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EX-32 - COMMUNITY FINANCIAL CORP /MD/v183686_ex32.htm
EX-31 - COMMUNITY FINANCIAL CORP /MD/v183686_ex31.htm

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 March 31, 2010

OR

¨           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      ¨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  May 4, 2010, the registrant had 2,990,520 shares of common stock outstanding.

 
 

 

TRI-COUNTY FINANCIAL CORPORATION

FORM 10-Q

INDEX

 
Page
PART I - FINANCIAL INFORMATION
3
   
Item 1 – Financial Statements (Unaudited)
 
   
Consolidated Balance Sheets - March 31, 2010
 
and December 31, 2009
3
   
Consolidated Statements of Income -
 
Three Months Ended March 31, 2010 and 2009
  4-5
   
Consolidated Statements of Cash Flows -
 
Three Months Ended March 31, 2010 and 2009
  6-7
   
Notes to Consolidated Financial Statements
  8-20
   
Item 2 – Management’s Discussion and Analysis of Financial Condition
 
and Results of Operations
    21-31
   
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
31
   
Item 4 – Controls and Procedures
31
   
PART II - OTHER INFORMATION
 
   
Item 1 –    Legal Proceedings
31
   
Item 1A – Risk Factors
31
   
Item 2 –    Unregistered Sales of Equity Securities and Use of Proceeds
32
   
Item 3 –    Defaults Upon Senior Securities
32
   
Item 4 –    [Removed and Reserved]
32
   
Item 5 –    Other Information
32
   
Item 6 –    Exhibits
32
   
SIGNATURES
33
 
 
2

 

PART I FINANCIAL STATEMENTS
ITEM I. FINANCIAL STATEMENTS
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS MARCH 31, 2010 AND DECEMBER 31, 2009 (UNAUDITED)

   
March 31, 2010
   
December 31, 2009
 
             
Assets
           
Cash and due from banks
  $ 15,468,016     $ 9,960,787  
Federal funds sold
    2,870,000       695,000  
Interest-bearing deposits with banks
    2,582,422       592,180  
Securities available for sale, at fair value
    49,873,539       53,926,109  
Securities held to maturity, at amortized cost
    90,715,509       90,287,803  
Federal Home Loan Bank and Federal Reserve Bank stock - at cost
    6,935,500       6,935,500  
Loans held for sale
    80,000       - -  
Loans receivable - net of allowance for loan losses of $7,245,630 and $7,471,314, respectively
    608,019,454       616,592,976  
Premises and equipment, net
    11,884,097       11,987,690  
Foreclosed real estate
    6,892,816       922,934  
Accrued interest receivable
    2,911,991       2,925,271  
Investment in bank owned life insurance
    11,048,142       10,943,396  
Other assets
    9,893,575       9,272,888  
                 
Total Assets
  $ 819,175,061     $ 815,042,534  
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest-bearing deposits
  $ 58,505,941     $ 70,001,444  
Interest-bearing deposits
    603,524,869       570,417,345  
Total deposits
    662,030,810       640,418,789  
Short-term borrowings
    251,096       13,080,530  
Long-term debt
    70,658,404       75,669,630  
Guaranteed preferred beneficial interest in junior subordinated debentures
    12,000,000       12,000,000  
Accrued expenses and other liabilities
    4,774,860       5,683,736  
                 
Total Liabilities
    749,715,170       746,852,685  
                 
Stockholders' Equity
               
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540
    15,540,000       15,540,000  
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777
    777,000       777,000  
Common Stock - par value $.01; authorized - 15,000,000 shares; issued 2,981,781 and 2,976,046 shares, respectively
    29,818       29,760  
Additional paid in capital
    16,786,015       16,754,627  
Retained earnings
    36,346,648       35,193,958  
Accumulated other comprehensive income
    382,929       284,474  
Unearned ESOP shares
    (402,519 )     (389,970 )
                 
Total Stockholders' Equity
    69,459,891       68,189,849  
                 
Total Liabilities and Stockholders' Equity
  $ 819,175,061     $ 815,042,534  
See notes to consolidated financial statements

 
3

 

TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009
   
Three Months Ended March 31,
 
   
2010
   
2009
 
INTEREST AND DIVIDEND INCOME:
           
Loans, including fees
  $ 8,758,786     $ 7,877,391  
Taxable interest and dividends on investment securities
    1,202,574       1,325,495  
Interest on deposits with banks
    2,177       190  
Total interest and dividend income
    9,963,537       9,203,076  
                 
INTEREST EXPENSES:
               
Deposits
    2,819,281       3,173,365  
Short-term borrowings
    10,854       23,866  
Long-term debt
    648,766       1,062,840  
Total interest expenses
    3,478,901       4,260,071  
                 
NET INTEREST INCOME
    6,484,636       4,943,005  
PROVISION FOR LOAN LOSSES
    858,374       532,885  
                 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    5,626,262       4,410,120  
 
 
4

 

TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(continued)
 
Three Months Ended March 31,
 
   
2010
   
2009
 
NONINTEREST INCOME:
           
Loan appraisal, credit, and miscellaneous charges
  $ 170,412     $ 115,678  
Income from bank owned life insurance
    104,746       101,257  
Service charges
    404,044       369,522  
Gain on sale of loans held for sale
    82,023       - -  
Total noninterest income
    761,225       586,457  
                 
NONINTEREST EXPENSES:
               
Salary and employee benefits
    2,362,534       2,150,776  
Occupancy expense
    427,644       404,527  
Advertising
    76,749       130,112  
Data processing expense
    246,140       226,175  
Professional fees
    158,839       157,609  
Depreciation of furniture, fixtures, and equipment
    127,598       148,142  
Telephone communications
    40,119       33,275  
Office supplies
    45,746       49,712  
FDIC Insurance
    352,106       89,664  
Other
    400,934       424,170  
Total noninterest expenses
    4,238,409       3,814,162  
                 
INCOME BEFORE INCOME TAXES
    2,149,078       1,182,415  
Income tax expense
    784,654       412,575  
NET INCOME
    1,364,424       769,840  
Preferred stock dividends
    211,733       211,733  
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
  $ 1,152,691     $ 558,107  
                 
INCOME PER COMMON SHARE
               
Basic
  $ 0.39     $ 0.19  
Diluted
  $ 0.38     $ 0.19  
                 
Dividends declared per common share
  $ 0.40     $ 0.40  

See notes to consolidated financial statements

 
5

 

TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009

   
Three Months Ended March 31,
 
   
2010
   
2009
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 1,364,424     $ 769,840  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
                 
Provision for loan losses
    858,374       532,885  
Depreciation and amortization
    251,863       287,453  
Loans originated for resale
    (3,144,500 )     (16,624,790 )
Proceeds from sale of loans originated for sale
    3,146,147       - -  
Gain on sale of loans held for sale
    (82,023 )     - -  
Net amortization of premium/discount on investment securities
    (88,162 )     (23,561 )
Increase in cash surrender of bank owned life insurance
    (104,746 )     (101,257 )
Deferred income tax benefit
    (133,570 )     (338,331 )
Decrease in accrued interest receivable
    13,280       97,906  
Increase in deferred loan fees
    (32,576 )     (45,180 )
Decrease in accounts payable, accrued expenses, other liabilities
    (908,876 )     (366,688 )
(Increase) decrease in other assets
    (537,836 )     487,920  
                 
Net cash provided by (used in) operating activities
    601,799       (15,323,803 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of investment securities available for sale
    (33,177 )     (2,765,018 )
Proceeds from redemption or principal payments of investment securities available for sale
    4,312,203       138,530  
Purchase of investment securities held to maturity
    (5,999,899 )     - -  
Proceeds from maturities or principal payments of investment securities held to maturity
    5,583,073       3,895,210  
Net decrease of FHLB and Federal Reserve stock
    - -       13,800  
Loans originated or acquired
    (55,440,499 )     (57,178,523 )
Principal collected on loans
    57,218,716       51,499,129  
Purchase of premises and equipment
    (148,270 )     (643,196 )
                 
Net cash provided by (used in) investing activities
    5,492,147       (5,040,068 )
 
 
6

 

TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(continued)
 
Three Months Ended March 31,
 
   
2010
   
2009
 
             
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Net increase in deposits
    21,612,021       29,100,925  
Payments of long-term borrowings
    (5,011,226 )     (5,010,785 )
Net decrease in short term borrowings
    (12,829,434 )     (1,115,870 )
Exercise of stock options
    31,446       60,775  
Excess tax benefits on stock-based compensation
    - -       2,543  
Dividends Paid
    (211,733 )     (131,745 )
Net change in unearned ESOP shares
    (12,549 )     (64,319 )
                 
Net cash provided by financing activities
    3,578,525       22,841,524  
                 
INCREASE IN CASH AND CASH EQUIVALENTS
  $ 9,672,471     $ 2,477,653  
                 
CASH AND CASH EQUIVALENTS - JANUARY 1
    11,247,967       14,474,532  
                 
CASH AND CASH EQUIVALENTS - MARCH 31
  $ 20,920,438     $ 16,952,185  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
Cash paid during the three months for:
               
Interest
  $ 3,636,279     $ 4,648,905  
Income taxes
  $ 283,000     $ - -  
Transfer from loans to foreclosed real estate
  $ 5,969,882     $ - -  

See notes to consolidated financial statements

 
7

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009

 
1.
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”) 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, 2009 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2009 Annual Report. The results of operations for the three months ended March 31, 2010 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 2010 presentation.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report for the year ended December 31, 2009.
 
 
2.
NATURE OF BUSINESS
The Company provides a variety of financial services to individuals and small businesses through its offices in Southern Maryland. Its primary deposit products are demand, savings, and time deposits, and its primary lending products are consumer and commercial mortgage loans, construction and land development loans, and commercial loans.

 
3.
FAIR VALUE MEASUREMENTS
Effective January 1, 2008, the Company adopted the Financial Accounting Standards Board’s (“FASB”) Accounting Standard’s Codification (“ASC”) Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities” which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans). FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
 
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
 
8

 
Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
 
Level 1 inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
 
Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
 
Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
 
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly or quarterly valuation process.
 
There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the three months ended March 31, 2010 and 2009, respectively.Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
 
Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, 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 March 31, 2010, 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.

 
9

 

Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, in the aggregate. Fair value is derived from secondary market quotations for similar instruments. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
 
Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold, using the specific identification method.
 
Foreclosed Real Estate
Foreclosed real estate is adjusted for fair value upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis:
The table below presents the recorded amount of assets and liabilities, as of March 31, 2010 measured at fair value on a recurring basis.
 
         
Fair Value Measurements
 
         
At March 31, 2010
 
         
Using:
 
   
Fair Value
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs (Level 3)
 
Description of Asset
                       
Securities available for sale:
                       
Asset-backed securities issued by GSEs
CMOs
  $ 41,816,251     $
-
    $ 41,816,251     $
-
 
MBS
    4,301,095      
-
      4,301,095      
-
 
Corporate equity securities
    38,387      
-
      38,387      
-
 
Bond mutual funds
    3,717,806      
-
      3,717,806      
-
 
Total securities available for sale
  $ 49,873,539     $
-
    $ 49,873,539     $
-
 
                                 
Loans held for sale
  $ 80,000     $
-
    $ 80,000     $
-
 
 
 
10

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of March 31, 2010 are included in the table below:

         
Fair Value Measurements
 
         
At March 31, 2010
 
         
Using:
 
   
Fair Value
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs (Level 3)
 
Description of Asset
                       
Impaired loans:
                       
Commercial real estate
  $ 3,005,985     $
-
    $ 3,005,985     $
-
 
Residential construction
    1,087,418      
-
      1,087,418      
-
 
Commercial lines of credit
    4,597,170      
-
      4,597,170      
-
 
Total impaired loans
  $ 8,690,573     $
-
    $ 8,690,573     $
-
 
                             
 
 
Foreclosed real estate
  $ 6,892,816     $
-
    $ 6,892,816     $
-
 

 
4.
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.

 
5.
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 March 31, 2010 and 2009, there were 253,359 and 190,479 shares, respectively, excluded from the diluted net income per share computation because inclusion of these options would be 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
 
   
March 31,
 
   
2010
   
2009
 
Net Income
  $ 1,364,424     $ 769,840  
Less: Dividends payable on preferred stock
    (211,733 )     (211,733 )
Net income available to common shareholders
  $ 1,152,691     $ 558,107  
                 
Average number of common shares outstanding
    2,978,388       2,951,122  
Effect of dilutive options
    21,125       38,982  
Average number of shares used to calculate earnings per share outstanding
    2,999,513       2,990,104  
 
 
11

 


 
6.
COMPREHENSIVE INCOME
Comprehensive income is net income adjusted for net unrealized holding gains or losses for the period.

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Net Income
  $ 1,364,424     $ 769,840  
Other comprehensive income net of tax:
               
Net unrealized holding gains arising during period
    98,455       212,987  
Comprehensive income
  $ 1,462,879     $ 982,827  

 
7.
STOCK-BASED COMPENSATION
The Company has stock-based incentive compensation plans to attract and retain key personnel in order to promote the success of the business. These plans are described in Note 13 to the consolidated financial statements included in our Annual Report to Stockholders for the year ended December 31, 2009. Stock-based compensation expense was not recognized for the quarters ended March 31, 2010 or 2009. The Company and the Bank currently maintain incentive plans which provide for payments to be made in cash, stock, or stock options. The Company has accrued the full amounts due under these plans, but currently it is not possible to identify the portion that will be paid out in the form of stock–based compensation because such payments are subject to the future election of the recipient. A summary of the Company’s stock option plans as of March 31, 2010 and changes during the three-month period then ended is presented below:

         
Weighted
         
Weighted-Average
 
         
Average
   
Aggregate
   
Contractual Life
 
         
Exercise
   
Intrinsic
   
Remaining In
 
   
Shares
   
Price
   
Value
   
Years
 
                         
Outstanding at December 31, 2009
    329,243     $ 16.04     $ 222,607        
Granted at fair value
    -       -                
Exercised
    (8,441 )     7.89       38,118        
Expired
    -       -                
Forfeited
    (1 )     7.90                
                               
Outstanding at March 31, 2010
    320,801     $ 16.26     $ 283,826      
1.6
 
                                 
Exercisable at March 31, 2010
    320,801     $ 16.26     $ 283,826      
1.6
 

The following table summarizes restricted stock award activity for the Company under the 2006 Equity Plan for the three months ended March 31, 2010:

   
Number
 of Shares
   
Weighted
Average Grant
 Date Fair 
Value
 
             
Nonvested at January 1, 2010
    5,360     $ 11.90  
Granted
    -       -  
Vested
    -       -  
Cancelled
    -       -  
                 
Nonvested at March 31, 2010
    5,360     $ 11.90  
 
 
12

 

 
8.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES
On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust, along with the $155,000 for Capital Trust II’s common securities, used the proceeds from this issuance to purchase $5,155,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust II’s obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company not earlier than June 15, 2010.
 
On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7,000,000 of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7,217,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust I’s obligations with respect to the capital securities. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company not earlier than July 22, 2009.

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

At the same time the Company issued its Series A Preferred Stock, it issued to the Treasury warrants to purchase Fixed Rate Cumulative Perpetual Preferred Stock, Series B Preferred Stock (“Series B Preferred Stock”) in the amount of 5% of the Series A Preferred Stock or 770 shares with a par value of $777,000. The warrants had an exercise price of $.01 per share. The Series B Preferred Stock has the same rights, preferences and privileges as the Series A Preferred Stock except, the Series B Preferred Stock has a dividend rate of 9%. These warrants were immediately exercised.
 
The Company believes that it is in compliance with all terms of the Preferred Stock Purchase Agreement.
 
13

 
 
10.
SECURITIES

   
March 31, 2010
 
   
Amortized
   
Gross Unrealized
   
Gross Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available for sale
                       
Asset-backed securities issued by GSEs
  $ 45,385,682     $ 793,084     $ 61,420     $ 46,117,346  
Corporate equity securities
    37,310       1,260       183       38,387  
Bond mutual funds
    3,601,227       116,579       -       3,717,806  
Total securities available for sale
  $ 49,024,219     $ 910,923     $ 61,603     $ 49,873,539  
                                 
Securities held to maturity
                               
Asset-backed securities issued by:
                               
GSEs
  $ 72,851,154     $ 1,536,999     $ 506,556     $ 73,881,597  
Other
    17,859,785       43,705       3,054,101       14,849,389  
Total debt securities held to maturity
    90,710,939       1,580,704       3,560,657       88,730,986  
                                 
U.S. Government obligations
    -       -       -       -  
Other investments
    4,570       -       -       4,570  
Total securities held to maturity
  $ 90,715,509     $ 1,580,704     $ 3,560,657     $ 88,735,556  

   
December 31, 2009
 
   
Amortized
   
Gross Unrealized
   
Gross Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available for sale
                       
Asset-backed securities issued by GSEs
  $ 49,617,856     $ 646,198     $ 30,628     $ 50,233,426  
Corporate equity securities
    37,310       1,416       163       38,563  
Bond mutual funds
    3,568,050       86,070       -       3,654,120  
Total securities available for sale
  $ 53,223,216     $ 733,684     $ 30,791     $ 53,926,109  
                                 
Securities held to maturity
                               
Asset-backed securities issued by:
                               
GSEs
  $ 71,276,709     $ 1,689,252     $ 137,919     $ 72,828,042  
Other
    19,005,847       12,088       3,353,964       15,663,971  
Total debt securities held to maturity
    90,282,556       1,701,340       3,491,883       88,492,013  
                                 
U.S. Government obligations
    -       -       -       -  
Other investments
    5,247       -       -       5,247  
Total securities held to maturity
  $ 90,287,803     $ 1,701,340     $ 3,491,883     $ 88,497,260  

At March 31, 2010 certain other securities with a carrying value of $3,429,476 were pledged to secure certain deposits. At March 31, 2010 securities with a carrying value of $41,654,762 were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.

 
14

 

Gross unrealized losses and estimated fair value by length of time that the individual available for sale securities have been in a continuous unrealized loss position at March 31, 2010 are as follows:

   
Less Than 12 Months
   
More Than 12 Months
   
Total
 
   
FairValue
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Asset-backed securities issued by GSEs:
  $ 8,204,202     $ 61,420     $
-
    $
-
    $ 8,204,202     $ 61,420  
Corporate Equity Securities
    127       183      
-
     
-
      127       183  
    $ 8,204,329     $ 61,603     $
-
    $
-
    $ 8,204,329     $ 61,603  

The available for sale investment portfolio has a fair value of $49,873,539 of which $8,204,329 of the securities have some unrealized losses from their amortized cost. Of these securities, $8,204,202, or 99%, are mortgage-backed securities issued by GSEs. The unrealized losses that exist in the asset-backed securities and mutual fund shares are the result of market changes in interest rates on similar instruments.
 
The asset-backed securities have an average duration of less than one year and are guaranteed by their issuer as to credit risk. Total unrealized losses on these investments are small (less than 1%). We believe that the losses in the equity securities are temporary. Persistent losses may require a reevaluation of these losses. 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 does not consider these investments to be other-than-temporarily impaired at March 31, 2010.

Gross unrealized losses and estimated fair value by length of time that the individual held to maturity securities have been in a continuous unrealized loss position at March 31, 2010 are as follows:

   
Less Than 12 Months
   
More Than 12 Months
   
Total
 
   
FairValue
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Asset-backed securities issued by GSEs:
  $ 8,016,099     $ 27,377     $ 12,976,535     $ 479,179     $ 20,992,634     $ 506,556  
Asset-backed securities issued by others:
    -       -       11,720,264       3,054,101       11,720,264       3,054,101  
    $ 8,016,099     $ 27,377     $ 24,696,799     $ 3,533,280     $ 32,712,898     $ 3,560,657  

The held to maturity investment portfolio has an estimated fair value of $88,735,555, of which $32,712,897 or 37%, of the securities have unrealized losses from their amortized cost. Of these securities, $20,992,634 or 64%, are mortgage-backed securities issued by GSEs and the remaining $11,720,264 are asset-backed securities issued by others. As with the available for sale securities, we believe that the losses are the result of general perceptions of safety and credit worthiness of the entire sector and a general disruption of orderly markets in the asset class. The securities issued by GSEs are guaranteed by the issuer. They have an average duration of less than two years. The average unrealized loss on GSE issued held to maturity securities is .70%. 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.
 
The asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches which absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. These securities have an average life under three years. Total unrealized losses on the asset-backed securities issued by others are $3,054,101 or 16%, of the amortized cost. 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.
 
15

 
The table below presents the Standard & Poor’s credit rating of available for sale and held to maturity asset-backed securities issued by GSEs and others at March 31, 2010:

Credit Rating
 
Amount
 
AAA
  $ 127,369,468  
AA+
    1,611,970  
AA-
    2,463,216  
A-
    1,218,479  
BBB+
    161,722  
BBB
    3,301,921  
B-
    701,510  
Total
  $ 136,828,286  

There were no sales of investments available for sale securities during the three-month period ended March 31, 2010 or March 31, 2009. Asset-backed securities are comprised of mortgage-backed securities as well as mortgage-derivative securities such as collateralized mortgage obligations and real estate mortgage investment conduits.

 
11.
NEW ACCOUNTING STANDARDS
FASB ASC TOPIC 105, “Generally Accepted Accounting Principles” (“GAAP”) establishes the Codification as the single source of authoritative GAAP in the United States except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) became effective on July 1, 2009. The provisions of FASB ASC Topic 105 were adopted for the year ending December 31, 2009 and did not have a material effect on the Company’s consolidated financial statements.
 
FASB ASC TOPIC 260, “Earnings per Share” provides guidance that requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and requires a company to retrospectively adjust its earnings per share data. The Company adopted this guidance effective March 31, 2009, and adoption did not have a material effect on consolidated results of operations or earnings per share.
 
FASB ASC TOPIC 320, “Investments - Debt and Equity Securities” provides guidance on impairment of securities. FASB ASC Topic 320 (1) changes existing guidance for determining whether an impairment is other than temporary to debt securities and (2) replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under ASC Topic 320, declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. The Company adopted this guidance effective September 30, 2009, and adoption did not have a material effect on the Company’s consolidated financial statements.
 
FASB ASC TOPIC 715, “Compensation - Retirement Benefits” provides guidance applicable to endorsement split-dollar life insurance arrangements, whereby the employer owns and controls the insurance policy or policies, that are associated with a postretirement benefit. ASC Topic 715 requires that for a split-dollar life insurance arrangement an employer should recognize a liability for future benefits if, in substance, a postretirement benefit plan exists or if the arrangement is, in substance, an individual deferred compensation contract based on the substantive agreement with the employee. The guidance is effective for fiscal years beginning after December 15, 2007. The Company adopted the guidance on January 1, 2008 and recognized a liability for future benefits in the amount of $314,847 as a cumulative effect adjustment to retained earnings.

 
16

 
 
FASB ASC TOPIC 805, “Business Combinations” provides guidance for business combinations for which the acquisition date is on or after December 15, 2008. These business combinations use “acquisition accounting” which recognizes and measures the goodwill acquired in the business combination and defines a bargain purchase, and requires the acquirer to recognize that excess as a gain attributable to the acquirer. The Company adopted this new guidance effective January 1, 2009, and adoption did not have a material impact on the Company’s consolidated financial statements.
 
FASB ASC TOPIC 810, “Consolidation” provides guidance that establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statement, but separate from the parent’s equity. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Management adopted this guidance effective March 31, 2009, and adoption did not have a material impact on the Company’s consolidated financial condition or results of operations.
 
Additional guidance issued under ASC Topic 810 related to variable interest entities (“VIEs”) amends the original guidance to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. This analysis identifies the primary beneficiary of a VIE as the enterprise that has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE. Additionally, this new guidance requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining it has the power to direct the activities of the VIE that most significantly impact the entity’s economic performance. It is effective at the beginning of a company’s first fiscal year that begins after November 15, 2009. Adoption of this new guidance, effective January 1, 2010, did not have a material impact on the Company’s consolidated financial statements.
 
FASB ASC TOPIC 815, “Derivatives and Hedging” provides guidance regarding disclosures for derivatives. This guidance requires qualitative disclosures about objectives and strategies for using derivative, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Adoption of this new guidance, effective January 1, 2009, did not have a material impact on the Company’s consolidated financial statements.
 
FASB 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. The provisions of ASC Topic 820 became effective for the Company on January 1, 2008 for financial assets and financial liabilities and became effective on January 1, 2010 for non-financial assets and non-financial liabilities.
 
Additional guidance under ASC Topic 820 affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC Topic 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. The Company adopted this guidance effective September 30, 2009, and adoption did not have a material effect on the Company’s consolidated financial statements.
 
17

 
Additional guidance (Accounting Standards Update (“ASU”) No. 2009-5) under ASC Topic 820 provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (1) the quoted price of the identical liability when traded as an asset, (2) quoted prices for similar liabilities or similar liabilities when traded as assets, or (3) another valuation technique that is consistent with the existing principles of ASC Topic 820, such as an income approach or market approach. The new guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The Company adopted this guidance effective September 30, 2009, and adoption did not have a material effect on the Company’s consolidated financial statements.
 
Additional guidance (ASU No. 2010-06) issued under ASC Topic 820 requires expanded disclosures related to fair value measurements including (i) 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, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) 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 (i) 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 (ii) 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 will be 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.
 
FASB ASC TOPIC 825, “Financial Instruments” permits entities to choose to measure eligible financial instruments at fair value at specified election dates. The fair value measurement option (1) may be applied instrument by instrument with certain exceptions, (2) is generally irrevocable and (3) is applied only to entire instruments and not to portions of instruments. Unrealized gains and losses on items for which the fair value measurement option has been elected must be reported in earnings at each subsequent reporting date. The provisions of ASC Topic 825 became effective for the Company on January 1, 2008.
 
FASB ASC TOPIC 855, “Subsequent Events” provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date, but before financial statements are issued or are available to be issued. The Company adopted this guidance effective September 30, 2009, and adoption did not have a material impact on the Company’s consolidated financial condition or results of operations.
 
FASB ASC TOPIC 860, “Transfers and Servicing” provides guidance that eliminates the concept of a “qualifying special-purpose entity” from the original accounting guidance and removes the exception from applying FASB guidance on consolidation of variable interest entities, to qualifying special-purpose entities. This guidance is effective at the beginning of a reporting entity’s first fiscal year that begins after November 15, 2009. Adoption of this new guidance, effective January 1, 2010, did not have a material impact on the Company’s consolidated financial statements.

 
18

 

 
12.
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.

   
March 31, 2010
   
December 31, 2009
 
         
Estimated
         
Estimated
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
Assets
                       
Cash and cash equivalents
  $ 20,920,438     $ 20,920,438     $ 11,247,967     $ 11,247,967  
Investment securities and stock in FHLB and FRB
    147,524,548       145,547,000       151,149,412       148,049,000  
Loans receivable, net
    608,099,454       604,698,000       616,592,976       610,998,000  
Foreclosed real estate
    6,892,816       6,892,816       922,934       922,934  
                                 
Liabilities
                               
Savings, NOW, and money market accounts
    251,214,099       251,214,099       259,160,873       246,139,000  
Time certificates
    410,816,711       415,804,000       381,257,916       384,848,000  
Long-term debt and other borrowed funds
    70,909,500       67,767,096       88,750,160       83,381,000  
Guaranteed preferred beneficial interest in junior subordinated securities
    12,000,000       2,400,000       12,000,000       2,400,000  

At March 31, 2010, the Company had outstanding loan commitments and standby letters of credit of $7.7 million and $23.3 million, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these instruments differs significantly from their carrying values.

Valuation Methodology

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

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

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

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

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

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

 
19

 
 
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  March 31, 2010 and December 31, 2009. 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.

 
20

 

ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including: discussions of Tri-County Financial Corporation’s (the “Company”) goals, strategies and expected outcomes; estimates of risks and future costs; and reports of the Company’s ability to achieve its financial and other goals. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. These forward-looking statements are subject to significant known and unknown risks and uncertainties because they are based upon future economic conditions, particularly interest rates, competition within and without the banking industry, changes in laws and regulations applicable to the Company, changes in accounting principles, and various other matters.  Additional factors that may affect our results are discussed in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (the “Form 10-K”) and Part II of this Quarterly Report on Form 10-Q under “Item 1A. Risk Factors.”  Because of these uncertainties, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The Company does not undertake – and specifically disclaims any obligation – to publicly release the result of any revisions that may be made to any forward-looking statement to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

GENERAL

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

The Bank serves Southern Maryland through its main office and nine branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince Frederick, Lusby, and California, Maryland.  The Bank is engaged in the commercial and retail banking business as authorized by the banking statutes of the State of Maryland and applicable Federal regulations.  The Bank accepts deposits and uses these funds, along with funds generated from operations and borrowings from the Federal Home Loan Bank (the “FHLB”), to fund loan originations to individuals, associations, partnerships and corporations and to invest in securities. The Bank makes real estate loans including residential first and second mortgage loans, home equity lines of credit, commercial mortgage loans, commercial loans, including secured and unsecured loans, and consumer loans.  The Bank is a member of the Federal Reserve and FHLB Systems. The Federal Deposit Insurance Corporation provides deposit insurance coverage up to applicable limits.

Since its conversion to a state chartered commercial bank in 1997, the Bank has sought to increase its commercial and commercial real estate lending as well as the level of transactional deposits.  As a result of this emphasis, the Bank’s percentage of assets invested in residential first mortgage lending has declined since 1997. Conversely, targeted loan types have increased.  The Bank has also seen an increase in transactional deposit accounts while the percentage of total liabilities represented by certificates of deposits has declined.  Management believes that these changes will enhance the Bank’s overall long-term financial performance.

Management recognizes that the shift in composition of the Bank’s loan portfolio away from residential first mortgage lending will increase its exposure to credit losses.  The Bank continues to evaluate its allowance for loan losses and the associated provision to compensate for the increased risk. Any evaluation of the allowance for loan losses is inherently inexact and reflects management’s expectations as to future interest rates, economic conditions in the Southern Maryland area as well as individual borrowers’ circumstances.  Management believes that its allowance for loan losses is adequate.  For further information on the Bank’s allowance for loan losses see the discussion in the sections captioned “Financial Condition” and “Critical Accounting Policies” as well as the relevant discussions in the Form 10-K and Annual Report for the year ended December 31, 2009.

 
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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 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.

Interest rates can directly influence the Bank’s funding costs and loan and investment yields, and also act to increase or decrease general economic activity. The federal funds target rate increased for much of 2006 and 2007, hitting a multi-year peak on September 29, 2007 of 5.25%. Shortly afterwards, it became clear that the U.S. economy suffered from an over-extension of credit in many sectors. This realization led to a sudden, dramatic decline in the availability of credit to many borrowers which deflated a housing price bubble and threatened to create a credit crisis.  The Federal Reserve reacted by cutting the Federal Funds rate by 50 basis points in September 2007.  Despite further Federal Reserve rate cuts, the crisis in housing, which was once confined to subprime mortgage loans continued to spread.  The U.S. Treasury responded by injecting capital directly into banks by using the Capital Purchase Program (“CPP”) of the Troubled Asset Repurchase Program (“TARP”).  The Federal Reserve, Treasury, FDIC and other governmental bodies chose to guarantee various forms of debt issuance to stave off a total collapse of credit markets.  In addition, the U.S. government provided cash and debt guarantees to many private companies.  Besides these policy moves, the Federal Reserve reduced the Federal Funds rate to a range of 0% to 0.25% in December 2008. The Federal Funds rate has stayed at this level since 2008.

SELECTED FINANCIAL DATA
           
   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
             
Condensed Income Statement
           
Interest and dividend income
  $ 9,963,537     $ 9,203,076  
Interest expense
    3,478,901       4,260,071  
Net interest income
    6,484,636       4,943,005  
Provision for loan loss
    858,374       532,885  
Noninterest income
    761,225       586,457  
Noninterest expense
    4,238,409       3,814,162  
Income before income taxes
    2,149,078       1,182,415  
Income taxes
    784,654       412,575  
Net income
    1,364,424       769,840  
Net income available to common shareholders
    1,152,691       558,107  
                 
Per Common Share
               
Basic earnings
  $ 0.39     $ 0.19  
Diluted earnings
  $ 0.38     $ 0.19  
Book value
  $ 17.82     $ 17.43  
 
RESULTS OF OPERATIONS – THREE MONTHS ENDED MARCH 31, 2010

Net income for the three-month period ended March 31, 2010 totaled $1,364,424 ($0.39 basic and $0.38 diluted earnings per common share), compared to $769,840 ($0.19 basic and diluted earnings per common share) for the same period in the prior year. Net income available to common shareholders for the three month period ended March 31, 2010 totaled $1,152,691 compared to $558,107 for the same period in the prior year.  The increase of $594,584, or 77.23% for net income or 106.54% for net income available to common shareholders, was primarily due to increases in net interest income of $1,541,631 and noninterest income of $174,768 offset by increases in noninterest expense of $424,247 and the provision for loan loss of $325,489.

 
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Three Months Ended
             
   
March 31,
             
   
2010
   
2009
   
$ Change
   
% Change
 
Interest and dividend income
  $ 9,963,537     $ 9,203,076     $ 760,461       8.26 %
Interest expense
    3,478,901       4,260,071       (781,170 )     (18.34 )%
Net interest income
    6,484,636       4,943,005       1,541,631       31.19 %
Provision for loan losses
    858,374       532,885       325,489       61.08 %

Interest income increased due to higher average balances in loans and investments, which were partially offset by lower interest rate yields on loans and investments.  Interest expense decreased due to lower interest rates paid on deposits and borrowings offset by higher average balances of deposits and borrowings for the period. The decreased yields and rates paid were due to lower market interest rates. The increase in the provision for loan losses was due to economic conditions that affected the loss factors used to compute the allowance as well as changes in the circumstances of specific impaired loans, increases in the level of delinquencies, charge-offs and nonperforming loans.

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

   
Three Months Ended
             
   
March 31,
             
   
2010
   
2009
   
$ Change
   
% Change
 
NONINTEREST INCOME:
                       
Loan appraisal, credit, and miscellaneous charges
  $ 170,412     $ 115,678     $ 54,734       47.32 %
Income from bank owned life insurance
    104,746       101,257       3,489       3.45 %
Service charges
    404,044       369,522       34,522       9.34 %
Gain on sale of  loans held for sale
    82,023       - -       82,023       n/a  
                                 
        Total noninterest income
  $ 761,225     $ 586,457     $ 174,768       29.80 %

Loan appraisal, credit, and miscellaneous charges increased due to an increase in the size of the loan portfolio compared to the same period in the prior year. Service charge revenues have increased primarily due to increases of per item charges on certain transactions and increases in total deposits. Gain on sale of loans held for sale increased because the Bank sold $3,146,147 in loans in 2010 compared to no sales in the same period in the prior year.

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

   
Three Months Ended
             
   
March 31,
             
   
2010
   
2009
   
$ Change
   
% Change
 
NONINTEREST EXPENSE:
                       
Salary and employee benefits
  $ 2,362,534     $ 2,150,776     $ 211,758       9.85 %
Occupancy expense
    427,644       404,527       23,117       5.71 %
Advertising
    76,749       130,112       (53,363 )     (41.01 %)
Data processing expense
    246,140       226,175       19,965       8.83 %
Professional fees
    158,839       157,609       1,230       0.78 %
Depreciation of furniture, fixtures, and equipment
    127,598       148,142       (20,544 )     (13.87 %)
Telephone communications
    40,119       33,275       6,844       20.57 %
Office supplies
    45,746       49,712       (3,966 )     (7.98 %)
FDIC Insurance
    352,106       89,664       262,442       292.69 %
Other
    400,934       424,170       (23,236 )     (5.48 %)
                                 
        Total noninterest expenses
  $ 4,238,409     $ 3,814,162     $ 424,247       11.12 %

The Companys noninterest expense increased by $424,247 or 11.12% from the comparable period in the prior year due to costs associated with the asset growth of the Bank, the rising cost of regulatory compliance and increasing FDIC assessments. Salary and employee benefits expense increased as the Bank added additional employees to support the Banks growth. FDIC insurance expense reflects increased insurance assessment rates that started during the third quarter of 2009. Advertising expense was less than the same period in the prior year due mainly to marketing campaign expenses incurred in the first quarter of 2009.

The Company recorded income tax expense of $784,654 or 36.5%, of pretax earnings of $2,149,078 for the three months ended March 31, 2010 compared with $412,575 or 34.9%, of pretax earnings of $1,182,415 for the three months ended March 31, 2009.

FINANCIAL CONDITION
   
March 31, 2010
   
December 31, 2009
   
$ Change
   
% Change
 
                         
Assets
                       
Cash and due from banks
  $ 15,468,016     $ 9,960,787     $ 5,507,229       55.29 %
Federal funds sold
    2,870,000       695,000       2,175,000       312.95 %
Interest-bearing deposits with banks
    2,582,422       592,180       1,990,242       336.09 %
Securities available for sale, at fair value
    49,873,539       53,926,109       (4,052,570 )     (7.52 )%
Securities held to maturity, at amortized cost
    90,715,509       90,287,803       427,706       0.47 %
Federal Home Loan Bank and Federal Reserve Bank stock - at cost
    6,935,500       6,935,500       - -       0.00 %
Loans held for sale
    80,000       - -       80,000       n/a  
Loans receivable – net of allowance for loan losses of $7,245,630 and $7,471,314, respectively
    608,019,454       616,592,976       (8,573,522 )     (1.39 )%
Premises and equipment, net
    11,884,097       11,987,690       (103,593 )     (0.86 )%
Foreclosed real estate
    6,892,816       922,934       5,969,882       646.84 %
Accrued interest receivable
    2,911,991       2,925,271       (13,280 )     (0.45 )%
Investment in bank owned life insurance
    11,048,142       10,943,396       104,746       0.96 %
Other assets
    9,893,575       9,272,888       620,687       6.69 %
                                 
Total Assets
  $ 819,175,061     $ 815,042,534     $ 4,132,527       0.51 %
 
 
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The Company increased some of its most liquid assets which are cash and due from banks, federal funds sold and interest-bearing deposits with banks. The securities available for sale portfolio decreased due to proceeds received from maturing asset-backed securities issued by government-sponsored entities. The securities held to maturity portfolio increased due to additional purchases of securities offset by principal paydowns, primarily of asset-backed securities issued by government-sponsored entities. The differences in allocations between the different cash and investment categories reflect operational needs. The $8,573,522 decline in net loans outstanding was caused by seasonal fluctuations in a few relationships and the resolution of a problem loan relationship that moved a construction and land development loan into foreclosure. The increase in foreclosed real estate is due to the resolution of the problem loan relationship. The increase in other assets was primarily due to increases to prepaid assets.

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

   
March 31, 2010
   
December 31, 2009
 
   
Amount
   
%
   
Amount
   
%
 
                         
Real Estate Loans
                       
Commercial
  $ 303,412,489       49.24 %   $ 292,987,963       46.88 %
Residential first mortgages
    118,224,360       19.19 %     116,225,733       18.59 %
Construction and land development
    51,512,016       8.36 %     62,509,558       10.00 %
Home equity and second mortgage
    25,192,408       4.09 %     25,133,155       4.02 %
Commercial loans
    98,493,827       15.98 %     108,657,910       17.38 %
Consumer loans
    1,436,924       0.23 %     1,607,765       0.26 %
Commercial equipment
    17,934,933       2.91 %     17,916,655       2.87 %
      616,206,957       100.00 %     625,038,739       100.00 %
Less:
                               
Deferred loan fees
    941,873       0.15 %     974,449       0.16 %
Allowance for loan loss
    7,245,630       1.18 %     7,471,314       1.20 %
      8,187,503               8,445,763