Edgar Filing: TRI COUNTY FINANCIAL CORP /MD/

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2012

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

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to ______

Commission File Number 0-18279

Tri-County Financial Corporation

(Exact name of registrant as specified in its charter)

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

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

(301) 645-5601

(Registrant's telephone number, including area code)

Not applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

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

Yes x No ¨

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

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

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

Yes ¨ No x

As of July 31, 2012, the registrant had 3,035,999 shares of common stock outstanding.

TRI-COUNTY FINANCIAL CORPORATION

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION		Page

Item 1 – Financial Statements (Unaudited)

Consolidated Balance Sheets – June 30, 2012 and December 31, 2011		3

Consolidated Statements of Income and Comprehensive Income -Three and Six Months Ended June 30, 2012 and 2011		4

Consolidated Statements of Cash Flows -Six Months Ended June 30, 2012 and 2011		5

Notes to Consolidated Financial Statements		7

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

Item 3 – Quantitative and Qualitative Disclosures about Market Risk		49

Item 4 – Controls and Procedures		49

PART II - OTHER INFORMATION

Item 1 – Legal Proceedings		50

Item 1A – Risk Factors		50

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		50

Item 3 – Defaults Upon Senior Securities		50

Item 4 – Mine Safety Disclosures		50

Item 5 – Other Information		50

Item 6 – Exhibits		50

SIGNATURES		51

PART I FINANCIAL STATEMENTS

TRI-COUNTY FINANCIAL CORPORATION

ITEM I. FINANCIAL STATEMENTS

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS JUNE 30, 2012 AND DECEMBER 31, 2011

	June 30, 2012			December 31, 2011
	(Unaudited)
Assets
Cash and due from banks	$	11,235,647		$	13,074,091
Federal funds sold		385,000			5,040,000
Interest-bearing deposits with banks		398,017			1,004,098
Securities available for sale (AFS), at fair value		40,665,026			41,827,612
Securities held to maturity (HTM), at amortized cost		126,915,558			153,516,839
Federal Home Loan Bank and Federal Reserve Bank stock - at cost		5,780,450			5,587,000
Loans receivable - net of allowance for loan losses of $7,464,137 and $7,655,041		734,414,892			710,088,775
Premises and equipment, net		19,322,261			16,440,902
Foreclosed real estate (OREO)		5,562,158			5,028,513
Accrued interest receivable		3,079,092			3,027,784
Investment in bank owned life insurance		18,417,201			18,098,085
Other assets		9,699,419			10,746,024

Total Assets	$	975,874,721		$	983,479,723

Liabilities and Stockholders' Equity

Liabilities
Deposits
Non-interest-bearing deposits	$	84,661,470		$	81,097,622
Interest-bearing deposits		731,112,854			746,155,579
Total deposits		815,774,324			827,253,201
Short-term borrowings		3,000,000			-
Long-term debt		60,552,148			60,576,595
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000			12,000,000
Accrued expenses and other liabilities		8,186,305			8,195,829

Total Liabilities		899,512,777			908,025,625

Stockholders' Equity
Preferred Stock, Senior Non-Cumulative Perpetual, Series C - par value $1,000;
authorized 20,000; issued 20,000		20,000,000			20,000,000
Common stock - par value $.01; authorized - 15,000,000 shares; issued
3,048,084 and 3,026,557 shares, respectively		30,481			30,266
Additional paid in capital		17,733,436			17,367,403
Retained earnings		39,283,317			38,712,194
Accumulated other comprehensive gain		297,350			289,599
Unearned ESOP shares		(982,640	)		(945,364	)

Total Stockholders' Equity		76,361,944			75,454,098

Total Liabilities and Stockholders' Equity	$	975,874,721		$	983,479,723

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)

THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012			2011
Interest and Dividend Income
Loans, including fees	$	9,286,377	$	9,012,635	$	18,511,260		$	17,873,206
Taxable interest and dividends on investment securities		815,101		889,515		1,696,918			1,859,352
Interest on deposits with banks		1,064		2,282		2,748			3,664
Total Interest and Dividend Income		10,102,542		9,904,432		20,210,926			19,736,222

Interest Expenses
Deposits		2,197,377		2,595,961		4,609,719			5,204,481
Short-term borrowings		15,910		10,022		31,751			24,455
Long-term debt		552,054		562,446		1,147,556			1,161,810
Total Interest Expenses		2,765,341		3,168,429		5,789,026			6,390,746

Net Interest Income		7,337,201		6,736,003		14,421,900			13,345,476
Provision for loan losses		436,431		890,861		777,505			2,896,691

Net Interest Income After Provision For Loan Losses		6,900,770		5,845,142		13,644,395			10,448,785

Noninterest Income
Loan appraisal, credit, and miscellaneous charges		202,127		193,633		383,441			351,731
Net losses on sale of OREO		-		-		(96,917	)		-
Income from bank owned life insurance		159,911		164,509		319,117			324,204
Service charges		465,391		539,874		1,001,903			966,833
Gain on sale of loans held for sale		69,366		54,583		135,341			80,158
Total Noninterest Income		896,795		952,599		1,742,885			1,722,926

Noninterest Expense
Salary and employee benefits		3,170,213		2,675,393		6,490,079			5,426,867
Occupancy expense		464,319		467,581		901,791			884,972
Advertising		179,083		115,341		259,091			234,037
Data processing expense		421,153		288,356		789,593			571,109
Professional fees		343,295		233,153		568,504			450,241
Depreciation of furniture, fixtures, and equipment		162,364		102,663		297,289			202,192
Telephone communications		48,312		44,207		92,086			86,231
Office supplies		71,928		37,109		133,990			75,900
FDIC Insurance		447,587		330,022		891,202			656,341
Valuation allowance on OREO		326,176		-		626,176			315,883
Other		729,256		629,473		1,211,304			1,130,749
Total Noninterest Expense		6,363,686		4,923,298		12,261,105			10,034,522

Income before income taxes		1,433,879		1,874,443		3,126,175			2,137,189
Income tax expense		492,727		654,648		1,079,770			675,896
Net Income	$	941,152	$	1,219,795	$	2,046,405		$	1,461,293
Preferred stock dividends		50,000		211,732		100,000			423,465
Net Income Available to Common Shareholders	$	891,152	$	1,008,063	$	1,946,405		$	1,037,828

Net Income	$	941,152	$	1,219,795	$	2,046,405		$	1,461,293
Other comprehensive income net of tax:
Net unrealized holding gains arising during period		49,657		130,007		7,751			32,557
Comprehensive income	$	990,809	$	1,349,802	$	2,054,156		$	1,493,850

Per Common Share
Basic earnings	$	0.29	$	0.33	$	0.64		$	0.34
Diluted earnings	$	0.29	$	0.33	$	0.64		$	0.34
Cash dividends paid	$	0.40	$	0.40	$	0.40		$	0.40

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2012 AND 2011

	Six Months Ended
	June 30,
	2012			2011

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,046,405		$	1,461,293
Adjustments to reconcile net income to net cash provided by operating activities:

Provision for loan losses		777,505			2,896,691
Depreciation and amortization		521,935			434,471
Loans originated for resale		(3,292,600	)		(2,992,200	)
Proceeds from sale of loans originated for sale		3,402,426			3,051,520
Gain on sale of loans held for sale		(135,341	)		(80,158	)
Net loss on the sale of OREO		96,917			-
Net amortization of premium/discount on investment securities		204,597			85,186
Increase in OREO valuation allowance		626,176			315,883
Increase in cash surrender of bank owned life insurance		(319,116	)		(324,204	)
Deferred income tax benefit		(345,542	)		259,178
Increase in accrued interest receivable		(51,308	)		(228,474	)
Stock based compensation		263,612			245,294
Decrease in deferred loan fees		(11,099	)		(456,619	)
Decrease in accounts payable, accrued expenses, other liabilities		(9,524	)		(370,871	)
Decrease (Increase) in other assets		1,388,154			(2,349,931	)

Net cash provided by operating activities		5,163,197			1,947,059

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of AFS investment securities		(10,077,772	)		(60,648	)
Proceeds from sale, redemption or principal payments of AFS investment securities		11,252,526			5,758,869
Purchase of HTM investment securities		(849,785	)		(99,951	)
Proceeds from maturities or principal payments of HTM investment securities		27,246,045			20,195,654
Net (increase) decrease of FHLB and Federal Reserve stock		(193,450	)		357,800
Loans originated or acquired		(125,552,773	)		(142,803,152	)
Principal collected on loans		98,929,725			102,193,367
Purchase of premises and equipment		(3,403,294	)		(1,796,266	)
Proceeds from sale of OREO		299,302			-

Net cash used in investing activities		(2,349,476	)		(16,254,327	)

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2012 AND 2011 (continued)

	Six Months Ended
	June 30,
	2012			2011

CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits	$	(11,478,877	)	$	29,349,504
Payments of long-term borrowings		(24,447	)		(10,023,487	)
Net increase in short term borrowings		3,000,000			1,044,127
Exercise of stock options		67,391			58,284
Dividends Paid		(1,321,571	)		(1,633,321	)
Net change in unearned ESOP shares		(1,942	)		(100,061	)
Redemption of common stock		(153,800	)		(224,625	)

Net cash (used in) provided by financing activities		(9,913,246	)		18,470,421

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	$	(7,099,525	)	$	4,163,153

CASH AND CASH EQUIVALENTS - JANUARY 1		19,118,189			9,823,436

CASH AND CASH EQUIVALENTS - JUNE 30	$	12,018,664		$	13,986,589

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the six months for:
Interest	$	5,797,788		$	6,516,129
Income taxes	$	1,020,000		$	929,500
Transfer from loans to foreclosed real estate	$	1,555,770		$	6,230,707
Issuance of common stock for payment of compensation	$	263,612		$	245,294

See notes to consolidated financial statements

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2012 AND 2011

BASIS OF PRESENTATION

General - The consolidated financial statements of Tri-County Financial Corporation (the “Company”) and its wholly owned subsidiary, Community Bank of Tri-County (the “Bank”), and the Bank’s wholly owned subsidiary, Community Mortgage Corporation of Tri-County, included herein are unaudited. However, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2011 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2011 Annual Report. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2012 presentation.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2011 Annual Report.

NATURE OF BUSINESS

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

FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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

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

There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the six months ended June 30, 2012 and the year ended December 31, 2011, respectively. The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Securities Available for Sale

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

Loans Receivable

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2011, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

Loans Held for Sale

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

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

Foreclosed Real Estate (OREO)

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

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets as of June 30, 2012 and December 31, 2011 measured at fair value on a recurring basis.

	June 30, 2012
Description of Asset	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Available for sale securities
Asset-backed securities issued by GSEs
CMOs	$	34,228,118	$	-	$	34,228,118	$	-
MBS		2,222,160		-		2,222,160		-
Corporate equity securities		37,331		-		37,331		-
Bond mutual funds		4,177,417		-		4,177,417		-
Total available for sale securities	$	40,665,026	$	-	$	40,665,026	$	-

	December 31, 2011
Description of Asset	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Available for sale securities
Asset-backed securities issued by GSEs
CMOs	$	35,062,072	$	-	$	35,062,072	$	-
MBS		2,648,043		-		2,648,043		-
Corporate equity securities		37,262		-		37,262		-
Bond mutual funds		4,080,235		-		4,080,235		-
Total available for sale securities	$	41,827,612	$	-	$	41,827,612	$	-

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may be required from time to time to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. 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 as of June 30, 2012 and December 31, 2011 are included in the table below.

	June 30, 2012
Description of Asset	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Loans with impairment
Commercial real estate	$	1,700,643	$	-	$	1,700,643	$	-
Home equity and second mtg.		54,318		-		54,318		-
Residential first mortgage		1,424,853		-		1,424,853		-
Commercial loans		291,323		-		291,323		-
Total loans with impairment	$	3,471,137	$	-	$	3,471,137	$	-

Foreclosed Real Estate	$	5,562,158	$	-	$	5,562,158	$	-

	December 31, 2011
Description of Asset	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Loans with impairment
Commercial real estate	$	1,170,467	$	-	$	1,170,467	$	-
Construction and land development		1,313,550		-		1,313,550		-
Residential first mortgage		505,206		-		505,206		-
Commercial loans		5,110,241		-		5,110,241		-
Total loans with impairment	$	8,099,464	$	-	$	8,099,464	$	-

Foreclosed Real Estate	$	5,028,513	$	-	$	5,028,513	$	-

Loans with impairment have unpaid principal balances of $4,989,245 and $10,096,399 at June 30, 2012 and December 31, 2011, respectively, and include impaired loans with a specific allowance.

INCOME TAXES

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

EARNINGS PER COMMON SHARE

Basic earnings per common share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as options and warrants. As of June 30, 2012 and 2011, there were 101,549 and 102,524 shares, respectively, excluded from the diluted net income per share computation because the exercise price of the stock options were greater than the market price, and thus were anti-dilutive. Basic and diluted earnings per share have been computed based on weighted-average common and common equivalent shares outstanding as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011
Net Income	$	941,152		$	1,219,795		$	2,046,405		$	1,461,293
Less: Dividends payable on preferred stock		(50,000	)		(211,732	)		(100,000	)		(423,465	)
Net income available to common shareholders	$	891,152		$	1,008,063		$	1,946,405		$	1,037,828

Average number of common shares outstanding		3,045,979			3,024,625			3,041,679			3,017,112
Effect of dilutive options		24,786			31,830			14,841			37,489
Average number of shares used to calculate diluted earnings per share		3,070,765			3,056,455			3,056,520			3,054,601

STOCK-BASED COMPENSATION

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

Stock-based compensation expense totaled $81,189 and $93,810 for the six months ended June 30, 2012 and 2011, respectively, which consisted of grants of restricted stock and restricted stock units. Stock-based compensation included director compensation for stock granted in lieu of cash compensation. All outstanding options were fully vested at December 31, 2011. The Company has not granted any stock options since 2007.

The fair value of the Company’s employee stock options is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.

The exercise price for options is set at the discretion of the committee administering the Plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is 10 years and the options vest at the discretion of the committee. The following tables below summarize outstanding and exercisable options at June 30, 2012 and December 31, 2011.

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

Outstanding at January 1, 2012		264,156		$	17.90	$	175,911
Granted at fair value		-			-
Exercised		(5,799	)		12.63		9,570
Expired		-
Forfeited		(2,044	)		19.73
Outstanding at June 30, 2012		256,313		$	18.00	$	302,545		1.4

Exercisable at June 30, 2012		256,313		$	18.00	$	302,545		1.4

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

Outstanding at January 1, 2011		299,237		$	16.86	$	524,392
Granted at fair value		-			-
Exercised		(33,163	)		8.75		286,061
Expired		(338	)		8.44
Forfeited		(1,580	)		15.00

Outstanding at December 31, 2011		264,156		$	17.90	$	175,911		1.7

Exercisable at December 31, 2011		264,156		$	17.90	$	175,911		1.7

Options outstanding are all currently exercisable and are summarized as follows:

Number Outstanding		Weighted Average	Weighted Average
June 30, 2012		Remaining Contractual Life	Exercise Price

	14,848	1 years	$	11.56
	54,098	2 years		12.95
	85,817	3 years		15.89
	80,138	4 years		22.29
	21,411	6 years		27.70
	256,313			18.00

The aggregate intrinsic value of outstanding stock options and exercisable stock options was $302,545 and $175,911 at June 30, 2012 and December 31, 2011, respectively. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $16.40 and $15.00 at June 30, 2012 and December 31, 2011, respectively, and the exercise price multiplied by the number of options outstanding.

The Company has outstanding restricted stock and stock units granted in accordance with the Plan. The following tables below summarize the unvested restricted stock awards and units outstanding at June 30, 2012 and December 31, 2011.

	Restricted Stock					Restricted Stock Units

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

Nonvested at January, 2012		8,113		$	16.47		6,845		$	15.00
Granted		15,473			15.09		2,105			16.40
Vested		(5,158	)		15.09		(3,739	)		14.80

Nonvested at June 30, 2012		18,428		$	15.70		5,211		$	16.40

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

Nonvested at January 1, 2011		2,720		$	11.90		3,739	$	15.00
Granted		12,934			16.49		3,106		15.00
Vested		(7,541	)		14.86		-		-

Nonvested at December 31, 2011		8,113		$	16.47		6,845	$	15.00

GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES

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

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

PREFERRED STOCK

Small Business Lending Fund Preferred Stock

On September 22, 2011, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with the Secretary of the Treasury (the “Secretary”), pursuant to which the Company issued 20,000 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $20,000,000. The Purchase Agreement was entered into, and the Series C Preferred Stock was issued, as authorized by the Small Business Lending Fund program.

The Series C Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the Series C Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QSBL” (as defined in the Purchase Agreement) by the Bank. Based upon the increase in the Bank’s level of QSBL over the baseline level calculated under the terms of the Purchase Agreement, the dividend rate for the initial dividend period has been set at one percent (1%). For the second through ninth calendar quarters, the dividend rate may be adjusted to between one percent (1%) and five percent (5%) per annum, to reflect the amount of change in the Bank’s level of QSBL. If the level of the Bank’s qualified small business loans declines so that the percentage increase in QSBL as compared to the baseline level is less than 10%, then the dividend rate payable on the Series C Preferred Stock would increase. For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between one percent (1%) and seven percent (7%) based upon the increase in QSBL as compared to the baseline. After four and one half years from issuance, the dividend rate will increase to nine percent (9%). In addition, beginning on January 1, 2014, and on all Series C Preferred Stock dividend payment dates thereafter ending on April 1, 2016, the Company will be required to pay to the Secretary, on each share of Series C Preferred Stock, but only out of assets legally available, a fee equal to 0.5% of the liquidation amount per share of Series C Preferred Stock.

The Series C Preferred Stock is non-voting, except in limited circumstances. If the Company misses five dividend payments, whether or not consecutive, the holder of the Series C Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s Board of Directors. The Series C Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of our federal banking regulator. The Company is permitted to repay its SBLF funding in increments of 25% or $5.0 million, subject to the approval of our federal banking regulator.

The Series C Preferred Stock was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register the Series C Preferred Stock under certain circumstances set forth in Annex E to the Purchase Agreement. The Series C Preferred Stock is not subject to any contractual restrictions on transfer.

Redemption of Series A and B Preferred Stock - Troubled Asset Relief Program’s (TARP) Capital Purchase Program

On September 22, 2011, the Company entered into a letter agreement (the “Repurchase Letter”) with the United States Department of the Treasury (the “Treasury”), in which the Company agreed to redeem, out of the proceeds of the issuance of the Series C Preferred Stock, all 15,540 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share (the “Series A Preferred Stock”), for a redemption price of $15,619,858, including accrued but unpaid dividends to the date of redemption and all 777 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series B, liquidation amount $1,000 per share (the “Series B Preferred Stock”), for a redemption price of $784,187, including accrued but unpaid dividends to the date of redemption.

The Company issued Series A Preferred Stock and Series B Preferred Stock on December 19, 2008. It was outstanding until redemption of 100% of all Series A Preferred Stock and Series B Preferred Stock on September 22, 2011. The annual dividend rates paid for Series A Preferred Stock and Series B Preferred Stock were 5% and 9%, respectively.

SECURITIES

	June 30, 2012
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs
Residential MBS	$	2,004,078	$	218,082	$	-	$	2,222,160
Residentail CMOs		34,035,060		204,893		11,835		34,228,118
Corporate equity securities		37,310		306		285		37,331
Bond mutual funds		3,893,639		283,778		-		4,177,417
Total securities available for sale	$	39,970,087	$	707,059	$	12,120	$	40,665,026

Securities held to maturity (HTM)
Asset-backed securities issued by GSEs
Residential MBS	$	32,870,312	$	1,233,232	$	-	$	34,103,544
Residential CMOs		84,304,790		709,054		33,639		84,980,205
Asset-backed securities issued by Others:								-
Residential MBS		-		-		-		-
Residential CMOs		8,990,484		175,927		998,052		8,168,359
Total debt securities held to maturity		126,165,586		2,118,213		1,031,691		127,252,108

U.S. government obligations		749,972		-				749,972
Other investments		-		-		-		-
Total securities held to maturity	$	126,915,558	$	2,118,213	$	1,031,691	$	128,002,080

	December 31, 2011
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs
Residential MBS	$	2,412,959	$	235,084	$	-	$	2,648,043
Residentail CMOs		34,848,180		248,508		34,616		35,062,072
Corporate equity securities		37,310		241		289		37,262
Bond mutual funds		3,840,473		239,762		-		4,080,235
Total securities available for sale	$	41,138,922	$	723,595	$	34,905	$	41,827,612

Securities held to maturity (HTM)
Asset-backed securities issued by GSEs
Residential MBS	$	35,929,199	$	854,497	$	10,960	$	36,772,736
Residential CMOs		106,998,467		1,104,141		27,411		108,075,197
Asset-backed securities issued by Others								-
Residential CMOs		9,839,222		15,364		1,421,477		8,433,109
Total debt securities held to maturity		152,766,888		1,974,002		1,459,848		153,281,042

U.S. government obligations		749,951		-		-		749,951
Total securities held to maturity	$	153,516,839	$	1,974,002	$	1,459,848	$	154,030,993

At June 30, 2012, certain asset-backed securities with a carrying value of $8.5 million were pledged to secure certain deposits. At June 30, 2012, asset-backed securities with a carrying value of $10.5 million were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.

At June 30, 2012 and December 31, 2011, the AFS and HTM asset-backed securities investment portfolios were $162,615,864, or 97%, and $190,477,003, or 98%, respectively, of the Company’s total AFS and HTM portfolios.

At June 30, 2012, 95% of the asset-backed securities portfolio was rated AAA by Standard & Poor’s or equivalent credit rating from other major rating agency. AFS asset-backed securities issued by GSEs had an average life of 2.92 years and average duration of 2.78 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs had an average life of 3.09 years and average duration of 2.92 years and are guaranteed by their issuer as to credit risk.

At December 31, 2011, 96% of the asset-backed securities portfolio was rated AAA by Standard & Poor’s or equivalent credit rating from other major rating agency. AFS asset-backed securities issued by GSEs had an average life of 1.65 years and average duration of 1.61 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs had an average life of 2.72 years and average duration of 2.57 years and are guaranteed by their issuer as to credit risk.

During the six months ended June 30, 2012 and for the year ended December 31, 2011, there were no sales of available for sale securities or held to maturity securities.

We believe that the securities with unrealized losses will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. We believe that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class. No charges related to other-than-temporary impairment were made during the six months ended June 30, 2012 and the year ended December 31, 2011. During the year ended December 31, 2009, the Company recorded a charge of $148,000 related to other-than-temporary impairment on a single CMO issue. At June 30, 2012, the CMO issue had a par value of $999,000, a market fair value of $768,000 and a carrying value of $607,000.

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

AFS Securities

At June 30, 2012, the AFS investment portfolio had a fair value of $40,665,026 with unrealized losses from their amortized cost of $12,120. Asset-backed securities and corporate securities with unrealized losses had a fair value of $11,019,712 and all unrealized losses were for less than twelve months.

At December 31, 2011, the AFS investment portfolio had a fair value of $41,827,612 with unrealized losses from their amortized cost of $34,905. Asset-backed securities and corporate securities with unrealized losses had a fair value of $18,170,977 and all unrealized losses were for less than twelve months.

HTM Securities

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at June 30, 2012 were as follows:

June 30, 2012	Less Than 12				More Than 12
	Months				Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Losses
Asset-backed securities issued by GSEs	$	18,789,945	$	20,457	$	2,568,623	$	13,182	$	21,358,568	$	33,639
Asset-backed securities issued by other		134,765		2,167		6,405,636		995,885		6,540,401		998,052
	$	18,924,710	$	22,624	$	8,974,259	$	1,009,067	$	27,898,969	$	1,031,691

At June 30, 2012, the HTM investment portfolio had an estimated fair value of $128,002,080, of which $27,898,969, or 22% of the securities, had some unrealized losses from their amortized cost. Of these securities, $21,358,568, or 77%, were mortgage-backed securities issued by GSEs and the remaining $6,540,401, or 23%, were asset-backed securities issued by others.

HTM securities issued by GSEs are guaranteed by the issuer. Total unrealized losses on the asset-backed securities issued by GSEs were $33,639, or 0.03%, of the amortized cost of $117,175,102. HTM asset-backed securities issued by GSEs with unrealized losses had an average life of 1.31 years and an average duration of 1.28 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

HTM asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches that absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $998,052, or 11.10%, of the amortized cost of $8,990,484. HTM asset-backed securities issued by others with unrealized losses had an average life of 2.44 years and an average duration of 1.79 years.

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at December 31, 2011 were as follows:

December 31, 2011	Less Than 12				More Than 12
	Months				Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Losses
Asset-backed securities issued by GSEs	$	30,220,777	$	33,796	$	2,847,703	$	4,575	$	33,068,480	$	38,371
Asset-backed securities issued by other		131,301		11,507		6,632,200		1,409,970		6,763,501		1,421,477
	$	30,352,078	$	45,303	$	9,479,903	$	1,414,545	$	39,831,981	$	1,459,848

At December 31, 2011, the HTM investment portfolio had an estimated fair value of $154,030,993, of which $39,831,981, or 26% of the securities, had some unrealized losses from their amortized cost. Of these securities, $33,068,480, or 83%, were mortgage-backed securities issued by GSEs and the remaining $6,763,501, or 17%, were asset-backed securities issued by others.

HTM securities issued by GSEs are guaranteed by the issuer. Total unrealized losses on the asset-backed securities issued by GSEs were $38,371, or 0.03%, of the amortized cost of $142,927,666. HTM asset-backed securities issued by GSEs with unrealized losses had an average life of 2.06 years and an average duration of 1.96 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

HTM asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches that absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $1,421,477, or 14.45%, of the amortized cost of $9,839,222. HTM asset-backed securities issued by others with unrealized losses had an average life of 2.35 years and an average duration of 1.61 years.

Credit Quality of Asset-Backed Securities

The tables below present the Standard & Poor’s or equivalent credit rating from other major rating agencies for AFS and HTM asset-backed securities issued by GSEs and others at June 30, 2012 and December 31, 2011 by carrying value. GSE asset-backed securities that were downgraded by Standard and Poor’s during 2011 were treated as AAA based on regulatory guidance.

June 30, 2012			December 31, 2011
Credit Rating		Amount	Credit Rating		Amount
AAA	$	153,953,157	AAA	$	181,958,323
A+		136,928	A+		142,808
A		788,302	A		-
BBB		162,882	BBB		1,258,268
BBB-		1,234,498	BBB-		1,061,017
BB+		1,122,404	BB+		1,240,901
BB		517,236	BB		337,998
BB-		1,215,199	BB-		615,716
B+		-	B+		246,345
CCC+		3,485,258	CCC+		3,615,627
Total	$	162,615,864	Total	$	190,477,003

10.

FORECLOSED REAL ESTATE (OREO)

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

	Six Months Ended June 30,
	2012			2011
Balance at beginning of year	$	5,028,513		$	10,469,302
Additions to underlying property		1,555,770			6,781,857
Disposals of underlying property		(395,949	)		(6,388,395	)
Valuation allowance		(626,176	)		(315,883	)
Balance at end of period	$	5,562,158		$	10,546,881

During the six months ended June 30, 2012, the Bank disposed of two OREO properties for proceeds of $299,032 and recognized net losses of $96,917. Current year OREO additions include two construction and land development projects valued at $1,038,000 that the Bank utilized the deposit method to account for the sale and transfer of legal title to the borrower. Payments of principal and interest will be recorded as a deposit (liability) until the transaction qualifies for full accrual or installment accounting treatment. As of June 30, 2012, the Bank has received $109,000 in payments on these projects. OREO carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs.

Expenses applicable to foreclosed assets include the following.

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Valuation allowance	$	326,176	$	-	$	626,176	$	315,883
Operating expenses		32,546		150,582		30,845		294,450
	$	358,722	$	150,582	$	657,021	$	610,333

Operating expenses for the six months ended June 30, 2012 included $7,600 in deposits refunded on sold foreclosed real estate.

11.

LOANS

Loans consist of the following:

	June 30, 2012		December 31, 2011

Commercial real estate	$	398,017,392	$	370,383,885
Residential first mortgages		178,459,492		164,543,309
Construction and land development		32,405,839		36,744,865
Home equity and second mortgage		22,525,909		24,138,324
Commercial loans		93,096,685		101,968,056
Consumer loans		1,007,453		1,000,983
Commercial equipment		17,151,518		19,760,753
		742,664,288		718,540,175
Less:
Deferred loan fees		785,259		796,359
Allowance for loan loss		7,464,137		7,655,041
		8,249,396		8,451,400

	$	734,414,892	$	710,088,775

At June 30, 2012, the Bank’s allowance for loan losses totaled $7,464,137 or 1.01% of loan balances as compared to $7,655,041 or 1.07% of loan balances at December 31, 2011. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, size, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

At December 31, 2011, gross loans included $2,356,196 from the sale of two foreclosed real estate properties that the Bank financed during 2011 that did not qualify for full accrual sales treatment under ASC Topic 360-20-40 “Property Plant and Equipment – Derecognition.” The Bank utilized the cost recovery method and deferred gain of $410,268. At June 30, 2012 and December 31, 2011, the deferred gain balance for these transactions was $410,268.

Risk Characteristics of Portfolio Segments

The Company manages its credit products and exposure to credit losses (credit risk) by the following specific portfolio segments (classes) which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:

Commercial Real Estate

Commercial and other real estate projects include office buildings, retail locations, churches and other special purpose buildings. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. The Bank generally limits its exposure to a single borrower to 15% of the Bank’s capital. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to twenty years.

Loans secured by commercial real estate are larger and involve greater risks than one-to-four family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.

Residential First Mortgages

Residential first mortgage loans made by the Bank are generally long term loans, amortized on a monthly basis, with principal and interest due each month. The initial contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank originates both fixed-rate and adjustable-rate residential first mortgages.

The annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also unquantifiable credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower.

Construction and Land Development

The Bank offers loans for the construction of one-to-four family dwellings. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. In addition, the Bank offers loans to acquire and develop land, as well as loans on undeveloped, subdivided lots for home building by individuals.

A decline in demand for new housing might adversely affect the ability of borrowers to repay these loans. Construction and land development loans are inherently riskier than providing financing on owner-occupied real estate. The Bank’s risk of loss is affected by the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. In addition, the volatility of the real estate market has made it increasingly difficult to ensure that the valuation of land associated with these loans is accurate. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, a project’s value might be insufficient to assure full repayment. As a result of these factors, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank forecloses on a project, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

Home Equity and Second Mortgage Loans

The Bank maintains a portfolio of home equity and second mortgage loans. These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage. This risk has been heightened as the market value of residential property has declined.

Commercial Loans

The Bank offers commercial loans to its business customers. The Bank offers a variety of commercial loan products including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. When making commercial business loans, the Bank considers the financial condition of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business, the viability of the industry in which the consumer operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable, or other security as determined by the Bank.

Commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.

Consumer Loans

The Bank has developed a number of programs to serve the needs of its customers with primary emphasis upon loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. Consumer loans entail greater risk from other loan types due to being secured by rapidly depreciating assets or the reliance on the borrower’s continuing financial stability.

Commercial Equipment Loans

These loans consist primarily of fixed-rate, short-term loans collateralized by a commercial customer’s equipment. When making commercial equipment loans, the Bank considers the same factors it considers when underwriting a commercial business loan. Commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic.

Allowance for Loan Losses

The following table details activity in the allowance for loan losses at and for the three and six months ended June 30, 2012 and June 30, 2011, respectively, and the year ended December 31, 2011 and loan receivable balances at June 30, 2012 and June 30, 2011, respectively, and at December 31, 2011. An allocation of the allowance to one category of loans does not prevent the Company’s ability to utilize the allowance to absorb losses in a different category. The loan receivables are disaggregated on the basis of the Company’s impairment methodology.

	Commercial Real Estate			Residential First Mortgage		Construction and Land Development		Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
At and For the Three Months Ended June 30, 2012

Allowance for loan losses:
Balance at April 1,	$	3,385,036		$	644,008	$	448,406	$	265,138		$	2,793,049		$	18,350		$	361,811		$	7,915,798
Charge-offs		(85,381	)		-		-		(41,942	)		(649,699	)		(14	)		(149,794	)		(926,830	)
Recoveries		-			37,247		-		-			1,491			-			-			38,738
Provisions		178,803			220,250		148,448		(10,405	)		(176,350	)		(20	)		75,705			436,431
Balance at June 30,	$	3,478,458		$	901,505	$	596,854	$	212,791		$	1,968,491		$	18,316		$	287,722		$	7,464,137
At and For the Six Months Ended June 30, 2012

Allowance for loan losses:
Balance at January 1,	$	2,525,199		$	539,205	$	354,385	$	143,543		$	3,850,294		$	19,119		$	223,296		$	7,655,041
Charge-offs		(121,833	)		-		-		(41,942	)		(693,048	)		(999	)		(149,794	)		(1,007,616	)
Recoveries		-			37,247		-		-			1,960			-			-			39,207
Provisions		1,075,092			325,053		242,469		111,190			(1,190,715	)		196			214,220			777,505
Balance at June 30,	$	3,478,458		$	901,505	$	596,854	$	212,791		$	1,968,491		$	18,316		$	287,722		$	7,464,137
Ending balance: individually evaluated for impairment	$	604,063		$	247,408	$	134,500	$	47,200		$	484,937		$	-		$	-		$	1,518,108
Ending balance: collectively evaluated for impairment	$	2,874,395		$	654,097	$	462,354	$	165,591		$	1,483,554		$	18,316		$	287,722		$	5,946,029
Loan receivables:
Ending balance	$	398,017,392		$	178,459,492	$	32,405,839	$	22,525,909		$	93,096,685		$	1,007,453		$	17,151,518		$	742,664,288
Ending balance: individually evaluated for impairment	$	38,727,469		$	6,328,588	$	7,812,520	$	409,348		$	18,536,881		$	68,192		$	803,700		$	72,686,698
Ending balance: collectively evaluated for impairment	$	359,289,923		$	172,130,904	$	24,593,319	$	22,116,561		$	74,559,804		$	939,261		$	16,347,818		$	669,977,590

	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.		Commercial Loans			Consumer Loans			Commercial Equipment			Total
At and For the Year Ended December 31, 2011

Allowance for loan losses:
Balance at January 1,	$	3,313,983		$	204,073		$	1,266,625		$	97,519	$	2,552,039		$	32,209		$	202,699		$	7,669,147
Charge-offs		(1,249,038	)		(49,002	)		(213,007	)		-		(2,441,076	)		(3,000	)		(150,005	)		(4,105,128	)
Recoveries		-			967			-			-		1,936			968			-			3,871
Provisions		460,254			383,167			(699,233	)		46,024		3,737,395			(11,058	)		170,602			4,087,151
Balance at December 31,	$	2,525,199		$	539,205		$	354,385		$	143,543	$	3,850,294		$	19,119		$	223,296		$	7,655,041
Ending balance: individually evaluated for impairment	$	423,093		$	113,000		$	100,000		$	42,340	$	1,318,502		$	-		$	-		$	1,996,935
Ending balance: collectively evaluated for impairment	$	2,102,106		$	426,205		$	254,385		$	101,203	$	2,531,792		$	19,119		$	223,296		$	5,658,106
Loan receivables:
Ending balance	$	370,383,885		$	164,543,309		$	36,744,865		$	24,138,324	$	101,968,056		$	1,000,983		$	19,760,753		$	718,540,175
Ending balance: individually evaluated for impairment	$	31,166,090		$	5,849,538		$	9,057,433		$	492,319	$	23,896,287		$	82,036		$	371,936		$	70,915,639
Ending balance: collectively evaluated for impairment	$	339,217,795		$	158,693,771		$	27,687,432		$	23,646,005	$	78,071,769		$	918,947		$	19,388,817		$	647,624,536

	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
At and For the Three Months Ended June 30, 2011

Allowance for loan losses:
Balance at April 1,	$	3,375,402		$	345,935		$	970,283		$	95,455		$	2,312,814		$	28,453		$	153,435		$	7,281,777
Charge-offs		(265,014	)		1			3			-			(809,044	)		-			1			(1,074,053	)
Recoveries		-			-			-			-			-			1,074			-			1,074
Provisions		359,721			13,603			(114,354	)		1,077			611,268			(2,570	)		22,116			890,861
Balance at June 30,	$	3,470,109		$	359,539		$	855,932		$	96,532		$	2,115,038		$	26,957		$	175,552		$	7,099,659
At and For the Six Months Ended June 30, 2011

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

Non-accrual and Past Due Loans

Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. There were no accruing loans 90 days or greater past due at June 30, 2012 and December 31, 2011. Consumer loans are typically charged-off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Non-accrual loans as of June 30, 2012 and December 31, 2011 were as follows:

	June 30, 2012				December 31, 2011
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	1,675,021		8	$	2,866,539		11
Residential first mortgages		3,430,204		9		2,438,771		7
Construction and land development		331,888		3		1,413,550		2
Home equity and second mortgage		227,296		5		291,285		7
Commercial loans		5,204,771		9		2,263,916		4
Consumer loans		-		-		500		1
Commercial equipment		102,814		4		236,056		3
	$	10,971,994		38	$	9,510,617		35

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $9,371,381 and $4,193,893 at June 30, 2012 and December 31, 2011, respectively. Interest due at stated rates, but not recognized on these balances at June 30, 2012 and December 31, 2011 was $355,654 and $172,399, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $1,600,613 and $5,316,724 at June 30, 2012 and December 31, 2011, respectively. Interest due not recognized on these balances at June 30, 2012 and December 31, 2011 was $243,664 and $242,705, respectively.

An analysis of past due loans as of June 30, 2012 and December 31, 2011 were as follows:

June 30, 2012	Current		31-60 Days		61-89 Days		90 or Greater Days		Total Past Due		Total Loan Receivables

Commercial real estate	$	393,504,269	$	2,838,102	$	-	$	1,675,021	$	4,513,123	$	398,017,392
Residential first mortgages		173,820,097		1,109,678		99,513		3,430,204		4,639,395		178,459,492
Construction and land dev.		32,073,951		-		-		331,888		331,888		32,405,839
Home equity and second mtg.		22,110,912		87,929		99,772		227,296		414,997		22,525,909
Commercial loans		85,783,837		1,467,140		640,937		5,204,771		7,312,848		93,096,685
Consumer loans		1,007,262		191		-		-		191		1,007,453
Commercial equipment		16,760,851		32,213		255,640		102,814		390,667		17,151,518
Total	$	725,061,179	$	5,535,253	$	1,095,862	$	10,971,994	$	17,603,109	$	742,664,288

December 31, 2011

Commercial real estate	$	367,415,647	$	101,699	$	-	$	2,866,539	$	2,968,238	$	370,383,885
Residential first mortgages		160,785,337		1,319,201		-		2,438,771		3,757,972		164,543,309
Construction and land dev.		35,331,315		-		-		1,413,550		1,413,550		36,744,865
Home equity and second mtg.		23,618,693		228,346		-		291,285		519,631		24,138,324
Commercial loans		95,961,076		49,781		3,693,283		2,263,916		6,006,980		101,968,056
Consumer loans		991,838		8,645		-		500		9,145		1,000,983
Commercial equipment		19,450,929		24,869		48,899		236,056		309,824		19,760,753
Total	$	703,554,835	$	1,732,541	$	3,742,182	$	9,510,617	$	14,985,340	$	718,540,175

Credit Quality Indicators

A risk grading scale is used to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received, and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are risk rated.

Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. These loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned (OAEM) or higher risk rating due to a delinquent payment history. At June 30, 2012 and December 31, 2011, $4,615,179 and $5,708,203 of these loans were rated OAEM or higher.

Management regularly reviews credit quality indicators as part of its individual loan reviews and on a monthly and quarterly basis. The overall quality of the Bank’s loan portfolio, including the composition of the loan portfolio, is assessed using the Bank’s risk grading scale, net charge-offs, nonperforming loans, delinquencies, performance of troubled debt restructured loans and the general economic conditions in the Company’s geographical market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators and allowance factors are adjusted based on management’s judgment during the monthly and quarterly review process.

Loans subject to risk ratings are graded on a scale of 1 to 10.

Ratings 1 thru 6 - Pass

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

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

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

Rating 8 - Substandard

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

Rating 9 - Doubtful

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

Rating 10 - Loss

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

Credit quality indicators as of June 30, 2012 and December 31, 2011 were as follows:

Credit Risk Profile by Internally Assigned Grade

	Commercial Real Estate				Construction and Land Dev.
	6/30/2012		12/31/2011		6/30/2012		12/31/2011

Unrated	$	13,327,650	$	1,003,553	$	150,378	$	-
Pass		348,635,657		338,952,446		24,448,778		27,687,432
Special mention		6,100,480		-		-		-
Substandard		29,903,605		30,391,213		7,806,683		9,057,433
Doubtful		50,000		-		-		-
Loss		-		36,673		-		-
Total	$	398,017,392	$	370,383,885	$	32,405,839	$	36,744,865

	Commercial Loans				Commercial Equipment
	6/30/2012		12/31/2011		6/30/2012		12/31/2011

Unrated	$	2,635,510	$	586,124	$	1,069,660	$	391,786
Pass		71,931,585		78,183,487		15,380,972		19,209,380
Special mention		538,440		-		695,735		-
Substandard		17,991,150		23,198,445		5,151		159,587
Doubtful		-		-		-		-
Loss		-		-		-		-
Total	$	93,096,685	$	101,968,056	$	17,151,518	$	19,760,753

Credit Risk Profile Based on Payment Activity

	Residential First Mortgages				Home Equity and Second Mtg.				Consumer Loans
	6/30/2012		12/31/2011		6/30/2012		12/31/2011		6/30/2012		12/31/2011

Performing	$	175,029,288	$	162,104,538	$	22,298,613	$	23,847,039	$	1,007,453	$	1,000,483
Nonperforming		3,430,204		2,438,771		227,296		291,285		-		500
Total	$	178,459,492	$	164,543,309	$	22,525,909	$	24,138,324	$	1,007,453	$	1,000,983

Impaired Loans and Troubled Debt Restructures (TDRs)

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

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

Interest payments made on impaired loans are applied to principal unless collectability of the principal amount is reasonably assured. Interest recognized on impaired loans is on a cash basis. Impaired loans, including TDRs, at June 30, 2012 and June 30, 2011, respectively, and at December 31, 2011 were as follows:

June 30, 2012	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Six Month Average Recorded Investment		Six Month Interest Income Recognized		Three Month Average Recorded Investment		Three Month Interest Income Recognized

Commercial real estate	$	7,809,718	$	5,097,362	$	2,304,706	$	7,402,068	$	604,063	$	7,836,028	$	225,935	$	7,821,751	$	91,009
Residential first mortgages		2,579,409		907,147		1,672,261		2,579,409		247,408		2,585,146		58,717		2,583,098		26,312
Construction and land dev.		1,851,415		1,716,915		134,500		1,851,415		134,500		2,189,748		29,988		2,020,582		12,947
Home equity and second mtg.		101,518		-		101,518		101,518		47,200		101,518		-		101,518		-
Commercial loans		2,670,650		1,894,390		776,260		2,670,650		484,937		2,664,394		51,967		2,671,025		23,628
Total	$	15,012,710	$	9,615,814	$	4,989,245	$	14,605,060	$	1,518,108	$	15,376,834	$	366,607	$	15,197,974	$	153,896

December 31, 2011	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized

Commercial real estate	$	8,405,656	$	6,404,447	$	1,593,560	$	7,998,006	$	423,093	$	6,880,651	$	375,203
Residential first mortgages		618,206		-		618,206		618,206		113,000		618,835		10,294
Construction and land dev.		3,130,466		1,716,915		1,413,550		3,130,466		100,000		3,193,938		84,107
Home equity and second mtg.		42,340		-		42,340		42,340		42,340		42,340		-
Commercial loans		8,798,072		2,369,329		6,428,743		8,798,072		1,318,502		9,188,371		314,216
Commercial equipment		129,876		129,876		-		129,876		-		147,035		8,905
Total	$	21,124,616	$	10,620,567	$	10,096,399	$	20,716,966	$	1,996,935	$	20,071,170	$	792,725

June 30, 2011	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Six Month Average Recorded Investment		Six Month Interest Income Recognized		Three Month Average Recorded Investment		Three Month Interest Income Recognized

Commercial real estate	$	11,107,498	$	8,446,709	$	2,253,139	$	10,699,848	$	297,488	$	9,131,959	$	271,124	$	9,927,954	$	129,907
Construction and land dev.		1,716,915		1,716,915		-		1,716,915		-		1,716,915		41,300		1,716,915		15,899
Commercial loans		9,157,106		2,652,194		6,504,912		9,157,106		1,068,912		10,568,967		201,326		9,862,888		95,834
Commercial equipment		234,139		206,358		27,780		234,139		27,780		264,955		11,880		258,778		2,976
Total	$	22,215,658	$	13,022,176	$	8,785,831	$	21,808,008	$	1,394,180	$	21,682,796	$	525,630	$	21,766,535	$	244,616

At June 30, 2012 and December 31, 2011, impaired loans totaled $14,605,060 and $20,716,966, respectively. Impaired loans had specific allocations within the allowance for loan losses or have been reduced by charge-offs to recoverable values. Allocations of the allowance for loan losses relative to impaired loans at June 30, 2012 and December 31, 2011 were $1,518,108 and $1,996,935, respectively.

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

TDRs, included in the impaired loan schedule above, as of June 30, 2012 and December 31, 2011 were as follows:

	June 30, 2012				December 31, 2011
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	5,880,022		10	$	7,696,921		10
Residential first mortgages		907,147		2		-		-
Construction and land development		1,716,915		1		1,716,915		1
Commercial loans		1,894,390		2		2,369,329		3
Commercial equipment		-		-		129,876		1
	$	10,398,474		15	$	11,913,041		15

At June 30, 2012, $10,106,139 or 97.19%, of TDRs were performing according to the terms of their restructured agreements compared to $11,113,326 or 93.3%, at December 31, 2011. Allocations of the allowance for loan losses relative to TDR impaired loans at June 30, 2012 and December 31, 2011 were $267,658 and $300,000, respectively. Interest income in the amount of $277,360 and $524,397 was recognized on these loans for the six months ended June 30, 2012 and year ended December 31, 2011, respectively.

During the six months ended June 30, 2012, the Bank modified five commercial real estate loans totaling $1,327,421 and two residential first mortgages totaling $907,368.

For the year ended December 31, 2011, TDR loans charged-off or transferred to OREO were $187,891. TDRs charged-off were for two commercial equipment loans totaling $76,592 and one TDR was transferred to foreclosed real estate for a commercial loan of $111,299. For the six months ended June 30, 2012, one commercial real estate relationship consisting of two commercial mortgage TDR loans was charged-off in the amount of $121,660 with the balance of $382,500 transferred to OREO.

12.

NEW ACCOUNTING STANDARDS

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Additional guidance issued Accounting Standards Update 2010-06 (“ASU”) under ASC Topic 820 requires expanded disclosures related to fair value measurements including (1) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (2) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (3) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (4) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. ASU 2010-06 further clarifies that (1) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (2) company’s should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy were required for the Company beginning January 1, 2011. The remaining disclosure requirements and clarifications made by ASU 2010-06 became effective for the Company on January 1, 2010. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

ASU No. 2011-02; A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“TDR”).
In April, 2011, FASB issued ASU No. 2011-02 intended to provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. This ASU was effective for the first interim or annual period beginning on or after June 15, 2011, and was applied retrospectively to the beginning of the annual period of adoption. As a result of applying the ASU, the Company may identify receivables that are newly considered impaired. The Company adopted the applicable guidance during the third quarter ended September 30, 2011 and it did not have a material impact on required disclosures in the Company’s consolidated financial statements.

ASU No. 2011-03; Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements. ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 was effective for the Company on January 1, 2012 and did not have a material impact on the Company’s consolidated financial statements.

ASU 2011-04; “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 was effective for the Company January 1, 2012 and did not have a material impact on the Company’s consolidated financial statements.

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

13. FAIR VALUE OF FINANCIAL INSTRUMENTS

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

June 30, 2012					Fair Value Measurements
Description of Asset	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Investment Securities - Available for Sale	$	40,665,026	$	40,665,026	$	-	$	40,665,026	$	-
Investment Securities - Held to Maturity		126,915,558		128,002,081		749,973		127,252,108		-
Federal Home Loan Bank and Federal Reserve Stock		5,780,450		5,818,000		-		5,818,000		-
Loans		734,414,892		755,143,310		-		755,143,310		-
Foreclosed Real Estate		5,562,158		5,562,158		-		5,562,158		-

Liabilities:
Savings, NOW and money market accounts	$	378,524,653	$	378,524,653	$	-	$	378,524,653	$	-
Time Deposits		437,249,671		442,937,199		-		442,937,199		-
Long-Term Debt		60,552,148		-		-		-		-
Short Term Borrowings		3,000,000		3,000,000		-		3,000,000		-
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000		2,400,000		-		2,400,000		-

December 31, 2011					Fair Value Measurements
Description of Asset	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Investment Securities - Available for Sale	$	41,827,612	$	41,827,612	$	-	$	41,827,612	$	-
Investment Securities - Held to Maturity		153,516,839		154,030,993		749,951		153,281,042		-
Federal Home Loan Bank and Federal Reserve Stock		5,587,000		5,624,000		-		5,624,000		-
Loans		710,088,775		726,238,000		-		726,238,000		-
Foreclosed Real Estate		5,028,513		5,028,513		-		5,028,513		-

Liabilities:
Savings, NOW and money market accounts	$	371,737,480	$	371,737,480	$	-	$	371,737,480	$	-
Time Deposits		455,515,721		462,192,000		-		462,192,000		-
Long-Term Debt		60,576,595		61,353,000		-		61,353,000		-
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000		2,400,000		-		2,400,000		-

At June 30, 2012, the Company had outstanding loan commitments and standby letters of credit of $21.4 million and $22.7 million, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these instruments differs significantly from their carrying values.

Valuation Methodology

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

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

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

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

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

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

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

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

The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2012 and December 31, 2011. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

ITEM 2

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

This document contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Tri-County Financial Corporation (the “Company”) and Community Bank of Tri-County (the “Bank”). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. The Company and the Bank’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company and the Bank’s market area, changes in real estate market values in the Company and the Bank’s market area and changes in relevant accounting principles and guidelines. Additional factors that may affect our results are discussed in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “Form 10-K”). These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

GENERAL

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

The Bank has sought to organically increase total assets through its targeted loan product lines. The Bank believes that its ability to offer fast, flexible, local decision-making will continue to attract significant new business relationships and enhance asset growth. The Bank’s marketing is directed towards growth in commercial loans, residential first mortgages and commercial real estate loans and increasing its balances of consumer and business transaction deposit accounts. The Bank believes that increases in transaction deposit accounts will lessen the Bank’s dependence on higher-cost funding, such as certificates of deposit and borrowings. Although management believes that this strategy will increase financial performance over time, increasing the balances of certain products, such as commercial lending and transaction accounts, may also increase the Bank’s noninterest expense. It recognizes that certain lending and deposit products increase the possibility of losses from credit and other risks.

The Bank continues to evaluate its allowance for loan losses and the associated provision to compensate for the inherent risk in the loan portfolio. Any evaluation of the allowance for loan losses is inherently inexact and reflects management’s expectations as to future interest rates and economic conditions in the region as well as individual borrowers’ circumstances. Management believes that its allowance for loan losses is adequate. For further information on the Bank’s allowance for loan losses see the discussion in the sections captioned “Financial Condition” and “Critical Accounting Policies” as well as the relevant discussions in the Form 10-K and Annual Report for the year ended December 31, 2011.

The Bank conducts business through its main office in Waldorf, Maryland and ten branch offices in Charles, Calvert and St. Mary’s counties in Southern Maryland and in King George, Virginia. The Bank is the second largest overall deposit holder in the Tri-County area according to the most recent 2011 FDIC Summary of Deposit Survey. The Bank completed the building of its operations center during the second quarter of 2012 in Waldorf, Maryland.

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

On September 23, 2011, the U.S. Department of Treasury purchased $20.0 million in the Company’s preferred stock under the Small Business Lending Fund (the “SBLF”). The SBLF is a program intended to encourage small business lending by providing capital to qualified community banks at favorable rates. SBLF dividend rates can fluctuate between 1% and 7% during the first four and one half years, depending on the level of the Bank’s small business lending. As of December 31, 2011, the Company’s dividend rate on the SBLF funds was 1%. The Company used $16.4 million of the proceeds from this investment to redeem all of the preferred stock that it sold to the Treasury under the TARP Capital Purchase Program (“TARP”) on December 19, 2008 as well as to pay any accrued but unpaid dividends. The net proceeds, after repurchasing the TARP securities, were invested by the Company in the Bank. During 2012, if the Company maintains its current investment in qualified small business lending, annual preferred dividends will decrease to $200,000 compared with previously paid annual TARP preferred dividends of $846,930. For additional information regarding SBLF, refer to Note 18 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

SELECTED FINANCIAL DATA
	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2012		2011		2012		2011

Condensed Income Statement
Interest and Dividend Income	$	10,102,542	$	9,904,432	$	20,210,926	$	19,736,222
Interest Expense		2,765,341		3,168,429		5,789,026		6,390,746
Net Interest Income		7,337,201		6,736,003		14,421,900		13,345,476
Provision for Loan Loss		436,431		890,861		777,505		2,896,691
Noninterest Income		896,795		952,599		1,742,885		1,722,926
Noninterest Expense		6,363,686		4,923,298		12,261,105		10,034,522
Income Before Income Taxes		1,433,879		1,874,443		3,126,175		2,137,189
Income Tax Expense		492,727		654,648		1,079,770		675,896
Net Income		941,152		1,219,795		2,046,405		1,461,293
Preferred Stock Dividends		50,000		211,732		100,000		423,465
Net Income Available to Common Shareholders		891,152		1,008,063		1,946,405		1,037,828

Per Common Share
Basic Earnings	$	0.29	$	0.33	$	0.64	$	0.34
Diluted Earnings	$	0.29	$	0.33	$	0.64	$	0.34
Cash Dividends Declared	$	0.40	$	0.40	$	0.40	$	0.40
Book Value	$	18.49	$	18.07	$	18.49	$	18.07

RESULTS OF OPERATIONS – SIX MONTHS ENDED JUNE 30, 2012

Net income available to common shareholders for the six-month period ended June 30, 2012 increased $908,577 to $1,946,405 ($0.64 basic and diluted earnings per common share), compared to $1,037,828 ($0.34 basic and diluted earnings per common share) for the same period in the prior year. The increase in net income available to common shareholders for the six months ended June 30, 2012 compared to the same six months in 2011 was due to a decrease in the provision for loan losses of $2,119,186, an increase in net interest income of $1,076,424 and noninterest income of $19,959 and a reduction in preferred stock dividends of $323,465. These positive impacts to net income were offset by increases in noninterest expense of $2,226,583 and income tax expense of $403,874.

	Six Months Ended June 30,
	2012		2011		$ Change			% Change
Interest and Dividend Income
Loans, including fees	$	18,511,260	$	17,873,206	$	638,054			3.57	%
Taxable interest and dividends on investment securities		1,696,918		1,859,352		(162,434	)		(8.74	%)
Interest on deposits with banks		2,748		3,664		(916	)		(25.00	%)
Total Interest and Dividend Income		20,210,926		19,736,222		474,704			2.41	%

Interest Expenses
Deposits		4,609,719		5,204,481		(594,762	)		(11.43	%)
Short-term borrowings		31,751		24,455		7,296			29.83	%
Long-term debt		1,147,556		1,161,810		(14,254	)		(1.23	%)
Total Interest Expenses		5,789,026		6,390,746		(601,720	)		(9.42	%)

Net Interest Income		14,421,900		13,345,476		1,076,424			8.07	%
Provision for loan losses		777,505		2,896,691		(2,119,186	)		(73.16	%)

Net Interest Income After Provision For Loan Losses	$	13,644,395	$	10,448,785	$	3,195,610			30.58	%

Interest and dividend income increased by $474,704 due to the growth of $88.0 million to the average balance of interest-earning assets from $809.1 million for the six months ended June 30, 2011 to $897.1 million for the six months ended June 30, 2012. This growth was partially offset by a reduction in the average yield on interest-earning assets from 4.88% for the six months ended June 30, 2011 to 4.51% for the six months ended June 30, 2012.

Interest expense decreased $601,720 due to a reduction in the average cost of funds on interest-bearing liabilities from 1.75% for the six months ended June 30, 2011 to 1.43% for the six months ended June 30, 2012. This was achieved by a decrease in the average rates paid on certificates of deposits and money market accounts, which declined from 1.96% and 1.02%, respectively, for the six months ended June 30, 2011 to 1.67% and 0.68%, respectively, for the six months ended June 30, 2012. The decline in the average cost of funds was partially offset by higher average deposit balances. Average customer deposits increased $75.4 million from $652.6 million for the six months ended June 30, 2011 to $728.0 million for the six months ended June 30, 2012.

The Company has been successful in increasing its core deposits and reducing the cost of funds in the low interest rate environment over the last several years and has limited the effect of the lower interest rate environment on loan rates through pricing and interest rate floors.

The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid thereon for the six months ended June 30, 2012 and 2011, respectively. There are no tax equivalency adjustments.

	For the Six Months Ended June 30,
			2012							2011
					Average							Average
	Average				Yield/			Average				Yield/
dollars in thousands	Balance		Interest		Cost			Balance		Interest		Cost
Assets
Interest-earning assets:
Loan portfolio (1)	$	712,597	$	18,511		5.20	%	$	653,757	$	17,873		5.47	%
Investment securities, federal funds
sold and interest-bearing deposits		184,477		1,700		1.84	%		155,359		1,863		2.40	%
Total interest-earning assets		897,074		20,211		4.51	%		809,116		19,736		4.88	%
Cash and cash equivalents		8,393							10,531
Other assets		53,564							54,154
Total Assets	$	959,031						$	873,801

Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Savings	$	31,716	$	38		0.24	%	$	32,528	$	55		0.34	%
Interest-bearing demand and money
market accounts		252,889		860		0.68	%		195,638		994		1.02	%
Certificates of deposit		443,425		3,711		1.67	%		424,464		4,156		1.96	%
Long-term debt		59,870		977		3.26	%		62,268		1,007		3.23	%
Short-term debt		7,228		32		0.89	%		3,953		24		1.21	%
Guaranteed preferrred beneficial interest
in junior subordinated debentures		12,000		171		2.85	%		12,000		155		2.58	%

Total Interest-Bearing Liabilities		807,128		5,789		1.43	%		730,851		6,391		1.75	%

Noninterest-bearing demand deposits		67,434							64,466
Other liabilities		7,421							6,636
Stockholders' equity		77,048							71,848
Total Liabilities and Stockholders' Equity	$	959,031						$	873,801

Net interest income			$	14,422						$	13,345

Interest rate spread						3.07	%						3.13	%
Net yield on interest-earning assets						3.22	%						3.30	%
Ratio of average interest-earning
assets to average interest bearing
liabilities						111.14	%						110.71	%

(1) Average balance includes nonaccrual loans

The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest earning asset and interest bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume.

	Six months ended June 30, 2012
	compared to six months ended
				June 30, 2011
				Due to
	Volume			Rate			Total

Interest income:
Loan portfolio	$	1,528		$	(890	)	$	638
Investment securities, federal funds
sold and interest bearing deposits		268			(431	)		(163	)
Total interest-earning assets	$	1,796		$	(1,321	)	$	475

Interest-bearing liabilities:
Savings		(1	)		(16	)		(17	)
Interest-bearing demand and money
market accounts		195			(329	)		(134	)
Certificates of deposit		159			(604	)		(445	)
Long-term debt		(39	)		9			(30	)
Short-term debt		14			(6	)		8
Guaranteed preferrred beneficial interest
in junior subordinated debentures		-			16			16
Total interest-bearing liabilities	$	328		$	(930	)	$	(602	)
Net change in net interest income	$	1,468		$	(391	)	$	1,077

The Company’s provision for loan losses decreased $2,119,186 and reflected improving asset quality and a decrease in the allowance for specific nonperforming loans based on management’s estimate of realizable value. The provision for loan losses was impacted by increasing average loan balances, economic conditions that affected the loss factors used to compute the allowance, the level of delinquencies and charge-offs. Overall delinquency, which includes all loans greater than 30 days past due increased from 2.09% at December 31, 2011 to 2.37% at June 30, 2012. Nonperforming loans as a percentage of total loans were 1.48% at June 30, 2012 compared to 1.65% at March 31, 2012 and 1.32% at December 31, 2011. Net charge-offs decreased $2,460,667 from $3,468,283 for the six months ended June 30, 2011 to $1,007,616 for the six months ended June 30, 2012.

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

	Six Months Ended June 30,
	2012			2011		$ Change			% Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges	$	383,441		$	351,731	$	31,710			9.02	%
Net losses on sale of OREO		(96,917	)		-		(96,917	)		n/a
Income from bank owned life insurance		319,117			324,204		(5,087	)		(1.57	%)
Service charges		1,001,903			966,833		35,070			3.63	%
Gain on sale of loans held for sale		135,341			80,158		55,183			68.84	%
Total Noninterest Income	$	1,742,885		$	1,722,926	$	19,959			1.16	%

Noninterest income increased primarily due to growth in service charge income and loan fees as a result of the increased asset size of the Bank. Gains on loan sales increased to $135,341 on sales of $3,286,050 for the six months ended June 30, 2012 compared to $80,158 on sales of $2,987,303 for the same period in 2011. During the six months ended June 30, 2012, the Bank disposed of two OREO properties for proceeds of $299,032 and recognized net losses of $96,917.

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

	Six Months Ended June 30,
	2012		2011		$ Change		% Change
Noninterest Expense
Salary and employee benefits	$	6,490,079	$	5,426,867	$	1,063,212		19.59	%
Occupancy expense		901,791		884,972		16,819		1.90	%
Advertising		259,091		234,037		25,054		10.71	%
Data processing expense		789,593		571,109		218,484		38.26	%
Professional fees		568,504		450,241		118,263		26.27	%
Depreciation of furniture, fixtures, and equipment		297,289		202,192		95,097		47.03	%
Telephone communications		92,086		86,231		5,855		6.79	%
Office supplies		133,990		75,900		58,090		76.53	%
FDIC Insurance		891,202		656,341		234,861		35.78	%
Valuation allowance on OREO		626,176		315,883		310,293		98.23	%
Other		1,211,304		1,130,749		80,555		7.12	%
Total Noninterest Expense	$	12,261,105	$	10,034,522	$	2,226,583		22.19	%

For the six months ended June 30, 2012, noninterest expense increased primarily due to growth in employee compensation, increased valuation allowance on OREO properties, increased FDIC insurance and one-time conversion related costs for a change of the Bank’s core service provider. Salary and employee benefits expense increased as the Bank added additional employees to support the Bank’s balance sheet growth and increased compliance needs. In addition, approximately $250,000 of employee compensation related to bonuses and overtime to implement the new core system. Data processing and professional fees increased from the comparable period in 2011 due mostly to conversion related costs. FDIC insurance grew as the Bank’s average asset size increased. Employee compensation, data processing, professional fees and FDIC insurance increased to support the growth of the Bank and to accommodate greater than before regulatory compliance costs for both existing regulation and the initial impact of the Dodd-Frank Act.

The Company recorded income tax expense of $1,079,770 or 34.5%, of pretax earnings of $3,126,175, for the six months ended June 30, 2012 compared with 675,896 or 31.6%, of pretax earnings of $2,137,189, for the six months ended June 30, 2011. The increase in the effective tax rate was the result of tax exempt income being relatively lower to total income in 2011.

The Company’s preferred stock dividends decreased $323,465 to $100,000 for the six months ended June 30, 2012 from $423,465 for the six months ended June 30, 2011. The decrease was due to the Company’s participation in SBLF and payoff of TARP during the third quarter of 2011. If the Company maintains its 1% dividend for 2012, the annual preferred SBLF dividend will decrease to $200,000 compared to a previous annualized cost of $846,930 for TARP participation.

RESULTS OF OPERATIONS – THREE MONTHS ENDED JUNE 30, 2012

Net income available to common shareholders for the three-month period ended June 30, 2012 decreased $116,911 to $891,152 ($0.29 basic and diluted earnings per common share), compared to $1,008,063 ($0.33 basic and diluted earnings per common share) for the same period in the prior year. The decrease in net income available to common shareholders for the three months ended June 30, 2012 compared to the same quarter in 2011 was attributable to increases in noninterest expense of $1,440,388 and a decrease in noninterest income of $55,804. These reductions of income were partially offset by increases in net interest income of $601,198 due to larger average loan balances and a lower cost of funds, a lower provision for loan losses of $454,430, a decrease in income tax expense of $161,921 and a decrease in preferred stock dividends of $161,732.

	Three Months Ended June 30,
	2012		2011		$ Change			% Change
Interest and Dividend Income
Loans, including fees	$	9,286,377	$	9,012,635	$	273,742			3.04	%
Taxable interest and dividends on investment securities		815,101		889,515		(74,414	)		(8.37	%)
Interest on deposits with banks		1,064		2,282		(1,218	)		(53.37	%)
Total Interest and Dividend Income		10,102,542		9,904,432		198,110			2.00	%

Interest Expenses
Deposits		2,197,377		2,595,961		(398,584	)		(15.35	%)
Short-term borrowings		15,910		10,022		5,888			58.75	%
Long-term debt		552,054		562,446		(10,392	)		(1.85	%)
Total Interest Expenses		2,765,341		3,168,429		(403,088	)		(12.72	%)

Net Interest Income		7,337,201		6,736,003		601,198			8.93	%
Provision for loan losses		436,431		890,861		(454,430	)		(51.01	%)

Net Interest Income After Provision For Loan Losses	$	6,900,770	$	5,845,142	$	1,055,628			18.06	%

Interest rate spread and net interest margin for the second quarter of 2012 improved to 3.14% and 3.28%, respectively, from 3.00% and 3.15%, respectively, for the first quarter 2012. Net interest income increased $252,502 from $7,084,699 for the three months ended March 31, 2012 to $7,337,201 for the three months ended June 30, 2012. The improvement was based on a decrease in the cost of interest-bearing liabilities. The average balances for both interest-bearing assets and interest-bearing liabilities were similar during both quarters and were not a material factor in the increase. Average deposit costs have fallen 11 basis points from 1.32% for the quarter ended March 31, 2012 to 1.21% for the quarter ended June 30, 2012. The positive trend of decreasing deposit funding costs is expected to continue during the third quarter based on the scheduled maturities of time deposits and current market rates. At June 30, 2012, the cost of deposits was 1.02%.

Interest and dividend income increased by $198,110 due to growth of $87.3 million to the average balance of interest-earning assets from $807.8 million for the three months ended June 30, 2011 to $895.1 million for the three months ended June 30, 2012. This growth was partially offset by a reduction in the average yield on interest-earning assets from 4.90% for the three months ended June 30, 2011 to 4.51% for the three months ended June 30, 2012.

Interest expense decreased $403,088 due to a reduction in the average cost of funds on interest-bearing liabilities from 1.73% for the three months ended June 30, 2011 to 1.37% for the three months ended June 30, 2012. This was achieved by a decrease in the average rates paid on certificates of deposits and money market accounts, which declined from 1.94% and 1.03%, respectively, for the three months ended June 30, 2011 to 1.65% and 0.61%, respectively, for the three months ended June 30, 2012. The decline in the average cost of funds was partially offset by higher average deposit balances. Average customer deposits increased $67.4 million from $659.1 million for the three months ended June 30, 2011 to $726.5 million for the three months ended June 30, 2012.

The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid thereon for the three months ended June 30, 2012 and 2011, respectively. There are no tax equivalency adjustments.

	For the Three Months Ended June 30,
			2012							2011
					Average							Average
	Average				Yield/			Average				Yield/
dollars in thousands	Balance		Interest		Cost			Balance		Interest		Cost
Assets
Interest-earning assets:
Loan portfolio (1)	$	721,400	$	9,286		5.15	%	$	658,599	$	9,012		5.47	%
Investment securities, federal funds
sold and interest-bearing deposits		173,721		817		1.88	%		149,228		893		2.39	%
Total interest-earning assets		895,121		10,103		4.51	%		807,827		9,905		4.90	%
Cash and cash equivalents		10,151							12,084
Other assets		54,370							55,030
Total Assets	$	959,642						$	874,941

Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Savings	$	32,561	$	5		0.06	%	$	31,777	$	24		0.30	%
Interest-bearing demand and money
market accounts		255,670		387		0.61	%		206,330		533		1.03	%
Certificates of deposit		438,242		1,805		1.65	%		420,947		2,039		1.94	%
Long-term debt		59,172		467		3.16	%		60,605		486		3.21	%
Short-term debt		7,590		16		0.84	%		1,129		10		3.54	%
Guaranteed preferrred beneficial interest
in junior subordinated debentures		12,000		85		2.83	%		12,000		77		2.57	%

Total Interest-Bearing Liabilities		805,235		2,765		1.37	%		732,788		3,169		1.73	%

Noninterest-bearing demand deposits		69,240							64,159
Other liabilities		7,979							6,348
Stockholders' equity		77,188							71,646
Total Liabilities and Stockholders' Equity	$	959,642						$	874,941

Net interest income				7,338							6,736

Interest rate spread						3.14	%						3.17	%
Net yield on interest-earning assets						3.28	%						3.34	%
Ratio of average interest-earning
assets to average interest bearing
liabilities						111.16	%						110.24	%

(1) Average balance includes nonaccrual loans

	Three months ended June 30, 2012
	compared to three months ended
				June 30, 2011
				Due to
	Volume			Rate			Total

Interest income:
Loan portfolio	$	808		$	(534	)	$	274
Investment securities, federal funds
sold and interest bearing deposits		115			(191	)		(76	)
Total interest-earning assets	$	923		$	(725	)	$	198

Interest-bearing liabilities:
Savings		-			(19	)		(19	)
Interest-bearing demand and money
market accounts		75			(221	)		(146	)
Certificates of deposit		71			(305	)		(234	)
Long-term debt		(11	)		(8	)		(19	)
Short-term debt		14			(8	)		6
Guaranteed preferrred beneficial interest
in junior subordinated debentures		-			8			8
Total interest-bearing liabilities	$	149		$	(553	)	$	(404	)
Net change in net interest income	$	774		$	(172	)	$	602

The Company’s provision for loan losses decreased $454,430 from the comparable period in 2011. The decrease in the Company’s provision for loan losses for the three months ended June 30, 2012 was primarily due to decreases in the allowance for specific nonperforming loans based on management’s estimate of realizable value and a decrease in charge-offs. Net charge-offs decreased $147,224 from $1,074,054 for the three months ended June 30, 2011 to $926,830 for the three months ended June 30, 2012.

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

	Three Months Ended June 30,
	2012		2011		$ Change			% Change
Noninterest Income
Loan appraisal, credit, and miscellaneous charges	$	202,127	$	193,633	$	8,494			4.39	%
Net losses on sale of OREO		-		-		-			n/a
Income from bank owned life insurance		159,911		164,509		(4,598	)		(2.79	%)
Service charges		465,391		539,874		(74,483	)		(13.80	%)
Gain on sale of loans held for sale		69,366		54,583		14,783			27.08	%
Total Noninterest Income	$	896,795	$	952,599	$	(55,804	)		(5.86	%)

The $55,804 decrease to noninterest income was principally due to a reduction in second quarter service charges compared to the prior year due to a one time one-month waiver of certain deposit account service charges during the Bank’s transition to a new core system.

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

	Three Months Ended June 30,
	2012		2011		$ Change			% Change
Noninterest Expense
Salary and employee benefits	$	3,170,213	$	2,675,393	$	494,820			18.50	%
Occupancy expense		464,319		467,581		(3,262	)		(0.70	%)
Advertising		179,083		115,341		63,742			55.26	%
Data processing expense		421,153		288,356		132,797			46.05	%
Professional fees		343,295		233,153		110,142			47.24	%
Depreciation of furniture, fixtures, and equipment		162,364		102,663		59,701			58.15	%
Telephone communications		48,312		44,207		4,105			9.29	%
Office supplies		71,928		37,109		34,819			93.83	%
FDIC Insurance		447,587		330,022		117,565			35.62	%
Valuation allowance on OREO		326,176		-		326,176			n/a
Other		729,256		629,473		99,783			15.85	%
Total Noninterest Expense	$	6,363,686	$	4,923,298	$	1,440,388			29.26	%

For the three months ended June 30, 2012, noninterest expense increased primarily due to growth in employee compensation, increased valuation allowance on OREO properties, increased FDIC insurance and one-time conversion related costs for a change of the Bank’s core service provider. Salary and employee benefits expense increased as the Bank added additional employees to support the Bank’s balance sheet growth and increased compliance needs. In addition, approximately $250,000 of second quarter 2012 employee compensation related to bonuses and overtime to implement the new core system. Data processing and professional fees increased from the comparable period in 2011 due mostly to conversion related costs. FDIC insurance grew as the Bank’s average asset size increased. Employee compensation, data processing, professional fees and FDIC insurance increased to support the growth of the Bank and to accommodate greater than before regulatory compliance costs for both existing regulation and the initial impact of the Dodd-Frank Act.

The Company recorded income tax expense of $492,727 or 34.4%, of pretax earnings of $1,433,879, for the three months ended June 30, 2012 compared with 654,648 or 34.9%, of pretax earnings of $1,874,443, for the three months ended June 30, 2011. The lower effective tax rate was the result of a higher relative percentage of tax exempt income as a percentage of pretax income than the comparable period of the prior year.

The Company’s preferred stock dividends decreased $161,732 to $50,000 for the three months ended June 30, 2012 from $211,732 for the three months ended June 30, 2011. The decrease was due to the Company’s participation in the SBLF and payoff of TARP during the third quarter of 2011.

FINANCIAL CONDITION

	June 30, 2012		December 31, 2011		$ Change			% Change
Assets
Cash and due from banks	$	11,235,647	$	13,074,091	$	(1,838,444	)		(14.06	%)
Federal funds sold		385,000		5,040,000		(4,655,000	)		(92.36	%)
Interest-bearing deposits with banks		398,017		1,004,098		(606,081	)		(60.36	%)
Securities available for sale (AFS), at fair value		40,665,026		41,827,612		(1,162,586	)		(2.78	%)
Securities held to maturity (HTM), at amortized cost		126,915,558		153,516,839		(26,601,281	)		(17.33	%)
Federal Home Loan Bank and Federal Reserve Bank stock - at cost		5,780,450		5,587,000		193,450			3.46	%
Loans receivable - net of allowance for loan losses of $7,464,137 and $7,655,041 respectively		734,414,892		710,088,775		24,326,117			3.43	%
Premises and equipment, net		19,322,261		16,440,902		2,881,359			17.53	%
Foreclosed real estate		5,562,158		5,028,513		533,645			10.61	%
Accrued interest receivable		3,079,092		3,027,784		51,308			1.69	%
Investment in bank owned life insurance		18,417,201		18,098,085		319,116			1.76	%
Other assets		9,699,419		10,746,024		(1,046,605	)		(9.74	%)

Total Assets	$	975,874,721	$	983,479,723	$	(7,605,002	)		(0.77	%)

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

	June 30, 2012		%			December 31, 2011		%

Commercial real estate	$	398,017,392		53.59	%	$	370,383,885		51.55	%
Residential first mortgages		178,459,492		24.03	%		164,543,309		22.90	%
Construction and land development		32,405,839		4.36	%		36,744,865		5.11	%
Home equity and second mortgage		22,525,909		3.03	%		24,138,324		3.36	%
Commercial loans		93,096,685		12.54	%		101,968,056		14.19	%
Consumer loans		1,007,453		0.14	%		1,000,983		0.14	%
Commercial equipment		17,151,518		2.31	%		19,760,753		2.75	%
		742,664,288		100.00	%		718,540,175		100.00	%
Less:
Deferred loan fees		785,259		0.11	%		796,359		0.11	%
Allowance for loan loss		7,464,137		1.01	%		7,655,041		1.07	%
		8,249,396					8,451,400

	$	734,414,892				$	710,088,775

Assets decreased primarily due to a decrease in securities and cash and cash equivalents, offsetting loan growth. Cash, maturing securities and Federal Home Loan Bank advances were utilized to fund loan growth and operating needs. The differences in allocations between the different cash and investment categories reflect operational needs.

Premises and equipment increased due primarily to construction completed during the second quarter of 2012 of the Bank’s new operations center in Waldorf, Maryland and its newest branch in King George, Virginia, which opened in March 2012. Other assets decreased due to a reduction in prepaid expenses.

Gross loan growth of $24,124,113 from $718,540,175 at December 31, 2011 to $742,664,288 at June 30, 2012, was due to net new loans of $27,633,507 in commercial real estate and $13,916,183 in residential mortgages offset by decreases of $8,871,371 in commercial loans, $4,339,026 in construction and land development loans, $2,609,235 in commercial equipment loans and a net decrease in other loan categories of $1,605,945. During 2010 and 2011, the Bank managed the relative size of the components of its loan portfolio to increase commercial real estate and residential first mortgage portfolios, growing from 46.88% and 18.59% of the loan portfolio, respectively, at December 31, 2009 to 53.59% and 24.03%, respectively, at June 30, 2012.

The table below highlights nonperforming asset ratio trends:

	As of June 30, 2012			As of March 31, 2012			As of December 31, 2011			As of December 31, 2010
Past due loans (PDLs) to total loans (31 to 89 days)		0.89	%		0.20	%		0.76	%		0.17	%
Nonperforming loans (NPLs) to total loans (>=90 days)		1.48	%		1.65	%		1.32	%		2.04	%
Total loan delinquency (PDLs + NPLs) to total loans		2.37	%		1.85	%		2.09	%		2.21	%
Nonperforming assets (NPLs +OREO) to total assets		1.69	%		1.71	%		1.48	%		2.71	%
Nonperforming assets to gross loans + OREO		2.21	%		2.25	%		2.01	%		3.56	%
Nonperforming assets + TDRs to total assets (a)		2.73	%		2.79	%		2.61	%		4.58	%

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

The Company’s nonperforming asset ratios improved from the first quarter of 2012. Although overall delinquency increased due to an increase in loans 31-89 days delinquent, nonperforming loans (loans 90 days or greater delinquent) decreased during the second quarter of 2012.

The Bank had 38 nonperforming loans at June 30, 2012 compared to 35 nonperforming loans at December 31, 2011. Nonperforming loans (loans 90 days or greater delinquent) decreased $1,122,490 from March 31, 2012 and increased $1,461,377 from December 31, 2011 to $10,971,994 at June 30, 2012. The Company’s allowance for loan losses decreased from $7,915,798 or 1.07% of loans, at December 31, 2011 to $7,464,137 or 1.01% of loans, at June 30, 2012 due to a reduction in specific reserves on loans evaluated for impairment and reflected a trend of improving asset quality over the last quarter. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to: the overall loss experience; current economic conditions; size, growth and composition of the loan portfolio; financial condition of the borrowers; and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance. Management believes that the allowance is adequate.

Nonperforming Loans (Nonaccrual Loans) by Portfolio Segment

	June 30, 2012				December 31, 2011
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	1,675,021		8	$	2,866,539		11
Residential first mortgages		3,430,204		9		2,438,771		7
Construction and land development		331,888		3		1,413,550		2
Home equity and second mortgage		227,296		5		291,285		7
Commercial loans		5,204,771		9		2,263,916		4
Consumer loans		-		-		500		1
Commercial equipment		102,814		4		236,056		3
	$	10,971,994		38	$	9,510,617		35

Commercial real estate has been impacted by economic conditions in our local market mainly due to higher vacancies in commercial office space. Nonperforming residential first mortgages are the result of specific customer issues with unemployment and other circumstances requiring the liquidation of family assets. The 2012 increase in commercial nonperforming loans was primarily for one well secured customer relationship. The Company has decreased nonperforming construction and land development loans from $9,504,414 at December 31, 2009 to $331,888 at June 30, 2012 as loans were foreclosed or projects were completed. The Company has reduced its holdings in construction and land development loans from $62,509,558, or 10.0% of total loans at December 31, 2009 to $32,405,839, or 4.36% of total loans at June 30, 2012. At June 30, 2012, the Bank provided for a specific allowance of $741,503 on nonperforming loans of $1,600,613 and no allowance on $9,371,381 of nonperforming loans. Specific allowances are based on management’s evaluation of the underlying collateral and utilization of the Bank’s credit evaluation criteria.

Management continues to monitor these loans and is working to resolve these loans in a manner that will preserve the most value for the Company. Additional loan information is presented in this Quarterly Report on Form 10-Q under Note 11 and for prior years is presented in the Company’s Form 10-K for the year ended December 31, 2011.

The following table sets forth information with respect to the Bank’s foreclosed real estate (OREO), nonaccrual loans and TDRs. The table includes a breakdown between nonperforming and impaired loans.

OREO, Nonperforming (Nonaccrual Loans) and Impaired Loans

	June 30, 2012			December 31, 2011


OREO	$	5,562,158		$	5,028,513

Nonperforming loans
Nonaccrual loans with impairment	$	1,308,278		$	4,517,009
Nonaccrual loans with no impairment		9,371,381			4,193,893
TDRs not performing according to terms		292,335			799,715

Total Nonperforming Loans	$	10,971,994		$	9,510,617

Total Nonperforming Assets	$	16,534,152		$	14,539,130

Impaired loans
Nonaccrual loans with impairment	$	1,308,278		$	4,517,009
Performing loans with impairment		2,898,308			4,286,916
TDRs not performing according to terms		292,335			799,715
TDRs performing according to terms		10,106,139			11,113,326

Total Impaired Loans	$	14,605,060		$	20,716,966

Asset Quality
Nonperforming loans (NPLs)	$	10,971,994		$	9,510,617
Nonperforming assets (NPLs + OREO)		16,534,152			14,539,130
Troubled debt restructures (TDRs)		10,398,474			11,913,041
Allowance for loan losses to total loans		1.01	%		1.07	%
Past due loans (PDLs) to total loans (31 to 89 days)		0.89	%		0.76	%
Nonperforming loans (NPLs) to total loans (>=90 days)		1.48	%		1.32	%
Total loan delinquency (PDLs + NPLs) to total loans		2.37	%		2.09	%
Allowance for loan losses to nonperforming loans		68.03	%		80.49	%
Nonperforming assets (NPLs +OREO) to total assets		1.69	%		1.48	%
Nonperforming assets to gross loans + OREO		2.21	%		2.01	%
Nonperforming assets + TDRs to total assets (a)		2.73	%		2.61	%

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

The Company’s June 30, 2012 OREO balance of $5,562,158 increased $533,645 compared to December 31, 2011, consisting of additions of $1,555,770 offset by valuation allowances of $626,176 to adjust for current appraised values and disposals of $395,949. During the six months ended June 30, 2012, the Bank disposed of two OREO properties for proceeds of $299,032 and recognized net losses of $96,917. Current year OREO additions include two construction and land development projects valued at $1,038,000 that the Bank utilized the deposit method to account for the sale and transfer of legal title to the borrower. Payments of principal and interest will be recorded as a deposit (liability) until the transaction qualifies for full accrual or installment accounting treatment. As of June 30, 2012, the Bank has received $109,000 in payments on these projects. OREO carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs.

	June 30, 2012		December 31, 2011		$ Change			% Change
Liabilities
Deposits
Non-interest-bearing deposits	$	84,661,470	$	81,097,622	$	3,563,848			4.39	%
Interest-bearing deposits		731,112,854		746,155,579		(15,042,725	)		(2.02	%)
Total deposits		815,774,324		827,253,201		(11,478,877	)		(1.39	%)
Short-term borrowings		3,000,000		-		3,000,000			n/a
Long-term debt		60,552,148		60,576,595		(24,447	)		(0.04	%)
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000		12,000,000		-			0.00	%
Accrued expenses and other liabilities		8,186,305		8,195,829		(9,524	)		(0.12	%)

Total Liabilities	$	899,512,777	$	908,025,625	$	(8,512,848	)		(0.94	%)

The decrease in deposits is consistent with normal seasonal fluctuations of customer accounts. During 2012, lower-cost transaction accounts continued to increase as a percentage of total deposits and have increased from 44.94% at December 31, 2011 to 46.40% at June 30, 2012. Since December 31, 2010, transaction deposits have increased $78,662,030 from $286,368,452, or 39.52% of deposits, to $378,524,653, or 46.40% at June 30, 2012. Total short-term borrowings increased to fund operating needs.

The most recent FDIC Annual Summary of Deposit Survey for deposits held on June 30, 2011 indicated that the Bank moved up one position this year to become the second largest overall deposit holder in the Tri-County area with a market share of 19.27%. Increasing deposit market share and core deposit relationships contributed significantly to the Bank’s strategy of reducing funding costs. Since the FDIC survey date, deposits increased $61,842,494 to $815,774,324 at June 30, 2012 from $753,931,830 at June 30, 2011.

	June 30, 2012			December 31, 2011			$ Change			% Change
Stockholders' Equity
Preferred Stock, Senior Non-Cumulative Perpetual, Series C - par value $1,000; authorized 20,000; issued 20,000	$	20,000,000		$	20,000,000		$	-			0.00	%
Common stock - par value $.01; authorized - 15,000,000 shares; issued 3,048,084 and 3,026,557 shares		30,481			30,266			215			0.71	%
Additional paid in capital		17,733,436			17,367,403			366,033			2.11	%
Retained earnings		39,283,317			38,712,194			571,123			1.48	%
Accumulated other comprehensive gain		297,350			289,599			7,751			2.68	%
Unearned ESOP shares		(982,640	)		(945,364	)		(37,276	)		3.94	%

Total Stockholders' Equity	$	76,361,944		$	75,454,098		$	907,846			1.20	%

The $907,846 increase in stockholders’ equity was due to net income of $2,046,405, net stock related activities of $175,261 and adjustments to other comprehensive income of $7,751 partially offset by payments of common stock dividends of $1,216,570 and preferred stock dividends of $105,001. Common stockholders' equity of $56,361,944 at June 30, 2012, resulted in a book value of $18.49 per common share.

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

For additional information regarding these arrangements, including collateral, refer to Note 10 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

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

Cash, federal funds sold, and interest-bearing deposits with banks as of June 30, 2012 totaled $12,018,664, a decrease of $7,099,525, or 37.13%, from the December 31, 2011 total of $19,118,189. The decrease in cash was primarily due to a decrease in deposits and the excess of loan originations over principal payments collected partially offset by proceeds received from maturing investment securities.

During the six months ended June 30, 2012, all financing activities used $9,913,246 in cash compared to $18,470,421 in cash provided for the same period in 2011. The decrease of cash flows from financing activities of $28,383,667 was primarily due to a net decrease in deposits of $40,828,381 as customer deposits for the six months ended June 30, 2012 decreased $11,478,877 compared to an increase in deposits of $29,349,504 for the six months ended June 30, 2011. This was partially offset by increases in cash provided of $11,954,913 for long-term debt and short term borrowing activity. The Bank increased short-term borrowings by $3,000,000 for the six months ended June 30, 2012 compared to an increase in short term borrowings of $1,044,127 for the same period in 2011. Additionally, scheduled pay downs on long-term debt decreased from $10,023,487 for the six months ended June 30, 2011 to $24,447 for the six months ended June 30, 2012. Other financing activities increased cash provided by $489,801.

Operating activities provided cash of $5,163,197 for the six months ended June 30, 2012 compared to $1,947,059 of cash provided for the same period of 2011, an increase in cash of $3,216,138 from the comparable period in 2011. Cash increased primarily due to an increase in net income and a decrease in other assets partially offset by a decrease in the provision for loan losses and an increase in deferred tax assets.

Investing activities used cash of $2,349,476 during the six months ended June 30, 2012 compared to $16,254,327 of cash used for the same period of 2011. The decrease in cash used of $13,904,851 was primarily due to the decrease in the excess of loan originations over principal payments collected which resulted in a $13,986,737 of the cash provided. For the six months ended June 30, 2012, loans originated exceeded principal collected by $26,623,048 compared to the six months ended June 30, 2011 where loans originated exceeded principal collected by $40,609,785. In addition, net investment transactions increased cash $1,225,840 from a $26,151,724 cash provided for the six months ended June 30, 2011 to $27,377,564 cash provided for the six months ended June 30, 2012. Lastly, net cash was provided from proceeds for the sale of foreclosed real estate of $299,302. These increased to cash were offset by an increase in net cash used of $1,607,028 for premises and equipment related principally to acquisition and construction costs for the operations center in Waldorf, Maryland and the King George, Virginia branch.

REGULATORY MATTERS

The Bank is subject to Federal Reserve Board capital requirements as well as statutory capital requirements imposed under Maryland law. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. The Company’s and the Bank’s actual capital amounts and ratios at June 30, 2012 are presented in the following table.

At June 30, 2012	Actual				Required for Capital Adequacy Purposes				To be Considered Well Capitalized Under Prompt Corrective Action
(in thousands)
Total Capital (to risk weighted assets)
The Company	$	95,529	12.55	%	$	60,878	8.00	%
The Bank	$	92,449	12.20	%	$	60,599	8.00	%	$	75,749	10.00	%

Tier 1 Capital (to risk weighted assets)
The Company	$	88,065	11.57	%	$	30,439	4.00	%
The Bank	$	84,985	11.22	%	$	30,299	4.00	%	$	45,449	6.00	%

Tier 1 Capital (to average assets)
The Company	$	88,065	9.16	%	$	38,449	4.00	%
The Bank	$	84,985	8.87	%	$	38,310	4.00	%	$	47,887	5.00	%

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are defined as those that involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The Company considers its determination of other-than-temporary-impairment, the allowance for loan losses, the valuation of foreclosed real estate and the valuation of deferred tax assets to be critical accounting policies.

The Company’s Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America and the general practices of the United States banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When these sources are not available, management makes estimates based upon what it considers to be the best available information.

Other-Than-Temporary-Impairment (“OTTI”)

Debt securities are evaluated quarterly to determine whether a decline in their value is other-than-temporary. The term “other-than-temporary” is not necessarily intended to indicate a permanent decline in value. It means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Under the revised guidance, for recognition and presentation of other-than-temporary impairments the amount of other-than-temporary impairment that is recognized through earnings for debt securities is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.

If management concludes an unrealized loss is temporary and our intention is to hold the investment until recovery of the amortized cost basis, which may be maturity, no charge to earnings is recorded. For additional information regarding the evaluation of OTTI, refer to Notes 4 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

Allowance for Loan Losses

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

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

Management utilizes a risk scale to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are risk rated. Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history. Management engages a third-party firm to perform loan reviews of its commercial loan portfolio.

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

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

For additional information regarding the allowance for loan losses, refer to Notes 1 and 5 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

Foreclosed Real Estate (Other Real Estate Owned “OREO”)

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

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

For additional information regarding foreclosed real estate, refer to Notes 1 and 7 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

Deferred Tax Assets

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

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

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

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

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

For additional information regarding the deferred tax assets, refer to Note 11 in the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2011.

ITEM 3. Quantitative and qualitative Disclosure about Market Risk

Not applicable as the Company is a smaller reporting company.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, (1) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal executive and financial officers as appropriate to allow timely decisions regarding required disclosure. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level. There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2012 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

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

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

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

(a)

Not applicable

(b)

Not applicable

(c)

On September 25, 2008, the Company announced a repurchase program under which it would repurchase up to 5% of its outstanding common stock or approximately 147,435 shares. As of June 30, 2012, 106,006 shares were available to be repurchased under the repurchase program. The following schedule provides repurchases for the three months ended June 30, 2012.

Total Number

of Shares

(d)

Purchased

Maximum

(a)

as Part of

Number of Shares

Total

(b)

Publicly

that May Yet Be

Number of

Average

Announced Plans

Purchased Under

Price Paid

the Plans or

Period

Purchased

per Share

Programs

April 1-30, 2012

9,000

17.09

9,000

106,006

May 1-31, 2012

106,006

June 1-30, 2012

106,006

Total

9,000

17.09

9,000

106,006

Item 3 - Default Upon Senior Securities - None

Item 4 – Mine Safety Disclosures – Not Applicable

Item 5 - Other Information - None

Item 6 - Exhibits

Exhibit 31 - Rule 13a-14(a) Certifications

Exhibit 32 - Section 1350 Certifications Exhibit 31 - Rule 13a-14(a) Certifications

SIGNATURES

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

	TRI-COUNTY FINANCIAL CORPORATION

Date: August 3, 2012	By:	/s/ Michael L. Middleton
		Michael L. Middleton Chief Executive Officer


Date: August 3, 2012	By:	/s/ William J. Pasenelli
		William J. Pasenelli President and Chief Financial Officer