12.

LOANS

Loans consist of the following:

	September 30, 2011		December 31, 2010

Commercial real estate	$	368,045,487	$	336,299,836
Residential first mortgages		157,753,718		136,048,577
Construction and land development		31,639,081		42,504,200
Home equity and second mortgage		24,328,456		24,379,664
Commercial loans		101,834,868		104,566,261
Consumer loans		1,098,280		1,273,080
Commercial equipment		20,087,754		17,983,648
		704,787,644		663,055,266
Less:
Deferred loan fees		373,494		936,183
Allowance for loan loss		7,256,898		7,669,147
		7,630,392		8,605,330

	$	697,157,252	$	654,449,936

At September 30, 2011, the Bank’s allowance for loan losses totaled $7,256,898 or 1.03% of loan balances as compared to $7,669,147 or 1.16% of loan balances at December 31, 2010. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, volume, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

The following table details activity in the allowance for loan losses and loan receivable balances for the nine months ended September 30, 2011 and the year ended December 31, 2010. An allocation of the allowance to one category of loans does not prevent the Company’s ability to utilize the allowance to absorb losses in a different category. The loan receivables are disaggregated on the basis of the Company’s impairment methodology.

At September 30, 2011	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147
Charge-offs		(1,189,959	)		(48,998	)		(212,993	)		-			(2,376,920	)		(2,000	)		(125,996	)		(3,956,866	)
Recoveries		-			-			-			-			1,091			2,181			-			3,272
Provisions		1,274,512			223,534			(249,377	)		(205	)		2,210,895			(6,031	)		88,017			3,541,345
Balance at September 30,	$	3,398,536		$	378,609		$	804,255		$	97,314		$	2,387,105		$	26,359		$	164,720		$	7,256,898
Ending balance: individually evaluated for impairment	$	280,000		$	-		$	100,000		$	-		$	1,318,557		$	-		$	-		$	1,698,557
Ending balance: collectively evaluated for impairment	$	3,118,536		$	378,609		$	704,255		$	97,314		$	1,068,548		$	26,359		$	164,720		$	5,558,341
Loan receivables:
Ending balance	$	368,045,487		$	157,753,718		$	31,639,081		$	24,328,456		$	101,834,868		$	1,098,280		$	20,087,754		$	704,787,644
Ending balance: individually evaluated for impairment	$	30,728,200		$	6,264,847		$	8,052,154		$	644,224		$	23,584,917		$	140,595		$	361,720		$	69,776,657
Ending balance: collectively evaluated for impairment	$	337,317,287		$	151,488,871		$	23,586,927		$	23,684,232		$	78,249,951		$	957,685		$	19,726,034		$	635,010,987

At December 31, 2010	Commercial Real Estate			Residential First Mortgage			Construction and Land Development			Home Equity and Second Mtg.			Commercial Loans			Consumer Loans			Commercial Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	2,661,371		$	127,848		$	1,696,396		$	130,692		$	2,109,513		$	63,989		$	681,505		$	7,471,314
Charge-offs		(525,992	)		(62,999	)		(2,248,967	)		(70,999	)		(568,992	)		(10,000	)		(255,996	)		(3,743,945	)
Recoveries		-			-			1,041			-			-			7,290			-			8,331
Provisions		1,178,604			139,224			1,818,155			37,826			1,011,518			(29,070	)		(222,810	)		3,933,447
Balance at December 31,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147
Ending balance: individually evaluated for impairment	$	500,000		$	-		$	-		$	-		$	1,449,179		$	-		$	48,456		$	1,997,635
Ending balance: collectively evaluated for impairment	$	2,813,983		$	204,073		$	1,266,625		$	97,519		$	1,102,860		$	32,209		$	154,243		$	5,671,512
Loan receivables:
Ending balance	$	336,299,836		$	136,048,577		$	42,504,200		$	24,379,664		$	104,566,261		$	1,273,080		$	17,983,648		$	663,055,266
Ending balance: individually evaluated for impairment	$	20,800,730		$	3,664,442		$	12,221,463		$	319,112		$	19,991,537		$	701		$	319,770		$	57,317,755
Ending balance: collectively evaluated for impairment	$	315,499,106		$	132,384,135		$	30,282,737		$	24,060,552		$	84,574,724		$	1,272,379		$	17,663,878		$	605,737,511

Non-accrual and Past Due Loans

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

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Non-accrual loans as of September 30, 2011 and December 31, 2010 were as follows:

	September 30, 2011				December 31, 2010
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	651,511		4	$	8,244,683		12
Residential first mortgages		1,757,858		5		1,746,786		6
Construction and land development		1,413,550		2		983,867		1
Home equity and second mortgage		274,186		6		232,644		5
Commercial loans		2,313,526		4		2,261,642		6
Consumer loans		600		1		701		1
Commercial equipment		224,135		3		48,456		1
	$	6,635,366		25	$	13,518,779		32

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $2,676,432 and $8,715,318 at September 30, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at September 30, 2011 and December 31, 2010 was $193,676 and $598,603, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $3,958,934 and $4,803,461 at September 30, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at September 30, 2011 and December 31, 2010 was $125,371 and $276,567, respectively.

An analysis of past due loans as of September 30, 2011 and December 31, 2010 were as follows:

	Current		31-60 Days		61-90 Days		Greater than 90 Days		Total Past Due		Total Loan Receivables		Loans > 90 Days and Accruing
September 30, 2011

Commercial real estate	$	366,842,930	$	551,045	$	-	$	651,512	$	1,202,557	$	368,045,487	$	-
Residential first mortgages		155,115,691		880,169		-		1,757,858		2,638,027		157,753,718		-
Construction and land dev.		30,225,531		-		-		1,413,550		1,413,550		31,639,081		-
Home equity and second mtg.		23,692,511		314,230		47,529		274,186		635,945		24,328,456		-
Commercial loans		95,783,479		3,737,863		-		2,313,526		6,051,389		101,834,868		-
Consumer loans		1,089,312		8,368		-		600		8,968		1,098,280		-
Commercial equipment		19,820,598		4,998		38,023		224,135		267,156		20,087,754		-
Total	$	692,570,052	$	5,496,673	$	85,552	$	6,635,367	$	12,217,592	$	704,787,644	$	-

December 31, 2010

Commercial real estate	$	327,358,352	$	696,801	$	-	$	8,244,683	$	8,941,484	$	336,299,836	$	-
Residential first mortgages		134,142,088		159,703		-		1,746,786		1,906,489		136,048,577		-
Construction and land dev.		41,520,333		-		-		983,867		983,867		42,504,200		-
Home equity and second mtg.		23,947,389		199,631		-		232,644		432,275		24,379,664		-
Commercial loans		102,221,510		83,109		-		2,261,642		2,344,751		104,566,261		-
Consumer loans		1,268,738		3,141		500		701		4,342		1,273,080		-
Commercial equipment		17,935,192		-		-		48,456		48,456		17,983,648		-
Total	$	648,393,602	$	1,142,385	$	500	$	13,518,779	$	14,661,664	$	663,055,266	$	-

Impaired Loans and Troubled Debt Restructures (TDRs)

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

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

Interest payments made on impaired loans are applied to principal unless collectability of the principal amount is reasonably assured. Interest recognized on impaired loans is on a cash basis. Impaired loans at September 30, 2011 and December 31, 2010 were as follows:

September 30, 2011	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Year to Date Interest Income Recognized

Commercial real estate	$	8,525,738	$	6,959,528	$	1,158,560	$	8,118,089	$	280,000	$	6,594,388	$	324,428
Construction and land dev.		3,130,466		1,716,915		1,413,550		3,130,466		100,000		3,215,095		75,499
Commercial loans		8,798,184		2,369,346		6,428,838		8,798,184		1,318,557		9,318,456		270,930
Commercial equipment		131,165		131,165		-		131,165		-		152,486		7,431
Total	$	20,585,553	$	11,176,954	$	9,000,948	$	20,177,904	$	1,698,557	$	19,280,425	$	678,288

December 31, 2010	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized

Commercial real estate	$	11,254,896	$	5,624,780	$	5,222,466	$	10,847,246	$	500,000	$	8,710,501	$	329,446
Residential first mortgages		928,847		928,847		-		928,847		-		924,163		52,516
Commercial loans		9,292,145		3,195,567		6,096,578		9,292,145		1,449,179		9,308,552		464,956
Commercial equipment		319,769		271,313		48,456		319,769		48,456		300,533		13,836
Total	$	21,795,657	$	10,020,507	$	11,367,500	$	21,388,007	$	1,997,635	$	19,243,749	$	860,754

At September 30, 2011 and December 31, 2010, impaired loans totaled $20,177,904 and $21,388,007, respectively. Impaired loans had specific allocations within the allowance for loan losses or have been reduced by charge-offs to recoverable values. Allocations of the allowance for loan losses relative to impaired loans at September 30, 2011 and December 31, 2010 were $1,698,557 and $1,997,635, respectively.

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

TDRs as of September 30, 2011 and December 31, 2010 were as follows:

	September 30, 2011				December 31, 2010
	Dollars		Number of Loans		Dollars		Number of Loans

Commercial real estate	$	7,722,811		10	$	6,847,618		6
Residential first mortgages		-		-		928,847		2
Construction and land development		1,716,915		1		-		-
Commercial loans		2,369,346		3		8,834,025		7
Commercial equipment		131,165		1		271,313		4
	$	11,940,237		15	$	16,881,803		19

At September 30, 2011, $11,644,674 or 97.52% of TDRs were performing according to the terms of their restructured agreements compared to $16,584,546 or 98.2% at December 31, 2010. As of September 30, 2011, $640,178 or four TDR agreements defaulted in the preceding twelve months, representing $76,591 in charge-offs and $563,587 in transfers to foreclosed real estate.

Credit Quality Indicators

A risk grading matrix is used to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received, and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $350,000 or greater are subject to being risk rated. Relationships that are comprised of only a few loans which are fully amortizing, secured by real estate and have not had a history of delinquency are exempt from the annual review. Loans are graded on a scale of 1 to 10.

Ratings 1 thru 6 - Pass

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

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

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

Rating 8 - Substandard

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

Rating 9 - Doubtful

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

Rating 10 - Loss

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

Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an OAEM or higher risk rating due to a delinquent payment history.

Management regularly reviews credit quality indicators in assessing the overall quality of the Bank’s loan portfolio including the composition of the loan portfolio, net charge-offs, nonperforming loans, performance of troubled debt restructured loans and general economic conditions in the Southern Maryland market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans.

Credit quality indicators as of September 30, 2011 and December 31, 2010 were as follows:

Credit Risk Profile by Internally Assigned Grade

	Commercial Real Estate				Construction and Land Dev.
	9/30/2011		12/31/2010		9/30/2011		12/31/2010

Unrated	$	332,872	$	1,074,330	$	139,778	$	-
Pass		337,429,257		317,579,637		23,447,149		30,274,737
Special mention		-		3,628,052		-		1,585,035
Substandard		30,283,358		14,017,818		8,052,154		10,644,428
Doubtful		-		-		-		-
Loss		-		-		-		-
Total	$	368,045,487	$	336,299,836	$	31,639,081	$	42,504,200

	Commercial Loans				Commercial Equipment
	9/30/2011		12/31/2010		9/30/2011		12/31/2010

Unrated	$	337,565	$	50,035	$	255,476	$	169,492
Pass		78,596,191		84,946,678		19,825,857		17,765,700
Special mention		-		2,814,668		-		-
Substandard		22,901,112		12,852,635		6,421		-
Doubtful		-		3,793,470		-		48,456
Loss		-		108,775		-		-
Total	$	101,834,868	$	104,566,261	$	20,087,754	$	17,983,648

Credit Risk Profile Based on Payment Activity

	Residential First Mortgages				Home Equity and Second Mtg.				Consumer Loans
	9/30/2011		12/31/2010		9/30/2011		12/31/2010		9/30/2011		12/31/2010

Performing	$	155,995,860	$	134,301,791	$	24,054,270	$	24,147,019	$	1,097,680	$	1,272,379
Nonperforming		1,757,858		1,746,786		274,186		232,645		600		701
Total	$	157,753,718	$	136,048,577	$	24,328,456	$	24,379,664	$	1,098,280	$	1,273,080