10-K 1 trif10k.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR [ ] 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 (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 such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark 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. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes No X --- --- The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $23 million based on the closing price 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 and by any stockholder beneficially owning more than 5% of the registrant's outstanding common stock are deemed to be shares held by affiliates. Number of shares of Common Stock outstanding as of March 3, 2004: 756,737 DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Stockholders for the fiscal year ended December 31, 2003. (Part II) 2. Portions of Proxy Statement for 2004 Annual Meeting of Stockholders. (Part III) ================================================================================ PART I 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 the 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 seven branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, and Lexington Park, Maryland. The Bank also expects to open an office in Prince Frederick, Maryland in 2004. The Bank also operates sixteen Automated Teller Machines ("ATMs") including seven stand-alone locations in the Tri-County area. The Bank also offers bank by phone and began offering internet banking in 2003. 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 ("FHLB") Systems and its deposits are insured up to applicable limits by Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Company's executive offices are located at 3035 Leonardtown Road, Waldorf, Maryland. Its telephone number is (301) 645-5601. The Bank also maintains a website at www.cbtc.com. ------------ 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. Recently, 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. LENDING ACTIVITIES GENERAL. The Bank offers a wide variety of 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 demand and installment loans. Most of the Bank's customers are residents of, or businesses located in the Southern Maryland 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. 1 The Bank's previous savings and loan charter restricted its ability to hold certain loan types in its portfolio. As a result, prior to its conversion to a state-chartered commercial bank, the Bank's loan portfolio was primarily comprised of residential mortgage loans. Since conversion, the Bank has moved to diversify its lending by adding a larger portion of commercial real estate, commercial, and consumer loans to its portfolio. Management believes that this diversification of the loan portfolio will increase the Bank's overall long-term financial performance. Management recognizes that these new loan types may increase the Bank's risk of losses due to loan default, although the Bank is taking measures to monitor and control the increased risk of these loan types. RESIDENTIAL FIRST MORTGAGE LOANS. Prior to its conversion to a commercial bank on March 29, 1997, residential first mortgages made up the majority of the Bank's loan portfolio. Since that date, residential first mortgage loans have represented a progressively smaller portion of the Bank's loan portfolio. Since December 31, 1997, residential first mortgage loans have decreased in dollar amount to $43.0 million from $62.2 million, while falling as a percentage of the loan portfolio to 19% from 50%. 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 10 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 and adjustable-rate residential first mortgages. The Bank offers fixed rate residential first mortgages on a variety of terms including loan periods from 10 to 30 years, and biweekly payment loans. Total fixed rate loan products in our residential first mortgage amount to $30 million as of December 31, 2003. Fixed-rate loans may also be packaged and sold in the secondary market, primarily to the Federal Home Loan Mortgage Corporation ("FHLMC"), private mortgage correspondents, the Federal National Mortgage Association ("FNMA") and the Mortgage Partnership Finance program of the FHLB of Atlanta. The Bank may also add these loans to its 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, 2003, the Bank serviced $54.7 million in residential mortgage loans for various organizations. The Bank also offers mortgages which are adjustable on a one, three, and five-year basis generally with limitations on upward adjustments of two percentage points per year and six percentage points over the life of the loan. The Bank markets adjustable-rate loans with rate adjustments based upon a United States Treasury bill index. As of December 31, 2003, the Bank had $13 million in residential mortgage loans using a U.S. Treasury bill index. 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. It is foreseeable that 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, depending on market conditions, 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 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 which 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 2 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, to a limited extent, office buildings, as well as churches and other special purpose projects. As a result, commercial real estate loans increased to $93.8 million or 42% of the loan portfolio during 2003. The primary security on a commercial real estate loan is the real property and the leases which 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 appraised value 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. 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 under its business plan as a commercial bank, the Bank is increasingly exposed to the risks posed by this type of lending. CONSTRUCTION AND LAND DEVELOPMENT LOANS. The Bank offers construction loans to individuals and building contractors primarily for the construction of one to four family dwellings. 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 construction/permanent loans provide for disbursement of loan funds based on draw requests submitted by the builder during construction and site inspections by independent inspectors. The Bank will also make a construction loan if the borrower has a commitment from another lender for a permanent loan at the completion of the construction. These loans typically have terms of six months. The application process includes the same items which are required for other mortgage loans and also requires the borrower to submit to the Bank accurate plans, specifications, and costs of the property to be constructed. These items are used as a basis to determine the appraised value of the subject property. 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 lend up to 80% of the appraised value. The Bank also offers builders lines of credit, which are revolving notes generally secured by real property. Outstanding builders lines of credit amounted to approximately $11.2 million at December 31, 2003. The Bank offers a builder's master note program in which the builder receives a revolving line of credit at a market rate and the Bank obtains security in the form of a first lien on home sites under construction. 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 $5.8 million at December 31, 2003. 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. In the event 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. As these 3 projects may take an extended period of time to complete, market, economic, and regulatory conditions may change during the construction or development period. HOME EQUITY AND SECOND MORTGAGE LOANS. The Bank has maintained a growing level of home equity and second mortgage loans in recent years. Home equity loans, which totaled $15 million at December 31, 2003, 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 $4 million at December 31, 2003 are fixed and variable-rate loans which have original terms between 5 and 15 years. Loan-to-value ratios of up to 80% or 95% are allowed depending on the specific loan program. These products represent 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. CONSUMER AND COMMERCIAL 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 and heavy equipment. The Bank also makes home improvement loans and offers both secured and unsecured lines of credit. The Bank also offers a variety of commercial loan services including term loans, lines of credit and equipment financing. The Bank's commercial loans are primarily underwritten on the basis of the borrower's ability to service the debt from income. Such loans are generally made for terms of five years or less at interest rates which adjust periodically. The higher interest rates and shorter loan terms available on commercial and consumer lending make these products attractive to the Bank. In particular, the consumer and commercial loan portfolio will increase its yield as interest rates increase. Consumer and commercial business loans, however, 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 as a result of the greater likelihood of damage, loss or depreciation. 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 which 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 which it has against the seller of the underlying collateral. 4 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.

(Dollars In Thousands) At December 31, --------------------------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Amount % Amount % Amount % Amount % Amount % ------ --- ------ --- ------ --- ------ --- ------ --- Real Estate Loans Commercial $ 93,825 42.46% $ 74,292 37.07% $ 65,617 33.39% $ 42,226 24.16% $ 29,947 20.08% Residential first mortgage 42,971 19.45% 48,976 24.44% 61,430 31.26% 67,975 38.89% 66,263 44.42% Construction and land development 19,599 8.87% 14,579 7.27% 18,136 9.23% 17,301 9.90% 17,142 11.49% Home equity and second mortgage 19,562 8.85% 19,007 9.48% 18,580 9.46% 18,637 10.66% 16,691 11.19% Commercial loans 30,436 13.77% 29,947 14.94% 18,539 9.44% 15,047 8.61% 10,025 6.72% Consumer loans 4,097 1.85% 4,623 2.31% 5,092 2.59% 5,512 3.15% 4,193 2.81% Commercial equipment 10,473 4.75% 9,007 4.49% 9,095 4.63% 8,098 4.63% 4,909 3.29% ------- ------- ------- ------- ------- ------- ------- ------- ------- ----- Total loans $ 220,963 100.00% $200,431 100.00% $196,489 100.00% $174,796 100.00% $149,170 100.00% ======= ======= ======= ======= ======= Less: Deferred loan fees 650 668 757 776 808 Loan loss reserve 2,573 2,314 2,282 1,930 1,653 --------- -------- -------- -------- -------- Loans receivable, net $ 217,740 $197,449 $193,450 $172,090 $146,710 ========== ========= ========= ========= ========

5 LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank solicits loan applications through its branch network, direct solicitation of customers, referrals from customers, and 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, credit reports, etc. vary by loan type. Loan processing functions are generally centralized except for small consumer loans. 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 $750,000, Senior Vice Presidents up to $400,000, and Business Development officers up to $150,000. Authorities may be combined up to $1,000,000. For residential mortgage loans, the residential loan underwriter may approve loans up to the conforming loan limit of $307,000. 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, ratify all real estate mortgages and approve all loans in excess of $1,000,000. 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, pay property taxes, and other conditions. Depending on market conditions, mortgage loans may be originated primarily with the intent to sell to third parties such as FNMA or FHLMC. During the year 2003, the Bank sold $17 million of mortgage loans which were originated during the year generating $505 thousand in income. In order 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, whole 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. 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 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 reserve for possible loan losses. Under this authority, the Bank would have been permitted to lend up to $4.0 million to any one borrower at December 31, 2003. 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 $4.6 million to any one borrower at December 31, 2003. At December 31, 2003, the largest amount outstanding to any one borrower and their related interests was $3.4 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 total amount of the Bank's outstanding commitments to originate loans at December 31, 2003, was approximately $2.9 million, excluding undisbursed portions of loans in process. It has been the Bank's experience that few commitments expire unfunded. 6 MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information at December 31, 2003 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.

(Dollars in Thousands) Due after 1 through Due within 1 5 years from Due more than year after December 31, 5 years from December 31, 2003 2003 December 31, 2003 Total ----------------- ---- ----------------- ----- Real Estate Loans Commercial $ 7,717 $16,763 $ 69,346 $ 93,825 Residential first mortgage 2,244 9,248 31,479 42,971 Construction 8,678 7,994 2,927 19,599 Home equity and second mortgage 16,085 1,770 1,707 19,562 Commercial loans 29,904 532 -- 30,436 Consumer loans 1,333 2,763 -- 4,096 Commercial equipment 2,257 7,886 330 10,473 ------- ------- -------- -------- Total loans $68,217 $46,956 $105,789 $220,963 ======= ======= ======== ========

The following table sets forth the dollar amount of all loans due after one year from December 31, 2003 which have predetermined interest rates and have floating or adjustable interest rates.

(Dollars in Thousands) Floating or Fixed Rates Adjustable Rates Total ----------- ---------------- ------- Real Estate Loans Commercial $ 7,672 $ 78,436 $ 86,108 Residential first mortgage 27,742 12,986 40,727 Construction 3,257 7,664 10,921 Home equity and second mortgage 3,477 -- 3,477 Commercial loans -- 532 532 Consumer loans 2,763 -- 2,763 Commercial equipment 7,446 770 8,216 ------- -------- -------- $52,357 $100,388 $152,745 ======= ======== ========

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. 7 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. 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 fair market value of approximately $706 thousand at December 31, 2003. FORECLOSED REAL ESTATE 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. The largest portion of the foreclosed real estate, $476 thousand, is related to one 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 the county is granted. Total sales price for Phase 2 would 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 thousand) 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. Other properties in the foreclosed real estate section of the balance sheet consist of various properties currently being marketed by the Bank. 8 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 impaired loans within the meaning of Statement of Financial Accounting Standards No. 114 and 118.

At December 31, ------------------------------------------------------------ 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (Dollars in Thousands) Restructured Loans $ -- $ -- $ -- $ -- $ -- ------ ------ ------ ------- ------ Accruing loans which are contractually past past due 90days or more: Real Estate Loans Commercial -- -- -- -- -- Residential first mortgage -- -- -- -- -- Construction and land development -- -- -- -- -- Home equity and second mortgage -- -- 25 102 171 Commercial loans -- -- -- -- -- Consumer loans -- -- -- -- -- Commercial equipment -- -- -- -- -- ------ ------ ------- -------- ------ Total -- -- 25 102 171 ------ ------ ------- -------- ------ Loans accounted for on a nonaccrual basis: Real Estate Loans Commercial -- -- -- -- -- Residential first mortgage 275 278 134 -- 20 Construction and land development -- -- -- -- -- Home equity and second mortgage -- 49 -- -- -- Commercial loans 103 269 -- -- -- Consumer loans 1 1 70 7 198 Commercial equipment -- -- -- -- -- -- -- -- -- -- Total 379 597 204 7 218 ------ ------ ------- -------- ------ Total non-performing loans $379 $597 $229 $109 $389 ====== ====== ======= ======== ====== Non-performing loans to total loans 0.17% 0.30% 0.12% 0.06% 0.26% ====== ====== ======= ======== ====== Allowance for loan losses to non-performing loans 678.33% 387.60% 996.51% 1,770.64% 424.94% ====== ====== ======= ======== ======

For a detailed discussion of foreclosed real estate at December 31, 2003 see the "Foreclosed Real Estate" section discussed previously. During the year ended December 31, 2003, gross interest income of $41 thousand would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. During the year 2003, the Company recognized $12 thousand in interest on these loans. 9 At December 31, 2003, 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 possible loan losses for the periods indicated.

2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (Dollars in Thousands) Balance at beginning of period $2,314 $2,282 $1,930 $1,653 $1,540 ====== ====== ====== ====== ====== Charge-offs: Real Estate Loans Commercial Residential first mortgage -- -- -- 56 -- Construction and land development -- 36 -- -- -- Home equity and second mortgage -- 21 -- -- -- Commercial loans 35 59 -- 33 102 Consumer loans 2 15 39 6 32 Commercial equipment 24 -- -- -- -- ------ ------ ------ ------ ------ Total Charge-offs: 61 131 39 95 134 ------ ------ ------ ------ ------ Recoveries: Real Estate Loans Commercial -- -- -- -- -- Residential first mortgage -- -- -- -- -- Construction and land development -- -- -- -- -- Home equity and second mortgage -- -- -- -- -- Commercial loans -- -- -- -- -- Consumer loans -- 3 31 -- -- Commercial equipment 2 -- -- 12 7 ------ ------ ------ ------ ------ Total Recoveries 2 3 31 12 7 ------ ------ ------ ------ ------ Net charge-offs 58 128 8 83 127 Provision for Possible Loan Losses 317 160 360 360 240 ------ ------ ------ ------ ------ Balance at End of Period $2,573 $2,314 $2,282 $1,930 $1,653 ====== ====== ====== ====== ====== Ratio of net charge-offs to average loans outstanding during the year 0.03% 0.06% 0.00% 0.05% 0.09% ====== ====== ====== ====== ======

10 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.

(Dollars in Thousands) At December 31, ------------------------------------------------------------------------- 2003 2002 2001 ---------------------- ------------------------- ---------------------- Percent Percent of Percent of of Loans Loans in Loans in in Each Each Each Category Category Category to Total to Total to Total Amount Loans Amount Loans Amount Loans ------ --------- ------ ---------- ------ --------- Real Estate Loans: Commercial $1,409 42.46% $1,077 37.07% $ 923 33.39% Residential first mortgage 64 19.45% 118 24.44% 160 31.26% Construction and land development 281 8.87% 211 7.27% 355 9.23% Home equity and second mortgage 244 8.85% 276 9.48% 373 9.46% Commercial loans 381 13.77% 434 14.94% 186 9.44% Consumer loans 63 1.85% 68 2.31% 102 2.59% Commercial equipment 131 4.74% 130 4.49% 183 4.63% ------ ------ ------ ------ ------ ------ Total allowance for loan losses $2,573 100.00% $2,314 100.00% $2,282 100.00% ====== ====== ====== ====== ====== ======

(Dollars in Thousands) At December 31, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Percent Percent of of Loans Loans in in Each Each Category Category to Total to Total Amount Loans Amount Loans ------ --------- ------ ---------- Real Estate Loans: Commercial $ 645 24.16% $ 399 20.08% Residential first mortgage 192 38.89% 632 44.42% Construction and land development 285 9.90% 164 11.49% Home equity and second mortgage 394 10.66% 159 11.19% Commercial loans 138 8.61% 178 6.72% Consumer loans 111 3.15% 55 2.81% Commercial equipment 165 4.63% 66 3.29% ------ ------ ------ ------ Total allowance for loan losses $1,930 100.00% $1,653 100.00% ====== ====== ====== ======

11 The Bank closely monitors the loan payment activity of all its loans. A loan loss provision is provided by a regular accrual. 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 generally accepted accounting principles 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 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. 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 FHLMC and FNMA. 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, respectively. 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, 2003, their market value was $104 million.

At December 31, ------------------------------------------------------------- 2003 2002 2001 ---- ---- ---- (In thousands) Asset-backed securities: FHLMC and FNMA $ 84,764 $ 29,200 $ 26,084 Other 7,284 7,930 8,993 -------- -------- -------- Total asset-backed securities 92,048 37,130 35,077 FHLMC and FNMA Stock 756 734 727 Bond mutual funds 2,838 3,962 -- U.S. Treasury bills 300 300 300 Other Investments 3,954 2,542 1,989 -------- -------- -------- Total investment securities 99,895 44,668 38,093 FHLB and Federal Reserve Bank stock 4,777 2,737 3,036 -------- -------- -------- Total investment securities and FHLB and Federal Reserve Bank stock $104,672 $ 47,405 $ 41,129 ======== ======== ========

12 The maturities and weighted average yields for investment securities available for sale and held to maturity at December 31, 2003 are shown below.

After One After Five One Year or Less Through Five Years Through Ten Years After Ten Years ------------------ ------------------ ------------------ ------------------ Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield ----- ----- ----- ----- ----- ----- ----- ----- (Dollars in thousands) Investment securities available for sale: Corporate equity securities $ 546 5.01% $ -- -- $ -- -- $ -- -- Asset-backed securities 9,295 4.41% 15,731 4.38% 5,389 4.31% 4,488 4.38% Mutual Funds 2,846 2.19% -- -- -- -- -- -- ------ ----- ------- ----- ------- ---- ------- ---- Total investment securities available for sale $12,687 3.94% $15,731 4.38% $ 5,389 4.31% $ 4,488 4.38% ======= ===== ======= ===== ======= ==== ======= ==== Investment securities held-to- maturity: Asset-backed securities $ 5,231 4.37% $17,727 4.37% $14,938 4.35% $19,456 4.37% Treasury bills 300 1.22% -- -- -- -- -- -- Other investments 34 6.57% 1,153 4.49% 2,766 3.13% -- -- ------- ----- ------- ----- ------- ---- ------- ---- Total investment securities held-to-maturity $ 5,565 4.21% $18,880 4.38% $17,704 4.16% $19,456 4.37% ======= ===== ======= ===== ======= ==== ======= ====

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 securities are issued by private issuers (defined as an issuer which is not a government or a government sponsored entity). The Company has no investment in any one issuer that is greater than a 10% equity interest as of December 31, 2003. For further information regarding the Company's investment securities, see Note 2 of Notes to Consolidated Financial Statements. 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 seven branches in the southern Maryland area. Consolidated total deposits were $228 million as of December 31, 2003. The Bank uses borrowings from the FHLB of Atlanta 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 year end 2003, no brokered deposits were held. 13 The following table sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.

2003 2002 2001 ------------------------ ---------------------- ---------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------- ------- ------- ------- ------- ------- (Dollars in thousands) Savings $ 32,772 0.21% $ 23,334 0.86% $ 19,723 2.01% Interest-bearing demand and money market accounts 67,346 0.66% 73,668 0.47% 72,052 2.35% Certificates of deposit 82,248 2.75% 70,885 4.10% 70,453 5.45% ----------- ----- ------- ----- ------- ----- Total interest-bearing deposits 182,366 1.57% 167,887 2.06% 162,228 3.65% Noninterest-bearing demand deposits 30,277 21,631 13,691 ----------- ------- ------- $212,643 1.35% $189,518 1.82% $175,919 3.37% =========== ===== ======== ===== ======== =====

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, 2003.

Certificates Maturity Period of Deposit --------------- ------------ (In thousands) Three months or less.................................... $ 4,402 Three through six months................................ 1,112 Six through twelve months............................... 14,493 Over twelve months...................................... 6,862 ----------- Total............................................ $ 26,869 ===========

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 35% of assets. 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. Information about borrowings for the years indicated (which consisted almost entirely of FHLB advances) is as follows:

At or for the Year Ended December 31, ------------------------------ 2003 2002 2001 ------ ------ ------ (Dollars in thousands) Long term amounts outstanding at end of period $63,051 $48,170 $48,650 Weighted average rate on outstanding long-term 4.55% 4.99% 5.41% Short-term borrowing outstanding at end of period 31,191 752 1,813 Weighted average rate on outstanding short-term 1.15% 0.89% 1.83% Maximum outstanding short-term debt at any month end 40,000 6,500 15,725 Average outstanding short-term debt 7,568 680 6,213 Approximate average rate paid on short term debt 1.26% 1.04% 5.75%

14 For more information regarding the Bank's borrowings, see Note 8 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 which 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. 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 15 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 sixth in deposit market share in the Tri-County area as of June 30, 2002, 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. 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 shareholder 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. 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. 15 Effective September 29, 1995, the Riegle-Neal Interstate Banking and Branching Efficiency of 1994 (the "Riegle-Neal Act") authorized the FRB to approve an application of an adequately capitalized and adequately managed bank holding company 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 which 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 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 will also be 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 which 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") on November 12, 1999, 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. 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 16 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 earning 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 FDICIA ("Federal Deposit Insurance Corporation Improvement Act"), 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. 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 $150 million or more. As of December 31, 2003, the Company's levels of consolidated regulatory capital exceeded the FRB's minimum requirements. SARBANES-OXLEY ACT OF 2002 AND RELATED REGULATIONS. On July 30, 2002, the Sarbanes-Oxley Act of 2002 ("SOX") was signed into law. SOX contains provisions addressing corporate and accounting fraud which both amended the Securities Exchange Act of 1934, as amended (the "Act") and directed the SEC to promulgate rules. SOX provided for the establishment of a new Public Company Accounting Oversight Board ("PCAOB"), to enforce auditing, quality control and independence standards for firms that audit public reporting companies and will be funded by fees from all public reporting companies. It is unlawful for any person that is not a registered public accounting firm ("RPAF") to audit a public reporting company. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The SEC has prescribed rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. SOX requires the RPAF that issues the audit report to attest to and report on management's assessment of the Company's internal controls. In addition, SOX requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC. SOX requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. SOX also increases the oversight and authority of audit committees of publicly traded companies. SOX imposed higher standards for auditor independence and restricts provisions of consulting services by auditing firms to companies they audit. Any non-audit services (subject to a 5% de minimis exception) being provided to an audit client require pre-approval by the Company's audit committee members. Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In 17 addition, all public reporting companies must disclose whether at least one member of the committee is an audit committee "financial expert" (as such terms is defined by the SEC rules) and if not, why not. Due to SOX, longer prison terms will be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited in a fund for the benefit of harmed investors. Although the Company anticipates it will incur additional expense in complying with the provisions of the Act and the related rules, management does not expect that such compliance will have a material impact on the Company's financial condition or results of operations. REGULATION OF THE BANK GENERAL. The Bank is a Maryland commercial bank and its deposit accounts are insured by the SAIF 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 Bank is required to file reports with the Commissioner and the FRB concerning its activities and financial condition and will be 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 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. 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. 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 1% to 2% above the minimum ratio, depending on the assessment of an individual organization's capital adequacy by its primary regulator. 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. 18 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; and subordinated debt and intermediate-term preferred stock. 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 federal banking agencies, including the FRB, have proposed a system for measuring and assessing the exposure of a bank's net economic value to changes in interest rates. The federal banking agencies, including the FRB, have stated their intention to propose a rule establishing an explicit capital charge for interest rate risk based upon the level of a bank's measured interest rate risk exposure after more experience has been gained with the proposed measurement process. FRB regulations do not specifically take into account interest rate risk in measuring the capital adequacy of bank holding companies. The FRB has issued regulations which 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 severe regulatory sanctions. As of December 31, 2003, 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 state banks, only in states which specifically allow for such branching. The Riegle-Neal Act also required the appropriate federal banking agencies to prescribe regulations which 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 19 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 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. DEPOSIT INSURANCE. The Bank is required to pay semi-annual assessments based on a percentage of its insured deposits to the FDIC for insurance of its deposits by the Savings Association Insurance Fund ("SAIF"). Under the Federal Deposit Insurance Act, the FDIC is required to set semi-annual assessments for SAIF-insured institutions to maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured deposits or at a higher percentage of estimated insured deposits that the FDIC determines to be justified for that year by circumstances raising a significant risk of substantial future losses to the SAIF. In the event that the SAIF should fail to meet its statutory reserve ratio, the FDIC would be required to set semi-annual assessment rates for SAIF members that are sufficient to increase the reserve ratio to 1.25% within one year or in accordance with such other schedule that the FDIC adopts by regulation to restore the reserve ratio in not more than 15 years. Under the risk-based deposit insurance assessment system adopted by the FDIC, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which is determined by the institution's capital level and supervisory evaluations. Based on the data reported to regulators for the date closest to the last day of the fourth month preceding the semi-annual assessment period, institutions are assigned to one of three capital groups -- "well capitalized, adequately capitalized or undercapitalized." Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Under the current assessment schedule, well capitalized banks with the best supervisory ratings are not required to pay any premium for deposit insurance. All SAIF-insured banks, however, are required to pay assessments to the FDIC to help fund interest payments on certain bonds issued by the Financing Corporation, an agency established by the federal government to finance takeovers of insolvent thrifts. 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 other types of transactions. An affiliate of a state member bank is any company or entity which 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 which 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 20 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 (up to $500,000) 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. U.S.A. PATRIOT ACT. The Patriot Act is intended to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. PERSONNEL As of December 31, 2003, the Bank had 94 full-time employees and 14 part-time employees. The employees are not represented by a collective bargaining agreement. The Bank believes its employee relations are good. EXECUTIVE OFFICERS The executive officers of the Company are as follows: MICHAEL L. MIDDLETON (56 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 Masters 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. Since January 1996, Mr. Middleton has served on the Board of Directors of the Federal Home Loan Bank of Atlanta, and currently serves as its Chairman, and also serves as its Board Representative to the Council of Federal Home Loan Banks. Mr. Middleton also serves on the board of the Baltimore Branch of the Federal Reserve Bank of Richmond. C. MARIE BROWN (61 years old) has been employed with the Bank since 1972 and has served as Chief Operating Officer since 1999. Prior to 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, of Zonta and serves on various administrative committees of the Hughesville Baptist Church and the board of the Charles County Chapter of the American Red Cross. H. BEAMAN SMITH (58 years old) was the Treasurer of the Company in 1998 and became Secretary-Treasurer in January 1999 and has been the president of Accoware, a computer software company, since 1989. Prior to that time, Mr. Smith was a majority owner of the Smith's Family Honey Company in Bryans Road, Maryland. Mr. Smith is a Vice President of Fry Plumbing Company of Washington, D.C., a Trustee of the Ferguson Foundation, a member of the Bryans Road Sports Council and the Treasurer of the Moyaone Association. GREGORY C. COCKERHAM (49 years old) joined the Bank in November 1988 and has served as Chief Lending Officer since 1996. Prior to his appointment as Senior Vice President, Mr. Cockerham served as Vice President of the Bank. Mr. Cockerham has been in banking for 22 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 (45 years old) joined the Bank as Chief Financial Officer in April 2000. Prior to joining the Bank, Mr. Pasenelli had been Chief Financial Officer of Acacia Federal Savings Bank, Annandale, 21 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. ITEM 2. PROPERTY ------------------ 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, 2003. Year Facility Leased Approximate Office Commenced or Square Location Operation Owned 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 Rd. 1961 Owned 2,500 Leonardtown, Maryland 101 Drury Drive 2001 Owned 2,645 La Plata, Maryland 10321 Southern Md. Blvd. 1991 Leased 1,400 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) 2,500 Charlotte Hall, Maryland Owned (Building) ---------------- ITEM 3. LEGAL PROCEEDINGS -------------------------- Neither the Company, the Bank, nor company and 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 fourth quarter of the fiscal year ended December 31, 2003. 22 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED SECURITY HOLDER MATTERS SMALL BUSINESS -------------------------------------------------------------------------------- The information contained under the section captioned "Market and Dividend Information" in the Company's Annual Report to Stockholders for the fiscal year ended December 31, 2003 (the "Annual Report") filed as Exhibit 13 hereto is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA -------------------------------- The information contained under the section captioned "Selected Financial Data" in the Annual Report is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND FINANCIAL CONDITION AND RESULTS OF OPERATION -------------------------------------------------------------------------------- The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition" of the Annual Report is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ------------------------------------------------------------------- Not applicable since the registrant qualified as a small business issuer. ITEM 8. FINANCIAL STATEMENTS ----------------------------- The Consolidated Financial Statements, Notes to Consolidated Financial Statements and Independent Auditors' Report in the Annual Report are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE -------------------------------------------------------------------------------- Not applicable. 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 recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. 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 reasonably likely to materially affect, the Company's internal control over financial reporting. 23 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------------------------------ For information concerning the Company's directors, the identification of the Audit Committee and the audit committee financial expert, the information contained under the section captioned "Proposal I -- Election of Directors" in the Company's definitive proxy statement for the Company's 2004 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, which is incorporated herein by reference. For information regarding compliance with Section 16(a) of the Exchange Act, the information contained under the section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement is incorporated herein by reference. The Company has adopted a Code of Ethics that applies to the Company's principal executive officer, principal financial officer, principal accounting officer and Controller, as well as all of its officer directors and employees, which is included herewith as Exhibit 14. ITEM 11. EXECUTIVE COMPENSATION -------------------------------- The information contained under the section captioned "Proposal I -- Election of Directors -- Executive Compensation, and "-- Directors' Compensation" in the Proxy Statement is incorporated herein 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 sections captioned "Proposal I -- Election of Directors" and "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (b) SECURITY OWNERSHIP OF MANAGEMENT Information required by this item is incorporated herein by reference to the section captioned "Proposal I -- Election of Directors" 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. 24 (d) EQUITY COMPENSATION PLANS The Company has adopted a variety of compensation plans pursuant to which equity may be awarded to participants including the Company's 1995 Stock Option and Incentive Plan and the 1995 Stock Option Plan for Non-Employee Directors. The Bank's Executive Incentive Compensation Plan provides for grants of options under the 1995 Stock Option and Incentive Plan if certain performance criteria are met. The following table sets forth certain information with respect to the Company's Equity Compensation Plans as of December 31, 2003.

(a) (b) (c) Number of securities remaining available for future issuance Number of securities to be Weighted-average exercise under equity compensation issued upon exercise price of outstanding plans (excluding securities Plan Category options, warrants, and rights options, warrants and rights reflected in column (a) ------------- ----------------------------- ---------------------------- -------------------------- Equity compensation plans approved by security holders 92,396 $ 25.18 30,024 Equity compensation plans not approved by security holders (1) 10,400 $ 25.49 6,642 ------- ----------------- ------ Total 102,796 $ 25.21 36,666 (2) ======= ================= ======

(1) Consists of the 1995 Stock Option Plan for Non-Employee Directors which provides grants of non-incentive options to directors who are not employees of the Company or its subsidiaries. Options are granted under the plan at an exercise price equal to their fair market value at the date of grant and have a term of ten years. Options are generally exercisable while an optionee serves as a director or within one year thereafter. (2) The 1995 Stock Option and Incentive Plan and 1995 Stock Option Plan for Non-Employee Directors each provide for a proportionate adjustment to the number of shares reserved thereunder in the event of a stock split, stock dividend reclassification, recapitalization or similar event. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section captioned "Proposal I -- Election of Directors" and "Transactions with the Company and the Bank" in the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ------------------------------------------------ The information required by this item is incorporated herein by reference to the section captioned "Relationship with Independent Auditors" in the Proxy Statement. 25 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K -------------------------------------------------------------------------- (a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT (1) Financial Statements. The following consolidated financial statements --------------------- are incorporated by reference from Item 7 hereof: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2003 and 2002 Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 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* 3.2 Amended and Restated Bylaws of Tri-County Financial Corporation **** 10.1 + Tri-County Financial Corporation 1995 Stock Option and Incentive Plan, as amended ** 10.2 + Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee Directors, as amended *** 10.3 + Employment Agreements with C. Marie Brown, as amended, and Gregory C. Cockerham **** 10.4 + Restated Employment Agreement with Michael L. Middleton. 10.5 + Guaranty Agreements with Michael L. Middleton, C. Marie Brown and Gregory C. Cockerham ** 10.6 + Executive Incentive Compensation Plan ** 10.7 + Executive Compensation Plan 2003 Amendment 10.8 + Employment Agreement with William J. Pasenelli ** 10.9 + Retirement Plan for Directors ** 10.10+ Split Dollar Agreements with Michael L. Middleton and C. Marie Brown ** 10.11+ Guaranty Agreement with William J. Pasenelli ***** 10.12+ Split Dollar Agreement with William J. Pasenelli ***** 10.13+ Salary Continuation Agreement with Michael L. Middleton 10.14+ Salary Continuation Agreement with C. Marie Brown 10.15+ Salary Continuation Agreement with Gregory C. Cockerham 10.16+ Salary Continuation Agreement with William J. Pasenelli 13 Annual Report to Stockholders for fiscal year ended December 31, 2003 14 Code of Ethics 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 ------------------- 26 + Management contract or compensatory plan required to be filed as an exhibit pursuant to Item 14(c). * Incorporated by reference to the Registrant's Registration Statement on Form S-4 (No. 33-31287). ** Incorporated by reference to the Registrant's Form 10-K for the fiscal year ended December 31, 2000. *** Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-70800). **** Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 ***** Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (b) REPORTS ON FORM 8-K. No reports on Form 8-K have been filed -------------------- during the last quarter of the fiscal year covered by this report. (c) 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. (d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. ----------------------------------------------------------------- There are no other financial statements and financial statement schedules which were excluded from the Annual Report pursuant to Rule 14a-3(b)(1) which are required to be included herein. 27 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 22, 2004 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 (Chief Financial and Executive Officer) Accounting Officer) Date: March 22, 2004 Date: March 22, 2004 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 22, 2004 Date: March 22, 2004 By: /s/ H. Beaman Smith By: /s/ A. Joseph Slater ------------------------------------- --------------------------- H. Beaman Smith A. Joseph Slater (Director and Secretary/Treasurer) (Director) Date: March 22, 2004 Date: March 22, 2004 By: /s/ Louis P. Jenkins, Jr. By: /s/ James R. Shepard ------------------------------------- ---------------------------- Louis P. Jenkins, Jr. James R. Shepard (Director) (Director) Date: March 22, 2004 Date: March 22, 2004