TRI-COUNTY FINANCIAL CORPORATION

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)


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

For the fiscal year ended December 31, 2006


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 No. 0-18279

TRI-COUNTY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Maryland				52-1652138

(State or 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)

Registrant’s telephone number, including area code: (301) 645-5601

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share
(Title of Class)

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer” in Exchange Act Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $49.9 million based on the closing price ($23.83 per share) at which the common stock, $0.01 par value, was sold on the last business day of the Company’s most recently completed second fiscal quarter. For purposes of this calculation only, the shares held by directors and executive officers of the registrant are deemed to be shares held by affiliates.

Number of shares of common stock outstanding as of March 15, 2007: 2,655,159

DOCUMENTS INCORPORATED BY REFERENCE

	1.		Portions of the Annual Report to Stockholders for the year ended December 31, 2006. (Part II)

	2.		Portions of the Proxy Statement for the 2007 Annual Meeting of Stockholders. (Part III)

PART I

This report contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on Tri-County Financial Corporation’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could affect actual results include interest rate trends, the general economic climate in the market area in which Tri-County Financial Corporation operates, as well as nationwide, Tri-County Financial Corporation’s ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Tri-County Financial Corporation assumes no obligation to update any forward-looking statements.

Item 1. Business

Tri-County Financial Corporation (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 Community Bank of Tri-County (the “Bank”), a Maryland-chartered commercial bank. The Bank was originally organized in 1950 as Tri-County Building and Loan Association of Waldorf, a mutual savings and loan association, and in 1986 converted to a federal stock savings bank and adopted the name Tri-County Federal Savings Bank. In 1997, the Bank converted to a Maryland-chartered commercial bank and adopted its current corporate title. The Company engages in no significant activity other than holding the stock of the Bank 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 counties of Charles, Calvert and St. Mary’s, (the “Tri-County area”) through its main office and eight branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince Frederick and California, Maryland. The Bank operates fifteen automated teller machines (“ATMs”) including six stand-alone locations in the Tri-County area. The Bank offers telephone and internet banking services. 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, including the acceptance of deposits, and the origination of loans to individuals, associations, partnerships and corporations. The Bank’s real estate financing consists of residential first and second mortgage loans, home equity lines of credit and commercial mortgage loans. Commercial lending consists of both secured and unsecured loans. The Bank is a member of the Federal Reserve and Federal Home Loan Bank (the “FHLB”) systems and its deposits are insured up to applicable limits by the Deposit Insurance Fund administered by the Federal Deposit Insurance Corporation (the “FDIC”).

The Company’s executive offices are located at 3035 Leonardtown Road, Waldorf, Maryland. Its telephone number is (301) 645-5601.

Available Information

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on its website, www.cbtc.com, as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission. Information on the website should not be considered a part of this Form 10-K.

Market Area

The Bank considers its principal lending and deposit market area to consist of the southern Maryland counties of Charles, Calvert and St. Mary’s. These counties have experienced significant population growth during the past decade due to their proximity to the rapidly growing Washington, D.C. and Baltimore metropolitan areas. Southern Maryland is generally considered to have more affordable housing than many other Washington and

Baltimore area suburbs. In addition, the area has experienced rapid growth in businesses and federal facilities located in the area. Major federal facilities include the Patuxent Naval Air Station in St. Mary’s County. The Patuxent Naval Air Station has undergone significant expansion in the last several years and is projected to continue to expand for several more years.

Rapid growth in our market area has been constrained by certain government policies, as all three counties have attempted to limit growth in certain areas. These policies have created some uncertainty about zoning and land use regulations. In some cases, real estate development work has been delayed or cancelled as a result of these policies. For example, Charles County introduced a user fee system, which would involve upfront payments in real estate development, but would remove subsequent regulatory delays. This system has not had an appreciable effect on the pace of residential development. Future regulatory events may adversely affect the Bank’s loan growth.

Competition

The Bank faces strong competition in the attraction of deposits and in the origination of loans. Its most direct competition for deposits and loans comes from other banks, savings and loan associations, and federal and state credit unions located in its primary market area. There are currently 14 FDIC-insured depository institutions operating in the Tri-County area including subsidiaries of several regional and super-regional bank holding companies. According to statistics compiled by the FDIC, the Bank was ranked third in deposit market share in the Tri-County area as of June 30, 2006, the latest date for which such data is available. The Bank faces additional significant competition for investors’ funds from mutual funds, brokerage firms, and other financial institutions. The Bank competes for loans by providing competitive rates, flexibility of terms, and service. It competes for deposits by offering depositors a wide variety of account types, convenient office locations and competitive rates. Other services offered include tax-deferred retirement programs, brokerage services, safe deposit boxes and miscellaneous services. The Bank has used direct mail, billboard and newspaper advertising to increase its market share of deposits, loans and other services in its market area. It provides ongoing training for its staff in an attempt to ensure high-quality service.

Lending Activities

General. The Bank offers a wide variety of real estate, consumer and commercial loans. The Bank’s lending activities include residential and commercial real estate loans, construction loans, land acquisition and development loans, equipment financing, and commercial and consumer loans. Most of the Bank’s customers are residents of, or businesses located in, the Tri-County area. The Bank’s primary market for commercial loans consists of small and medium-sized businesses located in southern Maryland. The Bank believes that this market is responsive to the Bank’s ability to provide personal service and flexibility. The Bank attracts customers for its consumer lending products based upon its ability to offer service, flexibility, and competitive pricing, as well as by leveraging other banking relationships such as soliciting deposit customers for loans.

Residential First Mortgage Loans. Residential first mortgage loans made by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The initial contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank originates both fixed-rate and adjustable-rate residential first mortgages.

The Bank offers fixed-rate residential first mortgages on a variety of terms including loan periods from ten to 30 years and bi-weekly payment loans. Total fixed-rate loan products in our residential first mortgage portfolio amounted to $69.5 million as of December 31, 2006. Fixed-rate loans may be packaged and sold to investors or retained in the Bank’s loan portfolio. Depending on market conditions, the Bank may elect to retain the right to service the loans sold for a payment based upon a percentage (generally 0.25% of the outstanding loan balance). These servicing rights may be sold to other qualified servicers. As of December 31, 2006, the Bank serviced $29.3 million in residential mortgage loans for others.

The Bank also offers mortgages that are adjustable on a one-, three-, and five-year basis generally with limitations on upward adjustments of two percentage points per repricing period and six percentage points over the

life of the loan. The Bank primarily markets adjustable-rate loans with rate adjustments based upon a United States Treasury Bill Index. As of December 31, 2006, the Bank had $11.3 million in adjustable-rate residential mortgage loans. The retention of adjustable-rate mortgage loans in the Bank’s loan portfolio helps reduce the negative effects of increases in interest rates on the Bank’s net interest income. Under certain conditions, however, the annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also unquantifiable credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. In addition, the initial interest rate on adjustable-rate loans is generally lower than that on a fixed-rate loan of similar credit quality and size.

The Bank makes residential first mortgage loans of up to 97% of appraised value or sales price of the property, whichever is less, to qualified owner-occupants upon the security of single-family homes. Non-owner occupied one- to four-family loans and loans secured by something other than residential real estate are generally permitted to a maximum 80% loan-to-value of the appraised value depending on the overall strength of the application. The Bank currently requires that substantially all residential first mortgage loans with loan-to-value ratios in excess of 80% carry private mortgage insurance to lower the Bank’s exposure to approximately 80% of the value of the property. In certain cases, the borrower may elect to borrow amounts in excess of 80% loan-to-value in the form of a second mortgage. The second mortgage will generally have a higher interest rate and shorter repayment period than the first mortgage on the same property.

All improved real estate that serves as security for a loan made by the Bank must be insured, in the amount and by such companies as may be approved by the Bank, against fire, vandalism, malicious mischief and other hazards. Such insurance must be maintained through the entire term of the loan and in an amount not less than that amount necessary to pay the Bank’s indebtedness in full.

Commercial Real Estate and Other Non-Residential Real Estate Loans. The Bank has increased its emphasis on loans for the permanent financing of commercial and other improved real estate projects, including office buildings, retail locations, churches, and other special purpose buildings. As a result, commercial real estate loans increased to $177.9 million, or 41.7%, of the loan portfolio at December 31, 2006. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. The Bank generally limits its exposure to a single borrower to 15% of the Bank’s capital and frequently participates with other lenders on larger projects. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price and have an initial contractual loan payment period ranging from three to 20 years. Virtually all of the Bank’s commercial real estate loans, as well as its construction loans discussed below, are secured by real estate located in the Bank’s primary market area. At December 31, 2006, the largest outstanding commercial real estate loan was a $3.8 million loan, which is secured by an apartment complex. This loan was performing according to its terms at December 31, 2006.

Loans secured by commercial real estate are larger and involve greater risks than one- to four-family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. As a result of the greater emphasis that the Bank places on commercial real estate loans, the Bank is increasingly exposed to the risks posed by this type of lending. To monitor cash flows on income properties, the Bank requires borrowers and loan guarantors, if any, to provide annual financial statements on multi-family or commercial real estate loans. In reaching a decision on whether to make a multi-family or commercial real estate loan, the Bank considers the net operating income of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property. Environmental surveys are generally required for commercial real estate loans over $250,000.

Construction and Land Development Loans. The Bank offers construction loans to individuals and building contractors for the construction of one- to four-family dwellings and commercial buildings. Construction loans totaled $42.7 million at December 31, 2006. Loans to individuals primarily consist of construction/permanent loans, which have fixed rates, payable monthly for the construction period and are followed by a 30-year, fixed- or adjustable-rate permanent loan. The Bank also provides construction and land development loans to home building and real estate development companies. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. Draws are made upon satisfactory completion of predefined stages

of construction or development. The Bank will typically lend up to the lower of 80% of the appraised value or purchase price.

In addition, the Bank offers loans for the purpose of acquisition and development of land, as well as loans on undeveloped, subdivided lots for home building by individuals. Land acquisition and development loans, included in construction loans discussed above, totaled $15.2 million at December 31, 2006. Bank policy requires that zoning and permits must be in place prior to making development loans.

The Bank’s ability to originate all types of construction and development loans is heavily dependent on the continued demand for single-family housing construction in the Bank’s market areas. If the demand for new houses in the Bank’s market areas were to decline, the Bank may be forced to shift a portion of its lending emphasis. There can be no assurance of the Bank’s ability to continue growth and profitability in its construction lending activities in the event of such a decline.

Construction and land development loans are inherently riskier than providing financing on owner-occupied real estate. The Bank’s risk of loss is dependent on the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or before the maturity of the loan, with a project having a value that is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank is forced to foreclose on a project before or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

Home Equity and Second Mortgage Loans. The Bank has maintained a portfolio of home equity and second mortgage loans. Home equity loans, which totaled $15.2 million at December 31, 2006, are generally made in the form of lines of credit with minimum amounts of $5,000, have terms of up to 20 years, variable rates priced at prime or some margin above prime, and require an 80% or 90% loan-to-value ratio (including any prior liens), depending on the specific loan program. Second mortgage loans, which totaled $9.4 million at December 31, 2006 are fixed and variable-rate loans that have original terms between five and 15 years. Loan-to-value ratios of up to 80% or 95% are allowed depending on the specific loan program.

These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second. The Bank believes that its policies and procedures are sufficient to mitigate the additional risk.

Commercial Loans. The Bank offers commercial loans to its business customers. The Bank offers a variety of commercial loan services including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. This portion of our portfolio has grown rapidly in the last several years, growing from $15.0 million and 8.6% of the portfolio in 2000 to $79.6 million and 18.7% of the overall loan portfolio at December 31, 2006. When making commercial business loans, the Bank considers the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flow of the business, the viability of the industry in which the consumer operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable, or other security as determined by the Bank. The higher interest rates and shorter loan terms available on commercial lending make these products attractive to the Bank. Commercial business loans, however, entail greater risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized

nature of collateral equipment would make full recovery from the sale of collateral problematic. The Bank attempts to control these risks by establishing guidelines that provide for over collateralization of the loans. At December 31, 2006, the largest outstanding commercial loan was $4.8 million to Charles County, which was unsecured. This loan was performing according to its terms at December 31, 2006.

Consumer Loans. The Bank has developed a number of programs to serve the needs of its customers with primary emphasis upon direct loans secured by automobiles, boats, recreational vehicles, and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. The higher interest rates and shorter loan terms available on consumer lending make these products attractive to the Bank. Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans, which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral may not provide an adequate source of repayment of the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee such as the Bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.

Commercial Equipment Loans. The Bank has also grown its commercial equipment financing. These loans consist primarily of fixed-rate, short-term loans collateralized by customers’ equipment including trucks, cars, construction equipment, and other more specialized equipment. When making commercial equipment loans, the Bank considers the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business, the viability of the industry in which the consumer operates, the value of the collateral and the borrower’s ability to repay the loans from income. The higher interest rates and shorter loan terms available on commercial equipment lending make these products attractive to the Bank. These loans entail greater risk than loans such as residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic. The Bank attempts to control these risks by establishing guidelines that provide for over collateralization of the loans.

Loan Portfolio Analysis. Set forth below is selected data relating to the composition of the Bank’s loan portfolio by type of loan on the dates indicated.


	At December 31,
	2006					2005					2004					2003					2002
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
Real estate loans:
Commercial	$	177,924		41.69	%	$	166,851		44.66	%	$	136,342		46.51	%	$	93,825		42.46	%	$	74,292		37.07	%
Residential first mortgage		80,781		18.93			73,628		19.71			59,087		20.16			42,971		19.45			48,976		24.44
Construction and land development		42,746		10.01			32,608		8.73			17,598		6.00			19,599		8.87			14,579		7.27
Home equity and second mortgage		24,572		5.76			25,884		6.93			23,925		8.16			19,562		8.85			19,007		9.48
Commercial loans		79,630		18.66			54,738		14.65			39,137		13.35			30,436		13.77			29,947		14.94
Consumer loans		2,813		0.66			3,128		0.84			3,462		1.18			4,097		1.85			4,623		2.31
Commercial equipment		18,288		4.29			16,742		4.48			13,596		4.64			10,473		4.74			9,007		4.49

Total loans		426,754		100.00	%		373,579		100.00	%		293,147		100.00	%		220,963		100.00	%		200,431		100.00	%

Less: Deferred loan fees, net		490					604					764					650					668
Loan loss reserve		3,784					3,383					3,058					2,573					2,314

Loans receivable, net	$	422,480				$	369,592				$	289,325				$	217,740				$	197,449

Loan Originations, Purchases and Sales. The Bank solicits loan applications through its branch network, directly through referrals from customers, and through marketing by commercial and residential mortgage loan officers. Loans are processed and approved according to guidelines deemed appropriate for each product type. Loan requirements such as income verification, collateral appraisal, and credit reports vary by loan type. Loan processing functions are generally centralized except for small consumer loans.

Loan Approvals, Procedures and Authority. Loan approval authority is established by Board policy and delegated as deemed necessary and appropriate. Loan approval authorities vary by individual with the President having approval authority up to $1.25 million, executive vice presidents up to $1.0 million, vice presidents up to $300,000, and business development officers up to $150,000. Authorities may be combined in an officers’ loan committee up to $2.0 million. In cases where time is of the essence, the officers’ loan committee consisting of at least three senior officers may unanimously approve loans up to the legal limit with a later ratification by the Board loan committee. For residential mortgage loans, the residential loan underwriter may approve loans up to the conforming loan limit of $417,000. Selected branch personnel may approve secured loans up to $75,000, and unsecured loans up to $50,000. A loan committee consisting of the President and two members of the Board (the “Board loan committee”) ratifies all commercial real estate loans and approves all loans in excess of $2.0 million, except for those noted above that exceed the $2.0 million limit in certain cases. Depending on the loan and collateral type, conditions for protecting the Bank’s collateral are specified in the loan documents. Typically these conditions might include requirements to maintain hazard and title insurance and to pay property taxes.

Depending on market conditions, mortgage loans may be originated primarily with the intent to sell to third parties such as Fannie Mae or Freddie Mac. However, no mortgage loans were sold by the Bank in 2006. To comply with internal and regulatory limits on loans to one borrower, the Bank routinely sells portions of commercial and commercial real estate loans to other lenders. The Bank also routinely buys portions of loans, or participation certificates from other lenders. The Bank only purchases loans or portions of loans after reviewing loan documents, underwriting support, and other procedures, as necessary. The Bank purchased $2.1 million in participations in 2006. Purchased loans are subject to the same regulatory and internal policy requirements as other loans in the Bank’s portfolio.

Loans to One Borrower. Under Maryland law, the maximum amount that the Bank is permitted to lend to any one borrower and his or her related interests may generally not exceed 10% of the Bank’s unimpaired capital and surplus, which is defined to include the Bank’s capital, surplus, retained earnings and 50% of its reserve for possible loan losses. Under this authority, the Bank would have been permitted to lend up to $6.8 million to any one borrower at December 31, 2006. By interpretive ruling of the Commissioner of Financial Regulation, Maryland banks have the option of lending up to the amount that would be permissible for a national bank, which is generally 15% of unimpaired capital and surplus (defined to include a bank’s total capital for regulatory capital purposes plus any loan loss allowances not included in regulatory capital). Under this formula, the Bank would have been permitted to lend up to $7.9 million to any one borrower at December 31, 2006. At December 31, 2006, the largest amount outstanding to any one borrower and his or her related interests was $7.1 million.

Loan Commitments. The Bank does not normally negotiate standby commitments for the construction and purchase of real estate. Conventional loan commitments are granted for a one-month period. The Bank’s outstanding commitments to originate loans at December 31, 2006 was approximately $12.8 million, excluding undisbursed portions of loans in process. It has been the Bank’s experience that few commitments expire unfunded.

Maturity of Loan Portfolio. The following table sets forth certain information at December 31, 2006 regarding the dollar amount of loans maturing in the Bank’s portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.


			Due after one year
	Due within one year		through five years		Due more than five
	after		from		years from
	December 31, 2006		December 31, 2006		December 31, 2006
	(Dollars in thousands)
Real estate loans
Commercial	$	22,700	$	25,548	$	129,676
Residential first mortgage		3,698		13,642		63,441
Construction and land development		39,032		3,714		—
Home equity and second mortgage		15,990		3,165		5,417
Commercial loans		79,630		—		—
Consumer loans		1,000		1,553		260
Commercial equipment		5,869		10,780		1,639

Total loans	$	167,919	$	58,402	$	200,433

The following table sets forth the dollar amount of all loans due after one year from December 31, 2006, which have predetermined interest rates and have floating or adjustable interest rates.


			Floating or
	Fixed Rates		Adjustable Rates		Total
	(Dollars in thousands)
Real estate loans
Commercial	$	15,348	$	139,876	$	155,224
Residential first mortgage		66,614		10,469		77,083
Construction and land development		—		3,714		3,714
Home equity and second mortgage		8,582		—		8,582
Commercial loans		—		—		—
Consumer loans		1,813		—		1,813
Commercial equipment		12,419		—		12,419

Total Loans	$	104,776	$	154,059	$	258,835

Delinquencies. The Bank’s collection procedures provide that when a loan is 15 days delinquent, the borrower is contacted by mail and payment is requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower and obtain payment. If these efforts prove unsuccessful, the Bank will pursue appropriate legal action including repossession of the collateral and other actions as deemed necessary. In certain instances, the Bank will attempt to modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs.

Non-Performing Assets and Asset Classification. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Residential mortgage loans are placed on non-accrual status when either principal or interest is 90 days or more past due unless they are adequately secured and there is reasonable assurance of full collection of principal and interest. Consumer loans generally are charged off when the loan becomes more than 120 days delinquent. Commercial business and real estate loans are placed on non-accrual status when the loan is 90 days or more past due or when the loan’s condition puts the timely repayment of principal and interest in doubt. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either

applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectibility of the loan.

Foreclosed Real Estate

Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed real estate until such time as it is sold. When such property is acquired, it is recorded at its fair market value. Subsequent to foreclosure, the property is carried at the lower of cost or fair value less selling costs. Additional write-downs as well as carrying expenses of the foreclosed properties are charged to expenses in the current period. The Bank had foreclosed real estate with a carrying value of approximately $460,884 at December 31, 2006.

Foreclosed real estate is recorded net of a valuation allowance. The allowance is adjusted as circumstances require. These adjustments in the allowance include changes in the value of the property as well as the sale or disposal of the foreclosed property. There is currently one property in foreclosed real estate. This property is related to a development project. This project was acquired in July 2001 by deed in lieu of foreclosure. The project is being developed in two phases. Preliminary approvals have been obtained for phase 1 and this portion of the project was sold in 2002. Phase 2 is under contract to sell and will be sold when preliminary approval from Charles County is granted. Approvals for building permits are generally granted within a school district as public facilities become available. Rights are generally granted to projects based upon dates of meeting certain criteria. During 2005, the County granted numerous permits to projects within the same school district. These grants would tend to move our project up in priority. No firm date for granting approval is now known. Total sales price for Phase 2 is expected to be $1.7 million. Under the terms of the agreement, the buyer is responsible for all development costs associated with both phases. The sales agreement provides for a minimal ($25,000) payment to the Bank should the buyer decide to not complete its purchase of Phase 2. The Bank did not provide financing for the sales agreement or subsequent development work. Based upon these facts and circumstances, the Bank recognized the sale of Phase 1 for accounting purposes. The Bank determined that no sales recognition on the agreement to sell Phase 2 is appropriate at this time. The amount of the remaining allowance and total carrying value of Phase 2 is periodically evaluated for possible impairment.

Delinquent and Nonaccrual Loans

The following table sets forth information with respect to the Bank’s non-performing loans for the dates indicated. At the dates shown, the Bank had no troubled debt restructuring or impaired loans within the meaning of Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” and 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures” and no accruing loans that are contractually past due 90 days or more.


	At December 31,
	2006		2005		2004		2003		2002
	(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Real estate loans
Commercial	$	390	$	—	$	—	$	—	$	—
Residential first mortgage		273		273		273		275		278
Construction and land development		—		—		—		—		—
Home equity and second mortgage		—		53		—		—		49
Commercial loans		303		258		393		103		269
Consumer loans		80		7		9		1		1
Commercial equipment		—		—		—		—		—

Total		1,046		591		675		379		597

Total non-performing loans	$	1,046	$	591	$	675	$	379	$	597

For a detailed discussion of foreclosed real estate at December 31, 2006 see the “Foreclosed Real Estate” section discussed previously. During the year ended December 31, 2006, gross interest income of $75,480 would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. During 2006, the Company recognized $18,121 in interest on these loans. 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 charged-off no later than 180 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. 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.

At December 31, 2006, there were no loans outstanding not reflected in the above table as to which known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms.

The following table sets forth an analysis of activity in the Bank’s allowance for loan losses for the periods indicated.


	At December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)
Balance at beginning of period	$	3,383		$	3,058		$	2,573		$	2,314		$	2,282

Charge-offs
Real estate loans:
Commercial		—			—			—			—			—
Residential first mortgage		—			—			—			—			—
Construction and land development		—			—			—			—			36
Home equity and second mortgage		—			—			—			—			21
Commercial loans		—			3			1			35			59
Consumer loans		8			2			3			2			15
Commercial equipment		—			4			14			24			—

Total charge-offs		8			9			18			61			131

Recoveries
Real estate loans:
Commercial		—			—			—			—			—
Residential first mortgage		—			—			33			—			—
Construction and land development		—			—			—			—			—
Home equity and second mortgage		—			—			—			—			—
Commercial loans		—			—			—			—			—
Consumer loans		3			—			9			—			3
Commercial equipment		—			5			8			2			—

Total recoveries		3			5			50			2			3

Net (recoveries) charge-offs		5			4			(32	)		58			128
Provision for loan losses		406			329			453			317			160

Balance at end of period	$	3,784		$	3,383		$	3,058		$	2,573		$	2,314

Ratio of net charge-offs (recoveries) to average loans outstanding during the year		0.00	%		0.00	%		(0.01	)%		0.02	%		0.06	%

The following table allocates the allowance for loan losses by loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.


	At December 31,
	2006					2005					2004					2003					2002
	(Dollars in thousands)
			Percent of					Percent of					Percent of					Percent of					Percent of
			Loans in					Loans in					Loans in					Loans in					Loans in
			Each					Each					Each					Each					Each
			Category					Category					Category					Category					Category
			to Total					to Total					to Total					to Total					to Total
	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
Real estate loans
Commercial	$	1,479		41.69	%	$	1,466		44.66	%	$	1,909		46.51	%	$	1,409		42.46	%	$	1,077		37.07	%
Residential first mortgage		97		18.93			73		19.71			59		20.16			64		19.45			118		24.44
Construction and land
development		662		10.01			502		8.73			132		6.00			281		8.87			211		7.27
Home equity and second mortgage		104		5.76			109		6.93			120		8.16			244		8.85			276		9.48
Commercial loans		1,135		18.66			709		14.65			530		13.35			381		13.77			434		14.94
Consumer loans		126		0.66			124		0.84			138		1.18			63		1.85			68		2.31
Commercial equipment		181		4.29			400		4.48			170		4.64			131		4.71			130		4.49


Total allowance for loan losses	$	3,784		100.00	%	$	3,383		100.00	%	$	3,058		100.00	%	$	2,573		100.00	%	$	2,314		100.00	%

The Bank closely monitors the loan payment activity of all its loans. The Bank periodically reviews the adequacy of the allowance for loan losses based on an analysis of the loan portfolio, the Bank’s historical loss experience, economic conditions in the Bank’s market area, and a review of selected individual loans. Loan losses are charged off against the allowance when the uncollectibility is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Bank believes it has established its existing allowance for loan losses in accordance with accounting principles generally accepted in the United States of America and is in compliance with appropriate regulatory guidelines. However, the establishment of the level of the allowance for loan losses is highly subjective and dependent on incomplete information as to the ultimate disposition of loans. Accordingly, there can be no assurance that actual losses may not vary from the amounts estimated or that the Bank’s regulators will not require the Bank to significantly increase or decrease its allowance for loan losses, thereby affecting the Bank’s financial condition and earnings. For a more complete discussion of the allowance for loan losses, see the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s 2006 Annual Report to Stockholders.

Investment Activities

The Bank maintains a portfolio of investment securities to provide liquidity as well as a source of earnings. The Bank’s investment securities portfolio consists primarily of mortgage-backed and other securities issued by U.S. government-sponsored enterprises (“GSEs”) including Freddie Mac and Fannie Mae. The Bank also has smaller holdings of privately issued mortgage-backed securities, U.S. Treasury obligations, and other equity and debt securities. As a member of the Federal Reserve and FHLB systems, the Bank is also required to invest in the stock of the Federal Reserve Bank of Richmond and FHLB of Atlanta.

The following table sets forth the carrying value of the Company’s investment securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the dates indicated. At December 31, 2006, their estimated fair value was $111.5 million.


	At December 31,
	2006		2005		2004
	(Dollars in thousands)
Asset-backed securities
Freddie Mac and Fannie Mae	$	72,602	$	84,334	$	155,678
Other		29,956		37,383		16,535

Total asset-backed securities		102,558		121,717		172,213

Freddie Mac and Fannie Mae stock		342		719		766
Bond mutual funds		3,262		127		630
Treasury bills		800		499		300
Other investments		145		604		1,781

Total investment securities		107,107		123,666		175,690
FHLB and Federal Reserve Bank stock		6,100		7,190		6,144

Total investment securities and FHLB and Federal Reserve Bank stock	$	113,207	$	130,856	$	181,834

The maturities and weighted average yields for investment securities available for sale and held to maturity at December 31, 2006 are shown below.


						After One					After Five
	One Year or Less					Through Five Years					Through Ten Years					After Ten Years
	Amortized		Average			Amortized		Average			Amortized		Average			Amortized		Average
	Cost		Yield			Cost		Yield			Cost		Yield			Cost		Yield
	(Dollars in thousands)
Investment securities available for sale
Corporate equity securities	$	255		4.70	%	$	—		0.00	%	$	—		0.00	%	$	—		0.00	%
Asset-backed securities		143		7.23	%		749		5.46	%		3,987		4.90	%		1,003		4.79	%
Mutual Funds		3,246		4.30	%		—		0.00	%		—		0.00	%		—		0.00	%


Total investment securities available for sale	$	3,644		4.45	%	$	749		0.00	%	$	3,987		4.90	%	$	1,003		4.79	%


Investment securities held-to- maturity
Asset-backed securities	$	7,240		4.94	%	$	29,248		5.04	%	$	29,881		5.36	%	$	30,492		5.79	%
Treasury bills		800		5.04	%		—		0.00	%		—		0.00	%		—		0.00	%
Other investments		11		4.68	%		134		4.68	%		—		0.00	%		—		0.00	%


Total investment securities held-to-maturity	$	8,051		4.95	%	$	29,382		5.03	%	$	29,881		5.36	%	$	30,492		5.79	%

The Bank’s investment policy provides that securities that will be held for indefinite periods of time, including securities that will be used as part of the Bank’s asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors, are classified as available for sale and accounted for at fair value. Management’s intent is to hold securities reported at amortized cost to maturity. Certain of the Company’s asset-backed securities are issued by private issuers (defined as an issuer that is not a government or a government-sponsored entity). Listed below are the Company’s investments in certain of these issuers that aggregate to more than 10% of the Company’s equity. For further information regarding the Company’s investment securities, see Note 3 of Notes to Consolidated Financial Statements.


Issuer	Book Value		Rating
Wells Fargo	$	6,023,058	AAA
Morgan Stanley	$	5,012,318	AAA
Countrywide	$	4,036,168	AAA

Deposits and Other Sources of Funds

General. The funds needed by the Bank to make loans are primarily generated by deposit accounts solicited from the communities surrounding its main office and eight branches in the southern Maryland area. Total deposits were $418.0 million as of December 31, 2006. The Bank uses borrowings from the FHLB of Atlanta, reverse repurchase agreements, and other sources to supplement funding from deposits.

Deposits. The Bank’s deposit products include savings, money market, demand deposit, IRA, SEP, Christmas clubs, and time deposit accounts. Variations in service charges, terms and interest rates are used to target specific markets. Ancillary products and services for deposit customers include safe deposit boxes, travelers checks, night depositories, automated clearinghouse transactions, wire transfers, ATMs, and online and telephone banking. The Bank is a member of JEANIE, Cirrus and STAR ATM networks. The Bank has occasionally used deposit brokers to obtain funds. At December 31, 2006, brokered deposits totaled $24.3 million. At December 31, 2005, brokered deposits totaled $24.7 million.

The following table sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.


	2006					2005					2004
	Average		Average			Average		Average			Average		Average
	Balance		Rate			Balance		Rate			Balance		Rate
	(Dollars in thousands)
Savings	$	34,570		1.18	%	$	36,696		0.59	%	$	37,776		0.47	%
Interest-bearing demand and money market accounts		104,410		2.92			89,394		1.55			85,212		0.89
Certificates of deposit		204,675		4.21			146,512		3.32			93,267		2.46

Total interest-bearing deposits		343,655		3.51			272,602		2.37			216,255		1.49
Noninterest-bearing demand deposits		42,030		—			39,855		—			32,909		—

Total	$	385,685		3.13		$	312,457		2.07		$	249,164		1.29

The following table indicates the amount of the Bank’s certificates of deposit and other time deposits of more than $100,000 by time remaining until maturity as of December 31, 2006.


	Certificates
Maturity Period	of Deposit
	(Dollars in thousands)
Three months or less		$26,242
Three through six months		7,912
Six through twelve months		17,785
Over twelve months		11,057

Total		$62,996

Borrowings. Deposits are the primary source of funds for the Bank’s lending and investment activities and for its general business purposes. The Bank uses advances from the FHLB of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB are secured by the Bank’s stock in the FHLB, a portion of the Bank’s residential mortgage loans, and its eligible investments. Generally the Bank’s ability to borrow from the FHLB of Atlanta is limited by its available collateral and also by an overall limitation of 40% of assets. In addition to advances the Bank uses reverse repurchase agreements to enhance its funding. Other short-term debt consists of notes payable to the U.S. Treasury on Treasury, tax and loan accounts. Long-term borrowings consist of adjustable-rate advances with rates based upon LIBOR, fixed-rate advances, and convertible advances. The table below sets forth information about borrowings for the years indicated.


	At or for the
	Year Ended December 31,
	2006			2005			2004
	(Dollars in thousands)
Long-term debt outstanding at end of period	$	96,046		$	107,824		$	82,931
Weighted average rate on outstanding long-term debt		4.42	%		4.25	%		4.20	%
Maximum outstanding long-term debt of any month end	$	108,078		$	107,826		$	82,931

Average outstanding long-term debt	$	101,520		$	93,409		$	73,830
Approximate average rate paid on long-term debt		4.42	%		4.25	%		4.44	%

Short-term debt outstanding at end of period	$	6,568		$	20,075		$	115,304
Weighted average rate on outstanding short-term debt		5.08	%		4.43	%		2.53	%
Maximum outstanding short-term debt at any month end	$	37,590		$	123,968		$	122,693
Average outstanding short-term debt	$	18,129		$	82,665		$	64,736
Approximate average rate paid on short-term debt		4.99	%		3.10	%		1.80	%

For more information regarding the Bank’s borrowings, see Note 9 of Notes to Consolidated Financial Statements.

Subsidiary Activities

Under the Maryland Financial Institutions Code, commercial banks may invest in service corporations and in other subsidiaries that offer the public a financial, fiduciary or insurance service. In April 1997, the Bank formed a wholly owned subsidiary, Community Mortgage Corporation of Tri-County, to offer mortgage banking, brokerage, and other services to the public. This corporation was inactive until 2001. At that time, the Bank transferred a property that was acquired by deed in lieu of foreclosure to this subsidiary in order to complete development of this parcel. In August 1999, the Bank formed a wholly-owned subsidiary, Tri-County Investment Corporation to hold and manage a portion of the Bank’s investment portfolio.

The Company has two direct subsidiaries other than the Bank. In July 2004, Tri-County Capital Trust I was established as a statutory trust under Delaware law as a wholly-owned subsidiary of the Company for the purpose of issuing trust-preferred securities. Tri-County Capital Trust I issued $7.0 million of trust-preferred securities on July 22, 2004. In June 2005, Tri-County Capital Trust II was also established as a statutory trust under Delaware law as a wholly-owned subsidiary of the Company for the purpose of issuing trust-preferred securities. Tri-County Capital Trust II issued $5.0 million of trust preferred securities on June 15, 2005.

SUPERVISION AND REGULATION

Regulation of the Company

General. The Company is a public company registered with the Securities and Exchange Commission (the “SEC”) and, as the sole stockholder of the Bank, it is a bank holding company and registered as such with the Board of Governors of the Federal Reserve System (the “FRB”). Bank holding companies are subject to comprehensive regulation by the FRB under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the regulations of the FRB. As a public company the Company is required to file annual, quarterly and current reports with the SEC, and as a bank holding company, the Company is required to file with the FRB annual reports and such additional information as the FRB may require, and is subject to regular examinations by the FRB. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. The following discussion summarizes certain of the regulations applicable to the Company but does not purport to be a complete description of such regulations and is qualified in its entirety by reference to the actual laws and regulations involved.

Under the BHCA, a bank holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. In evaluating such application, the FRB considers factors such as the financial condition and managerial resources of the companies involved, the convenience and needs of the communities to be served and competitive factors.

The Riegle-Neal Interstate Banking and Branching Efficiency of 1994 (the “Riegle-Neal Act”) authorized the FRB to approve an application of a bank holding company meeting certain qualitative criteria to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company’s home state, without regard to whether the transaction is prohibited by the laws of any state. The FRB may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Riegle-Neal Act also prohibits the FRB from approving such an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank’s home state or in any state in which the target bank maintains a branch. The Riegle-Neal Act does not affect the authority of states to limit the percentage of total insured deposits in the state that may be held or controlled by a bank or bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the Riegle-Neal Act. Under Maryland law, a bank holding company is prohibited from acquiring control of any bank if the bank holding company would control more than 30% of the total deposits of all depository institutions in the State of Maryland unless waived by the Commissioner of Financial Regulation.

Additionally, the federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks opted out of the Riegle-Neal Act by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997, which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. The State of Maryland did not pass such a law during this period. Interstate acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration amounts described above.

The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.

Effective with the enactment of the Gramm-Leach-Bliley Act (the “G-L-B Act”), bank holding companies whose financial institution subsidiaries are “well capitalized” and “well managed” and have satisfactory Community Reinvestment Act records can elect to become “financial holding companies”, which are permitted to engage in a broader range of financial activities than are permitted to bank holding companies. Financial holding companies are authorized to engage in, directly or indirectly, financial activities. A financial activity is an activity that is: (i) financial in nature; (ii) incidental to an activity that is financial in nature; or (iii) complementary to a financial activity and that does not pose a safety and soundness risk. The G-L-B Act includes a list of activities that are deemed to be financial in nature. Other activities also may be decided by the FRB to be financial in nature or incidental thereto if they meet specified criteria. A financial holding company that intends to engage in a new activity to acquire a company to engage in such an activity is required to give prior notice to the FRB. If the activity

is not either specified in the G-L-B Act as being a financial activity or one that the FRB has determined by rule or regulation to be financial in nature, the prior approval of the FRB is required.

Federal law provides that no person (broadly defined to include business entities) “directly or indirectly or acting in concert with one or more persons, or through one or more subsidiaries, or through one or more transactions,” may acquire “control” of a bank holding company or insured bank without the approval of the appropriate federal regulator, which in the Company’s (and Bank’s) case will be the FRB. Control is defined to mean direct or indirect ownership, control of, or holding irrevocable proxies representing 25% or more of any class of voting stock, control in any manner of the election of a majority of the bank’s directors or a determination by the FRB that the acquirer has or would have the power to direct, or directly or indirectly to exercise a controlling influence over, the management or policies of the institution. Acquisition of more than 10% of any class of a bank’s stock creates a rebuttable presumption of control under certain circumstances that requires that a filing be made with the FRB unless the FRB determines that the presumption has been rebutted. Any company that seeks to acquire 25% or more of a class of a bank’s voting stock, or otherwise acquire control, must first receive the prior approval of the FRB under the Bank Holding Company Act and no existing bank holding company may acquire more than 5% of any class of a nonsubsidiary bank’s voting stock without prior FRB approval.

The Maryland Financial Institutions Code prohibits a bank holding company from acquiring more than 5% of any class of voting stock of a bank or bank holding company without the approval of the Commissioner of Financial Regulation, except as otherwise expressly permitted by federal law or in certain other limited situations. The Maryland Financial Institutions Code additionally prohibits any person from acquiring voting stock in a bank or bank holding company without 60 days prior notice to the Commissioner if such acquisition will give the person control of 25% or more of the voting stock of the bank or bank holding company or will affect the power to direct or to cause the direction of the policy or management of the bank or bank holding company. Any doubt whether the stock acquisition will affect the power to direct or cause the direction of policy or management shall be resolved in favor of reporting to the Commissioner. The Commissioner may deny approval of the acquisition if the Commissioner determines it to be anti-competitive or to threaten the safety or soundness of a banking institution. Voting stock acquired in violation of this statute may not be voted for five years.

Dividends. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the FRB pursuant to Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), the FRB may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

Stock Repurchases. Bank holding companies are required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the their consolidated retained earnings. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. There is an exception for this approval requirement for certain well-capitalized, well-managed bank holding companies.

Capital Requirements. The FRB has established capital requirements, similar to the capital requirements for state member banks, for bank holding companies with consolidated assets of $500 million or more. As of December 31, 2006, the Company’s levels of consolidated regulatory capital exceeded the FRB’s minimum requirements.

Regulation of the Bank

General. The Bank is a Maryland commercial bank and its deposit accounts are insured by the Deposit Insurance Fund of the FDIC. The Bank is a member of the Federal Reserve and FHLB systems. The Bank is

subject to supervision, examination and regulation by Commissioner of Financial Regulation of the State of Maryland (the “Commissioner”) and the FRB and to Maryland and federal statutory and regulatory provisions governing such matters as capital standards, mergers, and establishment of branch offices. The FDIC, as deposit insurer, has certain secondary examination and supervisory authority. The Bank is required to file reports with the Commissioner and the FRB concerning its activities and financial condition and is required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other depository institutions.

As an institution with federally insured deposits, the Bank is subject to various operational regulations promulgated by the FRB, including Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund Transfers), Regulation P (Privacy), Regulation W (Transactions Between Member Banks and Their Affiliates), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD (Truth in Savings).

The system of regulation and supervision applicable to the Bank establishes a comprehensive framework for the operations of the Bank and is intended primarily for the protection of the FDIC and the depositors of the Bank. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities, including with respect to the classification of assets and the establishment of loss reserves for regulatory purposes. Changes in the regulatory framework could have a material effect on the Bank and its respective operations that in turn, could have a material effect on the Company. The following discussion summarizes certain of the regulations applicable to the Bank but does not purport to be a complete description of such regulations and is qualified in its entirety by reference to the actual laws and regulations involved.

Capital Adequacy. The FRB has established guidelines with respect to the maintenance of appropriate levels of capital by bank holding companies and state member banks, respectively. The regulations impose two sets of capital adequacy requirements: minimum leverage rules, which require bank holding companies and member banks to maintain a specified minimum ratio of capital-to-total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to “risk-weighted” assets.

The regulations of the FRB require bank holding companies and state member banks, respectively, to maintain a minimum leverage ratio of “Tier 1 capital” (as defined in the risk-based capital guidelines discussed in the following paragraphs) to total assets of 3.0%. Although setting a minimum 3.0% leverage ratio, the capital regulations state that only the strongest bank holding companies and banks, with composite examination ratings of 1 under the rating system used by the federal bank regulators, would be permitted to operate at or near such minimum level of capital. All other bank holding companies and banks are expected to maintain a leverage ratio of at least 4.0%. Any bank or bank holding company experiencing or anticipating significant growth would be expected to maintain capital well above the minimum levels. In addition, the FRB has indicated that whenever appropriate, and in particular when a bank holding company is undertaking expansion, seeking to engage in new activities, or otherwise facing unusual or abnormal risks, it will consider, on a case-by-case basis, the level of an organization’s ratio of tangible Tier 1 capital (after deducting all intangibles) to total assets in making an overall assessment of capital.

The risk-based capital rules of the FRB require bank holding companies and state member banks, respectively, to maintain minimum regulatory capital levels based upon a weighting of their assets and off-balance sheet obligations according to risk. Risk-based capital is composed of two elements: Tier 1 capital and Tier 2 capital. Tier 1 capital consists primarily of common stockholders’ equity, certain perpetual preferred stock (which must be noncumulative in the case of banks), and minority interests in the equity accounts of consolidated subsidiaries; less all intangible assets, except for certain servicing assets, purchased credit card relationships, deferred tax assets and credit enhancing interest-only strips. Tier 2 capital elements include, subject to certain limitations, the allowance for losses on loans and leases; perpetual preferred stock that does not qualify as Tier 1 capital and long-term preferred stock with an original maturity of at least 20 years from issuance; hybrid capital instruments, including perpetual debt and mandatory convertible securities, subordinated debt and intermediate-term preferred stock and up to 45% of unrealized gains on available for sale equity securities with readily determinable market values.

The risk-based capital regulations assign balance sheet assets and credit equivalent amounts of off-balance sheet obligations to one of four broad risk categories based principally on the degree of credit risk associated with the obligor. The assets and off-balance sheet items in the four risk categories are weighted at 0%, 20%, 50% and 100%. These computations result in the total risk-weighted assets. The risk-based capital regulations require all banks and bank holding companies to maintain a minimum ratio of total capital (Tier 1 capital plus Tier 2 capital) to total risk-weighted assets of 8%, with at least 4% as Tier 1 capital. For the purpose of calculating these ratios: (i) Tier 2 capital is limited to no more than 100% of Tier 1 capital; and (ii) the aggregate amount of certain types of Tier 2 capital is limited. In addition, the risk-based capital regulations limit the allowance for loan losses includable as capital to 1.25% of total risk-weighted assets.

FRB regulations and guidelines additionally specify that state member banks with significant exposure to declines in the economic value of their capital due to changes in interest rates may be required to maintain higher risk-based capital ratios.

The FRB has issued regulations that classify state member banks by capital levels and which authorize the FRB to take various prompt corrective actions to resolve the problems of any bank that fails to satisfy the capital standards. Under such regulations, a well capitalized bank is one that is not subject to any regulatory order or directive to meet any specific capital level and that has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An adequately capitalized bank is one that does not qualify as well capitalized but meets or exceeds the following capital requirements: a total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i) 4% or (ii) 3% if the bank has the highest composite examination rating. A bank not meeting these criteria is treated as undercapitalized, significantly undercapitalized, or critically undercapitalized depending on the extent to which the bank’s capital levels are below these standards. A state member bank that falls within any of the three undercapitalized categories established by the prompt corrective action regulation will be subject to regulatory sanctions. As of December 31, 2006, the Bank was well capitalized as defined by the FRB’s regulations.

Branching. Maryland law provides that, with the approval of the Commissioner, Maryland banks may establish branches within the State of Maryland without geographic restriction and may establish branches in other states by any means permitted by the laws of such state or by federal law. The Riegle-Neal Act authorizes the FRB to approve interstate branching de novo by merger by state member banks in any state that did not opt out and only in states that specifically allow for such branching. The Riegle-Neal Act also required the appropriate federal banking agencies to prescribe regulations that prohibit any out-of-state bank from using the interstate branching authority primarily for the purpose of deposit production. These regulations include guidelines to ensure that interstate branches operated by an out-of-state bank in a host state are reasonably helping to meet the credit needs of the communities which they serve.

Dividend Limitations. Pursuant to the Maryland Financial Institutions Code, Maryland banks may only pay dividends from undivided profits or, with the prior approval of the Commissioner, their surplus in excess of 100% of required capital stock. The Maryland Financial Institutions Code further restricts the payment of dividends by prohibiting a Maryland bank from declaring a dividend on its shares of common stock until its surplus fund equals the amount of required capital stock or, if the surplus fund does not equal the amount of capital stock, in an amount in excess of 90% of net earnings.

Without the approval of the FRB, a state member bank may not declare or pay a dividend if the total of all dividends declared during the year exceeds its net income during the current calendar year and retained net income for the prior two years. The Bank is further prohibited from making a capital distribution if it would be thereafter undercapitalized within the meaning of the prompt corrective action regulations discussed above. In addition, the Bank may not make a capital distribution that would reduce its net worth below the amount required to maintain the liquidation account established for the benefit of its depositors at the time of its conversion to stock form.

Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. The FDIC recently amended its risk-based assessment system for 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005 (“Reform Act”). Under the revised system, insured institutions are assigned to one of four risk categories based on

supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned. Risk category I, which contains the least risky depository institutions, is expected to include more than 90% of all institutions. Unlike the other categories, Risk Category I contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings and other information. Assessment rates are determined by the FDIC and currently range from five to seven basis points for the healthiest institutions (Risk Category I) to 43 basis points of assessable deposits for the riskiest (Risk Category IV). The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.

The Reform Act also provided for a one-time credit for eligible institutions based on their assessment base as of December 31, 1996. Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset assessments until exhausted. The Bank’s one-time credit is expected to approximate $195,719. The Reform Act also provided for the possibility that the FDIC may pay dividends to insured institutions once the Deposit Insurance fund reserve ratio equals or exceeds 1.35% of estimated insured deposits.

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. This payment is established quarterly and during the calendar year ending December 31, 2006 averaged 1.28 basis points of assessable deposits.

The Reform Act provided the FDIC with authority to adjust the Deposit Insurance Fund ratio to insured deposits within a range of 1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of 1.25%. The ratio, which is viewed by the FDIC as the level that the fund should achieve, was established by the agency at 1.25% for 2007.

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the FRB. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

Transactions with Affiliates. A state member bank or its subsidiaries may not engage in “covered transactions” with any one affiliate in an amount greater than 10% of such bank’s capital stock and surplus, and for all such transactions with all affiliates a state member bank is limited to an amount equal to 20% of capital stock and surplus. All such transactions must also be on terms substantially the same, or at least as favorable, to the bank or subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar types of transactions. Certain covered transactions, such as loans to affiliates, must meet specified collateral requirements. An affiliate of a state member bank is any company or entity that controls or is under common control with the state member bank and, for purposes of the aggregate limit on transactions with affiliates, any subsidiary that would be deemed a financial subsidiary of a national bank. In a holding company context, the parent holding company of a state member bank (such as the Company) and any companies that are controlled by such parent holding company are affiliates of the state member bank. The BHCA further prohibits a depository institution from extending credit to or offering any other services, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution, subject to certain limited exceptions.

Loans to Directors, Executive Officers and Principal Stockholders. Loans to directors, executive officers and principal stockholders of a state member bank must be made on substantially the same terms as those prevailing for comparable transactions with persons who are not executive officers, directors, principal stockholders or employees of the bank unless the loan is made pursuant to a compensation or benefit plan that is widely available to employees and does not favor insiders. Loans to any executive officer, director and principal stockholder together with all other outstanding loans to such person and affiliated interests generally may not exceed 15% of the bank’s unimpaired capital and surplus and all loans to such persons may not exceed the institution’s unimpaired capital and

unimpaired surplus. Loans to directors, executive officers and principal stockholders, and their respective affiliates, in excess of the greater of $25,000 or 5% of capital and surplus, or any loans aggregating $500,000 or more, must be approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. State member banks are prohibited from paying the overdrafts of any of their executive officers or directors unless payment is made pursuant to a written, pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or transfer of funds from another account at the bank. In addition, loans to executive officers may not be made on terms more favorable than those afforded other borrowers and are restricted as to type, amount and terms of credit.

Enforcement. The Commissioner has extensive enforcement authority over Maryland banks. Such authority includes the ability to issue cease and desist orders and civil money penalties and to remove directors or officers. The Commissioner may also take possession of a Maryland bank whose capital is impaired and seek to have a receiver appointed by a court.

The FRB has primary federal enforcement responsibility over state banks under its jurisdiction, including the authority to bring enforcement action against all “institution-related parties,” including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action may range from the issuance of capital directive or cease and desist order to removal of officers and/or directors, receivership, conservatorship or termination of deposit insurance. Civil money penalties cover a wide range of violations and actions, and range up to $25,000 per day or even up to $1 million per day (in the most egregious cases). Criminal penalties for most financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years.

Personnel

As of December 31, 2006, the Bank had 103 full-time employees and 7 part-time employees. The employees are not represented by a collective bargaining agreement. The Bank believes its employee relations are good.

Executive Officers of the Registrant

The executive officers of the Company are as follows

Michael L. Middleton (59 years old) is President and Chief Executive Officer of the Company and the Bank. He joined the Bank in 1973 and served in various management positions until 1979 when he became president of the Bank. Mr. Middleton is a Certified Public Accountant and holds a Master of Business Administration. As President and Chief Executive Officer of the Bank, Mr. Middleton is responsible for the overall operation of the Bank pursuant to the policies and procedures established by the Board of Directors. From 1996 to 2004, Mr. Middleton served on the Board of Directors of the Federal Home Loan Bank of Atlanta, and served as Chairman from 2003 to 2004. Mr. Middleton also served as Federal Home Loan Bank of Atlanta representative to the Council of Federal Home Loan Banks. Mr. Middleton currently serves on the board of the Baltimore Branch of the Federal Reserve Bank of Richmond.

C. Marie Brown (64 years old) has been employed with the Bank since 1972 and has served as Chief Operating Officer since 1999. Before her appointment as Chief Operating Officer, Ms. Brown served as Senior Vice President of the Bank. She is a supporter of the Handicapped and Retarded Citizens of Charles County, a member of the Zonta Club of Charles County and serves on various administrative committees of the Hughesville Baptist Church.

Gregory C. Cockerham (52 years old) joined the Bank in November 1988 and has served as Chief Lending Officer since 1996. Before his appointment as Executive Vice President, Mr. Cockerham served as Vice President of the Bank. Mr. Cockerham has been in banking for 28 years. He is a Paul Harris Fellow with the Rotary Club of Charles County and serves on various civic boards in the County.

William J. Pasenelli (48 years old) joined the Bank as Chief Financial Officer in April 2000. Before joining the Bank, Mr. Pasenelli had been Chief Financial Officer of Acacia Federal Savings Bank, Annandale,

Virginia since 1987. Mr. Pasenelli is a member of the American Institute of Certified Public Accountants, the DC Institute of Certified Public Accountants, and other civic groups.

James M. Burke (38 years old) joined the Bank in 2006. He serves as the Bank’s Executive Vice President — Credit. Before his appointment as Executive Vice President — Credit, he served as the Bank’s senior credit officer. Prior to joining the Bank, Mr. Burke served as Executive Vice President of Mercantile Southern Maryland Bank. Mr. Burke has 16 years of banking experience. Mr. Burke is member of the board of directors of Civista Medical Center and other civic groups.

James F. DiMisa (48 years old) joined the Bank in 2006. He serves as Executive Vice President- Bank Operations. Prior to joining the Bank, Mr. DiMisa served as Executive Vice President of Mercantile Southern Maryland Bank. Mr. DiMisa has 28 years of banking experience. Mr. DiMisa is a member of various civic and professional groups.

Item 1A. Risk Factors

An investment in shares of our common stock involves various risks. Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that we may believe are immaterial or unlikely. The value or market price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

Our business strategy includes the continuation of significant growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

Our assets have increased $293.4 million, or 104%, from $282.1 million at December 31, 2002 to $575.5 million at December 31, 2006, primarily due to increases in loans and investment securities. We expect to continue to experience growth in the amount of our assets, the level of our deposits and the scale of our operations. Achieving our growth targets requires us to attract customers that currently bank at other financial institutions in our market, thereby increasing our share of the market. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced bankers, the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or that we will successfully manage our growth. If we do not manage our growth effectively, we may not be able to achieve our business plan and our business and prospects could be harmed.

Certain interest rate movements may hurt our earnings.

Interest rates were at historically low levels. However, since June 30, 2004, the U.S. Federal Reserve has increased its target for the federal funds rate seventeen times, from 1.00% to 5.25%. While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer-term loans) have not. This “flattening” of the market yield curve has resulted in our interest rate spread declining from 3.21% at December 31, 2003 to 2.82% at December 31, 2006 and net interest margin declining from 3.44% at December 31, 2003 to 3.24% at December 31, 2006. If short-term interest rates continue to rise, and if rates on our deposits and borrowings reprice upwards faster than the rates on our long-term loans and investments, we would experience further compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability.

Our increased emphasis on commercial and construction lending may expose us to increased lending risks.

At December 31, 2006, our loan portfolio consisted of $177.9 million, or 41.7%, of commercial real estate loans, $42.7 million, or 10.0%, of construction and land development loans, $79.6 million, or 18.7%, of commercial business loans and $18.3 million, or 4.3%, of commercial equipment loans. We intend to increase our emphasis on these types of loans. These types of loans generally expose a lender to greater risk of non-payment and loss than

one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than one- to four-family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for the likely increase in probable incurred credit losses associated with the growth of such loans. Also, many of our commercial and construction borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.

Our recent results may not be indicative of our future operating results.

We have achieved significant growth in earnings per share in recent years. For example, net earnings per share (diluted) grew from $0.73 for the year ended December 31, 2002 to $1.58 for the year ended December 31, 2006. Our strong performance during this time period was, in part, the result of an extremely favorable interest rate environment. In the future, we may not have the benefit of a favorable interest rate environment. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or restrict our ability to increase earnings at this same rate.

Strong competition within our market area could hurt our profits and slow growth.

We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. According to the Federal Deposit Insurance Corporation, as of June 30, 2006, we held 11.2% of the deposits in Calvert, Charles and St. Mary’s counties, Maryland, which was the third largest market share of deposits out of the 14 financial institutions which held deposits in these counties. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.

If we do not achieve profitability on our new branch, it may negatively impact our earnings.

We opened our Prince Frederick branch office on May 19, 2005. Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel and an effective marketing strategy. Additionally, it takes time for a new branch to generate significant deposits and make sufficient loans to produce enough income to offset expenses, some of which, like salaries and occupancy expense, are relatively fixed costs. We expect that it may take a period of time before the new branch office can become profitable. During this period, operating this new branch office may negatively impact our net income.

If the value of real estate in southern Maryland were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.

With most of our loans concentrated in southern Maryland, a decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans. A decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values

are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters.

Our business is subject to the success of the local economy in which we operate.

Because the majority of our borrowers and depositors are individuals and businesses located and doing business in southern Maryland, our success depends to a significant extent upon economic conditions in southern Maryland. Adverse economic conditions in our market area could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the State of Maryland could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

The trading history of our common stock is characterized by low trading volume. Our common stock may be subject to sudden decreases.

Although our common stock trades on OTC Electronic Bulletin Board, it has not been regularly traded. We cannot predict the extent to which investor interest in us will lead to a more active trading market in our common stock or how liquid that market might become. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control.

The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

	Ø		actual or anticipated fluctuations in our operating results;

	Ø		changes in interest rates;

	Ø		changes in the legal or regulatory environment in which we operate;

	Ø		press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;

	Ø		changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;

	Ø		future sales of our common stock;

	Ø		changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and

	Ø		other developments affecting our competitors or us.

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at or above the price you desire. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance.

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

Community Bank of Tri-County is subject to extensive regulation, supervision and examination by the Commissioner of Financial Regulation of the State of Maryland, its chartering authority, the Federal Reserve Board, as its federal regulator, and by the Federal Deposit Insurance Corporation, as insurer of its deposits. Tri-County Financial Corporation is subject to regulation and supervision by the Federal Reserve Board. Such regulation and supervision govern the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and for the depositors and borrowers of Community Bank of Tri-County. The regulation and supervision by the Commissioner of Financial Regulation of the State of Maryland, the Federal Reserve Board and the Federal Deposit Insurance Corporation are not intended to protect the interests of investors in Tri-County Financial Corporation common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

Provisions of our articles of incorporation, bylaws and Maryland law, as well as state and federal banking regulations, could delay or prevent a takeover of us by a third party.

Provisions in our articles of incorporation and bylaws and the corporate law of the State of Maryland could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the price of our common stock. These provisions include: supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our board of directors and for proposing matters that shareholders may act on at shareholder meetings. In addition, we are subject to Maryland laws, including one that prohibits us from engaging in a business combination with any interested shareholder for a period of five years from the date the person became an interested shareholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors other than the candidates nominated by our Board.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

The following table sets forth the location of the Bank’s offices, as well as certain additional information relating to these offices as of December 31, 2006.

Year Facility

Leased

Date of

Approximate

Office

Commenced

Lease

Square

Location

Operation

Owned

Expiration

Footage

Main Office

3035 Leonardtown Road

1974

Owned

—

16,500

Waldorf, Maryland

Branch Offices

22730 Three Notch Road

1992

Owned

—

2,500

Lexington Park, Maryland

25395 Point Lookout Road

1961

Owned

—

1,700

Leonardtown, Maryland

101 Drury Drive

2001

Owned

—

2,645

La Plata, Maryland

10321 Southern Maryland Boulevard

1991

Leased

2009

2,500

Dunkirk, Maryland

8010 Matthews Road

1996

Owned

—

2,500

Bryans Road, Maryland

20 St. Patrick’s Drive

1998

Leased (Land)

—

2,840

Waldorf, Maryland

Owned (Building)

30165 Three Notch Road

2001

Leased (Land)

2026

2,800

Charlotte Hall, Maryland

Owned (Building)

200 Market Square

2005

Leased (Land)

2028

2,800

Prince Frederick, Maryland

Owned (Building)

Item 3. Legal Proceedings

Neither the Company, the Bank, nor any subsidiary is engaged in any legal proceedings of a material nature at the present time. From time to time the Bank is a party to legal proceedings in the ordinary course of business.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the quarter ended December 31, 2006.

PART II

Item 5. Market for Registrant’s Common Equity, Related Security Holder Matters and Issuer Purchases of Equity Securities

Market Price and Dividends on Registrant’s and Related Stockholder Matters.

The information contained under the section captioned “Market for the Registrant’s Common Stock and Related Security Holder Matters” in the Company’s Annual Report to Stockholders for the fiscal year ended December 31, 2006 (the “Annual Report”) filed as Exhibit 13 hereto is incorporated herein by reference.

Stock Performance Graph.

This information contained under the section captured “Stock Performance Group” of the Annual Report filed as Exhibit 13 hereto is incorporated by reference.

Recent Sales of Unregistered Securities.

On August 22, September 13, October 16 and October 18, 2006, the Company issued 5,000 shares of its common stock, par value $0.01 per share, respectively, in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. An underwriter was not utilized in the transactions. Shares were sold to two persons, both of whom were newly appointed directors of the Company and Community Bank of Tri-County and each were accredited investors. The Company received an aggregate of $177,500 in cash for the shares that were issued. There were no underwriting discounts or commissions. The net proceeds from the offering were used for general corporate purposes.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers for the Most Recent Fiscal Quarter.

Total Number

of Shares

Purchased

Maximum

as Part of

Number of Shares

Total

Publicly

that May Yet Be

Number of

Average

Announced Plans

Purchased Under

Shares

Price Paid

the Plans or

Period

Purchased

per Share

Programs

October 2006

Beginning date: October 1

Ending date: October 31

10,089

23.33

10,089

64,900

November 2006

Beginning date: November 1

Ending date: November 30

—

64,900

December 2006

Beginning date: December 1

Ending date: December 31

1,163

23.94

1,163

63,737

Total

11,252

23.40

11,252

63,737


(i)		On October 25, 2004, Tri-County Financial Corp. announced a repurchase program under which it would repurchase 39,000 shares. The Board of Directors authorized three-for-two stock splits of Tri-County Financial’s common stock in December 2004, December 2005 and November 2006, increasing the shares under this program to 131,625. The repurchase program will continue until it is completed or terminated by the Board of Directors.

Item 6. Selected Financial Data

The information contained under the section captioned “Selected Financial Data” of the Annual Report filed as Exhibit 13 hereto is incorporated herein by reference.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and results of Operations” of the Annual Report filed as Exhibit 13 hereto is incorporated herein by reference.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

The information contained in the section captioned “Asset/Liability Risk Management” of the Annual Report is incorporated herein by reference.

Item 8. Financial Statements and Supplementary Data

The Consolidated Financial Statements, Notes to Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm included in the Annual Report filed as Exhibit 13 hereto are incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. 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, is (1) recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) accumulated and communicated to the Company’s management, including its principal executive and principal 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 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.

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 likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information

Not applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant

For information concerning the Company’s directors, the information contained under the section captioned “Proposal 1 — Election of Directors” in the Company’s definitive proxy statement for the Company’s 2007 Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by reference. For information concerning the executive officers of the Company, see “Item 1 - - Business — Executive Officers” under Part I of this Annual Report on Form 10-K.

For information regarding compliance with Section 16(a) of the Exchange Act, the cover page of this Annual Report on Form 10-K and the information contained under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement are incorporated herein by reference.

For information concerning the Company’s code of ethics, the information contained under the section captioned “Corporate Governance — Code of Ethics and Business Conduct” in the Proxy Statement is incorporated by reference. A copy of the code of ethics and business conduct is filed as Exhibit 14 hereto.

For information regarding the audit committee and its composition and the audit committee financial expert, the section captioned “Corporate Governance — Committees of the Board of Directors — Audit Committee” in the Proxy Statement is incorporated by reference.

Item 11. Executive Compensation

For information regarding executive compensation, the information contained under the sections captioned “Executive Compensation” and “Directors’ Compensation” in the Proxy Statement is incorporated herein by reference.

For information regarding the compensation committee report, the section captioned “Compensation Committee Report” in the Proxy Statement is incorporated by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

(a) Security Ownership of Certain Owners

The information required by this item is incorporated herein by reference to the section captioned “Principal Holders of Voting Securities” in the Proxy Statement.

(b) Security Ownership of Management

Information required by this item is incorporated herein by reference to the section captioned “Principal Holders of Voting Securities” in the Proxy Statement.

(c) Changes in Control

Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.

(d) Equity Compensation Plan Information

The Company has adopted a variety of compensation plans pursuant to which equity may be awarded to participants. In 2005, the 1995 Stock Option and Incentive Plan and the 1995 Stock Option Plan for Non-Employee Directors expired. In 2005, the stockholders approved the Tri-County Financial Corporation 2005 Equity Compensation Plan. This plan covers employees and non-employee directors. The following table sets forth certain information with respect to the Company’s Equity Compensation Plans as of December 31, 2006.

(c)

Number of securities remaining

(a)

(b)

available for future issuance

Number of securities to be issued

Weighted average exercise

under equity compensation plans

upon exercise of outstanding

price of outstanding options,

(excluding securities reflected in

Plan Category

options, warrants, and rights

warrants, and rights

column (a))

Equity plans approved by security holders

356,897

$14.00

158,999

Equity compensation plans not approved by security holders (1)

60,200

13.05

—

Total

417,097

$13.86

158,999


(1)		Consists of the Company’s 1995 Stock Option Plan for Non-Employee Directors, which expired in 2005 and which provided grants of non-incentive stock options to directors who are not employees of the Company or its subsidiaries. Options were granted under the plan at an exercise price equal to their fair market value at the date of grant and had a term of ten years. Options are generally exercisable while an optionee serves as a director or within one year thereafter.

Item 13. Certain Relationships and Related Transactions

The information regarding certain relationships and related transactions, the section captioned “Relationships and Transactions with the Company and the Bank” in the Proxy Statement is incorporated herein by reference.

For information regarding director independence, the section captioned “Proposal 1 — Election of Directors” in the Proxy Statement is incorporated by reference.

Item 14. Principal Accountant Fees and Services

The information required by this item is incorporated herein by reference to the section captioned “Proposal 2 — Ratification of Appointment of Auditors” in the Proxy Statement.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) List of Documents Filed as Part of this Report

(1) Financial Statements. The following consolidated financial statements and notes related thereto are incorporated by reference from Item 7 hereof:

Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements

(2) Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements and related notes thereto.

(3) Exhibits. The following is a list of exhibits filed as part of this Annual Report on Form 10-K and is also the Exhibit Index.


No.		Description

3.1		Articles of Incorporation of Tri-County Financial Corporation (1)

3.2		Amended and Restated Bylaws of Tri-County Financial Corporation (2)

10.1*		Tri-County Financial Corporation 1995 Stock Option and Incentive Plan, as amended (3)

10.2*		Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee Directors, as amended (4)

10.3*		Employment Agreements with C. Marie Brown, as amended, and Gregory C. Cockerham (5)

10.4*		Employment Agreement with Michael L. Middleton (6)

10.5*		Guaranty Agreements with Michael L. Middleton, C. Marie Brown and Gregory C. Cockerham (3)

10.6*		Executive Incentive Compensation Plan (3)

10.7*		Executive Compensation Plan 2003 Amendment (7)

10.8*		Employment Agreement with William J. Pasenelli (3)

10.9*		Retirement Plan for Directors

10.10*		Split Dollar Agreements with Michael L. Middleton and C. Marie Brown (3)

10.11*		Guaranty Agreement with William J. Pasenelli (5)

10.12*		Split Dollar Agreement with William J. Pasenelli (5)

10.13*		Salary Continuation Agreement with Michael L. Middleton (7)

10.14*		Salary Continuation Agreement with C. Marie Brown (7)

10.15*		Salary Continuation Agreement with Gregory C. Cockerham (6)

10.16*		Salary Continuation Agreement with William J. Pasenelli (6)

10.17*		Amendment to the Community Bank of Tri-County Employment Agreement with C. Marie Brown (7)

10.18*		Amendment to the Community Bank of Tri-County Employment Agreement with Gregory C. Cockerham (8)

10.19*		Amendment to the Community Bank of Tri-County Employment Agreement with William J. Pasenelli (8)

10.20*		Tri-County Financial Corporation 2005 Equity Compensation Plan (9)

10.21*		Community Bank of Tri-County Deferred Compensation Plan

13		Annual Report to Stockholders for the year ended December 31, 2006

14		Code of Ethics (10)

21		Subsidiaries of the Registrant

23		Consent of Stegman & Company

31.1		Rule 13a-14a Certification of Chief Executive Officer

31.2		Rule 13a-14a Certification of Chief Financial Officer

32		Certification pursuant to 18 U.S.C. Section 1350


*		Management contract or compensatory arrangement.

(1)		Incorporated by reference to the Registrant’s Registration Statement on Form S-4 (No. 33-31287).

(2)		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.

(3)		Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.

(4)		Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-70800).

(5)		Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.

(6)		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006.

(7)		Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

(8)		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005.

(9)		Incorporated by reference to Appendix A in the definitive proxy statement (File No. 000-18279) filed with the Securities and Exchange Commission on April 11, 2005.

(10)		Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005.

(b)		Exhibits. The exhibits required by Item 601 of Regulation S-K are either filed as part of this Annual Report on Form 10-K or incorporated by reference herein.

(c)		Financial Statements and Schedules Excluded From Annual Report. There are no other financial statements and financial statement schedules which were excluded from this Annual Report pursuant to Rule 14a-3(b)(1) which are required to be included herein.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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: March 26, 2007	By:	/s/ Michael L. Middleton
		Michael L. Middleton
		President and Chief Executive Officer (Duly Authorized Representative)

Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


By:	/s/ Michael L. Middleton	By:	/s/ William J. Pasenelli
	Michael L. Middleton		William J. Pasenelli
	Director, President and Chief Executive Officer		Chief Financial Officer
	(Principal Executive Officer)		(Principal Financial and Accounting Officer)

Date: March 26, 2007		Date: March 26, 2007

By:	/s/ C. Marie Brown	By:	/s/ Herbert N. Redmond, Jr.
	C. Marie Brown		Herbert N. Redmond, Jr.
	Director and Chief Operating Officer		Director

Date: March 26, 2007		Date: March 26, 2007

By:	/s/ H. Beaman Smith	By:	/s/ A. Joseph Slater, Jr.
	H. Beaman Smith		A. Joseph Slater, Jr.
	Director		Director

Date: March 26, 2007		Date: March 26, 2007

By:	/s/ Louis P. Jenkins, Jr.	By:	/s/ James R. Shepherd
	Louis P. Jenkins, Jr.		James R. Shepherd
	Director		Director

Date: March 26, 2007		Date: March 26, 2007

By:	/s/ Philip T. Goldstein	By:	/s/ Joseph V. Stone, Jr.
	Philip T. Goldstein		Joseph V. Stone, Jr.
	Director		Director

Date: March 26, 2007		Date: March 26, 2007

Exhibit 10.9

COMMUNITY BANK OF TRI-COUNTY
RETIREMENT PLAN FOR DIRECTORS
(As amended and restated effective January 1, 2007)

This Community Bank of Tri-County Retirement Plan for Directors, originally effective as of January 1, 1995, is hereby amended and restated in its entirety effective as of January 1, 2007.

ARTICLE I
Definitions

1.1 “Agreement” shall mean the Deferred Compensation Agreement attached hereto as Exhibit A.

1.2 “Bank” shall mean Community Bank of Tri-County, or any successor thereto.

1.3 “Beneficiary” shall mean the Participant’s beneficiary designated pursuant to Article 5 of the Plan.

1.4 “Benefit Percentage” shall be determined based on the Participant’s completed calendar years of service on the Board as a Director, whether before or after the Effective Date, and shall be determined according to the following schedule:


Participant's	Participant's
Full Years of Service	Benefit Percentage
Less than 5		0	%
5 to 9		33-1/3	%
10 to 14		66-2/3	%
15 or More		100	%

1.5 “Board” shall mean the Board of Directors of the Bank.

1.6 “Cause” shall mean removal of a Director from service due to the following:

(i) indictment for, or conviction of, a criminal offense involving dishonesty or breach of trust resulting in a potential or actual penalty of imprisonment for one year or more;

(ii) the issuance by a banking agency of a cease and desist order for conduct involving dishonesty or breach of trust that is final and not subject to appeal; or

(iii) a finding by a regulatory agency whose decision is final of a violation of any law, rule or regulation governing banking, securities, commodities or insurance, or any final cease and desist order issued by a banking, securities, commodities or insurance regulatory agency.

1.7 “Change in Control” shall mean the occurrence of any of the following:

(i) Merger: The Company merges into or consolidates with another corporation, or merges another corporation into the Company and as a result less than a majority of the combined voting power of the resulting corporation immediately after the merger or consolidation is held by persons who were stockholders of the Company immediately before the merger or consolidation;

(ii) Acquisition of Significant Share Ownership: A report on Schedule 13D or another form or schedule (other than Schedule 13G) is filed or is required to be filed under Sections 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended, if the schedule discloses that the filing person or persons acting in concert has or have become the beneficial owner(s) of 25% or more of a class of the Company’s voting securities, but this clause (b) shall not apply to beneficial ownership of Company voting shares held in a fiduciary capacity by an entity of which the Company directly or indirectly beneficially owns fifty percent (50%) or more of its outstanding voting securities;

(iii) Change in Composition of the Board of Directors: During any period of two consecutive years, individuals who constitute the Company’s Board of Directors at the beginning of the two-year period cease for any reason to constitute at least a majority of the Company’s Board of Directors; provided, however, that for purposes of this clause (iii) each director who is first elected by the board (or first nominated by the board for election by the stockholders) by a vote of at least three-fourths (3/4) of the directors who were directors at the beginning of the period shall be deemed to have been a director at the beginning of the two-year period; or

(iv) Sale of Assets: The Company sells to a third party all or substantially all of its assets.

Notwithstanding anything herein to the contrary, the definition of Change of Control under this Plan shall be interpreted in accordance with Section 409A of the Internal Revenue Code of 1986 and any regulations issued thereunder, as amended from time to time.

1.8 “Code” shall mean the Internal Revenue Code of 1986, as amended.

1.9 “Company” shall mean Tri-County Financial Corporation, or any successor thereto.

1.10 “Deferral Account” shall have the meaning set forth in Section 5.2 of Article V of the Plan.

1.11 “Director” shall mean a member of the Board of Directors of the Bank and/or the Company.

1.12 “Disability” means a Director’s inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be

expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months.

1.13 “Effective Date” shall have the meaning set forth in Article XVIII.

1.14 “Participant” means anyone who is a Director at any time on or after the Effective Date (whether or not the Director is also an Employee).

1.15 “Plan” shall mean this Community Bank of Tri-county Retirement Plan for Directors.

1.16 “Surviving Spouse” shall mean the spouse of a Director at the time of the Director’s death, provided the Director and spouse are not then legally separated or divorced.

1.17 “Vested Percentage” shall be determined based on the number of the Participant’s full years of service as a Director, and shall be determined according to the following schedule:


Participant's	Participant's
Full Years of Service	Benefit Percentage
Less than 1		33-1/3	%
1		66-2/3	%
2 or more		100	%

Notwithstanding the foregoing, a Participant’s Vested Percentage shall increase to 100% in the event he or she separates from service for any reason after attaining age 72 or incurring a Disability, as determined by the Board.

ARTICLE II
Retirement Benefits

2.1 In the event of a Participant’s separation from service for any reason other than cause, death or Disability, the Participant shall be entitled to receive an annual benefit for ten (10) years in an amount equal to the product of (i) the Participant’s Benefit Percentage, (ii) the Participant’s Vested Percentage, and (iii) $3,500 (subject to adjustment by the Board). The payments due under this Article shall begin on the first day of the second month following the date of the Participant’s separation from service, and shall thereafter be made on the annual anniversary dates of the initial payment date. Except as provided in Article IV, no retirement benefits shall be payable hereunder after the death of the Participant.

2.2 Notwithstanding anything in the Plan to the contrary, no benefits shall be payable under this Article II following a Participant’s termination of service for Cause.

2.3 Unless otherwise addressed pursuant to an employment agreement between a Participant and the Company and/or the Bank in effect at the time of a Change in Control, benefits payable under Article II of the Plan in connection with a Change in Control shall be reduced to the extent necessary to ensure compliance with Section 280G of the Code, as amended, or any successor thereto.

ARTICLE III
Disability Benefits

3.1 In the event that a Participant terminates service due to Disability, the Participant shall receive an annual benefit for ten years in an amount equal to the product of (i) the Benefit Percentage and (ii) $3,500 (subject to adjustment by the Board) as of the 1^st day of the year in which the Participant terminates service due to Disability. The payments due under this Article III shall begin on the first day of the second month following the date of the Participant’s termination of service, and shall thereafter be made on the annual anniversary dates of the initial payment date. Except as provided in Article IV, no Disability benefits shall be payable hereunder after the death of the Participant.

ARTICLE IV
Death Benefit_

4.1 In the event that a Participant dies before collecting any of the benefits provided under Articles II or III, the Participant’s Surviving Spouse, or if none, the Participant’s estate, shall be entitled to receive a lump sum payment having a present value equal to five (5) times the annual amount that the Participant would have received under Article II if the Participant had both separated from service on the date of death and had a Vested Percentage equal to 100%. Payment of the death benefit shall be made on or before the first day of the second month following the date of the Participant’s death.

4.2 In the event that a Participant dies after commencing to receive the benefits provided under Article II or III, the Participant’s Surviving Spouse, or if none, the Participant’s estate, shall be entitled to receive a lump sum payment having a present value equal to the payments that the Participant would have received if the Participant had survived to collect all benefits that would have been paid under Article II or III, as applicable, from the date of the Participant’s death through the date on which the Participant would have received the fifth annual payment otherwise payable under Article II or III, as applicable. Payment of the applicable benefit shall be made on or before the first day of the second month following the date of the Participant’s death.

ARTICLE V
Deferred Compensation

This Article of the Plan establishes a deferred compensation program for Participants, subject to the terms and conditions set forth below.

5.1 A Plan Participant may elect to defer all or any portion of the fees and/or salary otherwise payable from the Bank and/or Company, in cash, for any calendar year in which the Plan is in effect. Deferral elections under the Plan for a given calendar year shall be made no later than December 31^st of the preceding calendar year or, for new Participants, within thirty (30) days of initial eligibility to participate in the Plan. Deferral elections, once made, shall continue in effect for subsequent calendar years unless a Participant files a new Agreement prior to December 31 of the year prior to the calendar year in which the change will take place. A subsequent deferral election will only become effective as of the following January 1^st.

5.2 Deferred amounts shall be credited by the Bank and the Company as of the end of each calendar quarter, in accordance with the Participant’s deferral election under the Agreement. The deferred amounts shall be credited to a bookkeeping account (“Deferral Account”) established in the name of each Participant, in accordance with the terms of the Participant’s deferral election.

5.3 In addition to the funds credited quarterly to the Deferral Accounts of Participants, each Deferral Account shall be adjusted as of the end of each calendar year by an amount equal to the consolidated ROE of the Company, as determined in accordance with generally accepted accounting principles (GAAP), which rate shall be adjusted as of each subsequent January 1^st.

5.4 A Participant’s Deferral Account shall be paid in the form of (1) a lump sum distribution or (2) equal installments over a period from one to five years, as elected by the Participant. Payment shall commence on or before the January 15^th immediately following the calendar year in which a Participant separates from service or on the date designated by the Participant in the Agreement. Notwithstanding the foregoing, a Participant’s Deferral Account will be paid to the Participant (or his Beneficiary or estate) in a lump sum as soon as practicable following the effective date of a Change in Control.

5.5 Upon the death of a Participant prior to receipt of all benefits payable under this Article, then such payment(s) shall be made in accordance with the Participant’s previous distribution election to the Beneficiary designated by the Participant in his or her Agreement (and in the absence of a validly designated Beneficiary, to the Participant’s estate).

5.6 Agreements made hereunder shall be prospective only and shall be irrevocable with respect to amounts deferred pursuant to the Agreement. Participants may not change a previously scheduled distribution election, unless such change is made in accordance with Section 409A of the Code. Notwithstanding the foregoing, a Participant may at any time and from time to time (i) change the Beneficiary designated in paragraph 3 of the Agreement, and/or (ii) change the deferral amounts for a subsequent calendar year in accordance with Section 5.1 of the Plan.

ARTICLE VI
Source and Form of Benefits

6.1 The Plan shall constitute an unfunded, unsecured promise to provide benefits in the future, to the extent such benefits become payable. Benefits shall be paid from the general assets of the Bank or Company, and no person shall, by virtue of this Plan, have any interest in such assets (other than as an unsecured creditor). In the event that a trust is established as described herein at Article IX, the trustee of such trust shall inform the Board annually prior to the commencement of each fiscal year as to the manner in which such trust assets shall be invested.

6.2 Notwithstanding anything herein to the contrary, to the extent required by Section 409A of the Code and the regulations issued thereunder, benefits payable under the Plan to any Participant who is a “specified employee” for purposes of Section 409A of the Code shall be delayed for a period of six months from the otherwise applicable distribution date.

ARTICLE VII
Assignment

7.1 Except as otherwise provided by this Plan, it is agreed that neither the Participant, nor any other person or persons, shall have any right to commute, sell, assign, transfer, encumber, pledge or otherwise convey the right to receive any benefits under this Plan.

ARTICLE VIII
No Retention of Services

8.1 The benefits payable under this Plan shall be independent of, and in addition to, any other compensation payable to a Participant, whether fees, bonus, retirement income under employee benefit plans sponsored or maintained by the Bank or the Company, or otherwise. This Plan shall not be deemed to constitute a contract of employment between the Bank or the Company and any Participant.

ARTICLE IX
Rights of Participants

9.1 The rights of the Participants under this Plan shall be solely those of unsecured creditors. In the event that the Bank or the Company establish an irrevocable trust in connection with the Plan (“Trust”), the trust assets shall remain at all times subject to claims by their general creditors in accordance with applicable law.

ARTICLE X
Automatic Cash-Out Upon a Change in Control

10.1 The provisions of this Article shall supersede any provisions of this Plan to the contrary. In the event of a Change in Control while a Participant is serving as a Director, the Participant’s Vested Percentage shall become 100%, and the present value of his benefits shall

be due and payable to the Participant (or, in the event of his death, his Surviving Spouse (for benefits pursuant to Article II of the Plan) or designated Beneficiary (for benefits pursuant to Article V of the Plan), or, if none, to his estate) in one lump sum payment within 10 days following such Change in Control. In the event of a Change in Control after a Participant terminates service, the present value of any benefits not yet paid to the Participant (or his Surviving Spouse, designated Beneficiary or his estate, as applicable, in the event of his death) shall be due and payable to the Participant (or his Surviving Spouse, designated Beneficiary or estate, as applicable in the event of his death) in one lump-sum payment within ten (10) days following the Change in Control.

ARTICLE XI
Reorganization

11.1 The Bank agrees that it will not merge or consolidate into any other corporation or organization, or permit its business activities to be taken over by any other organization, unless and until the succeeding or continuing corporation or other organization shall expressly assume the rights and obligations of the parties as herein set forth. The Bank further agrees that it will not cease its business activities or terminate its existence, other than as heretofore set forth in this paragraph, without having made adequate provision for the fulfillment of obligations under the Plan.

ARTICLE XII
Amendment and Termination

12.1 The Board may amend or terminate the Plan at any time; provided, however, that no amendment or termination shall, without the written consent of the affected Participants, alter or impair any rights of Participants under the Plan.

ARTICLE XIII
Governing Law

13.1 This Plan shall be construed and governed in all respects under and by the laws of the State of Maryland. If any provision of this Plan shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue to be fully effective.

ARTICLE XIV
Headings

14.1 Headings and subheadings in this Plan are inserted for convenience of reference only and constitute no part of this Plan.

ARTICLE XV
Gender

15.1 This Plan shall be construed, where required, so that the masculine gender includes the feminine.

ARTICLE XVI
Interpretation of the Plan

16.1 The Board shall have sole and absolute discretion to administer, construe, and interpret the Plan, and the decisions of the Board shall be conclusive and binding on all affected parties.

ARTICLE XVII
Legal Fees

17.1 In the event any dispute shall arise between a Participant and the Bank or the Company as to the terms or interpretation of this Plan, whether instituted by formal legal proceedings or otherwise, including any action taken by a Participant to enforce the terms of this Plan or in defending against any action taken by the Bank or the Company, the Bank or the Company shall reimburse the Participant for all costs and expenses, including reasonable attorneys’ fees, arising from such dispute, proceedings or actions: provided that the Participant shall return such amounts to the Bank or Company if he fails to obtain a final judgment by a court of competent jurisdiction (or a settlement of such dispute, proceedings, or actions) substantially in his favor. Such reimbursements to a Participant shall be paid within 10 days of the Participant furnishing written evidence, which may be in the form, among other things, of a canceled check or receipt, of any costs or expenses incurred by the Participant. Any such request for reimbursement by a Participant shall be made no more frequently than at 30 day intervals.

ARTICLE XVIII
Effective Date; Section 409A Compliance

18.1 The effective date of this restatement of the Plan shall be January 1, 2007. Unless terminated earlier in accordance with Article XII, this Plan shall remain in effect during the term of service of the Participants and until all benefits payable hereunder have been made.

Notwithstanding anything in this Plan to the contrary, the Plan and Agreements issued under the Plan shall be interpreted in accordance with, and incorporate the terms and conditions required by, Section 409A of the Code, together with any guidance issued thereunder, including guidance issued after the effective date of the Plan. The Board reserves the right, in its discretion, to adopt such amendments to the Plan and other policies and procedures (including amendments, policies and procedures with retroactive effect), or to take any other actions the Board determines to be necessary or appropriate to comply with the requirements of Section 409A of the Code.

Exhibit 10.21

COMMUNITY BANK OF TRI-COUNTY
EXECUTIVE DEFERRED COMPENSATION PLAN

The purpose of the Community Bank of Tri-County Executive Deferred Compensation Plan (hereinafter referred to as the “Plan”) is to aid in retaining and attracting officers of exceptional ability by providing them an opportunity to defer the payment of their current compensation to a later date, in accordance with the terms of the Plan. The effective date of the Plan is January 1, 2007.

ARTICLE I
Definitions

1.1 “Agreement” shall mean the Deferred Compensation Agreement attached hereto as Exhibit A.

1.2 “Bank” means the Community Bank of Tri-County, or any successor thereto.

1.3 “Beneficiary” shall mean the Participant’s beneficiary designated pursuant to Article 4 of the Plan.

1.4 “Board of Directors” shall mean the Board of Directors of the Bank.

1.5 “Cause” shall mean termination of employment due to the following: (i) acts of personal dishonesty which have resulted in loss to the Company, or one of its affiliates, (ii) intentional failure to perform stated duties, (iii) willful violation of any law, rule, regulation (other than traffic violations or similar offenses), (iv) becoming subject to the entry of a final cease and desist order which results in substantial loss to the Company or one of its affiliates, (v) conviction of a crime or act involving moral turpitude, (vi) willful breach of the Company’s code of conduct and business ethics, (vii) disqualification or prohibition by any governmental or self-regulatory authority from serving in the Participant’s then-current employment capacity or (viii) willful attempt to obstruct or failure to cooperate with any investigation authorized by the Board of Directors or any governmental or self-regulatory entity.

1.6 “Change in Control” means the occurrence of any of the following:

(a) Merger: The Company merges into or consolidates with another corporation, or merges another corporation into the Company and, as a result, less than a majority of the combined voting power of the resulting corporation immediately after the merger or consolidation is held by persons who were stockholders of the Company immediately before the merger or consolidation;

(b) Acquisition of Significant Share Ownership: A report on Schedule 13D or another form or schedule (other than Schedule 13G) is filed or is required to be filed under Sections 13(d) or 14(d) of the Securities Exchange Act of 1934, if the schedule discloses that the filing person(s) has or have become the beneficial owner(s) of twenty-five percent (25%) or more of a class of the Company’s voting securities, but this clause

(b) shall not apply to beneficial ownership of Company voting shares held in a fiduciary capacity by an entity of which the Company directly or indirectly beneficially owns fifty percent (50%) or more of its outstanding voting securities;

(c) Change in Board Composition: During any period of two consecutive years, individuals who constitute the Company’s Board of Directors at the beginning of the two-year period cease for any reason to constitute at least a majority of the Company’s Board of Directors; provided, however, that for purposes of this clause (c), each director who is first elected by the board (or first nominated by the board for election by stockholders) by a vote of at least three-fourths (3/4) of the directors who were directors at the beginning of the period shall be deemed to have been a director at the beginning of the two-year period; or

(d) Sale of Assets: The Company sells to a third party all or substantially all of its assets.

Notwithstanding anything herein to the contrary, the definition of Change in Control under this Plan shall be interpreted in accordance with Section 409A of the Code and any regulations issued thereunder, as amended from time to time.

1.7 “Code” shall mean the Internal Revenue Code of 1986, as amended.

1.8 “Company” shall mean Tri-County Financial Corporation, or any successor thereto.

1.9 “Compensation” shall mean base salary paid to a Participant during the applicable Plan Year.

1.10 “Deferral Account” shall mean the bookkeeping account to which amounts deferred under the Plan are credited in accordance with Article III of the Plan.

1.11 “Effective Date” shall have the meaning set forth in Article XVI.

1.12 “Participant” means an officer of the Bank designated by the Board of Directors as a Plan participant.

1.13 “Plan” shall mean this Community Bank of Tri-County Executive Deferred Compensation Plan.

1.14 “Plan Year” means a twelve month period commencing January 1st and ending the following December 31st.

ARTICLE II
Eligibility And Deferral Elections

2.1 Eligibility to participate in the Plan is limited to officers of the Bank who are designated as Participants by the Board of Directors.

2.2 A Plan Participant may elect to defer all or any portion of the Compensation otherwise payable from the Bank and/or Company, for any Plan Year in which the Plan is in effect. Deferral elections for a given Plan Year shall be made no later than December 31^st of the preceding Plan Year or, for new Participants, within thirty (30) days of initial eligibility to participate in the Plan.

2.3 Deferral elections pursuant to Section 3.2, once made, shall continue in effect for subsequent Plan Years unless a Participant files a new Agreement prior to December 31 of the Plan Year prior to the Plan Year in which the change will take place. A subsequent deferral election will only become effective as of the following January 1^st.

ARTICLE III
Deferred Compensation

3.1 Amounts deferred shall be credited by the Bank and the Company as of the end of each calendar quarter to the Deferral Account established in the name of each Participant, in accordance with the terms of the Participant’s deferral election under the Agreement. Participants shall be 100% vested in their Deferral Accounts at all times.

3.2 In addition to the funds credited quarterly to Participants’ Deferral Accounts, each Deferral Account shall be adjusted as of the end of each calendar year by an amount equal to the consolidated Return on Equity (“ROE”) of the Company, as determined in accordance with generally accepted accounting principles (GAAP), which rate shall be adjusted as of each subsequent January 1^st.

ARTICLE IV
Distributions

4.1 Upon any “separation from service” within the meaning of Section 409A of the Code, a Participant’s Deferral Account shall be distributed in the form of (1) a lump sum or (2) equal installments over a period from one to five years, as elected by the Participant. Payment shall be made or commence on or before the January 15^th immediately following the calendar year in which a Participant separates from service or on the date designated by the Participant in the Agreement. Notwithstanding anything in the Plan or an Agreement to the contrary, however, a Participant’s Deferral Account will be paid to the Participant (or his Beneficiary or estate) in a lump sum as soon as practicable following the effective date of a Change in Control.

4.2 Upon the death of a Participant prior to receipt of all benefits payable under this Article IV, the such payment(s) shall be made in accordance with the Participant’s previous

distribution election to the Beneficiary designated by the Participant in his or her Agreement (and, in the absence of a validly designated Beneficiary, to the Participant’s estate).

4.3 Agreements made hereunder shall be prospective only and shall be irrevocable with respect to amounts deferred pursuant to the Agreement. Participants may not change a previously scheduled distribution election, unless such change is made in accordance with Section 409A of the Code. Notwithstanding the foregoing, a Participant may at any time and from time to time (i) change the Beneficiary designated in paragraph 3 of the Agreement, and/or (ii) change the deferral amounts for a subsequent calendar year in accordance with Article II of this Plan.

ARTICLE V
Source and Form of Benefits

5.1 The Plan shall constitute an unfunded, unsecured promise to provide benefits in the future, to the extent such benefits become payable. Benefits shall be paid from the general assets of the Bank or Company, and no person shall, by virtue of this Plan, have any interest in such assets (other than as an unsecured creditor). In the event that a trust is established as described herein at Article VIII, the trustee of such trust shall inform the Board of Directors annually prior to the commencement of each fiscal year as to the manner in which such trust assets shall be invested.

5.2 Notwithstanding anything herein to the contrary, to the extent required by Section 409A of the Code and the regulations issued thereunder, benefits payable under the Plan to any Participant who is a “specified employee” for purposes of Section 409A of the Code shall be delayed for a period of six months from the otherwise applicable distribution date.

ARTICLE VI
Assignment

6.1 Except as otherwise provided by this Plan, it is agreed that neither the Participant, nor any other person or persons, shall have any right to commute, sell, assign, transfer, encumber, pledge or otherwise convey the right to receive any benefits under this Plan.

ARTICLE VII
No Retention of Services

7.1 The Plan shall not be deemed to constitute a contract of employment between the Bank or the Company and any Participant.

ARTICLE VIII
Rights of Participants

8.1 The rights of the Participants under this Plan shall be solely those of unsecured creditors. In the event that the Bank or the Company establish an irrevocable trust in connection with the Plan (“Trust”), the trust assets shall remain at all times subject to claims by their general creditors in accordance with applicable law.

ARTICLE IX
Reorganization

9.1 The Bank agrees that it will not merge or consolidate into any other corporation or organization, or permit its business activities to be taken over by any other organization, unless and until the succeeding or continuing corporation or other organization shall expressly assume the rights and obligations of the parties as herein set forth. The Bank further agrees that it will not cease its business activities or terminate its existence, other than as heretofore set forth in this paragraph, without having made adequate provision for the fulfillment of obligations under the Plan.

ARTICLE X
Amendment and Termination

10.1 The Board of Directors may amend or terminate the Plan at any time; provided, however, that no amendment or termination shall, without the written consent of the affected Participants, alter or impair any rights of Participants under the Plan.

ARTICLE XI
Governing Law

11.1 This Plan shall be construed and governed in all respects under and by the laws of the State of Maryland. If any provision of this Plan shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue to be fully effective.

ARTICLE XII
Headings

12.1 Headings and subheadings in this Plan are inserted for convenience of reference only and constitute no part of this Plan.

ARTICLE XIII
Gender

13.1 This Plan shall be construed, where required, so that the masculine gender includes the feminine.

ARTICLE XIV
Interpretation of the Plan

14.1 The Board of Directors shall have sole and absolute discretion to administer, construe, and interpret the Plan, and the decisions of the Board of Directors shall be conclusive and binding on all affected parties.

ARTICLE XV
Legal Fees

15.1 In the event any dispute shall arise between a Participant and the Bank or the Company as to the terms or interpretation of this Plan, whether instituted by formal legal proceedings or otherwise, including any action taken by a Participant to enforce the terms of this Plan or in defending against any action taken by the Bank or the Company, the Bank or the Company shall reimburse the Participant for all costs and expenses, including reasonable attorneys’ fees, arising from such dispute, proceedings or actions: provided that the Participant shall return such amounts to the Bank or Company if he fails to obtain a final judgment by a court of competent jurisdiction (or a settlement of such dispute, proceedings, or actions) substantially in his favor. Such reimbursements to a Participant shall be paid within 10 days of the Participant furnishing written evidence, which may be in the form, among other things, of a canceled check or receipt, of any costs or expenses incurred by the Participant. Any such request for reimbursement by a Participant shall be made no more frequently than at 30 day intervals.

ARTICLE XVI
Effective Date; Section 409A Compliance

16.1 The effective date of this Plan shall be January 1, 2007. Unless terminated earlier in accordance with Article X, this Plan shall remain in effect until all benefits payable hereunder have been made.

16.2 Notwithstanding anything in this Plan to the contrary, however, the Plan and Agreements issued under the Plan shall be interpreted in accordance with, and incorporate the terms and conditions required by, Section 409A of the Code, together with any guidance issued thereunder, including guidance issued after the effective date of the Plan. The Board of Directors reserves the right, in its discretion, to adopt such amendments to the Plan and other policies and procedures (including amendments, policies and procedures with retroactive effect), or to take any other actions its determines to be necessary or appropriate to comply with the requirements of Section 409A of the Code.

EXHIBIT 13

ANNUAL REPORT TO STOCKHOLDERS

Message from the chairman of the Board

Dear Shareholder:

I am pleased to report to you the results of operations of Tri-County Financial Corporation and its banking subsidiary, Community Bank of Tri-County for the year ended December 31, 2006. Net income increased to $4,441,257 compared to $3,979,343 for the year ended December 31, 2005. Basic earnings per share increased to $1.68 compared to $1.53 for the same period while diluted earnings per share were $1.58 compared to $1.44 for 2005. The per share numbers have been adjusted for the three for two stock split paid in December 2006.

During 2006, the Company increased its total assets by 6.32% to $575,496,014. This was achieved through growth in the loan portfolio and was funded by proceeds from the investment portfolio cash flow, as well as continued strong growth in retail deposits. The total deposits of the Bank increased by 15% to $418,013,402. As a result of the continued deposit growth, the Bank has moved from fourth to third position in total deposit market share for Southern Maryland.

As we look forward to 2007, several initiatives are underway and completion during the year is possible. The small branch facility at Leonardtown, Maryland will be replaced with a 13,500 square foot regional office and branch facility. Also, construction is expected to commence on the tenth branch to be located in Lusby, Maryland.

In 2006, the company declared and executed a three for two stock split for the third year in a row. It increased the cash dividend per share in 2007 to $0.40 or approximately 8.30%. Your management and Board of Directors appreciate the support of our shareholders and continue their commitment to enhancing share value while serving the needs of our many communities.

Yours truly,

Michael L. Middleton
Chairman of the Board

Tri-County Financial Corporation

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN

The table below shows the total return performance, for the year ended December 31, for each of the last five years for Tri-County Financial Corporation common stock compared to the NASDAQ Composite and the SNL Mid-Atlantic Bank Index. The table below the chart provides the corresponding data points.

TOTAL RETURN PERFORMANCE



	Period Ending
Index	12/31/01		12/31/02		12/31/03		12/31/04		12/31/05		12/31/06
Tri-County Financial Corporation		100.00		169.70		185.33		302.59		343.72		376.92
NASDAQ Composite		100.00		68.76		103.67		113.16		115.57		127.58
SNL Mid-Atlantic Bank Index		100.00		76.91		109.35		115.82		117.87		141.46

Management’s Discussion and Analysis

FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that are based on assumptions and may describe future plans, strategies, and expectations of Tri-County Financial Corporation (the “Company”) and Community Bank of Tri-County (the “Bank”). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions.

The Company and the Bank’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary, and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company and the Bank’s market area, changes in real estate market values in the Company and the Bank’s market area, and changes in relevant accounting principles and guidelines.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances.

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

OVERVIEW

Since its conversion to a commercial bank charter in 1997, the Bank has rapidly increased assets and market share by concentrating on building on its strength as a local bank. In particular, the Bank has sought to increase its portfolio of commercial business, commercial real estate, and construction loans as well as increasing its share of the local deposit market, particularly commercial and consumer transaction accounts. The Bank feels that its ability to offer fast, flexible, and local decision making make it attractive to many customers. The Bank has also increased its share of the local deposit market by emphasizing convenient service and attractive rates. This strategy to focus on commercial and consumer transaction accounts tends to decrease our reliance on time deposits to fund loans and increase net interest income. Also, the additions of these products will increase non-interest expense and the Bank’s credit risk profile.

During the last few years the banking industry has also continued to consolidate. Several of our competitors in the southern Maryland market have been acquired by larger national and regional banks. In addition, several major national and regional institutions have entered the market through de novo branch openings. The Bank recognizes that these existing and future competitors will continue to offer stiff competition for our local market. The Bank will continue to aggressively market its products and services throughout its market area and will add new products and services to meet the challenges of increased competition.

The Corporation has sought to increase shareholder value through the stock splits declared in December 2004, 2005, and 2006. These three-for-two stock splits in the form of a dividend are retroactively applied throughout this document to all per share numbers.

CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and the general practices of the United States 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. The Company considers its determination of the allowance for loan losses and the valuation allowance on its foreclosed real estate to be critical accounting policies. 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

Tri-County Financial Corporation

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. When these sources are not available, management makes estimates based upon what it considers to be the best available information.

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two principles of accounting: (a) Statement on Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and are estimable and (b) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, is determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows, or values observable in the secondary markets.

The loan loss allowance balance is an estimate based upon management’s evaluation of the loan portfolio. Generally, the allowance is comprised of a specific and a general component. The specific component consists of management’s evaluation of certain classified loans and their underlying collateral. Loans are examined to determine a specific allowance based upon the borrower’s payment history, economic conditions specific to the loan or borrower, or other factors that would impact the borrower’s ability to repay the loan on its contractual basis. Management assesses the ability of the borrower to repay the loan based upon any information available. Depending on the assessment of the borrower’s ability to pay the loan as well as the type, condition, and amount of collateral, management will establish an allowance amount specific to the loan.

In establishing the general component of the allowance, management analyzes non-classified and non-impaired loans in the portfolio including changes in the amount and type of loans. Management also examines the Bank’s history of write-offs and recoveries within each loan category. The state of the local and national economy is also considered. Based upon these factors, the Bank’s loan portfolio is categorized and a loss factor is applied to each category. These loss factors may be higher or lower than the Bank’s actual recent average losses in any particular loan category, particularly in loan categories where the Bank is rapidly increasing the size of its portfolio. Based upon these factors, the Bank will adjust the loan loss allowance by increasing or decreasing the provision for loan losses.

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 general component of the allowance. 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. For additional information regarding the allowance for loan losses, refer to Notes 1 and 4 to the Consolidated Financial Statements and the discussion under the caption “Provision for Loan Losses” below.

In addition to the loan loss allowance, the Company also maintains a valuation allowance on its foreclosed real estate. As with the allowance for loan losses, the valuation allowance on foreclosed real estate is based on SFAS No. 5, “Accounting for Contingencies,” as well as SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” These statements require that the Company establish a valuation allowance when it has determined that the carrying amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed asset is measured by the cash flows expected to be realized from its subsequent disposition. These cash flows should be reduced for the costs of selling or otherwise disposing of the asset.

In estimating the cash flows from the sale of foreclosed real estate, management must make significant assumptions regarding the timing and amount of cash flows. In cases where the real estate acquired is undeveloped land, management must gather the best available evidence regarding the market value of the property, including appraisals, cost estimates of development, and broker opinions. Due to the highly subjective nature of this evidence, as well as the limited market, long time periods involved, and substantial risks, cash flow estimates are highly subjective and subject to change. Errors regarding any aspect of the costs or proceeds of developing, selling, or otherwise disposing of foreclosed real estate could result in the allowance being inadequate to reduce carrying costs to fair value and may require an additional provision for valuation allowances.

Management’s Discussion and Analysis

COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

General. For the year ended December 31, 2006, the Company reported consolidated net income of $4,441,257 ($1.68 basic and $1.58 diluted earnings per share) compared to consolidated net income of $3,979,343 ($1.53 basic and $1.44 diluted earnings per share) for the year ended December 31, 2005. The increase in net income for 2006 was primarily attributable to increases in net interest income and noninterest income, which was partially offset by increases in the provision for loan losses and noninterest expenses. The Bank also substantially increased its loan portfolio and deposit balances. In 2006, the Bank used increases in deposit balances and proceeds from maturing securities to fund loan growth and reduce wholesale borrowings. The provision for loan losses increased in 2006 from 2005 levels due to increases in the loan portfolio, particularly in commercial real estate and commercial and construction lending. These loan types carry a greater risk of default than one- to four-family lending. The amount of increase was moderated by the Bank’s excellent record in loan quality. Noninterest income increased in 2006 due to increases in loan appraisal, credit, and miscellaneous charges, income from bank owned life insurance, increases in service charges, and recognition of a gain on the sale of certain investment securities compared to a loss on such sales in 2005. Noninterest expenses increased primarily due to increases in personnel, occupancy, data processing, and professional fees. Income tax expenses increased by $112,471, or 5.48%, in 2006.

For the year ended December 31, 2005, the Company reported consolidated net income of $3,979,343 ($1.53 basic and $1.44 diluted earnings per share) compared to consolidated net income of $3,719,834 ($1.44 basic and $1.38 diluted earnings per share) for the year ended December 31, 2004. The increase in net income for 2005 was primarily attributable to an increase in net interest income, a decline in provision for loan losses, and a small increase in noninterest income which was partially offset by increases in noninterest expenses. The Bank also substantially increased its loan portfolio and deposit balances. In 2005, the Bank used increases in loan and deposit balances to reduce investment securities and wholesale borrowings. In 2005, the Bank also used funds from the issuance of $5.0 million in trust preferred securities to further increase assets. These changes led to increases in net interest income in 2005. Provision for loan losses declined in 2005 from 2004 levels as loan growth in certain areas declined and the Bank maintained an excellent record in loan quality. Noninterest income increased in 2005 because the Bank had recognized a decline in the value of certain securities in 2004 while no recognition was required in 2005. Noninterest expenses increased primarily due to increases in personnel, occupancy, data processing, and professional fees. Income tax expenses increased by $610,950, or 42.40%, in 2005.

Net Interest Income. The primary component of the Company’s net income is its net interest income, which is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is determined by the spread between the yields earned on the Company’s interest-earning assets and the rates paid on interest-bearing liabilities as well as the relative amounts of such assets and liabilities. Net interest income, divided by average interest-earning assets, represents the Company’s net interest margin.

Net interest income for the year ended December 31, 2006 was $17,326,808 compared to $15,571,081 for the year ended December 31, 2005 and $13,799,929 for the year ended December 31, 2004. The $1,755,727 increase in the most recent year was due to an increase in interest income of $6,531,024, partially offset by the increase in interest expense of $4,775,297. For the year ended December 31, 2005, the $1,771,152 increase was due to an increase of $7,541,373 in interest income offset by an increase of $5,770,221 in interest expense for the same period. Changes in the components of net interest income due to changes in average balances of assets and liabilities and to changes caused by changes in interest rates are presented in the rate volume analysis below.

During 2006, the Company’s interest rate spread increased because the Bank’s yield on interest-earning assets increased at a faster rate than the increase in the cost of the Company’s interest-bearing liabilities. The Bank’s yield on loans increased as rates on certain loan types, particularly those based on the prime rate, increased as the Federal Reserve increased short-term interest rates. The Bank’s investment securities yields also increased. The cost of both wholesale borrowings and deposits increased from 2005 due to the Federal Reserve increase in interest rates and because the largest increase in deposits was from certificates of deposit. However, the Company’s average balances of investments, which tend to have lower interest rates than loans, decreased in 2006 from 2005, while the Company’s average balances of loans increased. The Company’s average balances of short-term borrowings, which tend to increase in cost faster than other liabilities, declined during 2006. Deposits, which tend to increase in cost more slowly than other liabilities, increased during the same time. These changes in the average balance sheet of the company from 2005 to 2006 tended to increase interest rate spread and the net yield on interest-earning assets.

During 2005, the Company’s interest-rate spread declined because the Bank’s yield on interest-earning assets increased at a slower rate

Tri-County Financial Corporation

than the increase in costs for interest-bearing liabilities. The Bank’s yield on loans increased as rates on certain loan types, particularly those based on the prime rate, increased as the Federal Reserve increased short-term interest rates. The Company’s investment securities yields increased at a much slower rate than loans, as most of the investments are fixed rate, and the Company did not make significant purchases of investments after the first quarter of 2005. The cost of both wholesale borrowings and deposits increased from 2004 due to the Federal Reserve increasing interest rates.

The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid thereon for the past three fiscal years.


	2006							2005							2004
					Average							Average							Average
	Average				Yield/			Average				Yield/			Average				Yield/
dollars in thousands	Balance		Interest		Cost			Balance		Interest		Cost			Balance		Interest		Cost
Assets
Interest-earning assets
Loan portfolio¹	$	398,381	$	29,292		7.35	%	$	332,348	$	22,358		6.73	%	$	254,605	$	16,033		6.30	%
Investment securities, federal funds sold and interest-bearing deposits		135,824		6,394		4.71	%		178,095		6,797		3.82	%		147,274		5,580		3.79	%

Total interest-earning assets		534,205		35,686		6.68	%		510,443		29,155		5.71	%		401,879		21,613		5.38	%

Cash and cash equivalents		4,072							5,437							2,937
Other assets		20,133							19,262							17,807


Total Assets	$	558,410						$	535,142						$	422,623


Liabilities and Stockholders’ Equity
Interest-bearing liabilities
Savings		34,570		409		1.18	%		36,696		216		0.59	%		37,776		176		0.47	%
Interest-bearing demand and money market accounts		104,410		3,053		2.92	%		89,394		1,387		1.55	%		85,212		755		0.89	%
Certificates of deposit		204,675		8,609		4.21	%		146,512		4,869		3.32	%		93,267		2,298		2.46	%
Long-term debt		101,520		4,491		4.42	%		93,409		3,966		4.25	%		73,830		3,280		4.44	%
Short-term debt		18,129		905		4.99	%		82,665		2,565		3.10	%		64,736		1,164		1.80	%
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000		892		7.43	%		9,916		581		5.86	%		3,255		140		4.31	%


Total Interest-Bearing Liabilities		475,304		18,359		3.86	%		458,592		13,584		2.96	%		358,076		7,813		2.18	%


Noninterest-bearing demand deposits		42,030							39,855							32,909
Other liabilities		4,444							4,474							3,178
Stockholders’ equity		36,632							32,221							28,460

Total Liabilities and Stockholders’ Equity	$	558,410						$	535,142						$	422,623


Net interest income			$	17,327						$	15,571						$	13,800

Interest rate spread						2.82	%						2.75	%						3.20	%

Net yield on interest-earning assets						3.24	%						3.05	%						3.43	%

Ratio of average interest-earning assets to average interest bearing liabilities						112.39	%						111.31	%						112.23	%


¹		Average balance includes non-accrual loans.

Management’s Discussion and Analysis

The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume.


	Year ended December 31, 2006									Year ended December 31, 2005
	compared to December 31, 2005									compared to December 31, 2004
dollars in thousands	Volume			Due to Rate			Total			Volume			Due to Rate			Total
Interest Income
Loan portfolio	$	4,855		$	2,079		$	6,934		$	5,231		$	1,094		$	6,325
Investment securities, federal funds sold and interest-bearing deposits		(1,989	)		1,586			(403	)		1,176			41			1,217

Total Interest-Earning Assets		2,866			3,665			6,531			6,407			1,135			7,542


Interest-Bearing Liabilities
Savings		(25	)		219			193			(7	)		47			40
Interest-bearing demand and money market accounts		439			1,227			1,666			65			567			632
Certificates of deposit		2,446			1,293			3,740			1,770			801			2,571
Long-term debt		359			166			525			831			(145	)		686
Short-term debt		(3,222	)		1,562			(1,660	)		556			845			1,401
Guaranteed preferred beneficial interest in junior subordinated debentures		155			156			311			391			50			441

Total Interest-Bearing Liabilities		152			4,623			4,775			3,606			2,165			5,771

Net Change in Net Interest Income	$	2,714		$	(958	)	$	1,756		$	2,801		$	(1,030	)	$	1,771

Provision for Loan Losses. The provision for loan losses for the year ended December 31, 2006 was $405,809, compared to $329,467 and $452,998 for the years ended December 31, 2005 and 2004, respectively. The loan loss provision increased in 2006 as the Bank continued to add loans to its portfolio particularly in the commercial and commercial equipment categories. The need to increase the loan loss provision was moderated by the Bank’s continued excellent credit quality and low level of charge-offs. In 2006, the Bank recorded net charge-offs of $5,422 (.00% of average loans). For the year ended December 31, 2005, the Company recorded net charge-offs of $4,000 (.00% of average loans) compared to net recoveries of $32,000 (.01% of average loans) in 2004. The loan loss allowance and the provision for loan losses is determined based upon an analysis of individual loans and the application of certain loss factors to different loan categories. Individual loans are analyzed for impairment as the facts and circumstances warrant. In addition, a general component of the loan loss allowance is added based on a review of the portfolio’s size and composition. At December 31, 2006, the allowance for loan losses equaled 362% of non-accrual and past due loans compared to 573% and 453% at December 31, 2005 and 2004, respectively.

Noninterest Income.


	Years Ended December 31,								% change			% change
	2006		2005			2004			2006 vs. 2005			2005 vs. 2004
Loan appraisal, credit, and miscellaneous charges	$	362,145	$	178,424		$	229,125			102.97	%		(22.13	%)
Net gain on sale of loans held for sale		—		—			21,404		na				(100.00	%)
Income from bank owned life insurance		328,586		251,220			261,411			30.80	%		(3.90	%)
Service charges		1,359,409		1,186,184			1,189,001			14.60	%		(0.24	%)
Gain on sale of asset		—		39,756			8,250			(100.00	%)		381.89	%
Gain (loss) on the sale of investment securities		197,001		(14,581	)		(61,875	)		1451.08	%		(76.43	%)
Recognition of other than temporary decline in value of marketable securities		—		—			(65,000	)	na				(100.00	%)

Total noninterest income	$	2,247,141	$	1,641,003		$	1,582,316			36.94	%		3.71	%

Tri-County Financial Corporation

Changes in noninterest income over the past three years have been the result of fluctuations in certain noninterest income categories, including gain on sale of loans, other income, service charges, and loan fees. Loan appraisal, credit, and miscellaneous charges are highly variable. Increases and decreases in this category reflect changes in lending volumes and patterns as well as competitive pressures. The absence of a gain on sale of loans held for sale in 2006 or 2005 reflects the Bank’s desire to keep more of its loan production in portfolio rather than selling it. Income from bank owned life insurance (BOLI) has increased in the last year as the Bank purchased an additional $2.0 million in BOLI in 2006. Service charges and fees are primarily generated by the Bank’s ability to attract and retain transaction-based deposit accounts and by loan-servicing fees net of amortization of and valuation allowances on mortgage servicing rights. In 2006, service charges increased over the prior year as the Bank increased its average transaction account balances during the year. The Bank also increased certain service fees on accounts during 2006. In 2005 and 2004, gains on sales of assets were recorded which were not present in 2006. In 2006, the Bank recorded a net gain on the sale of investment securities compared to losses in the two prior years as the Company sold $423,200 in investments compared to sales of $1,350,000 and $17,313,000 in 2005 and 2004, respectively.

Noninterest Expenses.


	Years Ended December 31,						% change			% change
	2006		2005		2004		2006 vs. 2005			2005 vs. 2004
Salary and employee benefits	$	7,006,369	$	5,849,226	$	5,432,898		19.78	%		7.66	%
Occupancy expense		1,316,261		1,156,775		858,891		13.79	%		34.68	%
Advertising		474,554		411,811		539,715		15.24	%		(23.70	%)
Data processing expense		821,392		665,981		550,781		23.34	%		20.92	%
Depreciation of furniture, fixtures, and equipment		513,348		452,037		372,237		13.56	%		21.44	%
Telephone communications		93,319		85,436		103,421		9.23	%		(17.39	%)
Valuation allowance on foreclosed real estate		—		—		114,606	na				(100.00	%)
ATM expenses		274,403		277,566		345,454		(1.14	%)		(19.65	%)
Office supplies		141,144		138,407		151,862		1.98	%		(8.86	%)
Professional fees		655,503		629,126		261,458		4.19	%		140.62	%
Office equipment expenses		49,816		50,318		90,520		(1.00	%)		(44.41	%)
Other		1,216,359		1,134,647		946,576		7.20	%		19.87	%

	$	12,562,468	$	10,851,330	$	9,768,419		15.77	%		11.09	%

The increases reflect growth in the Bank’s workforce to fully staff branches, an increasing need for highly skilled employees due to the higher complexity level of the Bank’s business, and continued increases in the Bank’s benefit and incentive costs. Expenses also included certain supplemental retirement benefits, which were funded by the BOLI income. In 2006, occupancy expenses reflected the opening of a new branch in 2005 as well as the write-down of a facility which will be replaced in 2007. In 2005, these expenses also reflected an additional branch. Advertising expenses have fluctuated during the three-year period. In 2006, advertising included several large scale campaigns to increase deposit market share. In 2005, advertising expenses declined from the prior year as certain advertising campaigns were curtailed. In 2004, advertising costs reflected several major advertising campaigns and marketing efforts. The increases in data processing costs are reflective of the Bank’s increased size of the loan and deposit portfolios as well as increases in certain third party processing costs related to data processing. These costs also reflect the increasing complexity of the Bank’s product line including the introduction of more sophisticated products for business customers. In 2006, depreciation expenses increased as the Bank continued to expand its branch network. In 2005, depreciation of furniture, fixtures, and equipment increased as the Bank opened a new branch requiring major purchases adding to the amount of assets being depreciated. Telephone communications expenses increased in 2006 as the Bank increased its usage of these services. The same expenses decreased in 2005 compared to 2004 reflecting changes in vendors and renegotiation of vendor contracts. In 2004, ATM expenses included costs relating to a systems conversion, which were nonrecurring. These costs declined in 2005 and 2006. Professional fees increased substantially from 2004 to 2005 as the Company incurred expenses to prepare for Sarbanes-Oxley Act certifications. These costs were steady from 2005 to 2006. Office equipment expenses decreased as a result of declining needs for certain specialized equipment, which is no longer needed after our systems conversion. Other noninterest expense increased due to the growing size of the Bank.

Management’s Discussion and Analysis

Income Tax Expense. During the year ended December 31, 2006, the Company recorded income tax expense of $2,164,415 compared to expenses of $2,051,944 and $1,440,994 in the two prior years. The Company’s effective tax rates for the years ended December 31, 2006, 2005, and 2004 were 32.76%, 34.02%, and 27.92%, respectively. The 2005 effective tax rate increased as the 2004 effective rate reflected a large donation of property made in 2004.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2006 AND 2005


	December 31,						% change
	2006			2005			2006 vs. 2005
Assets
Cash and due from banks	$	3,157,595		$	7,262,547			(56.52	%)
Fed Funds sold		772,351			640,818			20.53	%
Interest-bearing deposits with banks		14,260,560			14,671,875			(2.80	%)
Securities available for sale		9,301,676			7,178,894			29.57	%
Securities held to maturity		97,804,849			116,486,685			(16.04	%)
Federal Home Loan Bank and Federal Reserve Bank stock		6,100,400			7,190,300			(15.16	%)
Loans receivable, net		422,479,799			369,592,253			14.31	%
Premises and equipment, net		6,822,461			6,460,545			5.60	%
Foreclosed real estate		460,884			475,561			(3.09	%)
Accrued interest receivable		2,837,413			2,406,542			17.90	%
Investment in bank owned life insurance		8,762,761			6,434,175			36.19	%
Other assets		2,735,265			2,487,280			9.97	%


Total Assets	$	575,496,014		$	541,287,475			6.32	%


Liabilities
Deposits
Noninterest-bearing	$	43,723,436		$	44,325,083			(1.36	%)
Interest-bearing		374,289,966			319,048,657			17.31	%

Total deposits		418,013,402			363,373,740			15.04	%
Short-term borrowings		6,567,702			20,074,975			(67.28	%)
Long-term debt		96,045,936			107,823,759			(10.92	%)
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000			12,000,000			—
Accrued expenses and other liabilities		5,139,637			3,436,845			49.55	%

Total Liabilities		537,766,677			506,709,319			6.13	%


Stockholders’ equity
Common stock		26,423			17,610			50.05	%
Additional paid in capital		9,499,946			9,057,805			4.88	%
Retained earnings		28,353,792			25,580,634			10.84	%
Accumulated other comprehensive (loss) income		(53,822	)		49,362			(209.04	%)
Unearned ESOP shares		(97,002	)		(127,255	)		(23.77	%)

Total Stockholders’ Equity		37,729,337			34,578,156			9.11	%


Total Liabilities and Stockholders’ Equity	$	575,496,014		$	541,287,475			6.32	%

Tri-County Financial Corporation

In 2006, the Bank used the payments received from the maturation and repayment of its investment securities portfolio to make loans. The Bank also increased retail deposits and used the funds to pay down short-term wholesale borrowings as well as to increase earning assets. In 2006, cash and due from banks decreased as the Bank reduced its cash reserve needs through a process of reclassifying certain deposit accounts. Securities available for sale increased as the Bank purchased securities whose purpose included fulfilling CRA investment requirements. Securities held to maturity decreased due to continued principal repayments on the portfolio, which were used to fund loan growth. Federal Home Loan Bank and Federal Reserve Bank stock declined as the level of borrowings from the Federal Home Loan Bank system declined. Loans receivable increased as the Bank continued to add to its loan portfolio, primarily in the commercial business and commercial real estate product lines. The Bank has continued to use its ability to offer fast, flexible service to attract loan customers. Other lending products such as consumer lending have not been emphasized due to declining margins brought about by competitors such as captive finance companies. Accrued interest receivable increased due to higher levels of earning asset balances. Other assets increased due to an increase in certain prepaid tax accounts.

Deposits increased during 2006 as the Bank increased its market share through marketing campaigns and the introduction of additional deposit products. The Bank has attempted to increase all deposit types, but the largest increase was in certificates of deposit. Short- and long-term borrowings declined, as the Bank replaced borrowings with deposits.

Total equity increased during the year. In 2006, the Company earned net income of $4,441,257. The Company also sold additional shares of stock for $177,500. Other additions to stockholders’ equity were the result of the exercise of stock options ($156,122), tax benefits from the payment of common stock dividends to its ESOP, the exercise of non-incentive stock options ($23,111 and $42,315, respectively), and other changes in the unearned ESOP shares ($73,554). These additions to stockholders’ equity were partially offset by the payment of dividends of $972,966, the repurchase of common stock for $686,528, and a change in the accumulated other comprehensive loss account of $103,184.

ASSET/LIABILITY RISK MANAGEMENT

Net interest income (“NII”), the primary component of the Company’s net income, arises from the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities and the relative amounts of such assets and liabilities. As interest rates change, the yield on interest-earning assets and the cost of interest-bearing liabilities will also change. These changes can have a negative impact on net interest income as costs may rise faster than interest income. The variance in future financial performance caused by changes in interest rates can be broadly termed interest rate risk. Elements of interest rate risk include a mismatch between expected lives of current assets and liabilities (asset/liability mismatch), the ability of borrowers to prepay loans without penalty (prepayment risk), periodic and interest rate caps built into various loan types which limit interest rate adjustments, and adjustable rate liabilities and assets pricing based upon different indices (basis risk).

The Company attempts to measure these risks through various tools including financial modeling of current and projected balance sheets. Financial modeling simulates the effects on the Company’s financial position and net interest income of various interest rate scenarios. The Company uses several measures to gauge its interest rate risk including measuring the effect on NII of various interest rate scenarios, measuring the “gap” or mismatch in assets and liabilities repricing during a particular time period, and measuring the amount that the estimated market value of assets and liabilities would change given specific changes in interest rates. The table below sets forth an approximation of our exposure as a percentage of estimated net interest income for the next twelve months using interest income simulation. The simulation uses projected repricing of assets and liabilities at December 31, 2006 on the basis of contractual maturities, anticipated repayments and schedule rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of loans and securities we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that in turn affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and vice versa. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future security and loan repayment activity. The 200 and 100 basis point changes in rates in the following table are assumed to occur immediately.

Management’s Discussion and Analysis

Projected Percentage change in Net Interest Income at December 31, 2006


+200		+100				-100		-200
Basis points		Basis points		No Change		Basis points		Basis points
-2.27	%	-0.89	%	0.00	%	-2.05	%	-7.36	%

The rate scenarios noted above shows that the Company’s interest rate risk to its NII assuming no growth in the balance sheet and all interest rates moving in the same amounts is about -7.36%. The Company’s one-year-forward earnings will show a relative decline under both positive and negative parallel interest rate movements. These declines are small relative to the Company’s net income and primarily result from the projected actions of customers and others taking advantage of the optionality built into the various financial instruments which make up the Company’s assets and liabilities.

Management will continue to analyze, simulate, and control interest rate risk as the Company grows. The Company may from time to time determine that the use of different financial instruments including interest rate caps, floors, swaps, long-term borrowings, or other arrangements may be prudent. It is management’s belief that the changes in the Company’s balance sheet, including the increased emphasis on commercial lines of credit and certain other loans which tend to rapidly adjust to interest rate changes, and the declining importance of certain liabilities such as short-term borrowings including reverse repurchase agreements and other short-term liabilities will decrease the negative effects of changing interest rates on NII. However these loans carry an increased risk of default, and increases in retail deposits will tend to increase non-interest expenses.

LIQUIDITY AND CAPITAL RESOURCES

The Company currently has no business other than holding the stock of the Bank and engaging in certain passive investments and does not currently have any material funding requirements, except for payment of interest on subordinated debentures, the payment of dividends, and the repurchase of stock. 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 investment and operations are net income, deposits from its primary market area, borrowings, principal and interest payments on loans, principal and interest received on investment securities, and proceeds from the maturity and sale of investment securities. Its principal funding commitments are for the origination or purchase of loans, the purchase of securities, and the payment of maturing deposits. Deposits are considered the primary source of funds supporting the Bank’s lending and investment activities. The Bank also uses borrowings from the FHLB of Atlanta to supplement its funding activities. The amount of FHLB advances available to the Bank is limited to the lower of 40% of Bank assets or the amount supportable by eligible collateral such as FHLB stock, loans, and securities.

The Bank’s most liquid assets are cash, cash equivalents, and federal funds sold. 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 as of December 31, 2006 totaled $18,190,506, a decrease of $4,384,734 or 19.42% from the December 31, 2005 total of $22,575,240. This decrease was due to the Bank’s reduced needs for cash reserves after reclassi-fying certain deposit accounts as noted above.

The Bank’s principal sources of cash flows are its financing activities including deposits and borrowings. During 2006, all financing activities provided $28,167,675 in cash compared to $30,894,663 during 2005 and $149,495,361 during 2004. The decrease in cash flows from financing activities during the most recent period was principally due to a decline in the level of net increase of deposits. The net increase in deposits in 2005 was $96,619,236 compared to $54,639,662 in 2006. The decline in cash flows provided by deposits was offset by a significantly smaller use of cash in reducing net short-term borrowings. In 2006, short-term borrowings declined by $13,507,273 compared to a decline of $95,229,235 in 2005. By contrast, in 2004, short-term borrowing provided a net increase in cash of $84,112,925. Other significant cash flows from financing activities included the proceeds of long-term debt totaling $15,260,000, $30,000,000, and $30,000,000 during 2006, 2005, and 2004 respectively. In 2006, the Company had significantly more repayments of

Tri-County Financial Corporation

long-term debt than in the prior two years, $27,037,822 compared to $5,107,354 and $10,120,063 in 2006, 2005, and 2004 respectively. The Bank also receives cash from its operating activities which provided $6,314,581 in 2006 compared to cash flows of $5,242,895 and $6,290,408 during 2005 and 2004, respectively.

The Bank’s principal use of cash has been in investing activities including investments in loans for its portfolio, investment securities, and other assets. In 2006, the level of investing activity increased after a significant decline in 2005. In 2006, total net cash flow invested was $38,866,990 compared to $31,278,097 and $150,239,788 in 2005 and 2004. The principal reasons for the changes in invested cash are the fluctuations in the amount of funds used to buy investments, the funds provided by maturities and principal payments on investments, funds used for the origination of loans, and the cash provided by principal collected on loans.

Federal banking regulations require the Company and the Bank to maintain specified levels of capital. At December 31, 2006, the Company was in compliance with these requirements with a leverage ratio of 8.74%, a Tier 1 risk-based capital ratio of 11.12% and total risk-based capital ratio of 11.98%. At December 31, 2006, the Bank met the criteria for designation as a well-capitalized depository institution under Federal Reserve Board regulations. See Note 14 of the consolidated financial statements.

OFF BALANCE SHEET ARRANGEMENTS

In the normal course of its business, the Bank has committed to make credit available to its borrowers under various loan and other agreements provided that certain terms and conditions are met. For a discussion of these agreements including collateral and other arrangements see Note 11 to the consolidated financial statements.

CONTRACTUAL OBLIGATIONS

In the normal course of its business, the Bank commits to make future payments to others to satisfy contractual obligations. These commitments include commitments to repay short and long-term borrowings, and commitments incurred under operating lease agreements. These commitments are summarized below:


			Less Than 1						More Than 5
	Total		Year		1 to 3 Years		3 to 5 Years		Years
Long-term debt obligations	$	96,046	$	5,000	$	30,000	$	25,000	$	36,046
Short-term debt obligations		6,567		6,567		—		—		—
Deposits		418,014		382,194		34,120		1,701		—
Data processing servicing contracts		999		481		518		—		—
Operating lease obligations		5,715		342		831		615		3,927
Commitments to purchase or replace branches		4,400		4,400		—		—		—

	$	531,741	$	398,984	$	65,469	$	27,315	$	39,973

IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Management’s Discussion and Analysis

SELECTED FINANCIAL DATA


	Year Ended December 31,
dollars in thousands except per share data	2006			2005			2004			2003			2002
Operations Data
Net interest income	$	17,327		$	15,571		$	13,800		$	10,469		$	10,745
Provision for loan losses		406			329			453			317			160
Noninterest income		2,247			1,641			1,582			1,755			1,847
Noninterest expense		12,562			10,851			9,768			8,428			9,398
Net income	$	4,441		$	3,979		$	3,720		$	2,446		$	1,968

Share Data
Basic net income per common share	$	1.68		$	1.53		$	1.44		$	0.96		$	0.77
Diluted net income per common share	$	1.58		$	1.44		$	1.38		$	0.91		$	0.73
Cash dividends paid per common share	$	0.37		$	0.35		$	0.21		$	0.16		$	0.15
Weighted average common shares outstanding
Basic		2,637,531			2,597,806			2,579,264			2,544,899			2,569,782
Diluted		2,815,985			2,763,616			2,697,030			2,686,571			2,713,913

Financial Condition Data
Total assets	$	575,496		$	541,287		$	505,767		$	351,730		$	282,128
Loans receivable, net		422,480			369,592			289,325			217,740			197,449
Total deposits		418,013			363,374			266,755			227,555			203,025
Long and short term debt		102,614			127,899			198,235			94,242			48,922
Total stockholders’ equity	$	37,729		$	34,578		$	31,124		$	27,912		$	26,873

Performance Ratios
Return on average assets		0.80	%		0.74	%		0.87	%		0.78	%		0.72	%
Return on average equity		12.12	%		12.11	%		12.89	%		8.99	%		7.50	%
Net interest margin		3.24	%		3.05	%		3.43	%		3.55	%		4.20	%
Efficiency ratio		64.18	%		63.04	%		63.50	%		68.95	%		74.73	%
Dividend payout ratio		21.91	%		23.39	%		14.56	%		17.27	%		20.04	%

Capital Ratios
Average equity to average assets		8.74	%		8.55	%		9.29	%		8.04	%		9.53	%
Leverage ratio		8.74	%		8.55	%		9.29	%		8.04	%		9.53	%
Total risk-based capital ratio		11.98	%		11.84	%		11.89	%		12.20	%		13.77	%

Asset Quality Ratios
Allowance for loan losses to total loans		0.89	%		0.91	%		1.04	%		1.16	%		1.15	%
Nonperforming loans to total loans		0.25	%		0.16	%		0.23	%		0.17	%		0.30	%
Allowance for loan losses to nonperforming loans		361.59	%		572.96	%		452.97	%		678.30	%		387.60	%
Net charge-offs to average loans		0.00	%		0.00	%		-0.01	%		0.03	%		0.06	%

All per share amounts have been adjusted for the three for two stock splits which were effected in December 2004, 2005 and 2006.

Tri-County Financial Corporation

MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS

Market Information. The following table sets forth high and low bid quotations reported on the OTC Bulletin for the Company’s common stock for each quarter during 2006 and 2005. These quotes reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions. All per share amounts have been adjusted to reflect the three for two stock dividends effected in December 2005 and December 2006.


	High		Low
2005
Fourth Quarter	$	22.29	$	20.09
Third Quarter	$	22.22	$	19.11
Second Quarter	$	19.11	$	18.22
First Quarter	$	18.67	$	17.37


	High		Low
2006
Fourth Quarter	$	26.67	$	23.43
Third Quarter	$	24.33	$	23.67
Second Quarter	$	25.67	$	22.88
First Quarter	$	22.67	$	21.53

Holders. The number of stockholders of record of the Company at February 20, 2007 was 529.

Dividends. The Company has paid annual cash dividends since 1994. During fiscal years 2006 and 2005, the Company paid annual cash dividend of $0.37 and $0.35, respectively.

The Company’s ability to pay dividends is governed by the policies and regulations of the Federal Reserve Board (the “FRB”), which prohibits the payment of dividends under certain circumstances dependent on the Company’s financial condition and capital adequacy. The Company’s ability to pay dividends is also depending on the receipt of dividends from the Bank.

Federal regulations impose certain limitations on the payment of dividends and other capital distributions by the Bank. The Bank’s ability to pay dividends is governed by the Maryland Financial Institutions Code and the regulations of the FRB. Under the Maryland Financial Institutions Code, a Maryland bank (1) may only pay dividends from undivided profits or, with prior regulatory approval, its surplus in excess of 100% of required capital stock and (2) may not declare dividends on its common stock until its surplus funds equals the amount of required capital stock, or if the surplus fund does not equal the amount of capital stock, in an amount in excess of 90% of net earnings.

Without the approval of the FRB, a state member bank may not declare or pay a dividend if the total of all dividends declared during the year exceeds its net income during the current calendar year and retained net income for the prior two years. The Bank is further prohibited from making a capital distribution if it would not be adequately capitalized thereafter. In addition, the Bank may not make a capital distribution that would reduce its net worth below the amount required to maintain the liquidation account established for the benefit of its depositors at the time of its conversion to stock form.

Tri-County Financial Corporation

BOARD OF DIRECTORS

(seated left to right): C. Marie Brown, Executive Vice President, Chief Operating Officer; Michael L. Middleton, President and Chariman of the Board; Louis P. Jenkins, Jr., Jenkins Law Firm, LLC. (standing left to right): Herbert N. Redmond, Jr., President, D.H. Steffens Company; H. Beaman Smith, Secretary/Treasurer, President, Accoware Systems; James R. Shepherd, Business Development Specialist, Calvert County Department of Economic Development; Philip T. Goldstein, Owner, Philip T. Goldstein Real Estate Appraisals; Joseph V. Stone, Owner; Joseph Stone Insurance Agency; A. Joseph Slater, Jr., President, Southern Maryland Electric Cooperative.

Community Bank of Tri-County

EXECUTIVE OFFICERS

(seated): C. Marie Brown, Executive Vice President, Chief Operating Officer; Michael L. Middleton, President and Chief Executive Officer. (standing left to right): William J. Pasenelli, Executive Vice President, Chieft Financial Officer; Gregory C. Cockerham, Executive Vice President, Chief Lending Officer; James M. Burke, Executive Vice President, Credit Officer; James F. DiMisa, Executive Vice President, Operations.

BANK RISK ASSESSMENT TEAM

(seated): C. Marie Brown, Executive Vice President, Chief Operating Officer; Michael L. Middleton, President and Chief Executive Officer; Paige L. Watkins, Senior Vice President, Credit Administrator. (standing left to right): William J. Pasenelli, Executive Vice President, Chief Financial Officer; David D. Vaira, Senior Vice President, Treasurer/Cashier; Hillary P. Theriault, Assistant Vice President, Marketing Manager; James M. Burke, Executive Vice President, Credit Officer; Nancy C. Hayden, Vice President, Director of Information Technology; Rebecca J. Henderson, Vice President, Director of Branch Operations; James F. DiMisa, Executive Vice President, Operations; Gregory C. Cockerham, Executive Vice President, Chief Lending Officer.

Tri-County Financial Corporation

REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended
December 31, 2006, 2005, and 2004

Tri-County Financial Corporation

This Page Left Blank Intentionally

Tri-County Financial Corporation

TABLE OF CONTENTS


Report of Independent Registered Public Accounting Firm			20

Consolidated Financial Statements
Balance Sheets			21
Statements of Income			22
Statements of Changes in Stockholders’ Equity			23
Statement of Cash Flows			24

Notes to Consolidated Financial Statements			26

Tri-County Financial Corporation

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Tri-County Financial Corporation

We have audited the accompanying consolidated balance sheets of Tri-County Financial Corporation as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tri-County Financial Corporation as of December 31, 2006 and 2005, and the results of its consolidated operations and cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

Baltimore, Maryland
March 14, 2007

Tri-County Financial Corporation

CONSOLIDATED BALANCE SHEETS


	December 31,
	2006			2005
Assets
Cash and due from banks	$	3,157,595		$	7,262,547
Federal Funds sold		772,351			640,818
Interest-bearing deposits with banks at fair value		14,260,560			14,671,875
Securities available for sale		9,301,676			7,178,894
Securities held to maturity at amortized cost (fair value approximates $96,148,156 and $114,271,786, respectively)		97,804,849			116,486,685
Federal Home Loan Bank and Federal Reserve Bank stock- at cost		6,100,400			7,190,300
Loans receivable — net of allowance for loan losses of $3,783,721 and $3,383,334		422,479,799			369,592,253
Premises and equipment, net		6,822,461			6,460,545
Foreclosed real estate		460,884			475,561
Accrued interest receivable		2,837,413			2,406,542
Investment in bank owned life insurance		8,762,761			6,434,175
Other assets		2,735,265			2,487,280


Total Assets	$	575,496,014		$	541,287,475


Liabilities
Deposits
Noninterest- bearing	$	43,723,436		$	44,325,083
Interest-bearing		374,289,966			319,048,657

Total deposits		418,013,402			363,373,740
Short-term borrowings		6,567,702			20,074,975
Long-term debt		96,045,936			107,823,759
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000			12,000,000
Accrued expenses and other liabilities		5,139,637			3,436,845


Total Liabilities		537,766,677			506,709,319


Commitments and contingencies (Note 11)

Stockholders’ equity
Common stock — par value $.01; authorized - 15,000,000 shares; issued 2,642,288 and 1,760,991 shares, respectively		26,423			17,610
Additional paid in capital		9,499,946			9,057,805
Retained earnings		28,353,792			25,580,634
Accumulated other comprehensive (loss) income		(53,822	)		49,362
Unearned ESOP shares		(97,002	)		(127,255	)


Total Stockholders’ Equity		37,729,337			34,578,156


Total Liabilities and Stockholders’ Equity	$	575,496,014		$	541,287,475

See notes to consolidated financial statements.

Tri-County Financial Corporation

CONSOLIDATED STATEMENTS OF INCOME


	Years Ended December 31,
	2006		2005			2004
Interest and Dividend Income
Loans, including fees	$	29,292,419	$	22,357,616		$	16,033,239
Taxable interest and dividends on investment securities		6,211,393		6,707,913			5,551,943
Interest on deposits with banks		181,924		89,183			28,157

Total Interest and Dividend Income		35,685,736		29,154,712			21,613,339


Interest expense
Deposits		12,062,016		6,472,032			3,229,502
Short-term borrowings		921,934		2,564,550			1,163,647
Long-term debt		5,374,978		4,547,049			3,420,261

Total Interest Expenses		18,358,928		13,583,631			7,813,410


Net interest income		17,326,808		15,571,081			13,799,929
Provision for loan losses		405,809		329,467			452,998

Net Interest Income After Provision For Loan Losses		16,920,999		15,241,614			13,346,931


Noninterest income
Loan appraisal, credit, and miscellaneous charges		362,145		178,424			229,125
Net gain on sale of loans held for sale		—		—			21,404
Income from bank owned life insurance		328,586		251,220			261,411
Service charges		1,359,409		1,186,184			1,189,001
Gain on sale of asset		—		39,756			8,250
Gain (loss) on the sale of investment securities		197,001		(14,581	)		(61,875	)
Recognition of other than temporary decline in value of marketable securities		—		—			(65,000	)

Total Noninterest Income		2,247,141		1,641,003			1,582,316


Noninterest expenses
Salary and employee benefits		7,006,369		5,849,226			5,432,898
Occupancy expense		1,316,261		1,156,775			858,891
Advertising		474,554		411,811			539,715
Data processing expense		821,392		665,981			550,781
Depreciation of furniture, fixtures, and equipment		513,348		452,037			372,237
Telephone communications		93,319		85,436			103,421
Valuation allowance on foreclosed real estate		—		—			114,606
ATM expenses		274,403		277,566			345,454
Office supplies		141,144		138,407			151,862
Professional fees		655,503		629,126			261,458
Office equipment expenses		49,816		50,318			90,520
Other		1,216,359		1,134,647			946,576

Total Noninterest Expenses		12,562,468		10,851,330			9,768,419


Income before income taxes		6,605,672		6,031,287			5,160,828
Income tax expense		2,164,415		2,051,944			1,440,994

Net Income	$	4,441,257	$	3,979,343		$	3,719,834


Earnings per share*
Basic	$	1.68	$	1.53		$	1.44
Diluted	$	1.58	$	1.44		$	1.38

See notes to consolidated financial statements.


*		Share and per share data have been retroactively adjusted to effect the three-for-two common stock splits of December 2004, 2005, and 2006 as if they had occurred January 1, 2004.

Tri-County Financial Corporation

Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2006, 2005, and 2004


									Accumulated
									Other
	Common			Paid in		Retained			Comprehensive			Unearned
	Stock			Capital		Earnings			Income (Loss)			ESOP Shares			Total
Balance at January 1, 2004	$	7,533		$	7,975,035	$	20,071,630		$	(3,130	)	$	(139,159	)	$	27,911,909
Comprehensive Income
Net income							3,719,834									3,719,834
Change in unrealized gains on investment securities net of tax of $97,503										189,270						189,270

Total Comprehensive Income																3,909,104
Cash dividend $0.21 per share							(541,633	)								(541,633	)
Excess of fair market value over cost of leveraged ESOP shares released					28,670											28,670
Exercise of stock options		214			241,261											241,475
Repurchase of common stock		(93	)				(412,880	)								(412,973	)
Net change in unearned ESOP shares		(24	)										(20,139	)		(20,163	)
3 for 2 stock split in the form of a dividend		3,839					(3,839	)								—
Tax effect of the exercise of non-ISO stock options		—			7,186		—			—			—			7,186

Balance at December 31, 2004		11,469			8,252,152		22,833,112			186,140			(159,298	)		31,123,575
Comprehensive Income
Net income							3,979,343									3,979,343
Change in unrealized losses on investment securities net of tax of $70,460										(136,778	)					(136,778	)

Total Comprehensive Income																3,842,565
Cash dividend $0.35 per share							(930,669	)								(930,669	)
Excess of fair market value over cost of leveraged ESOP shares released					28,354											28,354
Exercise of stock options		231			259,755											259,986
Proceeds of private placement		158			472,882											473,040
Net change in unearned ESOP shares		(7	)										32,043			32,036
Repurchase of common stock		(60	)				(295,333	)								(295,393	)
3 for 2 stock split in the form of a dividend		5,819					(5,819	)								—
Tax effect of the exercise of non-ISO stock options		—			44,662		—			—			—			44,662

Balance at December 31, 2005		17,610			9,057,805		25,580,634			49,362			(127,255	)		34,578,156
Comprehensive Income
Net income							4,441,257									4,441,257
Change in unrealized losses on investment securities net of tax of $64,841										(103,184	)					(103,184	)

Total Comprehensive Income																4,338,073
Cash dividend $0,37 per share							(972,966	)								(972,966	)
Excess of fair market value over cost of leveraged ESOP shares released					43,306											43,306
Exercise of stock options		163			155,959											156,122
Proceeds of private placement		50			177,450											177,500
Net change in unearned ESOP shares		(5	)										30,253			30,248
Repurchase of common stock		(200	)				(686,328	)								(686,528	)
3 for 2 stock split in the form of a dividend		8,805					(8,805	)								—
Tax effect of the ESOP dividend					23,111											23,111
Tax effect of the exercise of non-ISO stock options		—			42,315		—			—			—			42,315

Balance at December 31, 2006	$	26,423		$	9,499,946	$	28,353,792		$	(53,822	)	$	(97,002	)	$	37,729,337

All per share amounts have been adjusted for the three for two stock splits, which were effected in December 2004, 2005, and 2006.

Tri-County Financial Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004


	2006			2005			2004
Cash Flows From Operating Activities
Net income	$	4,441,257		$	3,979,343		$	3,719,834
Adjustments to reconcile net income to net cash provided by operating activities:
Valuation allowance on foreclosed real estate		—			—			114,606
Provision for loan losses		405,809			329,467			452,998
(Gain) loss on sales of investment securities		(197,000	)		14,581			61,875
Recognition of other than temporary decline in value of marketable securities		—			—			65,000
Depreciation and amortization		1,001,638			811,866			636,711
Net amortization of premium/discount on mortgage backed securities and investments		27,749			341,858			116,256
Excess tax benefits on stock-based compensation		(42,315	)		—			—
Increase in cash surrender of bank owned life insurance		(328,586	)		(251,220	)		(261,411	)
Deferred income tax (benefit) expense		(412,681	)		(452,351	)		65,850
Increase in accrued interest receivable		(430,871	)		(536,407	)		(551,817	)
(Increase) decrease in deferred loan fees		(113,379	)		(160,660	)		114,618
Increase in accrued expenses and other liabilities		1,801,223			783,124			349,818
Decrease in other assets		161,737			386,834			906,843
Loss (gain) on disposal of premises and equipment		—			36,216			(8,250	)
Proceeds from sale of loans held for sale		—			—			496,284
Loss (gain) on sale of other real estate owned		—			(39,756	)		32,597
Gain on sales of loans held for sale		—			—			(21,404	)


Net Cash Provided by Operating Activities		6,314,581			5,242,895			6,290,408


Cash Flows From Investing Activities
Purchase of investment securities available for sale		(3,127,695	)		(9,655	)		(27,944,571	)
Proceeds from sale, redemption or principal payments of investment securities available for sale		1,033,358			5,540,515			53,031,692
Purchase of investment securities held to maturity		(5,100,000	)		(25,749,248	)		(143,349,900	)
Proceeds from maturities or principal payments of investment securities held to maturity		23,766,300			71,679,258			42,511,543
Net sale (purchase) of FHLB and Federal Reserve stock		1,089,900			(1,046,000	)		(1,367,450	)
Loans originated or acquired		(181,343,309	)		(202,475,708	)		(192,785,961	)
Principal collected on loans		128,163,333			122,039,699			120,633,447
Purchase of premises and equipment		(1,363,554	)		(1,296,714	)		(1,068,435	)
Proceeds from disposal of premises and equipment		—			—			8,250
Purchase of bank owned life insurance policies		(2,000,000	)		—			—
Proceeds of sale of foreclosed real estate		14,677			39,756			91,597


Net Cash Used in Investing Activities		(38,866,990	)		(31,278,097	)		(150,239,788	)

Tri-County Financial Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004


	2006			2005			2004
Cash Flows From Financing Activities
Net increase in deposits		54,639,662			96,619,236			39,199,936
Net increase (decrease) in short-term borrowings		(13,507,273	)		(95,229,235	)		84,112,925
Dividends paid		(972,966	)		(930,669	)		(541,633	)
Exercise of stock options		156,122			304,648			248,661
Excess tax benefits on stock-based compensation		42,315			—			—
Proceeds from private placement		177,500			473,040			—
Net change in unearned ESOP shares		96,665			60,390			8,508
Repurchase of common stock		(686,528	)		(295,393	)		(412,973	)
Proceeds from long-term borrowings		15,260,000			30,000,000			30,000,000
Payments of long-term borrowings		(27,037,822	)		(5,107,354	)		(10,120,063	)
Trust preferred debentures		—			5,000,000			7,000,000


Net Cash Provided by Financing Activities		28,167,675			30,894,663			149,495,361

(Decrease) Increase in Cash and Cash Equivalents		(4,384,734	)		4,859,461			5,545,981

Cash and Cash Equivalents at Beginning of Year		22,575,240			17,715,779			12,169,798


Cash and Cash Equivalents at End of Year	$	18,190,506		$	22,575,240		$	17,715,779


Supplementary Cash Flow Information
Cash paid during the year for
Interest	$	18,057,377		$	13,503,581		$	7,784,244
Income taxes		2,567,400			2,032,500			1,232,500

See notes to consolidated statements.

Notes To Consolidated Financial Statements

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Tri-County Financial Corporation and its wholly owned subsidiaries, Community Bank of Tri-County (the “Bank”), Tri-County Capital Trust I, and Tri-County Capital Trust II, and the Bank’s wholly owned subsidiaries, Tri-County Investment Corporation and Community Mortgage Corporation of Tri-County (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry. Certain reclassifications have been made to amounts previously reported to conform with classifications made in 2006.

Nature of Operations

The Company provides a variety of financial services to individuals and small businesses through its offices in southern Maryland. Its primary deposit products are demand, savings, and time deposits and its primary lending products are consumer and commercial mortgage loans, construction loans, and commercial loans.

Use of Estimates

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate, and deferred tax assets.

Significant Group Concentrations of Credit Risk

Most of the company’s activities are with customers located in the Southern Maryland area comprising St. Mary’s, Charles, and Calvert counties. Note 3 discusses the types of securities held by the Company. Note 4 discusses the type of lending in which the Company is engaged. The Company does not have any significant concentration to any one customer or industry.

Cast and Cash Equivalents

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less when purchased to be cash equivalents.

Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values are classified as “available for sale” and recorded at estimated fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the estimated fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Investment in Federal Reserve Bank and Federal Home Loan Bank of Atlanta stock are recorded at cost and are considered restricted as to marketability. The Bank is required to maintain investments in the Federal Reserve Bank and Federal Home Loan Bank based upon levels of financial activity.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Tri-County Financial Corporation

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold, using the specific identification method.

Loans Receivable

The Company originates mortgage, commercial, and consumer loans to customers. A substantial portion of the loan portfolio is represented by loans throughout southern Maryland. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

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 charged-off no later than 180 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.

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.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the size and composition of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance for loan losses consists of a specific component and a general component. The specific component relates to loans that are classified as either doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than carrying value of that loan. The general component covers the non-classified loans and is based on historical loss experience, peer group comparisons, industry data and loss percentages used for similarly graded loans adjusted for qualitative factors.

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.

Notes To Consolidated Financial Statements

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 restructuring agreement.

Servicing

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing based on relative estimated fair value. Estimated fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds, and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Servicing assets are evaluated for impairment based upon the estimated fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.

Premises and Equipment

Land is carried at cost. Premises and improvements and equipment are carried at cost, less accumulated depreciation and amortization computed by the straight-line method over the estimated useful lives of the assets, which are as follows


Buildings and improvements		10 - 50 years
Furniture and equipment		3-15 years
Automobiles		5 years

Maintenance and repairs are charged to expense as incurred while improvements that extend the useful life of premises and equipment are capitalized.

Foreclosed Real Estate

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or estimated fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or estimated fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in noninterest expense.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Advertising Costs

The Company expenses advertising costs as incurred.

Tri-County Financial Corporation

Income Taxes

The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Off Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under commercial lines of credit, letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Stock-Based Compensation

The Company has stock option and incentive plans to attract and retain key personnel in order to promote the success of the business. These plans are more fully described in Note 12.

Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). This statement replaced SFAS No. 123, “Accounting for Stock-based Compensation” and superseded APB No. 25. SFAS No. 123(R) requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. This statement was adopted using the modified prospective method of application, which requires the Company to recognize compensation expense on a prospective basis. Therefore, prior period financial statements have not been restated. Under this method, in addition to reflecting compensation expense for new share-based awards, expense is also recognized to reflect the remaining service period of outstanding awards that had been included in pro forma disclosures in prior periods. As of December 31, 2005, all outstanding options were fully vested, so no expense will be recognized for options outstanding as of that date. SFAS No. 123(R). Prior to 2006, the Company applied the intrinsic value method as outlined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations in accounting for stock options granted. Under the intrinsic value method, no compensation expense was recognized if the exercise price of the Company’s employee stock options equaled the market price of the underlying stock on the date of the grant. Accordingly, no compensation cost was recognized in the accompanying consolidated statements of earnings prior to 2006 on stock options granted to employees or directors, since all options granted under the Company’s incentive programs had an exercise price equal to the market value of the underlying common stock on the date of grant.

The Company and the Bank currently maintain incentive plans which provide for payments to be made in either cash or stock options. The Company has accrued the full amounts due under these plans, but currently it is not possible to identify the portion that will be paid out in the form of stock options.

Earnings Per Common Share

Basic earnings per common share represents income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. In 2005 and 2004 there were 59,526 and 69,407 options with an exercise price that exceeded the respective market price, which were excluded from the calculation as their effect would be anti-dilutive. No options were anti-dilutive as of December 31, 2006.

Earnings per common share have been computed based on the following:


	Years Ended December 31,
	2006		2005		2004
Net income	$	4,441,256	$	3,979,343	$	3,719,834


Average number of common shares outstanding		2,637,531		2,597,807		2,579,264
Effect of dilutive options		178,454		165,809		117,768

Average number of shares used to calculate earnings per share outstanding		2,815,985		2,763,616		2,697,032

Notes to Consolidated Financial Statements

The numbers of common shares outstanding have been adjusted to give retroactive effect to the three for two stock splits in December 2004, 2005, and 2006.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

The components of other comprehensive income and related tax effects are as follows


	Years Ended December 31,
	2006			2005			2004
Net income	$	4,441,257		$	3,979,343		$	3,719,834
Other comprehensive income items
Unrealized holding gains (losses) on available for sale securities net of tax expense (benefit) of $9,136, $(75,419), and $74,465, respectively		17,735			(146,110	)		148,473
Plus: Reclassification adjustment for (gains) losses net of tax (provision) benefit of ($76,082), $5,249 and $21,038, respectively		(120,919	)		9,332			40,797

Total other comprehensive income		(103,184	)		(136,778	)		189,270

Total Comprehensive Income	$	4,338,073		$	3,842,565		$	3,909,104

Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” which amends SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 simplifies the accounting for certain derivative embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a re-measurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the Company has not yet issued financial statements, including for interim periods, for that fiscal year. Management does not expect the adoption of SFAS 155 to have a material impact on the consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets- an amendment of FASB Statement No. 140.” This statement amends Statement No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. It requires an entity to recognize a servicing asset or servicing liability each time an obligation is undertaken to service a financial asset by entering into a servicing contract in certain situations and requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable. The statement permits the choice between the “amortization method” and the “fair value measurement method” for subsequent measurement of the servicing assets or liabilities and allows for a one-time reclassification of available-for-sale securities to trading securities at initial adoption. The statement also requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. The statement is effective for fiscal years beginning after September 15, 2006. The adoption of this statnadard is not anticipated to have a material impact on our financial condition, results of operations, or liquidity.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expects to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of (“FIN”) No. 48 to have a material impact on the consolidated financial statements.

In June 2006, the FASB ratified Emerging Issues Task Force (“EITF) No. 06-2, “Accounting for Sabbatical Leave and Other Similar

Tri-County Financial Corporation

Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (‘SAFS 43’) (“EITF 06-2”). EITF 06-2 provides guidelines under which sabbatical leave or other similar benefits provided to an employee are considered to accumulate, as defined in SFAS 43. If such benefits are deemed to accumulate, then the compensation cost associated with a sabbatical or other similar benefit arrangement should be accrued over the requisite service period. The provisions of the EITF are effective for fiscal years beginning after December 15, 2006 and allow for either retrospective application or a cumulative effect adjustment approach upon adoption. Management does not expect the adoption of (“EITF 06—2”) to have a material impact on the consolidated financial statements.

In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to existing accounting pronouncements that require or permit fair value measurements in which FASB had previously concluded fair value is the most relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, with early adoption encouraged. The Company is currently evaluating the impact the adoption of this interpretation will have on its financial condition and results of operations.

In September 2006, the FASB issued SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS 158 requires an employer to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. A public entity is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the first fiscal year ending after December 15, 2006. Management does not believe the adoption of this standard will have a material impact on the financial condition or the results of operations of the Company.

In September 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods as defined in SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. The EITF reached a consensus that Bank Owned Life Insurance policies purchased for this purpose do not effectively settle the entity’s obligation to the employee in this regard and, thus, the entity must record compensation costs and a related liability. Entities should recognize the effects of applying this Issue through either, (a) a change in accounting principle through a cumulative-effective adjustment to retained earnings or to other components of equity or net assets in the balance sheet as of the beginning of the year of adoption, or (b) a change in accuonting principle through retrospective application to all prior periods. This Issue is effective for fiscal years beginning after December 15, 2007. Management is currently evaluating the impact of adopting this Issue on the Company’s financial statements.

Staff Accounting Bulletin (SAB) 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 addresses how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. The effects of prior year uncorrected errors include the potential accumulation of improper amounts that may result in a material misstatement on the balance sheet or the reversal of prior period errors in the current period that result in a material misstatement of the current period income statement amounts. Adjustments to current or prior period financial statements would be required in the event that after application of various approaches for assessing materiality of a misstatement in current period financial statements and consideration of all relevant quantitative and qualitative factors, a misstatement is determined to be material. SAB 108 is applicable to all financial statements issued by the Corporation after November 15, 2006.

NOTE 2 — RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK

The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2006 and 2005, these reserve balances amounted to $847,000 and $4,359,000, respectively.

Notes to Consolidated Financial Statements

NOTE 3 — INVESTMENT SECURITIES


	December 31, 2006
			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated Fair
	Cost		Gains		Losses		Value
Securities Available for Sale
Asset-backed securities issued by GSEs	$	5,882,361	$	22,429	$	206,930	$	5,697,860
Corporate equity securities		254,810		86,873		—		341,683
Bond mutual funds		3,246,054		18,173		2,094		3,262,133

Total Securities Available for Sale	$	9,383,225	$	127,475	$	209,024	$	9,301,676


Securities Held-to-Maturity
Asset-backed securities issued by
GSEs	$	66,904,325	$	208,890	$	1,716,038	$	65,397,177
Other		29,955,894		211,181		360,726		29,806,349

Total Debt Securities Held-to-Maturity		96,860,219		420,071		2,076,764		95,203,526

U.S. government obligations		800,000		—		—		800,000
Other investments		144,630		—		—		144,630

Total Securities Held-to-Maturity	$	97,804,849	$	420,071	$	2,076,764	$	96,148,156


	December 31, 2005
			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated Fair
	Cost		Gains		Losses		Value
Securities Available for Sale
Asset-backed securities issued by GSEs	$	6,494,335	$	42,077	$	203,717	$	6,332,695
Corporate equity securities		481,010		239,338		1,000		719,348
Bond mutual funds		128,756		—		1,905		126,851

Total Securities Available for Sale	$	7,104,101	$	281,415	$	206,622	$	7,178,894


Securities Held-to-Maturity
Asset-backed securities issued by
GSEs	$	78,001,293	$	182,831	$	1,777,533	$	76,406,591
Other		37,382,662		53,007		673,204		36,762,465

Total Debt Securities Held-to-Maturity		115,383,955		235,838		2,450,737		113,169,056

U.S. government obligations		499,091		—		—		499,091
Other investments		603,639		—		—		603,639

Total Securities Held-to-Maturity	$	116,486,685	$	235,838	$	2,450,737	$	114,271,786

Other investments consist of certain certificate of deposit strip instruments whose fair value is based on market returns on similar risk and maturity instruments because no active market exists for these instruments. At December 31, 2006, U.S. government obligations with a carrying value of $800,000 were pledged to secure municipal deposits. In addition, at December 31, 2006, certain other securities with a carrying value of $7,100,000 were pledged to secure certain deposits. At December 31, 2006, securities with a carrying value of $92,911,006 were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.

Tri-County Financial Corporation

Gross unrealized losses and estimated fair value by length of time that the individual, available-for-sale securities have been in a continuous unrealized loss position at December 31, 2006 are as follows


			Continuous unrealized losses existing for
							Total
			Less Than		More Than		unrealized
	Fair Value		12 Months		12 Months		Losses
Asset-backed securities issued by GSEs	$	5,150,991	$	—	$	206,930	$	206,930
Bond mutual funds		94,893		—		2,094		2,094

	$	5,245,884	$	—	$	209,024	$	209,024

The available-for-sale investment portfolio has a fair value of $9,301,676 of which $5,245,884 of the securities have some unrealized losses from their amortized cost. Of these securities, $5,150,991, or 98%, are mortgage-backed securities issued by GSEs and $94,893, or 2%, are short duration mutual fund shares. The unrealized losses that exist in the mortgage-backed securities and mutual fund shares are the result of market changes in interest rates since the original purchase.

The mutual fund shares have a modest duration and are backed by one year adjustable-rate mortgage-backed securities. The asset-backed securities have an average duration of 3.3 years and are guaranteed by their issuer as to credit risk. Total unrealized losses on these investments are small (approximately 4%). Persistent losses may require a re-evaluation of these losses. These factors coupled with the fact the Company has both the intent and ability to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses in the available-for-sale portfolio are temporary.

Gross unrealized losses and estimated fair value by length of time that the individual held-to-maturity securities have been in a continuous unrealized loss position at December 31, 2006 are as follows


			Continuous unrealized losses existing for
							Total
			Less Than		More Than		unrealized
	Fair Value		12 Months		12 Months		Losses
Asset-backed securities issued by GSEs	$	49,193,723	$	1,450	$	1,714,588	$	1,716,038
Asset-backed securities issued by other		16,072,622		—		360,726		360,726

	$	65,266,345	$	1,450	$	2,075,314	$	2,076,764

The held-to-maturity investment portfolio has an estimated fair value of $96,148,156 of which $65,266,345 of the securities have some unrealized losses from their purchase price. Of these securities, $49,193,723 or 75%, are mortgage-backed securities issued by GSEs and the remainder, or $16,072,622, are mortgage-backed securities issued by others. The asset-backed securities have a duration of approximately four years, are guaranteed as to payment by the issuer, and have minimal losses compared to carrying value (approximately 3%). The unrealized losses that exist are the result of market changes in interest rates since the original purchase. These factors coupled with the Company’s intent and ability to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses in the held-to-maturity portfolio are temporary.

The amortized cost and estimated fair value of debt securities at December 31, 2006, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

Notes to Consolidated Financial Statements


	Available for Sale				Held to Maturity
	Amortized		Estimated		Amortized		Estimated
	Cost		Fair Value		Cost		Fair Value
Within one year	$	3,246,054	$	3,262,133	$	811,078	$	811,078
Over one year through five years		—		—		133,552		133,552
Over five years through ten years		—		—		—		—

		3,246,054		3,262,133		944,630		944,630
Mortgage-backed securities		6,137,171		6,039,543		96,860,219		95,203,526

	$	9,383,225	$	9,301,676	$	97,804,849	$	96,148,156

Total sales of investments available for sale during 2006, 2005, and 2004 were $226,199, $1,350,000, and $36,900,000, these sales produced a net gain (loss) of $197,001, $(14,582), and $(61,875). Asset-backed securities are comprised of mortgage-backed securities as well as mortgage-derivative securities such as collateralized mortgage obligations and real estate mortgage investment conduits.

NOTE 4 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

A summary of the balances of loans are as follows


	2006		2005
Commercial real estate	$	177,923,349	$	166,850,838
Residential first mortgages		80,781,271		73,627,717
Construction and land development		42,746,306		32,608,002
Home equity and second mortgage		24,572,235		25,884,406
Commercial loans		79,629,910		54,737,693
Consumer loans		2,812,945		3,128,425
Commercial equipment		18,287,840		16,742,220

		426,753,855		373,579,301


Less:
Deferred loan fees		490,335		603,714
Allowance for loan loss		3,783,721		3,383,334

		4,274,056		3,987,048

	$	422,479,799	$	369,592,253

An analysis of the allowance for loan losses follows


	2006		2005		2004
Balance January 1,	$	3,383,334	$	3,057,558	$	2,572,799
Add:
Provision charged to operations		405,809		329,467		452,998
Recoveries		2,759		5,184		49,083
Less:
Charge-offs		8,181		8,875		17,322

Balance, December 31	$	3,783,721	$	3,383,334	$	3,057,558

No loans included within the scope of SFAS No. 114 were identified as being impaired at December 31, 2006, 2005, or 2004 and for the years then ended.

Loans on which the recognition of interest has been discontinued, which were not included within the scope of SFAS No. 114, amounted to approximately $1,046,000, $591,000, and $675,000 at December 31, 2006, 2005, and 2004, respectively. If interest income had been recognized on nonaccrual loans at their stated rates during 2006, 2005, and 2004, interest income would have been increased by $75,480, $67,558, and $44,391, respectively. Income in the amount of $18,121, $7,763, and $21,955 was recognized on these loans in 2006, 2005, and 2004, respectively.

Tri-County Financial Corporation

Included in loans receivable at December 31, 2006 and 2005 is $3,179,142 and $1,682,994 due from officers and directors of the Bank. These loans are made in the ordinary course of business at substantially the same terms and conditions as those prevailing at the time for comparable transactions with outsiders and are not considered to involve more than the normal risk of collectibility. For the years ended December 31, 2006 and 2005, all loans to directors and officers of the Bank were performing according to the original loan terms. Activity in loans outstanding to officers and directors is summarized as follows


	2006			2005
Balance, beginning of year	$	1,682,994		$	1,268,353
New loans made during year		1,967,257			524,708
Repayments made during year		(991,108	)		(110,067	)
Changes due to changes in directors and officers		520,000			—

Balance, end of year	$	3,179,142		$	1,682,994

NOTE 5 — LOAN SERVICING

Loans serviced for others are not reflected in the accompanying balance sheets. The unpaid principal balances of mortgages serviced for others were $29,313,135 and $34,530,296 at December 31, 2006 and 2005, respectively.

Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income is recorded on the accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The following table presents the activity of the mortgage servicing rights.


	Year Ended December 31,
	2006			2005			2004
Balance at beginning of the year	$	326,061		$	477,202		$	676,940
Additions		—			—			7,861
Amortization		(111,102	)		(151,141	)		(207,599	)

	$	214,959		$	326,061		$	477,202

NOTE 6 — FORECLOSED REAL ESTATE

Foreclosed assets are presented net of an allowance for losses. An analysis of the allowance for losses on foreclosed assets is as follows


	Years ended December 31,
	2006		2005		2004
Balance at beginning of year	$	671,740	$	671,740	$	972,899
Provision for losses		—		—		114,606
Charge-offs		—		—		(415,765	)

Balance at end of year	$	671,740	$	671,740	$	671,740

Expenses applicable to foreclosed assets include the following


	Years ended December 31,
	2006		2005		2004
Net gain on sale of foreclosed real estate	$	—	$	—	$	—
Donation of property		—		—		25,000
Provision for losses		—		—		114,606
Operating expenses		3,632		3,083		6,278

	$	3,632	$	3,083	$	145,884

Notes to Consolidated Financial Statements

NOTE 7 — PREMISES AND EQUIPMENT

A summary of the cost and accumulated depreciation of premises and equipment follows


	2006		2005
Land	$	2,096,381	$	1,368,077
Building and improvements		5,856,357		5,579,868
Furniture and equipment		3,021,560		2,662,799
Automobiles		168,426		168,426

Total cost		11,142,724		9,779,170
Less accumulated depreciation		4,320,263		3,318,625

Premises and equipment, net	$	6,822,461	$	6,460,545

Certain bank facilities are leased under various operating leases. Rent expense was $292,196, $238,573, and $190,306 in 2006, 2005, and 2004, respectively. Future minimum rental commitments under non-cancellable operating leases are as follows:


2007	$	342,150
2008		456,021
2009		374,705
2010		305,252
2011		309,533
Thereafter		3,926,918


Total	$	5,714,579

In addition to the premises and equipment balances noted above, the Company has agreed to purchase additional land, and plans to rebuild one branch office and construct a new branch office in 2007. Total amounts to be purchased under these commitments are approximately $4.4 million.

NOTE 8 — DEPOSITS

Deposits at December 31 consist of the following:


	2006		2005
Noninterest-bearing demand	$	43,723,436	$	44,325,083
Interest-bearing demand		41,117,213		48,666,460
Money market deposits		91,072,187		40,195,630
Savings		30,187,404		34,800,535
Certificates of deposit		211,913,163		195,386,032

Total interest-bearing		374,289,966		319,048,657


Total deposits	$	418,013,403	$	363,373,740

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2006 and 2005 was $62,996,094 and $64,722,620, respectively.

Tri-County Financial Corporation

At December 31, 2006, the scheduled maturities of time deposits are as follows


2007	$	176,092,518
2008		22,507,476
2009		5,906,963
2010		5,705,602
2011		1,700,605

	$	211,913,163

NOTE 9 — SHORT-TERM BORROWINGS AND LONG-TERM DEBT

The Bank’s long-term debt consists of advances from the Federal Home Loan Bank of Atlanta. The Bank classifies debt based upon original maturity and does not reclassify debt to short term status during its life. These include fixed-rate, adjustable-rate, fixed convertible, and variable convertible advances. Rates and maturities on these advances are as follows


				Fixed Rate			Variable
	Fixed Rate			Convertible			Convertible
2006
Highest rate		5.15	%		6.25	%		4.91	%
Lowest rate		1.00	%		3.27	%		4.17	%
Weighted average rate		4.29	%		4.70	%		4.65	%
Matures through		2036			2014			2020

2005
Highest rate		5.43	%		6.25	%		3.88	%
Lowest rate		1.13	%		3.27	%		3.88	%
Weighted average rate		3.99	%		4.54	%		3.88	%
Matures through		2022			2014			2020

Average rates of long and short-term debt were as follows


	At or for the Year Ended December 31,
dollars in thousands	2006			2005			2004
Long-term debt
Maximum outstanding long-term debt of any month end	$	108,078		$	107,826		$	82,931
Average outstanding long-term debt		101,520			93,409			73,830
Approximate average rate paid on long-term debt		4.42	%		4.25	%		4.44	%
Short-term borrowing
Maximum outstanding short-term debt at any month end	$	37,590		$	123,968		$	122,693
Average outstanding short-term debt		18,129			82,665			64,736
Approximate average rate paid on short-term debt		4.99	%		3.10	%		1.80	%

The Bank’s fixed-rate debt generally consists of advances with monthly interest payments and principal due at maturity.

The Bank’s fixed-rate, convertible, long-term debt is callable by the issuer, after an initial period ranging from six months to five years. Advances become callable on dates ranging from 2007 to 2009. Depending on the specific instrument, the instrument is callable either continuously after the initial period (Bermuda option) or only at the date ending the initial period (European). All advances have a prepayment penalty, determined based upon prevailing interest rates. Variable convertible advances have an initial variable rate based on a discount to LIBOR. Depending on the specific instrument, the debt has a discount to LIBOR ranging from 43 to 50 basis points. After an initial period of two to five years, the advance will convert at the issuer’s option to a fixed-rate advance at a rate of 4.0% to 4.21% and a term of five to ten years. The contractual maturities of long-term debt are as follows

Notes to Consolidated Financial Statements

December 31, 2006


			Fixed Rate		Variable
	Fixed Rate		Convertible		Convertible		Total
Due in 2007	$	5,000,000	$	—	$	—	$	5,000,000
Due in 2008		—		—		—		—
Due in 2009		30,000,000		—		—		30,000,000
Due in 2010		5,000,000		10,000,000		—		15,000,000
Due in 2011		—		—		10,000,000		10,000,000

Thereafter		1,045,936		15,000,000		20,000,000		36,045,936

	$	41,045,936	$	25,000,000	$	30,000,000	$	96,045,936

From time to time, the Bank also has daily advances outstanding, which are classified as short-term borrowings. These advances are repayable at the Bank’s option at any time and reprice daily. These advances totaled $5,500,000 and $19,500,000 at December 31, 2006 and 2005, respectively. The rates on the short-term debt at December 31, 2006 and 2005 were 5.5% and 4.58% respectively.

Under the terms of an Agreement for Advances and Security Agreement with Blanket Floating Lien (the “Agreement”), the Company maintained eligible collateral consisting of one- to four-residential first mortgage loans, discounted at 80% of the unpaid principal balance, equal to 100% of its total outstanding long and short-term Federal Home Loan Bank advances. During 2003 and 2004, the Bank entered into addendums to the Agreement that expanded the types of eligible collateral under the Agreement to include certain commercial real estate and second mortgage loans. These loans are subject to eligibility rules, and collateral values are discounted at 50% of the unpaid loan principal balance. In addition, only 50% of total collateral for Federal Home Loan Bank advances may consist of commercial real estate loans. In addition, the Bank has pledged its Federal Home Loan Bank stock of $5,650,400 and securities with a carrying value of $92,911,006 as additional collateral for its advances. The Bank is limited to total advances of up to 40% of assets or $230,000,000. At December 31, 2006, the Bank had filed collateral statements identifying collateral sufficient to borrow $101,000,000 in addition to amounts already outstanding.

In addition, the Bank had outstanding notes payable to the U.S. Treasury, which are federal treasury tax and loan deposits accepted by the Bank and remitted on demand to the Federal Reserve Bank. At December 31, 2006 and 2005, such short-term borrowings were $1,067,702 and $574,975, respectively. The Bank pays interest on these balances at a slight discount to the federal funds rate. The notes are secured by investment securities with an amortized cost of approximately $1,759,000 and $624,000 at December 31, 2006 and 2005, respectively.

NOTE 10 — INCOME TAXES

Allocation of federal and state income taxes between current and deferred portions is as follows


	2006			2005			2004
Current
Federal	$	2,014,469		$	2,219,558		$	1,284,026
State		562,627			284,737			91,118

		2,577,096			2,504,295			1,375,144


Deferred
Federal		(347,874	)		(398,238	)		57,973
State		(64,807	)		(54,113	)		7,877

		(412,681	)		(452,351	)		65,850

Total Income Tax Expense	$	2,164,415		$	2,051,944		$	1,440,994

Tri-County Financial Corporation

The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows


	2006						2005						2004
				Percent of						Percent of						Percent of
				Pre Tax						Pre Tax						Pre Tax
	Amount			Income			Amount			Income			Amount			Income
Expected income tax expense at federal tax rate	$	2,245,928			34.00	%	$	2,050,638			34.00	%	$	1,754,682			34.00	%
State taxes net of federal benefit		328,561			4.97	%		152,212			2.52	%		65,337			1.27	%
Nondeductible expenses		4,779			0.07	%		3,124			0.05	%		2,527			0.05	%
Nontaxable income		(196,225	)		(2.97	%)		(154,337	)		(2.56	%)		(179,442	)		-3.48	%
Donation of property		—			—			—			—			(202,109	)		-3.92	%
Other		(218,628	)		(3.31	%)		307			—			—			—

	$	2,164,415			32.77	%	$	2,051,944			34.02	%	$	1,440,994			27.92	%

The net deferred tax assets in the accompanying balance sheets include the following components:


	2006		2005
Deferred tax assets
Deferred fees	$	3,298	$	4,583
Allowance for loan losses		1,431,675		1,277,020
Deferred compensation		704,417		471,786
Valuation allowance on foreclosed real estate		259,991		259,991
Unrealized loss on investment securities available for sale		27,726		—

		2,427,107		2,013,380


Deferred tax liabilities
FHLB stock dividends		152,896		152,896
Depreciation		362,946		389,626
Unrealized gain on investment securities available for sale		—		25,431

		515,842		567,953

	$	1,911,265	$	1,445,427

Retained earnings at December 31, 2006, included approximately $1.2 million of bad debt deductions allowed for federal income tax purposes (the “base year tax reserve”) for which no deferred income tax has been recognized. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, it would create income for tax purposes only and income taxes would be imposed at the then prevailing rates. The unrecorded income tax liability on the above amount was approximately $463,000 at December 31, 2006.

Prior to January 1, 1996, the Bank computed its tax bad debt deduction based upon the percentage of taxable income method as defined by the Internal Revenue Code. The bad debt deduction allowable under this method equaled 8% of taxable income determined without regard to the bad debt deduction and with certain adjustments. The tax bad debt deduction differed from the bad debt expense used for financial accounting purposes.

In August 1996, the Small Business Job Protection Act (the “Act”) repealed the percentage of taxable income method of accounting for bad debts effective for years beginning after December 31, 1995. The Act required the Bank to change its method of computing reserves for bad debts to the experience method. This method is available to banks with assets less than $500 million and allows the Bank to maintain a tax reserve for bad debts and to take bad debt deductions for reasonable additions to the reserve. As a result of this change, the Bank has to recapture into income a portion of its existing tax bad debt reserve. This recapture occurs ratably over a six-taxable year period, beginning with the 1998 tax year. For financial reporting purposes, this recapture does not result in additional tax expense as the Bank adequately provided deferred taxes in prior years. Furthermore, this change does not require the Bank to recapture its base-year tax reserve.

Notes to Consolidated Financial Statements

NOTE 11 — COMMITMENTS AND CONTINGENCIES

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are commitments to extend credit. These instruments may, but do not necessarily, involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet loans receivable.

As of December 31, 2006 and 2005, in addition to the undisbursed portion of loans receivable of approximately $17,897,673 and $23,051,485, respectively, the Bank had outstanding loan commitments approximating $12,824,000 and $5,537,000, respectively.

Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are issued primarily to support construction borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds cash or a secured interest in real estate as collateral to support those commitments for which collateral is deemed necessary. Standby letters of credit outstanding amounted to $8,382,853 and $8,183,000 at December 31, 2006 and 2005, respectively. In addition to the commitments noted above, customers had approximately $62,845,000 and $48,001,000 available under lines of credit at December 31, 2006 and 2005, respectively.

NOTE 12 — STOCK OPTION AND INCENTIVE PLAN

The Company has stock option and incentive plans to attract and retain personnel and provide incentive to employees to promote the success of the business. On January 31, 2005, the Company’s 1995 Stock Option and Incentive Plan and 1995 Stock Option Plan for Non-Employee Directors each expired. All shares authorized and available under this plan were awarded as of December 31, 2004. In May 2005, the 2005 Equity Compensation Plan was approved by the shareholders. The exercise price for options granted under this plan is set at the discretion of the committee administering this plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is ten years and the options vest at the discretion of the committee administering this plan. All outstanding options were fully vested at December 31, 2005

The company has authorized 247,500 shares for stock options. Currently 158,211 shares are available for options. The total intrinsic value of outstanding and exercisable options at December 31, 2006 is $4,250,000.

The following table summarizes activity in the plans:


	2006					2005					2004
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price
Outstanding at beginning of year		444,753		$	13.59		403,382		$	10.72		346,937		$	7.47
Granted		—					89,289			22.29		130,434			15.34
Exercised		(19,585	)		7.97		(46,980	)		5.53		(69,311	)		3.31
Forfeitures		(8,072	)		13.24		(938	)		11.99		(4,679	)		8.57

Outstanding at end of year		417,097			13.86		444,753			13.59		403,382			10.72

Tri-County Financial Corporation

Option amounts and exercise prices have been adjusted retroactively to give effect to the three for two stock splits. Options outstanding are all currently exercisable and are summarized as follows


Number Outstanding	Weighted Average Remaining	Weighted Average
December 31, 2006	Contractual Life	Exercise Price
33,193	2 years	$	7.16
23,126	3 years		7.88
37,639	4 years		7.90
40,851	5 years		7.90
22,822	6 years		11.56
71,088	7 years		12.91
99,878	8 years		15.89
88,502	9 years		22.29
417,097			13.86

The following table illustrates the effect on the net earnings per common share if the fair value method had been applied to all outstanding awards for the years ended December 31, 2005 and 2004, respectively:


	December 31,
	2005			2004
Net income, as reported	$	3,979,343		$	3,719,834
Additional expense had the Company adopted SFAS 123R		(942,297	)		(735,180	)

Pro forma net income	$	3,037,046		$	2,984,654

Earnings per share as reported
Basic	$	1.53		$	1.44
Diluted	$	1.44		$	1.38

Pro forma earnings per share
Basic	$	1.17		$	1.15
Diluted	$	1.10		$	1.11

Per share amounts have been adjusted retroactively to reflect the three for two stock splits in December 2004, December 2005, and December 2006.

For the purpose of computing the pro forma amounts indicated above, the fair value of each option on the date of grant is estimated using the Black-Scholes option pricing model with the following weighted-average assumptions used for the grants:


	2005			2004
Dividend yield		1.02	%		1.80	%
Expected volatility		34.89			25.51
Risk-free interest rate		4.66			4.31
Expected lives (in years)		10			10
Weighted average fair value	$	10.55		$	5.63

NOTE 13—EMPLOYEE BENEFIT PLANS

The Bank has an Employee Stock Ownership Plan (“ESOP”) which covers substantially all its employees. The ESOP acquires stock of Tri-County Financial Corporation. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Onwership Plans”. Accordingly, unencumbered shares held by the ESOP are treated as outstanding in computing earnings per share. Shares issued to the ESOP but pledged as collateral for loans obtained to provide funds to acquire the shares are not treated as outstanding in computing earnings per share. Dividends on ESOP shares are recorded as a reduction of retained earnings. Contributions are made at the discretion of the Board of Directors. Expense recognized for the years

Notes to Consolidated Financial Statements

ending 2006, 2005, and 2004 totaled $76,842, $64,837, and $78,421 respectively. As of December 31, 2006, the ESOP plan held 180,156 allocated and 8,020 unallocated shares with an approximate market value of $4,332,750 and $192,883, respectively.

The Company also has a 401 (k) plan. The Company matches a portion of the employee contributions. This ratio is determined annually by the Board of Directors. In 2006, 2005, and 2004, the Company matched one-half of the employee’s first 8% deferral. All employees who have completed six months of service and have reached the age of 21 are covered under this defined contribution plan. Contributions are determined at the discretion of the Board of Directors. For the years ended December 31, 2006, 2005, and 2004, the Company charged $129,027, $92,000, and $89,000, respectively, against earnings to fund the plan.

The Bank has a separate nonqualified retirement plan for non-employee directors. Directors are eligible for a maximum benefit of $3,500 a year for ten years following retirement from the Board of Community Bank of Tri-County. The maximum benefit is earned at 15 years of service as a non-employee director. Full vesting occurs after two years of service. Expense recorded for this plan was $7,193, $5,173, and $18,000 for the years ended December 31, 2006, 2005, and 2004, respectively.

In addition, the Bank has established a separate supplemental retirement plan for certain of the Bank’s key executives. This plan provides a retirement income payment for 15 years from the date of the employee’s expected retirement date. The payments are set at the discretion of the Board of Directors and vesting occurs ratably from the date of employment to the expected retirement date. Expense recorded for this plan totaled $341,000, $286,000, and $316,000 for 2006, 2005, and 2004 respectively.

NOTE 14—REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to total adjusted assets (as defined), and of risk-based capital (as defined) to risk-weighted assets (as defined). Management believes, as of December 31, 2006, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2006, the most recent notification from the Federal Reserve categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company’s or the Bank’s category. The Company’s and the Bank’s actual capital amounts and ratios for 2006 and 2005 are presented in the tables below.

Tri-County Financial Corporation


									To Be Considered Well
					Required for Capital				Capitalized Under
	Actual				Adequacy Purposes				Prompt Corrective Action
At December 31, 2006
Total capital (to risk weighted assets)
The Company	$	53,504	11.98	%	$	35,723	8.00	%
The Bank	$	52,388	11.78	%	$	35,648	8.00	%	$	44,560	10.00	%

Tier 1 capital (to risk weighted assets)
The Company	$	49,675	11.12	%	$	17,862	4.00	%
The Bank	$	48,559	10.92	%	$	17,824	4.00	%	$	26,736	6.00	%

Tier 1 capital (to average assets)
The Company	$	49,675	8.74	%	$	22,722	4.00	%
The Bank	$	48,559	8.58	%	$	22,682	4.00	%	$	28,353	5.00	%

At December 31, 2005
Total capital (to risk weighted assets)
The Company	$	49,544	11.84	%	$	33,463	8.00	%
The Bank	$	48,753	11.67	%	$	33,391	8.00	%	$	41,739	10.00	%

Tier 1 capital (to risk weighted assets)
The Company	$	46,161	11.04	%	$	16,731	4.00	%
The Bank	$	45,370	10.87	%	$	16,696	4.00	%	$	25,044	6.00	%

Tier 1 capital (to average assets)
The Company	$	46,161	8.55	%	$	21,590	4.00	%
The Bank	$	45,370	8.42	%	$	21,550	4.00	%	$	26,937	5.00	%

NOTE 15—FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of the Company.


	December 31, 2006				December 31, 2005
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Assets
Cash and cash equivalents	$	18,190,506	$	18,190,506	$	22,575,240	$	22,575,240
Investment securities and stock in FHLB and FRB		113,206,926		111,550,233		130,855,879		128.640.980
Loans receivable, net		422,479,799		425,336,840		369,592,253		370,164,000
Liabilities
Savings, checking, and money market accounts		206,100,240		206,100,240		167,987,707		167,987,707
Time certificates		211,913,163		211,025,358		195,386,032		189,574,936
Long-term debt and other borrowed funds		102,613,638		101,093,038		127,898,734		126,788,777
Guaranteed preferred beneficial interest in junior subordinated securities	$	12,000,000	$	12,000,000	$	12,000,000	$	12,000,000

At December 31, 2006 and 2005, the Company had outstanding loan commitments and standby letters of credit of $21 million and $14 million, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these

Notes to Consolidated Financial Statements

instruments differs significantly from their carrying values.

Valuation Methodology

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

Investment Securities — Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

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

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

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

Long-Term Debt and Other Borrowed Funds — These were valued using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar borrowings.

Guaranteed Preferred Beneficial Interest in Junior Subordinated Securities — These were valued using discounted cash flows. The discount rate was equal to the rate currently offered on similar borrowings.

Off-Balance Sheet Instruments — The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.

The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2006 and 2005. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

NOTE 16 — GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES

On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust was formed as a wholly owned subsidiary of the Company to issue $5,000,000 of variable-rate capital securities with an interest rate of 5.07% in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance to purchase $5,155,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust-preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust II’s obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior-subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company not earlier than June 15, 2010.

On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust was formed as a wholly owned subsidiary

Tri-County Financial Corporation

of the Company to issue $7,000,000 of variable-rate capital securities with an interest rate of 4.22% in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7,217,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust-preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust I’s obligations with respect to the capital securities. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company not earlier than July 22, 2009.

Costs associated with the issuance of the trust-preferred securities were less than $10,000 and were expensed as period costs.

NOTE 17 — PRIVATE PLACEMENTS

On December 30, 2005, the Company completed a private placement of securities in an offering exempt from registration under the Securities Act. The seven investors were officers, directors, and counsel for the Company. The offering was for 23,652 shares at $20.00 per share and raised $473,040. The costs of the offering were less than $5,000 and were expensed.

During 2006, the Company sold securities at the then current market value to new directors. The amount of total shares issued in this manner during 2006 was 7,500 shares at an average price of $23.67. All share and per share amounts have been adjusted for the three for two stock splits effected in December 2006, 2005, and 2004.

Notes to Consolidated Financial Statements

NOTE 18 — CONDENSED FINANCIAL STATEMENTS — PARENT COMPANY ONLY

Financial information pertaining only to Tri-County Financial Corporation is as follows

BALANCE SHEETS


	December 31,
	2006			2005
Assets
Cash — noninterest bearing	$	799,984		$	881,185
Cash — interest bearing		155,244			167,830
Investment securities available for sale		37,475			35,838
Investment in wholly owned subsidiaries		48,985,298			45,791,231
Other assets		565,881			853,740

Total Assets	$	50,543,882		$	47,729,824


Liabilities
Current liabilities	$	442,545		$	779,668
Guaranteed preferred beneficial interest in junior subordinated debentures		12,372,000			12,372,000

Total Liabilities		12,814,545			13,151,668


Stockholders’ Equity
Common stock		26,423			17,610
Surplus		9,499,946			9,057,805
Retained earnings		28,353,792			25,580,634
Total accumulated other comprehensive (loss) income		(53,822	)		49,363
Unearned ESOP shares		(97,002	)		(127,256	)

Total Stockholders’ Equity		37,729,337			34,578,156


Total Liabilities and Stockholders’ Equity	$	50,543,882		$	47,729,824

Tri-County Financial Corporation

CONDENSED STATEMENTS OF INCOME


	Year Ended December 31,
	2006			2005			2004
Dividends from subsidiary	$	2,000,000		$	17,00,000		$	—
Interest income		16,220			16,059			6,349
Interest expense		891,891			580,584			140,341

Net Interest Income		1,124,330			1,135,475			(133,992	)

Miscellaneous expenses		(420,129	)		( 257,031	)		(166,364	)

Income before income taxes and equity in undistributed net income of subsidiary		704,201			878,444			(300,356	)
Federal and state income tax benefit		439,804			279,328			102,120
Equity in undistributed net income of subsidiary		3,297,252			2,821,571			3,918,070

Net Income	$	4,441,257		$	3,979,343		$	3,719,834

CONDENSED STATEMENTS OF CASH FLOWS


	Year Ended December 31,
	2006			2005			2004
Cash Flows from Operating Activities
Net in come	$	4,441,257		$	3,979,343		$	3,719,834
Adjustments to reconcile net income to net cash provided by operating activities
Equity in undistributed earnings of subsidiary		(3,297,251	)		(2,821,571	)		(3,918,070	)
Excess tax benefits on stock-based compensation		(42,315	)		—			—
( Decrease) increase in other assets		(28,023	)		(659,666	)		763,470
Deferred income tax benefit		(56,117	)
Increase in current liabilities		77,191			489,477			30,835

Net Cash Provided by Operating Activities		1,094,742			987,583			596,069


Cash Flows from Investing Activities
Purchase of investment securities available for sale		(1,637	)		(1,172	)		(1,514	)

Net cash used by in vesting activities		(1,637	)		(1,172	)		(1,514	)


Cash Flows from Financing Activities
Sale of guaranteed preferred beneficial interests in junior subordinated securities		—			5,155,000			7,217,000
Downstream of capital to subsidiary		—			(5,000,000	)		(7,000,000	)
Investment in trust subsidiary		—			(155,000	)		(217,000	)
Dividends paid		(972,966	)		(930,669	)		(541,633	)
Proceeds from private placement		177,500			473,040			—
Exercise of stock options		156,122			304,648			248,661
Excess tax benefits on stock-based compensation		(42,315	)		—			—
Net change in ESOP loan		96,665			60,390			8,506
Redemption of common stock		(686,528	)		(295,393	)		(412,973	)

Net Cash Used in Financing Activities		(1,186,892	)		(387,984	)		(697,439	)


Increase (Decrease) in Cash		(93,787	)		598,427			(102,884	)

Cash at Beginning of Year		1,049,015			450,588			553,472


Cash at End of Year	$	955,228		$	1,049,015		$	450,588

Notes to Consolidated Financial Statements

NOTE 19 — QUARTERLY FINANCIAL RESULTS (UNAUDITED)


	2006		2006		2006		2006		2005		2005		2005		2005
	Fourth		Third		Second		First		Fourth		Third		Second		First
	Quarter		Quarter		Quarter		Quarter		Quarter		Quarter		Quarter		Quarter
Interest and dividend income	$	9,371,065	$	9,186,802	$	8,827,910	$	8,299,959	$	7,872,103	$	7,433,702	$	7,284,039	$	6,564,868
Interest Expense		4,995,112		4,844,077		4,473,923		4,045,816		3,838,465		3,566,630		3,369,456		2,809,080
Net interest income		4,375,953		4,342,725		4,353,987		4,254,143		4,033,638		3,867,072		3,914,583		3,755,788
Provision for loan loss		116,674		116,563		86,087		86,485		129,160		11,183		126,097		63,027
Net interest income after provision		4,259,279		4,226,162		4,267,900		4,167,658		3,904,478		3,855,889		3,788,486		3,692,761

Noninterest income		744,359		519,452		505,612		477,718		339,218		466,650		433,806		401,329
Noninterest expense		3,162,634		3,071,666		3,197,613		3,130,555		2,943,137		2,769,564		2,589,915		2,548,714

Income before income taxes		1,841,004		1,673,948		1,575,899		1,514,821		1,300,559		1,552,975		1,632,377		1,545,376
Provision for income taxes		534,872		570,895		516,964		541,684		414,733		562,908		553,288		521,015
Net Income	$	1,306,132	$	1,103,053	$	1,058,935	$	973,137	$	885,826	$	990,067	$	1,079,089	$	1,024,361

Earnings per common share
Basic	$	0.50	$	0.42	$	0.40	$	0.37	$	0.34	$	0.38	$	0.41	$	0.39
Diluted	$	0.46	$	0.39	$	0.37	$	0.35	$	0.32	$	0.35	$	0.39	$	0.37
Dividends paid	$	0.00	$	0.00	$	0.37	$	0.00	$	0.00	$	0.00	$	0.35	$	0.00

¹ All per amounts have been adjusted for the three for two stock splits effected in December 2006, 2005, and 2004.

² Earnings per share are based upon quarterly results and may not be additive to the annual earnings per share amounts.

EXHIBIT 21

SUBSIDIARIES OF THE REGISTRANT

Parent

Tri-County Financial Corporation


	Percentage			State of
	Owned			Incorporation
Subsidiary

Community Bank of Tri-County		100	%	Maryland

Tri-County Capital Trust I		100	%	Delaware

Tri-County Capital Trust II		100	%	Delaware

Subsidiaries of Community Bank of Tri-County

Community Mortgage Corporation of Tri-County		100	%	Maryland

Tri-County Investment Corporation		100	%	Delaware

EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation of our report dated March 14, 2007, relating to the 2006 consolidated financial statements of Tri-County Financial Corporation, by reference in Registration Statements Nos. 33-97174, 333-79237, 333-70800, and 333-125103, each of Form S-8, and in the Annual Report on Form 10-K of Tri-County Financial Corporation, for the year ended December 31, 2006.

Baltimore, Maryland
March 26, 2007

EXHIBIT 31.1

Certification

I, Michael L. Middleton, certify that:

1. I have reviewed this Annual Report on Form 10-K 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(s) 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(s) 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 of 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: March 26, 2007



	/s/ Michael L. Middleton
	Michael L. Middleton
	President and Chief Executive Officer (Principal Executive Officer)

EXHIBIT 31.2

Certification

I, William J. Pasenelli, certify that:

1. I have reviewed this Annual Report on Form 10-K of Tri-County Financial Corporation;

(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: March 26, 2007



	/s/ William J. Pasenelli
	William J. Pasenelli
	Chief Financial Officer (Principal Financial and Accounting Officer)

EXHIBIT 32

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002

The undersigned executive officers of Tri County Financial Corporation (the “Registrant”) hereby certify that this Annual Report on Form 10-K for the year ended December 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.



By:	/s/ Michael L. Middleton
	Name:	Michael L. Middleton
	Title:	President and Chief Executive Officer


By:	/s/ William J. Pasenelli
	Name:	William J. Pasenelli
	Title:	Chief Financial Officer

Date: March 26, 2007

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	Page
Part I

Item 1. Business		1
Item 1A. Risk Factors		23
Item 1B. Unresolved Staff Comments		26
Item 2. Properties		27
Item 3. Legal Proceedings		27
Item 4. Submission of Matters to a Vote of Securities Holders		27

Part II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		27
Item 6. Selected Financial Data		28
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation		28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk		29
Item 8. Financial Statements and Supplementary Data		29
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		29
Item 9A. Controls and Procedures		29
Item 9B. Other Information		29

Part III

Item 10. Directors and Executive Officers of the Registrant		29
Item 11. Executive Compensation		30
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		30
Item 13. Certain Relationships and Related Transactions		31
Item 14. Principal Accountant Fees and Services		31

Part IV

Item 15. Exhibits and Financial Statement Schedules		31
EX-10.9 RETIREMENT PLAN FOR DIRECTORS
EX-10.21 DEFERRED COMPENSATION PLAN
EX-13 ANNUAL REPORT
EX-21 SUBSIDIARIES OF THE REGISTRANT
EX-23 CONSENT OF STEGMAN & COMPANY
EX-31.1 SECTION 302, CERTIFICATION OF THE CEO
EX-31.2 SECTION 302, CERTIFICATION OF THE CFO
EX-32 SECTION 906, CERTIFICATION OF THE CEO & CFO