This section is intended to help potential investors understand our financial performance through a discussion of the factors affecting our consolidated financial condition. This section should be read in conjunction with the Consolidated Financial Statements and notes to the consolidated financial statements.

Overview

Bancorp is the holding company for the Bank. The Bank is a trust company chartered under Subtitle 2 of Title 3 of the Financial Institutions Article of the Annotated Code of Maryland. The Bank was formed in March 2004 and commenced banking operations on August 9, 2004. The Bank does not exercise trust powers, and our regulatory structure is the same as a Maryland-chartered commercial bank. As such, our business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. Typically, commercial real estate and business loans involve a higher degree of risk and carry a higher yield than one-to four-family residential loans. Although we plan to continue to focus on commercial customers, we intend to increase our originations of one- to four-family residential mortgage loans going forward, increasing our portfolio of mortgage lending and also selling select loans into the secondary markets.

We are headquartered in Ellicott City, Maryland and we consider our primary market area to be Howard County, Maryland and Anne Arundel County, Maryland. Our secondary market area, primarily for commercial lending, includes the Maryland counties of Baltimore, Carroll, Frederick, Montgomery and Prince George's as well as Baltimore City. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small to medium sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.

Our core business strategy is to deliver superior customer service that is supported by an extremely high level of banking sophistication. Our specialized community banking focus on both local markets and small business related market segments is combined with a broad array of products, new technology and seasoned banking professionals which positions the Bank differently than most competitors. Our experienced executives establish a relationship with each client and bring value to all phases of a client's business and personal banking needs. We call it Hands-On Service.

Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we pay on deposits and borrowings. Results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, deposit insurance and general administrative and data processing expenses. Our operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations.

Bancorp's total assets increased by over $42 million or 14% when comparing March 31, 2012 assets of $347.8 million to the $305.4 million at the same point in 2011. Total loans outstanding of $279.7 million at the end of March 2012, showed an increase of nearly 11% compared to total loans of $251.2 million on March 31, 2011. Demand deposits, which not only represent the lowest cost source of funding available to a bank, but also are most reflective of the core customer relationships targeted by the bank, grew from $50.5 million at March 31, 2011 to $72.2 million at the end of the first quarter of 2012, representing growth in this highly coveted deposit category of $21.7 million or 43%. Total deposits grew by $43.7 million or 18% when comparing March 31, 2012 to March 31, 2011. Because of the significant increases in deposits, even after funding the 11% loan growth, the bank was able to utilize the additional deposits to increase our balance sheet liquidity measures.

The first quarter of 2012 net income was $399 thousand, which represents an increase of 16% over net income for the first quarter of 2011. Net interest income for the quarter ended March 31, 2012 was $3.3 million versus $3.0 million for the first three months of 2011, an increase of approximately $264 thousand or 9%. Partially offsetting the increase in net interest income was a decrease in noninterest income for the first quarter of 2012 compared to the first quarter of 2011. Total noninterest income was $182 thousand for the first quarter of 2011, compared to a total of $85 thousand for the same period in 2012. This decrease of $97 thousand or 53% was impacted by a loss on the sale of one property classified as OREO, which resulted in a loss on the sale of $131 thousand in the first quarter of 2012. There were no such losses recorded in the first quarter of 2011. Total expenses were basically unchanged at $2.5 million for both the 2012 and 2011 periods.

We expect our initial public offering, pursuant to which we are offering up to 1,150,891 shares of our common stock, to close in July 2012. In addition, on March 28, 2012, we completed a private placement of our common stock, pursuant to which we entered into investment agreements with two institutional investors pursuant to which, subject to their respective terms and conditions, the investors are obligated to purchase from us an aggregate of between 517,354 and 603,699 shares of our common stock at $7.30 per share. Assuming the conditions to closing are satisfied, we expect the private placement to close simultaneously with our initial public offering. The net proceeds of the offering are expected to increase our capital levels, which will permit additional growth in our loan levels and asset size. This growth may be either organic growth which could take a longer time to occur, or the growth could come more quickly via merger or acquisition of other financial institutions. As this growth is realized, our operating results will reflect the additional income generated from the higher levels of earning assets.

Critical Accounting Policies

Our accounting and financial reporting policies conform to the accounting principles generally accepted in the United States of America and general practice within the banking industry. Accordingly, the financial statements require management to exercise significant judgment or discretion or make significant assumptions based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. In reviewing and understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. We consider the allowance for credit losses to be our most significant accounting policy, which is further described in the Notes to the financial statements.

The allowance for credit losses is established through a provision for credit losses charged against income. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impacted loans, value of collateral, estimated losses on our loan portfolios as well as consideration of general loss experience. Based on our estimate of the level of allowance for credit losses required, we record a provision for credit losses to maintain the allowance for credit losses at an appropriate level.

We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance for credit losses. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance for credit losses. Such agencies may require that we recognize additions to the allowance for credit losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management's estimates, additional provisions to the allowance for credit losses may be required that would adversely impact earnings in future periods.

We account for income taxes under the asset/liability method. We recognize deferred tax assets for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

We follow the provisions of ASC Topic 718 "Compensation," which requires the expense recognition over a service period for the fair value of share based compensation awards, such as stock options, restricted stock, and performance based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. Our practice is to utilize reasonable and supportable assumptions which are reviewed with the appropriate Board Committee.

Balance Sheet Analysis and Comparison of Financial Condition

A comparison between March 31, 2012 and December 31, 2011 balance sheets is presented below.

Assets

Total assets increased $24.7 million, or 7.7%, to $347.8 million at March 31, 2012 compared to $323.1 million at December 31, 2011. This asset growth was primarily due to a $14.7 million increase in cash and cash equivalents, a $7.2 million increase in investment securities and $3.2 million growth in total loans. The asset growth was funded primarily from increases in customer deposits, which increased from $262.6 million at December 31, 2011 to $284.9 million at March 31, 2012, an increase of $22.3 million or 8.5%. From a funding perspective, most important was the growth in noninterest-bearing deposits of $10.2 million or 16.4% from $62.0 million at December 31, 2011 to $72.2 million at March 31, 2012.

Securities Available for Sale

We currently hold both U.S. agency securities and mortgage backed securities in our securities portfolio, all of which are considered as available for sale. Our securities portfolio is used to provide the required collateral for funding via commercial customer repurchase agreements as well as to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposited funds. At both March 31, 2012 and December 31, 2011 we held an investment in stock of the Federal Home Loan Bank of Atlanta ("FHLB") of $1.3 million. This investment, which is required for continued membership, is based partially upon the dollar amount of borrowings outstanding from the FHLB. These investments are carried at cost. We have never held stock in Fannie Mae or Freddie Mac.

The following tables set forth the composition of our investment securities portfolio at the dates indicated.

(in thousands)                March 31, 2012                December 31, 2011
                         Amortized       Estimated      Amortized       Estimated
                           Cost         Fair Value         Cost        Fair Value
U.S. Federal agencies   $    20,035     $    20,022     $   12,774     $    12,773
Mortgage-backed                 505             539            568             603
Total                   $    20,540     $    20,561     $   13,342     $    13,376

We had securities available for sale of $20.6 million and $13.4 million at March 31, 2012 and December 31, 2011, respectively, which were recorded at fair value. This represents an increase of $7.2 million, or 53.7%, from the prior year end. We did not record any gains or losses on the sales or calls of securities or mortgage backed securities in either period presented.

With respect to our total portfolio of securities available for sale, we held certain securities that had unrealized losses of $13 thousand and $2 thousand at March 31, 2012 and December 31, 2011, respectively. The minimal changes in the fair value of these securities resulted primarily from interest rate fluctuations. We do not intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery, and we believe the collection of the investment and related interest is probable. Based on this analysis, we consider all of the unrealized losses to be temporary impairment losses.

Loan Portfolio

Total loans increased by $3.2 million or 1.1%, to $279.7 million at March 31, 2012 from $276.5 million at December 31, 2011. At March 31, 2012, total loans were 80.4% of total assets, down slightly compared to 85.6% of total assets at December 31, 2011. Loan growth throughout the banking industry has been impacted by decreased loan demand resulting from uncertain economic conditions.

The following table sets forth the composition of our loan portfolio at the dates indicated. We had loans held for sale of $970 thousand at March 31, 2012, and $646 thousand at December 31, 2011.

                                          Unaudited
                                          March 31,                     December 31,
(in thousands)                      2012         % of Total        2011         % of Total
Real estate
Construction and land                37,634             13.5 %   $  39,268             14.2 %
Residential - first lien             22,652              8.1        22,087              8.0
Residential - junior lien             8,934              3.2         9,242              3.3
Total residential real estate        31,586             11.3        31,329             11.3
Commercial - owner occupied          52,309             18.7        46,588             16.8
Commercial - non-owner occupied      79,285             28.3        76,880             27.8
Total commercial real estate        131,594             47.0       123,468             44.6
Total real estate loans             200,814             71.8       194,065             70.2
Commercial loans and leases          77,286             27.6        81,243             29.4
Consumer                              1,591              0.6         1,223              0.4
Total loans                       $ 279,691            100.0 %   $ 276,531            100.0 %

Deposits

Our deposits increased from $262.6 million at December 31, 2011 to $284.9 million at March 31, 2012, an increase of $22.3 million or 8.5%. The increase resulted primarily from a $10.2 million or 16.4% increase in noninterest-bearing checking accounts, which increased from $62.0 million at December 31, 2011 to $72.2 million at March 31, 2012. In addition, interest bearing certificate of deposit and money market accounts increased $10.9 million or 6.4% from December 31, 2011 to March 31, 2012. The growth in these deposits was more than sufficient to fund the growth in loans and assets. Other categories of deposits maintained their previous levels.

The following tables set forth the distribution of total deposits, by account type, at the dates indicated

                                                     March 31,                     December 31,
(dollars in thousands)                         2012         % of Total         2011         % of Total
Noninterest-bearing demand                      72,201               25 %   $   62,044               24 %
Interest-bearing checking                       18,281                6         17,687                7
Money market accounts                           65,918               23         61,267               23
Savings                                         11,211                4         10,644                4
Certificates of deposit $100,000 and over       81,536               29         79,718               30
Certificates of deposit under $100,000          35,752               13         31,282               12
Total deposits                              $  284,899              100 %   $  262,642              100 %

Borrowings

Customer deposits remain the primary source utilized to meet funding needs. Borrowings consist of overnight unsecured master notes, overnight securities sold under agreement to repurchase ("repurchase agreements") and FHLB advances. Our borrowings totaled $25.2 million at March 31, 2012 and $23.0 million at December 31, 2011, respectively. Short-term borrowings totaled $19.2 million at March 31, 2012 and $13.0 million at December 31, 2011. We had three long-term FHLB advances outstanding totaling $6 million at March 31, 2012 compared to five FHLB advances outstanding totaling $10 million at December 31, 2011.

Shareholders' Equity

Total shareholders' equity increased by $235 thousand or less than 1% from $36.6 million at December 31, 2011 to $36.9 million at March 31, 2012. The increase in shareholder's equity is the result of the retention of the earnings for the first quarter of 2012.

Total shareholders' equity at March 31, 2012 represents a capital to asset ratio of 10.60%, while the total shareholders' equity at December 31, 2011 represents a capital to asset ratio of 11.34%. Even though capital levels increased, the overall growth in asset levels resulted in a decline in the capital to asset ratio.

Average Balance and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

                                                     For the three months ended March 31,
                                               2012                                        2011
                               Average        Income          Yield        Average        Income          Yield
(dollars in thousands)         Balance       / Expense       / Rate        Balance       / Expense       / Rate
Earning assets
Loans and leases: 1
Commercial loans and leases   $  77,797     $     1,085          5.61 %   $  83,182     $     1,229          5.99 %
Commercial real estate          126,974           1,762          5.58       104,304           1,469          5.71
Construction and land            38,999             519          5.35        32,281             387          4.86
Residential real estate          31,301             391          5.03        32,538             403          5.02
Consumer                          1,272              16          5.03         1,320              15          4.73
Total loans and leases          276,343           3,773          5.49       253,625           3,503          5.60
Federal funds sold               28,567              13          0.19        13,713               6          0.18
Securities: 2
U.S. Gov agencies                14,264              10          0.27        12,580               9          0.29
Mortgage-backed                     575               7          4.69           948              12          5.13
Other investments                 1,314               7          2.13         1,515               3          0.80
Total securities                 16,154              23          0.58        15,043              24          0.65
Total earning assets            321,064           3,809          4.77       282,381           3,533          5.07
Cash and due from banks           3,445                                       2,758
Bank premises and
equipment, net                    9,509                                       9,231
Other assets                      6,879                                       8,536
Less: allowance for credit
losses                           (3,454 )                                    (3,718 )
Total assets                  $ 337,443                                   $ 299,188

Interest-bearing
liabilities
Deposits:
Interest-bearing demand
accounts                      $  16,422              17          0.43     $  16,204              17          0.43
Money market                     63,553             111          0.70        66,000             115          0.71
Savings                          10,959              17          0.64        13,514              22          0.67
Time deposits $100,000 and
over                             61,550             180          1.18        55,504             179          1.31
Other time deposits              51,741             137          1.07        40,537             117          1.17
Total interest-bearing
deposits                        204,224             463          0.91       191,759             450          0.95
Short-term borrowings            18,672              40          0.86        23,423              39          0.67
Long-term borrowing               9,758              24          0.98         6,022              26          1.74
Total interest-bearing
funds                           232,654             527          0.91       221,204             515          0.94
Noninterest-bearing
deposits                         66,963                                      47,648
Other liabilities and
accrued expenses                    846                                         694
Total liabilities               300,464                                     269,546
Shareholders' equity             36,979                                      29,642
Total liabilities &
shareholders' equity          $ 337,443                                   $ 299,188
Net interest rate spread 3                  $     3,282          3.86 %                 $     3,018          4.13 %
Effect of
noninterest-bearing funds                                        0.25                                        0.20
Net interest margin on
earning assets 4                                                 4.11 %                                      4.33 %

(1) Loan fee income is included in the interest income calculation, and nonaccrual loans are included in the average loan base upon which the interest rate earned on loans is calculated.

(2) Available for sale securities are presented at amortized cost

(3) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4) Net interest margin represents net interest income divided by average total interest-earning assets.

Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column is further broken down to show the impact of changes in either rates or volumes. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

                                               For the three months ended March 31,
                                                           2012 vs. 2011
                                                        Due to variances in
(in thousands)                                Total             Rates          Volumes1
Interest earned on:
Loans and leases:
Commercial loans and leases                $      (144 )     $      (323 )     $     179
Commercial real estate                             293              (139 )           432
Construction and land                              132               160             (28 )
Residential real estate                            (12 )               1             (13 )
Consumer                                             0                 4              (4 )
Taxable securities                                  (1 )             (10 )            10
Federal funds sold                                   7                 2               6
Interest-bearing deposits in other banks             -                 -               -
Total interest income                              276              (306 )           582

Interest paid on:
Savings deposits                                    (5 )              (4 )            (1 )
Checking plus interest deposits                      0                 0               0
Money market accounts                               (4 )              (4 )            (1 )
Time deposit $100,000 and over                       1               (73 )            74
Other time deposits                                 21               (40 )            61
Short-term borrowings                                0                40             (40 )
Long-term borrowing                                 (2 )             (47 )            45
Total interest expense                              12              (128 )           140
Net interest earned                        $       264       $      (178 )     $     442

(1) Change attributed to mix (rate and volume) are included in volume variance

Comparison of Results of Operations

A comparison between the three months ended March 31, 2012 and March 31, 2011 is presented below.

General

Net income available to common shareholders decreased $20 thousand, or 7.6%, to $242 thousand for the three months ended March 31, 2012 compared to net income of $262 thousand for the three months ended March 31, 2011. The decrease was primarily due to a $75 thousand, or 91.5%, increase in dividends paid on preferred stock. Partially offsetting the increased dividends was a $264 thousand increase in net interest income, which consisted of an increase of $276 thousand, a 7.8%, in interest income with an increase of only $12 thousand, or 2.3%, in interest expense. Excluding the $131,000 loss on the sale of other real . . .