		1,094
Residential mortgage-backed securities		37,289		727		105		37,911
Other equity securities		604		16		-		620

		$88,948		$955		$843		$89,060


	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
December 31, 2010
Available for sale
U.S. Government agency		$54,062		$209		$510		$53,761
State and municipal		1,079		10		-		1,089
Residential mortgage-backed securities		40,067		873		112		40,828
Other equity securities		599		18		-		617

		$95,807		$1,110		$622		$96,295

The amortized cost and estimated fair value of securities by contractual maturities at March 31, 2011 are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.


	March 31, 2011
	Available for Sale
	Amortized Cost		Estimated Fair Value
(dollars in thousands)
Due within one year		$5,005		$5,016
Due after one through five years		14,235		14,118
Due after five through ten years		24,256		23,830
Due after ten years		44,848		45,476
Equity securities		604		620

		$88,948		$89,060

The following table shows the level of the Company’s gross unrealized losses and the fair value of the associated securities by type and maturity for securities available for sale at March 31, 2011.


	Less than 12 months				12 months or more				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
(dollars in thousands)
U. S. Government agency		$29,742		$731		$842		$7		$30,584		$738
Residential mortgage-backed securities		5,725		22		2,276		83		8,001		105

		$35,467		$753		$3,118		$90		$38,585		$843

The unrealized losses that exist are the result of market changes in interest rates since the original purchase. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2011. The Company has used a variety of tools to analyze the contents of its security portfolio and at this time does not believe that the unrealized losses in the portfolio shown in the table above are other than temporary. At March 31, 2011 mortgaged-backed securities with a fair market value of $2.3 million carried bond ratings below investment grade. These securities were evaluated by an independent third-party consulting firm and were deemed by management not to be other-than-temporarily impaired at March 31, 2011. The valuation uses an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity. At March 31, 2011, both securities were current on both principal and interest payments.

Note F – Loans, Allowance For Credit Losses And Credit Quality

Major classifications of loans are as follows:


	March 31, 2011⁽¹⁾		December 31, 2010 ⁽¹⁾
Commercial
Real estate		$52,214		$51,359
Commercial		101,641		94,864
Construction		32,922		33,534
One to four-family		51,867		51,581
Home equity		35,961		36,697
Consumer		10,208		10,664

		284,813		278,699


Deferred loan fees, net		(205)		(162)
Allowance for credit losses		(6,892)		(6,853)

		(7,097)		(7,015)

Loans, net		$277,716		$271,684


The maturity and rate repricing distribution of the loan portfolio is as follows:

Repricing or maturing within one year		$114,127		$117,574
Maturing over one to five years		111,374		102,755
Maturing over five years		59,312		58,370

		$284,813		$278,699

^{(1) Excludes loans
held for sale}

The following table shows the allowance for credit losses and recorded investment in loans receivable for the period ended March 31, 2011:

Allowance for Credit Losses and Recorded Investment in Loans Receivable

for the Three Months Ended March 31, 2011


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential		Consumer		Unallocated		Total
March 31, 2011
Allowance for credit losses:
Beginning balance, January 1, 2011		$1,868		$3,205		$1,257		$523		$-		$6,853
Charge-offs		471		-		-		55		-		526
Recoveries		5		-		-		3		-		8
Provision		484		(151)		177		47		-		557

Ending balance, March 31, 2011		$1,886		$3,054		$1,434		$518		$-		$6,892

Period ending amount: Individually evaluated for impairment		$346		$351		$523		$185		$-		$1,405

Period ending amount: Collectively evaluated for impairment		$1,540		$2,703		$911		$333		$-		$5,487

Period ending amount: Loans acquired with deteriorating credit quality		$-		$-		$-		$-		$-		$-

Loans individually evaluated for impairment		$1,625		$1,644		$3,016		$436		$-		$6,721

Loans collectively evaluated for impairment		$50,589		$130,398		$87,333		$9,772		$-		$278,092

Nonaccrual loans totaled approximately $6.5 million and $7.8 million at March 31, 2011 and December 31, 2010, respectively, while loans past due greater than 90 days totaled $258,000 and $599,000 at March 31, 2011 and December 31, 2010, respectively. As of March 31, 2011 $1.4 million of loan loss allowances were allocated to all loans classified as impaired with $1.5 million of loan loss allowances allocated to all loans classified as impaired at December 31, 2010.

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management assigns a Risk Assessment Rating (“Risk Rating”) to extensions of credit based upon the degree of risk, the likelihood of repayment and the effect on the Bank’s safety and soundness. The Risk Rating, applied consistently, enables lending personnel and bank management to monitor the loan portfolio. The Risk Rating is an integral part of the bank’s loan loss provision formulation process and, properly maintained, the Risk Rating assessment can provide an early warning signal of deterioration in a credit.

The Company uses a risk rating matrix to assign a risk grade to each loan. The Risk Ratings are divided into five general categories:

1. Risk Ratings 1 - 6 are assigned to “Pass” credits.

2. Risk Rating 7 is assigned to “Pass” credits that are also considered “Watch” credits.

3. Risk Rating 8 is assigned to “Criticized” credits.

4. Risk Ratings 9 and 10 are assigned to “Classified” credits.

5. Risk Rating 11 is assigned to “Loss” credits.

A general description of the characteristics of the risk ratings are described below:

•

Risk ratings 1, 2 and 3 – these ratings have the highest degree of probability of repayment. Borrowers in this category are established entities, well-positioned within their industry with a proven track record of solid financial performance. These ratings are usually reserved for the strongest customers of the Bank who have strong capital, stable earnings and alternative sources of financing.

•

Risk ratings 4 and 5 – these ratings have a below and average degree of risk. The customers have generally strong to adequate net worth, stable earnings trends and strong to moderate liquidity.

•

Risk rating 6 – this category represents an above average degree of risk as to repayment with minimal loss potential. Borrowers in this category generally exhibit adequate operating trends, satisfactory balance sheet trends, moderate leverage and adequate liquidity; however, there is minimal excess operating cushion.

•

Risk rating 7 – this rating includes loans on management’s “Watch” list. Borrowers in this category generally exhibit characteristics of an acceptable/adequate credit, but may be experiencing income volatility, negative operating trends, and a more highly leveraged balance sheet.

•

Risk rating 8 – this rating is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This rating generally includes loans to borrowers with currently protected, but potentially weak assets that deserve management’s close attention.

•

Risk rating 9 – this rating is for loans considered “Substandard” in accordance with regulatory guidelines. This rating represent assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness, or weaknesses, that jeopardize liquidation of the debt and are characterized by the distinct possibility that the bank will sustain some loss if deficiencies are not corrected.

•

Risk rating 10 – this rating is for loans considered “Doubtful” in accordance with regulatory guidelines. Borrowers in this category have all the weaknesses inherent in a “Substandard” credit with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly improbable.

•

Risk rating 11 – this rating is for loans considered “Loss” in accordance with regulatory guidelines. This category represents loans that are considered uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification

does not mean that the asset has absolutely no recovery or salvage value, but simply it is neither practical nor desirable to defer writing off all or some portion of the credit, even though partial recovery may be effected in the future.

The following table presents credit quality indicators:

Credit Quality Indicators

as of March 31, 2011

(Dollars in thousands)


			Commercial Real Estate
	Commercial		Construction		Other
	2011		2011		2011
Risk Rating:
Other Assets Especially Mentioned		$6,156		$1,670		$8,927
Substandard		4,311		3,495		3,869
Doubtful		600		-		-
Loss		-		-		-

		$11,067		$5,165		$12,796


	Residential		Consumer
	Prime		Installment
	2011		2011
Risk Rating:
Other Assets Especially Mentioned		$2,441		$122
Substandard		4,118		537
Doubtful		-		-
Loss		-		-

		$6,559		$659

Credit Quality Indicators

as of December 31, 2010

(Dollars in thousands)


			Commercial Real Estate
	Commercial		Construction		Other
	2010		2010		2010
Risk Rating:
Other Assets Especially Mentioned		$7,358		$1,671		$8,938
Substandard		2,048		7,010		2,438
Doubtful		600		-		-
Loss		-		-		-

		$10,006		$8,681		$11,376


	Residential		Consumer
	Prime		Installment
	2010		2010
Risk Rating:
Other Assets Especially Mentioned		$1,517		$123
Substandard		3,868		575
Doubtful		-		-
Loss		-		-

		$5,385		$698

The following table presents an age analysis of past due loans receivable:

Age Analysis of Past Due Loans Receivable

As of March 31, 2011

(Dollars in thousands)


	30-59 Days Past Due		59-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
2011
Commercial		$25		$2,259		$1,625		$3,909		$48,305		$52,214		$3
Commercial Real Estate
Construction		3,320		-		-		3,320		29,602		32,922		-
Other		6,377		-		238		6,615		95,026		101,641		238
Residential		1,354		513		1,839		3,706		84,122		87,828		-
Consumer		372		-		203		575		9,633		10,208		17

		$11,448		$2,772		$3,905		$18,125		$266,688		$284,813		$258

Age Analysis of Past Due Loans Receivable

As of December 31, 2010

(Dollars in thousands)


	30-59 Days Past Due		59-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
2010
Commercial		$191		$691		$2,079		$2,961		$48,398		$51,359		$-
Commercial Real Estate
Construction		3,515		-		1,585		5,100		28,434		33,534		180
Other		488		239		1,449		2,176		92,688		94,864		419
Residential		1,669		596		1,795		4,060		84,218		88,278		-
Consumer		189		108		187		484		10,180		10,664		-

		$6,052		$1,634		$7,095		$14,781		$263,918		$278,699		$599

Total past due loans increased from $14.8 million to $18.1 million primarily due to two commercial real estate loans aggregating nearly $5.6 million. A payment was received on April 1, 2011 on one of the loans with an outstanding principal balance of $3.5 million bringing it to under 30 days past due.

Loans are considered impaired when, based on current information it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Bank may measure impairment based on a loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. Interest payments on impaired loans are typically applied to principal unless collectability is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans or portions thereof, are charged-off when deemed uncollectible.

The following tables presents a summary of impaired loans as of and for the three months ended March 31, 2011 and as of December 31, 2010 and for the year then ended:

Impaired Loans

as of and for the Three Month Period Ended March 31, 2011


(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded
Commercial		$996		$996		$-		$1,445		$14
Commercial real estate		238		238		-		831		-
Residential real estate		1,528		1,528		-		1,353		16
Consumer		176		176		-		359		4

		2,938		2,938		-		3,988		$34

With an allowance recorded
Commercial		$629		$629		$346		$937		$1
Commercial real estate		1,406		1,406		351		1,405		16
Residential real estate		1,488		1,488		523		1,491		4
Consumer		260		260		185		280		4

		3,783		3,783		1,405		4,113		25

Total
Commercial		$1,625		$1,625		$346		$2,382		$15
Commercial real estate		1,644		1,644		351		2,236		16
Residential real estate		3,016		3,016		523		2,844		20
Consumer		436		436		185		639		8

		$6,721		$6,721		$1,405		$8,101		$59

Impaired Loans

as of and for the Year Ended December 31, 2010


(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded
Commercial		$1,009		$1,009		$-		$539		$43
Commercial real estate		1,628		1,628		-		1,940		-
Residential real estate		1,478		1,478		-		1,060		73
Consumer		181		181		-		439		14

		4,296		4,296		-		3,978		$130

With an allowance recorded
Commercial		$1,098		$1,098		$545		$2,293		$3
Commercial real estate		1,405		1,405		351		3,371		24
Residential real estate		1,341		1,341		416		1,347		21
Consumer		249		249		150		241		19

		4,093		4,093		1,462		7,252		67

Total
Commercial		$2,107		$2,107		$545		$2,832		$46
Commercial real estate		3,033		3,033		351		5,311		24
Residential real estate		2,819		2,819		416		2,407		94
Consumer		430		430		150		680		33

		$8,389		$8,389		$1,462		$11,230		$197

Note G – Fair Value Measurements

Fair Value Hierarchy

Effective January 1, 2008, the Company adopted FASB’s guidance on “Fair Value Measurements.” The guidance defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The guidance applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the guidance establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

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 all other assets on a nonrecurring basis, such as loans held for sale, 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.

The guidance establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

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

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

Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the assets credit rating, prepayment assumptions and other factors such as credit loss assumptions

An asset or liability’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications of the Company’s assets and liabilities on a quarterly basis. During the quarter ended March 31, 2011, there were no transfers made between Level 1, 2, and 3 inputs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s assets measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

		000000		000000		000000		000000		000000		000000
(in thousands)			Fair Value Measurements at March 31, 2011 Using
Description	Fair Value March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Trading Gains and (Losses)		Total Changes in Fair Values Included in Period Earnings

Investment Securities Available for Sale – Debt Securities
Issued by the U.S. Treasury and Government agencies		$49,435		$-		$49,435		$-		$-		$-
Issued by State and municipal		1,094		-		1,094		-		-		-
Mortgage-backed securities issued by Government agencies		35,528		-		35,528		-		-		-
Other debt securities		2,383		-		107		2,276		-		-

Total Debt Securities		88,440		-		86,164		2,276		-		-


Investment Securities Available for Sale – Equity Securities
Mutual funds		620		-		620		-		-		-

Total Equity Securities		620		-		620		-		-


Total Assets Measured at Fair Value on a Recurring Basis		$89,060		$-		$86,784		$2,276		$-		$-

		000000		000000		000000		000000		000000		000000
(in thousands)			Fair Value Measurements at December 31, 2010 Using
Description	Fair Value December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Trading Gains and (Losses)		Total Changes in Fair Values Included in Period Earnings

Investment Securities Available for Sale – Debt Securities
Issued by the U.S. Treasury and Government agencies		$53,761		$-		$53,761		$-		$-		$-
Issued by State and municipal		1,089		-		1,089		-		-		-
Mortgage-backed securities issued by Government agencies		37,737		-		37,737		-		-		-
Other debt securities		3,091		-		690		2,401		-		-

Total Debt Securities		95,678		-		93,277		2,401		-		-


Investment Securities Available for Sale – Equity Securities
Mutual funds		617		-		617		-		-		-

Total Equity Securities		617		-		617		-		-


Total Assets Measured at Fair Value on a Recurring Basis		$96,295		$-		$93,894		$2,401		$-		$-


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) – Roll Forward at March 31, 2011

Investment Securities Available for Sale – Debt Securities
Beginning Balance			$2,401
Transfers in to Level 3			-
Transfers out of Level 3			-
Unrealized gains			16
Repayments			(141)

Ending Balance			$2,276

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, municipal bonds and corporate debt securities. Securities classified as Level 3 include securities below investment grade and asset-backed securities in illiquid markets. Level 3 securities include two private-label residential one to-four family mortgage backed securities. These 2005 senior tranches in a securitization trust were rated “Aa1 and Aaa” by Moody’s when purchased in 2005 and are currently rated “B3”. The Company engages the service of independent third party valuation professionals to estimate the fair value of these securities. The valuation is meant to be “Level Three” pursuant to FASB ASC Topic 820 – Fair Value Measurements and Disclosures. The valuation uses an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity. At March 31, 2011, both securities were current on both principal and interest payments, had a fixed weighted average coupon of 5.50% and weighted average remaining life of less than two years.

The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. 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 are included in the following tables.


(in thousands)			Fair Value Measurements at March 31, 2011 Using
Description	Fair Value March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Trading Gains and (Losses)		Total Changes in Fair Values Included in Period Earnings

Loans
Commercial		$1,279		$-		$1,279		$-		$-		$-
Commercial real estate		238		-		238		-		-		-
Residential real estate		2,493		-		2,493		-		-		-
Construction		1,055		-		1,055		-		-		-
Consumer		251		-		251		-		-		-

Total loans		5,316		-		5,316		-		-		-
Real estate owned		1,608		-		1,608		-		-		-
Other assets (repossessed assets)		145		-		145		-		-		-

Total Assets Measured at Fair Value on a Nonrecurring Basis		$7,069		$-		$7,069		$-		$-		$-


(in thousands)			Fair Value Measurements at December 31, 2010 Using
Description	Fair Value December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Trading Gains and (Losses)		Total Changes in Fair Values Included in Period Earnings

Loans
Commercial		$1,562		$-		$1,562		$-		$-		$-
Commercial real estate		1,449		-		1,449		-		-		-
Residential real estate		2,402		-		2,402		-		-		-
Construction		1,234		-		1,234		-		-		-
Consumer		280		-		280		-		-		-

Total loans		6,927		-		6,927		-		-		-
Real estate owned		1,608		-		1,608		-		-		-
Other assets (repossessed assets)		145		-		145		-		-		-

Total Assets Measured at Fair Value on a Nonrecurring Basis		$8,680		$-		$8,680		$-		$-		$-

Loans for which it is probable that the Company will not collect all of principal and interest due according to contractual terms are measured for impairment in accordance with guidance found in FASB ASC Topic 310 – Accounting by Creditors for Impairment of a Loan. Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using the discounted cash flow method. In our determination of fair value, we have categorized both methods of valuation as estimates based on Level 2 inputs.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal or utilizing some other method of valuation for the collateral and applying a discount factor to the value based on our loan review policy and procedures.

If the impaired loan is determined not to be collateral dependent, then the discounted cash flow method is used. This method requires the impaired loan to be recorded at the present value of expected future cash flow’s discounted at the loan’s effective interest rate. The effective interest rate of a loan is the contractual interest rate adjusted for any net deferred loan fees or costs, premiums, or discounts existing at origination or acquisition of the loan.

Management establishes a specific reserve for loans that have an estimated fair value below the carrying value. Nonperforming loans with a carrying amount of $6.7 million had specific reserves of $1.4 million as of March 31, 2011.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for credit losses. Losses are recognized in the period an obligation becomes uncollectible. The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though a partial recovery may occur in the future. During the three months ended March 31, 2011 the Company charged-off $526,000 of impaired loans to the allowance for credit losses.

Property acquired by the Company as a result of foreclosure on a mortgage loan will be classified as “real estate owned.” Personal property acquired through repossession will be

classified as “repossessed assets.” Property acquired will be recorded at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carried at the lower of cost or net realizable value. Any required write-down of the loan to its net realizable value will be charged against the allowance for credit losses. As of March 31, 2011 and as of December 31, 2010, the Company held $1.6 million in real estate owned as a result of foreclosure.

The Company records repossessed assets such as boats, automobiles or equipment at the lower of cost or estimated fair value on the acquisition date and at the lower of such initial amount or estimated fair value less selling costs thereafter. Estimated fair value is generally based upon independent values of the collateral obtained through valuation or listing services specifically used for the type of asset repossessed. We consider these collateral values to be estimated using Level 2 inputs. Repossessed assets totaled $145,000 at March 31, 2011 and December 31, 2010.

The estimated fair values of the Company’s financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.


	March 31, 2011				December 31, 2010
(dollars in thousands)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets
Cash and due from banks		$2,094		$2,094		$7,854		$7,854
Interest bearing balances with banks		13,612		13,612		16,856		16,856
Federal funds sold		17,405		17,405		11,984		11,984
Investment securities (total)		89,060		89,060		96,295		96,295
Federal Reserve and Federal Home Loan Bank stock		3,035		3,035		3,035		3,035
Loans and loans held for sale, net		278,180		278,579		273,063		273,454
Accrued interest receivable		1,450		1,450		1,567		1,567
Bank owned life insurance		5,483		5,483		5,442		5,442
Real estate owned		1,608		1,608		1,608		1,608
Financial liabilities
Noninterest bearing deposits		$45,759		$45,759		$45,514		$45,514
Interest bearing deposits		290,414		294,361		295,400		299,239
Securities sold under agreements to repurchase		12,717		12,717		14,558		14,558
Long-term borrowings		35,000		32,718		35,000		32,483
Junior subordinated debt		5,000		5,000		5,000		5,000
Accrued interest payable		184		184		187		187

The carrying amount of cash and due from banks, federal funds sold and interest bearing balances with banks approximates fair value.

The fair values of U.S. Treasury and Government agency securities and mortgage backed securities are determined using market quotations.

The carrying amount of Federal Reserve stock and Federal Home Loan Bank stock approximates fair value.

The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible credit losses. The fair value of loans held for sale are at the carrying value (lower of cost or market) since such loans are typically committed to be sold (servicing released) at a profit.

The carrying amount of accrued interest receivable approximates fair value.

The fair value of bank owned life insurance is the current cash surrender value which is the carrying value.

The carrying value of real estate owned approximates fair value at the reporting date.

The fair value of noninterest bearing deposits is the amount payable on demand at the reporting date, since generally accepted accounting standards does not permit an assumption of core deposit value.

The fair value of interest bearing transaction, savings, and money market deposits with no defined maturity is the amount payable on demand at the reporting date, since generally accepted accounting standards does not permit an assumption of core deposit value.

The fair value of certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposits would be accepted.

The carrying amount for customer repurchase agreements and variable rate borrowings approximate the fair values at the reporting date. The fair value of fixed rate Federal Home Loan Bank advances is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate Federal Home Loan Bank advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index.

The carrying amount of junior subordinated debentures approximate the fair values at the reporting date.

The carrying amount of accrued interest payable approximates fair value.

Management has reviewed the unfunded portion of commitments to extend credit, as well as standby and other letters of credit, and has determined that the fair value of such instruments is equal to the fee, if any, collected and unamortized for the commitment made.

Note H – Preferred Stock

The Company is authorized to issue up to 5,000,000 shares of preferred stock with a par value of $.01 per share. On January 30, 2009 the Company completed a transaction to participate in the Government sponsored Troubled Asset Relief Program which resulted in the Treasury purchasing 8,152 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) at a value of $8.2 million. The Series A Preferred Stock qualifies as Tier 1 Capital. The Series A Preferred Stock pays a dividend of 5% per annum; payable quarterly for five years then pays a dividend of 9% per annum thereafter. Dividends declared for each of the three months ended March 31, 2011 and 2010 was $102 thousand.

The warrant is exercisable at $4.08 per share at any time on or before January 30, 2019. The number of shares of common stock issuable upon exercise of the warrant and the exercise price per share will be adjusted if specific events occur.

Note I – New Accounting Pronouncements

Recent Accounting Provisions Adopted

All pending but not yet effective Accounting Standards Updates (“ASU”) were evaluated and only those listed below could have a material impact on the Company’s financial condition or results of operation.

In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures About Fair Value Measurement,” which provided guidance on disclosure requirements about transfers into and out of Levels 1, 2, and 3, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of the valuation technique (e.g., market approach, income approach, or cost approach) and inputs used to measure fair value was required for recurring, nonrecurring, and Level 2 and 3 fair value measurements. The guidance is effective for the Company’s interim and annual reporting periods beginning after December 15, 2009 except for gross basis presentation for Level 3 reconciliation, which is effective for interim and annual periods beginning after December 15, 2010. The disclosure did not have a material impact on our financial condition or results of operations.

In the second quarter 2010, additional guidance was issued under ASU No. 2010-20, “Receivables (Topic 310) - Disclosures about Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires additional disclosures related to the Allowance for Credit Losses with the objective of providing financial statement users with greater transparency about an entity’s loan loss reserves and overall credit quality. Additional disclosures include showing on a disaggregated basis the aging of receivables, credit quality indicators and troubled debt restructuring with its effect on the Allowance for Credit Losses. The provisions of this standard became effective for interim annual periods ending on or after December 15, 2010. The adoption of this standard did not have a material impact on our financial condition or results of operations but did increase the amount of disclosures in the notes to the financial statements.

ASU 2011-01, “Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.

In April 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU No. 2011-02 provides additional guidance and clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The provisions of ASU No. 2011-02 will be effective for the Company’s reporting period ended September 30, 2011 and will be applied retrospectively to January 1, 2011. As a result of the retrospective application, the Company

may identify loans that are newly considered impaired. The adoption of this ASU is not expected to have a material impact on the Company’s statements of operations and financial condition

In April, 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 affects all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The amendments in ASU No. 2011-03 remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. ASU No. 2011-03 also eliminates the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The guidance is effective for the Company’s reporting period ended March 31, 2012. The guidance will be applied prospectively to transactions or modifications of existing transaction that occur on or after January 1, 2012.

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

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the 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.

Significant accounting policies followed by the Company are presented in Note 1 to the Company’s 2010 consolidated financial statements which can be found on the Company’s Form 10-K and recent accounting provisions adopted have been presented herein in Note I. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts management has identified the determination of the allowance for credit losses to be the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

The allowance for credit losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet.

Allowance for Credit Losses Methodology

The Bank’s allowance for credit losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for credit losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The Bank estimates an acceptable allowance for credit loss with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on independent external loan reviews and regular internal reviews. The determination of the allowance for loan losses is based on a combination of the higher of the Bank’s historical loss experience or the peer group average historical loss experience and ten (10) qualitative factors for specific categories and types of loans. The combination of the loss experience factor and the total qualitative factors (“Total ALLL Factor”) is expressed as a percentage of the portfolio for specific categories and types of loans to create the inherent loss index for each loan portfolio. Individual loans deemed impaired are separated from the respective loan portfolios and a specific reserve allocation is assigned based upon Bank management’s best estimate as to the loss exposure for each loan. Each Total ALLL Factor is assigned a percentage weight and that total weight is applied to each loan category. The Total ALLL Factor is different for each loan type and for each risk assessment category within each loan type.

•

The Bank’s historical loss experience is calculated by aggregating the actual loan losses by category for the previous eight quarters and converting that total into a percentage for each loan category.

•

Peer Group average loss experience is calculated by averaging the industry loss experience by loan category over the last eight rolling quarters.

•

Qualitative factors include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; national and local economic trends and conditions; concentrations of credit; quality of the bank’s loan review system; and, external factors, such as competition, legal and regulatory requirements.

The total allowance for credit losses requires these changes as the percentage weight assigned to each Total ALLL Factor is increased or decreased due to its particular circumstance, as the various types and categories of loans change as a percentage of total loans and as the aggregate of specific allowances is adjusted due to an increase or decrease in impaired loans.

Management believes this approach effectively measures the risk associated with any particular loan or group of loans. The Bank’s Board of Directors engages an independent loan review consultant to evaluate the adequacy of the Bank’s allowance for credit losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated credit losses based upon judgments different from those of management. The Bank recorded a total provision for credit losses of $557,000 for the three month period ended March 31, 2011 and $236,000 for the same period in 2010. The aggregate provision was based upon the results of quarterly evaluations using a combination of factors including the level of nonperforming loans, the Bank’s growth in total gross loans and the Bank’s net credit loss experience. Total gross loans, including loans held for sale, increased by $6.1 million for the three months ended March 31, 2011 compared to the three months ended march 31, 2010. The Bank recorded charge-offs of $526,000 on loans deemed uncollectible and recovered $8,000 on previously charged-off loans. As of March 31, 2011, the Bank’s allowance for credit losses was $6.9 million or 2.42% of total loans and 102.5% of nonperforming loans as compared to $6.9 million, or 2.79% of total loans and 81.7% of nonperforming loans as of December 31, 2010.

The Bank continues to monitor and modify its allowance for credit losses as conditions dictate. While management believes that, based on information currently available, the Bank’s allowance for credit losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank’s level of allowance for credit losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance for credit losses will not be necessary if economic and other conditions differ substantially from economic and other conditions at the time management determined the current level of the allowance for credit losses. Management may in the future increase the level of the allowance as its loan portfolio increases or as circumstances dictate.

Activity in the allowance for credit losses for the three months ended March 31, 2011 and 2010 is shown below:


(dollars in thousands)	For the Three Months Ended March 31,
	2011		2010
Total loans outstanding - at March 31⁽¹⁾		$285,072		$277,765
Average loans outstanding year-to-date		282,037		277,266

Allowance for credit losses at beginning of period		$6,853		$7,926

Provision charged to expense		557		236

Chargeoffs:
Commercial loans		471		132
Real estate and construction		-		52
Consumer and other loans		55		237

Total		526		421

Recoveries:
Commercial loans		5		-
Real estate and construction		-		1
Consumer and other loans		3		4

Total		8		5


Net chargeoffs		518		416

Allowance for credit losses at end of year		$6,892		$7,746


Allowance for credit losses as a percent of total loans		2.42%		2.79%
Net chargeoffs (recoveries) as a percent of average loans		0.18%		0.15%

⁽¹⁾	Includes loans held for sale.

The Company’s nonperforming assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, loans with repossessed collateral and repossessed assets, totaled $8.5 million at March 31, 2011, compared to $10.1 million at December 31, 2010, a decrease in nonperforming assets of $1.6 million or 16.4%. The percentage of nonperforming assets to total assets was 1.99% at March 31, 2011, compared to 2.35% at December 31, 2010. The decrease in nonperforming assets was principally attributable to the payoff of one commercial mortgage ($1.0 million) and the charge-off of one commercial loan ($471,000), each of which had been classified as nonperforming at December 31, 2010.

The $8.5 million in nonperforming assets at March 31, 2011 included $6.5 million in nonaccrual loans, $258,000 in loans delinquent 90 days or more and $1.7 million in other assets. Included in the $6.8 million of nonaccrual and loans delinquent 90 days or more as of March 31, 2011 was $4.7 million of loans secured by real estate, $1.6 million of commercial and $436,000 of consumer and other loans. At December 31, 2010 assets classified as nonperforming totaled $10.1 million and consisted of $8.4 million in nonaccrual loans and loans delinquent 90 days or more and $1.7 million in other assets. Included in the $8.4 million of nonaccrual and loans delinquent 90 days or more was $5.7 million of loans secured by real estate, $2.1 million of commercial and $630,000 of consumer and other loans. At March 31, 2010, $14.1 million in nonperforming assets included $11.7 million in nonaccrual loans, $471,000 in loans delinquent 90 days or more and $1.9 million in other assets.

Comparison of Financial Condition at March 31, 2011 and December 31, 2010

Total assets of $426.1 million at March 31, 2011 were down 1.4% or $6.0 million compared to $432.1 million at December 31, 2010. Loan demand improved in the first quarter, with gross loans, including loans held for sale, totaling $285.3 million as of

March 31, 2011, an increase of $5.2 million from $280.1 million at December 31, 2010. The increase resulted primarily from the net origination of $5.7 million in real estate secured loans and $859,000 in commercial loans offset by the net sale of $915,000 of loans held for sale. The balance of investment securities decreased $7.2 million or 7.5% compared to December 31, 2010 while federal funds sold as of March 31, 2011 increased $5.4 million or 45.2% from December 31, 2010. The movement of balances allowed the Company to maintain sufficient liquidity for future loan generation while maximizing the yield on funds not specifically earmarked for growth or expansion.

Deposits of $336.2 million at March 31, 2011 represent a decrease of $4.7 million or 1. 4% from December 31, 2010 deposits of $340.9 million. Savings balances decreased $1.6 million in total, due in part to a $3.0 million transfer into a certificate of deposit. Certificate of deposit balances, however excluding the $3.0 million transfer decreased $2.8 million with $1.3 million of the decrease due to intentionally not renewing a number of higher rate certificates of deposit. Money market balances decreased $2.6 million due to several large one-time withdrawals.

Comparison of Operating Results for the Three Months Ended March 31, 2011 and 2010.

General. The Company recorded net income for the three months ended March 31, 2011 of $509,000, a decrease of $108,000 from net income of $617,000 in the first quarter of 2010. Net income available to common shareholders was $387,000 or $0.10 per basic and $0.09 per diluted common share, compared to a net income available to common shareholders of $497,000, or $0.13 per basic and diluted common share, for the three months ended March 31, 2010. Net interest income decreased $41,000 or 1.0% for the three months ended March 31, 2011 compared to the same in period in 2010. The Bank recorded $557,000 in provision for credit losses during the three months ended March 31, 2011, compared to $236,000 in provision for credit losses during the same period in 2010.

Interest Income. Interest income decreased $439,000 or 8.2% for the quarter ended March 31, 2011 compared to the same quarter in 2010. Income and fees on loans remained flat as income of $180,000 in interest was recognized from the payoff of a nonperforming loan. The $180,000 receipt offset the drop in income on loans resulting from lower yields. As a result of the one time payment the yield on the loan portfolio remained at 6.03% for the three months ended March 31, 2011 compared to the same 6.03% for the three months ended March 31, 2010. Income on the investment portfolio decreased $509,000 for the quarter ended March 31, 2011 compared to the same period in 2010 due both to a decrease in the volume of investments and the yields obtained on those investments. Average investment security balances decreased by $20.5 million compared to the same period in 2010 while the yield decreased to 3.01% from 4.26% for the same period. Interest income on federal funds sold and interest bearing deposits with banks decreased $1,000 to $11,000 from $12,000 for the three months ended March 31, 2011 compared to March 31, 2010.

Interest Expense. Interest expense decreased by $398,000 or 29.9% for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 as average interest bearing deposit balances decreased $16.7 million. Interest expense on interest bearing deposits for the quarter ending March 31, 2011 was $594,000 compared to $964,000 for the same period in 2010, a 38.4% decrease. The decrease in interest expense was due to the lower cost of all interest bearing deposit types with the yield dropping to 0.83% for the three months ended March 31, 2011 compared to 1.27% for the three months

ended March 31, 2010. The cost of certificates of deposit decreased to 1.47% from 2.06% for the quarter ended March 31, 2011 compared to the same period in 2010. The yield on the Bank’s savings accounts decreased to 0.73% from 1.13% while the yield on money market accounts decreased to 0.50% from 0.76% for the quarter ended March 31, 2010. The total cost of interest bearing liabilities decreased for the quarter ended March 31, 2011 to 1.09% from 1.48% for the quarter ended March 31, 2010. The Company’s overall cost of funds decreased to 0.97% from 1.33% for the same periods. Interest expense on long-term borrowings and junior subordinated debentures was $321,000 for the three months ended March 31, 2011 compared to $345,000 for the three months ended March 31, 2010, a decrease of $24,000 as average long-term borrowings decreased $4.3 million. The cost of the junior subordinated debt remained flat at 3.49% for the current quarter compared to the quarter ended March 31, 2010.

Net Interest Income. Net interest income is the difference between interest income and interest expense and is generally affected by increases or decreases in the amount of outstanding interest-earning assets and interest bearing liabilities (volume variance). This volume variance coupled with changes in interest rates on these same assets and liabilities (rate variance) equates to the total change in net interest income in any given period.

Net interest income decreased by $41,000 or 1.00% for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The decrease was due primarily to a decrease in interest income on investments.

For the three months ended March 31, 2011, the net interest margin improved to 4.00% compared to 3.87% for the three months ended March 31, 2010, with the interest rate spread for the same period increasing to 3.84% in the first quarter of 2011 from 3.67% in the same quarter in 2010. The increase in net interest margin was the result of the decrease in the yield on interest bearing liabilities.

Provision for Credit Losses. The Company recorded a provision for credit losses of $557,000 for the three months ended March 31, 2011 compared to $236,000 for the same period in 2010. The Bank recorded net charge-offs of $518,000 for the quarter ended March 31, 2011 compared to net charge-offs of $416,000 for the three months ended March 31, 2010. Nonperforming assets at quarter-end of $8.5 million were comprised of $6.5 million in nonaccrual loans, $258,000 of loans past due greater than ninety days and $1.7 million in other assets.

Noninterest Income. Noninterest income decreased by $44,000 or 10.7% to $368,000 for the three months ended March 31, 2011 from $412,000 for the same period of 2010. The decrease in noninterest income was due to lower fee income from mortgage banking activity and loans held for sale. Losses recognized on the disposal of fixed assets related to the planned closure of the Bank’s Market House branch contributed $31,000 to the decrease in income. Offsetting the decreases in income was the absence of losses on the sale of investment securities which totaled $55,000 for the three months ended March 31, 2010 compared to zero for the quarter ended March 31, 2011.

Noninterest Expense. Noninterest expense decreased by $170,000 or 5.3% for the three months ended March 31, 2011 compared to the same quarter in 2010. The decrease in noninterest expense consisted of a decrease in legal costs of $57,000, a decrease in costs for maintaining real estate owned and repossessed assets of $44,000 and a reduction in expenses associated with loans held for sale of $58,000. The reduction in legal fees was the result, in

part, of receiving reimbursement from the payoff of a nonperforming loan of $44,000, of legal costs previously incurred. The remaining decrease in legal expenses was the result of lower collection related expenses. The costs to maintain repossessed assets decreased for the quarter as no new assets were acquired through foreclosure or repossession. The decrease in costs for loans held for sale was volume related. Offsetting the decreases in noninterest expense was an increase in occupancy and equipment expense related to accelerating the depreciation of leasehold improvements at the Bank’s Market House branch that will be closed in May 2011.

Income Tax Expense. The Company recorded a tax expense of $237,000 for the three-month period ended March 31, 2011. The Company’s combined effective federal and state income tax rate was approximately 35.8% for the three months ended March 31, 2011 versus 37.2% for the three months ended March 31, 2010.

Rate/Volume Analysis

(dollars in thousands)


	Three Months Ended March 31, 2011 vs. 2010
			Due to Change in
	Increase or (Decrease)		Volume		Rate		Rate/ Volume
Interest income on:
Loans		$71		$71		$-		$-
Investment securities		(509)		(215)		(357)		63
Interest bearing deposits in other banks		(1)		-		(1)		-
Federal funds sold and other overnight investments		-		(1)		1		-

Total interest income		(439)		(145)		(357)		63

Interest expense on:
NOW accounts		(1)		1		(2)		-
Money market accounts		(31)		(4)		(28)		1
Savings accounts		(148)		(9)		(142)		3
Certificates of deposit		(190)		(76)		(136)		22
Repurchase agreements		(4)		3		(6)		(1)
Long-term borrowing		(24)		(33)		10		(1)
Junior subordinated debt		-		-		-		-

Total interest expense		(398)		(118)		(304)		24


Net interest income		($41)		($27)		($53)		$39

Consolidated Average Balances, Yields and Rates



(dollars in thousands)	Three Month Periods Ended

	March 31, 2011						March 31, 2010

	Average Balance		Interest (1)		Yield/ Rate		Average Balance		Interest (1)		Yield/ Rate

Assets
Interest earning assets
Federal funds sold and other overnight investments		$11,870		$7		0.24%		$14,302		$7		0.20%
Interest bearing deposits with banks		14,482		4		0.11%		13,892		5		0.15%
Investment securities (1)		95,278		708		3.01%		115,733		1,217		4.26%
Loans (2)		282,037		4,191		6.03%		277,266		4,120		6.03%

Total interest earning assets		403,667		4,910		4.93%		421,193		5,349		5.15%
Noninterest earning assets
Cash and due from banks		7,874						3,131
Other assets		15,744						15,587

Total Assets		$427,285						$439,911


Liabilities and Stockholders’ Equity
Interest bearing deposits
NOW accounts		$32,811		$11		0.14%		$29,173		$12		0.17%
Money market accounts		41,568		51		0.50%		43,542		82		0.76%
Savings accounts		139,661		250		0.73%		142,937		398		1.13%
Certificates of deposit		77,879		282		1.47%		92,932		472		2.06%
Repurchase agreements		13,559		17		0.51%		12,157		21		0.70%
Long-term borrowings		35,000		278		3.22%		39,318		302		3.12%
Junior subordinated debt		5,000		43		3.49%		5,000		43		3.49%

Total interest bearing liabilities		345,478		932		1.09%		365,059		1,330		1.48%

Noninterest bearing Liabilities
Demand deposit accounts		44,974						39,652
Other liabilities		1,945						1,440
Stockholders’ Equity		34,888						33,760

Total Liabilities and Stockholders’ Equity		$427,285						$439,911


Interest rate spread						3.84%						3.67%
Ratio of interest earning assets to interest bearing liabilities						116,84%						114.55%
Net interest income and net interest margin				$3,978		4.00%				$4,019		3.87%

(1)

No tax-equivalent adjustments are made, as the effect would not be material.

(2)

Includes nonaccrual loans

Liquidity

Liquidity is the capacity to change the nominal level and mix of assets or liabilities, for any purpose, quickly and economically. Poor or inadequate liquidity risk management could result in a critical situation in which the Bank would be unable to meet deposit withdrawal or loan funding requests from its customers. Either situation could potentially harm both the profits and reputation of the Bank.

The Company’s major source of liquidity is its deposit base. At March 31, 2011, total deposits were $336.2 million. Core deposits, considered to be stable funding sources and defined as all deposits except time deposits totaled $258.4 million or 76.9% of total deposits. Liquidity is also provided through the Company’s overnight investment in federal funds sold, interest bearing deposits with banks as well as securities available-for-sale and investment securities with maturities less than one year. At March 31, 2011, interest bearing deposits with banks, federal funds sold and other overnight investments totaled $31.0 million while investment securities available-for-sale totaled $89.1 million.

In addition, the Bank has external sources of funds, which can be used as needed. The FHLB is the primary source of this external liquidity. The FHLB has established credit availability for banks up to 40% of the bank’s total assets. The Bank currently has an approved line of credit with the FHLB of 25% of total assets with the ability to request an increase in the line if necessary. Total assets are based on the most recent quarterly financial information submitted by the Bank to the appropriate regulatory agency. The ability to borrow funds is subject to the Bank’s continued creditworthiness, compliance with the terms and conditions of the FHLB’s Advance Applications and the pledging of sufficient eligible collateral to secure advances. At March 31, 2011, the Bank had a $106.5 million credit limit with the FHLB with advances outstanding of $35.0 million. The Bank had collateral currently pledged sufficient to borrow up to $13.1 million of the remaining $71.5 million from the FHLB. The Bank also has the ability to borrow from the Federal Reserve Bank’s discount window. Additional collateral including cash, investment securities and home-equity loans are available for pledging purposes in the event the Bank would need to draw on the unused portion of the line of credit. Additionally, at March 31, 2011, the Bank had available credit with its correspondent banks of $14.2 million.

Capital Resources

Total stockholders’ equity was $35.0 million at March 31, 2011, representing an increase of $233,000 or 0.7% from December 31, 2010. The growth of stockholders’ equity in the first three months of 2011 was attributable to income of $509,000, stock based compensation and stock purchases through the Company’s Employee Stock Purchase Plan and the exercise of options totaling $54,000. Offsetting these increases was a decrease in the accumulated other comprehensive income of $228,000 resulting from lower market values of securities available-for-sale and from the payment of $102,000 in preferred stock dividends.

During the first quarter of 2009 the Company received an infusion of capital under TARP. Under TARP, the U. S. Treasury created the CPP, pursuant to which it provides access to capital that will serve as Tier 1 capital to financial institutions through a standardized program to acquire preferred stock (accompanied by warrants) from eligible financial institutions. On January 30, 2009, the Company sold 8,152 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to the Treasury under the CPP for a total purchase price of $8,152,000.

The Company currently has $5.0 million of junior subordinated debt issued in the form of trust preferred securities. Trust preferred securities are considered regulatory capital for purposes of determining the Company’s Tier 1 capital ratios. Regulatory guidance was issued by the Board of Governors of the Federal Reserve System ruled that banks could continue to include trust preferred securities in regulatory capital.

The following table summarizes the Company’s risk-based capital ratios:

Annapolis Bancorp, Inc.



	March 31, 2011		December 31, 2010		Minimum Regulatory Requirements		Well-Capitalized Regulatory Requirements

Risk Based Capital Ratios:
Tier 1 Capital		12.8%		12.8%		4.0%		6.0%
Total Capital		14.1%		14.1%		8.0%		10.0%
Tier 1 Leverage Ratio		9.4%		9.1%		4.0%		5.0%

As of March 31, 2011, both the Company and the Bank met the criteria for classification as a “well-capitalized” institution. Designation as a well-capitalized institution under these regulations is not a recommendation or endorsement of the Company or the Bank by federal bank regulators.

Risk Management

The Board of Directors is the foundation for effective corporate governance and risk management. The Board demands accountability of management, keeps stockholders’ and other constituencies’ interests in focus, advocates the upholding of the Company’s code of ethics, and fosters a strong internal control environment. Through its Audit Committee, the Board actively reviews critical risk positions, including market, credit, liquidity, and operational risk. The Company’s goal in managing risk is to reduce earnings volatility, control exposure to unnecessary risk, and ensure appropriate returns for risk assumed. Senior management manages risk at the business line level, supplemented with corporate-level oversight through the Asset Liability Committee, internal audit and quality control functions.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives regulators new authority to take control of and liquidate financial firms. The Dodd-Frank Act additionally creates a new independent federal regulator to administer federal consumer protection laws. The Dodd-Frank Act is expected to have a significant impact on the Company’s business operations as its provisions take effect.

The Company may be affected by the following provisions of the Dodd-Frank Act:

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Holding Company Capital Requirements – The Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to depository holding companies that are no less stringent than those that apply to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. The Company’s trust preferred securities were issued prior to May 19, 2010 and will not need to be excluded from Tier 1 capital.

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Deposit Insurance – The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits and provided unlimited federal deposit insurance until January 1, 2013, for noninterest-bearing demand transaction accounts at all depository institutions. Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premium paid to the Deposit Insurance Fund (“DIF”) will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount total insured deposits and eliminating the requirement that the FDIC pays dividends to depository institutions when the reserve ratio exceeds certain threshold. In December 2010, the FDIC increased the reserve ratio to 2.0 percent. The Dodd-Frank Act also eliminates the federal statutory prohibitions against the payment of interest on business transaction and other accounts.

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Corporate Governance – The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. It also mandates the enhancement of independence requirements of the compensation committee and adopts incentive based clawback policies for executive officers. The new legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 billion, regardless of whether the company is publicly traded or not. As a result of the Dodd-Frank Act, the SEC has prohibited broker discretionary voting on elections of directors and executive compensation matters.

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Prohibition Against Charter Conversions of Troubled Institutions – Effective one year after enactment, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.

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Interstate Branching – The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely. The Dodd-Frank Act restricts the preemption of state law by federal law and disallows subsidiaries and affiliates of federally regulated banks from availing themselves of such preemptions.

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Limits on Derivatives – Effective 18 months after enactment, the Dodd-Frank Act prohibits state-chartered banks from engaging in derivatives transactions unless the loans to one borrowers limit of the state in which the bank is chartered takes into considerations credit exposure to derivative transactions. For this purpose, derivative transactions includes any contract, agreement, swap, warrant note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure of occurrence of any event relating to, one or more commodities securities, currencies, interest or other rates indices or other assets.

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Transactions with Affiliates or Insiders – Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution and its affiliates. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved by the disinterested directors.

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Debit Card Interchange Fees – Effective July 21, 2011, the Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. Within nine months of enactment, the Federal Reserve Board is required to establish standards for reasonable and proportional fees which may take into account the costs of preventing fraud. The restrictions on interchange fees, however, do not apply to banks, that, together with their affiliates, have assets of less than $10 billion.

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Consumer Financial Protection Bureau – The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Graham-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with assets in excess of $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

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Financial Stability Oversight Council – The Dodd-Frank Act creates the Financial Oversight Stability Council that will recommend to the Federal Reserve Board increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.

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Mortgage Reform – The Dodd-Frank Act provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions.

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Well Capitalized and Well Managed – The Dodd-Frank Act requires financial holding companies, such as the Company, to be well capitalized and well managed as of July 21, 2011.

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The Electronic Fund Transfer Act – The Dodd-Frank Act amends the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

Emergency Economic Stabilization Act of 2008

On October 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”), which, among other measures, authorized the Secretary of the U. S. Treasury (“Treasury”) to establish the Trouble Asset Relief Program (the “TARP”). Pursuant to TARP, the Treasury has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. In addition, under TARP, the Treasury created the Capital Purchase Program (the “CPP”), pursuant to which it provides access to capital that will serve as Tier 1 capital to financial institutions through a standardized program to acquire preferred stock (accompanied by warrants) from eligible financial institutions. On January 30, 2009, the Company sold 8,152 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000 and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to the Treasury under the CPP for a total purchase price of $8,152,000.

Comprehensive Financial Stability Plan of 2009

On February 10, 2009, the Secretary of the Treasury announced a new comprehensive financial stability plan (the “Financial Stability Plan”), which builds upon existing programs and earmarks the second $350 billion of unused funds originally authorized under the EESA. The major elements of the Financial Stability Plan include: (i) a capital assistance program that will invest in convertible preferred stock of certain qualifying institutions, (ii) a consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances, (iii) a new public-private investment fund that will leverage public and private capital with public financing to purchase $500 billion to $1 trillion of legacy “toxic assets” from financial institutions, (iv) assistance for homeowners to reduce mortgage payments and interest rates and (v) establishment of loan modification guidelines for government and private programs. Institutions receiving assistance under the Financial Stability Plan going forward will be subject to higher transparency and accountability standards, including restrictions on dividends, acquisitions, executive compensation and additional disclosure requirements.

American Recovery and Reinvestment Act of 2009

On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “ARRA”), which is intended, among other things, to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting dislocations in the financial markets. ARRA also includes numerous non-economic recovery related items, including a limitation on executive compensation of certain of the most highly-compensated employees and executive officers of financial institutions, such as the Company, that participated in the TARP CPP. Compliance requirements under ARRA for TARP recipients, which will be further described in rules to be adopted by the Securities and Exchange Commission and standards to be established by the Treasury, include restrictions on executive compensation and corporate governance requirements.

The interim final rule (Interim Final Rule) of the Emergency Economic Stabilization Act of 2008 (EESA), as amended by the American Recovery and Reinvestment Act of 2009 (ARRA), provides guidance on the executive compensation and corporate governance provisions of EESA that apply to entities that receive financial assistance under the Troubled Asset Relief Program (TARP). Section 111 of EESA requires entities receiving financial assistance (TARP recipients) from the Department of the Treasury (Treasury) to meet appropriate standards for executive compensation and corporate governance. The requirements generally apply for any period during which any obligation arising from financial assistance under TARP remains outstanding.

The Company is a TARP recipient and is therefore subject to the provisions of the Interim Final Rule described above. However, all Executive Compensation Programs are administered through the Bank with the exception of any stock-based awards which are administered through the Company.

On June 10, 2009, the U.S. Treasury issued an interim final rule (the “Interim Final Rule”) that provides guidance on the executive compensation and corporate governance provisions of the EESA that apply to TARP recipients.

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Limits on compensation that exclude incentives for senior executive officers (SEOs) to take unnecessary and excessive risks that threaten the value of the TARP recipient.

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A provision for the recovery of any bonus, retention award, or incentive compensation paid to a SEO or the next twenty most highly compensated employees based on materially inaccurate statements of earnings, revenues, gains, or other criteria.

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Prohibition on making any golden parachute payment to a SEO or any of the next five most highly compensated employees.

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Prohibition on the payment or accrual of bonus or retention awards, or incentive compensation to SEOs or certain highly compensated employees, subject to certain exceptions for payments made in the form of restricted stock.

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Prohibition on employee compensation plans that would encourage manipulation of earnings reported by the TARP recipient to enhance an employee’s compensation.

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Establishment of a compensation committee of independent directors to meet semi-annually to review employee compensation plans and the risks posed by these plans to the TARP recipient.

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Adoption of excessive or luxury expenditures policy.

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Disclosure of perquisites offered to SEOs and certain highly compensated employees.

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Disclosure related to compensation consultant engagement.

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Prohibition on tax gross-ups to SEOs and certain highly compensated employees.

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Compliance with federal securities rules and regulations regarding submission of a non-binding resolution on SEO compensation to shareholders.

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The establishment of the Office of the Special Master for TARP Executive Compensation to address the application of these rules to TARP recipients and their employees.

The Interim Final Rule also establishes compliance reporting and recordkeeping requirements regarding executive compensation and corporate governance standards.

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In addition to the standards set forth in the Interim Final Rule certain standards established in prior interim final rules have been determined to not be inconsistent with the most recent rules and thus will continue to be required. The most notable standard from earlier interim final rules is the requirement that any TARP recipient not claim a deduction for compensation during a taxable year in excess of $500,000 for an SEO.

Regulatory Reform

In June 2009, President Obama’s administration proposed a wide range of regulatory reforms that, if enacted, may have significant effects on the financial services industry in the United States. Significant aspects of the administration’s proposals that may affect the Company included, among other things, proposals: (i) to reassess and increase capital requirements for banks and bank holding companies and examine the types of instruments that qualify as regulatory capital; (ii) to create a federal consumer financial protection agency to be the primary federal consumer protection supervisor with broad examination, supervision and enforcement authority with respect to consumer financial products and services; and (iii) to further limit the ability of banks to engage transactions with affiliates.

The U.S. Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions, including rules and regulations related to the administration’s proposals. Separate comprehensive financial reform bills intended to address the proposals set forth by the administration were introduced in both houses of Congress in the second half of 2010 and remain under review by both the U.S. House of Representatives and the U.S. Senate. In addition, both the U.S. Treasury Department and the Basel Committee have issued policy statements regarding proposed significant changes to the regulatory capital framework applicable to banking organizations, as discussed above. The Company cannot predict whether or in what form further legislation or regulations may be adopted or the extent to which the Company may be affected thereby.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4. Controls and Procedures

As of the end of the period covered by this report, based on an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act), each of the chief executive officer and the chief financial officer of the Company has concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in its Exchange Act reports is recorded, processed, summarized and reported within the applicable time periods specified by the Securities and Exchange Commission’s rules and forms.

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

Neither the Company nor the Bank is involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which involve amounts in the aggregate believed by management to be immaterial to the financial condition of the Company and the Bank.

Item 1A – Risk Factors

Not applicable.

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

None

Item 3 - Defaults Upon Senior Securities

None.

Item 4 - Reserved

Item 5 - Other Information

None

Item 6 – Exhibits

The following exhibits are filed as part of this report.


		3.1		Articles of Incorporation of Annapolis Bancorp, Inc.*
		3.2		Amended and Restated Bylaws of Annapolis Bancorp, Inc.**
		3.3		Articles of Incorporation of BankAnnapolis***
		3.4		Bylaws of BankAnnapolis***
		4.0		Stock Certificate of Annapolis National Bancorp, Inc.*
		4.1		Form of Stock Certificate for the Fixed Rate Cumulative Preferred Stock, Series A. *******
		4.2		Warrant To Purchase 299,706 Shares of Common Stock Of Annapolis Bancorp, Inc. *******
		10.1		Annapolis National Bancorp, Inc. Employee Stock Option Plan*+
		10.2		Annapolis National Bancorp, Inc. 2000 Employee Stock Option Plan****
		10.3		Annapolis Bancorp, Inc. 2006 Stock Incentive Plan*****
		10.4		Form of Stock Option Award Agreement*****
		10.5		Form of Restricted Share Award Agreement*****
		10.6		Form of Deferral Election Agreement for Deferred Share Units*****
		10.7		Annapolis Bancorp, Inc. 2007 Employee Stock Purchase Plan ******
		10.8		Securities Purchase Agreement by and between the United States Department of the Treasury and Annapolis Bancorp, Inc. dated January 30, 2009*******
		31.1		Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith)
		31.2		Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith)
		32.1		Certification Pursuant to 18 U.S.C. Section 1350 (filed herewith)
		32.2		Certification Pursuant to 18 U.S.C. Section 1350 (filed herewith)

		+		Management contract or compensatory plan or arrangement.
		*		Incorporated herein by reference to the Company’s Registration Statement on Form SB-2, as amended, Commission File Number 333-29841, filed with the Securities and Exchange Commission on June 23, 1997.
		**		Incorporated herein by reference to the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission on October 23, 2007.
		***		Incorporated herein by reference to the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2000, filed with the Securities and Exchange Commission on March 28, 2001.
		****		Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2000 annual meeting, filed with the Securities and Exchange Commission on April 5, 2000.
		*****		Incorporated herein by reference to the Company’s Registration Statement on Form S-8, Commission File Number 333-136382, filed with the Securities and Exchange Commission on August 8, 2006.
		******		Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2007 annual meeting, filed with the Securities and Exchange Commission on April 13, 2007.
		*******		Incorporated herein by reference to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 2, 2009.

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.

ANNAPOLIS BANCORP, INC.

(Registrant)

Date:

May 13, 2011

/s/ Richard M. Lerner

Richard M. Lerner

Chief Executive Officer

Date:

May 13, 2011

/s/ Edward J. Schneider

Edward J. Schneider

Chief Financial Officer

ANNAPOLIS BANCORP INC - FORM 10-Q - May 13, 2011

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