Due Within One Year			Due Over One To Five Years			Due Over Five Years			Total
					(In Thousands)
Real Estate - mortgage:
Residential		$	4,887		$	2,425		$	61,029		$	68,341
Commercial			8,646			24,476			20,042			53,164
Construction and land development			346			527			736			1,609
Installment			1,085			10,443			3,516			15,044
Credit Card			144			-			-			144
Indirect automobile			999			45,611			5,929			52,539
Commercial			5,077			-			-			5,077
		$	21,184		$	83,482		$	91,252		$	195,918

Real Estate Lending. The Bank offers long-term mortgage financing for residential and commercial real estate as well as shorter term construction and land development loans. Residential mortgage and residential construction loans are originated with fixed rates, while commercial mortgages may be originated on either a fixed or variable rate basis. Commercial construction loans are generally originated on a variable rate basis. Substantially all of the Bank’s real estate loans are secured by properties in Anne Arundel County, Maryland. Under the Bank’s loan policies, the maximum permissible loan-to-value ratio for owner-occupied residential mortgages is 80% of the lesser of the purchase price or appraised value. The Bank, however, will make loans secured by owner-occupied residential real estate with loan-to-value ratios up to 95% (some restrictions may apply), provided the borrower obtains private mortgage insurance for the portion of the loan in excess of 80%. For residential investment properties, the maximum loan-to-value ratio is 80%. The maximum permissible loan-to-value ratio for residential and residential construction loans is 80%. The maximum loan-to-value ratio for permanent commercial mortgages is 75%. The maximum loan-to-value ratio for land development loans is 70% and for unimproved land is 65%. The Bank also offers home equity loans secured by the borrower’s primary residence, provided that the aggregate indebtedness on the property does not exceed 80% of its value.

Commercial Lending. The Bank’s commercial loan portfolio consists of demand, installment and time loans for commercial purposes. The Bank’s business demand, installment and time lending includes various working capital loans, equipment, vehicles, lines of credit and letters of credit for commercial customers. Demand loans require the payment of interest until called, while installment loans require a monthly payment of principal and interest, and time loans require at maturity a single payment of principal and interest due monthly. Such loans may be made on a secured or an unsecured basis. All such loans are underwritten on the basis of the borrower’s creditworthiness rather than the value of the collateral.

4

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Installment Lending. The Bank makes consumer and commercial installment loans for the purchase of automobiles, boats, other consumer durable goods, capital goods and equipment. Such loans provide for repayment in regular installments and are secured by the goods financed. Also included in installment loans are overdraft loans and other credit repayable in installments. As of December 31, 2006, approximately 68.7% of the installment loans in the Bank’s portfolio (other than indirect automobile lending) had been originated for commercial purposes and 31.3% had been originated for consumer purposes.

Indirect Automobile Lending. The Bank commenced its indirect automobile lending program in January 1998. The Bank finances new automobiles for terms of up to 72 months and used automobiles for terms of up to 60 months. For used vehicles, the age of the vehicle plus the term of the loan cannot exceed eight years. The Bank does not lend more than the MSRP on new vehicles. On used vehicles, the Bank will not lend more than 110% of the average wholesale published in a nationally recognized used vehicle pricing guide. The Bank requires all borrowers to obtain vendor’s single interest coverage protecting the Bank against loss in the case a borrower’s automobile insurance lapses. The Bank originates indirect loans through a network of approximately 48 dealers which are primarily new car dealers located in Anne Arundel County and the surrounding counties. Participating dealers take loan applications from their customers and transmit them to the Bank for approval.

Other Loans. The Bank offers overdraft protection lines of credit, tied to checking accounts, as a convenience to qualified customers.

Although the risk of non-payment for any reason exists with respect to all loans, certain other specific risks are associated with each type of loan. The primary risks associated with commercial loans, including commercial real estate loans, are the quality of the borrower’s management and a number of economic and other factors which induce business failures and depreciate the value of business assets pledged to secure the loan, including competition, insufficient capital, product obsolescence, changes in the borrowers’ cost, environmental hazards, weather, changes in laws and regulations and general changes in the marketplace. Primary risks associated with residential real estate loans include fluctuating land and property values and rising interest rates with respect to fixed-rate, long-term loans. Residential construction lending exposes the Company to risks related to builder performance. Consumer loans, including indirect automobile loans, are affected primarily by domestic economic instability and a variety of factors that may lead to the borrower’s unemployment, including deteriorating economic conditions in one or more segments of a local or broader economy. Because the Bank deals with borrowers through an intermediary on indirect automobile loans, this form of lending potentially carries greater risks of defects in the application process for which claims may be made against the Bank. Indirect automobile lending may also involve the Bank in consumer disputes under state “lemon” or other laws. The Bank seeks to control these risks by following strict underwriting and documentation guidelines. In addition, dealerships are contractually obligated to indemnify the Bank for such losses for a limited period of time.

The Bank’s lending activities are conducted pursuant to written policies approved by the Board of Directors intended to ensure proper management of credit risk. Loans are subject to a well defined credit process that includes credit evaluation of borrowers, establishment of lending limits and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances, as well as procedures for on-going identification and management of credit deterioration. Regular portfolio reviews are performed by the Bank’s Senior Credit Officer to identify potential underperforming loans and other credit facilities, estimate loss exposure and to ascertain compliance with the Bank’s policies. On a quarterly basis, the Bank’s Internal Auditor performs an independent loan review in accordance with the Bank’s loan review policy. For significant problem loans, management review consists of evaluation of the financial strengths of the borrower and any guarantor, the related collateral, and the effects of economic conditions.

The Bank’s loan approval policy provides for various levels of individual lending authority. The maximum aggregate lending authority granted by the Bank to any one Lending Officer is $750,000. A combination of approvals from certain officers may be used to lend up to an aggregate of $1,000,000. The Bank’s Executive Committee is authorized to approve loans up to $2.0 million. Larger loans must be approved by the full Board of Directors.

Under Maryland law, the maximum amount which the Bank is permitted to lend to any one borrower and their 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 allowance for possible loan losses. Under this authority, the Bank would have been permitted to lend up to $3.42 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 $5.28 million to any one borrower at December 31, 2006. It is currently the Bank’s policy to limit its exposure to any one borrower to no more than $3.16 million in the aggregate unless any borrowings exceeding this amount are approved by a 75% vote of the Board of Directors. At December 31, 2006, the largest amount outstanding to any one borrower and its related interests was $4,140,000.

5

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Non-Performing Loans

It is the policy of the Bank to reverse accrued, and discontinue the accrual of, interest when a loan becomes 90 days or more delinquent and circumstances indicate that collection is doubtful.

The Bank seeks to control delinquencies through diligent collection procedures. For consumer loans, the Bank sends out payment reminders on the seventh and twelfth days after a payment is due. If a consumer loan becomes 15 days past due, the account is transferred to the Bank’s collections department, which will contact the borrower by telephone and/or letter before the account becomes 30 days past due. If a consumer loan becomes more than 30 days past due, the Bank will continue its collection efforts and will move to repossession or foreclosure by the 45th day if the Bank has reason to believe that the collateral may be in jeopardy or the borrower has failed to respond to prior communications. The Bank will move to repossess or foreclose in all instances in which a consumer loan becomes more than 60 days delinquent. After repossession of a motor vehicle, the borrower has a 15-day statutory right to redeem the vehicle and is entitled to 10 days’ notice before the sale of a repossessed vehicle. The Bank sells the vehicle as promptly as feasible after the expiration of these periods. If the amount realized from the sale of the vehicle is less than the loan amount, the Bank will seek a deficiency judgment against the borrower. The Bank follows similar collection procedures with respect to commercial loans.

The following table sets forth the amount of the Bank’s restructured loans, non-accrual loans and accruing loans 90 days or more past due at the dates indicated:

 

		At December 31,
		2006			2005			2004			2003			2002
		(Dollars In Thousands)
Restructured Loans		$	-		$	-		$	95		$	-		$	41
Non-accrual loans:
Real estate - mortgage:
Residential		$	3		$	14		$	122		$	34		$	264
Commercial			-			-			255			265			178
Real estate - construction			-			-			-			-			7
Installment			46			159			205			250			112
Commercial			8			12			16			23			10
Total non-accrual loans			57			185			598			572			571
Accruing loans past due 90 days or more
Real estate - mortgage:
Residential			2			1			1			5			1
Commercial			-			-			-			-			-
Real estate - construction			-			3			6			6			-
Installment			-			-			-			-			13
Credit card & related			-			-			-			-			-
Total accruing loans past due 90 days or more			2			4			7			11			15
Total non-accrual and past due loans		$	59		$	189		$	605		$	583		$	586
Non-accrual and past due loans to gross loans			0.03	%		0.10	%		0.33	%		0.33	%		0.36	%
Allowance for credit losses to non-accrual and past due loans			3,116.95	%		1,164.55	%		398.68	%		385.25	%		429.13	%

For the year ended December 31, 2006, interest of $10,658 would have been accrued on non-accrual loans if such loans had been current in accordance with their original terms. During that period, interest on non-accrual loans was not included in income. $50,872, or 88.6%, of the Bank’s total $57,429 non-accrual loans at December 31, 2006 were attributable to 4 borrowers. No charge-offs have previously been taken on these loans. One of these borrowers with a loan totaling $2,551 was in bankruptcy at that date. Because of the legal protections afforded to borrowers in bankruptcy, collections on such loans are difficult and the Bank anticipates that such loans may remain delinquent for an extended period of time. Each of these loans is secured by collateral with a value well in excess of the current active balance of the Bank’s loan.

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At December 31, 2006, there were no loans outstanding not reflected in the above table as to which known information about the borrower’s possible credit problems caused management to have serious doubts as to the ability of the borrowers to comply with present loan repayment terms. These loans consist of loans which were not 90 days or more past due but where the borrower is in bankruptcy or has a history of delinquency or the loan to value ratio is considered excessive due to deterioration of the collateral or other factors.

At December 31, 2006, the Company had $50,000 in real estate acquired in partial or total satisfaction of debt, compared to $50,000 and $171,882 in such properties at December 31, 2005 and 2004, respectively. All such properties are recorded at the lower of cost or fair value at the date acquired and carried on the balance sheet as other real estate owned. Losses arising at the date of acquisition are charged against the allowance for credit losses. Subsequent write-downs that may be required and expense of operation are included in non-interest expense. Gains and losses realized from the sale of other real estate owned are included in non-interest income or expense. For a description of the properties comprising other real estate owned at December 31, 2006, see “Item 2. -- Properties.”

Allowance For Credit Losses

The Bank’s allowance for credit losses is based on the probable estimated losses that may be sustained in its loan portfolio.  The allowance is based on two basic principles of accounting.  (1) Statement of Financial Accountings Standards (SFAS) No. 5 “Accounting for Contingencies”, which requires that losses be accrued when they are probable of occurring and estimable, and (2) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectibility of the principal is unlikely. The allowance, based on evaluations of the collectibility of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, value of collateral, and current economic conditions and trends that may affect the borrower’s ability to pay.

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		Year Opened		Owned/ Leased		Book Value		Approximate Square Footage		Deposits
Main Office:
101 Crain Highway, S.E. Glen Burnie, MD 21061		1953		Owned		$668,641		10,000		$87,092,950
Branches:
Odenton 1405 Annapolis Road Odenton, MD 21113		1969		Owned		203,934		6,000		37,849,403
Riviera Beach 8707 Ft. Smallwood Road Pasadena, MD 21122		1973		Owned		150,590		2,500		31,871,974
Crownsville 1221 Generals Highway Crownsville, MD 21032		1979		Owned		337,292		3,000		46,687,399
Severn 811 Reece Road Severn, MD 21144		1984		Owned		225,593		2,500		27,313,105
South Crain 7984 Crain Highway Glen Burnie, MD 21061		1995		Leased		65,027		2,600		22,819,320
Linthicum Burwood Village Shopping Center Glen Burnie, MD 21060		2005		Leased		230,139		2,500		9,084,044
Severna Park 534 Ritchie Highway Severna Park, MD 21146		2002		Leased		188,849		2,184		12,115,262
Operations Centers:
106 Padfield Blvd. Glen Burnie, MD 21061		1991		Owned		1,046,123		16,200		N/A
103 Crain Highway, S.E. Glen Burnie, MD 21061		2000		Owned		289,823		3,727		N/A

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At December 31, 2006, the Bank owned one foreclosed real estate property with a total book value of $ 50,000. The Bank is holding this commercial property for sale.

		Year Ended December 31,
		2006			2005			2004			2003			2002
		(Dollars In Thousand Except Per Share Data)
Operations Data:
Net Interest Income		$	11,821		$	11,966		$	12,016		$	11,263		$	11,368
Provision for Credit Losses			62			(50	)		340			40			-
Other Income			2,244			2,114			2,372			2,289			2,485
Other Expense			10,682			10,625			10,360			9,748			9,957
Net Income			2,720			2,775			3,056			3,077			2,811
Share Data:
Basic Net Income Per Share		$	1.10		$	1.13		$	1.25		$	1.27		$	1.17
Diluted Net Income Per Share			1.10			1.13			1.25			1.27			1.17
Cash Dividends Declared Per Common Share			0.54			0.49			0.43			0.36			0.34
Weighted Average Common Shares Outstanding:
Basic			2,472,803			2,456,723			2,442,944			2,430,603			2,416,703
Diluted			2,472,803			2,456,723			2,442,944			2,430,603			2,420,087
Financial Condition Data:
Total Assets		$	317,746		$	306,561		$	302,312		$	302,252		$	279,406
Loans Receivable, Net			193,337			190,205			182,291			172,819			158,287
Total Deposits			274,833			265,248			261,674			256,908			241,420
Long Term Borrowings			7,140			7,171			7,200			7,227			7,251
Junior Subordinated Debentures			5,155			5,155			5,155			5,155			5,155
Total Stockholders’ Equity			28,201			26,625			25,744			23,948			21,789
Performance Ratios:
Return on Average Assets			0.84	%		0.89	%		1.00	%		1.05	%		1.05	%
Return on Average Equity			10.00			10.50			12.51			13.56			14.49
Net Interest Margin (1)			4.31			4.46			4.61			4.48			4.76
Dividend Payout Ratio			49.18			43.52			34.67			29.53			29.70
Capital Ratios:
Average Equity to Average Assets			8.36	%		8.47	%		8.16	%		7.76	%		9.03	%
Leverage Ratio			10.30			10.17			9.85			9.25			9.07
Total Risk-Based Capital Ratio			17.07			16.98			16.40			15.79			15.28
Asset Quality Ratios:
Allowance for Credit Losses to Gross Loans			0.94	%		1.14	%		1.30	%		1.28	%		1.56	%
Non-accrual and Past Due Loans to Gross Loans			0.03	%		0.10	%		0.33	%		0.33	%		0.36	%
Allowance for Credit Losses to Non- Accrual and Past Due Loans			3,116.95	%		1,164.55	%		398.68	%		385.25	%		429.13	%
Net Loan Charge-offs (Recoveries) to Average Loans			0.23	%		0.09	%		0.10	%		0.18	%		0.26	%

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(1) Presented on a tax-equivalent basis

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

When used in this discussion and elsewhere in this Annual Report on Form 10-K, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “intends”, “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and readers are advised that various factors, including regional and national economic conditions, unfavorable judicial decisions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected. The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Overview

During 2006, net interest income before provision for credit losses declined to $11,821,431 from $11,966,103 in 2005, and net income decreased to $2,720,045 from $2,774,741 in 2005. In 2006, the Company saw continued growth in both deposits and the loan portfolio. Non-interest bearing deposits decreased by $4,584,623, and interest bearing deposits increased by $14,169,812. The loan portfolio increased by $3,131,606, primarily due to an increase in commercial mortgage participation loans.

All per share amounts throughout this report have been adjusted to give retroactive effect to a six-for-five stock dividend paid on January 6, 2004 and a 20% stock dividend paid on January 23, 2006.

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 $2,720,045 ($1.10 basic and diluted earnings per share) compared to consolidated net income of $2,774,741 ($1.13 basic and diluted earnings per share) for the year ended December 31, 2005 and consolidated net income of $3,055,501 ($1.25 basic and diluted earnings per share) for the year ended December 31, 2004.

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 income producing assets. 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 is affected by the mix of loans in the Bank’s loan portfolio. Currently a majority of the Bank’s loans are mortgage and construction loans secured by real estate and indirect automobile loans secured by automobiles. These types of loans are made at interest rates lower than unsecured loans. While the Bank’s loan volume increased in 2004 and 2005, this loan mix produced lower yields on the Company’s interest-earning assets. Meanwhile, market forces resulted in higher rates of interest being paid by the Bank on deposits and borrowings used to fund income producing assets resulting in a decline in net interest income for 2005. In January of 2006, the Bank initiated a plan to increase net interest income by reducing its portfolio of lower yielding loans, acquiring additional deposits, expanding its customer base and increasing the Bank’s higher yielding commercial loan portfolio. As part of this plan, the Bank attracted additional deposits by temporarily offering above market rate savings products which resulted in over $27 million in additional deposits which were invested in marketable securities and overnight deposits making them readily available to fund loans. The Bank also hired a new commercial loan officer to increase its ability to reach this market segment. In accordance with this plan, the Bank successfully increased its higher yield commercial loans resulting in increased loan volume and yield on commercial mortgages, although the commercial loan volume increase was less than anticipated. Over the same period, yields on new indirect automobile loans increased as outstanding lower interest indirect loans matured. As a result, the Bank earned higher yields on its interest earning assets. However, market forces required us to pay higher rates of interest on deposits and borrowings used to fund income producing assets resulting in an overall decline in net interest income for 2006.

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Consolidated net interest income for the year ended December 31, 2006 was $11,821,431 compared to $11,966,103 for the year ended December 31, 2005 and $12,016,466 for the year ended December 31, 2004. The $114,672 decrease for the most recent year was primarily due to an increase in deposit expense offset by increases in U.S. Government agency securities, state and municipal securities, other income and loan income. The $50,363 decrease in net interest income for 2005 as compared to 2004 was primarily due to an increase in deposit expense, partially offset by an increase in loan income. The after tax net interest income for 2006 was $12,741,143, a $9,019 or 0.07% decrease from the after tax net interest income for 2005, which was $12,750,162, a $195,909 or 1.51% decrease from the $12,946,071 after tax net interest income for 2004.

Interest expense increased from $4,131,459 in 2005 to $5,833,765 in 2006, a $1,702,306 or a 41.21 % increase, primarily due to an increase in deposit expense due to rates rising and a special offered on 15 month certificates of deposit and IRAs. Interest expense increased from $3,644,661 in 2004 to $4,131,459 in 2005, a $486,798 or a 13.36% increase, primarily due to an increase in deposit expense due to rates increasing. Net interest margin for the year ended December 31, 2006 was 4.31% compared to 4.46% and 4.61% for the years ended December 31, 2005 and 2004, respectively.

The following table allocates changes in income and expense attributable to the Company’s interest-earning assets and interest-bearing liabilities for the periods indicated between changes due to changes in rate and changes in volume. Changes due to rate/volume are allocated to changes due to volume.

		Year Ended December 31,
		2006			VS.			2005			2005			VS.			2004
					Change Due To:									Change Due To:
		Increase/ Decrease			Rate			Volume			Increase/ Decrease			Rate			Volume
		(In Thousands)
ASSETS:
Interest-earning assets:
Federal funds sold		$	87		$	82		$	5		$	54		$	70		$	(16	)
Interest-bearing deposits			156			45			111			40			11			29
Investment securities:
U.S. Treasury securities, obligations of U.S. government agencies and mortgage-backed securities			933			352			581			197			70			127
Obligations of states and political subdivisions(1)			258			(27	)		285			(438	)		0			(438	)
All other investment securities			(3	)		53			(56	)		20			22			(2	)
Total investment securities			1,188			378			810			(221	)		92			(313	)
Loans, net of unearned income:
Demand, time and lease			24			65			(41	)		99			91			1
Mortgage and construction			339			178			161			474			(65	)		539
Installment and credit card			(157	)		218			(375	)		(151	)		(270	)		119
Total gross loans(2)			206			461			(255	)		422			(238	)		660
Allowance for credit losses			-			-			-			-			-			-
Total net loans			206			461			(255	)		422			(238	)		660
Total interest-earning assets		$	1,637		$	966		$	671		$	295		$	(65	)	$	360
LIABILITIES:
Interest-bearing deposits:
Savings and NOW		$	(7	)	$	23		$	(30	)	$	13		$	9		$	4
Money market			1			16			(15	)		20			29			(9	)
Other time deposits			1,696			953			743			446			422			24
Total interest-bearing deposits			1,690			992			698			479			460			19
Non-interest-bearing deposits			-			-			-			-			-			-
Borrowed funds			13			23			(10	)		7			41			(34	)
Total interest-bearing liabilities		$	1,703		$	1,015		$	688		$	486		$	501		$	(15	)

 

(1) Tax equivalent basis. (2) Non-accrual loans included in average balances.

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The following table provides information for the designated periods with respect to the average balances, income and expense and annualized yields and costs associated with various categories of interest-earning assets and interest-bearing liabilities.

		Year Ended December 31,
		2006									2005									2004
		Average Balance			Interest			Yield/ Cost			Average Balance			Interest			Yield/ Cost			Average Balance			Interest			Yield/ Cost
		(Dollars In Thousands)
ASSETS:
Interest-earning assets:
Federal funds sold		$	3,848		$	200			5.20	%	$	3,682		$	113			3.07	%	$	4,962		$	59			1.18	%
Interest-bearing deposits			4,901			233			4.76			2,008			77			3.84			1,126			37			3.29
Investment securities:
U.S. Treasury securities, obligations of U.S. government agencies and mortgage-backed securities			66,501			3,347			5.04			53,521			2,414			4.51			50,575			2,217			4.38
Obligations of states and political subdivisions(1)			38,723			2,516			6.50			34,391			2,258			6.57			41,016			2,696			6.57
All other investment securities			4,257			375			8.81			4,996			378			7.57			5,019			358			7.13
Total investment securities			109,481			6,238			5.70			92,908			5,050			5.44			96,610			5,271			5.46
Loans, net of unearned income:
Demand, time and lease			5,064			456			9.01			5,597			432			7.72			5,556			333			5.99
Mortgage and construction			111,426			7,307			6.56			109,025			6,968			6.40			100,590			6,494			6.46
Installment and credit card			70,216			4,068			5.80			77,084			4,225			5.49			74,902			4,376			5.84
Total gross loans(2)			186,706			11,831			6.34			191,706			11,625			6.07			181,048			11,203			6.19
Allowance for credit losses			(2,071	)								(2,301	)								(2,338	)
Total net loans			184,635			11,831			6.41			189,404			11,625			6.14			178,710			11,203			6.27
Total interest-earning assets			302,865			18,069			5.97			288,002			16,865			5.86			281,408			16,570			5.89
Cash and due from banks			9,493									11,020									11,203
Other assets			13,045									13,275									13,162
Total assets		$	325,403								$	312,297								$	305,773
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Interest-bearing deposits:
Savings and NOW		$	77,761			274			0.36	%	$	85,005			281			0.33	%	$	83,354			268			0.32	%
Money market			16,415			106			0.65			19,389			105			0.55			21,146			85			0.40
Other time deposits			109,499			4,401			4.02			86,051			2,705			3.15			84,621			2,259			2.66
Total interest-bearing deposits			203,675			4,781			2.35			190,445			3,091			1.63			189,121			2,612			1.38
Short-term borrowed funds			1,603			81			5.06			1,815			66			3.64			3,983			57			1.43
Long-term borrowed funds			12,309			972			7.90			12,339			974			7.90			12,367			976			7.89
Total interest-bearing liabilities			217,587			5,834			2.69			204,599			4,131			2.02			205,471			3,645			1.77
Non-interest-bearing deposits			79,199									79,843									74,686
Other liabilitiesS			1,407									1,395									1,191
Stockholders’ equity			27,210									26,460									24,425
Total liabilities and equity		$	325,403								$	312,297								$	305,773
Net interest income					$	12,235								$	12,734								$	12,925
Net interest spread									3.28	%								3.84	%								4.12	%
Net interest margin									4.31	%								4.46	%								4.61	%

 

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1   Tax equivalent basis.   The incremental tax rate applied was 35.90% for 2006 and 34.56% for 2005. 2   Non-accrual loans included in average balance.

Provision For Credit Losses. During the year ended December 31, 2006, the Company made a provision of $62,000 for credit losses, compared to a reverse provision of $50,000 for credit losses for the year ended December 31, 2005, and a provision of $340,000 for the year ended December 31, 2004. At December 31, 2006, the allowance for credit losses equaled 2,829.23% of non-accrual and past due loans compared to 1,164.55% and 398.68% at December 31, 2005 and 2004, respectively. During the year ended December 31, 2006, the Company recorded net charge-offs of $424,256 compared to $160,544 and $174,501 in net charge-offs during the years ended December 31, 2005 and 2004, respectively.

Other Income. Other income includes service charges on deposit accounts, other fees and commissions, net gains on investment securities, and income on life insurance. Other income increased from $2,113,824 in 2005 to $2,244,390 in 2006, a $130,566, or 6.18% increase. The increase was primarily due to an increase in other fees and commissions and an increase in gains on investment securities. Other income decreased from $2,371,636 in 2004 to $2,113,824 in 2005, a $257,812, or 10.87% decrease. The decrease was primarily due to a decrease on gains on investment securities.

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Other Expenses. Other expenses increased from $10,624,797 in 2005 to $10,668,465 in 2006, a $43,668 or 0.42% increase. This increase, which consists of non-interest operating expenses, was primarily due to an increase in salaries, employee benefits, and occupancy costs offset by a decrease in other miscellaneous expenses. Other expenses increased from $10,359,377 in 2004 to $10,624,797 in 2005, a $265,420 or 2.56% increase. This increase was primarily due to an increase in salaries and occupancy costs due to an additional branch being opened.

Income Taxes. During the year ended December 31, 2006, the Company recorded income tax expense of $687,115, compared to income tax expense of $730,389 for the year ended December 31, 2005. This decrease was primarily due to more tax exempt income on municipal securities. During the year ended December 31, 2005, the Company recorded income tax expense of $730,389, compared to income tax expense of $633,224 for the year ended December 31, 2004.

Comparison of Financial Condition at December 31, 2006, 2005 and 2004

The Company’s total assets increased to $317,745,601 at December 31, 2006 from $306,560,991 at December 31, 2005. The Company’s total assets increased to $306,560,991 at December 31, 2005 from $302,312,126 at December 31, 2004.

The Company’s net loan portfolio increased to $193,336,604 at December 31, 2006 compared to $190,204,998 at December 31, 2005 and $182,291,292 at December 31, 2004. The increase in the loan portfolio during the 2006 period is primarily due to an increase in commercial mortgages, and mortgage participations purchased partially offset by a decline in indirect automobile loans. The increase in the loan portfolio during the 2005 period is primarily due to an increase in commercial and industrial mortgages, and indirect automobile loans.

During 2006, the Company’s total investment securities portfolio (including both investment securities available for sale and investment securities held to maturity) totaled $96,494,659, a $9,214,772 or 10.56%, increase from $87,279,887 at December 31, 2005. This increase is primarily attributable to an increase in state and municipal securities and mortgage backed securities, offset by a decrease in corporate trust preferred securities. During 2005, the Company’s total investment securities portfolio (including both investment securities available for sale and investment securities held to maturity) totaled $87,279,887, a $7,626,160 or 8.04%, decrease from $94,906,047 at December 31, 2004. This decrease is primarily attributable to a decrease in state and municipal securities.

Deposits as of December 31, 2006 totaled $274,883,457, an increase of $9,585,189, or 3.61%, from the $265,248,268 total as of December 31, 2005. Deposits as of December 31, 2005 totaled $265,248,268, an increase of $3,574,225, or 1.37%, from the $261,674,043 total as of December 31, 2004. Demand deposits as of December 31, 2006 totaled $74,729,298, a $4,584,623, or 5.78%, decrease from $79,313,921 at December 31, 2005. NOW and Super NOW accounts, as of December 31, 2006, decreased by $3,117,348, or 18.61% from their 2005 level to $22.274.015. Money market accounts decreased by $1,405,734, or 8.39%, from their 2005 level, to total $15,341,221 at December 31, 2006. Savings deposits decreased by $4,985,894, or 9.03%, from their 2005 level, to $50,234,238 at December 31, 2006. Time deposits over $100,000 totaled $30,178,739 on December 31, 2006, an increase of $7,761,121, or 34.62% from December 31, 2005. Other time deposits (made up of certificates of deposit less than $100,000 and individual retirement accounts) totaled $82,075,945 on December 31, 2006, a $15,917,665 or 24.06% increase from December 31, 2005.

Total stockholders’ equity as of December 31, 2006 increased by $1,575,072, or 5.92%, from the 2005 period. The increase was attributed to an increase in retained earnings, common stock and surplus, offset by a decrease in accumulated other comprehensive income, net of tax. Total stockholders’ equity as of December 31, 2005 increased by $881,033, or 3.42%, from the 2004 period. The increase was attributed to an increase in retained earnings and surplus, offset by a decrease in accumulated other comprehensive income, net of tax.

Off-Balance Sheet Arrangements, Contractual Obligations, and Commitments

Off-Balance Sheet Arrangements. The Bank is a party to financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated financial statements.

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Loan commitments and lines of credit are agreements to lend to customers as long as there is no violation of any conditions of the contracts. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Many of the loan commitments and lines of credit are expected to expire without being drawn upon; accordingly, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral or other security obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, accounts receivable, inventory, property and equipment, personal residences, income-producing commercial properties, and land under development. Personal guarantees are also obtained to provide added security for certain commitments.

Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to guarantee the installation of real property improvements and similar transactions. 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 collateral and obtains personal guarantees supporting those commitments for which collateral or other securities is deemed necessary.

The Bank’s exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. As of December 31, 2006, the Bank has accrued $200,000 for unfunded commitments related to these financial instruments with off balance sheet risk, which is included in other liabilities.

Contractual Obligations. The following table presents, as of December 31, 2006, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.

					PAYMENTS DUE IN
(IN THOUSANDS)		NOTE REFERENCE			ONE YEAR OR LESS			ONE TO THREE YEARS			THREE TO FIVE YEARS			OVER FIVE YEARS			TOTAL
Deposits without a stated maturity (a),(c)			9		$	162,578		$	-		$	-		$	-		$	162,578
Time deposits (a)			9			77,463			22,253			11,296			1,243			112,255
Short-term borrowings (a)			6			545			-			-			-			545
Long-term borrowings (b)			7,8			579			1,166			12,735			-			14,480
Operating leases			5			233			402			212			1,729			2,576

 

(a)	Excludes interest

(b)	Includes Junior Subordinated Debentures and semi-annual payments (made in March and September) of $273,215. This is also assuming that the Debentures will be paid off in September 2010.

(c)	Includes non-interest bearing deposits

Commitments. The following table details the amounts and expected maturities of significant commitments as of December 31, 2006. Further discussion of these commitments is included in Note 16 to the consolidated financial statements.

		PAYMENTS DUE IN
(IN THOUSANDS)		ONE YEAR OR LESS			ONE TO THREE YEARS			THREE TO FIVE YEARS			OVER FIVE YEARS			TOTAL
Loan commitments:
Other mortgage loans		$	528		$	-		$	-		$	-		$	528
Construction & land development			482			-			-			-			482
Unused lines of credit:
Home-equity lines			630			810			645			4,326			6,411
Commercial lines			10,805			-			-			-			10,805
Unsecured consumer lines			780			-			-			-			780
Secured consumer lines			30			-			-			-			30
Letters of credit			11			-			-			285			296

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Market Risk Management

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates or equity pricing. The Company’s principal market risk is interest rate risk that arises from its lending, investing and deposit taking activities. The Company’s profitability is dependent on the Bank’s net interest income. Interest rate risk can significantly affect net interest income to the degree that interest bearing liabilities mature or reprice at different intervals than interest earning assets. The Bank’s Asset/Liability and Risk Management Committee oversees the management of interest rate risk. The primary purpose of the committee is to manage the exposure of net interest margins to unexpected changes due to interest rate fluctuations. The Company does not utilize derivative financial or commodity instruments or hedging strategies in its management of interest rate risk. The primary tool used by the committee to monitor interest rate risk is a “gap” report which measures the dollar difference between the amount of interest bearing assets and interest bearing liabilities subject to repricing within a given time period. These efforts affect the loan pricing and deposit rate policies of the Company as well as the asset mix, volume guidelines, and liquidity and capital planning.

The following table sets forth the Bank’s interest-rate sensitivity at December 31, 2006.

		0-3 Months			Over 3 To 12 Months			Over 1 Through 5 Years			Over 5 Years			Total
		(Dollars In Thousands)
Assets:
Cash and due from banks		$	-		$	-		$	-		$	-		$	9,348
Federal funds and overnight deposits			3,972			-			-			-			3,972
Securities			-			299			10,222			85,974			96,495
Loans			12,731			8,453			83,482			91,252			195,918
Fixed Assets			-			-			-			-			3,406
Other Assets			-			-			-			-			8,607
Total assets		$	16,703		$	8,752		$	93,704		$	177,226		$	317,746
Liabilities:
Demand deposit accounts		$	-		$	-		$	-		$	-		$	74,729
NOW accounts			22,274			-			-			-			22,274
Money market deposit accounts			15,341			-			-			-			15,341
Savings accounts			50,234			195			-			-			50,429
IRA accounts			2,879			12,300			14,181			1,154			30,514
Certificates of deposit			11,584			50,505			19,368			89			81,545
Other liabilities			-			-			-			-			9,558
Junior Subordinated Debenture			-			-			-			-			5,155
Stockholders’ equity			-			-			-			-			28,201
Total liabilities and Stockholders’ equity		$	102,312		$	63,000		$	33,549		$	1,243		$	317,746
GAP		$	(85,609	)	$	(54,248	)	$	60,155		$	175,983
Cumulative GAP			(85,609	)		(139,857	)		(79,702	)		96,281
Cumulative GAP as a % of total assets			(26.95	%)		(44.02	%)		(25.09	%)		30.31	%

 

The foregoing analysis assumes that the Bank’s assets and liabilities move with rates at their earliest repricing opportunities based on final maturity. Mortgage backed securities are assumed to mature during the period in which they are estimated to prepay and it is assumed that loans and other securities are not called prior to maturity. Certificates of deposit and IRA accounts are presumed to reprice at maturity. NOW savings accounts are assumed to reprice at within three months although it is the Company’s experience that such accounts may be less sensitive to changes in market rates.

In addition to gap analysis, the Bank utilizes a simulation model to quantify the effect a hypothetical immediate plus or minus 200 basis point change in rates would have on net interest income and the economic value of equity. The model takes into consideration the effect of call features of investments as well as prepayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model and, in the Bank’s experience, the changes historically realized have been narrower than those projected by the model. However, the Bank believes that the model is a prudent forecasting tool. As of December 31, 2006, the model produced the following sensitivity profile for net interest income and the economic value of equity.

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	Immediate Change in Rates
	-200	-100	+100	+200
	Basis Points	Basis Points	Basis Points	Basis Points
% Change in Net Interest Income	-4.8%	-0.8%	-1.4%	-3.6%
% Change in Economic Value of Equity	-9.5%	-1.5%	-5.4%	-12.0%

Liquidity and Capital Resources

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

The Bank’s principal sources of funds for investments and operations are net income, deposits from its primary market area, principal and interest payments on loans, interest received on investment securities and proceeds from maturing investment securities. Its principal funding commitments are for the origination or purchase of loans and the payment of maturing deposits. Deposits are considered 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 deposits, residential and small business lending, and to meet specific and anticipated needs.

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

Cash and cash equivalents (cash due from banks, interest-bearing deposits in other financial institutions, and federal funds sold), as of December 31, 2006, totaled $13,319,978, a decrease of $2,129,749 or 13.79%, from the December 31, 2005 total of $15,449,727. Most of this decrease was due to interest-bearing deposits in FHLB but was offset by an increase in federal funds sold.  

As of December 31, 2006, the Bank was permitted to draw on a $38.0 million line of credit from the FHLB of Atlanta. Borrowings under the line are secured by a floating lien on the Bank’s residential mortgage loans and its portfolio of U.S. Government and agency securities. As of December 31, 2006, a $7 million long-term convertible advance was outstanding under this line. In addition the Bank has a secured line of credit in the amount of $5 million from another commercial bank on which there is no outstanding balance at December 31,2006. Furthermore, on September 7, 2000, the Company issued $5,155,000 of its 10.6% Junior Subordinated Deferrable Interest Debentures to Glen Burnie Statutory Trust I, a Connecticut statutory trust wholly owned by the Company. The Trust, in turn, issued $5,000,000 of its 10.6% capital securities to institutional investors. The debentures are scheduled to mature on September 7, 2030, unless called by the Company not earlier than September 7, 2010. As of December 31, 2006, the full $5,155,000 was outstanding.

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 10.18%, a Tier 1 risk-based capital ratio of 16.03% and total risk-based capital ratio of 17.02%. At December 31, 2006, the Bank met the criteria for designation as a well capitalized depository institution under FDIC regulations.

Impact of Inflation and Changing Prices

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, 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 mature. 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. 

Critical Accounting Policies

The Company’s accounting policies are more fully described in Note 1 of the Notes to the Consolidated Financial Statements, starting on page F-8 and are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. As discussed there, the preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, the determination of estimates requires the exercise of judgment. Management has used the best information available to make the estimations necessary to value the related assets and liabilities based on historical experience and on various assumptions which are believed to be reasonable under the circumstances. Actual results could differ from those estimates, and such differences may be material to the financial statements. The Company reevaluates these variables as facts and circumstances change. Historically, actual results have not differed significantly from the Company’s estimates. The following is a summary of the more judgmental accounting estimates and principles involved in the preparation of the Company’s financial statements, including the identification of the variables most important in the estimation process:

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Allowance for Credit Losses. The Bank's allowance for credit losses is determined based upon estimates that can and do change when the actual events occur, including historical losses as an indicator of future losses, fair market value of collateral, and various general or industry or geographic specific economic events.  The use of these estimates and values is inherently subjective and the actual losses could be greater or less than the estimates.  For further information regarding our allowance for credit losses, see “Allowance for Credit Losses” under Item 1- “Business” of this Annual Report.

Accrued Taxes. Management estimates income tax expense based on the amount it expects to owe various tax authorities. Income taxes are discussed in more detail in Note 10 to the consolidated financial statements. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position.

Recently Issued Accounting Pronouncements

In February 2006, the FASB issued Statement No. 155 (SFAS 155), Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140. SFAS No. 155 simplifies accounting for certain hybrid instruments currently governed by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, by allowing fair value remeasurement of hybrid instruments that contain an embedded derivative that otherwise would require bifurcation. SFAS No. 155 also eliminates the guidance in SFAS No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets, which provides such beneficial interests are not subject to SFAS No. 133. SFAS No. 155 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125, by eliminating the restriction on passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company feels that this pronouncement will not have a significant impact on the financial statements.

In March 2006, the FASB issued Statement No. 156 (SFAS 156), Accounting for Servicing of Financial Assets- an amendment of FASB Statement No. 140. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in specific situations. Additionally, the servicing asset or servicing liability shall be initially measured at fair value; however, an entity may elect the “amortization method” or “fair value method” for subsequent balance sheet reporting periods. SFAS No. 156 is effective as of an entity’s first fiscal year beginning January 1, 2007. Early adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year. The Company feels that this pronouncement will not have a significant impact on the financial statements.

In September 2006, the FASB issued Statement No. 157 (SFAS 157), Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The provisions should be applied prospectively, except for certain specifically identified financial instruments. The Company is currently reviewing this pronouncement.

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In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company feels that this pronouncement will not have a significant impact on the financial statements at the current time.

In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 06-5, Accounting for Purchases of Life Insurance — Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. FASB Technical Bulletin No. 85-4 requires that the amount that could be realized under the insurance contract as of the date of the statement of financial position should be reported as an asset. Since the issuance of FASB Technical Bulletin No. 85-4, questions arose regarding whether “the amount that could be realized” should consider 1) any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value and 2) the contractual ability to surrender all of the individual-life policies (or certificates in a group policy) at the same time. EITF 06-5 determined that “the amount that could be realized” should 1) consider any additional amounts included in the contractual terms of the policy and 2) assume the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). Any amount that is ultimately realized by the policy holder upon the assumed surrender of the final policy (or final certificate in a group policy) shall be included in the “amount that could be realized.” An entity should apply the provisions of EITF 06-5 through either a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or a change in accounting principle through retrospective application to all prior periods. The provisions of EITF 06-5 are effective for fiscal years beginning after December 15, 2006. Management has not yet completed its evaluation of the impact that EITF 06-5 will have.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this item may be found in Item 7 of Part II of this report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation-Market Risk Management”, which is incorporated herein by reference.

F-7

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. Summary of Significant Accounting Policies

The Bank of Glen Burnie (the “Bank”) provides financial services to individuals and corporate customers located in Anne Arundel County and surrounding areas of Central Maryland, and is subject to competition from other financial institutions. The Bank is also subject to the regulations of certain Federal and State of Maryland (the “State”) agencies and undergoes periodic examinations by those regulatory authorities. The accounting and financial reporting policies of the Bank conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the banking industry.

Significant accounting policies not disclosed elsewhere in the consolidated financial statements are as follows:

Principles of Consolidation:

The consolidated financial statements include the accounts of Glen Burnie Bancorp (“Bancorp” or the “Company”) and its subsidiaries, The Bank of Glen Burnie and GBB Properties, Inc., a company engaged in the acquisition and disposition of other real estate. Intercompany balances and transactions have been eliminated. The Parent Only financial statements (see Note 21) of the Company account for the subsidiaries using the equity method of accounting.

The Company determines whether is has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity under accounting principles generally accepted in the United States. Voting interest entities are entities, in which the total equity investment at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. The Company consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, variable interest entities (VIE’s) are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in an entity is present when an enterprise has a variable interest, or a combination of variable interest, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. The Company’s wholly owned subsidiary, Glen Burnie Statutory Trust I, is a VIE for which the Company is not the primary beneficiary. Accordingly, the accounts of this entity are not included in the Company’s consolidated financial statements.

Use of Estimates:

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted within the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Securities Held to Maturity:

Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the effective interest rate method over the period to maturity. Securities transferred into held to maturity from the available for sale portfolio are recorded at fair value at time of transfer with unrealized gains or losses reflected in equity and amortized over the remaining life of the security.

 

F-8

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies (continued)

Securities Available for Sale:

Marketable debt securities not classified as held to maturity are classified as available for sale. Securities available for sale may be sold in response to changes in interest rates, loan demand, changes in prepayment risk, and other factors. Changes in unrealized appreciation (depreciation) on securities available for sale are reported in other comprehensive income, net of tax. Realized gains (losses) on securities available for sale are included in other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. The gains and losses on securities sold are determined by the specific identification method. Premiums and discounts are recognized in interest income using the effective interest rate method over the period to maturity. Additionally, declines in the fair value of individual investment securities below their cost that are other than temporary are reflected as realized losses in the consolidated statements of income.

 

Other Securities:

Federal Home Loan Bank (“FHLB”) and Maryland Financial Bank (“MFB”) stocks are equity interests that do not necessarily have readily determinable fair values for purposes of Statement of Financial Accounting Standards (“SFAS”) No 115, Accounting for Certain Investments in Debt and Equity Securities, because their ownership is restricted and they lack a market. FHLB stock can be sold back only at its par value of $100 per share and only to the FHLB or another member institution.

Loans and Allowance for Credit Losses:

Loans are generally carried at the amount of unpaid principal, adjusted for deferred loan fees, which are amortized over the term of the loan using the effective interest rate method. Interest on loans is accrued based on the principal amounts outstanding. It is the Bank’s policy to discontinue the accrual of interest when a loan is specifically determined to be impaired or when principal or interest is delinquent for ninety days or more. When a loan is placed on nonaccrual status all interest previously accrued but not collected is reversed against current period interest income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Cash collections on such loans are applied as reductions of the loan principal balance and no interest income is recognized on those loans until the principal balance has been collected. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The carrying value of impaired loans is based on the present value of the loan’s expected future cash flows or, alternatively, the observable market price of the loan or the fair value of the collateral.

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans and actual loss experience, current economic events in specific industries and geographical areas, including unemployment levels, and other pertinent factors, including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.

The allowance for loan losses typically consists of an allocated component and an unallocated component. The components of the allowance for loan losses represent an estimation done pursuant to either SFAS No 5, Accounting for Contingencies, or SFAS No 114, Accounting by Creditors for Impairment of a Loan. The allocated component of the allowance for loan losses reflects expected

F-9

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies (continued)

losses resulting from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The historical loan loss element is determined statistically using a loss migration analysis that examines loss experience and the related internal gradings of loans charged off. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for loan losses also includes consideration of concentrations and changes in portfolio mix and volume.

Any unallocated portion of the allowance reflects management’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the unallocated allowance includes a component that explicitly accounts for the inherent imprecision in loan loss migration models. The historical losses used in the migration analysis may not be representative of actual unrealized losses inherent in the portfolio. At December 31, 2006, there was no unallocated component of the allowance reflected in the allowance for credit losses.

Reserve for Unfunded Commitments:

The reserve for unfunded commitments is established through a provision for unfunded commitments charged to other expenses. The reserve is calculated by utilizing the same methodology and factors as the allowance for credit losses. The reserve, based on evaluations of the collectibiltiy of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on unfunded commitments (off-balance sheet financial instruments) that may become uncollectible in the future.

Other Real Estate Owned (“OREO”):

OREO comprises properties acquired in partial or total satisfaction of problem loans. The properties are recorded at the lower of cost or fair value (appraised value) at the date acquired. Losses arising at the time of acquisition of such properties are charged against the allowance for credit losses. Subsequent write-downs that may be required and expenses of operation are included in other income or expenses. Gains and losses realized from the sale of OREO are included in other income or expenses. No loans were converted to OREO in 2006, 2005, or 2004. The Bank financed no sales of OREO for 2006, 2005, or 2004.

Bank Premises and Equipment:

Bank premises and equipment are stated at cost less accumulated depreciation. The provision for depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the lesser of the terms of the leases or their estimated useful lives. Expenditures for improvements that extend the life of an asset are capitalized and depreciated over the asset’s remaining useful life. Gains or losses realized on the disposition of premises and equipment are reflected in the consolidated statements of income. Expenditures for repairs and maintenance are charged to other expenses as incurred. Computer software is recorded at cost and amortized over three to five years.

Intangible Assets:

A core deposit intangible asset of $544,652, relating to a branch acquisition, has been amortized on the straight-line method over 10 years. Accumulated amortization totaled $544,652, $544,652, and

F-10

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies (continued)

$503,802 at December 31, 2006, 2005, and 2004, respectively. Amortization expense totaled $0, $40,850, and $54,465 for the years ended December 2006, 2005, and 2004, respectively.

Long-Lived Assets:

The carrying value of long-lived assets and certain identifiable intangibles, including goodwill, is reviewed by the Bank for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, as prescribed in SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset. As of December 31, 2006, 2005, and 2004, certain loans existed which management considered impaired (See Note 4).

Income Taxes:

The provision for Federal and state income taxes is based upon the results of operations, adjusted for tax-exempt income. Deferred income taxes are provided by applying enacted statutory tax rates to temporary differences between financial and taxable bases.

Temporary differences which give rise to deferred tax benefits relate principally to deferred compensation and benefit plans, allowance for credit losses, alternative minimum tax credits, net unrealized depreciation on investment securities available for sale, and reserve for unfunded commitments.

Temporary differences which give rise to deferred tax liabilities relate principally to accumulated depreciation, accumulated securities discount accretion, and net unrealized appreciation on investment securities available for sale.

Credit Risk:

The Bank has deposits in other financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2006, the Bank had unsecured deposits and Federal funds sold with two separate financial institutions of approximately $4,073,000.

Cash and Cash Equivalents:

The Bank has included cash and due from banks, interest-bearing deposits in other financial institutions, and Federal funds sold as cash and cash equivalents for the purpose of reporting cash flows.

Accounting for Stock Options:

On January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payments, for accounting and reporting for stock-based compensation plans. SFAS No. 123R defines a fair value at grant date based method of accounting for measuring compensation expense for stock-based plans to be recognized in the statement of income. For 2005 and 2004, the Company applied Accounting Principles Board Opinion (APB) No. 25 and related Interpretations for accounting and reporting for these plans. If compensation cost for these periods had been determined based on the fair value at the grant date for awards under this plan consistent with the methods outlined in SFAS No. 123R, there would be no change in reported net income for the years ending December 31, 2005 and 2004 (See Note 17).

Earnings per share:

Basic earnings per common share are determined by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share are calculated including the average dilutive common stock equivalents outstanding during the period. Dilutive common equivalent shares consist of stock options, calculated using the treasury stock method.  

F-11

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies (continued)

Financial Statement Presentation:

Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation.

Note 2. Restrictions on Cash and Due from Banks

The Federal Reserve requires the Bank to maintain noninterest-bearing cash reserves against certain categories of average deposit liabilities. Such reserves averaged approximately $5,530,000, $5,976,000, and $5,684,000 during the years ended December 31, 2006, 2005, and 2004, respectively.

Note 3. Investment Securities

 

F-12

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Investment Securities (continued)

	December 31, 2004		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
	Available for sale:
	U.S. Government agencies		$	12,511,877		$	93,242		$	487,504		$	12,117,615
	State and municipal			35,956,838			1,237,281			88,450			37,105,669
	Corporate trust preferred			5,008,127			459,840			-			5,467,967
	Mortgage-backed			38,563,539			187,391			163,324			38,587,606
			$	92,040,381		$	1,977,754		$	739,278		$	93,278,857
	Held to maturity:
	State and municipal		$	682,945		$	71,933		$	-		$	754,878
	Mortgage-backed			944,245			62,771			-			1,007,016
			$	1,627,190		$	134,704		$	-		$	1,761,894

 

The gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 are as follows: