BAY BANCORP, INC. - FORM 10-Q

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - BAY BANCORP, INC.	ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - BAY BANCORP, INC.	ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - BAY BANCORP, INC.	ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - BAY BANCORP, INC.	ex31-1.htm

United States Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURIIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-23090

CARROLLTON BANCORP

(Exact name of registrant as specified in its charter)

MARYLAND		52-1660951
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046

(Address of principal executive offices) (Zip Code)

(410) 312-5400

(Registrant’s telephone number, including area code)

(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 ý No o

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 (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

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

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

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

Yes o No x

Indicate the number shares outstanding of each of the issuer’s classes of

common stock, as of the latest practicable date:

2,576,388 common shares outstanding at May 11, 2011

CARROLLTON BANCORP

CONTENTS

PART I - FINANCIAL INFORMATION		PAGE

	Item 1. Financial Statements:
	Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010	4
	Consolidated Statements of Income for the Three Months Ended March 31, 2011 and 2010 (unaudited)	5
	Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2011 and 2010 (unaudited)	6
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (unaudited)	7
	Notes to Consolidated Financial Statements	8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
	Item 3. Quantitative and Qualitative Disclosures about Market Risk	33
	Item 4. Controls and Procedures	33
PART II - OTHER INFORMATION		33
	Item 1. Legal Proceedings	33
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	33
	Item 3. Defaults Upon Senior Securities	33
	Item 4. (Removed and Reserved)	33
	Item 5. Other Information	33
	Item 6. Exhibits	33

PART I

ITEM 1. FINANCIAL STATEMENTS

CARROLLTON BANCORP

CONSOLIDATED BALANCE SHEETS

	March 31, 2011			December 31, 2010
	(unaudited)
ASSETS
Cash and due from banks	$	2,855,755		$	2,123,757
Federal funds sold and other interest-bearing deposits		4,153,961			4,539,096
Federal Home Loan Bank stock, at cost		3,463,000			3,463,000
Investment securities:
Available for sale		27,820,698			28,125,809
Held to maturity (fair value of $4,037,402 and $4,474,091)		3,873,022			4,283,575
Loans held for sale		24,357,671			32,754,383
Loans, less allowance for loan losses of $4,613,605 and $4,481,236		276,673,006			284,747,653
Premises and equipment		7,079,386			6,989,272
Accrued interest receivable		1,256,529			1,327,035
Bank owned life insurance		4,969,552			4,931,581
Deferred income taxes		4,698,082			4,682,996
Foreclosed real estate		4,255,969			4,509,551
Other assets		4,490,692			4,013,022
	$	369,947,323		$	386,490,730

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	68,679,695		$	66,253,472
Interest-bearing		239,959,441			235,376,059
Total deposits		308,639,136			301,629,531
Advances from the Federal Home Loan Bank		24,950,000			48,300,000
Accrued interest payable		113,842			132,328
Accrued pension plan		1,378,336			1,354,082
Other liabilities		1,437,818			1,679,721
		336,519,132			353,095,662

STOCKHOLDERS’ EQUITY
Preferred stock, par value $1.00 per share (liquidation preference of $1,000 per share) authorized 9,201 shares; issued and outstanding 9,201 as of March 31, 2011 and December 31, 2010 (discount of $253,763 as of March 31, 2011 and $275,829 as of December 31, 2010)		8,947,237			8,925,171
Common stock, par $1.00 per share; authorized 10,000,000 shares; issued and outstanding 2,573,088 as of March 31, 2011 and December 31, 2010		2,573,088			2,573,088
Additional paid-in capital		15,713,872			15,713,872
Retained earnings		9,922,350			9,888,133
Accumulated other comprehensive income		(3,728,356	)		(3,705,196	)
		33,428,191			33,395,068
	$	369,947,323		$	386,490,730

See accompanying notes to consolidated financial statements.

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended March 31,
	2011			2010
	(unaudited)			(unaudited)
Interest income:
Loans	$	4,065,366		$	4,305,430
Investment securities:
Taxable		293,954			491,587
Nontaxable		76,707			95,675
Dividends		7,261			6,266
Federal funds sold and interest-bearing deposits with other banks		1,100			12,746

Total interest income		4,444,388			4,911,704
Interest expense:
Deposits		806,744			1,267,326
Borrowings		212,124			328,537

Total interest expense		1,018,868			1,595,863

Net interest income		3,425,520			3,315,841

Provision for loan losses		114,217			134,686

Net interest income after provision for loan losses		3,311,303			3,181,155

Noninterest income:
Electronic banking fees		608,564			513,099
Mortgage-banking fees and gains		775,594			740,613
Brokerage commissions		200,247			197,850
Service charges on deposit accounts		123,736			149,405
Other fees and commissions		79,246			94,817
Write down of impaired securities		(167,467	)		(753,537	)
Security (losses) gains, net		(2,603	)		—

Total noninterest income		1,617,317			942,247

Noninterest expenses:
Salaries		1,889,913			1,787,696
Employee benefits		635,484			449,852
Occupancy		597,718			597,071
Professional services		191,925			83,276
Furniture and equipment		147,884			147,421
Other operating expenses		1,240,934			1,351,777

Total noninterest expenses		4,703,858			4,417,093

Income (loss) before income taxes		224,762			(293,691	)

Income tax expense (benefit)		53,467			(162,439	)

Net income (loss)		171,295			(131,252	)
Preferred stock dividends and discount accretion		137,078			135,484
Net income available to common stockholders	$	34,217		$	(266,736	)

Basic net income per common share	$	0.01		$	(0.10	)

Diluted net income per common share	$	0.01		$	(0.10	)

See accompanying notes to consolidated financial statements.

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Three Months Ended March 31, 2011 and 2010 (unaudited)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Comprehensive Income
Balance December 31, 2010	$	8,925,171	$	2,573,088	$	15,713,872	$	9,888,133		$	(3,705,196	)
Net income		—		—		—		171,295			—		$	171,295
Changes in unrealized gains (losses) on available for sale securities, net of tax		—		—		—		—			(23,160	)		(23,160	)
Comprehensive income (loss)													$	148,135
Accretion of discount associated with U.S. Treasury preferred stock		22,066		—		—		(22,066	)		—
Preferred stock cash dividend		—		—		—		(115,012	)		—
Balance March 31, 2011	$	8,947,237	$	2,573,088	$	15,713,872	$	9,922,350		$	(3,728,356	)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Comprehensive Income
Balance December 31, 2009	$	8,842,222	$	2,568,588	$	15,694,328	$	11,736,797		$	(3,623,860	)
Net income		—		—		—		(131,252	)		—		$	(131,252	)
Changes in unrealized gains (losses) on available for sale securities, net of tax		—		—		—		—			920,272			920,272
Cash flow hedging derivatives		—		—		—		—			(45,359	)		(45,359	)
Comprehensive income													$	743,661
Accretion of discount associated with U.S. Treasury preferred stock		20,472		—		—		(20,472	)		—
Stock-based compensation		—		—		496		—			—
Issuance of stock under 2007 Equity Plan		—		600		2,256		—			—
Preferred stock cash dividend		—		—		—		(115,012	)		—
Cash dividends, $0.04 per share		—		—		—		(102,744	)		—
Balance March 31, 2010	$	8,862,694	$	2,569,188	$	15,697,080	$	11,367,317		$	(2,748,947	)

See accompanying notes to consolidated financial statements.

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2011 and 2010

	Three Months Ended March 31,
	2011			2010
	(unaudited)			(unaudited)
Cash flows from operating activities:
Net income (loss)	$	171,295		$	(131,252	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		114,217			134,686
Depreciation and amortization		181,660			214,149
Amortization of premiums and discounts		(11,970	)		(17,836	)
Write down of impaired securities		167,467			753,537
Loss on sale of securities		2,603			—
Loans held for sale made, net of principal sold		8,396,712			9,171,502
Loss (gain) on sale of foreclosed real estate		29,021			(2,126	)
Loss (gain) on disposal of premises and equipment		1,101			(2,596	)
2007 Equity Plan stock issued		—			2,856
Stock based compensation expense		—			496
Decrease (increase) in:
Accrued interest receivable		70,506			199,033
Prepaid income taxes		44,068			(581,794	)
Deferred income taxes		24,253			—
Cash surrender value of bank owned life insurance		(37,971	)		(42,407	)
Other assets		(535,466	)		596,791
Increase (decrease) in:
Accrued interest payable		(18,486	)		(13,888	)
Deferred loan origination fees		(25,316	)		(24,123	)
Other liabilities		(241,903	)		87,240
Net cash provided by operating activities		8,331,791			10,344,268

Cash flows from investing activities:
Proceeds from sales of securities available for sale		1,800			—
Proceeds from maturities of securities available for sale		1,227,026			3,908,842
Proceeds from maturities of securities held to maturity		411,950			420,397
Purchase of securities available for sale		(1,121,457	)		—
Loans made, net of principal collected		7,985,746			421,925
Purchase of premises and equipment		(259,147	)		(106,926	)
Proceeds from sale of foreclosed real estate		224,561			112,526
Proceeds from sale of premises and equipment		—			51,821
Net cash provided by investing activities		8,470,479			4,808,585
Cash flows from financing activities:
Net increase (decrease) in time deposits		2,835,639			(12,123,063	)
Net increase (decrease) in other deposits		4,173,966			(1,375,889	)
Payments of Federal Home Loan Bank advances		(23,350,000	)		(2,500,000	)
Net decrease in other borrowed funds		—			(2,484,857	)
Dividends paid		(115,012	)		(217,756	)
Net cash used by financing activities		(16,455,407	)		(18,701,565	)
Net increase (decrease) in cash and cash equivalents		346,863			(3,548,712	)
Cash and cash equivalents at beginning of period		6,662,853			23,333,372
Cash and cash equivalents at end of period	$	7,009,716		$	19,784,660

Supplemental information:
Interest paid on deposits and borrowings	$	1,037,354		$	1,609,751
Income taxes paid	$	9,399		$	284,504
Transfer of loan to foreclosed real estate	$	—		$	—

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the three months ended March 31, 2011 and 2010 is unaudited)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements prepared for Carrollton Bancorp (“the Company”) have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto, included in the Company’s 2010 Annual Report on Form 10-K (“2010 Form 10-K”) filed with the Securities and Exchange Commission (“SEC”).

The consolidated financial statements include the accounts of the Company’s subsidiary, Carrollton Bank, Carrollton Bank’s wholly-owned subsidiaries, Carrollton Mortgage Services, Inc. (“CMSI”), Carrollton Financial Services, Inc. (“CFS”), Mulberry Street, LLC (“MSLLC”), and Carrollton Bank’s 96.4% owned subsidiary, Carrollton Community Development Corporation (“CCDC”) (collectively, the “Bank”). All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements as of March 31, 2011 and for the three months ended March 31, 2011 and 2010 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of financial position and results of operations for those periods. The results of operations for the three months ended March 31, 2011, are not necessarily indicative of the results that will be achieved for the entire year.

Management has evaluated all significant events and transactions that occurred after March 31, 2011 through the date these financial statements were issued for potential recognition or disclosure in these financial statements.

Reclassifications

Certain items in prior financial statements have been reclassified to conform to the current presentation.

Derivative Instruments and Hedging Activities

The Company accounts for derivative instruments and hedging activities utilizing accounting guidance established for Accounting for Derivative Instruments and Hedging Activities, as amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair value using Level 2 inputs as defined in Note 8. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in “Other Comprehensive Income,” net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.

Management periodically reviews contracts from various functional areas of the Company to identify potential derivatives embedded within selected contracts. Management has identified potential embedded derivatives in certain loan commitments for residential mortgages where the Company has intent to sell to an outside investor. Due to the short-term nature of these loan commitments and the minimal historical dollar amount of commitments outstanding, the corresponding impact on the Company’s financial condition and results of operation has not been material.

The Company entered into an interest rate Floor transaction on December 14, 2005. The Floor had a notional amount of $10.0 million with a minimum interest rate of 7.00% based on U.S. prime rate and was initiated to hedge exposure to the variability in the future cash flows derived from adjustable rate home equity loans in a declining interest rate environment. The Floor had a term of five years. This interest rate Floor was designated a cash flow hedge, as it was designed to reduce variation in overall changes in cash flow below the above designated strike level associated with the first Prime based interest payments received each period on its then existing loans. The interest rate of these loans changed whenever the repricing index changed, plus or minus a credit spread (based on each loan’s underlying credit characteristics), until the interest rate Floor matured on December 14, 2010. When the Prime rate index fell below the strike level of the Floor prior to maturity, the Floor’s counterparty paid the Bank the difference between the strike rate and the rate index multiplied by the notional value of the Floor multiplied by the number of days in the period divided by 360 days.

NOTE 2 – NET INCOME PER SHARE

The calculation of net income per common share is as follows:

	Three Months Ended March 31,
	2011		2010
Basic:
Net income (loss)	$	171,295	$	(131,252	)
Net income (loss) available to common stockholders		34,217		(266,736	)
Average common shares outstanding		2,573,088		2,569,168
Basic net income (loss) per common share	$	0.01	$	(0.10	)
Diluted:
Net income (loss)	$	171,295	$	(131,253	)
Net income (loss) available to common stockholders		34,217		(266,736	)
Average common shares outstanding		2,573,088		2,569,168
Stock option adjustment		—		—
Average common shares outstanding - diluted		2,573,088		2,569,168
Diluted net income (loss) per common share	$	0.01	$	(0.10	)

NOTE 3 – INVESTMENT SECURITIES

Investment securities are summarized as follows:

	Amortized cost		Unrealized gains		Unrealized losses		Fair value
March 31, 2011
Available for sale
U.S. government agency	$	1,866,971	$	89,864	$	—	$	1,956,835
Mortgage-backed securities		14,997,249		852,179		15,375		15,834,053
State and municipal		7,133,212		242,472		6		7,375,678
Corporate bonds		8,167,380		101,375		5,953,452		2,315,303
		32,164,812		1,285,890		5,968,833		27,481,869
Equity securities		296,293		106,400		63,864		338,829
	$	32,461,105	$	1,392,290	$	6,032,697	$	27,820,698
Held to maturity
Mortgage-backed securities	$	2,648,022	$	128,437	$	—	$	2,776,459
State and municipal		1,225,000		35,943		—		1,260,943
	$	3,873,022	$	164,380	$	—	$	4,037,402

	Amortized cost		Unrealized gains		Unrealized losses		Fair value
December 31, 2010
Available for sale
U.S. government agency	$	1,949,329	$	103,157	$	—	$	2,052,486
Mortgage-backed securities		15,016,062		1,023,923		—		16,039,985
State and municipal		7,140,031		152,711		—		7,292,742
Corporate bonds		8,321,853		91,685		6,063,876		2,349,662
		32,427,275		1,371,476		6,063,876		27,734,875
Equity securities		300,695		106,323		16,084		390,934
	$	32,727,970	$	1,477,799	$	6,079,960	$	28,125,809
Held to maturity
Mortgage-backed securities	$	3,058,575	$	146,057	$	—	$	3,204,632
State and municipal		1,225,000		44,459		—		1,269,459
	$	4,283,575	$	190,516	$	—	$	4,474,091

As of March 31, 2011 securities with unrealized losses segregated by length of impairment were as follows:

	Less than 12 months				12 months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	1,104,243	$	15,375	$	—	$	—	$	1,104,243	$	15,375
State and municipals		224,995		6		—		—		224,995		6
Corporate bonds		—		—		317,243		5,953,452		317,243		5,953,452
Equity securities		—		—		232,429		63,864		232,429		63,864
	$	1,329,238	$	15,381	$	549,672	$	6,017,316	$	1,878,910	$	6,032,697

Contractual maturities of debt securities at March 31, 2011 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for sale				Held to maturity
Maturing	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	—	$	—	$	—	$	—
Over one to five years		3,922,993		4,122,453		—		—
Over five to ten years		2,280,544		2,399,602		1,225,000		1,260,943
Over ten years		10,964,026		5,125,761		—		—
Mortgage-backed securities		14,997,249		15,834,053		2,648,022		2,776,459
	$	32,164,812	$	27,481,869	$	3,873,022	$	4,037,402

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. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time, the Company will receive full value for the securities. Management and the Investment Committee of the Board of Directors continuously evaluate securities for possible sale due to credit quality. Any sale and reinvestment decisions will be approved by the Investment Committee. Excluding the trust preferred securities, unrealized losses exist on five available-for-sale securities and total $79,245 at March 31, 2011. The fair value is expected to recover as the investments approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of these securities are impaired due to reasons of credit quality. Accordingly, as of March 31, 2011 management believes the impairments detailed in the table above, except for the trust preferred securities described below, are temporary and no impairment loss has been realized in the Company’s consolidated income statement.

At March 31, 2011 and December 31, 2010, the Company owned six collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (“PreTSLs”). The market for these securities at March 31, 2011 and December 31, 2010 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which PreTSLs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as no new PreTSLs have been issued since 2007. Currently very few market participants are willing or able to transact for these securities.

The market values for these securities (and any securities other than those issued or guaranteed by the U.S. Treasury) are very depressed relative to historical levels. Thus, in today’s market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general versus being an indicator of credit problems with a particular issuer.

Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:

·	The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at March 31, 2011 and December 31, 2010;

·	An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates; and

·	Our PreTSLs will be classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to determine fair value at the measurement date.

The following table (Dollars in Thousands) lists the class, credit rating, deferrals and defaults of the six trust preferred securities (PreTSL):

PreTSL	Class	Moody Credit Rating	Deferrals			Defaults
PreTSL	Class	Moody Credit Rating	Amount	Percent		Amount	Percent
IV	Mezzanine	Ca	6,000	9.02	%	12,000	18.05	%
XVIII	C	Ca	77,340	11.43		91,000	13.45
XIX	B	C	76,900	10.99		93,500	13.36
XIX	C	Ca	76,900	10.99		93,500	13.36
XXII	B-1	Caa2	257,500	18.57		182,000	13.13
XXIV	C-1	Ca	219,000	20.85		182,800	17.40

Based on qualitative considerations such as a down-grade in credit rating, defaults of underlying issuers and an analysis of expected cash flows, we determined in prior periods that three PreTSLs included in corporate bonds were other-than-temporarily impaired (OTTI). Those PreTSLs were written down in the periods in which the impairments were identified. One of the three securities required additional adjustments and we wrote our investment in this PreTSL down $167,467 through earnings during the first quarter of 2011 to the present value of expected cash flows at March 31, 2011, to properly reflect credit losses associated with this PreTSL. The remaining fair value of these three securities was $36,137 at March 31, 2011. The issuers of these securities are primarily banks, but some of the pools do include a limited number of insurance companies. The Company uses the OTTI evaluation model prepared by an independent third party to compare the present value of expected cash flows to the previous estimate to ensure there are no adverse changes in cash flows during the quarter. The OTTI model considers the structure and term of the PreTSLs and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. Cash flows are projected using a forward rate LIBOR curve, as these PreTSLs are variable rate instruments. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments.

NOTE 4 – LOANS

Major classifications of loans at are as follows:

	March 31, 2011			December 31, 2010
Commercial loans:
Commercial mortgages - investor	$	91,911,367		$	86,569,680
Commercial mortgages – owner occupied		47,657,287			58,753,876
Construction and development		14,782,201			14,460,580
Commercial and industrial loans		37,413,312			38,289,199
Total commercial loans		191,764,167			198,073,335
Consumer loans:
Residential mortgages		50,602,445			51,498,271
Home equity lines of credit		38,281,173			38,956,859
Other		595,012			631,294
Total consumer loans		89,478,630			91,086,424
Deferred costs, net		43,814			69,130
Total loans		281,286,611			289,228,889
Allowance for loan losses		(4,613,605	)		(4,481,236	)
Net loans	$	276,673,006		$	284,747,653

The Bank makes loans to customers located primarily in Maryland, Virginia, Pennsylvania, and Delaware. Although the loan portfolio is diversified, its performance will be influenced by the regional economy.

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

	March 31, 2011		December 31, 2010
Repricing or maturing within one year	$	132,320,310	$	125,896,421
Maturing over one to five years		97,745,111		103,443,196
Maturing over five years		51,221,190		59,889,272
	$	281,286,611	$	289,228,889

Loan balances have been adjusted by the following deferred amounts:

	March 31, 2011			December 31, 2010
Deferred origination costs and premiums	$	875,352		$	914,744
Deferred origination fees and unearned discounts		(831,538	)		(845,614	)
Net deferred costs (fees)	$	43,814		$	69,130

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies, and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower's ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower's management possesses sound ethics and solid business acumen, the Company's management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company's commercial real estate portfolio are diverse in terms of type. This diversity helps reduce the Company's exposure to adverse economic events that affect any industry. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

The Company originates consumer loans, including mortgage loans and loans originated with the intent to sell in the secondary market, utilizing credit score analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by credit policies, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Company utilizes external consultants to conduct independent loan reviews. These consultants review and validate the credit risk program on a periodic basis. Results of these reviews are presented to management and the Board of Directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company's policies and procedures.

Concentrations of Credit. The Company makes loans to customers located in Maryland, Virginia, Pennsylvania and Delaware. Although the loan portfolio is diversified, its performance will be influenced by the regional economy.

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Non-accrual loans, segregated by class of loans, were as follows:

	March 31, 2011		December 31, 2010
Commercial loans:
Commercial mortgages - investor	$	2,647,957	$	1,051,459
Commercial mortgages – owner occupied		3,049,496		—
Construction and development		2,839,049		2,839,049
Commercial and industrial loans		1,635,878		155,520
Consumer loans:
Residential mortgages		292,349		802,735
Home equity lines of credit		226,953		173,014
Other		—		—
Total	$	10,691,682	$	5,021,777
Unrecorded interest on nonaccrual loans	$	436,960	$	241,031
Interest income recognized on nonaccrual loans	$	29,004	$	138,722

An age analysis of past due loans, segregated by class of loans, as of March 31, 2011 were as follows:

	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Commercial loans:
Commercial mortgages – investor	$	388,074	$	2,647,957	$	3,036,031	$	88,875,336	$	91,911,367	$	—
Commercial mortgages – owner occupied		8,372		3,049,496		3,057,868		44,599,419		47,657,287		—
Construction and development		—		2,839,049		2,839,049		11,943,152		14,782,201		—
Commercial and industrial loans		1,830,595		1,635,878		3,466,473		33,946,839		37,413,312		—
Consumer loans:
Residential mortgages		1,483,918		259,214		1,743,132		48,859,313		50,602,445		—
Home equity lines of credit		509,935		23,766		533,701		37,747,472		38,281,173		—
Other		6,367		—		6,367		588,645		595,012		—
Deferred costs, net		—		—		—		43,814		43,814		—
Total	$	4,227,261	$	10,455,360	$	14,682,621	$	266,603,990	$	281,286,611	$	—

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated on an individual loan basis for all such loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Impaired loans are defined as loans that have been assessed for impairment and have been determined to either need a write down or specific reserve. Impaired loans as of March 31, 2011, are set forth in the following table.

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Commercial loans:
Commercial mortgages – investor	$	4,812,115	$	—	$	4,249,514	$	4,249,514	$	504,534	$	4,251,288
Commercial mortgages – owner occupied		4,836,300		—		4,836,300		4,836,300		279,000		4,847,744
Construction and development		4,536,422		—		2.839,050		2.839,050		141,952		2,860,050
Commercial and industrial loans		149,957		—		149,957		149,957		29,957		149,902
Consumer loans:
Residential mortgages		858,970		—		734,230		734,230		245,579		794,732
Home equity lines of credit		139,888		—		139,888		139,888		23,689		141,074
Total	$	15,333,652	$	—	$	12,948,939	$	12,948,939	$	1,224,711	$	13,044,790

Nonperforming assets and loans past due 90 days or more but accruing interest were as follows:

	March 31, 2011		December 31, 2010
Nonaccrual loans	$	10,691,682	$	5,021,777
Restructured loans		8,337,368		7,795,668
Foreclosed real estate		4,255,969		4,509,551
Total nonperforming assets	$	23,285,019	$	17,326,996

One restructured note totaling $340,000 is more than 30 days past due. All other restructured notes are paying in accordance with the terms of the agreement.

Credit Quality Indicators.

As part of the on-going monitoring of the credit quality of the Company's loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans (see details above) and (v) the general economic conditions in the Company’s market.

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of loans characterized as “watch list” or classified is as follows:

Risk Rating 5: Watch

Loans with a 5 risk rating are secured by generally acceptable assets which reflect above average risk. Loans rated 5 warrant closer scrutiny by management than is routine, due to circumstances affecting the borrower, the borrower’s industry or the overall economic environment. Borrowers may reflect weaknesses such as inconsistent or weak earnings, break even or moderately deficit cash flow, thin liquidity, minimal capacity to increase leverage, or volatile market fundamentals or other industry risks. Such loans are typically secured by acceptable collateral, at or near appropriate margins, with realizable liquidation values.

Commercial real estate loans with a 5 risk rating may possess a debt-service coverage (“DSC”) ratio which is positive but still short of Lending Policy standards, or a loan-to-value (“LTV”) ratio which exceeds our Lending Policy but is less than 90%. Such loans may not meet conventional market terms and could require a higher risk lender for third party take-outs, and borrowers/guarantors capacity to provide support, if necessary, could be marginal.

Risk Rating 6: Special Mention

The Comptroller’s Handbook for National Bank Examiners defines “Special Mention” as follows: “A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.”

Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow and/or negative trends in earnings. LTV ratio substantially exceeds normal standards, and access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.

Risk Rating 7: Substandard

Loans with a 7 risk rating are classified “Substandard.” The Comptroller’s Handbook for National Bank Examiners defines “Substandard” as follows: “A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must 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 as substandard.”

Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate DSC ratio, or marginal liquidity and capitalization. For commercial real estate loans with a 7 risk rating, the orderly liquidation of the debt is jeopardized due to lack of timely project completion, deficiency of project marketability, inadequate cash flow or collateral support, or failure of the project to meet economic expectations. Repayment of such loans may depend upon liquidation of collateral, or upon other credit risk mitigation. These loans require more intensive supervision by bank management.

Risk Rating 8: Doubtful.

Loans with an 8 risk rating are classified “Doubtful.” The Comptroller’s Handbook for National Bank Examiners defines “Doubtful” as follows: “An asset classified doubtful has all the weaknesses inherent in one that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the asset, and which are expected to be completed within a relatively short period of time, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.” All assets classified as doubtful require a specific reserve of no less than 50%, are on non-accrual status, and necessitate a plan for liquidation.

Risk Rating 9: Loss

Loans with a 9 risk rating are classified “Loss.” The Comptroller’s Handbook for National Bank Examiners defines “Loss” as follows: “Assets classified losses are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.” Long term recoveries should not be allowed while the asset remains booked. Losses should be taken in the period in which they surface as uncollectible. The bankruptcy of a borrower with an unsecured credit requires that the loss be taken immediately.

The following table presents the balances of classified loans by class of commercial loan. Classified loans include loans in Risk Grades 5, 6 and 7. The Company has no loans with risk ratings of 8 or 9.

	Risk Rating
	5		6		7		Total
Commercial mortgages - investor	$	3,971,214	$	—	$	4,381,941	$	8,353,155
Commercial mortgages – owner occupied		3,614,075		—		1,786,805		5,400,880
Construction and development		2,005,738		—		2,839,050		4,844,788
Commercial and industrial loans		2,468,001		2,435,876		1,710,836		6,614,713
Total	$	12,059,028	$	2,435,876	$	10,718,632	$	25,213,536

Net (charge-offs)/recoveries, segregated by class of loans, were as follows for the periods ended March 31:

	2011			2010
Commercial loans:
Commercial mortgages – investor	$	—		$	(3,403	)
Commercial mortgages – owner occupied		—			—
Construction and development		—			—
Commercial and industrial loans		5,487			2,020
Consumer loans:
Residential mortgages		(64,200	)		(10,609	)
Home equity lines of credit		76,865			18,722
Other		—			1,629
Total	$	18,152		$	8,359

The following table details the allocation of the allowance for loan losses by portfolio segment as of March 31, 2011 and December 31, 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	2011		2010
Commercial loans:
Commercial mortgages - investor	$	1,085,519	$	1,073,448
Commercial mortgages – owner occupied		497,785		460,914
Construction and development		1,176,573		1,112,103
Commercial and industrial loans		789,061		754,770
Consumer loans:
Residential mortgages		789,338		821,197
Home equity lines of credit		258,528		243,119
Other		16,801		15,685
Total	$	4,613,605	$	4,481,236

Transactions in the allowance for loan losses for the periods ended March 31 were as follows:

	2011		2010
Beginning balance	$	4,481,236	$	4,322,604
Provision charged to operations		114,217		134,686
Recoveries		83,766		22,371
		4,679,219		4,479,661
Loans charged off		65,614		14,012
Ending balance	$	4,613,605	$	4,465,649

Loans with a balance of approximately $120.2 million and $110.9 million were pledged as collateral to the Federal Home Loan Bank of Atlanta as of March 31, 2011 and December 31, 2010, respectively.

NOTE 5 – STOCK BASED COMPENSATION

At the Company’s annual stockholders’ meeting on May 15, 2007, the 2007 Equity Plan was approved. Under this plan, 500,000 shares of the Common Stock of the Company were reserved for issuance. Also, in accordance with the 2007 Equity Plan, 300 shares of unrestricted Company Stock are issued to each non-employee director in May of each year. One director receives cash in lieu of stock due to restrictions by his/her employer on receiving stock of a company. Also, in accordance with the 2007 Equity Plan, 300 shares were awarded to each new director as of the effective date of their acceptance onto the board. No new grants will be made under the 1998 Long Term Incentive Plan. However, incentive stock options issued under this plan will remain outstanding until exercised or until the tenth anniversary of the grant date of such options.

There was no stock based compensation expense recognized during the first three months of 2011 compared to $496 during the first three months of 2010. As of March 31, 2011, there was no unrecognized stock option expense related to nonvested stock options.

Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the vesting period of the award (3 years) or the fair value of common stock on the date of issuance.

NOTE 6 - COMMITMENTS AND CONTINGENT LIABILITIES

The Company enters into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit and letters of credit. The Company applies the same credit policies to these off-balance sheet arrangements as it does for on-balance-sheet instruments.

Additionally, the Company enters into commitments to originate residential mortgage loans to be sold in the secondary market, where the interest rate is determined prior to funding the loan. The commitments on mortgage loans to be sold are considered derivatives. The intent is that the borrower has assumed the interest rate risk on the loan. As a result, the Company is not exposed to losses due to interest rate changes. As of March 31, 2011 the difference between the market value and the carrying amount of these commitments is immaterial and therefore, no gain or loss has been recognized in the financial statements.

Outstanding loan commitments, unused lines of credit, and letters of credit were as follows:

	March 31, 2011		December 31, 2010		March 31, 2010
Loan commitments	$	18,316,911	$	16,741,858	$	21,986,041
Unused lines of credit		44,381,406		64,689,835		68,620,063
Letters of credit		3,248,106		3,665,222		4,551,275

NOTE 7 – TARP CAPITAL PURCHASE PROGRAM

On February 13, 2009, as part of the TARP Capital Purchase Program, the Company entered into a Letter Agreement, and the related Securities Purchase Agreement — Standard Terms (collectively, the ‘‘Purchase Agreement’’), with the United States Department of the Treasury (‘‘Treasury’’), pursuant to which the Company issued (i) 9,201 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference $1,000 per share (‘‘Series A Preferred Stock’’), and (ii) a warrant to purchase 205,379 shares of the Company’s common stock, par value $1.00 per share. The Company raised $9,201,000 through the sale of the Series A Preferred Stock that qualifies as Tier 1 capital. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum until February 15, 2014. Beginning February 16, 2014, the dividend rate will increase to 9% per annum. Dividends are payable quarterly. The redemption of the Series A Preferred Stock requires prior regulatory approval.

The warrant is exercisable in whole or in part at $6.72 per share at any time on or before February 13, 2019. Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the warrant.

The Series A Preferred Stock and the warrant were issued in a transaction exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company registered for resale the warrant and the shares of common stock underlying the warrant (the ‘‘warrant shares’’) on February 13, 2009. Neither the Series A Preferred Stock nor the warrant is subject to any contractual restrictions on transfer.

The Purchase Agreement also subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the ‘‘EESA’’) and the American Recovery and Reinvestment act of 2009. As a condition to the closing of the transaction, the Company’s Senior Executive Officers, as defined in the Purchase Agreement each: (i) voluntarily waived any claim against the Treasury or the Company for any changes to such Senior Executive Officer’s compensation or benefits that are required to comply with the regulation issued by the Treasury under the TARP Capital Purchase Program as published in the Federal Register on October 20, 2008, and acknowledging that the regulation may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements (including so called ‘‘golden parachute’’ agreements) as they relate to the period the Treasury holds any equity or debt securities of the Company acquired through the TARP Capital Purchase Program; and (ii) entered into an amendment to Messrs Altieri and Jewell and Mrs. Stokes’ employment agreements that provide that any severance payments made to such officers will be reduced, as necessary, so as to comply with the requirements of the TARP Capital Purchase Program.

The Treasury’s current consent shall be required for any increase in the common dividends per share until February 13, 2012, unless prior to such date, the Series A preferred stock is redeemed in whole or the Treasury has transferred all of the Series A Preferred Stock to third parties.

NOTE 8 – FAIR VALUE

The fair value of an asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.

The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company uses the following methods and significant assumptions to estimate fair value for financial assets and financial liabilities:

Securities available for sale: The fair value of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities. When the market for securities is indeterminable due to inactive trading or when the few observable transactions and market quotations that are available are not reliable for determining fair value, an income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs provides an equally or more representative fair value than the market approach valuation used at prior measurement dates. Equity securities are reported at fair value using Level 1 inputs.

Derivatives: Derivatives are reported at fair value utilizing Level 2 inputs. The Company obtains dealer quotations to value its derivatives. For purposes of potential valuation adjustments to its derivative position, the Company evaluates the credit risk of its counterparty. Accordingly, the Company has considered factors such as the likelihood of default by the counterparty and the remaining contractual life, among other things, in determining if any fair value adjustment related to credit risk is required.

Loans held for sale: The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted pricing exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan, including the current interest rate of similar loans.

Impaired loans and foreclosed real estate: Nonrecurring fair value adjustments to loans and foreclosed real estate reflect full or partial write-downs that are based on the loan’s or foreclosed real estate’s observable market price or current appraised value of the collateral in accordance with “Accounting by Creditors for Impairment of a Loan”. Since the market for impaired loans and foreclosed real estate is not active, loans or foreclosed real estate subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral may be classified as Level 2 or Level 3 depending on the type of asset and the inputs to the valuation. When appraisals are used to determine impairment and these appraisals are based on a market approach incorporating a dollar-per-square-foot multiple, the related loans or foreclosed real estate are classified as Level 2. If the appraisals require significant adjustments to market-based valuation inputs or apply an income approach based on unobservable cash flows to measure fair value, the related loans or foreclosed real estate subjected to nonrecurring fair value adjustments are typically classified as Level 3 because Level 3 inputs are significant to the fair value measurement.

The following table represents the Company’s financial assets measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010:

Carrying Value at March 31, 2011:

	Total		(Level 1)		(Level 2)		(Level 3)

Available for sale securities	$	27,820,698	$	338,826	$	27,164,629	$	317,243

Carrying Value at December 31, 2010:

	Total		(Level 1)		(Level 2)		(Level 3)

Available for sale securities	$	28,125,809	$	390,934	$	27,361,333	$	373,542

During the first three months of 2011, the Company recognized $167,467 of other-than-temporary impairment charges related to one debt security issued by financial institutions.

The following table reconciles the beginning and ending balances of available for sale securities measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the three months ended March 31, 2011 and 2010.

	Three Months Ended
	March 31,
		2011			2010
Balance, beginning of period	$	373,542		$	1,810,070
Total gains (losses) realized and unrealized:
Included in earnings		(167,467	)		(753,537	)
Included in other comprehensive income		111,168			762,188
Transfer to (from) Level 3		—			—
Balance, end of period	$	317,243		$	1,818,721

Certain other assets are measured at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. For assets measured at fair value on a nonrecurring basis during the first three months of 2011 that were still held in the balance sheet at period end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at period end.

Carrying Value at March 31, 2011:

	Total		(Level 1)		(Level 2)		(Level 3)
Loans held for sale	$	24,357,671	$	—	$	24,357,671	$	—
Impaired loans		12,948,939		—		12,948,939		—
Other real estate owned (OREO)		4,255,969		—		4,255,969		—

During the first three months of 2011, the Company recognized losses related to certain assets that are measured at fair value on a nonrecurring basis (i.e. loans and loans held for sale). Losses related to loans of $65,614 were recognized as charge-offs for loan losses. There was a $29,021 net loss on sale of two foreclosed real estate properties. During the first three months of 2011, there were no losses related to loans held for sale accounted for at the lower of cost or fair value or write downs of foreclosed real estate properties.

The following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets as of December 31, 2010.

Carrying Value at December 31, 2010:

	Total		(Level 1)		(Level 2)		(Level 3)
Loans held for sale	$	32,754,383	$	—	$	32,754,383	$	—
Impaired loans		10,101,483		—		10,101,483		—
Other real estate owned (OREO)		4,509,551		—		4,509,551		—

FASB ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. A detailed description of the valuation methodologies used in estimating the fair value of financial instruments is set forth in the 2010 Form 10-K.

The estimated fair values of financial instruments were as follows:


	March 31, 2011				December 31, 2010

	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Financial assets
Cash and cash equivalents	$	7,009,716	$	7,009,716	$	6,662,853	$	6,662,853
Investment securities (total)		31,693,720		31,858,100		32,409,384		32,599,900
Federal Home Loan Bank stock		3,463,000		3,463,000		3,463,000		3,463,000
Loans held for sale		24,357,671		24,454,537		32,754,383		32,852,418
Loans, net		276,673,006		282,490,463		284,747,653		290,910,582

Financial liabilities
Non-interest-bearing deposits	$	68,679,695	$	68,679,695	$	66,253,472	$	66,253,472
Interest-bearing deposits		239,959,441		233,695,867		235,376,059		229,643,059
Advances from the Federal Home Loan Bank		24,950,000		25,310,000		48,300,000		48,807,000

NOTE 9 – INTEREST RATE FLOOR DERIVATIVE

The interest rate floor derivative matured during the fourth quarter of 2010, and therefore had no fair value as of March 31, 2011. The fair value of the derivative instrument, which is included in other assets in the unaudited condensed consolidated balance sheet as of March 31, 2010, was $270,126. The effect of the derivative instrument designated as a cash flow hedge on the Company’s unaudited condensed consolidated statement of income for the three months ended March 31, 2010, was $94,792.

NOTE 10 – NEW AUTHORITATIVE ACCOUNTING GUIDANCE

In April 2011, the FASB issued amended accounting and disclosure guidance relating to a creditor’s determination of whether a restructuring is a troubled debt restructuring. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. The amendments are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. As a result of the application of the amendments, receivables previously measured under loss contingency guidance that are newly considered impaired should be disclosed, along with the related allowance for credit losses, as of the end of the period of adoption. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The deferred credit risk disclosure guidance issued in July 2010 relating to troubled debt restructurings will now be effective for interim and annual periods beginning on or after June 15, 2011. The Company intends to comply with the new accounting and disclosure requirements and does not expect them to have a significant effect on its consolidated financial statements.

In December 2010, the FASB issued amended disclosure guidance relating to the pro forma information for business combinations that occurred in the current reporting period. The amended disclosure states that if an entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company intends to comply with the new accounting and disclosure requirements and does not expect them to have a significant effect on its consolidated financial statements.

In October 2010, the FASB issued amended accounting guidance relating to the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units with zero or negative carrying amounts, an entity is required to perform “Step Two” of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The Company does not anticipate that the adoption of this guidance will have a significant impact on the reporting of its financial position or results of its operations.

ITEM 2.

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

THE COMPANY

Carrollton Bancorp was formed on January 11, 1990 and is a Maryland chartered bank holding company. The Company holds all of the outstanding shares of common stock of Carrollton Bank. The Bank, formed on April 10, 1900, is a commercial bank that provides a full range of financial services to individuals, businesses and organizations through its branch and loan origination offices and its automated teller machines. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation. The Bank considers its core market area to be the Baltimore Metropolitan Area.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates,” and similar expressions also identify forward-looking statements. The statements in this report with respect to, among other things, our plans, strategies, objectives and intentions and the anticipated results thereof, reinstatement of dividends, improved earnings, future increases in loans held for sale, increased loan demand in the future, asset quality improvements, the recovery of fair value of available-for sale securities, the allowance for loan losses, anticipated increases in the value of trust preferred securities held in our investment portfolio as the economy improves, the impact of new accounting guidance, liquidity sources, capital ratios/levels and the impact of pending legal proceedings, are forward-looking. These forward-looking statements are based on our current intentions, beliefs, and expectations.

These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of, among other things, interest rate fluctuations, changes in monetary policy, a further deterioration of economic conditions in the Baltimore Metropolitan area, a deterioration in our local real estate market and the economy generally or a slowing recovery, higher than anticipated loan losses or the insufficiency of the allowance for loan losses, changes in federal and state bank laws and regulations, including as a result of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and changes in accounting standards that may adversely affect us or the banking industry as a whole, our ability to implement our business strategy, and other risks described in this report, in the Company’s 2010 Form 10-K, and in our other filings with the SEC. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. We undertake no obligation to update or revise the information contained in this report whether as a result of new information, future events or circumstances, or otherwise. Past results of operations may not be indicative of future results. Readers should carefully review the risk factors described in other documents that we file from time to time with the SEC.

BUSINESS AND OVERVIEW

The Company is a bank holding company headquartered in Columbia, Maryland, with one wholly-owned subsidiary, Carrollton Bank. The Bank has four subsidiaries, CMSI, CFS, and MSLLC that are wholly owned, and CCDC, which is 96.4% owned.

The Bank is engaged in general commercial and retail banking business, with ten branch locations. The Bank attracts deposit customers from the general public and uses such funds, together with other borrowed funds, to make loans. Our results of operations are primarily determined by the difference between interest income earned on interest-earning assets, primarily interest and fee income on loans, and interest paid on our interest-bearing liabilities, including deposits and borrowings.

During 2004, the Bank opened a mortgage subsidiary, Carrollton Mortgage Services, Inc. (“CMSI”). CMSI is in the business of originating residential mortgage loans to be sold and has one branch location. The mortgage-banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale on the secondary market, as well as the origination of loans to be held in our loan portfolio. Mortgage-banking products include Federal Housing Administration and the Federal Veterans Administration loans, conventional and nonconforming first and second mortgages, and construction and permanent financing. Loans originated by CMSI are generally sold into the secondary market but may be considered for retention by the Bank as part of our balance sheet strategy.

CFS provides brokerage services and a variety of financial planning and investment options to customers through INVEST Financial Corp. pursuant to a service agreement with INVEST and recognizes commission income as these services are provided. The investment options CFS offers through this arrangement include mutual funds, U.S. government bonds, tax-free municipals, individual retirement account rollovers, long-term care, and health care insurance services. INVEST is a full-service broker/dealer, registered with the Financial Industry Regulatory Authority (“FINRA”) and the SEC, a member of Securities Investor Protection Corporation (“SIPC”), and licensed with state insurance agencies in all 50 states. CFS refers clients to an INVEST representative for investment counseling prior to purchase of securities.

MSLLC manages and disposes of real estate acquired through foreclosure.

CCDC promotes, develops, and improves the housing and economic conditions of people in Maryland. We coordinate our efforts to identify opportunities with a local non-profit ministry whose mission and vision is to eliminate poverty housing in the region by building decent houses for affordable homeownership throughout Anne Arundel County and the Baltimore metropolitan region. CCDC generates revenue through the origination of loans for the purchase of these homes.

We reported net income for the three months ended March 31, 2011 of $171,295 compared to a net loss of $131,252 for the comparable period in 2010. Net income available to common stockholders for the three month period ended March 31, 2011 was $34,217 ($0.01 per diluted share) compared to net loss available to common stockholders of $266,736 ($0.10 loss per diluted share) for the prior year period.

Return on average assets and return on average equity are key measures of our performance. Return on average assets, the quotient of net income divided by total average assets, measures how effectively the Company utilizes its assets to produce income. The Company’s return on average assets for the three months ended March 31, 2011 was 0.19% compared to a loss on average assets of 0.13% for the three month period ended March 31, 2010. Return on average equity, the quotient of net income divided by average equity, measures how effectively the Company invests its capital to produce income. Return on average equity for the three month period ended March 31, 2011 was 2.08% compared to a loss of 1.49% for the corresponding period in 2010.

Net interest income increased $109,679, or 3.31%, for the three month period ended March 31, 2011 compared to the same period in 2010, while our net interest margin increased to 3.93% for the three months ended March 31, 2011 from 3.40% for the comparable period in 2010. Net interest margin, a profitability measure, is the dollar difference between interest income from earning assets, including loans and investments, and interest expense paid on deposits and other borrowings expressed as a percentage of average earning assets. The dramatic improvement in net interest income while asset yields are declining is a result of our strategy focused on reducing excess balance sheet liquidity and reducing the cost of our interest-bearing liabilities.

The overall improvements in operating results for the first quarter of 2011 compared to the same period in 2010 is primarily a result of the stabilization of Trust Preferred securities held in our securities portfolio. During the first quarter of 2011, we recorded a write-down of Trust Preferred securities in the amount of $167,000 compared to $754,000 during the same period in 2010.

No dividends were declared or paid to common stockholders during the first quarter of 2011 as we continue the temporary suspension of dividends in recognition of our limited earnings during recent quarters. It is our intention to reinstate the payment of dividends when earnings improve and capital preservation efforts boost our capital ratios. During the first quarter of 2010, we declared a dividend of $0.04 per share to stockholders.

CURRENT STRATEGY

Our Board of Directors and senior management are currently employing a strategy designed to strengthen the balance sheet and improve operating results by improving asset quality, reducing higher cost funding sources, and pursuing operating efficiencies through the use of technology and strategic partners. The objective is to strengthen our overall foundation during these difficult and uncertain economic times in order to take advantage of opportunities that we expect will emerge as the business environment clarifies and improves.

The newly enacted financial regulatory reform measures pursuant to the Dodd-Frank Act, along with the ongoing instability in the residential and commercial real estate markets, have created a great deal of uncertainty within the community banking industry. In addition, uncertainty about future tax policy and the cost of employment associated with healthcare reform add uncertainty to planning for operational costs. We have chosen to carefully evaluate all growth opportunities with this uncertainty in mind, carefully limiting decisions that could be impacted by circumstances beyond our control.

We have narrowed our focus for targeted growth on the following customer groups:

·	Small and mid-sized businesses, including service firms, manufacturing companies and distributors;

·	Executives and professionals, including attorneys, accountants, medical professionals, consultants, corporate executives and their firms;

·	Non-profit associations, including charities, foundations, professional/trade associations, homeowner/condo associations, and faith based organizations; and

·	High net worth individuals and affluent families.

The Bank will serve its customers by utilizing its existing branch network as well as by providing internet based services, remote deposit capture, courier service, and loan production business offices.

Going forward, our business strategy will include:

·	Increasing awareness and consideration in the business marketplace through directed marketing and direct sales efforts;

·	Leading with deposit and cash management products;

·	Retaining and growing existing customer relationships;

·	Growing our Small Business Administration loan portfolio; and

·	Increasing adoption and usage of online products.

Our effort to improve net interest margin by reducing balance sheet liquidity and high cost funding sources has dramatically improved net interest margins from 3.40% for the three months ended March 31, 2010 to 3.93% for the same period in 2011. The 53 basis points improvement is primarily a result of reducing the cost of interest-bearing liabilities by 44 basis points through the reduction of borrowed funds and renewal of certificates of deposit at significantly lower rates. The annualized benefit of a 53 basis points improvement in net interest margin is approximately $1.9 million on the Bank’s average earning assets of $353.1 million for the three months ended March 31, 2011.

Our efforts to reduce non-performing assets and improve operating efficiencies will take longer to appear in operating results. The reduction of non-performing assets is subject to the market conditions associated with the commercial real estate market, while operating efficiencies will be geared towards growing the business without a proportionate increase in operating costs. We have intentionally avoided dramatic cost reductions that would impair our ability to take advantage of growth opportunities as they appear.

We believe that we will ultimately need to raise additional capital to redeem our outstanding preferred stock issued to the U.S. Treasury under the Capital Purchase Program and support balance sheet growth. Fortunately, we remain “well capitalized” for regulatory purposes, which allows us to carefully assess various capital alternatives and determine which alternative is best for the Company and our existing stockholders. Management and a committee of the Board of Directors are constantly evaluating market conditions and opportunities so that we are in a position to act quickly if the right opportunity arises.

CRITICAL ACCOUNTING POLICIES

The Company’s financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets. One of the most critical accounting policies applied is related to the valuation of the loan portfolio.

A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs. The allowance for loan losses is one of the most difficult and subjective judgments that we make. The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio. Current trends in delinquencies and charge-offs, the views of bank regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors. The analysis also requires consideration of the economic climate and direction, and change in the interest rate environment, which may affect a borrower’s ability to pay, legislation influencing the banking industry, and economic conditions specific to the Bank’s service areas. Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

Another critical accounting policy is related to the securities we own. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, 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 an investment. Management reviews other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

FINANCIAL CONDITION

Investment Securities

The investment portfolio consists primarily of securities available for sale. Securities available for sale are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. Investment securities we anticipate holding until the investment’s maturity date are recorded at amortized cost.

The investment portfolio consists primarily of U.S. Government agency securities, mortgage-backed securities, corporate bonds, state and municipal obligations, and equity securities. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. We use the investment portfolio as a source of both liquidity and earnings.

Investment securities decreased $715,664, or 2.21%, to $31.7 million at March 31, 2011, from $32.4 million at December 31, 2010. The decrease is primarily the result of $1.6 million principal paydowns on mortgage-backed securities and the $167,467 other-than-temporary loss on Trust Preferred securities, partially offset by the purchase of a $1.1 million mortgage-backed security with an estimated maturity date of May 2019 and a yield of 4.02%. Management’s continuing investment strategy is to use liquidity from maturing investments to fund our liquidity needs so we can reduce our use of high cost certificates of deposit and borrowed funds. Management continues to investigate investment options that will produce the most efficient use of excess funds.

Loans Held for Sale

Loans held for sale decreased $8.4 million from $32.8 million at December 31, 2010, to $24.4 million at March 31, 2011. Generally, loans originated with the intention of being sold to a third party remain on our balance sheet for approximately 45 days. During March 2011, loans originated with the intention of being sold totaled $20.4 million compared to $34.0 million during December 2010. Loan originations are historically seasonal, with originations during the first quarter of each year lagging behind the volume of loans originated during the warmer three quarters of the year. We are hopeful that loans held for sale balances will increase during the remaining quarters of 2011 as the weather warms, the economy improves, and borrowers take advantage of the continued historically low interest rate environment. Loans held for sale are carried at the lower of cost or the committed sale price, determined on an individual loan basis.

Loans

Gross loans, excluding loans held for sale, decreased 2.75% to $281.3 million at March 31, 2011 compared to $289.2 million at March 31, 2010, resulting from tempered loan demand as businesses continue to limit borrowing to expand their operations during the continued sluggish and uncertain economy.

Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt. Placing a loan on nonaccrual status means that we no longer accrue interest on such loan and reverse any interest previously accrued but not collected. Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current.

A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans’ effective interest rates for loans that are not collateral dependent.

At March 31, 2011, we had 17 impaired loans totaling approximately $12.9 million, nine of which have been classified as nonaccrual. The valuation allowance for impaired loans was $1.2 million as of March 31, 2011.

The following table provides information concerning non-performing assets and past due loans at the dates indicated:

	March 31, 2011		December 31, 2010		March 31, 2010

Nonaccrual loans	$	10,691,682	$	5,021,777	$	7,618,076
Restructured loans		8,337,368		7,795,668		3,989,204
Foreclosed real estate		4,255,969		4,509,551		1,916,297

Total nonperforming assets	$	23,285,019	$	17,326,996	$	13,523,577

Accruing loans past-due 90 days or more	$	—	$	—	$	—

Allowance for Loan Losses

The allowance for loan losses represents management’s best estimate of probable losses in the existing loan portfolio. We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses.

We base the evaluation of the adequacy of the allowance for loan losses upon loan categories. We categorize loans as commercial loans or consumer loans. We further divide commercial and consumer loans by collateral type and whether the loan is an installment loan or a revolving credit facility. We apply historic loss ratios to each subcategory of loans within the commercial and consumer loan categories. Loss ratios are determined based upon the most recent three years of history for each loan subcategory.

We further divide commercial loans by risk rating and apply loss ratios by risk rating to determine estimated loss amounts. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral separately and assign loss amounts based upon the evaluation.

With respect to commercial loans, management assigns a risk rating of one through nine to each loan at inception, with a risk rating of one having the least amount of risk and a risk rating of nine having the greatest amount of risk. The risk rating is reviewed at least annually based on, among other things, the borrower’s financial condition, cash flow and ongoing financial viability; the collateral securing the loan; the borrower’s industry; and payment history. We evaluate loans with a risk rating of five or greater separately and allocate a portion of the allowance for loan losses based upon the evaluation, if necessary.

We consider delinquency rates and other qualitative or environmental factors that may cause estimated credit losses associated with our existing portfolio to differ from historical loss experience. These factors include, but are not limited to, changes in lending policies and procedures, changes in the nature and volume of the loan portfolio, changes in the experience, ability and depth of lending management and the effect of other external factors such as economic factors, competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio.

Our policies require an independent review of assets on a regular basis and we believe that we appropriately reclassify loans as warranted. We believe that we use the best information available to make a determination with respect to the allowance for loan losses, recognizing that the determination is inherently subjective and that future adjustments may be necessary depending upon, among other factors, a change in economic conditions of specific borrowers or generally in the economy and new information that becomes available to us. However, there are no assurances that the allowance for loan losses will be sufficient to absorb losses on non-performing assets, or that the allowance will be sufficient to cover losses on non-performing assets in the future.

The allowance for loan losses was $4.6 million at March 31, 2011, which was 1.64% of loans compared to $4.5 million at December 31, 2010, which was 1.52% of loans. During the first three months of 2011, we experienced net recoveries of $18,152 compared to net recoveries of $8,359 during the same period of 2010. The ratio of net loan losses to average loans outstanding was (0.01)% for the three months ended March 31, 2011 compared to the net loan loss ratio of 0.00% for the first three months of 2010. The ratio of nonperforming assets, including accruing loans past-due 90 days or more but excluding renegotiated loans, as a percentage of period-end loans and foreclosed real estate increased to 4.82% at March 31, 2011, compared to 2.92% at December 31, 2010.

The following table shows the activity in the allowance for loan losses:

	Three Months Ended March 31,						Year Ended December 31,
	2011			2010			2010

Allowance for loan losses - beginning of period	$	4,481,236		$	4,322,604		$	4,322,604

Provision for loan losses		114,217			134,686			4,106,353
Charge-offs		(65,614	)		(14,012	)		(4,026,093	)
Recoveries		83,766			22,371			78,372
Allowance for loan losses - end of period	$	4,613,605		$	4,465,649		$	4,481,236

Funding Sources

Deposits

Total deposits increased by $7.0 million, or 2.32%, to $308.6 million as of March 31, 2011, from $301.6 million as of December 31, 2010. Our successful efforts to attract additional deposits, particularly from the small and mid-sized business segments, are evidenced this quarter by increases in all deposit categories as of March 31, 2011, compared to December 31, 2010. Demand deposits grew by $2.4 million, or 3.66%, to $68.7 million at the end of the first quarter of 2011 compared to $66.3 million at 2010 year end. Interest-bearing accounts, excluding certificate of deposit accounts, increased by $1.7 million to $98.2 million at March 31, 2011, compared to $96.5 million at December 31, 2010. Certificate of deposit accounts increased by 2.04% from $138.9 million at December 31, 2010 to $141.7 million March 31, 2011.

Included in our certificate of deposit portfolio are brokered certificates of deposit through the Promontory Interfinancial Network. Through this deposit matching network and its certificate of deposit account registry service (CDARS), we obtained the ability to offer our customers access to Federal Deposit Insurance Company (“FDIC”) insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through CDARS on behalf of a customer, we receive matching deposits through the network’s reciprocal deposit program. We can also place deposits through this network without receiving matching deposits. At March 31, 2011, we had $24.0 million in CDARS through the reciprocal deposit program compared to $21.4 million at December 31, 2010. We did not have any non-reciprocal deposits in the CDARS program as of March 31, 2011, or as of December 31, 2010.

Borrowings

Total borrowings decreased $23.4 million, or 48.34%, to $25.0 million at March 31, 2011 compared to $48.3 million at the end of 2010. The decrease in borrowings is a result of a decline in the loan portfolio, including loans held for sale, of $16.3 million during the first quarter of 2011 and an increase in total deposits of $7.0 million during the same period, which resulted in our requiring fewer borrowings during the first quarter of 2011.

All borrowings at March 31, 2011 and December 31, 2010 consisted of advances from the Federal Home Loan Bank (“FHLB”). At the end of the first quarter 2011, outstanding advances included seven fixed rate credit loans totaling $21.6 million with the latest maturity date of June 2013 and one adjustable rate credit loan of $3.4 million. At December 31, 2010, outstanding advances included 11 fixed rate credit loans totaling $37.5 million with the latest maturity date of June 2013 and one adjustable rate credit loan of $10.8 million.

CAPITAL RESOURCES

Bank holding companies and banks are required by the Board of Governors of the Federal Reserve (the “Federal Reserve”) and the FDIC to maintain levels of Tier 1 (or Core) and Tier 2 capital measured as a percentage of assets on a risk-weighted basis. Capital is primarily represented by stockholders’ equity, adjusted for the allowance for loan losses and certain issues of preferred stock, convertible securities, and subordinated debt, depending on the capital level being measured. Assets and certain off-balance sheet transactions are assigned to one of five different risk-weighting factors for purposes of determining the risk-adjusted asset base. The minimum levels of Tier 1 and Total capital to risk-adjusted assets are 4% and 8%, respectively, under the regulations.

In addition, the Federal Reserve and the FDIC require that bank holding companies and banks maintain a minimum level of Tier 1 (or Core) capital to average total assets excluding intangibles for the current quarter. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but an individual institution could be required to be maintained at a higher level based on its regulator’s assessment of its risk profile. As of March 31, 2011 and December 31, 2010, the Company is considered well capitalized. The Bank also exceeded the FDIC required minimum capital levels to be considered well capitalized at those dates. Management knows of no conditions or events that would change this classification.

The following table summarizes the Company’s capital ratios:

	March 31, 2011			December 31, 2010			Minimum Regulatory Requirements			To Be Well Capitalized
Risk-based capital ratios:
Tier 1 capital		10.17	%		10.12	%		4.00	%		6.00	%
Total capital		11.37			11.35			8.00			10.00
Tier 1 leverage ratio		9.66			9.45			4.00			5.00

Total stockholders’ equity increased 0.1%, or $33,123 during the quarter ended March 31, 2011 compared to December 31, 2010, remaining at $33.4 million at March 31, 2011. The slight increase was due to net income of $171,295, partially offset by dividends paid on preferred stock of $115,012 and change in the fair market value of our available for sale securities of $23,160, net of deferred taxes.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of the Company’s earnings. Net interest income is a function of several factors, including changes in the volume and mix of interest-earning assets and funding sources, and market interest rates. While management policies influence these factors, external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve are also important.

Net interest income increased $109,679 or 3.3% to $3.4 million for the three month period ended March 31, 2011 compared to $3.3 million for the same period in 2010.

Total interest income decreased $467,316 or 9.5%, for the three month period ended March 31, 2011 compared to the same period in 2010. Interest and fee income on loans decreased $240,064, or 5.6%, for the three month period ended March 31, 2011 compared to the same period in 2010. The decrease in the three month period is a result of the yield on loans declining from 5.72% to 5.36% while average loans increased $2.4 million to $307.6 million. The decrease in yields is a result of higher yielding commercial and residential mortgages paying down and being replaced by lower yield loans as we remain in a historically low interest rate cycle.

Interest income from investment securities, overnight investments, and interest-bearing deposits was $370,895 for the three month period ended March 31, 2011, compared to $590,890 for the same period in 2010. The average investment portfolio decreased 38.9%, or $23.4 million, from March 31, 2010 to March 31, 2011, while the overall yield on investments increased from 3.97% to 4.08% for the same period. The decline in the investment portfolio resulted from management’s decision to shrink the balance sheet by using cash flow from investments to reduce high-cost borrowings. The slight increase in yields resulted from maturities and calls of securities that carried lower yields than the securities remaining in our portfolio. The yield on Federal Funds Sold and other interest-bearing deposits decreased to 0.09% for the first three months of 2011 compared to 0.20% for the same period in 2010. The decrease in the yield on Federal Funds Sold is primarily related to the decrease in excess reserves held with the Federal Reserve, which paid a higher rate than other correspondent banks during both quarters.

Interest expense decreased $576,995, or 36.2%, for the three month period ended March 31, 2011 compared to the same period in 2010. The primary reason for this decrease is that the cost of interest-bearing liabilities decreased to 1.54% for the first three months of 2011 compared to 1.98% for the first three months of 2010. The decrease in the cost of interest-bearing liabilities was primarily related to management’s continuing focus on reducing high-cost certificates of deposit and borrowings. The cost of average deposits for the first three months of 2011 declined to 1.37% from 1.84% for the first three months of 2010. Also contributing to the decrease in interest expense during the 2011 period was a decrease in average interest-bearing deposits to $239.5 million from $279.1 million during the 2010 period. Similarly, the Company reduced interest expense on borrowed funds by $116,413 from the first quarter of 2010 to the first quarter of 2011 by reducing the average balance on borrowed funds by 38.7% to $29.1 million from $47.5 million for the first three months of 2011 and 2010, respectively.

The increase in net interest income during the three month period ended March 31, 2011 is due to increases in our net interest margin during the period. As discussed above, net interest margin is the difference between interest income and interest expense expressed as a percentage of average earning assets. The net interest margin increased to 3.93% for the three months ended March 31, 2011 from 3.40% for the comparable period in 2010. The improvement in the net interest margin resulted from management’s aggressive reduction of high cost certificates of deposit and borrowed funds and from reducing excess balance sheet liquidity.

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

	Three Months Ended March 31, 2011								Three Months Ended March 31, 2010
	Average								Average
	Balance			Interest		Yield			Balance			Interest			Yield

ASSETS
Interest-earning assets:
Federal funds sold, Federal Reserve Bank and Federal Home Loan Bank deposit	$	5,137,155		$	1,100		0.09	%	$	26,151,729		$	12,746			0.20	%
Federal Home Loan Bank stock		3,463,000			7,027		0.82	%		3,876,100			2,638			0.28	%
Investment securities:
U.S. government agency		1,907,566			24,642		5.24	%		13,756,458			167,369			4.93	%
State and municipal		8,362,740			76,846		3.73	%		10,419,400			95,808			3.73	%
Mortgage backed securities		17,968,664			245,997		5.55	%		24,690,028			341,423			5.61	%
Corporate bonds		8,042,196			23,176		1.17	%		9,875,525			(17,338	)		-0.71	%
Other		582,992			234		0.16	%		1,549,399			3,628			0.95	%
		36,864,158			370,895		4.08	%		60,290,810			590,890			3.97	%
Loans:
Demand and time		37,704,638			458,014		4.93	%		37,128,488			444,133			4.85	%
Residential mortgage (a)		113,476,327			1,386,310		4.95	%		102,339,155			1,384,738			5.49	%
Commercial mortgage and construction		155,854,015			2,205,595		5.74	%		164,735,326			2,458,063			6.05	%
Installment		615,347			15,447		10.18	%		1,016,705			18,496			7.38	%
		307,650,327			4,065,366		5.36	%		305,219,674			4,305,430			5.72	%
Total interest earning assets		353,114,640			4,444,388		5.10	%		395,538,313			4,911,704			5.04	%
Noninterest bearing cash		3,058,825								6,119,405
Premises and equipment		7,062,415								7,210,983
Other assets		19,354,995								16,517,267
Allowance for loan losses		(4,559,041	)							(4,354,458	)
Unrealized gains (losses) on available for sale securities, net		(4,687,116	)							(4,480,297	)
	$	373,344,718							$	416,551,213
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing deposits:
Savings and NOW	$	53,963,643		$	33,346		0.25	%	$	50,055,783		$	30,076			0.24	%
Money market		43,448,581			71,965		0.67	%		46,643,585			98,218			0.85	%
Certificates of deposit		142,040,143			701,433		2.00	%		182,430,385			1,139,032			2.53	%
		239,452,367			806,744		1.37	%		279,129,753			1,267,326			1.84	%
Borrowed funds		29,148,333			212,124		2.95	%		47,531,630			328,537			2.80	%
Total interest bearing liabilities		268,600,700			1,018,868		1.54	%		326,661,383			1,595,863			1.98	%
Noninterest bearing deposits		68,270,623								51,021,605
Other liabilities		3,116,847								3,063,676
Stockholders' equity		33,356,548								35,804,549
Total liabilities and stockholders' equity	$	373,344,718							$	416,551,213
Net interest margin (b)	$	353,114,640		$	3,425,520		3.93	%	$	395,538,313		$	3,315,841			3.40	%

(a) Includes loans held for sale.
(b) Net interest margin is the ratio of net interest income to total average interest-earning assets.

Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. On a monthly basis, management reviews all loan portfolios to determine trends and monitor asset quality. For consumer loan portfolios, this review generally consists of reviewing delinquency levels on an aggregate basis with timely follow-up on accounts that become delinquent. In commercial loan portfolios, delinquency information is monitored and periodic reviews of business and property leasing operations are performed on an individual loan basis to determine potential collection and repayment problems. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

We recorded a provision for loan losses of $114,217 for the three month period ended March 31, 2011 compared to $134,686 for the same period in 2010. Nonaccrual loans, restructured loans, foreclosed real estate, and delinquent loans over 90 days still accruing interest to total loans and foreclosed real estate increased to 7.51% at March 31, 2011 from 5.31% at December 31, 2010.

Non-interest Income

Non-interest income for the three months ended March 31, 2011 was $1.6 million compared to $942,247 for the same period in 2010, an increase of $675,070, or 71.6%. This increase is primarily attributable to a decrease in losses on securities, as well as to increased fee income generated by our electronic banking division’s fee-based income. Partially offsetting these increases were declines in service charges income on deposit accounts and other fees and commissions during the first quarter of 2011 compared to the same period in 2010.

Brokerage commissions from services provided by CFS increased slightly by $2,397, or 1.21%, to $200,247 for the three month period ended March 31, 2011, compared to $197,850 during the same period in 2010 as investor demand for non-banking financial service products and services remained largely unchanged between the first quarters of 2010 and 2011.

Electronic banking fee income increased by $95,465, or 18.61%, for the three month period ended March 31, 2011 compared to the corresponding period in 2010. Electronic banking income is comprised of three sources: national point of sale (“POS”) sponsorships, ATM fees, and check card fees. The Company sponsors merchants who accept ATM cards for purchases within various networks (i.e. STAR, PULSE, NYCE). This national POS sponsorship income represents approximately 87% of total electronic banking revenue. Fees from ATMs represent approximately 4% of total electronic banking revenue. Fees from check cards and other service charges represent approximately 9% of electronic banking revenue. The higher fee income during the 2011 period is a result of an increased client base which generates a larger volume of fee-based transactions.

Mortgage banking revenue, net of commissions paid to mortgage lenders, increased by $34,981 to $775,594 for the three months ended March 31, 2011 from $740,613 for the same period in 2010, which is attributable to higher prices obtained from investors on loans sold and a 2.48% increase in originations during the three month period in 2011 compared to the same period in 2010. With interest rates remaining consistently low for more than one year, consumer demand for refinancings between the first quarter of 2011 and the first quarter of 2010 was relatively flat. As the economy strengthens, we anticipate increased consumer demand for financing of owner-occupied, residential properties.

Services charges on deposit accounts decreased by 17.2% to 123,736 for the first quarter of 2011 compared to $149,405 during the same three months of 2010. A decrease of $16,926 in non-sufficient funds fee income during the first three months of 2011 compared to the same period in 2010 was the primary reason for the overall decrease in service charges on deposit accounts income.

Other fees and commissions were $79,246 for the first quarter of 2011 compared to $94,817 for the first quarter of 2010. The $15,571 decrease relates primarily to the collection of one-time fees for letters of credit and loan prepayment fees during the first quarter of 2010.

We incurred losses on securities of $170,070 for the three month period ended March 31, 2011, compared to losses of $753,537 for the same period in 2010. The improvement relates to the stabilization of Trust Preferred securities held in our investment portfolio. During the first quarter of 2011, we recorded a write-down of Trust Preferred securities in the amount of $167,467 compared to $753,537 during the same period in 2010, an improvement of $586,070. These securities were written down through the income statement as the quarterly impairment analysis dictated. Impairments resulted from the deferral of dividends by several financial institutions or complete failure of the institution that hold the underlying debt obligations on these securities. It is possible that continuation of the current economic environment will result in additional write-downs resulting from future deferrals or failures. While this creates volatility in our earnings, the write-downs have very little effect on the Bank’s regulatory capital position since the regulatory capital calculations allocate enough capital to cover the unrealized losses. Management is hopeful that these investments will increase in value as the economy improves and management will continuously evaluate all strategies to maximize the ultimate value realized from these investments.

Non-interest Expense

Non-interest expenses increased by $286,765 for the three month period ended March 31, 2011, compared to the same period in 2010. The 6.49% increase between the first quarter of 2011 and 2010 includes a change in the structure of the mortgage banking division during the first quarter of 2010 that resulted in a shift of costs that were previously recorded as an offset to mortgage fee income, and to increased costs associated with past due loans and foreclosed properties. These increased expenses were partially offset by a non-recurring lawsuit settlement during the first quarter of 2010 and a deposit premium acquisition cost fully amortizing between the comparable quarters.

Salaries and employee benefits increased $287,849, or 12.9%, to $2.5 million during the first quarter of 2011 compared to $2.2 million during the first quarter of 2010. This increase is primarily related to increases in salaries and employee benefits resulting from a change in the structure of our mortgage origination business. In the first quarter of 2010, the majority of mortgage fee income was earned as a fixed fee paid by CMSI to the Bank based upon a percentage of the principal amount of loans originated and sold into the secondary market. In addition, all salaries and benefits of the loan officers were effectively reimbursed to the Bank from CMSI and therefore were not included in non-interest expenses. Under the new structure, which went into effect on March 1, 2010, we earn all of the fees received from borrowers and secondary market investors in connection with CMSI’s origination and sale of loans into the secondary market, and we pay the loan officers’ commissions, benefits and other expenses directly. The commissions are deducted from the mortgage fee income and as a result reduce the mortgage-banking fee portion of non-interest income. Any benefits or additional incentives are now recorded as salaries or benefits and therefore increase non-interest expense. Due primarily to the change of CMSI’s business structure, salary expense increased by $102,217 and employee benefit expense increased by $185,632 for the three months ended March 31, 2011 compared to the same period in 2010. No profitability incentives were earned during the first quarter of 2010.

Occupancy expense increased by $647 to $597,718 for the three months ended March 31, 2011, compared to $597,071 for the same three month period in 2010. Included in the slightly higher occupancy expenses for the 2011 period compared to the 2010 period were increases in real estate taxes of $4,592 and maintenance and repairs to buildings and premises of $11,772. These increased costs were offset by reductions in other occupancy costs of $15,817, primarily related to lower costs for snow removal during the first three months of 2011 compared to the first three months of 2010.

Professional services were $191,925 for the first quarter of 2011 compared to $83,276 for the first quarter of 2010, an increase of $108,649, or 130.5%. Included in the increased professional services expenses for the 2011 period compared to the 2010 period were higher consulting costs of $36,574 primarily related to retaining a business and strategic firm to enhance our growth and profitability efforts, an increase of $44,461 in legal fees mainly associated with increased costs associated with past due loans and foreclosed properties, and higher investment advisory and audit exam fees of $27,614 as both functions were outsourced in 2010 after the first quarter.

Furniture and equipment expense increased marginally by $463 year to date through March 31, 2011 compared to the same period in 2010, or 0.31%. During the first quarter of 2011 compared to the first quarter of 2010, slight increases in furniture and equipment depreciation, equipment rental and equipment maintenance expenses were offset by reductions in non-capital equipment purchases, personal property taxes, and automobile depreciation.

Other operating expenses decreased $110,843, or 8.2%, from $1.35 million during the first three months of 2010 to $1.24 million during the first three months of 2011. A non-recurring lawsuit settlement of $175,000 during the first quarter of 2010 is the most significant contributing factor to reduced other operating expenses. We trimmed marketing and advertising expenses by $15,864, or 21.8%, through vendor management and by focusing on reaching our target markets mentioned above, particularly small and mid-sized businesses. In June 2010, a deposit premium became fully amortized that reduced other operating expenses by $30,794 when comparing the first three months of 2011 to the first three months of 2010. Partially offsetting these decreased expenses was an increase of $115,337 in loan expense related primarily to past due loans and foreclosed properties, including attorney fees and court costs, paid to resolve credit issues that we expect will ultimately improve our asset quality.

Income Taxes

For the three month period ended March 31, 2011, we recorded income tax expense of $53,467 compared to a $162,439 tax benefit for the same period in 2010. The effective tax rate, which may fluctuate from year to year due to changes in the mix of tax-exempt loans, investments and operating losses, was 23.8% for the 2011 period as compared to (55.3)% for the 2010 period. The effective tax rates can fluctuate widely as a result of the proportion of tax-exempt income to total taxable income.

LIQUIDITY AND CAPITAL EXPENDITURES

Liquidity

Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers, as well as to meet current and planned expenditures.

Our liquidity is derived primarily from our deposit base and equity capital. Additionally, liquidity is provided through our portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, and securities available for sale. Such assets totaled $59.2 million, or 16.0%, of total assets at March 31, 2011.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $65.9 million at March 31, 2011. Of this total, management places a high probability of required funding within one year of approximately $24.5 million. The amount remaining is unused home equity lines and other consumer lines on which management places a low probability of funding.

We also have external sources of funds through the Federal Reserve Bank (“FRB”) and FHLB, which we can draw upon when required. We have a line of credit totaling approximately $54.5 million with the FHLB based on qualifying loans pledged as collateral. In addition, we can pledge securities at the FRB and FHLB and borrow approximately 97% of the fair market value of the securities. We had $12.5 million of securities pledged at the FHLB under which the Bank could have borrowed approximately $12.1 million. Also, the Bank has $3.9 million of securities pledged at FRB under which it could have borrowed approximately $3.8 million. Outstanding borrowings at the FHLB were $25.0 million at March 31, 2011. Fixed rate borrowings from FHLB include $10.0 million maturing during the second quarter of 2011, $9 million maturing in 2012, and $2.6 million maturing during 2013. The interest rates on these borrowings range from 3.175% to 4.33%. An overnight adjustable rate credit of $3.4 million was also outstanding as of March 31, 2011. The interest rate on this borrowing was 0.375% as of March 31, 2011. The overnight borrowings can be paid down or extended based upon the liquidity needs of the Company. Additionally, we have an unsecured federal funds line of credit of $5.0 million and a $10.0 million secured federal funds line of credit with other institutions. The secured federal funds line of credit with another institution would require the Bank to transfer securities pledged at the FHLB or FRB to this institution before it could borrow against this line. There was no balance outstanding under these lines at March 31, 2011. These lines bear interest at the current federal funds rate of the correspondent bank.

MARKET RISK AND INTEREST RATE SENSITIVITY

The Company’s interest rate risk represents the level of exposure it has to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The Asset/Liability Management Committee of the Bank’s Board of Directors (the “ALCO”) oversees our management of interest rate risk. The objective of the management of interest rate risk is to optimize net interest income during periods of volatility as well as stable interest rates while maintaining a balance between the maturity and repricing characteristics of assets and liabilities that is consistent with our liquidity, asset and earnings growth, and capital adequacy goals.

Due to changes in interest rates, the level of income for a financial institution can be affected by the repricing characteristics of its assets and liabilities. At March 31, 2011, we are in an asset sensitive position. Management continuously takes steps to reduce higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing. An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates.

INFLATION

Inflation may be expected to have an impact on the Company’s operating costs and thus on net income. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect the Company’s results of operations unless the fees charged by the Company could be increased correspondingly. However, the Company believes that the impact of inflation was not material for the first three months of 2011 or 2010.

OFF-BALANCE SHEET ARRANGEMENTS

We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit. In addition, we have certain operating lease obligations.

Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures (as that term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to provide material information about the Company to the chief executive officer, the chief financial officer, and others within the Company so that information may be recorded, processed, summarized, and reported as required under the SEC’s rules and forms. The Company’s chief executive officer and chief financial officer have evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report and, based on that evaluation, have each concluded that such disclosure controls and procedures are effective as of March 31, 2011.

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15 under the Exchange Act) during the quarter ended March 31, 2011, that have materially affected or are reasonably likely to materially affect the internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is involved in various legal actions arising from normal business activities. In management’s opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on our results of operation or financial condition.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors from those disclosed in Item 1A “Risk Factors” in our 2010 Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. (REMOVED AND RESERVED)

ITEM 5. OTHER INFORMATION

The company has notified Treasury that it will not make the dividend payment on the Series A Preferred Stock issued to Treasury under the Troubled Asset Relief Program Capital Purchase Program due on May 15, 2011. Under the terms of the Series A Preferred Stock, dividend payments are cumulative and failure to pay dividends for six dividend periods would trigger board appointment rights for the holder of the TARP preferred stock. The Company has paid all dividends due prior to the May 15, 2011 dividend payment. As a result, as of May 15, 2011, the Company will be $115,013 in arrears on dividend payments on the Series A Preferred Stock.

ITEM 6. EXHIBITS

(a)	Exhibits
	(31.1)	Rule 13a-14(a) Certification by the Principal Executive Officer

	(31.2)	Rule 13a-14(a) Certification by the Principal Financial Officer

	(32.1)	Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002

	(32.2)	Certification by the Principal Financial Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002

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.

		CARROLLTON BANCORP

		PRINCIPAL EXECUTIVE OFFICER:

Date	May 16, 2011	/s/Robert A. Altieri

		Robert A. Altieri
		President and Chief Executive Officer

		PRINCIPAL FINANCIAL OFFICER:

Date	May 16, 2011	/s/Mark A. Semanie

		Mark A. Semanie
		Chief Financial Officer

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BAY BANCORP, INC. Reports