UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

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

For the Quarterly Period Ended September 30, 2010

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

For the transition period from              to             

Commission File Number 0-22961

ANNAPOLIS BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	52-1595772
(State or other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

1000 Bestgate Road, Annapolis, Maryland 21401

(Address of principal executive offices)

(410) 224-4455

(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for a shorter period that the registrant was required to submit and post such files).    YES  ¨    NO   ¨

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	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  ¨    NO  x

At October 31, 2010, the Registrant had 3,920,126 shares of common stock outstanding.

TABLE OF CONTENTS

	PAGE
PART I – FINANCIAL INFORMATION
Item 1 – Financial Statements
Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009		1
Consolidated Statements of Operations for the Three and Nine Month Periods Ended September  30, 2010 and 2009 (unaudited)		2
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) for the Nine Month Periods Ended September 30, 2010 and 2009 (unaudited)		3
Consolidated Statements of Cash Flows for the Nine Month Periods Ended September  30, 2010 and 2009 (unaudited)		4-5
Notes to Consolidated Financial Statements (unaudited)		6-18
Item  2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		18-31
Item 3 – Quantitative and Qualitative Disclosures About Market Risk		32
Item 4 – Controls and Procedures		32
PART II – OTHER INFORMATION
Item 1 – Legal Proceedings		32
Item 1A – Risk Factors		32
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		32
Item 3 – Defaults Upon Senior Securities		32
Item 4 – Reserved		32
Item 5 – Other Information		32
Item 6 – Exhibits		33
SIGNATURES		34
CERTIFICATIONS		35-40

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

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

as of September 30, 2010 and December 31, 2009

(unaudited)

(in thousands)

	(Unaudited)		(Audited)
	September 30, 2010		December 31, 2009
Assets
Cash and due from banks	$	17,018	$	5,936
Interest-bearing deposits with banks		7,396		10,000
Federal funds sold and other overnight investments		14,112		8,828
Investment securities available for sale, at fair value		95,868		117,883
Federal Reserve and Federal Home Loan Bank stock		3,080		3,260
Loans held for sale		2,066		3,296
Loans, less allowance for credit losses of $7,394 and $7,926		270,283		270,736
Premises and equipment, net		8,895		9,274
Accrued interest receivable		1,429		1,934
Deferred income taxes		2,755		3,902
Investment in bank owned life insurance		5,392		4,226
Real estate owned		1,739		2,398
Other assets		2,506		2,659
Total Assets	$	432,539	$	444,332
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	43,874	$	40,834
Interest-bearing		288,352		309,629
Securities sold under agreements to repurchase		22,792		14,642
Long-term borrowings		35,000		40,000
Guaranteed preferred beneficial interests in junior subordinated debentures		5,000		5,000
Accrued interest payable and other liabilities		2,177		1,595
Total liabilities		397,195		411,700
Stockholders’ Equity
Preferred stock, par value $0.01 per share; authorized 5,000,000 shares; Series A, $1,000 per share liquidation preference, shares issued and outstanding 8,152 shares at September 30, 2010 and at December 31, 2009, net of discount		8,043		7,985
Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 3,914,941 shares at September 30, 2010 and 3,867,006 at December 31, 2009		39		39
Warrants		234		234
Paid in capital		11,604		11,501
Retained earnings		14,358		13,367
Accumulated other comprehensive income (loss)		1,066		(494	)
Total stockholders’ equity		35,344		32,632
Total liabilities and stockholders’ equity	$	432,539	$	444,332

1

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

for the Three and Nine Month Periods Ended September 30, 2010 and 2009

(unaudited)

(in thousands, except Shares and Per Share data)

	For the Three Months					For the Nine Months
	Ended September 30,					Ended September 30,
	2010			2009		2010			2009
Interest income
Loans	$	3,928		$	3,962	$	11,934		$	11,844
Investment securities		825			1,419		3,056			3,795
Interest-bearing deposits with banks		7			17		18			48
Federal funds sold and other overnight investments		11			6		29			46
Total interest income		4,771			5,404		15, 037			15,733
Interest expense
Interest-bearing deposits		734			1,214		2,556			4,444
Securities sold under agreements to repurchase		27			31		77			91
Long-term borrowings		285			312		868			927
Junior subordinated debentures		47			48		133			160
Total interest expense		1,093			1,605		3,634			5,622
Net interest income		3,678			3,799		11,403			10,111
Provision for credit losses		622			1,102		1,221			6,113
Net interest income after provision for credit losses		3,056			2,697		10,182			3,998
Noninterest income
Service charges and fees		309			316		882			903
Mortgage banking fees		23			27		55			73
Other fee income		146			84		358			344
Loss on sale of securities		—			—		(55	)		—
Gain on sale of loans		21			47		104			112
(Loss) gain on sale of real estate owned and repossessed assets		(30	)		8		18			8
Total noninterest income		469			482		1,362			1,440
Noninterest expense
Personnel		1,721			1,543		5,228			4,785
Occupancy and equipment		414			377		1,205			1,138
Data processing		212			208		629			640
Professional fees		95			197		420			548
Marketing		69			9		249			216
FDIC Insurance		140			139		427			464
Other operating expenses		421			341		1,278			1,108
Total noninterest expense		3,072			2,814		9,436			8,899
Income (loss) before income taxes		453			365		2,108			(3,461	)
Income tax expense (benefit)		154			142		754			(1,373	)
Net income (loss)		299			223		1,354			(2,088	)
Preferred stock dividend and discount accretion		123			120		364			322
Net income (loss) available to common shareholders	$	176		$	103	$	990		($	2,410	)
Basic earnings (loss) per common share	$	0.04		$	0.03	$	0.25		($	0.63	)
Basic weighted average shares		3,914,706			3,860,788		3,906,077			3,855,076
Diluted earnings (loss) per common share	$	0.04		$	0.03	$	0.25		($	0.63	)
Diluted weighted average shares		3,952,674			3,860,788		3,944,045			3,855,076

2

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

and Comprehensive Income (Loss)

for the Nine Month Periods Ended September 30, 2010 and 2009

(unaudited)

(dollars in thousands)

	Preferred Stock		Common Stock		Warrants		Paid in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total			Comprehensive Income
Balances, January 1, 2010	$	7,985	$	39	$	234	$	11,501	$	13,367		($	494	)	$	32,632
Net income		—		—		—		—		1,354			—			1,354		$	1,354
Stock options exercised and restricted stock issued		—		—		—		43		—			—			43			—
Preferred stock dividend declared and discount accretion		58		—		—		—		(363	)		—			(305	)		—
Stock-based compensation		—		—		—		53		—			—			53			—
Employee stock purchase plan		—		—		—		7		—			—			7			—
Reclassification adjustment for securities losses, net of taxes of $20 included in net income		—		—		—		—		—			35			35			35
Unrealized gain on investment securities, net of taxes of $996		—		—		—		—		—			1,525			1,525			1,525
Balances, September 30, 2010	$	8,043	$	39	$	234	$	11,604	$	14,358		$	1,066		$	35,344		$	2,914
	Preferred Stock		Common Stock		Warrants		Paid in Capital		Retained Earnings			Accumulated Other Comprehensive Loss			Total			Comprehensive Loss
Balances, January 1, 2009	$	—	$	38	$	—	$	11,299	$	15,517		($	40	)	$	26,814
Net loss		—		—		—		—		(2,088	)		—			(2,088	)	($	2,088	)
Issuance of Series A, preferred stock, net of discount		7,918		—		—		—		—			—			7,918			—
Issuance of warrants to purchase common stock		—		—		234		—		—			—			234			—
Stock options exercised and restricted stock issued		—		—		—		63		—			—			63
Preferred stock dividend declared and discount accretion		49		—		—		—		(322	)		—			(273	)		—
Stock-based compensation		—		—		—		71		—			—			71			—
Employee stock purchase plan		—		1		—		10		—			—			11			—
Unrealized loss on investment securities, net of taxes of $60		—		—		—		—		—			(94	)		(94	)		(94	)
Balances, September 30, 2009	$	7,967	$	39	$	234	$	11,443	$	13,107		($	134	)	$	32,656		($	2,182	)

3

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

for the Nine Month Periods Ended September 30, 2010 and 2009

(unaudited)

(in thousands)

	For the Nine Months Ended September 30,
	2010			2009
Cash flows from operating activities
Net income (loss)	$	1,354		($	2,088	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Depreciation and amortization		469			443
Amortization of premiums and accretions of discounts, net		288			218
Provision for credit losses		1,221			6,113
Origination of loans held for sale		(15,726	)		(21,041	)
Proceeds from sale of loans held for sale		17,060			20,927
Stock based compensation		53			71
Deferred income taxes		130			(2,038	)
Earnings on life insurance policies		(166	)		(107	)
Loss on sale of securities		55			—
Gain on sale of loans held for sale		(104	)		(112	)
Gain on sale of real estate owned and repossessed assets		(18	)		(8	)
Decrease (increase) in:
Accrued interest receivable		505			(59	)
Prepaids		269			(117	)
Other assets		(76	)		(11	)
(Decrease) increase in:
Accrued interest payable		(24	)		(57	)
Accrued income taxes, net of taxes refundable		23			346
Other liabilities		583			(8,414	)
Net cash provided by (used in) operating activities		5,896			(5,934	)
Cash flows from investing activities
Proceeds from sales and maturities of securities available for sale		60,267			52,094
Purchase of securities available for sale		(35,838	)		(94,116	)
Net (increase) decrease in federal funds sold		(5,284	)		8,137
Net decrease (increase) in interest-bearing certificates of deposit		2,604			(6,000	)
Net increase in loans receivable		(1,485	)		(12,182	)
Purchase of life insurance policy		(1,000	)		—
Purchase of premises and equipment, net of disposals		(122	)		(173	)
Proceeds from sales of real estate owned and repossessed assets		1,386			181
Net cash provided by (used in) investing activities		20,528			(52,059	)
Cash flows from financing activities
Net (decrease) increase in:
Time deposits		(14,203	)		4,969
Other deposits		(4,034	)		43,961
Securities sold under agreements to repurchase		8,150			3,917
Issuance of preferred stock and warrants		—			8,152
Repayment of long-term borrowing		(5,000	)		—
Proceeds from stock options exercised		43			63
Proceeds from issuance of common stock		7			11
Payment of preferred stock dividend		(305	)		(221	)
Net cash (used in) provided by financing activities		(15,342	)		60,852
Net increase in cash		11,082			2,859
Cash and cash equivalents, beginning of period		5,936			4,346
Cash and cash equivalents, end of period	$	17,018		$	7,205

4

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (continued)

for the Nine Month Periods Ended September 30, 2010 and 2009

(unaudited)

(in thousands)

	For the Nine Months Ended September 30,
	2010		2009
Supplemental cash flow information
Interest paid, including interest credited to accounts	$	3,615	$	6,062
Income taxes paid	$	1,083	$	611
Non-cash investing activities
Transfers from loans to real estate owned	$	621	$	—
Transfers from loans to other assets	$	96	$	1,021

5

Annapolis Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

for the Nine Month Periods Ended September 30, 2010 and 2009

(unaudited)

Note A – Basis of Presentation

The accompanying unaudited consolidated financial statements of Annapolis Bancorp, Inc. (the “Company”) have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments, including normal recurring accruals, necessary for a fair presentation have been made. These results are not necessarily indicative of the results that may be expected for the full calendar year

The consolidated balance sheet as of December 31, 2009 has been derived from the audited consolidated financial statements included in the Company’s 2009 Annual Report on Form 10-K. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been omitted in accordance with standards for the preparation of interim consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2009 Form 10-K. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2010.

The Company has evaluated subsequent events that may have occurred after the date of the financial statements for potential recognition and/or disclosure in this Quarterly Report on Form 10-Q.

Note B – Business

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

The Bank currently conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals from its headquarters in Annapolis, its six other branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Anne’s County, Maryland. The Bank has built its reputation on exemplary customer service and outreach to the communities surrounding each of the Bank’s locations. The Bank is committed to offering products and services that focus on relationship banking and provide an alternative to the large multi-regional financial institutions that are so pervasive in the markets the Bank serves. The Bank has selected its newest locations based on demographics and business development opportunities. The Bank attracts most of its customer deposits from Anne Arundel County, Maryland, and to a lesser extent, Queen Anne’s County, Maryland. The Bank’s lending operations are centered in Anne Arundel County, but extend throughout Central and Southern Maryland.

6

Note C – Stock Based Compensation

Stock based-compensation expense for the nine month periods ended September 30, 2010 and 2009 was $53,000 and $71,000, respectively. Stock-based compensation expense recognized in the consolidated statements of income for the first three quarters of 2010 and 2009 reflects estimated forfeitures. Stock-based compensation recognized in the three month period ended September 30, 2010 and 2009 was $33,000 and $25,000, respectively.

During the three quarters of 2010 and 2009, there were no options granted to employees or directors of the Company or Bank.

Stock option activity for the nine months ended September 30, 2010 and 2009 was as follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at January 1, 2010		183,819		$	5.05
Grants		—			—
Exercised		(17,776	)		2.42
Forfeitures		(6,221	)		7.24
Expired		(35,552	)		2.42
Outstanding as of September 30, 2010		124,270		$	6.06
Exercisable at September 30, 2010		121,378		$	6.00		3.0	$	41,000
Outstanding at January 1, 2009		216,261		$	4.87
Grants		—			—
Exercised		(7,777	)		2.64
Forfeitures		—			—
Outstanding as of September 30, 2009		208,484		$	4.95
Exercisable at September 30, 2009		194,620		$	4.66		2.8	$	34,000

The aggregate intrinsic value in the table above represents the total pre-tax value of the exercisable in-the-money options (that is, the difference between the closing stock price on the last trading day in the first nine months of 2010 and 2009, and the exercise price of the options multiplied by the number of shares) on September 30, 2010 and September 30, 2009. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised was $28,000 for the nine months ended September 30, 2010, and $2,000 for the nine months ended September 30, 2009. The total fair value of options that vested during the nine month period ending September 30, 2010 was $26,000 and $43,000 for the nine months ended September 30, 2009.

As of September 30, 2010, $8,000 of total unrecognized costs related to unvested options is expected to be recognized over a weighted average period of 1.2 years. As of September 30, 2009, $51,000 of total unrecognized costs related to unvested options was expected to be recognized over a weighted average period of 0.6 years.

7

During the third quarter of 2010 an employee of the Bank was awarded 5,000 restricted shares and 10,000 deferred restricted share units. The restricted shares vest in two equal installments beginning on September 27, 2011. The deferred restricted share units vest in five equal installments beginning on September 27, 2011 with the issuance of the underlying shares deferred until September 27, 2015. The market value on the award was $4.08 per share. There were no restricted shares granted to employees during the third quarter of 2009.

During the first quarter of 2010, an employee of the Bank was awarded 3,000 restricted shares at a market value of $3.75 per share. One-third of the restricted shares vest on each of the employee’s first three anniversaries of employment with the Bank, with the shares being fully vested on March 15, 2013. During the first quarter of 2009, an employee of the bank was awarded 1,500 restricted share units at a market value of $2.35 per share. Two-thirds of the restricted share units issued in the first quarter of 2009 have already vested. With the remaining 500 restricted share units vesting on December 13, 2010.

There were no restricted shares granted to employees during the second quarter of 2010. During the second quarter of 2009 an employee of the Bank was awarded 25,000 deferred restricted share units and 10,000 restricted shares. The deferred restricted share units vest in five equal installments beginning on April 27, 2010 with the issuance of the underlying shares deferred until April 27, 2014. The restricted shares vest in two equal annual installments beginning April 27, 2010. The market value of the shares on the date of the award was $3.50 per share. As of September 30, 2010, 5,000 of the 10,000 restricted shares have vested.

There were no restricted shares granted to non-employee directors during the third quarter of 2010 and 2009. During the first quarter of 2010, non-employee directors of the Bank were awarded a total of 15,384 shares of restricted stock at a market value of $3.90 per share in lieu of an annual retainer. These shares vest on January 28, 2011. During the first quarter of 2009, non-employee directors of the Bank were awarded a total of 22,000 shares of restricted stock at a market value of $2.50 per share in lieu of an annual retainer. These shares vested on January 23, 2010. There were no restricted shares granted to non-employee directors during the second quarter of 2010. During the second quarter of 2009, a new non-employee director was awarded 1,005 shares of restricted stock in lieu of a cash retainer at a market value of $2.90 per share. These shares vested on January 23, 2010. The award, which totaled $2,917, was based on the new director’s prorated share of an annual retainer of $5,000.

Non-compensation related expense of $15,000 was recognized for each of the three month periods ended September 30, 2010 and 2009, respectively and $45,000 and $43,000 for the nine month periods ending September 30, 2010 and 2009, respectively relating to the shares issued to non-employee directors. As of September 30, 2010, 6,000 restricted share units of the 92,384 restricted shares and restricted share units outstanding have vested; the remaining 86,384 shares will vest over a weighted average period of 1.3 years.

8

Restricted stock activity for the nine months ended September 30, 2010 and 2009 was as follows:

	Shares			Weighted Average Grant Price
Outstanding at January 1, 2010		98,005		$	3.69
Grants		33,384			3.90
Issued		(28,005	)		2.68
Forfeitures		(11,000	)		8.92
Outstanding as of September 30, 2010		92,384		$	3.45
Outstanding at January 1, 2009		19,150		$	8.47
Grants		59,505			3.15
Issued		(8,150	)		7.87
Forfeitures		—			—
Outstanding as of September 30, 2009		70,505		$	4.05

As of September 30, 2010, $238,000 of total unrecognized costs related to unvested restricted shares and restricted share units is expected to be recognized over a weighted average period of 1.3 years. As of September 30, 2009, $176,000 of total unrecognized costs related to unvested restricted shares and restricted share units was expected to be recognized over a weighted average period of 2.0 years.

Note D – Earnings Per Share

Information regarding earnings per share is summarized as follows:

Computation of Earnings Per Share

(in thousands, except Earnings Per Share)

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2010		2009		2010		2009
Net income (loss) available to common shareholders	$	176	$	103	$	990	($	2,410	)
Weighted average common shares outstanding		3,915		3,861		3,906		3,855
Basic Earnings (Loss) Per Common Share	$	0.04	$	0.03	$	0.25	($	0.63	)
Net income (loss) available to common shareholders	$	176	$	103	$	990	($	2,410	)
Weighted average common shares outstanding		3,915		3,861		3,906		3,855
Effect of potential dilutive common shares		38		—		38		—
Total weighted average diluted common shares outstanding		3,953		3,861		3,944		3,855
Diluted Earnings (Loss) Per Common Share	$	0.04	$	0.03	$	0.25	($	0.63	)

Basic earnings (loss) per share are calculated using the weighted-average number of shares of common stock outstanding during the period. Diluted earnings (loss) per common share are calculated using the weighted-average number of shares of common stock plus dilutive potential shares of common stock outstanding during the period. Potential common shares consist of stock

9

options and restricted stock, restricted share units and warrants. For each of the three and nine months ended September 30, 2010 and 2009, 389,116 and 391,297 shares of common stock, respectively, attributable to outstanding stock options, restricted stock, restricted share units and warrants were excluded from the calculations of diluted earnings per share because their effect was anti-dilutive.

Note E – Investment Securities

Investment securities are summarized as follows:

	Amortized		Unrealized		Unrealized		Estimated Fair
(dollars in thousands)	Cost		Gains		Losses		Value
September 30, 2010
Available for sale
U.S. Government agency	$	47,244	$	587	$	42	$	47,789
State and municipal		1,079		38		—		1,117
Mortgage-backed securities		45,190		1,285		140		46,335
Other equity securities		594		33		—		627
	$	94,107	$	1,943	$	182	$	95,868
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
December 31, 2009
Available for sale
U.S. Government agency	$	55,558	$	137	$	907	$	54,788
State and municipal		1,080		10		1		1,089
Mortgage-backed securities		61,482		615		682		61,415
Other equity securities		578		13		—		591
	$	118,698	$	775	$	1,590	$	117,883

The amortized cost and estimated fair value of securities by contractual maturities at September 30, 2010 are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

	September 30, 2010
	Available for Sale
	Amortized Cost		Estimated Fair Value
(dollars in thousands)
Due within one year	$	5,067	$	5,073
Due after one through five years		12,383		12,472
Due after five through ten years		20,369		20,713
Due after ten years		55,694		56,983
Equity securities		594		627
	$	94,107	$	95,868

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The following table shows the level of the Company’s gross unrealized losses and the fair value of the associated securities by type and maturity for securities available for sale at September 30, 2010.

	Less than 12 months				12 months or more				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
(dollars in thousands)
U. S. Government agency	$	6,778	$	29	$	975	$	13	$	7,753	$	42
Mortgage-backed securities		1,994		2		2,558		138		4,552		140
	$	8,772	$	31	$	3,533	$	151	$	12,305	$	182

The unrealized losses that exist are the result of market changes in interest rates since the original purchase. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2010. The Company has used a variety of tools to analyze the contents of its security portfolio and at this time does not believe that the unrealized losses in the portfolio are other than temporary.

Note F – Fair Value Measurements

Fair Value Hierarchy

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

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

Level 2 inputs – Inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs that are derived principally from or can be corroborated by observable market data by correlation or other means.

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

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

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In January 2010, FASB issued the update “Improving Disclosures About Fair Value Measurements,” which added disclosure requirements about transfers in and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring Level 2 and 3 fair value measurements. The adoption of this update which was subsequently codified into “Fair Value Measurements and Disclosures,” only affected the requirements for fair value measurements and as a result had no impact on the Company’s statements of income and condition.

This update also requires that Level 3 activity about purchases, sales, issuances, and settlements be presented on a gross basis rather than a net number as currently permitted. This provision of the update is effective for the Company’s reporting period ending March 31, 2011. As this provision amends only the disclosure requirements for fair value measurements, the adoption will have no impact on the Company’s statements of condition and income.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s assets measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

			Fair Value Measurements
(dollars in thousands)			at September 30, 2010 Using
Description	Fair Value September 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investment Securities Available for Sale – Debt Securities
Issued by the U.S. Treasury and Government agencies	$	47,789	$	—	$	47,789	$	—
Issued by State and municipal		1,117		—		1,117		—
Mortgage-backed securities issued by Government agencies		42,706		—		42,706		—
Other debt securities		3,629		—		3,629		—
Total Debt Securities		95,241		—		95,241		—
Investment Securities Available for Sale – Equity Securities
Mutual funds		627		—		627		—
Total Equity Securities		627		—		627		—
Total Assets Measured at Fair Value on a Recurring Basis	$	95,868	$	—	$	95,868	$	—

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			Fair Value Measurements
(dollars in thousands)			at December 31, 2009 Using
Description	Fair Value December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investment Securities Available for Sale – Debt Securities
Issued by the U.S. Treasury and Government agencies	$	54,788	$	—	$	54,788	$	—
Issued by State and municipal		1,089		—		1,089		—
Mortgage-backed securities issued by Government agencies		56,377		—		56,377		—
Other debt securities		5,038		—		5,038		—
Total Debt Securities		117,292		—		117,292		—
Investment Securities Available for Sale – Equity Securities
Mutual funds		591		—		591		—
Total Equity Securities		591		—		591		—
Total Assets Measured at Fair Value on a Recurring Basis	$	117,883	$	—	$	117,883	$	—

Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the following tables.

			Fair Value Measurements
(dollars in thousands)			at September 30, 2010 Using
Description	Fair Value September 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Loans
Commercial	$	1,670	$	—	$	1,670	$	—
Commercial real estate		1,431		—		1,431		—
Residential real estate		2,109		—		2,109		—
Construction		2,815		—		2,815		—
Consumer		669		—		669		—
Total loans		8,694		—		8,694		—
Real estate owned		1,739		—		1,739		—
Other assets (repossessed property)		100		—		100		—
Total Assets Measured at Fair Value on a Non-Recurring Basis	$	10,533	$	—	$	10,533	$	—

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			Fair Value Measurements
(dollars in thousands)			at December 31, 2009 Using
Description	Fair Value December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Loans
Commercial	$	4,987	$	—	$	4,987	$	—
Commercial real estate		2,217		—		2,217		—
Residential real estate		1,454		—		1,454		—
Construction		4,644		—		4,644		—
Consumer		448		—		448		—
Total loans		13,750		—		13,750		—
Real estate owned		2,398		—		2,398		—
Other assets (repossessed property)		122		—		122		—
Total Assets Measured at Fair Value on a Recurring Basis	$	16,270	$	—	$	16,270	$	—

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

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

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

Management establishes a specific reserve for loans that have an estimated fair value below the carrying value. Nonperforming loans had a carrying value of $13.2 million as of September 30, 2010. Of the $13.2 million of nonperforming loans, $6.8 million had specific reserves of $2.5 million.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for credit losses. Losses are recognized in the period an obligation becomes uncollectible. The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though a partial recovery may occur in the future. During the nine months ended September 30, 2010 the Company charged-off $1.8 million of impaired loans to the allowance for credit losses.

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Property acquired by the Company as a result of foreclosure on a mortgage loan will be classified as “real estate owned.” Personal property acquired through repossession will be classified as “repossessed assets.” Property acquired will be recorded at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carried at the lower of cost or net realizable value. Any required write-down of the loan to its net realizable value will be charged against the allowance for credit losses. As of September 30, 2010 the Company held $1.7 million in real estate owned as a result of foreclosure. Real estate owned carried at appraised value are considered to be using Level 2 inputs. The Company held $2.4 million in real estate owned as a result of foreclosure as of December 31, 2009.

The Company records repossessed assets such as boats, automobiles or equipment at the lower of cost or estimated fair value on the acquisition date and at the lower of such initial amount or estimated fair value less selling costs thereafter. Estimated fair value is generally based upon independent values of the collateral obtained through valuation or listing services specifically used for the type of asset repossessed. We consider these collateral values to be estimated using Level 2 inputs. Repossessed assets totaled $100,000 at September 30, 2010 and $122,000 at December 31, 2009.

FASB guidance permits, but does not require, entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. The Company has not elected the fair value option for any financial assets or liabilities at September 30, 2010.

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

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	September 30, 2010				December 31, 2009
	Carrying		Estimated Fair		Carrying		Estimated Fair
(dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Cash and due from banks	$	17,018	$	17,018	$	5,936	$	5,936
Interest bearing balances with banks		7,396		7,396		10,000		10,000
Federal funds sold		14,112		14,112		8,828		8,828
Investment securities		95,868		95,868		117,883		117,883
Federal Reserve and Federal Home Loan Bank stock		3,080		3,080		3,260		3,260
Loans and loans held for sale, net		272,349		273,207		274,166		274,056
Accrued interest receivable		1,429		1,429		1,934		1,934
Bank owned life insurance		5,392		5,392		4,266		4,266
Real estate owned		1,739		1,739		2,398		2,398
Financial liabilities
Noninterest-bearing deposits	$	43,874	$	43,874	$	40,834	$	40,834
Interest-bearing deposits		288,352		289,168		309,629		315,343
Securities sold under agreements to repurchase		22,792		22,792		14,642		14,642
Long-term borrowings		35,000		31,508		40,000		38,308
Junior subordinated debt		5,000		5,000		5,000		5,000
Accrued interest payable		187		187		211		211

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

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

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

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

The carrying amount of accrued interest receivable approximates fair value.

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

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

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

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

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

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

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

The carrying amount of accrued interest payable approximates fair value.

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

Note H – Preferred Stock

On January 30, 2009, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), 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) 8,152 shares of Fixed Rate Cumulative preferred Stock, Series A, liquidation preference $1,000 per share (“Series A preferred stock”), and (ii) a warrant to purchase 299,706 shares of the Company’s common stock, par value $0.01 per share, for an aggregate purchase price of $8,152,000 in cash.

The Series A preferred stock qualifies as Tier 1 capital and 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. On and after February 15, 2012, the Company may, at its option, redeem shares of Series A preferred stock, in whole or in part, at any time and from time to time, for cash at a per share amount equal to the sum of the liquidation preference per share plus any accrued and unpaid dividends to but excluding the redemption date. Prior to February 15, 2012, the Company may redeem shares of Series A preferred stock only if it has received aggregate gross proceeds of not less than $2,038,000 from one or more qualified equity offerings, and the aggregate redemption price may not exceed the net proceeds received by the Company from such offerings. The redemption of the Series A preferred stock requires prior regulatory approval.

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

17

Note I – New Accounting Pronouncements

Recent Accounting Provisions Adopted

In April 2010, FASB issued ASU No. 2010-18, “Receivables” (Topic 310), Effect of a Loan Modification When the Loan is Part of a Pool that is Accounted for as a Single Asset. Modifications of loans that are accounted for within a pool do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. ASU No. 2010-18 is effective for modifications of loans accounted for within pools for the first interim or annual period ending on or after July 15, 2010 and are to be applied prospectively although early application is permitted. The adoption of this guidance did not have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.

All pending but not yet effective Accounting Standards Updates (“ASU”) were evaluated, none of which had a material impact on the Company’s financial condition or results of operations.

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

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

Significant accounting policies followed by the Company are presented in Note 1 to the Company’s 2009 consolidated financial statements which can be found on the Company’s Form 10-K and recent accounting provisions adopted have been presented herein in Note I. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts management has identified the determination of the allowance for credit losses to be the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

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

Allowance for Credit Losses Methodology

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

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

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

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

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

Management believes this approach effectively measures the risk associated with any particular loan or group of loans. The Bank’s Board of Directors engages an independent loan review consultant to evaluate the adequacy of the Bank’s allowance for credit losses. In addition,

19

various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated credit losses based upon judgments different from those of management. The Bank recorded a total provision for credit losses of $622,000 for the three month period ended September 30, 2010 and $1.1 million for the same period in 2009. For the nine month periods ended September 30, 2010 and 2009 the Bank recorded provisions of $1.2 million and $6.1 million, respectively. The aggregate provision was based upon the results of quarterly evaluations using a combination of factors including the level of nonperforming loans, the Bank’s growth in total gross loans and the Bank’s net credit loss experience. Total gross loans, including loans held for sale, decreased by $2.3 million for the nine months ended September 30, 2010. For the same period the Bank recorded charge-offs of $1.8 million, which included one loan for $1.0 million, on loans deemed uncollectible and recovered $37,000 on previously charged-off loans. As of September 30, 2010, the Bank’s allowance for credit losses was $7.4 million or 2.64% of total loans and 64.9% of nonperforming loans as compared to $7.9 million, or 2.81% of total loans and 47.2% of nonperforming loans as of December 31, 2009.

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

Activity in the allowance for credit losses for the nine months ended September 30, 2010 and 2009 is shown below:

(dollars in thousands)	For the Nine Months
	Ended September 30,
	2010			2009
Total loans outstanding - at September 30(1)	$	279,743		$	279,144
Average loans outstanding year-to-date(1)	$	276,931		$	271,843
Allowance for credit losses at beginning of period	$	7,926		$	4,123
Provision charged to expense		1,221			6,113
Charge-offs:
Commercial loans		1,242			369
Real estate and construction		221			168
Consumer and other loans		327			715
Total		1,790			1,252
Recoveries:
Commercial		3			—
Real estate and construction		3			95
Consumer and other loans		31			13
Total		37			108
Net charge-offs		1,753			1,144
Allowance for credit losses at end of year	$	7,394		$	9,092
Allowance for credit losses as a percent of total loans		2.64	%		3.26	%
Net charge-offs as a percent of average loans		0.63	%		0.42	%

⁽¹⁾ Includes loans held for sale.

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The Company’s nonperforming assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, loans with repossessed collateral and repossessed assets, totaled $13.2 million at September 30, 2010, compared to $19.3 million at December 31, 2009, a decrease of $6.1 million or 31.6%. The percentage of nonperforming assets to total assets was 3.06% at September 30, 2010, compared to 4.35% at December 31, 2009. The decrease in nonperforming assets was principally attributable to the payoff of one commercial loan ($4.6 million) that had been classified as nonperforming, the transfer of two loans ($2.6 million) to performing status, a $1.0 million partial charge-off of a loan with the remaining balance still considered to be nonperforming and the addition of a $1.1 million commercial construction loan.

The $13.2 million in nonperforming assets at September 30, 2010 included $10.6 million in nonaccrual loans, $763,000 in loans delinquent 90 days or more and $1.8 million in other assets. Of the $11.4 million in nonaccrual and loans delinquent 90 days or more at September 30, 2010, $8.2 million were secured by real estate, $2.4 million were commercial loans and $770,000 were consumer and other loans. At December 31, 2009 assets classified as nonperforming totaled $19.3 million and consisted of $16.8 million in nonaccrual loans and loans delinquent 90 days or more and $2.5 million in other assets. Included in the $16.8 million of nonaccrual and loans delinquent 90 days or more was $9.5 million of loans secured by real estate, $6.7 million of commercial and $517,000 of consumer and other loans.

Comparison of Financial Condition at September 30, 2010 and December 31, 2009

During the first nine months of 2010, the Company strategically lowered total assets ending the third quarter at $432.5 million as of September 30, 2010 compared to $444.3 million at December 31, 2009. Total assets decreased $11.8 million or 2.7% for the nine months ended September 30, 2010. In the first quarter of 2010 the Company’s used low yielding federal funds sold to pay down $5.0 million of higher priced Federal Home Loan Bank convertible debt.

The Company lowered the average maturity of its investment portfolio by selling a number of longer term government agency securities and several private issued mortgage-backed securities. The redemption of a number of callable securities immediately prior to September 30, 2010 resulted in an increase in federal funds sold balances and a decrease in investment securities. Investment securities decreased $22.0 million or 18.7% compared to December 31, 2009.

Gross loans including loans held for sale at September 30, 2010 totaled $279.7 million compared to $282.0 million at December 31, 2009, a decrease of $2.3 million or 0.8%. Loan production improved slightly during the most recent quarter but for the nine months ended September 30, 2010 continued to be negatively impacted by general economic conditions. The decrease in loans can be attributed to the sale of $1.5 million (net of new loans originated) of mortgage loans held for sale, the payoff of $3.5 million of commercial and real estate loans and the $1.0 million partial charge-off of a commercial term loan.

Deposits of $332.2 million at September 30, 2010 represent a decrease of $18.2 million or 5.2% from December 31, 2009 deposits of $350.5 million. Certificates of deposit decreased $14.2 million or 14.7% as certificates of deposit opened by customers primarily to take advantage of higher yields were not renewed at maturity when yields were reduced. Partially offsetting the decrease in certificates of deposit was an increase in demand deposit balances of $3.0 million or 7.4%.

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The Company maintained $5,000,000 in variable rate capital securities that had been issued to institutional investors. The securities take the form of junior subordinated debentures. The current rate on these debentures is 3.44%. The capital securities are scheduled to mature on March 26, 2033. The capital securities are now callable on a quarterly basis.

On January 30, 2009, the Company sold 8,152 shares of the Series A Preferred Stock, having a liquidation amount per share equal to $1,000, and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to Treasury under TARP CPP for a total purchase price of $8,152,000.

Comparison of Operating Results for the Nine Months Ended September 30, 2010 and 2009.

General. The Company recorded net income of $1.4 million for the nine months ended September 30, 2010, compared to a net loss of $2.1 million, for the nine months ended September 30, 2009. Net income available to common shareholders for the nine months ended September 30, 2010 was $990,000 or $0.25 per basic and diluted common shares compared to a net loss of $2.4 million or ($0.63) per basic and diluted shares available to common shareholders for the nine months ended September 30, 2009. Net interest income increased by $1.3 million or 12.8% for the nine months ended September 30, 2010 compared to the same period in 2009. The provision for credit losses decreased $4.9 million or 80.0% from $6.1 million for the nine months ended September 30, 2009 to $1.2 million for the nine months ended September 30, 2010. The decrease in provision expense was the result of improved asset quality and a decrease in outstanding loan balances as of September 30, 2010 compared to September 30, 2009.

Interest Income. Total interest income decreased $696,000 or 4.4% for the nine months ended September 30, 2010 compared to the same period in 2009 as a result of lower yields on real estate loans and investment securities. Interest on investment securities decreased $739,000 or 19.5% as the yield on the portfolio decreased to 3.78% from 4.65% for the nine months ended September 30, 2010 compared to the same period in 2009. Income on the loan portfolio increased $90,000 for the nine months ended September 30, 2010 to $11.9 million from $11.8 million for the nine months ended September 30, 2009 due in part to an increase in average loan balances of $5.1 million and the recognition of income from several loans previously classified as nonaccrual that had either been paid off or returned to performing status as of September 30, 2010. The yield, however, on the loan portfolio decreased to 5.76% for the nine months ended September 30, 2010 from 5.83% for the nine months ended September 30, 2009.

Interest Expense. Total interest expense decreased by $2.0 million or 35.4% for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The decrease was due to reducing the yields on the Company’s interest-bearing accounts including the “Superior Savings” product. The Company’s savings product had an average balance of $141.4 million for the nine months ended September 30, 2010 and a yield of 1.03% compared to an average balance of $141.8 million and a yield of 1.90% for the nine months ended September 30, 2009. Contributing to the decrease in interest expense was the lower yields on all other deposit products, primarily money market accounts and certificates of deposit and the lower yields on repurchase agreements and junior subordinated debt. The average rate of interest paid on all interest-bearing liabilities was 1.36% for the nine months ended September 30, 2010 compared to 2.02% for the nine months ended September 30, 2009. Interest expense on long-term borrowings and junior subordinated debentures was $1.0 million for the nine months ended September 30, 2010 compared to $1.1 million for the nine months ended September 30, 2009, a decrease of $86,000. The decrease was a result of the yield on the trust preferred securities decreasing to 3.56% for the nine months ended September 30, 2010 compared to 4.28% for the same period in 2009.

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Net Interest Income. Net interest income increased by $1.3 million or 12.8% for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase was primarily the result of the lower overall cost of deposits and borrowed funds. The Company’s cost of funds decreased to 1.22% for the nine months ended September 30, 2010 compared to 1.83% for the nine months ended September 30, 2009.

For the nine months ended September 30, 2010, the net interest margin increased to 3.68% compared to 3.18% for the nine months ended September 30, 2009. The increase in net interest margin was primarily the result of the lower cost of funds. The yield on earning assets decreased to 4.85% for the nine months ended September 30, 2010 from 4.95% for the same period in 2009. Approximately $280,000 of interest and fees on loans previously categorized as nonaccrual was recognized during the nine month period end September 30, 2010. Approximately $30,000 in interest was reversed on loans placed on nonaccrual during the same period. During the nine months ended September 30, 2009 a reduction in income due to the reversal of previously earned interest on loans categorized as nonaccrual of $101,000 was recognized.

Provision for Credit Losses. The Bank recorded a provision for credit losses of $1.2 million for the nine months ended September 30, 2010 compared to $6.1 million for the same period in 2009. The provision was based on the composition and credit quality of the loan portfolio as of September 30, 2010 and reflected the loss experience used to calculate the allowance for credit losses and the qualitative factors relating to local economic conditions. Total gross loans decreased by $2.3 million for the nine month period ended September 30, 2010 compared to December 31, 2009. The Bank recorded net charge-offs on loans deemed uncollectible of $1.8 million for the nine months ended September 30, 2010 including the charge-off of one loan for $1.0 million compared to net charge-offs of $1.1 million for the same period in 2009.

Noninterest Income. Total noninterest income of $1.4 million reflected a decrease of $78,000 or 5.4% for the nine months ended September 30, 2010 compared to the same period in 2009. The decrease in noninterest income was due to a reduction in rental income as a result of the conclusion, in December 2009, of the sublet agreement of a portion of the Bank’s headquarters building, a decrease in fees earned from the Bank’s mortgage operations and losses recorded on the sale of several investment securities.

Noninterest Expense. Total noninterest expense increased by $537,000 or 6.0% for the nine months ended September 30, 2010 compared to the same period in 2009. The increase in total noninterest expense during the first nine months of 2010 compared with the same period in 2009 resulted from increased personnel expense of $443,000 related to staff additions and increased benefit costs. Other expense increased by $170,000 over the same period in 2009 primarily due to costs associated with managing real estate owned and repossessed assets. FDIC expense decreased $37,000 for the nine month period ending September 30, 2010 as the nine month period ended September 30, 2009 included a Special Assessment from the FDIC. Contributing to the decrease in FDIC expense was lower deposit levels, which were partially offset by higher assessment rates.

Income Tax Expense. The Company recorded income tax expense for the nine-month period ended September 30, 2010 of $754,000 compared to a tax benefit of $1.4 million recorded

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for the nine months ended September 30, 2009 as a result of the net loss incurred for the nine months ended September 30, 2009. The Company’s combined effective federal and state income tax rate was approximately 35.8% (expense) for the nine months ended September 30, 2010 versus 39.7% (benefit) for the nine months ended September 30, 2009. The decrease in the effective tax rate for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 was the result of being able to exclude a higher level of state tax exempt investment income.

The table below sets forth certain information regarding changes in interest income and interest expense attributable to (1) changes in volume (change in volume multiplied by the old rate); (2) changes in rates (change in rate multiplied by the old volume); and (3) changes in rate/volume (change in rate multiplied by change in volume).

Rate/Volume Analysis

(dollars in thousands)	Nine Months Ended September 30, 2010 vs. 2009
				Due to Change in
	Increase or (Decrease)			Volume			Rate			Rate/ Volume
Interest income on:
Loans	$	90		$	222		($	129	)	($	3	)
Investment securities available for sale		(739	)		(30	)		(715	)		6
Interest-bearing deposits with banks		(30	)		(35	)		18			(13	)
Federal funds sold and other overnight investments		(17	)		25			(27	)		(15	)
Total interest income		(696	)		182			(853	)		(25	)
Interest expense on:
NOW accounts		(4	)		4			(7	)		(1	)
Money market accounts		(104	)		(30	)		(81	)		7
Savings accounts		(928	)		(7	)		(924	)		3
Certificates of deposit		(852	)		(195	)		(725	)		68
Securities sold under agreements to repurchase		(14	)		(1	)		(13	)		—
Long-term borrowing		(59	)		(83	)		26			(2	)
Guaranteed preferred beneficial interests in junior subordinated debentures		(27	)		—			(27	)		—
Total interest expense		(1,988	)		(312	)		(1,751	)		75
Net interest income	$	1,292		$	494		$	898		($	100	)

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Consolidated Average Balances, Yields and Rates

(dollars in thousands)	Nine Month Periods Ended
	September 30, 2010							September 30, 2009
	Average Balance		Interest (1)		Yield/ Rate			Average Balance		Interest (1)		Yield/ Rate
Assets
Interest earning assets
Interest-bearing deposits with banks		8,194		18		0.29	%		13,727		48		0.47	%
Federal funds sold and other overnight investments	$	21,234	$	29		0.18	%	$	30,086	$	46		0.20	%
Investment securities available for sale		108,046		3,056		3.78	%		108,893		3,795		4.65	%
Loans (2)		276,931		11,934		5.76	%		271,843		11,844		5.83	%
Total interest earning assets		414,405		15,037		4.85	%		424,549		15,733		4.95	%
Noninterest earning assets
Cash and due from banks		5,808							7,037
Other assets		15,401							13,022
Total Assets	$	435,614						$	444,608
Liabilities and Stockholders’ Equity
Interest-bearing Liabilities
NOW accounts	$	29,743	$	35		0.16	%	$	26,919	$	39		0.19	%
Money market accounts		42,236		217		0.69	%		46,642		321		0.92	%
Savings accounts		141,354		1,084		1.03	%		141,830		2,012		1.90	%
Certificates of deposit		87,439		1,220		1.87	%		96,527		2,072		2.87	%
Securities sold under agreements to repurchase		14,958		77		0.69	%		15,060		91		0.81	%
Long-term borrowings		36,424		868		3.19	%		40,000		927		3.10	%
Guaranteed preferred beneficial interests in junior subordinated debentures		5,000		133		3.56	%		5,000		160		4.28	%
Total interest-bearing liabilities		357,154		3,634		1.36	%		371,978		5,622		2.02	%
Noninterest-bearing liabilities
Noninterest-bearing deposits		42,194							38,477
Other liabilities		1,724							2,005
Stockholders’ Equity		34,542							32,148
Total Liabilities and Stockholders’ Equity	$	435,614						$	444,608
Interest rate spread						3.49	%						2.93	%
Ratio of interest earning assets to interest-bearing liabilities						116.03	%						114.13	%
Net interest income and net interest margin			$	11,403		3.68	%			$	10,111		3.18	%

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

(2) Includes loans held for sale.

Comparison of Operating Results for the Three Months Ended September 30, 2010 and 2009.

General. The Company recorded net income for the three months ended September 30, 2010 of $299,000 compared to net income of $223,000 for the three months ended September 30, 2009. Net income available to common shareholders was $176,000 or $0.04 per basic and diluted common share, compared to a net income available to common shareholders of $103,000 or $0.03 per basic and diluted common share for the three months ended September 30, 2009. Net interest income decreased by $121,000 or 3.2% for the three months ended September 30, 2010 compared to the same in period in 2009. The Bank recorded $622,000 in provision for credit losses during the three months ended September 30, 2010, compared to $1.1 million in provision for credit losses during the same period in 2009.

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Interest Income. Interest income decreased $633,000 or 11.7% for the quarter ended September 30, 2010 compared to the same quarter in 2009 as a result of a decrease in the level of average earning assets, a decrease in the yield on the loan portfolio and a decrease in the level and yield on the investment portfolio. Average earning assets decreased $18.2 million to $409.5 million for the quarter ended September 30, 2010 from $427.7 million for the same period in 2009 while the yield on loan portfolio decreased to 5.62% from 5.72% for the three months ended September 30, 2010 compared to September 30, 2009. The decrease in earning assets was the result of a reduced level of investment securities as funds received for called securities were used to repay $5.0 million of Federal Home Loan Bank convertible advances and to fund the attrition of deposit balances as the Bank lowered interest rates on the majority of its deposit products. Income on the investment portfolio decreased $594,000 for the quarter ended September 30, 2010 compared to the same period in 2009 as average investment security balances decreased by $27.0 million compared to the same period in 2009 and the yield decreased to 3.28% from 4.44% for the same period.

Interest Expense. Interest expense decreased by $512,000 or 31.9% for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 while average interest-bearing deposit balances decreased $20.0 million. The decrease in average interest-bearing deposit balances was a result of lowering the rates offered on the majority of its deposit product, resulting in planned run-off of the previously higher paying account types such as certificates of deposit. Interest expense on interest-bearing deposits for the quarter ending September 30, 2010 was $734,000 compared to $1.2 million for the same period in 2009, a 39.5% decrease. The decrease in interest expense was due to the lower cost of all interest-bearing deposit types with the yield dropping to 0.99% for the three months ended September 30, 2010 compared to 1.54% for the three months ended September 30, 2009. A decrease in the Company’s cost of savings accounts to 0.89% from 1.34%, a decrease in the cost of the Company’s money market accounts to 0.57% from 0.85% and a decrease to 1.69% from 2.56% in the cost of the Company’s certificates of deposit contributed to the reduction in interest expense. The total yield on interest-bearing liabilities decreased for the quarter ended September 30, 2010 to 1.24% from 1.71% for the quarter ended September 30, 2009. The Company’s overall cost of funds decreased to 1.10% from 1.54% for the same periods. Interest expense on long-term borrowings and junior subordinated debentures was $332,000 for the three months ended September 30, 2010 compared to $360,000 for the three months ended September 30, 2009, a decrease of $28,000 as average long-term borrowings decreased to $40.0 million from $45.0 million. The cost of borrowings for the three month periods ending September 30, 2010 and 2009 increased slightly to 3.29% from 3.17% for the same period in 2009.

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

Net interest income decreased by $121,000 or 3.2% for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decline was due primarily to a decrease in the yield on earning assets.

For the three months ended September 30, 2010, the net interest margin improved to 3.56% compared to 3.52% for the three months ended September 30, 2009, with the interest rate spread for the same period increasing to 3.38% in the third quarter of 2010 from 3.31% in the same

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quarter in 2009. The increase in the net interest margin was the result of a decrease in the yield paid on interest-bearing liabilities to 1.24% from 1.71%. The returns on federal funds sold, interest bearing balances with banks, and the overall investment portfolio were negatively impacted by the lower rate environment as re-investment rates have continued to fall quarter over quarter.

Provision for Credit Losses. The Bank recorded a provision for credit losses of $622,000 for the three months ended September 30, 2010 compared to $1.1 million for the same period in 2009. The decrease in provision was due to in part to lower levels of nonperforming assets and lower loans outstanding. The Bank recorded net charge-offs of $9,000 for the quarter ended September 30, 2010 compared to net charge-offs of $529,000 for the three months ended September 30, 2009. The third quarter 2009 charge-offs were predominately boat loans while there were no such charge-offs in the third quarter 2010. Nonperforming assets totaling $13.2 million at quarter-end and were comprised of $10.6 million of nonaccrual loans, $763,000 in loans delinquent greater than ninety days and $1.8 million in other assets.

Noninterest Income. Noninterest income decreased by $13,000 or 2.7% to $469,000 for the three months ended September 30, 2010 from $482,000 for the same period of 2009. Improvement in income earned on bank-owned life insurance and fees on loans held for sale was offset by a reduction in rental income and due to losses on the disposition of repossessed assets. The reduction in rental income was the result of the conclusion, in December 2009, of the sublet agreement of a portion of the Bank’s headquarters building.

Noninterest Expense. Noninterest expense increased by $258,000 or 9.2% for the three months ended September 30, 2010 compared to the same quarter in 2009. The increase in noninterest expense was the result of higher compensation expense. Offsetting a portion of the increase were lower professional fees, primarily legal expenses of $102,000 compared to the same quarter in 2009. Included in 2009 results were significant legal fees related to loan collection efforts.

Income Tax Expense. The Company recorded tax expense of $154,000 for the three-month period ended September 30, 2010. The Company’s combined effective federal and state income tax rate was approximately 34.0% for the three months ended September 30, 2010 versus 38.9% for the three months ended September 30, 2009. The decrease in the effective tax rate for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 was the result of being able to exclude a higher level of state tax exempt investment income.

Liquidity

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

The Company’s major source of liquidity is its deposit base. At September 30, 2010, total deposits were $332.2 million. Core deposits, considered to be stable funding sources and defined as all deposits except time deposits totaled $249.5 million or 75.1% of total deposits. Liquidity is also provided through the Company’s overnight investment in federal funds sold, deposits with banks as well as securities available-for-sale and investment securities with maturities less than

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one year. At September 30, 2010, deposits with banks, federal funds sold and other overnight investments totaled $36.8 million while investment securities available-for-sale totaled $95.9 million.

In addition, the Bank has external sources of funds, which can be used as needed. The FHLB is the primary source of this external liquidity. The FHLB has established credit availability for banks up to 40% of the bank’s total assets. The Bank currently has an approved line of credit with the FHLB of 25% of total assets with the ability to request an increase in the line if necessary. Total assets are based on the most recent quarterly financial information submitted by the Bank to the appropriate regulatory agency. The ability to borrow funds is subject to the Bank’s continued creditworthiness, compliance with the terms and conditions of the FHLB’s Advance Applications and the pledging of sufficient eligible collateral to secure advances. At September 30, 2010, the Bank had a $108.1 million credit limit with the FHLB with advances outstanding of $35.0 million. The Bank had loans currently pledged as collateral sufficient to borrow up to $9.4 million of the remaining $73.1 million from the FHLB. The Bank also has the ability to borrow from the Federal Reserve Bank’s discount window. Additional collateral including cash, investment securities and home-equity loans are available for pledging purposes in the event the Bank would need to draw on the unused portion of the line of credit. Additionally, at September 30, 2010, the Bank had available credit with its correspondent banks of $14.2 million.

Capital Resources

Total stockholders’ equity was $35.3 million at September 30, 2010, representing an increase of $2.7 million or 8.3% from December 31, 2009. The growth of stockholders’ equity in the first nine months of 2010 was primarily attributable to net income of $1.3 million and an increase in the accumulated other comprehensive income of $1.6 million resulting from higher market values of securities available-for-sale. Offsetting these increases was a decrease in retained earnings from the declaration of $305,000 in preferred stock dividends.

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

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

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

Annapolis Bancorp, Inc.

	September 30, 2010			December 31, 2009			Minimum Regulatory Requirements			Well-Capitalized Regulatory Requirements
Risk Based Capital Ratios:
Tier 1 Capital		13.0	%		12.5	%		4.0	%		6.0	%
Total Capital		14.3	%		13.7	%		8.0	%		10.0	%
Tier 1 Leverage Ratio		9.0	%		8.6	%		4.0	%		5.0	%

As of September 30, 2010, both the Company and the Bank met the criteria for classification as a “well-capitalized” institution. Designation as a well-capitalized institution under these regulations is not a recommendation or endorsement of the Company or the Bank by federal bank regulators.

Risk Management

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

Emergency Economic Stabilization Act of 2008

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

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. Title XIII of the Dodd-Frank Act known as the “Pay it Back Act,” amends the EESA, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) (See below) and other related acts to limit the TARP and earmark certain funds be used for deficit reduction. The Pay it Back Act, reduces the amount of TARP funds available to the Treasury by $225 billion, ends the Treasury’s ability to fund new programs under TARP as of June 25, 2010, prohibits the Treasury from using repaid TARP funds and requires certain funds received by the Treasury to be used to reduce the deficit.

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American Recovery and Reinvestment Act of 2009

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

Comprehensive Financial Stability Plan of 2009

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

Regulation and Supervision

In addition to the other information contained in this Quarterly Report on Form 10-Q, the following information represents material updates and additions to the information previously disclosed in the Company’s Annual Report on Form 10-K under the section “Regulation and Supervision,” filed with the Securities and Exchange Commission on March 25, 2010.

Dodd-Frank Wall Street Reform and Consumer Protection Act. This new law will have a broad impact on the financial services industry including significant changes to the current bank regulatory structure that will affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, such as us. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

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Certain provisions of the Dodd-Frank Act relevant to the business of the Company and the Bank are summarized below:

• Creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulators.

• Gives state attorney generals the ability to enforce federal consumer protection laws.

• Eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts.

• Enhances lending limits strengthening the existing limits on a depository institution’s credit exposure to one borrower.

• Increased capital and liquidity requirements.

• Increased regulatory examination fees.

• Broadens the base for FDIC insurance assessments from deposits to average consolidated total assets less tangible equity capital of a financial institution.

• Makes permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provide unlimited federal deposit insurance through December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions. Requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials.

• Directs the Federal Reserve Board (the “FRB”) to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

• Requires the FRB to develop regulatory capital requirements for bank holding companies that are no less stringent than those applicable to banks themselves. That would eliminate certain instruments, such as trust preferred securities, from inclusion in tier 1 capital. However, existing issuances are grandfathered for holding companies of less than $15 billion in total assets.

• Exempts non-accelerated filers, such as the Company, from the auditor attestation requirements on management’s assessment of internal controls. However, the requirement of an assessment by management of the issuer’s internal controls is not affected by this amendment.

Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the Office of the Comptroller of the Currency and the FDIC. Further, the Dodd-Frank Act addresses many corporate governance and executive compensation matters that will affect most U.S. publicly traded companies including us.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

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

Item 1A – Risk Factors

Not applicable.

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

None

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Reserved

Item 5 – Other Information

None

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Item 6 – Exhibits

The following exhibits are filed as part of this report.

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

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

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SIGNATURES

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

		ANNAPOLIS BANCORP, INC.
			(Registrant)
Date:	November 12, 2010		/s/    Richard M. Lerner
			Richard M. Lerner
			Chief Executive Officer
			(principal executive officer)
Date:	November 12, 2010		/s/    Edward J. Schneider
			Edward J. Schneider
			Chief Financial Officer
			(principal accounting and financial officer)

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