Edgar Filing: SEVERN BANCORP INC

june06svbi10q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

0-49731

(Commission File No.)

SEVERN BANCORP, INC.

(Exact Name of registrant as Specified in Its Charter)

Maryland	52-1726127
(State of incorporation)	(IRS employer identification number)
1919 A West Street, Annapolis, Maryland		21401
(Address of principal executive offices)		(Zip Code)

410-268-4554

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2). Yes [ ] No [ X]

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

The registrant has 9,150,250 shares of Common Stock, par value $0.01 per share, outstanding at August 10, 2006

SEVERN BANCORP, INC. AND SUBSIDIARIES

Table of Contents

PART I - FINANCIAL INFORMATION		Page
Item 1.	Financial Statements
	Consolidated Statements of Financial Condition as of June 30, 2006 (Unaudited) and December 31, 2005	1
	Consolidated Statements of Income (Unaudited) for the Three Months and Six Months Ended June 30, 2006 and 2005	2
	Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2006 and 2005	3
	Notes to Consolidated Financial Statements (Unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18

Item 4.	Controls and Procedures	18

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	19

Item 1A.	Risk Factors	19

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19

Item 3.	Defaults Upon Senior Securities	19

Item 4.	Submission of Matters to a Vote of Security Holders	19

Item 5.	Other Information	20

Item 6.	Exhibits	20

SIGNATURES		21

PART I- FINANCIAL INFORMATION

Item 1. Financial Statements

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands, except per share amounts)

		June 30,			December 31,
		2006			2005
		(Unaudited	)
ASSETS
Cash and due from banks	$	11,154		$	8,771
Interest bearing deposits in other banks		1,535			301
Federal funds sold		7,528			15,923
Cash and cash equivalents		20,217			24,995
Investment securities held to maturity		7,911			8,290
Loans held for sale		600			3,216
Loans receivable, net of allowance for loan losses of
$8,262 and $7,505, respectively		833,609			776,117
Premises and equipment, net		24,560			19,963
Federal Home Loan Bank of Atlanta stock at cost		9,108			8,513
Accrued interest receivable and other assets		8,701			8,680

Total assets	$	904,706		$	849,774

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits	$	633,456		$	594,893
Short-term borrowings		-			26,000
Long-term borrowings		165,000			132,000
Subordinated debentures		20,619			20,619
Accrued interest payable and other liabilities		5,850			3,550

Total liabilities		824,925			777,062


Stockholders’ Equity
Common stock, $0.01 par value, 20,000,000 shares authorized;
9,149,950 and 8,318,184 issued and outstanding, respectively		91			83
Additional paid-in capital		28,193			11,516
Retained earnings		51,497			61,113

Total stockholders' equity		79,781			72,712

Total liabilities and stockholders' equity	$	904,706		$	849,774

The accompanying notes to consolidated financial statements are an integral part of these statements.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(dollars in thousands, except per share data)

	For Three Months Ended				For Six Months Ended
	June 30,				June 30,
		2006		2005		2006		2005

Interest Income
Loans	$	17,148	$	13,480	$	33,005	$	25,775
Securities, taxable		68		89		139		174
Other		329		160		656		293
Total interest income		17,545		13,729		33,800		26,242

Interest Expense
Deposits		5,788		3,821		10,614		7,210
Short-term borrowings		159		269		245		381
Long-term borrowings		1,818		1,137		3,750		2,139
Total interest expense		7,765		5,227		14,609		9,730

Net interest income		9,780		8,502		19,191		16,512
Provision for loan losses		375		453		757		695
Net interest income after provision for loan losses		9,405		8,049		18,434		15,817

Other Income
Real estate commissions		1,003		143		1,069		291
Real estate management fees		138		109		247		209
Mortgage banking activities		245		391		444		710
Other		5		154		231		293
Total other income		1,391		797		1,991		1,503

Non-Interest Expenses
Compensation and related expenses		3,066		2,270		5,333		4,523
Occupancy		182		175		371		353
Other		757		811		1,340		1,660
Total non-interest expenses		4,005		3,256		7,044		6,536

Income before income tax provision		6,791		5,590		13,381		10,784
Income tax provision		2,704		2,054		5,312		4,098

Net income	$	4,087	$	3,536	$	8,069	$	6,686

Basic earnings per share	$	.45	$	.39	$	.88	$	.73

Diluted earnings per share	$	.45	$	.39	$	.88	$	.73

Common stock dividends declared per share	$	.06	$	.05	$	.12	$	.11

The accompanying notes to consolidated financial statements are an integral part of these statements.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

	For The Six Months Ended June 30,
		2006			2005

Cash Flows from Operating Activities

Net income	$	8,069		$	6,686
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of deferred loan fees		(2,128	)		(1,798	)
Net amortization of premiums and discounts		15			16
Provision for loan losses		757			695
Provision for depreciation		200			188
Gain on sale of loans		(189	)		(396	)
Proceeds from loans sold to others		16,477			35,257
Loans originated for sale		(13,672	)		(36,222	)
Stock-based compensation expense		99			-
Increase in accrued interest receivable and other assets		(21	)		(479	)
Increase in accrued interest payable and other liabilities		2,300			2,160

Net cash provided by operating activities		11,907			6,107

Cash Flows from Investing Activities

Principal collected on mortgage backed securities		364			609
Net increase in loans		(56,121	)		(82,580	)
Investment in premises and equipment		(4,797	)		(5,727	)
Purchase of Federal Home Loan Bank of Atlanta stock		(595	)		(2,530	)
Net cash used in investing activities		(61,149	)		(90,228	)

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (CONTINUED)

(dollars in thousands)

	For The Six Months Ended June 30,
		2006		2005

Cash Flows from Financing Activities

Net increase in deposits		38,563		35,256
Net increase (decrease) in short-term borrowings		(26,000	)	31,000
Additional borrowed funds, long-term		40,000		20,000
Repayment of borrowed funds, long term		(7,000	)	(2,000	)
Redemption of preferred securities of subsidiary		-		(4,000	)
Cash dividends paid		(1,099	)	(998	)

Net cash provided by financing activities		44,464		79,258

Decrease in cash and cash equivalents		(4,778	)		(4,863	)
Cash and cash equivalents at beginning of year		24,995			18,038

Cash and cash equivalents at end of period	$	20,217		$	13,175

Supplemental disclosure of cash flows information:
Cash paid during period for:

Interest paid	$	14,577		$	9,429

Income taxes paid	$	5,645		$	4,236

The accompanying notes to consolidated financial statements are an integral part of these statements.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Principles of Consolidation

The unaudited consolidated financial statements include the accounts of Severn Bancorp, Inc. (the “Company”), and its wholly owned subsidiaries, Louis Hyatt, Inc., SBI Mortgage Company and SBI Mortgage Company’s subsidiary, Crownsville Development Corporation, and its subsidiary, Crownsville Holdings I, LLC, and Severn Savings Bank, FSB (the “Bank”), and the Bank’s subsidiaries, Homeowners Title and Escrow Corporation, Severn Financial Services Corporation, SSB Realty Holdings, LLC, SSB Realty Holdings II, LLC, HS West, LLC (“HS West”) and Severn Preferred Capital Corporation. All intercompany accounts and transactions have been eliminated in the accompanying financial statements.

Severn Preferred Capital Corporation, which qualified as a real estate investment trust (“REIT) under the Internal Revenue Code of 1986, as amended, liquidated effective January 31, 2005.

Note 2 - Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods presented have been made. Such adjustments were of a normal recurring nature. The results of operations for the six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006 or any other interim period. The unaudited consolidated financial statements for the three and six months ended June 30, 2006 should be read in conjunction with the audited consolidated financial statements and related notes, which are incorporated by reference in the Company’s Annual Report on Form 10-K, for the fiscal year ended December 31, 2005.

Note 3 - Cash Flow Presentation

In the statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, Federal Home Loan Bank of Atlanta (“FHLB Atlanta”) overnight deposits, and federal funds sold. Generally, federal funds are sold for one-day periods.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued

Note 4 - Earnings Per Share and Stock Dividend

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for each period. Diluted earnings per share is computed by dividing net income by weighted average number of shares of common stock outstanding after consideration of the dilutive effect of the Company’s outstanding stock options. Potential common shares related to stock options are determined using the treasury share method. For the three and six month period ended June 30, 2006, all of the Company’s outstanding stock options, which totaled 113,300, were included in the diluted earnings per share calculation. There were no outstanding stock options for the three and six month periods ended June 30, 2005. The below amounts have been retroactively adjusted to give effect to a 10% stock dividend declared on February 21, 2006, effective for shares outstanding on March 28, 2006. The accompanying Statement of Financial Condition as of June 30, 2006 reflects the issuance of 831,766 shares of common stock and the $16,585,000 transfer from retained earnings to common stock and additional paid-in capital related to this 10% stock dividend.

	Three Months Ended			Six Months Ended
	June 30,			June 30,
		2006	2005		2006	2005
Common shares - weighted average (basic)		9,149,950	9,149,950		9,149,950	9,149,950
Common share equivalents - weighted average		10,096	-		3,011	-
Common shares - diluted		9,160,046	9,149,950		9,152,961	9,149,950

Note 5 - Reclassifications

Certain prior year’s amounts have been reclassified to conform to the current year’s method of presentation.

Note 6 - Guarantees

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued have expiration dates within one year. The credit risks involved in issuing letters of credit are essentially the same as those that are involved in extending loan facilities to customers. The Company generally holds collateral supporting these commitments. The Company had $6,366,000 of standby letters of credit outstanding as of June 30, 2006. Management believes that the proceeds obtained through a liquidation of collateral would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The amount of the liability as of June 30, 2006 and December 31, 2005 for guarantees under standby letters of credit issued is not material.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued

Note 7 - Regulatory Matters

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

The following table presents the Bank’s capital position:

	Actual		Actual		To Be Well Capitalized Under
	at June 30, 2006		at December 31, 2005		Prompt Corrective Provisions
Tangible (1)	10.4	%	10.3	%	N/A
Tier I Capital (2)	12.3	%	12.2	%	6.0	%
Core (1)	10.4	%	10.3	%	5.0	%
Total Capital (2)	13.4	%	13.3	%	10.0	%

(1) To adjusted total assets

(2) To risk-weighted assets.

Note 8 - Stock-Based Compensation

The Company currently has a stock-based compensation plan in place for directors, officers, and other key employees of the Company. Under the terms of the plan, the Company grants stock options for the purchase of the Company’s common stock. The stock-based compensation is granted under terms and conditions determined by the Stock Option Committee of the Board of Directors. Stock options generally have a term of five years with a maximum term of ten years, and are granted with an exercise price at least equal to the fair market value of the common stock on the date the options are granted. Generally, options granted to directors of the Company vest immediately, and options granted to officers and employees vest over a five-year period, although the Stock Option Committee has the authority to provide for different vesting schedules.

Effective January 1, 2006, the Company adopted SFAS 123R using the modified-prospective transition method. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the statement of income at fair value. Under the modified-prospective transition method, the Company would recognize an expense over the remaining required service period for any stock options granted prior to January 1, 2006 for the portion of those grants for which the requisite service has not yet been rendered of which there were none. Accordingly, no adjustment was made to prior period amounts nor was any expense recorded for options granted prior to January 1, 2006 for which their requisite service period had been rendered by that date. Stock-based compensation expense for the six months ended June 30, 2006 and June 30, 2005 totaled $99,000 and $0, respectively.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued

The weighted average grant-date fair value of options granted in February 2006, adjusted for stock dividends, was $6.73. The fair value of the options awarded under the option plan is estimated on the date of grant using the Black-Scholes valuation model, which is dependent upon certain assumptions as presented below

	2006
Expected life (in years)	4.83
Risk-free interest rate	4.59%
Expected volatility	53.66%
Expected dividend yield	4.54%

The expected life of the options was estimated using the average vesting period of the options granted and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the grant date. Volatility of the Company’s stock price was based on historical volatility. Dividend yield was based on historical dividends divided by the average market price for that period.

Information regarding the Company’s stock option plan as of June 30, 2006 is as follows:

			Weighted
		Weighted	Average	Aggregate
		Average	Remaining	Intrinsic
	Shares	Price	Life	Value
Options outstanding, beginning of year	-	$ -
Options granted	113,300	17.43
Options outstanding, end of quarter	113,300	$17.43	4.48		$640,000
Options exercisable, end of quarter	9,900	$17.18	2.65		$ 53,000
Option price range at end of quarter	$17.18 to $18.90

There were no stock options exercised during the six months ended June 30, 2006 or June 30, 2005.

Note 9 - Commitments

HS West is constructing a building in Annapolis, Maryland to serve as the Company’s and the Bank’s administrative headquarters. A branch office of the Bank will be included. As of June 30, 2006, HS West has incurred approximately $20.6 million of costs. The total cost is expected to be approximately $25.7 million after interior fit-out, with completion anticipated in the fall of 2006.

SEVERN BANCORP, INC. AND SUBSIDIARIES

Annapolis, Maryland

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued

Note 10 - Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No.155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have a material impact on the Company’s financial statements.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Company will be as of the beginning of fiscal 2007. Management does not believe the adoption of SFAS 156 will have a material effect on the Company’s financial statements.

In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event.” This position amends SFAS 123R to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee’s control does not meet certain conditions in SFAS 123R until it becomes probable that the event will occur. The guidance in this FASB Staff Position shall be applied upon initial adoption of Statement 123R. Management has implemented FAS123R in the first quarter of 2006. Such implementation will not have a material effect on the Company’s financial statements.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - and interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Company

The Company is a savings and loan holding company chartered in the state of Maryland in 1990. It conducts business through three subsidiaries: the Bank, which is the Company’s principal subsidiary; Louis Hyatt, Inc., doing business as Hyatt Commercial, a commercial real estate brokerage and property management company; and SBI Mortgage Company, which holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation, doing business as Annapolis Equity Group, which acquires real estate for syndication and investment purposes. The Bank has three branches in Anne Arundel County, Maryland, which offer a full range of deposit products. The Bank originates mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware and Northern Virginia. The Bank, through its subsidiary HS West, is currently constructing a building in Annapolis, Maryland to serve as the Company’s and the Bank’s administrative headquarters. A branch of the Bank will be included. As of June 30, 2006, HS West had incurred approximately $20.6 million of costs. The total cost is expected to be approximately $25.7 million after interior fit-out, with completion expected in the fall of 2006. The Company’s common stock trades under the symbol “SVBI” on the Nasdaq Capital Market.

Forward Looking Statements

In addition to the historical information contained herein, the discussion in this report contains forward-looking statements that involve risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. The forward-looking statements contained herein include, but are not limited to, those with respect to management’s determination of the amount of loan loss allowance; the effect of changes in interest rates; and changes in deposit insurance premiums. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” “would,” “could,” “should,” “guidance,” “potential,” “continue,” “project,” “forecast,” “confident,” and similar expressions are typically used to identify forward-looking statements. The Company’s operations and actual results could differ significantly from those discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences include, but are not limited to, changes in the economy and interest rates in the nation and Company’s general market area, federal and state regulation, competition and other factors detailed from time to time in the Company’s filings with the Securities and Exchange Commission (the “SEC”), including “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in note 1 of the audited consolidated financial statements as of December 31, 2005 which were filed on Form 10-K. Of these significant accounting policies, the Company considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Company has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements.

The Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (Statement 123R) in the first quarter of 2006, using the “modified prospective method”. Prior to the implementation of FAS 123R, stock options issued under shareholder approved employee and director stock option plans were accounted for under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). Under APB 25, no compensation expense was recognized related to these plans. Stock options are granted at exercise prices not less than the fair value of the common stock on the date of grant. See Note 8 (Stock-Based Compensation) of the accompanying financial statements.

Overview

The primary business of the Company is mortgage lending. The demand for construction lending and purchase money mortgage lending during the first six months of 2006 continued to remain strong, though loan origination activity began to slow. The Company continues to earn a good “spread “ between its cost of funds and what it earns on loans, even though interest rates have steadily risen over the past three years from their historical low levels. In spite of higher interest rates, and indications that loan demand may decrease, the Company’s loan growth in its portfolio has been strong. Loan receivables, net of the allowance for loan losses, increased $57,492,000, or 7.4%, to $833,609,000 at June 30, 2006, compared to $776,117,000 at December 31, 2005.

It is generally anticipated that interest rates will continue to increase. The Company expects to be challenged as it seeks to grow assets in the form of mortgage loans in an environment where its cost of borrowing and interest rates on deposits are likely to increase. As interest rates increase, there may be less demand for mortgage loan refinancing. The Company will continue to balance its pricing and duration of its loan portfolio against the risks of rising costs of its deposits and borrowings.

The continued success and attraction of the markets in which the Company operates will also be important to the Company’s ability to originate and grow its mortgage loans, as will the Company’s continuing ability to maintain low overhead.

Results of Operations

Net income increased by $551,000, or 15.6%, to $4,087,000 for the second quarter of 2006, compared to $3,536,000 for the second quarter of 2005. Basic and diluted earnings per share increased by $.05 or 12.8% to $.44 for the second quarter of 2006, compared to $.39 for the second quarter of 2005. Net income for the six months ended June 30, 2006 increased by $1,383,000, or 20.7%, to $8,069,000, compared to $6,686,000 for the same period in 2005. Basic and diluted earnings per share for the six months ended June 30, 2006 increased by $.15, or 20.5%, to $.88, compared to $.73 for the same period in 2005. The increase in net income and basic and diluted earnings per share over last year is a result of continued growth in the Company’s mortgage portfolio coupled with the Company’s continued ability to maintain low operating expenses. The Company’s interest rate spread increased by .05%, to 4.32% for the six months ended June 30, 2006, compared to 4.27% for the same period in 2005.

Net interest income, which is interest earned net of interest charges, increased by $1,278,000, or 15.0%, to $9,780,000 for the second quarter of 2006, compared to $8,502,000 for the second quarter of 2005. Net interest income for the six months ended June 30, 2006 increased by $2,679,000, or 16.2%, to $19,191,000, compared to $16,512,000 for the same period in 2005. The primary reason for the increase in net interest income was the Company’s growth in interest earning assets. This increase was a result of the continued loan demand and growth of the Company’s mortgage portfolio. Net yield on interest earning assets for the six months ended June 30, 2006 was 4.61% compared to 4.53% for the same period in 2005, a rise of .08%. The growth in net yield was primarily a result of a larger increase in interest earning assets compared to interest-bearing liabilities.

The provision for loan losses decreased by $78,000, or 17.2%, to $375,000 for the second quarter of 2006, compared to $453,000 for the second quarter of 2005. The provision for loan losses for the six months ended June 30, 2006 increased by $62,000, or 8.9%, to $757,000, compared to $695,000 for the same period in 2005. The provision for loan losses and allowance for loan losses are based on management’s judgment and evaluation of the loan portfolio. Management assesses the adequacy of the allowance for loan losses and the need for any addition thereto, by considering the nature and size of the loan portfolio, overall portfolio quality, review of specific problem loans, economic conditions that may affect the borrowers’ ability to pay or the value of property securing loans, and other relevant factors. While management believes the current allowance for loan losses is adequate, changing economic and other conditions may require future adjustments to the allowance for loan losses.

Other income increased by $594,000, or 74.5%, to $1,391,000 for the second quarter of 2006, compared to $797,000 for the second quarter of 2005. Other income for the six months ended June 30, 2006 increased by $488,000, or 32.5%, to $1,991,000, compared to $1,503,000 for the same period in 2005. The primary reason for the increase in other income in those periods was an increase in real estate commissions. Real estate commissions increased $860,000, or 601.4%, to $1,003,000 for the second quarter of 2006, compared to $143,000 for the second quarter of 2005. Real estate commissions for the six months ended June 30, 2006 increased $778,000, or 267.4%, to $1,069,000, compared to $291,000 for the same period in 2005. This increase was a result of the settlement of three commercial properties at Hyatt Commercial in the second quarter. In addition, mortgage-banking activities decreased by $146,000, or 37.3%, to $245,000 for the second quarter of 2006, compared to $391,000 for the same period in 2005. This decrease was primarily a result of a $131,000 decrease in gain on sale of loans, and a $15,000 decrease in mortgage processing and servicing fees. These decreases were a result of a decrease in loans sold on the secondary market, and in residential loans being refinanced during the second quarter of 2006 compared to the second quarter of 2005. Mortgage banking activity decreased by $266,000, or 37.5%, to $444,000 for the six months ended June 30, 2006, compared to $710,000 in the same period in 2005. This decrease was primarily a result of a $199,000 decrease in gain on sale of loans, and a $67,000 decrease in mortgage processing and servicing fees.

Total non-interest expenses increased by $749,000, or 23.0%, to $4,005,000 for the second quarter of 2006, compared to $3,256,000 for the second quarter of 2005. Total non-interest expenses for the six months ended June 30, 2006 increased $508,000, or 7.8%, to $7,044,000, compared to $6,536,000 for the same period in 2005. Compensation and related expenses increased by $796,000, or 35.1%, to $3,066,000 for the second quarter of 2006, compared to $2,270,000 for the same period in 2005. Total compensation and related expenses for the six months ended June 30, 2006 increased by $810,000, or 17.9%, to $5,333,000, compared to $4,523,000 for the same period in 2005. This increase was primarily because of commissions paid by Hyatt Commercial to the commercial real estate agent involved in the three commercial property settlements in the second quarter of 2006, and higher salaries and commissions paid in 2006. Other non-interest expenses decreased by $54,000, or 6.7%, to $757,000 for the second quarter of 2006, compared to $811,000 for the second quarter of 2005. Other non-interest expenses for the six months ended June 30, 2006 decreased $320,000, or 19.3%, to $1,340,000, compared to $1,660,000 for the same period in 2005. The decrease in 2006 was primarily due to one-time write-offs of $214,000 taken in the first quarter of 2005.

Income Taxes

The income tax provision increased by $650,000, or 31.6%, to $2,704,000 for the second quarter of 2006, compared to $2,054,000 for the second quarter of 2005. The income tax provision for the six months ended June 30, 2006 increased by $1,214,000, or 29.6%, to $5,312,000, compared to $4,098,000 for the same period in 2005. The effective tax rate for the six months ended June 30, 2006 was 39.7% compared to 38.0% for the same period in 2005.

Analysis of Financial Condition

Total assets increased by $54,932,000, or 6.5%, to $904,706,000 at June 30, 2006, compared to $849,774,000 at December 31, 2005. Cash and cash equivalents decreased by $4,778,000, or 19.1%, to $20,217,000 at June 30, 2006, compared to $24,995,000 at December 31, 2005. This decrease was primarily due to decreased federal funds sold to satisfy loans growth. Loan demand continued to grow during 2006, as net loans receivable increased $57,492,000, or 7.4%, to $833,609,000 at June 30, 2006, compared to $776,117,000 at December 31, 2005. Loans held for sale decreased $2,616,000, or 81.3%, to $600,000 at June 30, 2006, compared to $3,216,000 at December 31, 2005. Total deposits increased $38,563,000, or 6.5%, to $633,456,000 at June 30, 2006 compared to $594,893,000 at December 31, 2005. This increase is primarily attributable to an ongoing campaign by the Company to attract money market deposit accounts and promotions to obtain shorter-term certificates of deposit. FHLB Atlanta advances increased $7,000,000, or 4.4%, to $165,000,000 at June 30, 2006, compared to $158,000,000 as of December 31, 2005. This is a result of purchasing long term FHLB Atlanta advances to assist with loan growth and to take advantage of current market rates in a rising rate environment.

Stockholders’ Equity

Total stockholders’ equity increased $7,069,000, or 9.7%, to $79,781,000 at June 30, 2006 compared to $72,712,000 as of December 31, 2005. This increase is primarily a result of net earnings, offset by dividends declared.

Asset Quality

Non-accrual loans (those loans 120 or more days in arrears) increased $281,000, or 16.6%, to $1,974,000 as of June 30, 2006, compared to $1,693,000 as of December 31, 2005. This increase is a result of an increase in the number and size of loans that were 120 or more days in arrears at June 30, 2006. There were no charge offs in the six months ended June 30, 2006. At June 30, 2006, the total allowance for loan losses was $8,262,000, which was .99% of total net loans, compared with $7,505,000, which was .96% of total net loans as of December 31, 2005. The allowance for loan losses is based on management’s judgment and evaluation of the loan portfolio. Management assesses the adequacy of the allowance for loan losses and the need for any addition thereto, by considering the nature and size of the loan portfolio, overall portfolio quality, review of specific problem loans, economic conditions that may affect the borrowers’ ability to pay or the value of property securing loans, and other relevant factors. While management believes the current allowance is adequate, changing economic and other conditions may require future adjustments to the allowance for loan losses.

Liquidity

The Company’s liquidity is determined by its ability to raise funds through loan payments, maturing investments, deposits, borrowed funds, capital, and the sale of loans. Based on the internal and external sources available, the Company’s liquidity position exceeded anticipated short-term and long-term needs at June 30, 2006. Additionally, loan payments, maturities, deposit growth and earnings contribute a flow of funds available to meet liquidity requirements.

In assessing its liquidity, the management of the Company considers operating requirements, anticipated deposit flows, expected funding of loans, deposit maturities and borrowing availability, so that sufficient funds may be available on short notice to meet obligations as they arise so that the Company may take advantage of business opportunities.

Management believes it has sufficient cash flow and liquidity to meet its current commitments. Certificates of deposit, which are scheduled to mature in less than one year, totaled $400,265,000 at June 30, 2006. Based on past experience, management believes that a significant portion of such deposits will remain with the Company. At June 30, 2006, the Company had commitments to originate loans of $34,189,000, unused lines of credit of $34,986,000, and commitments under standby letters of credit of $6,366,000. In addition, the Company expects to incur an additional $5,096,000, including interior fit-out, for construction costs associated with its new headquarters. The Company has the ability to reduce its commitments for new loan originations, adjust other cash outflows, and borrow from FHLB Atlanta should the need arise. As of June 30, 2006, outstanding FHLB Atlanta borrowings totaled $165,000,000, and the Company had available to it up to an additional $104,395,000 in borrowing availability from FHLB Atlanta.

Net cash provided by operating activities increased $5,800,000 to $11,907,000 for the six months ended June 30, 2006, compared to $6,107,000 for the same period in 2005. This increase is primarily the result of a net increase in proceeds of loans sold to others to loans originated for sale and higher net income in 2006. Net cash used in investing activities decreased $29,079,000 to $61,149,000 for the six months ended June 30, 2006, compared to $90,228,000 for the same period in 2005. This decrease is primarily due to a decrease in loan originations. Net cash provided by financing activities decreased by $34,794,000 to $44,464,000 for the six months ended June 30, 2006, compared to $79,258,000 for the same period in 2005. This decrease is primarily due to a decrease in short-term borrowings from FHLB Atlanta partially offset by an increase in long term FHLB advances. As a result, cash and cash equivalents increased $7,042,000 to $20,217,000 at June 30, 2006, compared to $13,175,000 at June 30, 2005.

Effects of Inflation

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

Average Balance Sheet

The following table presents the Company’s distribution of the average consolidated balance sheets and net interest analysis for the six months ended June 30, 2006 and June 30, 2005.

	Six Months Ended June 30, 2006			Six Months Ended June 30, 2005
	Average Balance	Interest	Rate Annualized	Average Balance	Interest	Rate Annualized
	(dollars in thousands)
ASSETS
Loans (1)	$804,120	$33,005	8.21%	$706,514	$25,775	7.30%
Investments (2)	5,000	76	3.04%	5,000	77	3.08%
Mortgage-backed securities	3,116	63	4.04%	4,526	97	4.29%
Other interest-earning assets (3)	20,728	656	6.33%	12,732	293	4.60%

Total interest-earning assets	832,964	33,800	8.12%	728,772	26,242	7.20%

Non-interest earning assets	40,011			24,322

Total assets	$872,975			$753,094

LIABILITIES AND STOCKHOLDERS' EQUITY
Savings and checking deposits	$141,177	1,192	1.69%	$159,123	1,106	1.39%
Certificates of deposit	473,942	9,422	3.98%	383,244	6,104	3.19%
Short-term borrowings	8,500	245	5.76%	27,333	381	2.79%
Long-term borrowings	145,833	3,750	5.14%	94,333	2,139	4.53%

Total interest-bearing liabilities	769,452	14,609	3.80%	664,033	9,730	2.93%

Non-interest bearing liabilities	26,621			25,742

Stockholders' equity	76,902			63,319

Total liabilities and stockholders’ equity	$872,975			$753,094

Net interest income and interest rate spread		$19,191	4.32%		$16,512	4.27%

Net interest margin			4.61%			4.53%

Average interest-earning assets to average interest-bearing liabilities			108.25%			109.75%

(1)	Non-accrual loans are included in the average balances and in the computation of yields.

(2)	The Company does not have any tax-exempt securities.

(3)	Other interest-earning assets includes interest-bearing deposits in other banks, federal funds and FHLB stock investments.

Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of financial position. The contract amounts of these instruments express the extent of involvement the Company has in each class of financial instruments.

The Company’s exposure to credit loss from non-performance by the other party to the above mentioned financial instruments is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at June 30, 2006, as a liability for credit loss.

Off-balance sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:

Financial Instruments Whose Contract		Contract Amount At
Amounts Represent Credit Risk		June 30, 2006
		(dollars in thousands)
Standby letters of credit	$	6,366
Home equity lines of credit	$	24,310
Unadvanced construction commitments	$	115,047
Loan commitments	$	9,879
Lines of credit	$	34,986
Loans sold with limited repurchase
provisions	$	9,215

Legal Proceedings

There are various claims pending involving the Company, arising in the normal course of business. Management believes, based upon consultation with legal counsel, that liabilities arising from these proceedings, if any, will not be material to the Company’s financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in market risk since December 31, 2005, as reported in Company’s Form 10-K filed with the SEC on or about March 21, 2006.

Item 4. Controls and Procedures

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)) as of June 30, 2006. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2006, the Company’s disclosure controls and procedures were effective in reaching a reasonable level of assurance that (i) information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information required to be disclosed by the Company in its reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

None other than ordinary routine litigation incidental to the Company’s business.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risk factors in our Annual Report on Form 10-K have not materially changed. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

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

The Company held its Annual Meeting of Shareholders on April 26, 2006, at which it (a) re-elected four individuals to serve additional three-year terms as directors and (b) ratified the appointment of Beard Miller Company LLP as the Company’s independent auditors for the fiscal year ending December 31, 2006.

The names of the Directors who were re-elected at the Annual Meeting of Shareholders are as follows:

	Votes For	Votes Against	Votes Withheld
Alan J. Hyatt	7,361,469	0	57,222
Louis DiPasquale, Jr.	7,417,091	0	1,600
Melvin G. Meekins, Jr.	7,359,469	0	59,222
Keith Stock	7,417,091	0	1,600

The names of the Directors whose terms of office continued after the Annual Meeting of Shareholders are as follows:

Melvin Hyatt

S. Scott Kirkley

Ronald P. Pennington

T. Theodore Schultz

Albert W. Shields

The shareholders of the Company ratified the appointment of Beard Miller Company LLP as the Company’s independent auditors for the fiscal year ending December 31, 2006

	Votes For	Votes Against	Votes Abstain
Appointment of Beard Miller Company LLP as independent auditors	7,414,991	1,700	2,000

Item 5. Other Information.

None.

Item 6. Exhibits.

Exhibit No. Description

31.1 Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2 Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.

Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Under the requirements 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.

		SEVERN BANCORP, INC.


August 11, 2006		Alan J. Hyatt
		Alan J. Hyatt, Chairman of the Board, President and Chief Executive Officer
		(Principal Executive Officer)


August 11, 2006		Thomas G. Bevivino
		Thomas G. Bevivino, Chief Financial Officer
		(Principal Financial and Accounting Officer)

Exhibit Index

Exhibit No. Description

31.1 Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2 Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.

Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002