10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended March 31, 2005

OR

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

For the transition period from                      to                     

Commission File Number 0-18279

Tri-County Financial Corporation

(Exact name of registrant as specified in its charter)

Maryland	52-1652138
(State of other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
3035 Leonardtown Road, Waldorf, Maryland	20601
(Address of principal executive offices)	(Zip Code)

(301) 843-0854

(Registrant’s telephone number, including area code)

Not applicable

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

As of April 26, 2005, the registrant had 1,163,336 shares of common stock outstanding.

TRI-COUNTY FINANCIAL CORPORATION

FORM 10-Q INDEX

	Page
PART I — FINANCIAL INFORMATION
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets – March 31, 2005 and December 31, 2004	3
Consolidated Statements of Income and Comprehensive Income - Three Months Ended March 31, 2005 and 2004	4 - 5
Consolidated Statements of Cash Flows — Three Months Ended March 31, 2005 and 2004	6 - 7
Notes to Consolidated Financial Statements	8 - 10
Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations	11 - 16
Item 3 - Quantitative and Qualitative Disclosures about Market Risk	16
Item 4 – Controls and Procedures	16
PART II — OTHER INFORMATION
Item 1 – Legal Proceedings	17
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3 – Defaults Upon Senior Securities	17
Item 4 – Submission of Matters to a Vote of Security Holders	17
Item 5 – Other Information	17
Item 6 – Exhibits	17
SIGNATURES	18
EX-31 SECTION 302, CERTIFICATION OF THE CEO
EX-32 SECTION 906, CERTIFICATION OF THE CFO

PART I — FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS MARCH 31, 2005 AND DECEMBER 31, 2004

	March 31, 2005			December 31, 2004
	(Unaudited)
ASSETS
Cash and due from banks	$	3,685,193		$	6,018,096
Federal Funds sold		297,526			777,519
Interest-bearing deposits with banks		11,899,569			10,920,164
Securities available for sale – at fair value		10,716,985			12,948,971
Securities held to maturity — at amortized cost		171,539,879			162,741,155
Federal Home Loan Bank and Federal Reserve Bank stock — at cost		7,461,500			6,144,300
Loans receivable — net of allowance for loan losses of $3,120,585 and $3,057,558, respectively		316,947,399			289,325,051
Premises and equipment, net		6,535,118			6,011,913
Foreclosed real estate		475,561			475,561
Accrued interest receivable		2,086,200			1,870,135
Investment in bank-owned life insurance		6,244,084			6,182,955
Other assets		2,111,663			2,351,303
TOTAL ASSETS	$	540,000,677		$	505,767,123
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Noninterest-bearing deposits	$	39,257,084		$	35,552,503
Interest-bearing deposits		241,306,544			231,202,001
Total deposits		280,563,628			266,754,504
Short-term borrowings		125,064,912			115,304,210
Long-term debt		92,848,897			82,931,113
Guaranteed preferred beneficial interest in junior subordinated debentures		7,000,000			7,000,000
Accrued expenses and other liabilities		2,501,187			2,653,721
Total liabilities		507,978,624			474,643,548
STOCKHOLDERS’ EQUITY:
Common stock — par value $.01; authorized - 15,000,000 shares; issued 1,158,320 and 1,146,864 shares		11,583			11,469
Additional paid in capital		8,435,572			8,252,152
Retained earnings		23,815,705			22,833,112
Accumulated other comprehensive(loss) income		(113,526	)		186,140
Unearned ESOP shares		(127,281	)		(159,298	)
Total stockholders’ equity		32,022,053			31,123,575
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	540,000,677		$	505,767,123

See notes to consolidated financial statements

3

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2005 AND 2004

	2005		2004
INTEREST INCOME:
Interest and fees on loans	$	4,811,653	$	3,546,545
Taxable interest and dividends on investment securities		1,739,523		1,042,650
Interest on deposits with banks		13,692		4,616
Total interest income		6,564,868		4,593,811
INTEREST EXPENSE:
Interest on deposits		1,011,619		700,170
Interest on short-term borrowings		800,303		78,622
Interest on long-term debt		997,158		785,497
Total interest expense		2,809,080		1,564,289
NET INTEREST INCOME		3,755,788		3,029,522
PROVISION FOR LOAN LOSSES		63,027		70,202
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,692,761		2,959,320

4

TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004

	2005			2004
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges		62,907			66,204
Net gain on sale of loans held for sale		—			21,404
Net gain on the sale of foreclosed property		36,000			—
Income from bank-owned life insurance		61,129			73,848
Loss on sale of investment securities		(14,581	)		—
Service charges		255,874			234,772
Total noninterest income		401,329			396,228
NONINTEREST EXPENSE:
Salary and employee benefits		1,463,962			1,298,380
Occupancy		231,873			181,873
Advertising		87,412			142,539
Data processing		160,824			151,998
Legal and professional fees		119,445			38,155
Depreciation of furniture, fixtures and equipment		87,100			87,200
Telephone communications		29,194			37,975
Valuation allowance on foreclosed real estate		—			113,827
ATM expenses		69,794			80,098
Office supplies		30,364			39,419
Office equipment		9,702			26,391
Other		259,044			197,868
Total noninterest expenses		2,548,714			2,395,723
INCOME BEFORE INCOME TAXES		1,545,376			959,825
Income tax expense		521,015			70,627
NET INCOME		1,024,361			889,198
OTHER COMPREHENSIVE INCOME NET OF TAX
Net unrealized holding (losses) gains arising during period		(299,666	)		66,152
COMPREHENSIVE INCOME	$	724,695		$	955,350
INCOME PER COMMON SHARE
Basic	$	0.89		$	0.79
Diluted		0.84			0.75

Share and per share data have been retroactively adjusted to effect a three for two common stock split declared on October 22, 2004 as if it had occurred on January 1, 2004.

See notes to consolidated financial statements

5

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2005 AND 2004

	Three Months Ended
	March 31,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,024,361		$	889,198
Adjustments to reconcile net income to net cash provided by operating activities:
Valuation allowance on foreclosed real estate		—			113,827
Provision for loan losses		63,027			70,202
Gain on sale of foreclosed property		(36,000	)		—
Loss on sales of investment securities		14,581			—
Depreciation and amortization		170,100			143,049
Net amortization of premium/discount on investment securities		58,139			119,478
Increase in cash surrender of bank-owned life insurance		(61,129	)		(17,883	)
Deferred income tax benefit		51,110			—
Increase in accrued interest receivable		(216,065	)		(19,553	)
Decrease in deferred loan fees		(121,043	)		(36,970	)
Decrease in accrued expenses and other liabilities		(152,534	)		(408,674	)
Decrease in other assets		342,902			272,359
Gain on sales of loans held for sale		—			(21,404	)
Proceeds from sale of loans held for sale		—			496,284
Net cash provided by operating activities		1,137,449			1,599,913
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities available for sale		(3,653	)		(7,503,838	)
Proceeds from sale, redemption or principal payments of investment securities available for sale		1,759,327			8,857,505
Purchase of investment securities held to maturity		(25,049,248	)		(7,969,601	)
Proceeds from maturities or principal payments of investment securities held to maturity		16,200,076			4,054,035
Net purchase of FHLB and Federal Reserve Bank stock		(1,317,200	)		(320,200	)
Loans originated or acquired		(69,587,499	)		(44,183,877	)
Principal collected on loans		42,023,167			24,382,698
Purchase of premises and equipment		(693,305	)		(219,883	)
Proceeds from foreclosed real estate		36,000			25,000
Net cash used in investing activities		(36,632,335	)		(22,878,161	)

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TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004

	Three Months Ended
	March 31,
	2005			2004
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		13,809,124			12,537,258
Proceeds from long-term borrowings		10,000,000			20,000,000
Payments of long-term borrowings		(82,214	)		(10,095,898	)
Net increase (decrease) in short-term borrowings		9,760,702			(3,570,983	)
Exercise of stock options		155,168			197,155
Net change in unearned ESOP shares		60,395			74,011
Repurchase of common stock		(41,780	)		(152,558	)
Net cash provided by financing activities		33,661,394			18,988,985
DECREASE IN CASH AND CASH EQUIVALENTS		(1,833,491	)		(2,289,263	)
CASH AND CASH EQUIVALENTS — JANUARY 1		17,715,779			12,169,798
CASH AND CASH EQUIVALENTS — MARCH 31	$	15,882,288		$	9,880,535
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the three months for:
Interest	$	2,763,742		$	1,669,753
Income taxes	$	—		$	—

See notes to consolidated financial statements

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.	BASIS OF PRESENTATION
	General - The consolidated financial statements of Tri-County Financial Corporation (the “Company”) and its wholly owned subsidiary, Community Bank of Tri-County (the “Bank”) included herein are unaudited; however, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of Management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2004 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2004 Annual Report. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2005 presentation.
	It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report for the year ended December 31, 2004.
2.	NATURE OF BUSINESS
	The Company, through its bank subsidiary, provides domestic financial services primarily in southern Maryland. The primary financial services include real estate, commercial and consumer lending, as well as traditional demand deposits and savings products.
3.	INCOME TAXES
	The Company uses the liability method of accounting for income taxes as required by SFAS No. 109, “Accounting for Income Taxes.” Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse.
4.	EARNINGS PER SHARE
	Earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as options and warrants. As of March 31, 2005, there were no shares excluded from the diluted net income per share computation because the average market price exceeded the exercise price of all outstanding options. Basic and diluted earnings per share, have been computed based on weighted-average common and common equivalent shares outstanding as follows:

	Three Months Ended
	March 31,
	2005		2004
Basic		1,151,932		1,134,567
Diluted		1,223,417		1,191,996

     Share and per share data have been retroactively adjusted to effect a three for two common stock split declared on October 22, 2004 as if it had occurred on January 1, 2004.

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5.	STOCK-BASED COMPENSATION
	Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for these plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. The Company has elected to continue with the accounting methodology in Opinion No. 25. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them.
	In December 2004, FASB issued SFAS No. 123R, “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock Issued for Employees.” SFAS No. 123R requires that all share-based payments to employees, including grants of employee stock options, be valued at fair value on the grant date and be expensed over the applicable vesting period. SFAS No. 123R is effective for the Company on January 1, 2006. The Company will transition to SFAS No. 123R using the “modified prospective application.” Under the “modified prospective application,” compensation costs will be recognized in the financial statements for all new share-based payments granted after January 1, 2006. Additionally, the Company will recognize compensation costs for the portion of previously granted awards for which the requisite service has not been rendered (“nonvested awards”) that are outstanding as of January 1, 2006 over the remaining requisite service period of the awards. The compensation expense to be recognized for the non-vested awards will be based on the fair value of the awards. The Company does not expect the impact of utilizing the “modified prospective application” to adopt SFAS No. 123R to be materially different from the pro-forma information shown below.
	No options were awarded during the three-month period ended March 31, 2005, and all options outstanding as of December 31, 2004 were vested; therefore, no awards of options or vesting of previously awarded options have been recognized for pro-forma disclosure purposes during the quarter ended March 31, 2005.
	If the Company had elected to recognize stock-based compensation cost based on fair value at the grant dates for awards consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been changed to the pro-forma amounts shown below for the three-month periods ended March 31, 2005 and 2004.

	2005		2004
Net Income as reported	$	1,024,361	$	889,198
Less pro-forma stock-based compensation expense determined under the fair value method, net of tax effects.		—		60,000
Pro-forma net income	$	1,024,361	$	829,198
Net income per share
Basic — as reported	$	0.89	$	0.79
Basic – pro-forma	$	0.89	$	0.73
Diluted — as reported	$	0.84	$	0.75
Diluted – pro-forma	$	0.84	$	0.69

Share and per share data have been retroactively adjusted to effect a three for two common stock split declared on October 22, 2004 as if it had occurred on January 1, 2004.

9

6.	NEW ACCOUNTING STANDARDS
	In December 2004, the Financial Accounting Standards Board (“FASB”) issued SAFS No. 153, “Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions.” This statement amends the principal that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of non-monetary assets that do not have commercial substance. This Statement is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of this standard is not expected to have a material impact on financial condition, results of operations, or liquidity.
	In March 2004, FASB Emerging Issues Task Force (EITF) released Issue 03-01, “Meaning of Other Than Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 provides guidance for determining whether impairment for certain debt and equity investments is other-than-temporary and the measurement of the impaired loss. Certain disclosure requirements of EITF 03-1 were adopted in 2003 and the Company complied with the new disclosure requirements in its consolidated financial statements. The recognition and measurement requirements of EITF 03-01 were initially effective for periods beginning after June 15, 2004. In September 2004, however, the FASB staff issued FASB Staff Position (“FSP”) EITF 03-1-1, which delayed the effective date for certain measurement and recognition guidance contained in Issue 03-1. The FSP requires the application of pre-existing other-than-temporary guidance during the period of delay until a final consensus is reached. Management does not anticipate the issuance of the final consensus will have a material impact on financial condition, results of operations, or liquidity.
	In December 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. SOP 03-3 requires acquired loans, including debt from the seller for those-individually-evaluated loans that have evidence of deterioration in credit quality since origination, and it is probable all contractual cash flows on the loan will be unable to be collected. SOP 03-3 also requires the excess of all undiscounted cash flows expected to be collected at acquisition over the purchase’s initial investment to be recognized as interest income on a level-yield basis over the life of the loan. Subsequent increases in cash flows expected to be collected are recognized as impairment. Loans carried at fair value, loans held for sale, and loans to borrowers in good standing under revolving credit agreements are excluded from the scope of SOP 03-3. The guidance is effective for loans acquired in fiscal years beginning after December 15, 2004 and is not expected to have a material impact on the Company’s financial condition, result of operations, or liquidity.

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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION

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

GENERAL

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

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

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

Management recognizes that the shift in composition of the Bank’s loan portfolio will tend to increase its exposure to credit losses. The Bank continues to evaluate its allowance for loan losses and the associated provision to compensate for the increased risk. Any evaluation of the allowance for loan losses is inherently inexact and reflects management’s expectations as to future economic conditions in the Southern Maryland area as well as individual borrower’s circumstances. Management believes that its allowance for loan losses is adequate. For further information on the Bank’s allowance for loan losses see the discussion in the sections captioned “Financial Condition” and “Critical Accounting Policies” as well as the relevant discussions in the Form 10-K and annual report for the year ended December 31, 2004.

For several quarters until the fourth quarter of 2004, the economy was recovering from a mild recession. In the last several quarters, the Federal Reserve has signaled through rate increases its belief that the economy’s greatest danger appears to be inflation rather than recession. Accordingly the Federal Funds rate has increased from its recent low of 1.00% in June 2004 to 2.75% in March of 2005. While we believe that we are positioned to perform well in a moderate rate increase environment, substantially higher interest rates could effect our future financial performance particularly if key interest rates increased funding costs faster than they increased yields on earning assets. Our ability to increase asset yields in a rising interest rate environment is limited by periodic and lifetime caps on interest rates embedded in many of our loans and investments. In addition, certain of our loans and investments are for fixed rates. Moreover, substantially higher interest rates would tend to increase borrowing costs for our customers and might lead to an increase in loan

11

delinquency caused by the borrowers’ inability to pay these higher costs in some cases.

SELECTED FINANCIAL DATA

	Three Months Ended
	March 31,
	2005		2004
Condensed Income Statement
Interest Income	$	6,564,868	$	4,593,811
Interest Expense		2,809,080		1,564,289
Net Interest Income		3,755,788		3,029,522
Provision for Loan Loss		63,027		70,202
Noninterest Income		401,329		396,228
Noninterest Expense		2,548,714		2,395,723
Income Before Income Taxes		1,545,376		959,825
Income Taxes		521,015		70,627
Net Income	$	1,024,361	$	889,198
Per Common Share
Basic Earnings	$	0.89	$	0.79
Diluted Earnings	$	0.84	$	0.75
Book Value	$	27.65	$	25.12

Share and per share data have been retroactively adjusted to effect a three for two common stock split declared on October 22, 2004 as if it had occurred on January 1, 2004.

RESULTS OF OPERATIONS

Net income for the three-month period ended March 31, 2005 totaled $1,024,361 ($0.89 basic and $0.84 diluted earnings per share) compared with a total of $889,198 ($0.79 basic and $0.75 diluted earnings per share) for the same period in the prior year. This increase of $135,163 or 15.20% was caused by an increase in net interest income combined with a slight decline in provision for loan loss, a small increase in non-interest income, which offset higher non-interest expense and higher tax expense. For the three-month period ended March 31, 2005, interest income increased by $1,971,057 or 42.91% to $6,564,868. The increase was due to higher average balances of earning assets which offset slightly lower yields. The Bank earned slightly lower yields as the percentage of its assets invested in securities increased and the percentage of assets invested in loans decreased. Interest expense also increased to $2,809,080 in the three-month period ending March 31, 2005 as compared to $1,564,289 in the same period in the prior year, an increase of $1,244,791 or 79.58%. The increase was the result of higher average balances and slightly higher rates. The average rate paid on liabilities increased as the Bank made greater use of non-retail deposit funding sources. The changes in interest income and expense reflect the effects of the changing interest rate environment, increased size of the balance sheet, and changes in balance sheet composition that have taken place in the last year.

Provision for loan losses decreased slightly from prior year levels to $63,027 for the three months ended March 31, 2005 from $70,202 for the three month period ended March 31, 2004. The decrease in provision expense was caused by the Bank’s continued success in controlling delinquency and write-offs in its loan portfolio. Management will continue to periodically review its allowance for loan losses and the related provision and adjust as deemed necessary. This review will include a review of economic conditions nationally and locally, as well as a review of the performance of significant major loans and the overall portfolio.

Noninterest income increased to $401,329 for the three-month period ending March 31, 2005, an increase of $5,101 or 1.29% over the prior year total of $396,228. In 2005, the Bank sold certain foreclosed property which had previously been written off. The gain of $36,000 was recognized in 2005, while no similar gain was recognized in 2004. Loan appraisal, credit, and miscellaneous charges decreased by $3,297 to $62,907. These charges are highly variable and collection of them is often dependent on specific local market conditions. The Bank reported a net gain on selling mortgage loans of $21,404 in 2004. No gains from selling loans were earned in 2005. The Bank recorded a decline in income from bank-owned life insurance based on a decline in yield in 2005. The Bank also recorded a loss of $14,581 in

12

2005 on the sale of certain short-term securities compared to no loss in 2004. Finally, service charges increased to $255,874 in 2005 from the prior year amount of $234,772, an increase of $21,102 or 8.99% due to higher amounts of activity in certain demand deposit accounts.

Noninterest expense for the three-month period increased by $152,991 or 6.39% to $2,548,714 from $2,395,723 in the same period for the prior year. Salary and employee benefits increased by 12.75% to $1,463,962 from $1,298,380 for the same period in the prior year. The increase was attributable to an increase in employees and to increases in average salary costs per employee. Occupancy expense increased from $181,873 to $231,873, an increase of 27.49%, due to additional locations. Advertising expenses decreased to $87,412 from $142,539, a decrease of $55,127 or 38.68%. The reduction in expenses was attributable to the internalization of the marketing function as well as the realignment of expenses to coincide with objectives. Data processing expense increased to $160,824 from a prior year total of $151,998, an increase of $8,826 or 5.81%. This increase was due to increases in the Bank’s size and customer base. Legal and professional fees increased to $119,445 from $38,155, an increase of $81,290 or 213.05%. This increase in expense included increased expenses relating to preparing the Company to meet the additional requirements of Sarbanes–Oxley compliance including increases in outsourced accounting, legal, and other professional services. Telephone communications declined to $29,194 from $37,975 in the prior year, a decline of $8,781 or 23.12%. This decline reflected a change in service providers which offset higher usage. The provision for valuation allowances on foreclosed real estate decreased to $0 in 2005 from $113,827 for the three months ended March 31, 2004 as no further increases to the valuation allowance were considered necessary. ATM related expenses decreased by $10,304 to $69,794 for the period ending March 31, 2005, a decrease of 12.86% due to price concessions by our ATM service providers. Office supplies expense decreased to $30,364 from the prior year amount of $39,419, a decrease of $9,055 or 22.97%. These expenses related to increased marketing efforts in the prior year. Office equipment expenses decreased to $9,702 in 2005 from $26,391 in 2004, a decrease of $16,689 or 63.24%. This decrease was caused by the retirement of certain equipment. Other expenses increased to $259,044 from $197,868 an increase of $61,176 or 30.92%, reflecting larger asset size and increased overall business activity.

Income tax expense increased to $521,015 or 33.71% of pretax income in the current year, from $70,627 or 7.36% of pretax income in the prior year. The prior year’s low income tax rate was primarily attributable to the contribution of a foreclosed property to an environmental organization which generated a large income tax deduction, effectively reducing the overall rate.

FINANCIAL CONDITION

Assets

Total assets as of March 31, 2005 increased by $34,233,554 or 6.77% to $540,000,677 from the December 31, 2004 level of $505,767,123. Cash and due from banks decreased by $2,332,903 or 38.76% from December 31, 2004’s total. Federal funds sold decreased to $297,526 from $777,519, a decline of $479,993 or 61.73%. Interest-bearing deposits with banks increased by $979,405 or 8.97% during the period to $11,899,569 at March 31, 2005. Changes in the amounts of these cash equivalents reflect short-term cash changes to fund loans and investments. Investment securities, including both the available for sale and held to maturity portfolios, increased from $175,690,126 to $182,256,864, an increase of $6,566,738 or 3.74%. Increases were primarily the result of additional purchases of investments, primarily floating rate longer-term securities which adjust to a margin over LIBOR.

The Bank’s loan portfolio increased by $27,622,348 or 9.55% during the three-month period ended March 31, 2005 to $316,947,399 from $289,325,051 at December 31, 2004. The increase was primarily the result of increases in the Bank’s portfolio of commercial real estate loans, residential construction loans, and commercial lines of credit. The increase in commercial real estate lending was a reflection of the strong local economy and continuing sales efforts by the Bank in this area. Residential construction has increased as local builders continue to develop land. The increase in commercial lines of credit reflect the Bank’s continued effort to build its commercial lending business. At March 31, 2005 the Bank’s allowance for loan losses totals $3,120,585 or 0.95% of loan balances as compared to $3,057,558 or 1.04% of loan balances at December 31, 2004. 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. Management believes that the allowance is adequate. Additional loan information for prior years is presented in the Company’s Form 10-K for the year ended December 31, 2004.

13

The following table sets forth information concerning the Bank’s aggregate loans by type at the dates indicated.

	March 31, 2005					December 31, 2004
	Amount		%			Amount		%
Real Estate Loans
Commercial	$	146,295,636		45.62	%	$	136,341,597		46.51	%
Residential first mortgages		62,396,013		19.46	%		59,087,000		20.16	%
Residential construction		24,044,973		7.50	%		17,597,911		6.00	%
Second mortgage loans		24,804,287		7.73	%		23,925,108		8.16	%
Commercial lines of credit		44,264,377		13.80	%		39,136,778		13.35	%
Consumer loans		3,509,695		1.09	%		3,462,613		1.18	%
Commercial equipment		15,396,335		4.80	%		13,595,978		4.64	%
Total		320,711,316		100.00	%		293,146,983		100.00	%
Less:
Deferred loan fees		643,332		0.20	%		764,374		0.26	%
Allowance for loan losses		3,120,585		0.97	%		3,057,558		1.04	%
Total	$	316,947,399				$	289,325,051

The following table summarizes changes in the allowance for loan losses for the periods indicated.

	3 Months Ended		3 Months Ended
	March 31, 2005		March 31, 2004
Beginning Balance	$	3,057,558	$	2,572,799
Charge-Offs		—		—
Recoveries		—		7,923
Net Charge-Offs		—		(7,923	)
Additions Charged to Operations		63,027		70,202
Balance at the end of the Period	$	3,120,585	$	2,650,924

The following table provides information with respect to our non-performing assets at the dates indicated.

	Balances as of			Balances as of
	March 31, 2005			December 31, 2004
Restructured Loans	$	—		$	—
Accruing loans which are contractually past due 90 days or more:	$	—		$	—
Loans accounted for on a non-accrual basis	$	679,980		$	674,961
Total non-performing loans	$	679,980		$	674,961
Non-performing loans to total loans		0.21	%		0.22	%
Allowance for loan losses to non-performing loans		458.92	%		453.00	%

14

Premises and equipment increased due to the renovation of parts of the home office building and the construction of the Prince Frederick Branch. These improvements were partially offset by depreciation. Accrued interest receivable increased by $216,155 due to increases in asset size. Investment in bank-owned life insurance increased due to income accruals. Other assets decreased to $2,111,663 from $2,351,303 at December 31, 2004.

Liabilities

Deposit balances increased by $13,809,124 or 5.18% for the three months ended March 31, 2005. This increase was primarily in interest bearing deposits. Management believes that ongoing stock market volatility combined with questions about certain mutual fund operations has made bank deposits more attractive to the general public. The Bank has also increased marketing efforts for all deposit products in the last year. Short-term borrowings increased to $125,064,912, an increase of $9,760,702 or 8.47% while long term-debt also increased to $92,848,897, an increase of $9,917,784, or 11.96%. These funds were used to fund loans and purchase investments. Accrued expenses decreased slightly to $2,501,187. The decline was caused by the timing of certain tax payments.

Stockholders’ Equity

Stockholders’ equity increased $898,478 or 2.89% to $32,022,053 at March 31, 2005 compared to $31,123,575 at December 31, 2004. This reflects the net income of $1,024,361 for the three months period. Other changes in equity occurred as a result of using $41,780 to purchase 1,198 shares, the exercise of stock options of $155,168, and activity related to the ESOP shares of $60,395. Book value on a per share basis was $27.65 at March 31, 2004, as compared to $27.14 at December 31, 2004.

LIQUIDITY AND CAPITAL RESOURCES

The Company currently has no business other than that of the Bank and does not currently have any material funding commitments, other than the payment of dividends, the payment of dividends and principal on debentures, and the repurchase of common shares. The Company’s principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends.

The Bank’s principal sources of funds for investments and operations are net income, deposits from its primary market area, principal and interest payments on loans, interest received on investment securities and proceeds from maturing investment securities. Its principal funding commitments are for the origination or purchase of loans and the payment of maturing deposits. Deposits are considered a primary source of funds supporting the Bank’s lending and investment activities. The Bank also uses various wholesale funding instruments including FHLB advances and reverse repurchase agreements. The Bank may borrow up to 40% of consolidated Bank assets on a line of credit available from the FHLB. As of March 31, 2005, the maximum available under this line would be $216 million, while outstanding advances totaled $141 million. In order to draw on this line the Bank must have sufficient collateral. Qualifying collateral includes residential 1-4 family first mortgage loans, certain second mortgage loans, certain commercial real estate loans, and various investment securities. At March 31, 2005, the Bank had pledged collateral sufficient to draw $164 million under the line.

The Bank’s most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, federal funds sold, and money market mutual funds. The levels of such assets are dependent on the Bank’s operating financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows.

Cash, cash equivalents, and interest-bearing deposits with banks as of March 31, 2005 totaled $15,882,288, a decrease of $1,833,491 or 10.35% from the December 31, 2004 total of $17,715,779. This decrease was due to the Bank’s increase in loans and investment securities.

The Bank’s principal sources of cash flows are its financing activities including deposits and borrowings. During the first quarter in 2005, all financing activities provided $33,661,394 in cash compared to $18,988,985 for the first quarter of 2004. The increase in cash flows from financing activities during the most recent period was principally due to an increase in borrowing activity in 2005. Short-term borrowing provided a net increase in cash of $9,760,702 in 2005, compared to a use of cash of $3,570,983 in 2004. During the first quarter of 2005, net deposit growth was $13,809,124 compared to $12,537,258 in 2004. The Bank also receives cash from its operating activities, which provided $1,137,449 in the first quarter of 2005 compared to $1,599,913 during the first quarter of 2004. The decrease in operating cash flows

15

during 2005 was primarily due to a decrease in proceeds from sale of loans held for sale.

The Bank’s principal use of cash has been in investing activities including its investments in loans for portfolio, investment securities and other assets. During the quarter ended March 31, 2005, the Bank invested a total of $36,632,446 compared to $22,878,161 in 2004. The principal reason for the increase in cash used in investing activities was an increase in the purchase of investments.

REGULATORY MATTERS

The Bank is subject to Federal Reserve Board capital requirements as well as statutory capital requirements imposed under Maryland law. At March 31, 2005, the Bank’s tangible, leverage and risk-based capital ratios were 7.21%, 9.52% and 10.27%, respectively. These levels are in excess of the required 4.0%, 4.0% and 8.0% ratios required by the Federal Reserve Board as well as the 5.0%, 5.0%, and 10% ratios required to be considered well capitalized.

CRITICAL ACCOUNTING POLICIES

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within the financial statements is, to a significant extent, financial information that is based on measures of financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning of income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

The Company considers the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) SFAS 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral, a borrower’s prospects of repayment, and in establishing allowance factors on the non-specific allowance. The establishment of allowance factors is a continuing exercise, based on management’s continuing assessment of the global factors such as delinquencies, loss history, trends in the volume and term of loans, national and local economic trends, concentration of credit, loan classification, and other factors. Changes in allowance factors will have a direct impact on the amount of the provision and a corresponding effect on net income. Errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge offs.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable. The Company qualifies as a “small business issuer.”

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, (1) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal and executive and financial officers as appropriate to allow timely decisions regarding required disclosure. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in

16

achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

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

Item 2 — Unregistered sales of equity securities and use of proceeds

(a)	Not applicable
(b)	Not applicable
(c)	The following table sets forth information regarding the Company’s repurchases of its Common Stock during the quarter ended March 31, 2005.

					(c)		(d)
					Total Number		Maximum
					of Shares		Number of
					Purchased		Shares
	(a)				as Part of		that May Yet Be
	Total		(b)		Publicly		Purchased
	Number of		Average		Announced Plans		Under
	Shares		Price Paid		or		the Plans or
Period	Purchased		per Share		Programs		Programs
January 2005		1,106	$	34.63		1,106		55,894
February 2005		92		38.00		92		55,802
March 2005		—		—		—		55,802
Total		1,198	$	34.89		1,198		55,802

On October 25, 2004, Tri-County Financial Corporation announced a repurchase program under which it would repurchase 57,000 shares of its common stock. The program will continue until it is completed or terminated by the Board of Directors.

Item 3 — Default Upon Senior Securities — None

Item 4 — Submission of Matters to a Vote of Security Holders —None

Item 5 — Other Information — None

17

Item 6 — Exhibits

Exhibit 31 Rule 13a-14(a) Certifications

Exhibit 32 Section 1350 Certifications

18

SIGNATURES

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

		TRI-COUNTY FINANCIAL CORPORATION:
Date:	May 12, 2005	By:	/s/ Michael L. Middleton
			Michael L. Middleton, President
			and Chairman of the Board
Date:	May 12, 2005	By:	/s/ William J. Pasenelli
			William J. Pasenelli, Executive
			Vice President and Chief
			Financial Officer

EX-31

Certification

I, Michael L. Middleton, President and Chief Executive Officer of Tri-County Financial Corporation, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Tri-County Financial Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and
(c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board or directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	May 12, 2005
		/s/ Michael L. Middleton
		Michael L. Middleton
		President and Chief Executive Officer

Certification

I, William J. Pasenelli, Executive Vice President, Treasurer and Chief Financial Officer of Tri-County Financial Corporation, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Tri-County Financial Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and
(c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board or directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	May 12, 2005	/s/ William J. Pasenelli
		William J. Pasenelli
		Executive Vice President and Chief Financial Officer

EX-32

CERTIFICATION

     This Report on Form 10-Q of Tri-County Financial Corporation (the “Company”) for the quarter ended March 31, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in this Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:	May 12, 2005	By:	/s/ Michael L. Middleton
			Michael L. Middleton
			President and Chief Executive Officer
Date:	May 12, 2005	By:	/s/ William J. Pasenelli
			William J. Pasenelli
			Executive Vice President and Chief Financial Officer