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GLEN BURNIE BANCORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 14, 2014

Forward-Looking Statements

When used in this discussion and elsewhere in this Form 10-Q, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and readers are advised that various factors could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. While it is impossible to identify all such factors, such factors include, but are not limited to, those risks identified in the Company's periodic reports filed with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K.



The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Overview

Glen Burnie Bancorp, a Maryland corporation (the "Company"), through its subsidiary, The Bank of Glen Burnie, a Maryland banking corporation (the "Bank"), operates a commercial bank with eight offices in Anne Arundel County Maryland. The Company had consolidated net income of $435,000 ($0.16 basic and diluted earnings per share) for the second quarter of 2014, compared to the second quarter of 2013 consolidated net income of $640,000 ($0.24 basic and diluted income per share), a 32.03% decrease. Year-to-date net income was $908,000 ($0.33 basic and diluted earnings per share), compared to the 2013 consolidated net income of $1,169,000 ($0.43 basic and diluted income per share), a 22.33% decrease. The decrease in net income for the second quarter was primarily due to increases in other expenses and provision for loan losses, a reversal of accrued interest from a loan which was classified as non-performing during the quarter, and a decrease in income on state and municipal securities, partially offset by a decrease in income tax expense. During the three months ended June 30, 2014, deposits increased by $8,164,000 and net loans increased by $2,734,000. The decrease in net income for the six months was primarily due to increases in other expenses, provision for loan losses, the reversal of accrued interest from a loan which was classified as non-performing during the second quarter, and a decrease in state and municipal security income. This was partially offset by a decrease in deposit expense and income tax expense and the gains on investment securities and loan income. During the six months ended June 30, 2014, deposits increased by $21,284,000 and net loans increased by $10,598,000.



Results Of Operations

Net Interest Income. The Company's consolidated net interest income prior to provision for credit losses for the three and six months ended June 30, 2014 was $2,932,000 and $6,019,000, compared to $3,009,000 and $5,922,000, respectively, for the same period in 2013, a decrease of $77,000 (2.56%) for the three months and an increase of $97,000 (1.64%) for the six months. Interest income for the second quarter decreased from $3,708,000 in 2013 to $3,560,000 in 2014, a 3.99% decrease. Interest income for the six months decreased from $7,338,000 in 2013 to $7,235,000 in 2014, a 1.40% decrease. Although interest income on performing loans was approximately the same in both periods, a higher volume of loans was required in the 2014 period to maintain the same income due to the interest rate environment. The decreases in interest income for the three and six month periods were primarily due to a reversal of accrued interest from a loan which was classified as non-performing during the quarter, and a decrease in state and municipal security income.



Interest expense for the second quarter decreased from $699,000 in 2013 to $628,000 in 2014, a 10.16% decrease. Interest expense for the six months decreased from $1,416,000 in 2013 to $1,216,000 in 2014, a 14.12% decrease.

The

decrease was due to the lower interest rates paid on deposit balances.

Net interest margins on a tax equivalent basis for the three and six months ended June 30, 2014 was 3.33% and 3.54%, compared to 3.86% and 3.95% for the three and six months ended June 30, 2013. The decrease of the net interest margin for the second quarter was primarily due to declining yields on earning assets. - 13 -

Provision for Credit Losses. The Company made a provision for credit losses of $112,000 and $150,000 during the three and six month periods ending June 30, 2014 and $0 during the three and six month periods ending June 30, 2013. As of June 30, 2014, the allowance for credit losses equaled 70.28% of non-accrual and past due loans compared to 68.78% at December 31, 2013 and 53.54% at June 30, 2013. During the three and six month periods ended June 30, 2014, the Company recorded a net charge-off of $425,000 and $459,000, compared to net charge-offs of $162,000 and $179,000 during the corresponding period of the prior year. On an annualized basis, net charge-offs for the 2014 period represent 0.33% of the average loan portfolio. Other Income. Other income increased from $502,000 for the three month period ended June 30, 2013, to $510,000 for the corresponding 2014 period, an $8,000 (1.59%) increase. Other income increased from $881,000 for the six month period ended June 30, 2013, to $943,000 for the corresponding 2014 period, a $62,000 (7.04%) increase. The increase for the six and three month periods were due to an increase in gains on investment securities and other non-interest income, partially offset by a reduction in service charges. Other Expenses. Other expenses increased from $2,723,000 for the three month period ended June 30, 2013, to $2,832,000 for the corresponding 2014 period, a $109,000 (4.00%) increase. Other expenses increased from $5,408,000 for the six month period ended June 30, 2013, to $5,747,000 for the corresponding 2014 period, a $339,000 (6.27%) increase. The increase for the three month period was primarily due to an increase in other professional services along with an increase in other loan expense. The increase for the six month period was primarily due to an increase in losses on other real estate of $91,000, a $53,000 increase in the FDIC assessment, a $23,000 increase in credit reports, a $77,000 increase in other professional services and a $33,000 increase in other loan expenses and increases in salaries and employee benefits. Income Taxes. During the three and six months ended June 30, 2014, the Company recorded income tax expense of $63,000 and $157,000, compared to income tax expense of $148,000 and $226,000 for the same respective periods in 2013. The Company's effective tax rate for the three and six month period in 2014 was 12.65% and 14.74%, respectively, compared to 18.78% and 16.20% for the prior year period. The decrease in the effective tax rate for the three and six month periods was due to the increase in the proportion of state and municipal income. Comprehensive Income. In accordance with regulatory requirements, the Company reports comprehensive income in its financial statements. Comprehensive income consists of the Company's net income, adjusted for unrealized gains and losses on the Bank's investment portfolio of investment securities. For the second quarter of 2014, comprehensive income, net of tax, totaled $1,089,000, compared to the June 30, 2013 comprehensive income (loss) of ($1,560,000). Year-to-date, comprehensive income, net of tax, totaled $2,737,000, compared to the June 30, 2013 comprehensive income (loss) of ($1,440,000). The increase for the three and six month periods were due to an increase in the net unrealized gain on securities during those periods.



Financial Condition

General. The Company's assets increased to $400,562,000 at June 30, 2014 from $377,194,000 at December 31, 2013, primarily due to an increase in cash and cash equivalents, investment securities and an increase in loans funded primarily by deposit growth. The Bank's net loans totaled $281,282,000 at June 30, 2014, compared to $270,684,000 at December 31, 2013, an increase of $10,598,000 (3.92%), primarily attributable to an increase in purchase money mortgages and indirect lending, offset by decreases primarily in commercial and industrial mortgages and refinance loans. The Company's total investment securities portfolio (investment securities available for sale) totaled $83,760,000 at June 30, 2014, an $9,446,000 (12.71%) increase from $74,314,000 at December 31, 2013. The Bank's cash and due from banks (cash due from banks, interest-bearing deposits in other financial institutions, and federal funds sold), as of June 30, 2014, totaled $16,565,000, an increase of $5,612,000 (51.24%) from the December 31, 2013 total of $10,953,000. The increase in cash, cash equivalents and investments was a result of the excess in deposits available to fund loans. Deposits as of June 30, 2014, totaled $345,087,000, which is an increase of $21,284,000 (6.57%) from $323,803,000 at December 31, 2013. Demand deposits as of June 30, 2014, totaled $90,793,000, which is an increase of $4,045,000 (4.66%) from $86,748,000 at December 31, 2013. NOW accounts as of June 30, 2014, totaled $30,818,000, which is an increase of $2,826,000 (10.10%) from $27,992,000 at December 31, 2013. Money market accounts as of June 30, 2014, totaled $18,879,000, which is a decrease of $341,000 (1.77%), from $19,220,000 at December 31, 2013. Savings deposits as of June 30, 2014, totaled $73,433,000, which is an increase of $2,154,000 (3.02%) from $71,279,000 at December 31, 2013. Certificates of deposit over $100,000 totaled $36,152,000 on June 30, 2014, which is an increase of $7,235,000 (25.02%) from $28,917,000 at December 31, 2013. Other time deposits (made up of certificates of deposit less than $100,000 and individual retirement accounts) totaled $95,012,000 on June 30, 2014, which is a $5,363,000 (5.98%) increase from the $89,649,000 total at

December 31, 2013. - 14 - Asset Quality. The following tables set forth the amount of the Bank's current, past due, and non-accrual loans by categories of loans and restructured loans, at the dates indicated.



The following table analyzes the age of past due loans, including both accruing and non-accruing loans, segregated by class of loans as of the three months ended June 30, 2014 and the year ended December 31, 2013.

At June 30, 2014 90



Days or

(Dollars in Thousands) 30-89 Days More



and

Current Past Due Still



Accruing Nonaccrual Total

Commercial and industrial $ 4,017 $ - $

- $ - $ 4,017 Commercial real estate 63,908 15 - 2,287 66,210 Consumer and indirect 84,216 1,482 3 281 85,982 Residential real estate 126,820 860 43 1,175 128,898 $ 278,961$ 2,357 $ 46 $ 3,743$ 285,107 At December 31, 2013 90



Days or

(Dollars in Thousands) 30-89 Days More



and

Current Past Due Still



Accruing Nonaccrual Total

Commercial and industrial $ 4,159 $ - $

- $ 14 $ 4,173 Commercial real estate 66,191 173 1,177 1,238 68,779 Consumer and indirect 71,755 1,137 - 338 73,230 Residential real estate 126,934 157 431 1,123 128,645 $ 269,039$ 1,467 $ 1,608 $ 2,713$ 274,827

The balances in the above charts have not been reduced by the allowance for loan loss and the unearned income on loans. For the period ending June 30, 2014, the allowance for loan loss is $2,663,000 and the unearned income is $1,162,000. For the period ending December 31, 2013, the allowance for loan loss is $2,972,000 and the unearned income is $1,171,000. At At June 30, December 31, 2014 2013 (Dollars in Thousands)

Restructured loans $ - $ - Non-accrual and 90 days or more and still accruing loans to gross loans 1.33 % 1.58 %



Allowance for credit losses to non-accrual and 90 days or more and still accruing loans 70.28 %

68.78 % At June 30, 2014, there was $5,319,000 in loans outstanding, included in the current and 30-89 days past due columns 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. Such loans consist of loans which were not 90 days or more past due but where the borrower is in bankruptcy or has a history of delinquency, or the loan to value ratio is considered excessive due to deterioration of the collateral or other factors. - 15 -

Non-accrual loans with specific reserves at June 30, 2014 are comprised of:



Consumer loans - Three loans to three borrowers in the amount of $227,000 with a specific reserve of $112,000 established for the loan.

Commercial Real Estate - Three loans to three borrowers in the amount of $2,287,000, secured by commercial and/or residential properties with a specific reserve of $266,000 established for the loans.

Residential Real Estate - Three loans to three borrowers in the amount of $659,000, secured by residential property with a specific reserve of $218,000 established for the loans.

Below is a summary of the recorded investment amount and related allowance for losses of the Bank's impaired loans at June 30, 2014 and December 31, 2013.

(Dollars in thousands) Unpaid Interest Average Recorded Principal Income Specific Recorded June 30, 2014 Investment Balance Recognized Reserve Investment Impaired loans with specific reserves: Real-estate - mortgage: Residential $ 835 835 10 249 839 Commercial 2,287 2,287 36 266 2,356 Consumer 301 301 9 132 301 Installment - - - - - Home Equity - - - - - Commercial 259 259 6 259 261 Total impaired loans with specific reserves $ 3,682 3,682 61 906 3,757 Impaired loans with no specific reserve: Real-estate - mortgage: Residential $ 509 842 1 n/a 779 Commercial 4,723 4,723 99 n/a 4,754 Consumer 124 124 - n/a - Installment 272 272 - n/a - Home Equity - - - n/a - Commercial 88 88 2 n/a 90 Total impaired loans with no specific reserve $ 5,716 6,049 102 - 5,623 - 16 - (Dollars in thousands) Unpaid Interest Average Recorded Principal Income Specific Recorded December 31, 2013 Investment Balance Recognized Reserve Investment Impaired loans with specific reserves: Real-estate - mortgage: Residential $ 559 559 16 155 564 Commercial 2,187 2,187 56 551 2,272 Consumer 394 394 21 179 394 Installment - - - - - Home Equity - - - - - Commercial 279 279 11 279 287 Total impaired loans with specific reserves $ 3,419 3,419 104 1,164 3,517 Impaired loans with no specific reserve: Real-estate - mortgage: Residential $ 1,070 1,070 39 n/a 1,071 Commercial 1,177 1,177 47 n/a 1,232 Consumer 11 11 - n/a - Installment 180 180 - n/a - Home Equity 52 52 - n/a 51 Commercial - - - n/a - Total impaired loans with no specific reserve $ 2,490 2,490 86 - 2,354 Credit Quality Information The following tables represent credit exposures by creditworthiness category for the quarter ending June 30, 2014 and the year ended December 31, 2013. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Bank's internal creditworthiness is based on experience with similarly graded credits. Loans that trend upward toward higher credit grades typically have less credit risk and loans that migrate downward typically have more credit risk.



The Bank's internal risk ratings are as follows:

1 Superior - minimal risk (normally supported by pledged deposits, United States government securities, etc.)



2 Above Average - low risk. (all of the risks associated with this credit based

on each of the bank's creditworthiness criteria are minimal)

3 Average - moderately low risk. (most of the risks associated with this credit

based on each of the bank's creditworthiness criteria are minimal)



4 Acceptable - moderate risk. (the weighted overall risk associated with this

credit based on each of the bank's creditworthiness criteria is acceptable)

5 Other Assets Especially Mentioned - moderately high risk. (possesses

deficiencies which corrective action by the bank would remedy; potential

watch list) 6 Substandard - (the bank is inadequately protected and there exists the distinct possibility of sustaining some loss if not corrected) 7 Doubtful - (weaknesses make collection or liquidation in full, based on currently existing facts, improbable) 8 Loss - (of little value; not warranted as a bankable asset)



Loans rated 1-4 are considered "Pass" for purposes of the risk rating chart below.

- 17 -



Risk ratings of loans by categories of loans are as follows:

Commercial



Consumer

June 30, 2014 and Commercial and



Residential

(Dollars in Thousands) Industrial Real Estate Indirect Real Estate Total

Pass $ 3,655$ 58,070$ 83,718$ 127,491$ 272,934 Special mention 15 1,131 1,690 458 3,294 Substandard 347 7,009 501 548 8,405 Doubtful - - 73 - 73 Loss - - - 401 401 $ 4,017$ 66,210$ 85,982$ 128,898$ 285,107 Non-accrual - 2,287 281 1,175 3,743

Troubled debt restructures - -

- - - Number of TDRs contracts - - - - - Non-performing TDRs - - - - - Number of TDR accounts - - - - - Commercial Consumer December 31, 2013 and Commercial and Residential



(Dollars in Thousands) Industrial Real Estate Indirect Real Estate Total

Pass $ 3,595$ 59,915$ 71,554$ 126,774$ 261,838 Special mention 299 5,500 1,102 1,312 8,213 Substandard 279 3,364 508 559 4,710 Doubtful - - 66 - 66 Loss - - - - - $ 4,173$ 68,779$ 73,230$ 128,645$ 274,827 Non-accrual 14 1,238 338 1,123 2,713

Troubled debt restructures - - - - - Number of TDRs contracts - -

- - - Non-performing TDRs - - - - - Number of TDR accounts - - - - -

Other Real Estate Owned. At June 30, 2014, the Company had $163,000 in real estate acquired in partial or total satisfaction of debt, compared to $1,171,000 at December 31, 2013. This decrease for 2014 was the result of $91,000 being written off on three properties and three properties with a value of $917,000 being sold. Currently one property is left on OREO at June 30, 2014. All such properties are recorded at the lower of cost or fair value (net realizable value) at the date acquired and carried on the balance sheet as other real estate owned. Losses arising at the date of acquisition are charged against the allowance for credit losses. Subsequent write-downs that may be required and expense of operation are included in non-interest expense. Gains and losses realized from the sale of other real estate owned are included in non-interest income or expense. Allowance For Credit Losses. The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. The allowance, based on evaluations of the collectability of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations are performed for each class of loans and take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, value of collateral securing the loans and current economic conditions and trends that may affect the borrowers' ability to pay. For example, delinquencies in unsecured loans and indirect automobile installment loans will be reserved for at significantly higher ratios than loans secured by real estate. Based on that analysis, the Bank deems its allowance for credit losses in proportion to the total non-accrual loans and past due loans to be sufficient. - 18 -



Transactions in the allowance for credit losses for the six months ended June 30, 2014 and the year ended December 31, 2013 were as follows:

Commercial Consumer June 30, 2014 and Commercial and Residential (Dollars in Thousands) Industrial Real Estate Indirect Real Estate Unallocated Total

Balance, beginning of year $ 413$ 898$ 1,188 $ 593 $ (120 )$ 2,972 Provision for credit losses 70 (408 ) 184 385 (81 ) 150 Recoveries 2 45 128 6 - 181 Loans charged off (14 ) (137 ) (293 ) (196 ) - (640 ) Balance, end of quarter $ 471$ 398$ 1,207 $ 788 $ (201 )$ 2,663 Individually evaluated for impairment: Balance in allowance $ 259$ 266$ 132 $ 249 $ - $ 906 Related loan balance 347 7,010 697 1,344 - 9,398 Collectively evaluated for impairment: Balance in allowance $ 212$ 132$ 1,075 $ 539 $ (201 )$ 1,757 Related loan balance 3,670 59,200 85,285 127,554 - 275,709 Commercial Consumer December 31, 2013 and Commercial and Residential (Dollars in Thousands) Industrial Real Estate Indirect Real Estate Unallocated Total Balance, beginning of year $ 542$ 1,183$ 1,057 $ 393 $ 133 $ 3,308 Provision for credit losses 46 (374 ) 469 372 (253 ) 260 Recoveries 27 89 314 7 - 437 Loans charged off (202 ) - (652 ) (179 ) - (1,033 ) Balance, end of year $ 413$ 898$ 1,188 $ 593 $ (120 )$ 2,972 Individually evaluated for impairment: Balance in allowance $ 279$ 551$ 179 $ 155 $ - $ 1,164 Related loan balance 279 3,364 637 1,629 - 5,909 Collectively evaluated for impairment: Balance in allowance $ 134$ 347$ 1,009 $ 438 $ (120 )$ 1,808 Related loan balance 3,894 65,415 72,593 127,016 - 268,918 - 19 - As of June 30, 2014 and December 31, 2013, the allowance for loan losses included an unallocated shortfall in the amount of ($201,000) and ($120,000), respectively. Management is comfortable with the shortfall amounts as they are within the internal Bank policy of 5% tolerance for actual required reserves. At At June 30, June 30, 2014 2013 (Dollars in Thousands) Average loans $ 277,473$ 252,132

Net charge-offs to average loans (annualized) 0.33 % 0.14 %



During 2014, loans to 35 borrowers and related entities totaling approximately $640,000 were determined to be uncollectible and were charged off.

Reserve for Unfunded Commitments. As of June 30, 2014, the Bank had outstanding commitments totaling $24,345,000. These outstanding commitments consisted of letters of credit, undrawn lines of credit, and other loan commitments. The following table shows the Bank's reserve for unfunded commitments arising from these transactions: Six Months Ended June 30, 2014 2013 (Dollars in Thousands) Beginning balance $ 200$ 200 Provisions charged to operations - - Ending balance $ 200$ 200



Contractual Obligations and Commitments. No material changes, outside the normal course of business, have been made during the second quarter of 2014.

Market Risk and Interest Rate Sensitivity

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates or equity pricing. The Company's principal market risk is interest rate risk that arises from its lending, investing and deposit taking activities. The Company's profitability is dependent on the Bank's net interest income. Interest rate risk can significantly affect net interest income to the degree that interest bearing liabilities mature or reprice at different intervals than interest earning assets. The Bank's Asset/Liability and Risk Management Committee oversees the management of interest rate risk. The primary purpose of the committee is to manage the exposure of net interest margins to unexpected changes due to interest rate fluctuations. The Company does not utilize derivative financial or commodity instruments or hedging strategies in its management of interest rate risk. The primary tool used by the committee to monitor interest rate risk is a "gap" report which measures the dollar difference between the amount of interest bearing assets and interest bearing liabilities subject to repricing within a given time period. These efforts affect the loan pricing and deposit rate policies of the Company as well as the asset mix, volume guidelines, and liquidity and capital planning. - 20 - The following table sets forth the Company's interest-rate sensitivity at June 30, 2014. Over 1 Over 3 to Through Over 0-3 Months 12 Months 5 Years 5 Years Total (Dollars in Thousands) Assets: Cash and due from banks $ - $ - $ - $ - $ 9,499 Federal funds and overnight deposits 7,066 - - - 7,066 Securities - - 329 83,431 83,760 Loans 15,779 10,398 61,510 193,595 281,282 Fixed assets - - - - 3,736 Other assets - - - - 15,219 Total assets $ 22,845$ 10,398$ 61,839$ 277,026$ 400,562 Liabilities: Demand deposit accounts $ - $ - $ - $ - $ 90,793 NOW accounts 30,818 - - - 30,818

Money market deposit accounts 18,879 - -

- 18,879 Savings accounts 73,433 - - - 73,433 IRA accounts 1,580 12,598 24,572 4,494 43,244 Certificates of deposit 8,571 27,595 46,146 5,608 87,920 Long-term borrowings - - 20,000 - 20,000 Other liabilities - - - - 1,626 Stockholders' equity: - - - - 33,849 Total liabilities and stockholders' equity $ 133,281$ 40,193$ 90,718$ 10,102$ 400,562 GAP $ (110,436 )$ (29,795 )$ (28,879 )$ 266,924 Cumulative GAP $ (110,436 )$ (140,231 )$ (169,110 )$ 97,814 Cumulative GAP as a % of total assets -27.57 % -35.01 % -42.22 % 24.42 % The foregoing analysis assumes that the Company's assets and liabilities move with rates at their earliest repricing opportunities based on final maturity. Mortgage backed securities are assumed to mature during the period in which they are estimated to prepay and it is assumed that loans and other securities are not called prior to maturity. Certificates of deposit and IRA accounts are presumed to reprice at maturity. NOW savings accounts are assumed to reprice at within three months although it is the Company's experience that such accounts may be less sensitive to changes in market rates. In addition to GAP analysis, the Bank utilizes a simulation model to quantify the effect a hypothetical immediate plus or minus 200 basis point change in rates would have on net interest income and the economic value of equity. The model takes into consideration the effect of call features of investments as well as prepayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of June 30, 2014, the model produced the following sensitivity profile for net interest income and the economic value of equity. Immediate Change in Rates -200 -100 +100 +200 Basis Points Basis Points Basis Points Basis Points

% Change in Net Interest Income -4.1 % -1.0 % 1.4 % 3.5 % % Change in Economic Value of Equity -13.5 % -4.9

% -4.1 % -10.5 % - 21 -



Liquidity and Capital Resources

The Company currently has no business other than that of the Bank and does not currently have any material funding commitments. The Company's principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends. The Bank's principal sources of funds for investments and operations are net income, deposits from its primary market area, principal and interest payments on loans, interest received on investment securities and proceeds from maturing investment securities. Its principal funding commitments are for the origination or purchase of loans and the payment of maturing deposits. Deposits are considered a primary source of funds supporting the Bank's lending and investment activities. The Bank's most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, federal funds sold, certificates of deposit with other financial institutions that have an original maturity of three months or less and money market mutual funds. The levels of such assets are dependent on the Bank's operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows. The Bank's cash and cash equivalents (cash due from banks, interest-bearing deposits in other financial institutions, and federal funds sold), as of June 30, 2014, totaled $16,565,000, an increase of $5,612,000 (51.24%) from the December 31, 2013 total of $10,953,000. As of June 30, 2014, the Bank was permitted to draw on a $67,918,000 line of credit from the FHLB of Atlanta. Borrowings under the line are secured by a floating lien on the Bank's residential mortgage loans. At June 30, 2014, there was nothing outstanding in short-term borrowings from FHLB. As of June 30, 2014, there were $20.0 million in long-term convertible advances outstanding with various monthly and quarterly call features and with final maturities through August 2018. In addition, the Bank has three unsecured federal funds lines of credit in the amount of $3.0 million, $5.0 million and $8.0 million, of which nothing was outstanding as of June 30, 2014. The Company's stockholders' equity increased $2,265,000 (7.17%) during the six months ended June 30, 2014, due mainly to an increase in other comprehensive gain (loss), net of taxes, and an increase in retained net income from the period. The Company's accumulated other comprehensive gain (loss), net of taxes increased by $1,829,000 (155.26%) from ($1,178,000) at December 31, 2013 to $651,000 at June 30, 2014, as a result of an increase in the market value of securities classified as available for sale. Retained earnings increased by $357,000 (1.76%) as the result of the Company's net income for the six months, partially offset by dividends. The Federal Reserve Board and the FDIC have established guidelines with respect to the maintenance of appropriate levels of capital by bank holding companies and state non-member banks, respectively. The regulations impose two sets of capital adequacy requirements: minimum leverage rules, which require bank holding companies and 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. At June 30, 2014, the Bank was in full compliance with these guidelines with a Tier 1 leverage ratio of 8.35%, a Tier 1 risk-based capital ratio of 12.56% and a total risk-based capital ratio of 13.65%. - 22 -



Critical Accounting Policies and Estimates

The Company's accounting policies are more fully described in its Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and are essential to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. As discussed there, the preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, the determination of estimates requires the exercise of judgment. Management has used the best information available to make the estimations necessary to value the related assets and liabilities based on historical experience and on various assumptions which are believed to be reasonable under the circumstances. Actual results could differ from those estimates, and such differences may be material to the financial statements. The Company reevaluates these variables as facts and circumstances change. Historically, actual results have not differed significantly from the Company's estimates. The following is a summary of the more judgmental accounting estimates and principles involved in the preparation of the Company's financial statements, including the identification of the variables most important in the estimation process: Allowance for Credit Losses. The Bank's allowance for credit losses is determined based upon estimates that can and do change when the actual events occur, including historical losses as an indicator of future losses, fair market value of collateral, and various general or industry or geographic specific economic events. The use of these estimates and values is inherently subjective and the actual losses could be greater or less than the estimates. For further information regarding the Bank's allowance for credit losses, see "Allowance for Credit Losses", above. Accrued Taxes. Management estimates income tax expense based on the amount it expects to owe various tax authorities. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Company's tax position.


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