Exhibit (a) to Schedule 13E-3

                                  [PRELIMINARY]
                          HARBOR BANKSHARES CORPORATION
                             25 WEST FAYETTE STREET
                            Baltimore, Maryland 21201


                                 October__, 2006

To Our Shareholders:


       On behalf of our Board of Directors, we cordially invite you to attend
the Annual Meeting of Shareholders of Harbor Bankshares Corporation to be held
at Harbor's main office at 25 West Fayette Street, Baltimore, Maryland 21201 on
Wednesday, November __, 2006, at 12:00 noon Eastern Time. The formal Notice of
Annual Meeting appears on the next page.


       At the Annual Meeting, you will be asked to consider and vote on the
approval of a merger agreement which provides for the merger of Harbor
Bankshares Corporation with Harbor Merger Corporation, its wholly-owned
subsidiary, in what is commonly referred to as a "going private" transaction.
Harbor Bankshares Corporation will continue after the merger as the surviving
company.

       The purpose of the merger is to reduce the number of our shareholders of
record to fewer than 300, as required for the suspension of our reporting
requirements under Section 13 of the Securities Exchange Act of 1934, in order
to eliminate the significant expense required to comply with the those
requirements.

       If you approve the merger agreement and the merger is completed, each
share of Harbor Bankshares Corporation common stock owned of record at the
effective time of the merger by a shareholder owning 100 or fewer shares (other
than shareholders who properly exercise their rights as objecting shareholders)
will be converted into the right to receive from Harbor Bankshares Corporation
$31.00 in cash per share, without interest. Shares owned of record by a holder
of more than 100 shares will remain as outstanding shares of Harbor Bankshares
Corporation common stock after the merger and those shareholders will not
receive any cash payment.

       Because Harbor Bankshares Corporation has a large number of shareholders
who own 100 or fewer shares each, we expect that the merger will reduce the
number of shareholders of record by approximately 58%, but will reduce the
number of total outstanding shares by less than 2%.

       Our Board of Directors believes that the merger agreement is fair to our
shareholders and is in the best interests of Harbor Bankshares Corporation and
its affiliated and unaffiliated shareholders and unanimously recommends that
shareholders vote FOR approval of the merger agreement, and FOR adjournment of
the meeting if necessary to solicit additional votes for approval of the merger
agreement. The approval of the merger agreement requires the affirmative vote of
the holders of at least two-thirds (2/3) of the outstanding voting shares of
Harbor Bankshares Corporation common stock, including a majority of voting
shares held by shareholders who are not Directors or executive officers of
Harbor.

       The enclosed proxy statement gives you detailed information about the
Annual Meeting, the merger, and related matters. We urge you to read carefully
the enclosed proxy statement, including the considerations discussed under
"SPECIAL FACTORS," beginning on page 12, and the appendices to the proxy
statement, which include the merger agreement. Shareholders also are asked to
reelect Nathaniel Higgs, Delores G. Kelley, Erich March, and Stanley W. Tucker
as Class II Directors for three-year terms.

         In deciding how to vote, you should consider that Directors and
executive officers of Harbor have interests in addition to those as shareholders
that may conflict with the interests of unaffiliated shareholders. Please see
"How do the Board of Directors and the executive officers recommend that I
vote?" on page 8.

       It is important that your views be represented whether or not you attend
the Annual Meeting. Your vote is important, whether you own a few shares or
many. We urge you to vote your shares either in person at the Annual Meeting or
by returning your proxy as soon as possible. THE BOARD OF DIRECTORS RECOMMENDS
THAT SHAREHOLDERS VOTE FOR APPROVAL OF THE MERGER, FOR ADJOURNMENT OF THE ANNUAL
MEETING, IF NECESSARY, AND FOR REELECTION OF THE FOUR CLASS II DIRECTORS.


       Sincerely,

       Joseph Haskins, Jr.
       Chairman, President, and Chief
         Executive Officer


                          HARBOR BANKSHARES CORPORATION
                             25 WEST FAYETTE STREET
                            BALTIMORE, MARYLAND 21201

                    NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

                                               To Be Held November __, 2006


       To Our Shareholders:


       The Annual Meeting of Shareholders of Harbor Bankshares Corporation will
be held at Harbor's main office at 25 West Fayette Street, Baltimore, Maryland
21201 on Wednesday, November __, 2006, at 12:00 noon Eastern Time, for the
following purposes:

                    o Proposal I--To consider and vote upon a proposal to
                      approve the Agreement and Plan of Merger, dated as of
                      September __, 2006, by and between Harbor Bankshares
                      Corporation and Harbor Merger Corporation, a Maryland
                      corporation and wholly-owned subsidiary of Harbor
                      Bankshares Corporation (the "merger subsidiary"), pursuant
                      to which the merger subsidiary will merge with and into
                      Harbor Bankshares Corporation, with Harbor Bankshares
                      Corporation being the surviving corporation;


                    o Proposal II--To consider and vote upon the proposal for an
                      adjournment of the Annual Meeting to solicit additional
                      proxies for approval of Proposal I, if necessary.

                    o Proposal III--To elect four Class II Directors, each to
                      serve for a three-year term; and

                    o To act upon such other matters as may properly come before
                      the Annual Meeting or any adjournments or postponements
                      thereof.

       Note: The Board of Directors is not aware of any other business to come
before the Special meeting.


       The Board of Directors has fixed the close of business on October __,
2006, as the record date for determination of shareholders entitled to vote at
the Annual Meeting. The Harbor Board of Directors unanimously recommends that
you vote FOR approval of the merger agreement, FOR an adjournment of the Annual
Meeting to solicit additional proxies for approval of the merger agreement, if
necessary, and FOR the election of four Class II Directors.


       Only shareholders of record of Harbor Bankshares Corporation voting
common stock at the close of business on the record date will be entitled to
notice of, and to vote at the Annual Meeting or any adjournment thereof. To
grant a proxy to vote your shares, you may complete and return the enclosed
proxy card. You also may vote in person at the Annual Meeting. Please vote
promptly whether or not you expect to attend the Annual Meeting. In the event
that there are not sufficient votes to vote upon the merger or to approve other
business properly before the Annual Meeting, the Annual Meeting may be adjourned
in order to permit further solicitation of proxies by Harbor Bankshares
Corporation.

       You are requested to fill in and sign the enclosed Form of Proxy and to
mail it in the enclosed envelope. The Proxy will not be used if you attend and
choose to vote in person at the Annual Meeting. EXECUTED BUT UNMARKED PROXIES
WILL BE VOTED FOR PROPOSAL I TO APPROVE THE AGREEMENT AND PLAN OF MERGER, FOR
PROPOSAL II FOR AN ADJOURNMENT OF THE ANNUAL MEETING TO SOLICIT ADDITIONAL
PROXIES FOR APPROVAL OF PROPOSAL I, IF NECESSARY. AND FOR THE ELECTION OF THE
FOUR CLASS II DIRECTORS.

       Harbor Bankshares Corporation's only class of voting stock is its common
stock, par value $0.01 per share. A complete list of shareholders entitled to
vote at the Annual Meeting will be available for inspection by any shareholder
at the offices of Harbor Bankshares Corporation during ordinary business hours
for a period of at least ten days prior to the Annual Meeting.

       By Order of the Board of Directors,


       George F. Vaeth, Jr.
       Corporate Secretary
       Baltimore, Maryland
       October__, 2006


       YOUR VOTE IS IMPORTANT. PLEASE PROMPTLY SIGN, DATE, AND RETURN THE
ENCLOSED PROXY CARD. IF YOU ATTEND THE ANNUAL MEETING AND DECIDE THAT YOU WISH
TO VOTE IN PERSON OR FOR ANY OTHER REASON DESIRE TO REVOKE YOUR PROXY, YOU CAN
DO SO AT ANY TIME PRIOR TO ITS USE.


                          HARBOR BANKSHARES CORPORATION
                             25 WEST FAYETTE STREET
                            BALTIMORE, MARYLAND 21201


                                 PROXY STATEMENT
                     FOR THE ANNUAL MEETING OF SHAREHOLDERS

                         To Be Held on November __, 2006


                                  INTRODUCTION



       This Proxy Statement is being sent to holders of the common stock, $0.01
par value, of Harbor Bankshares Corporation, a Maryland corporation ("Harbor" or
the "Company"), in connection with the solicitation of proxies by the Board of
Directors of Harbor for use at the 2006 Annual Meeting of Shareholders to be
held at Harbor's main office at 25 West Fayette Street, Baltimore, Maryland
21201 on Wednesday, November __, 2006, at 12:00 noon Eastern Time, and at any
adjournment or postponement of the meeting, for the following purposes:

                    o Proposal I--To consider and vote upon a proposal to
                      approve the Agreement and Plan of Merger, dated as of
                      September __, 2006, by and between Harbor Bankshares
                      Corporation and Harbor Merger Corporation, a Maryland
                      corporation and wholly-owned subsidiary of Harbor
                      Bankshares Corporation (the "merger subsidiary"), pursuant
                      to which the merger subsidiary will merge with and into
                      Harbor Bankshares Corporation, with Harbor Bankshares
                      Corporation being the surviving corporation;


                    o Proposal II--To consider and vote upon the proposal for an
                      adjournment of the Annual Meeting to solicit additional
                      proxies for approval of Proposal I, if necessary.

                    o Proposal III--To elect four Class II Directors, each to
                      serve for a three-year term; and

                    o To act upon such other matters as may properly come before
                      the Annual Meeting or any adjournments or postponements
                      thereof.

       THE PURPOSE OF THE AGREEMENT AND PLAN OF MERGER IS TO ALLOW HARBOR TO
ELIMINATE THE SUBSTANTIAL EXPENSES OF BEING A SECURITIES AND EXCHANGE COMMISSION
("SEC") REPORTING COMPANY UNDER THE SECURITIES EXCHANGE ACT OF 1934. IF APPROVED
AND COMPLETED, THE MERGER WILL REDUCE THE NUMBER OF HARBOR RECORD SHAREHOLDERS
TO FEWER THAN 300, AND WILL ALLOW HARBOR TO TERMINATE THE REGISTRATION OF ITS
COMMON STOCK UNDER THE EXCHANGE ACT.

       IN THE MERGER, HOLDERS OF RECORD OF 100 OR FEWER SHARES WILL RECEIVE
$31.00 PER SHARE IN EXCHANGE FOR THEIR SHARES; HOLDERS OF MORE THAN 100 SHARES
WILL REMAIN SHAREHOLDERS OF HARBOR AFTER THE MERGER. THE MERGER CANNOT OCCUR
UNLESS THE MERGER AGREEMENT IS APPROVED BY THE HOLDER OF AT LEAST TWO-THIRDS
(2/3) OF THE OUTSTANDING SHARES OF HARBOR COMMON STOCK THAT ARE ELIGIBLE TO
VOTE, INCLUDING A MAJORITY OF VOTING SHARES HELD BY SHAREHOLDERS WHO ARE NOT
DIRECTORS OR EXECUTIVE OFFICERS OF HARBOR.

       THIS DOCUMENT PROVIDES YOU WITH DETAILED INFORMATION ABOUT THE PROPOSED
MERGER. PLEASE SEE THE "SUMMARY TERM SHEET" ON PAGE 4 AND THE OTHER MATERIAL
REFERRED TO THEREIN FOR IMPORTANT ADDITIONAL INFORMATION AND "WHERE YOU CAN FIND
MORE INFORMATION" ON PAGE 49 FOR ADDITIONAL INFORMATION ABOUT HARBOR ON FILE
WITH THE SEC.


       This Proxy Statement and the accompanying form of proxy are being sent to
Harbor shareholders on or about October__, 2006.

       Only shareholders of record of voting common stock at the close of
business on October __, 2006, the record date, are entitled to notice of and to
vote at the annual meeting and any adjournment or postponement of the meeting.
As of __________, 2006, there were 675,579 shares of Harbor common stock, par
value $0.01 per share, outstanding, consisting of 641,784 shares of voting
common stock and 33,795 shares of nonvoting common stock.


       The cost of soliciting proxies will be borne by Harbor. In addition to
the solicitation of proxies by mail, Harbor also may solicit proxies personally
or by telephone or other means through its Directors, officers, and regular
employees. Harbor also will request persons, firms, and corporations holding
shares in their names or in the name of nominees that are beneficially owned by
others to send proxy materials to and obtain proxies from those beneficial
owners and will reimburse the holders for their reasonable expenses in doing so.

       For additional information regarding the annual meeting and related
corporate matters, please see "COMPANY CORPORATE GOVERNANCE" on page 40 and "THE
ANNUAL MEETING" on page 47.

                                       1


       THIS TRANSACTION HAS NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE FAIRNESS OR
MERITS OF SUCH TRANSACTION OR UPON THE ACCURACY OR ADEQUACY OF THE INFORMATION
CONTAINED IN THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.

                                       2


                          HARBOR BANKSHARES CORPORATION
                                 PROXY STATEMENT
                                TABLE OF CONTENTS


INTRODUCTION................................................................................................................1
PROPOSAL I--AGREEMENT AND PLAN OF MERGER....................................................................................6
SUMMARY TERM SHEET..........................................................................................................6
      o     Why is Harbor proposing the merger?.............................................................................6
      o     What are the effects of not being a reporting company?..........................................................6
      o     What will I receive if the merger is approved by shareholders and becomes effective?............................6
      o     When will the merger become effective?..........................................................................6
      o     Who are "Filing Persons" and "Affiliates"?......................................................................6
      o     Does the Board of Directors believe that the terms of the merger are fair?......................................7
      o     What is the merger, and how will Harbor be operated after the merger?...........................................7
      o     What vote is required to approve the merger agreement?..........................................................7
      o     Who is entitled to vote?........................................................................................7
      o     How do the Board of Directors and the executive officers recommend that I vote?.................................8
      o     How do I vote?..................................................................................................8
      o     Do I have appraisal or dissenter's rights?......................................................................8
      o     What are the federal income tax implications of the merger?.....................................................8
      o     Should I send in my certificates now?...........................................................................8
      o     Who can help answer my questions?...............................................................................8
STATEMENT REGARDING FORWARD-LOOKING INFORMATION.............................................................................8
SUMMARY FINANCIAL INFORMATION...............................................................................................9
   Selected Historical Financial Information................................................................................9
   Summary Unaudited Pro Forma Financial Information.......................................................................10
CONSOLIDATED UNAUDITED RATIO OF EARNINGS TO FIXED CHARGES..................................................................11
SPECIAL FACTORS............................................................................................................12
   Background of the Merger................................................................................................12
   Reasons for the Merger..................................................................................................14
   Recommendation of the Board of Directors; Fairness of the Merger Proposal...............................................16
   Merger Subsidiary's Determination of Fairness of the Merger Proposal....................................................17
   Fairness Determination by Filing Persons................................................................................17
   Opinion of Financial Advisor............................................................................................17
   Updated Opinion.........................................................................................................18
   Initial Opinion.........................................................................................................23
   Price Adjustment since Initial Opinion Date.............................................................................23
   Effects of the Merger...................................................................................................24
   Effects of the Merger on Shareholders...................................................................................26
   Interests of Executive Officers and Directors in the Merger.............................................................27
   Conduct of Harbor's Business after the Merger...........................................................................28
   Fees and Expenses.......................................................................................................28
   Accounting Treatment....................................................................................................29
   Material U.S. Federal Income Tax Consequences...........................................................................29
APPRAISAL RIGHTS OF HARBOR SHAREHOLDERS....................................................................................31
GOVERNMENTAL REQUIREMENTS..................................................................................................33
MARKET FOR COMMON STOCK AND DIVIDENDS......................................................................................33
THE PARTIES................................................................................................................33
   Harbor Bankshares Corporation...........................................................................................33
   The Harbor Bank of Maryland.............................................................................................33
   Harbor Merger Corporation...............................................................................................33


                                       3


   Security Ownership of Certain Beneficial Owners and Management..........................................................34
   Recent Transactions.....................................................................................................35
   Prior Stock Purchases...................................................................................................35
THE MERGER AGREEMENT.......................................................................................................35
   Structure of the Merger.................................................................................................35
   Conversion of Shares in the Merger......................................................................................35
   Treatment of Options....................................................................................................36
   Exchange of Certificates................................................................................................36
   Effective Time of the Merger............................................................................................37
   Directors and Officers..................................................................................................37
   Articles of Incorporation and Bylaws....................................................................................37
   Representations and Warranties..........................................................................................37
   Conditions to the Completion of the Merger..............................................................................37
   Termination of Merger Agreement.........................................................................................38
PROPOSAL II--ADJOURNMENT OF THE ANNUAL MEETING.............................................................................39
PROPOSAL III--ELECTION OF DIRECTORS........................................................................................39
   Directors to be elected at the 2006 Annual Meeting to serve until the 2008 Annual Meeting (Class II)....................39
   Continuing Directors....................................................................................................39
COMPANY CORPORATE GOVERNANCE...............................................................................................40
   General.................................................................................................................40
   Board Organization and Operation........................................................................................40
   Board Committees........................................................................................................41
   Nomination Process......................................................................................................41
   Director Attendance at the Corporation Annual Meeting...................................................................42
   Shareholder Communication with the Board................................................................................42
   Shareholder Proposals...................................................................................................42
   Section 16(a) Beneficial Ownership Reporting Compliance.................................................................42
   Code of Ethics and Business Conduct.....................................................................................43
OWNERS OF MORE THAN 5% OF HARBOR COMMON STOCK..............................................................................43
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS...........................................................................43
   Summary Compensation Table..............................................................................................43
   Option Grants in Last Fiscal Year.......................................................................................44
   Aggregated Option Exercises in Last Fiscal Year and Year End Value of Options...........................................44
   Compensation of Directors...............................................................................................44
   Mr. Haskins' Employment Agreement and Retirement Benefit................................................................45
   Information Regarding Mr. Hernandez.....................................................................................45
   Certain Relationships and Related Transactions..........................................................................46
INDEPENDENT PUBLIC ACCOUNTANTS.............................................................................................46
   General.................................................................................................................46
   Audit and Non-Audit Fees................................................................................................46
   Policy on Audit Committee Pre-Approval of Audi and Non-Audit Services...................................................47
THE ANNUAL MEETING.........................................................................................................47
   Purpose.................................................................................................................47
   Date, Place and Time of Annual Meeting..................................................................................47
   Shares Entitled to Vote; Quorum and Vote Required.......................................................................47
   Voting Procedures and Revocation of Proxies.............................................................................48
   Attending the Annual Meeting............................................................................................48
   Annual Report...........................................................................................................48
   Other Matters to be Considered..........................................................................................48
   Solicitation of Proxies and Expenses....................................................................................48
OTHER MATTERS..............................................................................................................48
WHERE YOU CAN FIND MORE INFORMATION........................................................................................49

                                       4



DOCUMENTS INCORPORATED BY REFERENCE........................................................................................49
Appendix A--Agreement and Plan of Merger
Appendix B--Fairness Opinion
Appendix C--Rights of Objecting Shareholders
Appendix D--Form 10-KSB
Appendix E--Form 10-QSB for the quarter ended June 30, 2006


                                       5


                    PROPOSAL I--AGREEMENT AND PLAN OF MERGER

                               SUMMARY TERM SHEET

       THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROXY STATEMENT
REGARDING THE PROPOSED TRANSACTION AND MAY NOT CONTAIN ALL OF THE INFORMATION
THAT IS IMPORTANT TO YOU. FOR A MORE COMPLETE DESCRIPTION OF THE TERMS AND
CONDITIONS OF THE TRANSACTION AND ITS EFFECTS, YOU SHOULD CAREFULLY READ THIS
ENTIRE DOCUMENT, THE ATTACHMENTS, AND ANY OTHER DOCUMENTS TO WHICH WE REFER.

       o WHY IS HARBOR PROPOSING THE MERGER?

       The purpose of the merger is to reduce the number of shareholders of
record below 300, which will enable Harbor to terminate the registration of its
common stock under the Securities Exchange Act of 1934.

       By terminating the Harbor's registration under that Act, we hope to:

                    o Achieve significant savings in ongoing legal and
                      accounting costs related to the reporting process and
                      shareholder communications required by the Act;

                    o Avoid significant expenses and efforts that would be
                      necessary for the Company to comply with additional
                      procedures relating to internal control that otherwise are
                      required by year-end 2007 under the Sarbanes-Oxley Act and
                      SEC regulations; and.

                    o Enable management, employees, and the Board of Directors
                      to focus their efforts on the operations and management of
                      the Company's business, rather than the reporting
                      processes.

       See "SPECIAL FACTORS--Reasons for the Merger" on page 14.

       o WHAT ARE THE EFFECTS OF NOT BEING A REPORTING COMPANY?

       After we terminate the registration of our common stock, we will no
longer prepare and file the quarterly, annual, and other reports and proxy
statements with the Securities and Exchange Commission. We will continue to
issue reports and proxy materials, but these may not contain all of the
information that is contained in the annual report and proxy statements that
Harbor currently distributes.

       Harbor common stock is not currently traded on any exchange and will not
be listed or quoted on any exchange following the merger, but is traded from
time to time in the over the counter market. After we terminate the registration
of our common stock, we will not be eligible for future quotation or listing on
any stock exchange or organized market, and the number of trading markets where
the shares may be traded by market makers will be limited.


       Harbor and its wholly owned subsidiary, Harbor Bank of Maryland ("Harbor
Bank" or the "Bank") will continue to be highly regulated and subject to
periodic examination by federal and state bank regulatory agencies


       See "Special Factors--Effects of the Merger" on page 17 and `--Reasons
for the Merger" on page 14.

       o WHAT WILL I RECEIVE IF THE MERGER IS APPROVED BY SHAREHOLDERS AND
         BECOMES EFFECTIVE?

       If the merger is approved by shareholders and becomes effective:

                    o Each holder of 100 or fewer shares of common stock will
                      receive $31.00 in cash per share. Share ownership will be
                      calculated by adding all shares registered in the same
                      manner under procedures established by Harbor.


                    o Each holder of more than 100 shares of common stock will
                      continue as a Harbor shareholder and will own the same
                      number of shares as the holder owned before the merger.


       o WHEN WILL THE MERGER BECOME EFFECTIVE?

       The Board of Directors currently plans to make the merger effective
within thirty calendar days of the date on which shareholders approve the
merger.

       o WHO ARE "FILING PERSONS" AND "AFFILIATES"?


       Under the SEC rules that govern going-private transactions, Harbor and
the merger subsidiary are "Filing persons," and they and each of their Directors
and executive officers are "Affiliates." Each of the Filing Persons and
Affiliates has determined that the terms of the merger are substantively and
procedurally fair to shareholders who will receive cash for their shares in the
merger, unaffiliated shareholders who will not receive cash in the merger, and
affiliated shareholders. No executive officers or Directors of Harbor own 100 or
fewer shares of Harbor common stock, and, accordingly, no executive officers or
Directors of Harbor will receive cash in the merger. As a result of the merger,
the percentage of common shares beneficially owned by Directors and executive
officers of Harbor will increase by less than 2%. See "SPECIAL
FACTORS--INTRODUCTION" on page 27.


                                       6


       o DOES THE BOARD OF DIRECTORS BELIEVE THAT THE TERMS OF THE MERGER ARE
         FAIR?

       Yes. The Board of Directors and each of the executive officers believes
that the terms of the merger, including the amount to be paid per share, are
fair to and in the best interests of Harbor and all of its shareholders. In
reaching its conclusion, the Board considered, among other things:

                    o The matters discussed under "Reasons for the Merger";

                    o The opinion of Harbor's financial advisor, Danielson
                      Associates, as to the fair value of the common stock;


                    o Harbor's current financial position and its available
                      sources of liquidity;


                    o Harbor's business and financial prospects;

                    o The continued costs of compliance with Harbor's reporting
                      obligations under the Exchange Act; and

                    o The current and historical prices for our common stock and
                      the liquidity of the market for the common stock.

       The members of the Board of Directors and the executive officers have
specifically determined that the transaction is financially and procedurally
fair to unaffiliated shareholders. See "Special Factors-Reasons for the Merger"
on page 14, "-Recommendation of the Board of Directors; Fairness of the Merger
Proposal" on page 16, "-Fairness Determination by Filing Persons" on page 17,
"-Opinion of Financial Advisor" on page 17, and "-Price Adjustment since Opinion
Date" on page 23.

       o WHAT IS THE MERGER, AND HOW WILL HARBOR BE OPERATED AFTER THE MERGER?


       In the merger, Harbor Merger Corporation, a newly formed wholly-owned
subsidiary of Harbor, will merge with and into Harbor, with harbor being the
surviving corporation. As a result of the merger, shareholders who own 100 or
fewer shares of Harbor common stock, except for shares owned by shareholders who
properly exercise their rights to object to the merger, will receive $31.00 in
cash for each share owned, without interest. Shareholders who own more than 100
shares of Harbor common stock will continue to hold shares of Harbor common
stock and will not receive any cash in connection with the merger. Approximately
12,478 shares, or less than 2% of total outstanding shares, are expected to be
exchanged for cash in the merger. The estimated costs of the merger, including
cash to be paid to shareholders with 100 or fewer shares, is $486,818, or less
than 3% of total stockholder's equity at June 30, 2006.

       After the merger, Harbor will continue to operate as a bank holding
company and as the parent corporation for Harbor Bank, and expects its business
and operations to continue as they are currently being conducted, but without
the need to file reports with the SEC. Also, the executive officers and
Directors of Harbor will continue to be the executive officers and Directors of
Harbor following the merger. We expect to complete the merger in November __,
2006.


       See: "THE MERGER AGREEMENT" on page 35 and the copy of the merger
agreement attached as Appendix A.

       o WHAT VOTE IS REQUIRED TO APPROVE THE MERGER AGREEMENT?


       The affirmative vote of least two-thirds (2/3) of the outstanding shares
of Harbor common stock eligible to vote is needed for approval of the merger.
Members of Harbor's Board of Directors and executive officers having the power
to vote approximately 193,177 or 30.1% of the 641,784 outstanding voting shares
have indicated that they intend to vote FOR the merger. The members of the Board
of Directors and the executive officers do not intend to acquire any additional
shares of common stock prior to approval of the merger. The approval of
approximately 52% of the remaining 448,607 outstanding voting shares owned by
other, unaffiliated shareholders will be required for approval of the merger.
All holders of record of Harbor voting common stock as of October __, 2006, will
receive a copy of this proxy statement and are entitled to vote at the Annual
Meeting.


       o WHO IS ENTITLED TO VOTE?


       Shareholders of voting common stock as of the close of business on
October __, 2006, the record date, are entitled to vote at the meeting. Each
share of voting common stock is entitled to one vote. See "The Annual
Meeting-Shares Entitled to Vote; Quorum and Vote Required" on page 47.


                                       7


       o HOW DO THE BOARD OF DIRECTORS AND THE EXECUTIVE OFFICERS RECOMMEND THAT
         I VOTE?

       The Board of Directors, by a unanimous vote, has approved the merger
agreement and recommends that you vote FOR approval of the merger agreement.
Executive officers who are not Directors also recommend that you vote FOR
approval. You should note that all of the Directors and executive officers own
more than 100 shares and expect to remain Harbor shareholders after the merger,
and that no Director or executive officer is expected to receive cash in the
merger. As you consider the recommendation of the Board of Directors, you should
be aware that the Directors and officers of Harbor have interests in addition to
their interests as shareholders of Harbor that may conflict with the interests
of shareholders who will be cashed out in the merger or non-affiliated
shareholders who will not be cashed out in the merger. See "Special
Factors-Interests of Executive Officers and Directors in the Merger" on page 27.

       o HOW DO I VOTE?

       Each shareholder should sign and date the enclosed proxy card and return
it to us in the prepaid envelope. Unless contrary instructions are indicated on
the proxy, all shares represented by valid proxies received pursuant to this
solicitation will be voted in favor of the merger and in favor of the election
of all nominees as Director. If you own your shares through a bank, broker, or
other nominee, you must vote through your record holder. See "THE ANNUAL
MEETING" on page 47.

       o DO I HAVE APPRAISAL OR DISSENTER'S RIGHTS?

       Yes. If the merger is approved by the shareholders and is completed, any
shareholder who properly perfects his or her right to object to the merger will
be entitled to receive an amount of cash equal to the fair value of his shares
rather than the consideration provided by the merger agreement. See "APPRAISAL
RIGHTS OF HARBOR SHAREHOLDERS" on page 31.

       o WHAT ARE THE FEDERAL INCOME TAX IMPLICATIONS OF THE MERGER?

       The receipt of cash in the merger will be taxable for United States
federal income tax purposes. You will be treated as either having sold your
shares of Harbor common stock for the cash received or as having received the
cash as a dividend. In general, your receipt of cash in exchange for your shares
of Harbor common stock will be treated as a sale or exchange and you will
recognize gain or loss in an amount equal to the cash received less your
adjusted tax basis of your shares exchanged for such cash if you actually and
constructively own no shares of Harbor common stock immediately after the
exchange. If you actually or constructively own shares of Harbor common stock
after the exchange, your receipt of cash in exchange for your shares of Harbor
common stock may be taxed as a dividend. Shareholders who do not receive cash
should not recognize any gain or loss on continuing to hold their shares of
Harbor common stock as a result of the merger.

       See "SPECIAL FACTORS--Material U.S. Federal Income Tax Consequences" on
page 29.

       o SHOULD I SEND IN MY CERTIFICATES NOW?


       No. After the effectiveness of the merger, holders of 100 or fewer shares
will be sent a letter of transmittal and instructions for submitting shares for
payment. Holders of more than 100 shares will not be required to exchange their
certificates. See "THE MERGER AGREEMENT--Exchange of Certificates" on page 36.


       o WHO CAN HELP ANSWER MY QUESTIONS?

       If you have additional questions about the merger, you should contact
Teodoro J. Hernandez, Vice President and Treasurer, at Harbor Bankshares
Corporation, 25 West Fayette Street, Baltimore, MD 21201, telephone (410)
528-1800.



                 STATEMENT REGARDING FORWARD-LOOKING INFORMATION

       THIS PROXY STATEMENT AND THE DOCUMENTS INCORPORATED BY REFERENCE IN THIS
PROXY STATEMENT INCLUDE FORWARD-LOOKING STATEMENTS SUCH AS: STATEMENTS OF
HARBOR'S GOALS, INTENTIONS, AND EXPECTATIONS; ESTIMATES OF RISKS AND OF FUTURE
COSTS AND BENEFITS; AND STATEMENTS OF HARBOR'S ABILITY TO ACHIEVE FINANCIAL AND
OTHER GOALS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO SIGNIFICANT
UNCERTAINTIES BECAUSE THEY ARE BASED UPON: THE AMOUNT AND TIMING OF FUTURE
CHANGES IN INTEREST RATES, MARKET BEHAVIORS, AND OTHER ECONOMIC CONDITIONS;
FUTURE LAWS AND REGULATIONS; AND A VARIETY OF OTHER MATTERS. BECAUSE OF THESE
UNCERTAINTIES, THE ACTUAL FUTURE RESULTS MAY BE MATERIALLY DIFFERENT FROM THE
RESULTS INDICATED BY THESE FORWARD-LOOKING STATEMENTS. IN ADDITION, HARBOR'S
PAST PERFORMANCE DOES NOT NECESSARILY INDICATE ITS FUTURE RESULTS.

                                       8


                          SUMMARY FINANCIAL INFORMATION

SELECTED HISTORICAL FINANCIAL INFORMATION


                                               As of and for the Six
                                                Months Ended June 30,         As of and for the Years Ended December
                                               ----------------------  ----------------------------------------------------
                                                 2006       2005         2005       2004       2003       2002       2001
                                               ------  --------------  ---------  --------   --------   --------   --------
                                                                (Dollars in thousands, except per share data)
OPERATIONS DATA:
Interest income.............................   $  8,436     $   7,062  $  12,648  $ 11,886   $ 11,886   $ 11,647   $ 13,609
Interest expense............................      2,814         1,618      2,283     2,411      2,411      3,402      5,973
                                               --------     ---------  ---------  --------   --------   --------   --------
Net interest income.........................      5,622         5,444     11,227    10,365      9,475      8,245      7,636
Provision for loan losses...................        135           240        410       360        755        340        400
Non-interest income.........................        784           939      1,771     1,514      2,506      2,220      2,329
Non-interest expense........................      4,880         4,825      9,638     9,295      8,610      8,575      8,526
                                               --------     ---------  ---------  --------   --------   --------   --------
Income before taxes.........................      1,391         1,318      2,950     2,224      2,616      1,550      1,039
Income taxes................................        496           486      1,067       762        831        473        309
                                               --------     ---------  ---------  --------   --------   --------   --------
Net income..................................   $    895     $     832  $   1,883  $  1,462   $  1,785   $  1,077   $    730
                                               ========     =========  =========  ========   ========   ========   ========


PER SHARE DATA:
Net income-basic............................   $   1.32     $    1.20  $    2.73  $   2.07   $   2.46   $   1.47   $   1.02
Net income-diluted..........................       1.24          1.11       2.55      1.93       2.36       1.43       0.99
Cash dividends declared per share...........       0.50          0.40       0.40      0.35       0.25       0.25          0
Book value per share........................      25.50         23.61      24.73     23.04      21.69      19.23      16.72

BALANCE SHEET DATA:
Total assets................................   $258,174     $ 243,475  $ 256,636  $235,464   $219,547   $210,234   $186,586
Deposits....................................    228,475       217,905    229,845   210,224    195,901    193,294    171,531
Total net loans.............................    203,460       179,101    188,936   172,205    149,729    120,523    105,847
Total shareholders' equity..................     17,230        16,248     16,954    16,240     15,274     14,149     12,241

PERFORMANCE RATIOS:
Return on average assets...................        0.70%         0.71%      0.78%     0.63%      0.84%      0.54%      0.37%
Return on average equity....................      10.60         10.30      11.57      9.33      12.23       8.20       6.20
Dividends declared to diluted net income....      30.16         18.02      15.69     18.13      10.59      17.48         NA

CAPITAL RATIOS:
Tier 1 regulatory capital to average assets.       7.37%         7.52%      7.31%     7.36%      7.46%      5.20%      5.40%
Average equity to average assets............       6.64          6.95       6.74      7.27       6.48       5.24       4.77


                                       9


SUMMARY UNAUDITED PRO FORMA FINANCIAL INFORMATION


       The following table sets forth the Harbor's shareholders' equity accounts
as of June 30, 2006, and pro forma equity accounts as of such date as if the
merger were then effective, resulting in the cashing out of 12,478 shares of
common stock for an aggregate payment of $486,818, including payments for shares
of stock of $386,818 and payment of related professional and other costs of
$100,000. Shares acquired will be classified as authorized and unissued.
Harbor's shareholder's equity as of the date of this proxy statement, the date
of the Annual Meeting, or as of any other day, may be higher or lower than the
amount set forth below, as a result of earnings or losses from operations, the
payment of dividends or other distributions, and changes in the value of
Harbor's available for sale securities. This table indicates that, on a pro
forma basis, book value per share decreases by $0.25, or less than 1%, as a
result of the merger,


(In thousands, except per share data)                                 Actual                   Pro forma
                                                                  --------------             -------------
Common stock (par value $0.01 per share):
     Authorized 10,000,000 shares; issued
     675,579, including 33,795 common nonvoting
     Shares                                                       $            6             $           6
Additional paid in capital                                                 6,405                     5,918
Retained earnings                                                         11,405                    11,405
Accumulated other comprehensive loss                                       (586)                     (586)
                                                                  --------------             -------------
     Total Shareholders' Equity                                   $       17,230             $      16,743
                                                                  ==============             =============

     Common equity per share                                      $        25.50             $       25.25

       The following table sets forth Harbor's and the Bank's actual and
estimated pro forma regulatory capital ratios as of June 30, 2006, as if the
merger were effective as of that date, resulting in the cashing out of 12,478
shares of common stock for an aggregate payment of $442,143.

                                                                      Actual                   Pro forma
                                                                  --------------             -------------
Total Capital to risk weighted assets
     Harbor Bankshares Corporation                                     11.10.%                   10.88%
     Harbor Bank of Maryland                                           10.94%                    10.72%

Tier I Capital to risk weighted assets
     Harbor Bankshares Corporation                                      8.64%                     8.42%
     Harbor Bank of Maryland                                            9.95%                     9.73%

Tier I Capital to average assets
     Harbor Bankshares Corporation                                      7.47%                     7.28%
     Harbor Bank of Maryland                                            8.54%                     8.35%


       The above table indicates that, on a pro forma basis, regulatory capital
ratios decrease by less than 25 one-hundredth of a percent and remain in excess
of the levels required for well capitalized status for regulatory purposes.

                                       10




            CONSOLIDATED UNAUDITED RATIO OF EARNINGS TO FIXED CHARGES

RATIO OF EARNINGS TO FIXED CHARGES


                                                      Six Months                       Years ended December 31
                                                        Ended        ------------------------------------------------------------
                                                    June 30, 2006        2005        2004         2003        2002        2001
                                                    ---------------  -----------  ----------   ---------  -----------  ----------
INCLUDING INTEREST ON DEPOSITS
      Earnings:
        Pre-tax income (loss)                              $ 1,391      $ 2,951     $ 2,224     $ 2,616      $ 1,550     $ 1,039
        Plus: Fixed charges                                  2,858        3,851       2,333       2,514        3,541       6,118
                                                    ---------------  -----------  ----------   ---------  -----------  ----------
           Total Earnings                                  $ 4,249      $ 6,802     $ 4,557     $ 5,130      $ 5,091     $ 7,157
                                                    ===============  ===========  ==========   =========  ===========  ==========

      Fixed Charges:
        Interest expensed and capitalized interest         $ 2,814      $ 3,787     $ 2,283     $ 2,411      $ 3,402     $ 5,973
        Rent expense (for operating leases)                    146          213         168         343          464         482
        Ratio of interest expense included
           in rent expense                                     30%          30%         30%         30%          30%         30%
         Estimated interest within rental expense             43.8         63.9        50.4       102.9        139.2       144.6
            Total Fixed Charges                            $ 2,858      $ 3,851     $ 2,333     $ 2,514      $ 3,541     $ 6,118
                                                    ===============  ===========  ==========   =========  ===========  ==========

      Ratio of Earnings to Fixed Charges
        with Interest on Deposits                             149%         177%        195%        204%         144%        117%
                                                    ===============  ===========  ==========   =========  ===========  ==========


EXCLUDING INTEREST ON DEPOSITS
      Earnings:
        Pre-tax income (loss)                              $ 1,391      $ 2,951     $ 2,224     $ 2,616      $ 1,550     $ 1,039
        Plus: Fixed charges                                    356          529         381         278          280         296
                                                    ---------------  -----------  ----------   ---------  -----------  ----------
           Total Earnings                                  $ 1,747      $ 3,480     $ 2,605     $ 2,894      $ 1,830     $ 1,335
                                                    ===============  ===========  ==========   =========  ===========  ==========

      Fixed Charges:
        Interest expensed and capitalized interest           $ 312        $ 465       $ 331       $ 175        $ 141       $ 151
        Rent expense (for operating leases)                    146          213         168         343          464         482
        Ratio of interest expense included
           in rent expense                                     30%          30%         30%         30%          30%         30%
         Estimated interest within rental expense             43.8         63.9        50.4       102.9        139.2       144.6
            Total Fixed Charges                              $ 356        $ 529       $ 381       $ 278        $ 280       $ 296
                                                    ===============  ===========  ==========   =========  ===========  ==========

      Ratio of Earnings to Fixed Charges
        without  Interest on Deposits                         491%         658%        683%       1041%         653%        451%
                                                    ===============  ===========  ==========   =========  ===========  ==========


                                       11


                                 SPECIAL FACTORS


BACKGROUND OF THE MERGER

       Harbor was organized in 1992 to be the registered holding company for the
Bank. Harbor became a "public" company filing reports with the Securities and
Exchange Commission in 1992. No organized market for the Harbor common stock has
ever existed, however, and trading is infrequent and sporadic. From time to time
over the years, management has informally discussed the alternatives available
to the Company to cease being a reporting company and the relative benefits and
costs of deregistration with counsel to the Company. No formal presentations
were made by counsel or management on this issue, and no outside evaluation or
opinion as to the value of the Company's common stock was solicited. No
follow-up on these discussions occurred, and the Company continued to file
reports and other documents with the Securities and Exchange Commission.

         In July 2002, the Public Company Accounting Reform and Investor
Protection Act of 2002, commonly referred to as Sarbanes-Oxley, was signed into
law. Although Sarbanes-Oxley was enacted in 2002, many of its provisions and the
provisions of regulations of the Securities and Exchange Commission that were
required by Sarbanes-Oxley, did not immediately take effect, but instead have
been implemented over time. Some provisions are still in the process of
implementation. Since its enactment, Sarbanes-Oxley has created significant
additional and increasing regulatory burdens and costs for Harbor. However,
Harbor will not bear the full burden of Sarbanes-Oxley until, at the earliest,
the application to Harbor of the requirements regarding internal controls over
financial reporting under Sarbanes-Oxley Section 404, which is now scheduled for
year end 2007. Harbor' estimates of the costs of Section 404 compliance and the
experience of the larger companies that were required to comply at year-end 2004
with these requirements indicates that significant costs and burdens will result
from compliance with Section 404 in addition to the substantial burdens and
costs that currently apply to Harbor.

       Management and the Board of Directors from time to time received
information from Company counsel, its independent accountants, banking industry
trade groups, and other sources regarding the requirements of these new
provisions of law and regulation. As a result of the implementation of these new
provisions, management and the Board of Directors became concerned that the new
procedures and disclosures required to comply with Sarbanes-Oxley would
significantly increase the management, staff, and Board time and resources
dedicated to the securities reporting and disclosure process, including the time
needed for training employees in the particulars of the new provisions and
additional procedures involved in the management attestations and certifications
of internal controls and financial statements. Concern also arose with respect
to potential increases in expenses incurred for those processes, including the
fees of counsel, accountants, and other compliance advisors and service
providers. The Board of Directors and management were also concerned about the
potential additional civil and criminal proceedings or liabilities to which the
President and Chief Financial Officer could become subject as a result of the
new financial statement certification requirements, and Harbor's potential
liability to indemnify them if they successfully defended themselves, and the
costs of the Company's participation in any such suit, investigation, or
proceeding.

       In the third quarter of 2004, management informally discussed with
Harbor's special legal counsel the ability to deregister, and the procedure
Harbor should follow in pursuing a possible deregistration transaction.
Following those discussions, management began a study of the potential costs and
benefits to Harbor of deregistration, and, from time to time, had additional
discussions with legal counsel regarding deregistration and the costs of
Sarbanes-Oxley compliance and of fulfilling the reporting obligations of a
public company. At a regular meeting of the Board of Directors on May 11, 2005,
management discussed the effects on Harbor and its shareholders of
deregistration and the related costs and benefits, and formally proposed that
the Board of Directors consider a transaction which would result in the
reduction of the number of shareholders of record sufficient to permit the
Company to deregister the common stock under the Securities Act of 1934.
Following discussion, the Board voted to proceed with the process in general,
but did not at that time determine the timing, structure, or terms of any
transaction. Following that meeting, members of management engaged in further
discussions with legal counsel and Harbor's independent accountants regarding
the process of deregistration, and began the preparation of the necessary
filings. After considering the proposals of several investment banking and
financial advisory firms experienced in the valuation and appraisal of financial
institutions, Harbor retained the firm of Danielson Associates, Inc., Rockville,
Maryland, to provide it with an appraisal of the shares and an opinion that the
price to be paid for shares which would be cashed out was a fair price for the
common stock. Danielson Associates was selected because of its extensive
experience, over a twenty year period, in the valuation and appraisal of
financial institutions in connection with mergers, acquisitions, stock
offerings, repurchases, fairness opinions, and similar matters; its reputation
in the financial services industry for providing such services; the
recommendation of counsel, who had previously worked with Danielson Associates;
and the price of obtaining the appraisal and opinion from Danielson Associates,
which was substantially below the prices quoted by other investment banks.
Danielson Associates also had assisted Harbor with respect to the valuation of
its common stock in the past. The opinion of Danielson Associates is summarized
below, and its fairness opinion is attached as Appendix B hereto.

                                       12



       Harbor's Board of Directors considered the deregistration at its regular
meeting on December 14, 2005. In attendance for its consideration of this matter
were a representative of Danielson Associates and outside legal counsel as well
as the President and CEO and the Treasurer. At that meeting, the Board discussed
the structure and effects of deregistration of Harbor as a public company and
the merger; the effects of the merger on Harbor, on shareholders whose shares
would be acquired in the merger, and on the remaining shareholders; the
fiduciary duties of Directors to shareholders; and related matters. In the
meeting, outside legal counsel described the process and alternative structures
of deregistration to the Board, and the representative of Danielson Associates
presented its report, which had previously been distributed to the Board,
regarding the fair value of Harbor common stock. Following discussion, the Board
unanimously determined that the merger was fair to Harbor and its shareholders,
established a price of $29.00 per share to be paid per share to shareholders
whose shares would be purchased in the merger, and authorized and directed
executive management to proceed with the appropriate actions to effect the
merger. The Board of Directors subsequently increased the price to $31.00 per
share. See "Price Adjustment since Initial Opinion Date" on page 23.

       As described below, Harbor's Board of Director's determined that the
accomplishing the deregistration by merger was superior to each of the other
alternatives discussed at its meeting of December 14, 2006:


                    o Tender Offer. In a tender offer, Harbor would offer to
                      purchase common shares, following the rules established
                      for tender offers by the Securities and Exchange
                      Commission. This method allows shareholders to choose
                      whether or not to have their shares cashed out, as long as
                      the conditions to the tender offer are met. The primary
                      disadvantage to this method is the lack of certainty that
                      a sufficient number of holders will tender their shares to
                      allow the deregistration.

                    o Reverse Split. In a reverse split, Harbor would exchange
                      one new share of common stock for a fixed number of
                      outstanding shares, but would pay cash instead of issuing
                      any fractional shares. The exchange ratio in a reverse
                      split would be based upon the estimated number of
                      shareholders to be cashed out in order to reduce the
                      number of record holders below 300. Just as in the case of
                      the merger: (i) approval of more than 2/3 of the common
                      stock entitled to vote would be required; (ii) shares
                      would be required to be cashed out; and (iii) shareholders
                      would be entitled to appraisal rights. The primary
                      disadvantage of this method is the increased cost
                      necessitated by the cashing out of fractional shares of
                      holders who would remain record holders after the reverse
                      split. In addition, Harbor believes that reverse splits
                      are more complex and more difficult to explain to
                      shareholders than mergers.

                    o Market Acquisition of Shares. Acquisition of shares on the
                      market was believed to be impractical, given the lack of
                      an established trading market. This method also (i) would
                      not provide any certainty that the number of shareholders
                      would be reduced by a sufficient number, and (ii) would
                      allow shareholders to sell a part of their holdings, while
                      continuing to be record holders of other shares.


                    o The Merger. The Board of Directors of Harbor selected the
                      merger over the above alternatives after a review of the
                      comparative advantages and disadvantages of this approach.
                      Approval of the merger requires the affirmative vote of at
                      least two-thirds of the voting shares, including over 50%
                      of the shares held by nonaffiliates. If that approval is
                      received, Harbor can be assured that the reduction in
                      record holders necessary for deregistration can be
                      achieved. This certainty, however, is the result of
                      mandatory conversion of the shares held by owners of
                      record of 100 or fewer shares--if the merger is approved
                      by shareholders and completed, the shareholders who hold
                      of record 100 or fewer shares will receive cash for their
                      shares, either through the conversion of their shares into
                      the right to receive $31.00 per share or through the
                      exercise of appraisal rights, and will not continue as
                      record shareholders of Harbor. The Board of Directors,
                      Harbor, and the merger subsidiary all have determined that
                      this price is fair to unaffiliated and affiliated
                      shareholders, and shareholders who will receive cash and
                      shareholders who own more than 100 shares, and will not
                      receive cash in the merger. Shareholders with 100 or fewer
                      shares prior to the record date can remain shareholders by
                      purchasing additional shares, or can purchase shares after
                      the merger, subject to the availability of Harbor common
                      stock. The use of the merger requires Harbor to expend
                      funds for legal, accounting, and other expenses. The Board
                      determined that a market acquisition of shares sufficient
                      to meet the criteria for deregistration would be
                      improbable, given the illiquid market for Harbor common
                      stock. Each of the other alternatives, a tender offer or
                      reverse split, also would require the expenditure of funds
                      in amounts believed to be at least as much as those
                      required in connection with the merger. The amount of
                      Harbor funds spent on shares, and the effects on Harbor
                      capital, operations, and ownership, of a deregistration
                      effected by means of a merger are believed to be at least
                      as favorable as those achievable by the other methods. For
                      a further description of the effects of the merger, please
                      see "Effects of the Merger" on page 24.


                                       13



       The Board of Directors determined the 100-share threshold for
determination of shareholders who will be cashed out in the merger based upon
the "round number" of shares held of record to be cashed out that would be
likely to result in fewer than 300 post-merger record holders without
unnecessary cost. The determination was not based upon the identity of any
shareholders or on any characteristics of any holder or group of holders other
than the number of shares held of record.

       At its meeting of April 19, 2006, the Board reviewed the price to be paid
to shareholders whose shares will be purchased in the merger based upon factors
it previously had considered and upon the performance of Harbor since the
original price was determined. As a result of that review, the Board unanimously
increased the price to be paid per share in the merger to $31.00 per share from
the original $29.00 per share. See "Price Adjustment since Initial Opinion Date"
on page 23.


       See "Special Factors--Recommendation of the Board of Directors; Fairness
of the Merger Proposal" on page 16, and "SUMMARY FINANCIAL INFORMATION" on page
9.

REASONS FOR THE MERGER

       The primary purpose of the merger is to reduce the number of holders of
the common stock below 300, which will enable Harbor to suspend filing periodic
and annual reports with the SEC and to no longer incur the significant costs of
complying with the reporting requirements of the Exchange Act. The elimination
of those requirements will allow management to refocus the time spent preparing
reporting documents and engaging in securities law compliance activities onto
the pursuit of operational and business goals. In considering the proposed
amendments, the Board of Directors considered the benefits and costs to Harbor
and the shareholders set forth below, and the factors discussed under the
caption "Background of the Merger."

                    o Harbor believes that as a result of the merger it will be
                      able to realize cost savings of at least $87,600 annually
                      by eliminating the requirements to make periodic public
                      reports and by reducing the expenses of shareholder
                      communications, including legal expense ($12,000),
                      accounting expense ($30,000), printing ($20,000), postage
                      ($1,800), data entry, stock transfer, and other
                      administrative expenses ($7,500), as well as a result of
                      reduced staff and management time ($10,000) spent on
                      reporting and securities law compliance matters, and
                      reduction in aggregate total dividend costs ($6,300). In
                      addition, Harbor will avoid the costs of initial
                      compliance with the internal control over financial
                      reporting systems requirements of the Sarbanes Oxley Act,
                      currently expected to be required for public companies of
                      Harbor's size by year-end 2007, which are estimated to
                      range from $150,000 to $200,000, and continued annual
                      costs of related compliance and reporting in amounts not
                      determined. The Board of Directors believes that the
                      increased disclosure and procedural requirements will
                      result in continuing increased legal, accounting, and
                      administrative expense, and the diversion of Board of
                      Directors, management, and staff effort without a
                      commensurate benefit to the shareholders.

                    o Given the absence of a public market for the common stock,
                      and the sporadic and limited trading in the common stock,
                      the Board of Directors does not believe that the costs of
                      reporting are justified. Harbor's earnings are sufficient
                      to permit Harbor's expected growth, and Harbor is not
                      dependent on access to the capital markets to obtain
                      additional financing. If it becomes necessary to raise
                      additional capital, Harbor believes that there are
                      adequate sources of additional capital available, whether
                      through borrowing at the holding company level, or through
                      private or institutional sales of equity or debt
                      securities, although there can be no assurance that Harbor
                      will be able to raise additional capital when required, or
                      that the cost of such capital will be attractive.

                                       14


                    o The merger is expected to result in the cashing-out at a
                      price determined to be fair by the Board of Directors of
                      the common stock owned by approximately 360 shareholders
                      (58% of the total number of record holders) who, at the
                      Effective Time of the merger, own 100 or fewer shares of
                      Harbor common stock. However, these shareholders together
                      own less than 2% of Harbor's outstanding common stock.

                    o Harbor and the Bank would continue to be minority-owned
                      institutions after the merger.


                    o The merger will enable small shareholders to divest
                      themselves of their positions without the expenditure of
                      efforts disproportionate to the value of their holdings,
                      without transaction expenses, and at a price which is
                      significantly higher than recent trades of which Harbor is
                      aware, which have ranged from $25.00 to $31.00 per share.


                    o Shareholders who receive cash in the merger generally are
                      expected to be subject to federal income taxes on any
                      gains as if the shares were sold on the market. (See
                      "SPECIAL FACTORS--Material U.S. Federal Income Tax
                      Consequences" on page 29.)

                    o The merger and deregistration will have little if any
                      effect on the ability to trade common stock, as no
                      organized market currently exists. Trades will continue to
                      be the result of direct communications between buyers and
                      sellers. The amount paid for the shares being cashed out
                      may result in an increase in the pricing level of future
                      trades, although there can be no assurance that higher
                      prices for the common stock will result or that a
                      continuing shareholder will be able to sell shares at the
                      price being paid to shareholders being cashed out.

                    o Operating as a private company will allow management to
                      better focus its efforts on the operations of the Bank,
                      which will benefit our customers and the communities in
                      which we operate.

                    o The merger will permit a significant percentage of our
                      shareholders to continue as shareholders and to enjoy the
                      benefits of share ownership, including dividends, when and
                      if declared, potential capital appreciation, and civic
                      benefits from owning shares in a community oriented
                      institution such as Harbor. At the same time, Harbor will
                      be relieved of significant expense and diversion of
                      management time and effort, which may result in improved
                      operating efficiencies and reduced need for additional
                      compliance-related employees, and in potentially increased
                      net earnings.

                    o Harbor and the Bank would continue to be highly regulated
                      and subject to periodic examination by the federal and
                      state bank regulatory agencies. The management and Board
                      of Directors of Harbor would not be affected by the
                      transaction. Substantial information about Harbor's
                      financial affairs would remain available to interested
                      shareholders.

                    o Harbor believes that no material adverse impact on
                      Harbor's financial position would result from the
                      transaction. The payment of cash from Harbor's capital
                      accounts, however, could result in a future reduction in
                      earnings or reduced asset levels as a result of reduced
                      capital levels and compliance with regulatory capital
                      requirements. The Board of Directors considered the impact
                      of reduced capital levels, but determined that Harbor's
                      and Bank's capital levels would remain more than
                      sufficient to meet the levels required for well
                      capitalized status under applicable regulations after the
                      merger, and that any reduction in income resulting from
                      reduced assets would likely be offset by cost savings
                      realized as a result of deregistration.

                                       15



                    o The Board of Directors has determined that the price to be
                      paid for the shares of Harbor common stock to be cashed
                      out in the merger is fair and that this deregistration
                      transaction is procedurally fair to Harbor shareholders
                      who will be cashed out in the merger. The Board of
                      Directors also has determined that the transaction is
                      financially and procedurally fair to the remaining
                      shareholders of Harbor, including non-affiliates and
                      affiliates. The Board of Directors has determined that the
                      price at which shares will be cashed out is a fair price
                      for the Harbor common stock. In reaching this conclusion
                      the Board of Directors considered the valuation factors
                      summarized in the opinion of its financial advisor, and
                      the factors stated above and under "Recommendation of the
                      Board of Directors; Fairness of the Merger Proposal,"
                      below. In particular, the Board considered that the $31.00
                      price represents 11.2 times trailing twelve month earnings
                      at June 30,, 2006, and 122% of book value per common share
                      at June 30, 2006. Please see "Opinion of Financial
                      Advisor" on page 17.


RECOMMENDATION OF THE BOARD OF DIRECTORS; FAIRNESS OF THE MERGER PROPOSAL


       The Board of Directors has unanimously determined that the merger is in
the best interests of Harbor and all of its shareholders, and is substantively
and procedurally fair to: (i) shareholders who will receive cash for their
shares in the merger, and (ii) other unaffiliated shareholders. The Board also
believes that the process by which the transaction was approved is fair to all
of Harbor's shareholders, and fair to unaffiliated shareholders receiving cash
in the merger as well as those unaffiliated shareholders who will retain their
shares after the merger. The Board's determination as to the per share price of
$31.00 was made following a vote of the members of the Board of Directors at
which the price was approved by a unanimous vote. As set forth in the section
entitled "Special Factors - Background of the merger," prior to voting upon the
per share price, the members of the Board of Directors agreed that the
going-private transaction is in the best interests of Harbor and all of its
shareholders and, based upon the report and opinion provided by Danielson
Associates and other factors, unanimously agreed that the per share price to be
paid in the merger is fair to all of the shareholders of Harbor and unanimously
approved the merger agreement, which included the $31.00 per share price. The
Board of Directors adopted the conclusions and analysis of the Danielson Report.
The Board of Directors also believes that the process by which the transaction
is to be approved by shareholders is fair. The Board of Directors established
that the transaction is procedurally fair to the unaffiliated shareholders
although it did not retain separate, independent counsel or appraisers to
represent solely unaffiliated shareholders. The Board of Directors, however,
satisfied the procedural and other requirements of Maryland law, which require
it to act in the best interests of all of its shareholders, require the approval
of a super-majority of more than 2/3 of the shares entitled to vote as a
condition to the merger; and provide dissenter's appraisal rights. Because
officers and Directors own approximately 30% of outstanding shares that will be
entitled to vote in the merger and have pledged not purchase any additional
shares of common stock prior to the vote of shareholders, approval of the merger
effectively requires the approval of more than a majority of unaffiliated
shareholders. As described further below, the Board of Directors obtained the
opinion of an independent financial advisor as to the fairness of the cash-out
price to all shareholders, including, specifically, unaffiliated shareholders.
The Board of Directors established an increased cash out price based upon the
updated opinion of the financial advisor at its meeting of September 13, 2006.
In light of these factors, the Board believes that appointing separate
independent counsel or appraisers is unnecessary, and would unnecessarily
require additional expense.


       The Board of Directors unanimously recommends that the shareholders vote
FOR approval of the merger agreement. Each member of the Board of Directors and
each executive officer of Harbor has advised Harbor that he or she intends to
vote his or her shares in favor of the merger agreement for the reasons
described above. As you consider the recommendation of the Board of Directors,
you should be aware that the Directors and officers of Harbor have interests in
addition to their interests as shareholders of Harbor that may conflict with the
interests of shareholders who will be cashed out in the merger or non-affiliated
shareholders who will not be cashed out in the merger. See "Special
Factors-Interests of Executive Officers and Directors in the Merger" on page 27.


       As of October __, 2006, the Directors and executive officers of Harbor
and the Bank (16 persons) beneficially owned a total of 193,177 shares of
Harbor's outstanding common stock, or approximately 30.1% (not including any
shares that may be acquired pursuant to the exercise of stock options), of the
total shares entitled to vote at the Annual Meeting. None of these officers or
Directors intends to acquire additional shares of common stock before the merger
agreement is approved. Accordingly, the approval of unaffiliated shareholders
owning an additional 234,679 shares is necessary for the approval of the merger
agreement.


       The Board has the authority to reject (and not implement) the merger
(even after approval thereof by shareholders) if it determines subsequently that
the merger is not then in the best interests of Harbor and its shareholders.

                                       16


MERGER SUBSIDIARY'S DETERMINATION OF FAIRNESS OF THE MERGER PROPOSAL

       The merger subsidiary and its Board of Directors believe that the merger
is fair to, and in the best interests of, all of Harbor's shareholders. The
merger subsidiary and its Board of Directors have determined that the merger is
fair to the unaffiliated shareholders who will receive cash in the merger and
those who will retain their shares of Harbor common stock after the merger. The

merger subsidiary and its Board also believe that the process by which the
transaction was approved is fair to all of Harbor's shareholders and have
concluded that the process was fair to unaffiliated shareholders receiving cash
in the merger as well as those unaffiliated shareholders who will retain their
shares after the merger. In reaching its conclusions, the merger subsidiary
relied upon the factors considered by, and has expressly adopted the analyses
and conclusions of, Harbor's Board of Directors. See "Special
Factors--Recommendation of the Board of Directors; Fairness of the Merger
Proposal" on page 16. Merger subsidiary has not received a report, opinion, or
appraisal from an outside party. The merger agreement has been approved by
merger subsidiary's Board of Directors and by Harbor, as the sole shareholder of
merger subsidiary.

FAIRNESS DETERMINATION BY FILING PERSONS


       Harbor and the merger subsidiary are deemed to be "Filing Persons" under
the SEC rules that govern going-private transactions. These rules require each
filing person to state whether the transaction is fair to unaffiliated security
holders.

       In expressing its belief as to the fairness of the transaction to the
unaffiliated shareholders, each of the Filing Persons has relied upon the
factors considered by Harbor's Board of Directors, including Danielson
Associates' analyses and opinion, and has adopted Harbor's Board of Directors'
analysis and conclusions. See "Special Factors--Recommendation of the Board of
Directors; Fairness of the Merger Proposal." Based on those factors, each of the
Filing Persons believes that the merger agreement and the process by which the
transaction was approved are fair to each of the unaffiliated shareholders,
including those who will receive cash in the merger and those who will retain
their shares of Harbor common stock. Neither the Filing Persons nor Harbors'
Board of Directors have received any report, opinion, or appraisal from an
outside party that is materially related to the merger other than the report of
Danielson Associates. The belief of each of the Filing Persons and Affiliates is
such person's individual belief and does not constitute investment advice. If a
shareholder is unsure of whether to vote in favor of the merger agreement, that
shareholder should consider the recommendation of the Board of Directors or
consult with the shareholder's personal financial advisor.


       Each of the Filing Persons also adopts the purpose and reasons for the
merger, and the decision regarding the alternative structures for the going
private transaction of the Board of Directors. See "SPECIAL FACTORS - Background
of the Merger" on page 12, and "-Reasons for the Merger on page 14.

OPINION OF FINANCIAL ADVISOR


       Harbor retained Danielson Associates Inc. ("Danielson Associates") to
perform an independent appraisal of the "fair" market value of the common stock
of Harbor. Market value is defined as the price at which the common stock would
change hands between a willing seller and a willing buyer, each having
reasonable knowledge of relevant facts and assuming a significant amount of
stock changing hands daily to assure a true reflection of market forces.
Danielson Associates rendered its initial written and oral opinion as of
December 8, 2005, to Harbor at its meeting of the Board of Directors on December
14, 2005. Danielson delivered an updated opinion as of August 29, 2006, which
was considered by the Board of Directors on September 13, 2006. (For
convenience, the initial and updated opinions are referred to together as the
"opinion".) No limitations were imposed by Harbor's Board of Directors upon
Danielson Associates with respect to the investigation made or procedures
followed by it in arriving at its opinion. The description of the opinion in
this proxy statement has been reviewed by Danielson Associates, and is in a form
acceptable to it.


       Danielson Associates is regularly engaged in the valuation of banks and
bank holding companies in connection with mergers, acquisitions, and other
securities transactions; and has knowledge of, and experience with Maryland and
other mid-Atlantic markets and banking organizations operating in those markets.
Danielson Associates was selected by Harbor because of its knowledge of,
expertise with, and reputation in the financial services industry.

       In arriving at its opinion, Danielson Associates:

                                       17



                    o Reviewed certain business and financial information
                      relating to Harbor including reports of condition and
                      income and related schedules (commonly referred to as
                      "call reports") filed by the Bank with federal banking
                      regulators from 1990 through June 30, 2006, the annual
                      reports of Harbor on Form 10-KSB for 2003, 2004, and 2005,
                      the quarterly reports of Harbor on Form 10-QSB for
                      September 30, 2005 and June 30, 2006, and the proxy
                      statement for the 2005 annual meeting of shareholders.


                    o Discussed the past and current operations, financial
                      condition, and prospects of Harbor with its senior
                      executives.

                    o Reviewed and compared the pricing ratios, to the extent
                      publicly available, with those of comparable institutions.

                    o Considered such other factors as it deemed appropriate.

       Danielson Associates did not obtain any independent appraisal of assets
or liabilities of Harbor. Further, Danielson Associates did not independently
verify the information provided by Harbor and assumed the accuracy and
completeness of all such information.

       In arriving at its opinion, Danielson Associates performed a variety of
financial analyses. Danielson Associates believes that its analyses must be
considered as a whole and that consideration of portions of such analyses could
create an incomplete view of Danielson Associates' appraisal. The preparation of
an appraisal of "fair" market value is a complex process involving subjective
judgments and is not necessarily susceptible to partial analysis or summary
description.

       In its analyses, Danielson Associates made certain assumptions with
respect to industry performance, business and economic conditions, and other
matters, many of which were beyond Harbor's control. Any estimates contained in
Danielson Associates analyses are not necessarily indicative of future results
of value, which may be significantly more or less favorable than such estimates.
Estimates of the value of companies do not purport to be appraisals or
necessarily reflect the prices at which companies or their securities may
actually be sold.


       INITIAL OPINION AND UPDATED OPINION. Danielson employed the same
methodology in the appraisal of fair market value of Harbor's common stock in
its initial opinion of December 8, 2005, and in its updated opinion of August
29, 2006. The initial opinion included reliance upon financial information for
Harbor and comparable institutions through September 30, 2005, or earlier dates
to the extent necessary. Based on its methodology, Danielson Associates arrived
at its opinion that the "fair" value of the Harbor common stock as of December
8, 2005, was between $28.13 and $29.63 per share with the midpoint being $28.88
per share. Danielson Associates' initial opinion sated that, as of that date,
any price in this range would have been a "fair" price for purposes of the
merger. The Board of Directors established the price of $29.00 per share to be
paid in the merger based upon that earlier analysis and opinion. However,
Danielson Associates' updated report, using the same methodology but with more
recent financial information, concluded that the "fair" value of the Harbor
common stock as of August 29, 2006, was between $30.53 and $32.17 per share with
the midpoint being $31.35 per share. In Danielson Associates' opinion, as of
that date, any price in this range would have been a "fair" price for purposes
of the merger. The Board of Directors has relied upon the updated analysis and
opinion of Danielson Associates in establishing the increased price of $31.00
per share at its meeting of September 13, 2006. This $31.00 price is the same as
that set by the Board at its meeting of April 19, 2006. Please see "Price
Adjustment since Initial Opinion Date" on page 23.

UPDATED OPINION.

       Following is a summary of selected analyses considered by Danielson
Associates in connection with its updated opinion. Please see, "Initial
Opinion." on page 23, and "Price Adjustment since Initial Opinion Date" on page
23 for additional information regarding the initial opinion and the Board's
price determinations.

       COMPARABLE COMPANIES. In determining what is a "fair" price for the
outstanding shares of Harbor common stock, Harbor was compared with four groups
of publicly-traded banking organizations. The first group is comprised of
commercial banking organizations based in urban areas that have assets between
$150 and $525 million, have returns on average assets approximately .50% or
greater, and trade on a national exchange ("urban exchange group"). The second
group consists of commercial banking organizations with the same restrictions as
the urban exchange group but which trade instead on the over-the-counter
bulletin Board market ("urban OTC group"). These banking organizations are
sometimes referred to as "banks" for simplicity. The banks in these groups are
either small urban banks or minority-owned banks. The analysis was complicated
by the fact that very few small urban banks or banks that are minority-owned
have publicly traded stock. However, the banks in these four groups are similar
to Harbor and are believed to provide the best measurement of Harbor's stock
value. The initial comparisons are to three groups of non-minority banks in
urban areas, but the primary comparison on which Harbor's valuation is based is
to a group comprised of other minority-owned banks. The composition of the
comparable company groups is described below.


                                       18



                    o URBAN EXCHANGE GROUP - This group is comprised of thirteen
                      commercial banks based in urban areas along the east coast
                      that have assets between $150 and $525 million, have
                      returns on average assets of approximately .50% or more,
                      and trade on a national exchange. The stocks of these
                      banks, with three exceptions, trade on average more than
                      2,000 shares each day.

                    o URBAN OTC GROUP - This group consists of ten commercial
                      banks with the same restrictions as the urban exchange
                      group, but which trade on the over-the-counter bulletin
                      board market. The stocks of most of these banks are less
                      liquid than those of the urban exchange group and trade on
                      average a little over 900 shares each day.

                    o URBAN MOST APPLICABLE GROUP - Since the first two groups
                      contained several newly-formed banks and banks with much
                      better performance than Harbor, a third group was created
                      from the banks in the urban exchange group and the urban
                      OTC group which eliminated those less comparable banks.
                      The remaining five banks are the banks most applicable to
                      Harbor based on location, performance, and history.

                    o MINORITY-OWNED GROUP - Includes banks that are among the
                      total seventeen minority-owned publicly-traded banks.
                      Several different minorities are represented in the total
                      seventeen institutions- African-American, Hispanic, and
                      Asian and women. Some of these banks are comparable to
                      Harbor but others because of their size, performance, or
                      minority orientation are not comparable. Accordingly,
                      banks with assets over $900 million or other attributes
                      that would make them not comparable to Harbor were
                      excluded from this group. The remaining six minority-owned
                      banks are most comparable to Harbor


       The first two groups of urban comparables, and the third group which is a
mix of the first two, provides a base from which to view the pricing of a
non-minority-owned bank located in a city. As will be discussed later,
minority-owned banks tend to serve larger more densely populated urban areas and
typically have a lower valuation.

       FINANCIAL COMPARISONS


                    o URBAN EXCHANGE GROUP. The urban exchange group's financial
                      performance was comparable to Harbor's. The urban exchange
                      group's median returns on average assets and equity of .91
                      and 10.07% were similar to Harbor's .77% and 11.65%,
                      respectively. Nonperforming assets ("NPAs") as a percent
                      of assets were .14% for Harbor which was lower than the
                      .23% for the comparable group. The urban exchange group
                      had equity-to-assets of 7.77% while Harbor's was 6.67%.
                      Harbor's net interest income of 4.53% of average assets in
                      the twelve months ending June 30, 2006, was higher than
                      the urban exchange group median of 3.73%, but this was
                      more than offset by net operating expense that was about
                      one and a half times the comparative group's median. The
                      urban exchange group's stock price multiples were diverse.
                      The price times earnings multiples for these banks, ranged
                      from 13.0 to 29.6 times earnings, with a median of 19.6
                      times earnings. The price-to-book ratios also had a wide
                      range with a low of 141%, a high of 311% and a median of
                      179%.

                    o URBAN OTC GROUP. The urban OTC group performed much better
                      than Harbor with median returns on average assets and
                      equity of 1.16% and 14.74%, respectively, compared to .77%
                      and 11.65%, respectively, for Harbor. Equity-to-assets was
                      similar with the urban OTC group having a median of 7.53%
                      to Harbor's 6.67%. Once again the NPAs of the comparable
                      group were higher than Harbor's, at .34% of assets versus
                      .14% of assets for Harbor. In comparing income and expense
                      ratios, Harbor outperformed the OTC group in terms of net
                      interest income but gave away its advantage with higher
                      net operating expense. Harbor had net interest income to
                      average assets of 4.53% for the twelve months ended June
                      30, 2006, versus a median of 4.36% for the urban OTC
                      group. Net operating expense was the opposite with Harbor
                      having a much higher net operating expense to average
                      assets of 3.24% compared to 2.31% for the comparable
                      group. As a result Harbor's net operating income as a
                      percent of assets was lower than that of the comparable
                      group's median - 1.29% to 2.10%. The pricing ratios for
                      the urban OTC group were just as diverse as the urban
                      exchange group's. Price-to-earnings multiples ranged from
                      11.2 to 32.0, with a median of 17.8. Price-to-book
                      multiples ranged from 150% to 366% of book with a median
                      of 244%.


                                       19



                    o URBAN MOST APPLICABLE GROUP. Since the members of the
                      urban exchange group and the urban OTC group were selected
                      based on their having similar assets to Harbor and being
                      in urban markets, there were differences in their other
                      characteristics that distort their comparability to
                      Harbor. For example, the pricing multiples of the urban
                      exchange group and the urban OTC group were in the range
                      of 11 to 32 times earnings and 141% to 366% of book, but
                      these groups contain several newly formed banks and banks
                      with far superior performance that are valued at high
                      multiples. As noted above, the Urban Most Applicable Group
                      was created by eliminating less comparable banks that were
                      new or high performance banks. The urban most applicable
                      group's five banks had median returns on average assets
                      and equity of .86% and 12.49%, respectively. While this
                      was higher than Harbor's .77% and 11.65%, respectively,
                      both are in the range of moderate performing banks.

                    o MINORITY-OWNED GROUP. There are seventeen publicly traded
                      minority-owned institutions as defined by the Federal
                      Reserve Bank. These banks represent African-American,
                      Hispanic, Asian and women minorities. Some of these banks
                      are comparable to Harbor but others because of their size,
                      performance, or minority orientation are not comparable
                      and have been excluded. Danielson Associates determined
                      that the remaining six banks that are most comparable to
                      Harbor provide the best basis on which to value its stock.

                      The minority-owned institutions that were non-comparable
                      were excluded based on size, performance, or minority
                      orientation. The five banks with assets over $900 million
                      were so much larger than Harbor that they were not
                      comparable. In terms of performance there were two banks
                      whose performance was too far above Harbor's to be
                      comparable and four banks whose performance was too far
                      below Harbor's to be comparable. The two top performers
                      all had returns on equity of over 16% and the four poorly
                      performing banks all had returns on equity below 5.25%. In
                      addition two of these poor performers with assets under
                      $100 million and were too small to be comparable, and a
                      third had high NPAs which might add another reason that it
                      would be not comparable.

                      Four of the six remaining minority-owned institutions (the
                      "minority-owned group") were all African-American owned,
                      three of which were banks and the other a thrift. The
                      largest in the group was the New York City based thrift
                      Carver Bancorp, Inc. ("Carver") with assets of $655
                      million and the smallest was the Portland, Oregon based
                      Albina Community Bancorp ("Albina") with assets of $125
                      million The other four banks were the Atlanta, Georgia
                      based Citizens Bancshares Corporation ("Citizens"), the
                      Durham North Carolina based M&F Bancorp, Inc. ("M&F"), and
                      the Washington, D.C. based Abigail Adams National Bancorp,
                      Inc. ("Adams") and IBW Financial Corporation ("IBW").
                      Harbor with assets of $258 million was below the median of
                      this group of $333 million.

                      Equity as a percent of assets was similar for five of the
                      banks, but the sixth, Albina, was substantially lower. The
                      group median was 7.62% compared to Harbor's
                      capital-to-assets of 6.67%.

                      In terms of performance the six banks in the
                      minority-owned group had performance comparable but below
                      that of Harbor. Returns on average equity ranged from
                      6.67% to 10.53% with a median of 7.91%. Harbor's return on
                      average equity was 11.65% but it was aided by its low
                      capital ratio. Median return on average assets of .63% was
                      closer, compared to Harbor's return on average assets of
                      .77%. The bank with the lowest NPAs-to-assets was Adams at
                      .31% and the highest was Citizens at 1.22%. Harbor's
                      NPAs-to-assets of .14% was substantially better than peer
                      levels.


                                       20



                      Harbor's net interest income to average assets of 4.53%
                      was inside the range of 3.02% to 4.59%, and above the
                      median of 4.18%. In terms on net operating expense to
                      average assets Harbor's 3.24% was again inside the range
                      of 2.15% to 3.67%, but was above the median of 3.19%.

                      The pricing of the minority-owned group varied widely.
                      Price earnings multiples ranged from 7.7 to 24.4 times
                      earnings with a median of 14.0 times, while price-to-book
                      ratios ranged from 79% to 224%, with a median of 93%.
                      Absent adjustments for illiquidity of the market for the
                      stock discussed below, Harbor's common stock would be
                      expected to trade within the comparative groups' normal
                      range of earnings multiples, as its financial
                      characteristics are comparable with those of the
                      comparative groups. However, the banking organizations
                      most similar to Harbor, the urban minority owned banks, do
                      not trade in line with the pricing values of the other
                      comparable groups', and as a result the fair value of
                      Harbor will similarly not be in line with the pricing
                      values of the other groups. (Although Danielson reviewed
                      current and historical trading in Harbor stock, it
                      concluded that number of shares traded was too small on
                      which to base a valuation.)

       VALUATION METHODS. A number of methodologies can be used to establish a
fair price for shares of an unlisted stock, including (a) sale prices of similar
companies, (b) liquidation value, (c) discounted dividends analysis under
certain earnings and growth assumptions, and (d) comparisons with stock prices
of similar companies that are publicly-traded. Danielson Associates determined
that a comparison with stock prices of similar publicly traded companies was the
best method for the valuation of Harbor's common stock. The first three methods
are primarily utilized when there is either a likely sale of the company, a
possibility of failing, or adequate comparisons do not exist. These last three
methods were not used for the Harbor valuation because Harbor is not considering
a sale, it is not in danger of failing, and there are applicable market
comparables on which to base a valuation of its stock. Thus, Harbor's value has
been established on a "going-concern value" basis by comparisons to stock prices
of urban and minority-owned banks with similar size, performance, and market
characteristics after which certain discounts were applied. Danielson Associates
determined that the number of Harbor shares traded during 2005 and 2006 to the
date of the updated opinion was too small on which to base a valuation and did
not consider them in the valuation.

                    o EARNINGS DERIVED VALUATION. The methods by which bank
                      stocks are normally valued are (a) price times earnings,
                      (b) price-to-book, and (c) price-to-assets. Generally, the
                      best method of valuation when earnings are normal, or can
                      be normalized, is price times earnings. Price-to-book is
                      used when price times earnings cannot be used because
                      earnings are not normal or cannot easily be normalized.
                      Price-to-assets is used when price-to book does not
                      provide a meaningful valuation. As Harbor's earnings had
                      been sustained for several years through June 30, 2006,
                      Danielson determined that the valuation should be based
                      primarily on earnings.

                      The first two groups considered were the urban exchange
                      group and the urban OTC group. A number of the banks in
                      these two groups were eliminated to form a single group
                      with more similarities to Harbor, but the pricing
                      multiples of the larger groups than were reviewed for
                      reference. The urban exchange group had thirteen banks and
                      a median price times earnings multiple of 19.6. The urban
                      OTC group had ten banks and had a median price times
                      earnings multiple of 17.8.

                      When the new banks and high performers in the urban
                      exchange group and the OTC group were eliminated there
                      were five banks remaining. These five banks comprise the
                      urban most applicable group and had financial conditions
                      and performance similar to Harbor's. The median price
                      times earnings of this group were 15.4. That the price
                      times earnings were lower than those of the larger groups
                      is not surprising as new banks are often valued based on
                      anticipated future performance and high performing banks
                      may merit a higher multiple.

                      The final comparative group and the most relevant to
                      Harbor is the minority-owned group. Four of these six
                      banks all are African-American owned and serve urban areas
                      like Harbor. In addition, they all have similarities in
                      financial condition and performance. The median price
                      times earnings for this group is 14.0.

                      The price times earnings multiples for the four
                      comparables groups were 19.6X, 17.8X, 15.4X and 14.0X. The
                      latter two multiples - for the urban most applicable and
                      the minority-owned group - are the most comparable.


                                       21



                    o STOCK TRANSACTIONS. There have been only 16 known Harbor
                      stock transactions since December 31, 2004. In 2005, the
                      stock traded consistently around $25.00 per share except
                      for two trades around $19.00 per share. In 2006, the stock
                      continued trading around $25.00 per share but the three
                      most recent trades were for $29.73, $28.00, and $31.00 per
                      share. At a price of $31.00 based on current financial
                      data, Harbor common stock trades for 11.6 times
                      fully-diluted earnings and 122% of book. Trading volume in
                      2006 was just 11,181 and in 2005, 34,875 shares traded.
                      However, Danielson Associates determined that the trading
                      volume was insufficient on which to base a valuation and
                      did not considered Harbor's current or historical trading
                      prices in its valuation.

                    o DISCOUNTED DIVIDENDS ANALYSIS. Danielson Associates
                      applied present value calculations to Harbor's estimated
                      dividend stream under several specific growth and earnings
                      scenarios. The projected dividend streams and terminal
                      values, which were based on a range of earnings multiples,
                      were then discounted to present value using discount rates
                      based on assumptions regarding the rates of return
                      required by holders or prospective buyers of Harbor common
                      stock. In performing this analysis, Danielson Associates
                      used the following assumptions: (a) growth rate of 6%; (b)
                      ending price/earnings ratios of 12X and 14X; (c) tax rate
                      of 36%; (d) discount rates of 10% and 12%; and (e)
                      dividends in amounts so that capital over 6.50% is paid
                      out as dividends. Based on this analysis, the value of the
                      Harbor common stock would be between $30.53 and $32.17 per
                      share.


                    o OTHER FACTORS. In addition to performing the analyses
                      summarized above, Danielson Associates also considered
                      other factors. These included the general trading levels
                      for comparable banks, the past financial performance,
                      their market positions and future prospects and general
                      economic conditions.

       VALUE ADJUSTMENTS. In order to determine the "fair" price for shares of
Harbor common stock, it was necessary to consider how it differs from the
comparable banks and make the adjustments reflecting the differences. These
adjustments considered such items as profitability, capital, growth momentum,
market, deposit mix, asset mix and quality, management, liquidity of common
stock as well as any unique circumstances. These valuation adjustments, other
than the minority ownership discount which is based on the comparative pricing
levels of the comparative groups, are not mathematically derived, but are based
on a subjective analysis based on the experience of Danielson Associates and its
review of market reactions to valuation issues over more than 20 years. In
performing its analysis, Danielson believed that a discount of between 5% and
15% was appropriate to account for the illiquidity of the common stock, and an
additional discount of 15% was appropriate to account for the other interrelated
factors of market, growth, and minority ownership.

       When all of the elements of possible adjustments to the value of Harbor
are considered, it merits discounts based on market, stock liquidity, and
minority ownership.

                    o MARKET. Harbor has continued to look for branches in
                      growing areas within its market, but the majority of its
                      branches and deposits are in Baltimore City, a declining
                      market. This is particularly important in a valuation
                      since part of the value of a banking organization is its
                      growth opportunities and the likelihood that it will be
                      acquired. Harbor's market limits both its potential growth
                      and is likely to deter most potential acquirers. Thus,
                      market is a reason for a downward value adjustment in
                      comparison to the urban most applicable group, which
                      generally served better markets, but not the
                      minority-owned group, which served similar large urban
                      markets.

                    o STOCK LIQUIDITY. Harbor differs from most of the
                      comparable banking organizations in the illiquidity of its
                      stock. The comparable banks, generally, do not trade
                      extensively, but they are listed on either a national
                      exchange or trade over-the-counter. Harbor is not listed
                      on any exchange, and its stock trades very sporadically.

                    o MINORITY OWNERSHIP. A significant characteristic of Harbor
                      is its minority ownership, particularly its
                      African-American ownership. This characteristic is
                      reflected in the minority-owned group, but not in the
                      urban most applicable group. This minority-ownership
                      adversely affects the value of the stock by decreasing the
                      likelihood Harbor will be sold, and thus its potential
                      sale value. Investors do not consider minority banks
                      likely to sell, and, thus, no acquisition premium is
                      normally included in the value. The reason for this
                      perception is that minority banks seldom are sold
                      willingly because there is a stronger community commitment
                      than for most non-minority urban banks and non-minority
                      banks, which represent the bulk of possible buyers, have
                      minimal interest in acquiring minority banks because of
                      the poor economic dynamics of the urban markets they
                      normally serve and the potential run-off of customers
                      after a merger. In the view of Danielson Associates, a
                      non-minority bank may buy a minority bank, but it is
                      unlikely to pay a full premium for it.

                                       22


       CONCLUSION. In the opinion of Danielson Associates, the best guide as to
the value of Harbor's stock is the price times earnings multiples of other
African-American banks having similar size and performance, and being located in
similar urban markets, and that the value determined by the urban most
applicable group - which is slightly lower - should also be considered, but only
to determine that the value is to the lower half of the range determined by the
minority-owned group.

       Since no comparable banking organizations used in the various analyses
are totally identical to Harbor, the results do not represent mathematical
certainty. Instead the comparisons rely on the likelihood that the median stock
prices of comparable banks are applicable to the stock value of Harbor.


       Based on these comparisons, an analysis of Harbor's past performance and
future potential and by applying discounts for market, stock liquidity and its
minority ownership, Danielson Associates arrived at its updated opinion that the
"fair" value of its common stock as of August 29, 2006, is between $30.53 and
$32.17 per share with the midpoint being $31.35 per share. In Danielson
Associates' opinion, any price in this range would be a "fair" price for
purposes of the merger.

       The summary set forth above is not a complete description of the analyses
and procedures performed by Danielson Associates in the course of arriving at
its opinion. The full texts of the report of Danielson Associates dated December
8, 2005, and the updated report dated August 29, 2006, which set forth the
assumptions made and matters considered, are available for inspection and
copying at Harbor's principal executive offices during regular business hours by
any interested shareholder, or the representative of any shareholder designated
in writing. Danielson Associates' opinion is directed only to the "fairness" of
the value of Harbor common stock and does not constitute a recommendation to any
Harbor shareholder as to how such shareholder should vote.

INITIAL OPINION.

         The initial opinion, dated December 8, 2005, employed the same
methodology described above, but, did not reflect results or other financial
data for Harbor or comparable banks for periods after that date. In addition,
the updated opinion reflected several changes in the peer group composition
based upon changes in the financial data, including the elimination of one bank
from the Urban Exchange Group based upon its pending acquisition, the
elimination of one bank from the Urban OTC Group due to its deregistration, the
elimination of those two banks from the Urban Most Applicable Group, and a
change in the composition and increase by two of the Minority-Owned Group. The
price times earnings multiples for the four comparables groups in the initial
report were 22.7X, 17.8X, 15.5X and 14.0X. As noted above, Danielson Associates
arrived at its opinion that the "fair" value of the Harbor common stock as of
December 8, 2005, was between $28.13 and $29.63 per share with the midpoint
being $28.88 per share. In Danielson Associates' initial opinion, as of that
date, any price in this range would have been a "fair" price for purposes of the
merger. The Board of Directors established the price of $29.00 per share to be
paid in the merger based upon that earlier analysis and opinion.

         COMPENSATION OF DANIELSON ASSOCIATES. Pursuant to an agreement,
Danielson Associates will be paid fees of approximately $10,750, plus reasonable
out-of-pocket expenses.

PRICE ADJUSTMENT SINCE INITIAL OPINION DATE

       At its meeting of December 14, 2005, the Board originally established a
price of $29.00 per share for shares to be purchased in the merger in
consideration of the opinion of Danielson Associates and other factors. At its
meeting of April 19, 2006, the Board reviewed the price to be paid to
shareholders whose shares will be purchased in the merger based upon factors it
previously had considered and upon the performance of Harbor since the opinion
of Danielson Associates was rendered and the original price was determined. In
its review the Board considered the significant growth in net income and the
resulting effect on book value since September 30, 2005. As a result of that
review, the Board unanimously increased the price to be paid per share in the
merger to $31.00 per share from the original $29.00 per share. This increased
price was within the range subsequently established in Danielson's updated
opinion. The Board of Directors determined to maintain that price based upon
review of that updated opinion at its meeting of September 13, 2006.


                                       23


EFFECTS OF THE MERGER

       The merger will have various effects on Harbor, as described below.

       REDUCTION IN THE NUMBER OF SHAREHOLDERS. We believe that the merger will
reduce the number of record shareholders from approximately 626 to approximately
266, and the number of outstanding shares of voting common stock from 641,784 as
of the record date, to approximately 629,306 after the merger. The merger will
have no effect on the number of shares nonvoting common stock (33,795).


       DECREASE IN BOOK VALUE. Assuming: the price to be paid to holders of 100
or fewer shares of common stock will be $31.00 per share, (ii) the maximum
number of shares of common stock expected to be cashed-out as a result of the
merger is 12,478 , (iii) the total cost to Harbor (including expenses) of
effecting the merger is expected to be approximately $486,818, and (iv) at June
30, 2006, aggregate shareholders' equity in Harbor was approximately $17.2
million, or $25.50 per share. Based upon these facts and assumptions, Harbor
expects that, as a result of the merger:

                    o Aggregate shareholders' equity of Harbor as of June 30,
                      2006, will be reduced from approximately $17.2 million on
                      a historical basis to approximately $16.7 million on a pro
                      forma basis; and

                    o The book value per share of common stock as of June 30,
                      2006, will be reduced from $25.50 per share on a
                      historical basis to $25.25 per share on a pro forma basis.

       DECREASE IN CAPITAL. The merger will reduce Harbor's capital. However,
Harbor expects that its regulatory capital ratios will continue to exceed the
levels required for "well capitalized" banking organizations. Harbor's tier 1
capital to risk-weighted assets ratio will decrease from 8.64% on a historical
basis to approximately 8.42% on a pro forma basis. Harbor's tier 1 to average
assets ratio will decrease from 7.47% on a historical basis to approximately
7.28% on a pro forma basis, and its total risk-based capital ratio will decrease
from 11.10.% on a historical basis to approximately 10.88% on a pro forma basis.
All regulatory capital ratios have been calculated assuming that 12,478 shares
are cashed-out in the merger.

       SUSPENSION OF EXCHANGE ACT REPORTING OBLIGATIONS. Once our common stock
is no longer held by 300 or more shareholders of record, we plan to file a Form
15 with the SEC, which will suspend our obligation to file reports under section
13(a) of the Exchange Act, including quarterly reports on form 10-QSB, annual
reports on Form 10-KSB, and current reports on form 8-K. We expect that
termination of the registration of the Harbor common stock will occur 90 days
after the filing of the Form 15, after which we will no longer be required to
file other reports required to be filed by issuers of registered securities
under the Exchange Act and the related requirements of the Sarbanes-Oxley Act.
Suspension of our reporting obligations under Section 13(a) of the Exchange Act
and related provisions of the Sarbanes-Oxley Act will substantially reduce the
information we are required to furnish to our shareholders and to the SEC.
Deregistration of the Harbor shares would also make certain provisions of the
Exchange Act, such as proxy statement disclosure in connection with shareholder
meetings, no longer applicable to Harbor. Accordingly, we estimate it will
eliminate costs and expenses associated with continuance of the Exchange Act
registration, estimated at approximately $100,000 per year. In addition, Harbor
will avoid the costs of initial compliance with the internal control systems
requirements of the Sarbanes Oxley Act of 2002, currently expected to be
required for public companies of Harbor's size by year-end 2007, which are
estimated to range from $150,000 to $200,000, and continued annual compliance
costs related to those requirements in amounts not determined. We intend to
apply for such suspension of registration as soon as practicable following
completion of the merger.


       EFFECT ON MARKET FOR SHARES. Harbor common stock is not currently traded
on any exchange. Following the merger, Harbor's common stock will not be listed
or quoted on any exchange following the merger, and the number of trading
markets where the shares could be traded by market makers will be limited..
Because we will no longer be required to file reports under the Exchange Act,
the market for shares of Harbor common stock may be adversely affected.
Currently, there is minimal liquidity in our shares of common stock and there
may be a further reduction in the liquidity of our common stock after the
merger.

       EFFECT ON DIVIDENDS. The principal source of our cash revenues comes from
dividends received from the Bank. The amount of dividends that may be paid by
the Bank to us depends on the Bank's earnings and capital position and is
limited by federal and state law, regulations, and policies. In addition to the
availability of funds from the Bank, our future dividend policy is subject to
the discretion of our Board of Directors and will depend upon a number of
factors, including future earnings, financial condition, cash needs, and general
business conditions. If dividends should be declared in the future, the amount
of such dividends cannot be estimated and it cannot be known whether such
dividends would continue for future periods.

                                       24


       We anticipate that the merger will not have a material effect on our
dividend policy, and we intend to continue paying an annual cash dividend;
however, any future declaration and payment of dividends will depend upon, among
other factors, our results of operations and financial condition, future
prospects, regulatory limitations and capital requirements, and other factors
deemed relevant by the Board of Directors.

       Furthermore, in 2003 in connection with the private placement of trust
preferred securities, we formed Harbor Bankshares Corporation Capital Trust (the
"Trust") as a subsidiary and issued $7.2 million of floating rate junior
subordinated debentures to the Trust. The floating rate junior subordinated
debentures pay interest quarterly, and as a result, we may be required to reduce
the amount of, or stop paying, dividends on Harbor common stock in order to make
such payments of interest and repayment of principal. See "-- Financial Effects
of the Merger; Financing of the Merger," below.


       FINANCIAL EFFECTS OF THE MERGER; FINANCING OF THE MERGER. We expect that
the purchase of the cashed-out shares in the merger will cost no more than
approximately $386,818 which does not include approximately $100,000 in
professional fees and other expenses we anticipate incurring in the course of
the transaction. In addition, we do not expect that the completion of the merger
will have any material adverse effect on our capital adequacy, liquidity,
results of operations, or cash flow. Because we currently do not know the actual
number of shares that will be cashed-out in the merger, we do not know the exact
amount of cash we will pay to shareholders in the merger. However, our
obligation to consummate the merger under the merger agreement is conditioned on
the aggregate number of shares of Harbor common stock owned by shareholders who
are to be cashed-out or who have properly perfected their rights as objecting
shareholders not exceeding 1.0% of the issued and outstanding shares of Harbor
common stock. It is anticipated, however, that, if necessary, we will waive the
condition to closing that limits the amount of shareholders being cashed out to
1% of our shares and, therefore, that all shareholders who own 100 or fewer
shares will be cashed out. You should read the discussion under "The Merger
Agreement--Conditions to the Completion of the Merger" on page 33 for a
description of conditions to the obligations of the parties to consummate the
merger and "Special Factors--Fees and Expenses" on page 23 for a description of
the fees and expenses that we expect to incur in connection with the merger.
Funds for the acquisition of shares are expected to be obtained by means of a
dividend from the Bank, the funds for which would be obtained from the Bank's
general working capital. As of June 30, 2006, the Bank could pay in excess of $9
million in dividends to Harbor without regulatory approval. The board of
directors of the Bank has the authority to declare and pay dividends to Harbor,
and has indicated its intention to declare a dividend in to Harbor in an amount
sufficient to provide the funds required by Harbor for the purchase of shares in
the Merger without material condition. Accordingly, no alternative financial
arrangements have been made.

       OWNERSHIP PERCENTAGE OF OFFICERS AND DIRECTORS. As a result of the
merger, we expect that (a) the percentage ownership of all shares of outstanding
common stock of Harbor held by current executive officers and Directors of
Harbor and the Bank as a group (16 persons) will increase by less than 1%, from
28.6% to approximately 29.1% (excluding the effect of options); (b) the
percentage ownership of all shares of outstanding voting common stock of Harbor
held by current executive officers and Directors of Harbor and the Bank as a
group will increase less than 1%, from 30.1% to 30.7%; (c) the percentage of
beneficial ownership of voting common stock (including shares issuable upon the
exercise of stock options that are or will become exercisable within 60 days of
October __, 2006) held by current executive officers will increase by less than
1%, from 40.9% to 41.6%; (c) the collective book value as of June 30, 2006, of
the shares of Harbor common stock held by our current officers and Directors, as
a group, will decrease from approximately $4.93 million on a historical basis to
approximately $4.88 million on a pro forma basis; and (d) the collective pro
rata interest of our current officers and Directors, as a group, in the net
income of Harbor for the quarter ended June 30, 2006, will increase from
$256,000 on a historical basis (based on the number of shares beneficially owned
by such officers and Directors as of the record date) to approximately $261,000
on a pro forma basis (based on the number of shares we anticipate such officers
and Directors to own beneficially immediately after the merger). For a
description of the assumptions used in determining the numbers of shares and
related percentages that we expect to be held by executive officers and
Directors immediately following the merger, please see footnotes under "THE
PARTIES--Security Ownership of Certain Beneficial Owners and Management" on page
34.


                                       25


       The Board of Directors of Harbor was aware of these interests and
considered them in approving the merger agreement. See "SPECIAL
FACTORS--Background of the Merger" on page 12.


       NO FURTHER REPORTING OBLIGATIONS UNDER THE EXCHANGE ACT. After the merger
and the filing of the After the planned deregistration of the Harbor common
stock, Harbor will no longer will file Forms 10-QSB, 10-KSB or 8-K, or any other
reports with the SEC. See "Suspension of Exchange Act Reporting Obligations,"
above and "Conduct of Harbor's Business after the Merger" on page 28.


EFFECTS OF THE MERGER ON SHAREHOLDERS


       GENERAL. The merger will affect Harbor shareholders as described below
(Shareholders who elect to exercise rights as objecting shareholder should refer
to "APPRAISAL RIGHTS OF HARBOR SHAREHOLDERS" on page 31.)


       SHAREHOLDERS WITH 100 OR FEWER SHARES OF HARBOR COMMON STOCK. If you are
a shareholder who holds 100 or fewer shares of Harbor common stock before the
merger:

                    o You will receive $31.00 in cash, without interest, for
                      each share you own at the effective time of the merger.

                    o You will not have to pay any brokerage commissions or
                      other service charges in connection with the merger.

                    o All amounts owed to you will be subject to applicable
                      federal, state, and local income taxes.

                    o You will have no further interest in Harbor with respect
                      to your cashed-out shares. Your only right will be to
                      receive cash for those shares.

                    o You will receive a letter of transmittal from Harbor as
                      soon as practicable after the merger with instructions on
                      how to surrender your existing certificate(s) in exchange
                      for your cash payment.

       If you want to continue to remain a shareholder of Harbor after the
merger, you may do so by purchasing a sufficient number of shares of Harbor
common stock from other shareholders prior to the effective time of the merger
so that you hold more than 100 shares at the effective time of the merger. As
described in the section "THE MERGER AGREEMENT--Conversion of Shares in the
Merger" on page 35, there are specific provisions regarding the treatment of
shares held in nominee form, or "street name."

       The merger will have the same effect on shareholders regardless of
whether they are affiliated or unaffiliated shareholders. As used in this proxy
statement, the term "affiliated shareholder" means any shareholder who is a
Director or executive officer of Harbor, and the term "unaffiliated shareholder"
means any holder of Harbor common stock who is not an affiliate of Harbor. The
effects of the merger on a shareholder will vary depending on whether all of the
shareholder's shares will be cashed-out in the merger. The determination of
whether or not any particular shares of Harbor common stock will be cashed-out
in the merger will be based on whether the holder of those shares holds either
100 or fewer shares or more than 100 shares. Since a shareholder may
beneficially own shares held by more than one holder of shares, a shareholder
may beneficially own both shares that will be cashed-out in the merger and
shares that will remain outstanding in the merger.

       CASHED-OUT SHAREHOLDERS. Shareholders owning 100 or fewer shares
immediately prior to the effective time of the merger will, upon consummation of
the merger:

                    o Receive $31.00 in cash, without interest, per share;

                    o No longer have any equity interest in Harbor and therefore
                      will not participate in its future potential earnings or
                      growth, if any, as a shareholder; and

                    o Be required to pay federal and, if applicable, state and
                      local income taxes on the cash amount received in the
                      merger. See "SPECIAL FACTORS--Material U.S. Federal Income
                      Tax Consequences" on page 29.

       REMAINING SHAREHOLDERS. The effects of the merger on shareholders owning
more than 100 shares immediately prior to the effective time of the merger will
upon consummation of the merger include:

                                       26


                    o Continued Ownership of Shares. Shareholders who own more
                      than 100 shares immediately prior to the effective time of
                      the merger will continue to be shareholders of Harbor and
                      will own the same number of shares after the merger as
                      they owned immediately before the merger.


                    o Ownership Percentage. Remaining shareholders will have an
                      increased ownership percentage in Harbor as a result of
                      the merger. However, fewer than 2% of the Harbor's
                      outstanding shares of voting common stock will be
                      exchanged for cash in the merger. Accordingly, the
                      percentage changes in the ownership of the remaining
                      affiliated and unaffiliated shareholders will be
                      immaterial. The aggregate beneficial ownership of
                      affiliated shareholders will not increase by a material
                      amount and, after the merger, unaffiliated shareholders
                      will continue to own more shares than affiliated
                      shareholders. The aggregate beneficial ownership of voting
                      common stock by affiliated shareholders, including the
                      effect of unexercised stock options, will increase by less
                      than 1%, from 40.9% to 41.6%, as result of the merger,
                      while the aggregate beneficial ownership of voting common
                      stock by unaffiliated shareholders will decrease by less
                      than 1%, from 59.09 % to 58.41%, calculated on the same
                      basis. Accordingly, there will be no material change in
                      the ownership of Harbor's shareholders who are not cashed
                      out in the merger.

                    o Decreased Access to Information. If the merger is
                      effected, we intend to suspend our reporting obligations
                      to the SEC under the Exchange Act and deregister Harbor's
                      common stock. As a result, we will no longer be subject to
                      the periodic reporting requirements and the proxy rules of
                      the Exchange Act.


                    o Decreased Liquidity. The liquidity of the shares of our
                      common stock held by remaining shareholders may be further
                      reduced by the merger due to the suspension of our filing
                      requirements under the Exchange Act.


                    o Reduced Capital. Harbor's regulatory capital ratios will
                      be reduced. Harbor's tier 1 capital to risk-weighted
                      assets ratio will decrease from 8.64% on a historical
                      basis to approximately 8.42% on a pro forma basis.
                      Harbor's tier 1 to average assets ratio will decrease from
                      7.47% on a historical basis to approximately 7.28% on a
                      pro forma basis, and its total risk-based capital ratio
                      will decrease from 11.10.% on a historical basis to
                      approximately 10.88% on a pro forma basis. All regulatory
                      capital ratios have been calculated assuming that 12,478
                      shares are cashed-out in the merger. It is anticipated
                      that Harbor and the Bank will continue to meet the tests
                      for "well capitalized" status for regulatory capital
                      purposes.

                    o Reduced Book Value Per Share. The book value per share of
                      Harbor common stock as of June, 2006, will be reduced from
                      $25.50 per share on a historical basis to approximately
                      $25.25 per share on a pro forma basis.


INTERESTS OF EXECUTIVE OFFICERS AND DIRECTORS IN THE MERGER

       The Board of Directors believes that it has acted in the best interests
of Harbor and its shareholders. However, as you consider the recommendation of
the Board of Directors, you should be aware that the Directors and officers of
Harbor have interests in addition to their interests as shareholders of Harbor
that may conflict with the interests of shareholders who will be cashed out in
the merger or unaffiliated shareholders who will not be cashed out in the
merger.


       As a result of the merger, we expect that (a) the percentage ownership of
all shares of outstanding common stock of Harbor held by current executive
officers and Directors of Harbor and the Bank as a group (16 persons) will
increase by less than 1%, from 28.6% to approximately 29.1% (excluding the
effect of options); (b) the percentage ownership of all shares of outstanding
voting common stock of Harbor held by current executive officers and Directors
of Harbor and the Bank as a group will increase less than 1%, from 30.1% to
30.7%; (c) the percentage of beneficial ownership of voting common stock
(including shares issuable upon the exercise of stock options that are or will
become exercisable within 60 days of October __, 2006) held by current executive
officers will increase by less than 1%, from 40.9% to 41.6%; (c) the collective
book value as of June 30, 2006, of the shares of Harbor common stock held by our
current officers and Directors, as a group, will decrease from approximately
$4.93 million on a historical basis to approximately $4.88 million on a pro
forma basis; and (d) the collective pro rata interest of our current officers
and Directors, as a group, in the net income of Harbor for the six months ended
June 30, 2006, will increase from $256,000 on a historical basis (based on the
number of shares beneficially owned by such officers and Directors as of the
record date) to approximately $261,000 on a pro forma basis (based on the number
of shares we anticipate such officers and Directors to own beneficially
immediately after the merger). For a description of the assumptions used in
determining the numbers of shares and related percentages that we expect to be
held by executive officers and Directors immediately following the merger,
please see footnotes under "THE PARTIES--Security Ownership of Certain
Beneficial Owners and Management" on page 34.


                                       27


       The Board of Directors of Harbor was aware of these interests and
considered them in approving the merger agreement. See "Special
Factors--Background of the Merger" on page 12.

CONDUCT OF HARBOR'S BUSINESS AFTER THE MERGER


         Harbor will complete the deregistration process by filing a Form 15
with the SEC promptly following the merger. Termination of the registration of
Harbor's common stock will take effect ninety days after the filing of the Form
15, unless the SEC determines that a shorter period is appropriate. However,
Harbor's obligations to file reports required pursuant to Section 13(a) of the
Exchange Act, including the obligation to file Forms 10-KSB, 10-QSB, and 8-K,
will be immediately suspended upon the filing of the Form 15. These filing
obligations would resume if the Form 15 were withdrawn by Harbor or denied by
the Securities and Exchange Commission, if Harbor registers shares under the
Securities Act of 1933, or if the number of Harbor's record holders subsequently
exceeds 500. Harbor has no plans to withdraw the Form 15, to register securities
under the Securities Act, or to increase its number of record holders to more
than 500. Harbor's obligations under other provisions of the Exchange Act,
including the requirements of Section 14 of the Act relating to proxy
solicitations, are not suspended upon filing of the Form 15, and will continue
until the registration of Harbor's common stock is terminated as described
above.


       Following the merger and deregistration, Harbor and its subsidiaries,
including the Bank, will continue to conduct their existing operations in the
same manner as now conducted. The executive officers and Directors immediately
prior to the merger will be the executive officers and Directors of Harbor after
the merger. The articles of incorporation and bylaws of Harbor will remain in
effect and unchanged by the merger. The deposits of the Bank will continue to be
insured by the Federal Deposit Insurance Corporation and Harbor and the Bank
will continue to be regulated by the federal and state bank regulatory agencies
as before the merger.

       Harbor believes that there are significant advantages in becoming a
private company, including the substantial savings in costs and management time
described above, and Harbor plans to avail itself of any other opportunities it
may have as a private company, including, but not limited to, making any public
or private offering of its shares, expansion by creation of new offices or by
acquisition, or entering into any other arrangement or transaction as it may
deem appropriate. Although management does not now have an intent to enter into
any such transaction nor is management currently in negotiations with respect to
any such transaction, there exists the possibility that Harbor may enter into
such an arrangement or transaction in the future, and the remaining shareholders
of Harbor may receive payment for their shares in any such transaction at
amounts lower than, equal to, or in excess of the amount paid to cashed-out
shareholders in the merger. Any future decision to publicly offer shares or take
any other action that would result in Harbor's again being subject to the
reporting obligations of the Exchange Act would be made only after consideration
of the related disadvantages and costs of re-registration versus the advantages
of such action. The Board of Directors does not anticipate that Harbor will take
any such action in the foreseeable future, and intends that Harbor will remain
deregistered after the filing of the Form 15.

       Other than as described in this proxy statement, neither Harbor nor its
management has any current plans or proposals to effect any extraordinary
corporate transaction, such as a merger, reorganization, or liquidation; to sell
or transfer any material amount of its assets; to change its Board of Directors
or management; to change materially its indebtedness or capitalization; or
otherwise to effect any material change in its corporate structure or business.

FEES AND EXPENSES


       Harbor estimates that merger related fees and expenses, consisting
primarily of financial advisory fees, SEC filing fees, fees and expenses of
attorneys and accountants and other related charges, will total approximately
$100,000, assuming the merger is completed. This amount consists of the
following estimated fees:


                                       28



Description                                           Amount
-----------                                           ------
Advisory fees and expenses                           $10,750
Legal fees and expenses                               70,000
Accounting fees and expenses                           7,500
SEC filing fee                                            75
Printing, solicitation and mailing costs              11,675
                                                    --------
Total                                               $100,000
                                                    ========


ACCOUNTING TREATMENT

       Harbor anticipates that it will account for the purchase of outstanding
Harbor common stock in the merger from shareholders as a purchase and retirement
of stock.

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

       The following discussion summarizes the material U.S. federal income tax
consequences to the shareholders of Harbor with respect to the merger. The
discussion is based upon the Internal Revenue Code, its legislative history,
applicable U.S. Treasury regulations, existing administrative interpretations,
and court decisions currently in effect. Any of these authorities could be
repealed, overruled, or modified at any time after the date of this proxy
statement, and any such change could be applied retroactively. This discussion
does not address any alternative minimum tax consequences or the tax
consequences under state, local, or foreign laws.

       The discussion that follows neither binds nor precludes the Internal
Revenue Service from adopting a position contrary to that expressed in this
document, and we cannot assure you that such a contrary position could not be
asserted successfully by the Internal Revenue Service or adopted by a court if
the positions were litigated. Harbor has not obtained a ruling from the Internal
Revenue Service or a written opinion from tax counsel with respect to the United
States federal income tax consequences discussed below.

       This discussion assumes that you hold your shares of Harbor common stock
as a capital asset within the meaning of Section 1221 of the Internal Revenue
Code. This discussion is only for general information and does not address all
aspects of federal income taxation that may be important to you in light of your
particular circumstances or if you are subject to certain rules, such as those
rules relating to shareholders who are not citizens or residents of the United
States, financial institutions, tax-exempt organizations and entities (including
IRAs), insurance companies, dealers in securities, shareholders, who hold
options to acquire shares of our common stock, and shareholders who acquired
their shares of common stock through the exercise of employee stock options or
similar derivative securities or otherwise as compensation.

       Federal income tax consequences to shareholders who do not receive cash
in the merger. If you (a) continue to hold shares of Harbor common stock
immediately after the merger, and (b) you receive no cash as a result of the
merger, then you will not recognize any gain or loss in the merger and you will
have the same adjusted tax basis and holding period in your shares of Harbor
common stock as you had in such stock immediately prior to the merger.

       Federal income tax consequences to shareholders who receive cash in the
merger. An exchange of your shares of Harbor common stock for cash pursuant to
the merger will be a taxable transaction. If you receive cash in exchange for
your Harbor common stock as a result of the merger, the cash you received will
be treated as a redemption of your shares of Harbor common stock exchanged
therefor under Section 302 of the Internal Revenue Code. Under Section 302 of
the Internal Revenue Code, a shareholder who exchanges his or her shares of
Harbor common stock for cash will be treated as having sold his or her shares of
Harbor common stock if the exchange meets one of the following three tests:

                    o The exchange results in a "complete termination" of his or
                      her equity interest in Harbor;

                    o The exchange is "substantially disproportionate" with
                      respect to the shareholder; or

                    o The cash received is "not essentially equivalent to a
                      dividend" with respect to the shareholder.

                    o For purposes of these tests, in addition to the shares of
                      Harbor common stock you actually own, you may be deemed to
                      own constructively certain shares of Harbor common stock
                      under the constructive ownership rules of Section 318 of
                      the Internal Revenue Code. Generally, the constructive
                      ownership rules under Section 318 of the Internal Revenue
                      Code treat a shareholder as owning:

                                       29


                         (a) Shares of stock owned by certain relatives,
                         related corporations, partnerships, estates or
                         trusts, and

                         (b) Shares of stock the shareholder has an option to
                         acquire.

       Because the constructive ownership rules are complex, each shareholder
should consult his or her own tax advisor as to the applicability of these
rules.

       Cashed-out shareholders who do not actually or constructively own any
shares of Harbor common stock after the merger. In general, if you receive cash
in exchange for your shares of Harbor common stock as a result of the merger but
do not actually or constructively own any shares of Harbor common stock
immediately after the merger, you will be treated as having sold your shares of
Harbor common stock for the cash received. You will recognize gain or loss on
the exchange in an amount equal to the difference between the cash you receive
for your cashed-out shares of Harbor common stock and your aggregate adjusted
tax basis in such stock. Your gain will be a capital gain provided you held your
shares of Harbor common stock as a capital asset within the meaning of Section
1221 of the Internal Revenue Code as of the effective time change effective time
of the merger.

       Shareholders receiving cash who actually or constructively continue to
own any shares of Harbor common stock after the merger. If you receive cash in
exchange for your shares of Harbor common stock as a result of the merger and
are treated as directly or constructively owning shares of Harbor common stock
immediately after the merger, then you will be treated as having sold your
shares of Harbor common stock for the cash received only if you meet one of the
three tests mentioned above and described below.

       You will satisfy the "complete termination" test if you receive cash in
exchange for your shares of Harbor common stock pursuant to the merger and you
completely terminate your direct and constructive ownership interest in Harbor.
If you would otherwise satisfy the complete termination requirement but for your
constructive ownership of shares of Harbor common stock held by family members,
you may, in certain circumstances, be entitled to disregard such constructive
ownership. You should check with your own tax advisor as to whether you would be
entitled to disregard such constructive ownership and the required filings with
the Internal Revenue Service pursuant to such a decision.

       You will satisfy the "substantially disproportionate" test if immediately
after the merger you actually and constructively own less than 50% of the total
combined voting power of all classes of Harbor stock entitled to vote and your
percentage interest in Harbor (i.e., the number of voting shares actually and
constructively owned by you divided by the number of voting shares outstanding)
is less than 80% of your percentage interest in Harbor immediately prior to the
merger.

       You will satisfy the "not essentially equivalent to a dividend" test if
the reduction in your percentage interest in Harbor, as described above,
constitutes a "meaningful reduction of your proportionate interest" given your
particular facts and circumstances. The Internal Revenue Service has indicated
in published rulings that a minority shareholder whose relative stock interest
is minimal (i.e., less than 1%) and who exercises no control with respect to
corporate affairs is considered to have a "meaningful reduction" generally if
the shareholder has some reduction in the shareholder's stock ownership
percentage.

       If you satisfy one of these three tests, you will be treated as having
sold your shares of Harbor common stock for the cash exchanged therefor and will
recognize gain or loss on the exchange in an amount equal to the difference
between the cash you receive for your cashed-out shares of Harbor common stock
and your aggregate adjusted tax basis in such stock. Your gain will be a capital
gain provided you held your shares of Harbor common stock as a capital asset
within the meaning of Section 1221 of the Internal Revenue Code as of the
effective time of the merger.

       If you do not satisfy one of these three tests, you will be treated as
having received a dividend to the extent of our current and accumulated earnings
and profits, which we anticipate will be sufficient to cover the amount of any
such dividend and will be includible in your gross income as ordinary income in
its entirety, without reduction for the adjusted tax basis of your shares of
Harbor common stock exchanged for cash. No loss will be recognized. If the
exchange is treated as a dividend, your adjusted tax basis in your shares of
Harbor common stock exchanged for cash generally will be added to your tax basis
in your remaining shares of Harbor common stock. To the extent that cash
received in exchange for your shares of Harbor common stock is treated as a
dividend to a corporate shareholder, the corporate shareholder will be: (i)
eligible for a dividends-received deduction (subject to applicable limitations);
and (ii) subject to the "extraordinary dividend" provisions of the Internal
Revenue Code. To the extent, if any, the cash received by you exceeds our
current and accumulated earnings and profits, it will be treated first as a
tax-free return of your adjusted tax basis in the shares surrendered and
thereafter as a capital gain.

                                       30


       CAPITAL GAIN AND LOSS. For individuals, net capital gain (defined
generally as your total capital gains in excess of capital losses for the year)
recognized upon the sale of capital assets that have been held for more than 12
months generally are subject to tax at a rate not to exceed 15%. Net capital
gain recognized from the sale of capital assets that have been held for 12
months or less will continue to be subject to tax at ordinary income tax rates.
In addition, capital gain recognized by a corporate taxpayer will continue to be
subject to tax at the ordinary income tax rates applicable to corporations.
There are limitations on the deductibility of capital losses.

       BACKUP WITHHOLDING. If you receive cash in the merger, you will be
required to provide your social security or other taxpayer identification
numbers (or, in some instances, additional information) in connection with the
merger to avoid backup withholding requirements that might otherwise apply. The
letter of transmittal will require you to deliver such information when your
shares of Harbor common stock certificates are surrendered following the
effective time of the merger. Failure to provide such information may result in
backup withholding.

       AS EXPLAINED ABOVE, THE AMOUNTS PAID TO YOU AS A RESULT OF THE MERGER MAY
RESULT IN DIVIDEND INCOME, CAPITAL GAIN INCOME, OR SOME COMBINATION OF DIVIDEND
AND CAPITAL GAIN INCOME TO YOU DEPENDING ON YOUR INDIVIDUAL CIRCUMSTANCES. THE
U.S. FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS BASED UPON CURRENT LAW,
WHICH IS SUBJECT TO CHANGE POSSIBLY WITH RETROACTIVE EFFECT. YOU SHOULD CONSULT
YOUR TAX ADVISOR AS TO THE PARTICULAR FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER
TAX CONSEQUENCES OF THE TRANSACTION THAT ARE APPLICABLE TO YOU IN LIGHT OF YOUR
SPECIFIC CIRCUMSTANCES.

                     APPRAISAL RIGHTS OF HARBOR SHAREHOLDERS

       Any shareholder of Harbor who does not vote in favor of the merger and
the transactions contemplated by the merger agreement and who has given prior
written notice to Harbor of his or her objection to the proposed transaction and
who otherwise complies with the procedures set forth in Title 3, Subtitle 2 of
the MGCL, will be entitled to receive payment in cash of the fair value of his
or her shares of Harbor common stock instead of receiving the merger
consideration. A copy of Title 3, Subtitle 2 of the MGCL is included as Appendix
C to this proxy statement.

       If you want to demand payment of the fair value of your shares of Harbor
common stock, you must fully comply with the procedures set out in the MGCL. The
required procedures are summarized below. The following summary is not intended
to be a compete statement of all aspects of the procedures set forth in the
MGCL, and is qualified in its entirety by reference to the text of the statute
included in Appendix C. If you intend to exercise your rights as an objecting
shareholder, you should be aware that cash paid to you will likely result in
receipt of taxable income. (See "--Material U.S. Federal Income Tax
Consequences").

       Only holders of record of shares of Harbor common stock can object to the
merger and demand to receive the fair value of the shares in cash. If your
shares are not registered in your name, your record holder must follow the
procedures to perfect your right to object to the merger and receive cash for
the fair value of your shares.

                    o First, you must submit a written notice to Harbor at or
                      prior to the meeting, stating that you object to the
                      proposed merger. You should send your notice to:

                      Harbor Bankshares Corporation
                      25 West Fayette Street
                      Baltimore, MD 21201
                      Attention: Teodoro J. Hernandez
                                 Vice President and Treasurer

                    o You must then not vote your shares in favor of the merger.
                      This means that you should either (a) not return a proxy
                      card and not vote in person in favor of the adoption of
                      the merger agreement, (b) return a proxy card with the
                      "Against" or "Abstain" box checked; (c) vote in person
                      against the approval of the merger agreement; or (d)
                      register in person an abstention from the proposal to
                      approve the merger agreement. Merely voting against the
                      merger or abstaining from or not voting in favor of the
                      merger will not constitute notice of objection or dissent,
                      and will not entitle you to payment in cash of the fair
                      value of your shares.

                                       31


                    o Promptly after the effectiveness of the merger, Harbor
                      will write to objecting shareholders of Harbor, notifying
                      them of the date on which the articles of merger were
                      accepted for record. This notice will be sent by certified
                      mail, return receipt requested, to the address you provide
                      in your notice, or if no address is indicated, to the
                      address which appears on Harbor's shareholder records.

                    o Within twenty (20) days of the date on which the articles
                      of merger were accepted for record, an objecting
                      shareholder must make a written demand for payment of the
                      fair value of his or her stock, stating the number and
                      class of shares for which payment is demanded. The written
                      demand for payment should be sent to:

                      Harbor Bankshares Corporation
                      25 West Fayette Street
                      Baltimore, MD 21201
                      Attention: Teodoro J. Hernandez
                                 Vice President and Treasurer


       Harbor's notice of the date on which the articles of merger were accepted
may contain an offer of payment of the amount which Harbor believes is the fair
value of the Harbor common stock, and certain financial disclosures. If you have
followed all of the procedural steps required to demand payment of fair value
and have not received payment for your shares, you may, or Harbor may, within
fifty (50) days of the acceptance of the articles of merger, petition the court
for an appraisal of the fair value of your shares of Harbor common stock as of
the date of the Harbor shareholder meeting, without including any appreciation
or depreciation resulting directly or indirectly from the merger or its
proposal.

       Any shareholder who files a notice of objection, but fails to file a
written demand for the payment of fair value in a timely manner will be bound by
the shareholder vote and will not be entitled to receive payment in cash as a
holder of objecting shares.

       If you demand payment for your stock as an objecting shareholder, you
have no right to receive any dividends or other distributions on such shares, or
the cash consideration into which such shares would be converted, after close of
business on the date of the Harbor shareholder meeting at which the merger is
approved, and have no other rights, including voting rights, with respect to
such shares, except the payment of fair value.

       If you demand payment for your shares, your rights as a shareholder will
be restored if the demand for payment is withdrawn, a petition of appraisal is
not filed within the time required, a court determines that you are not entitled
to relief, or the merger is abandoned or rescinded. A demand for payment may be
withdrawn only with the consent of Harbor.

       If the court finds that a shareholder is entitled to an appraisal of his
or her stock, the court will appoint three disinterested appraisers to determine
the fair value of the stock on the terms and conditions the court considers
proper. Within sixty (60) days after appointment, or such longer period as the
court may direct, the appraisers must file with the court and mail to each
shareholder who is a party to the proceeding their report stating their
conclusion as to the fair value of the stock. Within fifteen (15) days after the
filing of the report, any party may object to the report and request a
rehearing. The court, upon motion of any party, will enter an order either
confirming, modifying, or rejecting the report and, if confirmed or modified,
enter judgment directing the time within which payment must be made.

       If the report is rejected, the court may determine the fair value or
remit the proceeding to the same or other appraisers. Any judgment entered
pursuant to a court proceeding will include interest from the date of the
shareholders' vote at the meeting, unless the court finds that the shareholder's
refusal to accept a written offer to purchase the shares was arbitrary and
vexatious or not in good faith.

       The costs of the appraisal proceedings, including compensation and
expenses of the appraisers, will be the responsibility of Harbor, except that
all or any part of such expenses may be apportioned and assessed against any or
all of the objecting shareholders to whom an offer to pay for such shareholder's
shares has been made, if the court finds the failure to accept such offer was
arbitrary, vexatious, or not in good faith. Costs of the proceedings may not
include fees and expenses of counsel. Costs of the proceedings may include fees
and expenses of experts only if Harbor did not make an offer of payment for your
stock or if the value of the stock as determined in the appraisal proceeding
materially exceeds the amount offered by Harbor.

                                       32


       The preceding is a summary of the material aspects of Title 3, Subtitle 2
of the MGCL, and is qualified by reference to the text of the statute. The full
text of Title 3, Subtitle 2, which we urge you to read in its entirety, is
included as Appendix C to this proxy statement.

                            GOVERNMENTAL REQUIREMENTS

       In connection with the merger, Harbor will be required to make a number
of filings with and obtain a number of approvals from various federal and state
governmental agencies, including:

                    o Filing of articles of merger with the Maryland Department
                      of Assessments and Taxation in accordance with the MGCL
                      after the approval of the merger agreement by Harbor's
                      shareholders; and

                    o Complying with federal and state securities laws,
                      including Harbor's and merger subsidiary's filing, prior
                      to the date of this proxy statement, of a Rule 13e-3
                      Transaction Statement on Schedule 13E-3 with the SEC.

                      MARKET FOR COMMON STOCK AND DIVIDENDS


         Harbor Bankshares Corporation is traded is traded in the "Other OTC"
market or privately and is not listed on any exchange. During 2005 and 2004,
there was little trading activity in the stock. The bid and asked price during
2005 and 2004 was $25.00 per share. Quotes are available under the symbol
HRBK.PK. The most recent known trade was at $31.00 on August 22, 2006.


         Dividends when and if declared, are paid annually in the first quarter.
See "Summary Financial Information" on page 9.

                                   THE PARTIES

HARBOR BANKSHARES CORPORATION


       Harbor Bankshares Corporation (the Corporation) is a bank holding company
with one bank subsidiary and two other Community Development financial
subsidiaries, one for profit, The Harbor Bank of Baltimore LLC and a non-profit,
The Harbor Bank CDC. Both were established during 2002. The Corporation had no
investment in either subsidiary as of October __, 2006. The Corporation was
organized under the laws of the State of Maryland in 1992. On November 2, 1992,
Harbor Bankshares Corporation acquired all outstanding stock of The Harbor Bank
of Maryland (the Bank), headquartered in Baltimore, Maryland.


THE HARBOR BANK OF MARYLAND

       The Harbor Bank of Maryland is a Maryland chartered commercial bank
headquartered in Baltimore, Maryland. The Bank was opened on September 13, 1982.
The deposits of the Bank are insured by the Federal Deposit Insurance
Corporation.

       The Bank conducts general banking business in seven (7) locations and
serves primarily the Baltimore Metropolitan area. It offers checking, savings,
and time deposits, commercial, real estate, personal, home improvement,
automobile and other installment loans, credit cards and term loans. The Bank is
also a member of a local and national ATM network. The retail nature of the Bank
allows for full diversification of deposits and borrowers so it is not dependent
upon a single or a few customers.

       Harbor Financial Services, a company dealing with the sale of mutual
funds, stocks, insurance, etc., was established as a subsidiary of the Bank
during May 1997 in order to compete with that expanding market.

HARBOR MERGER CORPORATION

       Harbor Merger Corporation, or the merger subsidiary, is a recently-formed
Maryland corporation. It was organized as a wholly-owned subsidiary of Harbor
for the sole purpose of facilitating the merger. It has engaged in no business
activities and has no assets or liabilities of any kind, other than those
incident to its formation. The merger subsidiary does not own any shares of
Harbor common stock, nor will it acquire any such shares before the merger. Its
existence will cease upon consummation of the merger. The address and telephone
number of principal offices of the merger subsidiary are the same as Harbor's.

                                       33


SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT


       There were 675,579 shares of the Common Stock issued and outstanding on
October __, 2006, of which 641,784 were shares of voting common stock. The
following table shows the beneficial ownership of the voting common stock as of
this date by: (1) each of Harbor's current named executive officers and
Directors and (2) all of Harbor's current Directors and executive officers as a
group.


                                                         NUMBER OF SHARES
                                                           BENEFICIALLY                    PERCENTAGE OF SHARES
NAME OF BENEFICIAL OWNER(1)(2)                                OWNED(3)                      BENEFICIALLY OWNED
-------------------------------                           -----------------                 ------------------
Joseph Haskins, Jr. (4)...................................     95,538                              13.79%
Teodoro J. Hernandez (5) .................................      8,775                               1.35%
Darius L. Davis (6) ......................................      3,048                               *
James H. DeGraffereidt, Jr. (7) ..........................     13,928                               2.14%
Louis J. Grasmick (8) ....................................     23,227                               3.56%
Nathaniel Higgs (9) ......................................      9,545                               1.48%
Delores G. Kelley (10) ...................................     16,923                               2.60%
Erich March (11) .........................................     26,093                               4.00%
John Paterakis (12) ......................................     58,789                               9.16%
John D. Ryder ............................................      3,219                               *
James Scott, Jr. (13) ....................................      3,747                               *
Edward St. John ..........................................     13,488                               2.10%
Walter S. Thomas (14) ....................................        228                               *
Stanley W. Tucker (15) ...................................     13,268                               2.07%
George F. Vaeth, Jr. (16) ................................     20,725                               3.18%
All Directors and executive officers
     as a group (16 persons) (17) ........................    307,493                              40.91%

------------
*        Less Than 1%
(1)      Unless otherwise specified, the address of these persons is c/o Harbor
         Bankshares Corporation, 25 West Fayette Street, Baltimore, Maryland
         21201.
(2)      The Corporation uses the SEC's definition of beneficial ownership. This
         means that the person named in this table have sole or shared voting
         and/or investment power over the shares shown. Beneficial ownership
         also includes shares underlying options currently exercisable or
         exercisable within 60 days.
(3)      Unless otherwise specified, the number of shares shown represents
         shares of Common Stock.
(4)      Represents 44,600 shares of Common Stock and 50,938 shares of Common
         Stock issuable upon the exercise of options.
(5)      Represents 8,775 shares of Common Stock issuable upon the exercise of
         options.
(6)      Represents 3,048 shares of Common Stock issuable upon the exercise of
         options.
(7)      Represents 4,325 hares of Common Stock and 9,603 shares of Common Stock
         issuable upon the exercise of options.
(8)      Represents 13,227 shares of Common Stock (including 3,848 shares
         jointly owned with Mr. Grasmick and his son and 8,780 shares jointly
         owned by Mr. Grasmick and his wife) and 10,000 shares of Common Stock
         issuable upon the exercise of options.
(9)      Represents 4,545 shares of Common Stock (including 4,175 shares jointly
         owned by Reverend Higgs and his wife) and 5,000 shares of Common Stock
         issuable upon the exercise of options.
(10)     Represents 6,923 shares of Common Stock (including 619 shares jointly
         owned by Dr. Kelley and her husband) and 10,000 shares of Common Stock
         issuable upon the exercise options.
(11)     Represents 16,093 shares of Common Stock (including 15,435 shares owned
         by a corporation over which Mr. March has the power to vote) and 10,000
         shares of Common Stock issuable upon the exercise of options.
(12)     Includes 32,874 shares of Common Stock owned by three corporations
         controlled by Mr. Paterakis (J and B Associates, Inc. - 16,437 shares;
         H & S Bakery, Inc. - 6,164 shares; Northeast Food, Inc. 10,273 shares)
         and 11,300 shares of Common Stock owned by Paterakis Limited
         Partnership, LLP.
(13)     Includes 3,430 shares of Common Stock jointly owned by Mr. Scott and
         his wife.
(14)     The number of shares of Common Stock owned does not include 3,757
         shares owned by a religious organization over which Pastor Thomas has
         the power to vote.
(15)     Includes 13,234 shares of Common Stock owned by MMG ventures L.P. over
         which Mr. Tucker has authority to vote.
(16)     Represents 10,725 shares of Common Stock and 10,000 shares of Common
         Stock issuable upon the exercise of options.
(17)     Represents 193,177 shares of Common Stock and 117,364 shares of Common
         Stock issuable upon the exercise of options.

                                       34


RECENT TRANSACTIONS

       On February 13, 2006, Harbor repurchased 10,000 shares of common stock
beneficially owned by Director Stanley W. Tucker at a price of $25.00 per share.
Neither Harbor nor any Filing Person or Affiliate engaged in any other purchase,
sale, or other transaction in the common stock during the sixty days preceding
the date of this proxy statement.

PRIOR STOCK PURCHASES


       During the years 2005 and though October __, 2006, Harbor has repurchased
a total of 42,000 shares beneficially owned by Director Stanley W. Tucker,
including the 10,000 shares noted above in "Recent Transactions," all at a per
share price of $25.00.


       Since December 31, 2002, no Filing Persons have purchased any other
shares other than upon exercise of stock options under the Harbor stock option
plans. Directors and officers have agreed not to purchase any additional shares
of voting common stock prior to approval of the merger.

                              THE MERGER AGREEMENT

       Following is a summary of the material terms of the merger agreement, a
copy of which is attached as Appendix A to this proxy statement. Because this is
a summary, it does not include all of the information that may be important to
you. You should read the entire merger agreement and this proxy statement and
related appendices before deciding how to vote at the Annual Meeting.

STRUCTURE OF THE MERGER

       The merger subsidiary will be merged with and into Harbor, which will be
the surviving corporation. The merger will occur following the approval of the
merger agreement by the shareholders of Harbor and the satisfaction of other
conditions to the merger.

CONVERSION OF SHARES IN THE MERGER

       The merger agreement provides that, at the effective time of the merger:

                    o Subject to the following, all outstanding shares of Harbor
                      common stock held of record by a holder holding 100 or
                      fewer shares of Harbor common stock immediately prior to
                      the effective time will, without any action on the part of
                      the holder thereof, be converted into the right to receive
                      to $31.00 per share, without interest (the "merger
                      consideration"). Harbor may presume that all street shares
                      are held by holders holding 100 or fewer shares
                      immediately prior to the effective time unless a
                      beneficial owner of street shares is able to demonstrate
                      to Harbor's satisfaction that such shares are held
                      beneficially by a holder holding more than 100 shares
                      immediately prior to the merger date. In that case, such
                      shares will remain outstanding with all rights,
                      privileges, and powers existing immediately before the
                      merger;

                    o All outstanding shares of Harbor common stock other than
                      those described above as being converted into the right to
                      receive the merger consideration or shares for which
                      rights objecting shareholders are perfected will remain
                      outstanding with all rights, privileges, and powers
                      existing immediately before the merger; and

                    o The outstanding shares of merger subsidiary will, without
                      any action on the part of the holder thereof, be canceled.

       The merger agreement further provides that:

                    o No holder holding, of record or beneficially, immediately
                      prior to the merger more than 100 shares (including any
                      combination of record shares or street shares) in the
                      aggregate will be entitled to receive any merger
                      consideration with respect to the shares so held other
                      than by exercising his or her dissenter's rights; and

                    o It is a condition precedent to the right of any holder to
                      receive the merger consideration, if any, payable with
                      respect to the shares held by such holder that such holder
                      certify to Harbor in the letter of transmittal delivered
                      by Harbor as described below that such holder held, of
                      record and beneficially, immediately prior to the merger
                      100 or fewer shares (including any combination of record
                      shares and street shares) in the aggregate.

                                       35


     In general, calculations of shares held of record shall be made in
     accordance with Securities and Exchange Commission Rule 12g5-1, and
     accordingly:

                    o The number of shares held of record will be calculated by
                      adding all shares registered in the same manner;

                    o Shares held in street name beneficially owned by a
                      shareholder will not be aggregated with shares registered
                      in such shareholder's own name, and

                    o Shares owned by related persons or in different capacities
                      will not be aggregated.

     Harbor may in its sole discretion, but shall not have any obligation to (a)
     presume that any shares of Common Stock held in a discrete account (whether
     record or beneficial) are held by a person distinct from any other person,
     notwithstanding that the registered or beneficial holder of a separate
     discrete account has the same or a similar name as the holder of a separate
     discrete account; and (b) aggregate the shares of Common Stock held
     (whether of record or beneficially) by any person or persons that Harbor
     determines to constitute a single shareholder for purposes of determining
     the number of shares of Common Stock held by such shareholder.

     Harbor will presume that all shares held in street name are held by
     shareholders holding more than 100 shares of Common Stock immediately prior
     to the Effective Time unless Harbor determines, or a beneficial owner of
     shares held in street name is able to demonstrate to Harbor's satisfaction,
     that such shares are held beneficially by a shareholder holding 100 or
     fewer shares of Common Stock immediately prior to the Effective Time, in
     which case such shares will be deemed to be Cash-Out shares.

     Harbor (and any other person or entity to which it may delegate or assign
     any responsibility or task with respect thereto) shall make all decisions
     regarding the application of this section in good faith and in accordance
     with the principles of Securities and Exchange Commission Rule 12g5-1 and
     the rules and presumptions stated above. Harbor shall have full discretion
     and exclusive authority to (i) make such inquiries, whether of any
     shareholder(s) or otherwise, as it may deem appropriate and (ii) resolve
     and determine all ambiguities, questions of fact, and interpretive and
     other matters relating to this Section. All such determinations by Harbor
     shall be final.

TREATMENT OF OPTIONS

       The merger agreement provides that at the effective time each option to
acquire shares of Harbor common stock which is outstanding and unexercised
immediately prior thereto pursuant to the Harbor Stock Option Plan, shall remain
outstanding.

EXCHANGE OF CERTIFICATES

       The merger agreement provides that promptly after the merger, Harbor will
mail a letter of transmittal to each shareholder, who based on information
available to Harbor, appears to have their shares converted into the right to
receive the merger consideration (other than shares as to which objecting
shareholder rights have been perfected). The letter of transmittal will contain
a certification as to the number of shares held and such other matters as Harbor
may determine and will specify that delivery will be effected, and risk of loss
and title to the certificates representing shares of Harbor common stock
("Certificates") will pass, only upon delivery of the Certificates to Harbor and
instructions to effect the surrender of the Certificates in exchange for the
merger consideration, if any, payable with respect to such Certificates.

       Upon surrender of a Certificate for cancellation to Harbor, together with
a letter of transmittal, duly completed and executed and containing the
certification that the holder of the Certificate holds 100 or fewer shares, and
such other customary documents as may be required pursuant to such instructions,
the holder of such Certificate will, subject to the above provisions of the
merger agreement, be entitled to receive the merger consideration. In the event
of a transfer of ownership of shares which is not registered in the share
transfer records of Harbor, the merger consideration, if any, payable in respect
of such shares may be paid or issued to the transferee if the Certificate
representing such shares is presented to Harbor, accompanied by all documents
required to evidence and effect such transfer and by evidence that any
applicable stock transfer taxes have been paid.

       YOU SHOULD NOT SEND YOUR STOCK CERTIFICATES NOW. YOU SHOULD SEND THEM
ONLY AFTER YOU RECEIVE A LETTER OF TRANSMITTAL FROM HARBOR. LETTERS OF
TRANSMITTAL AND RELATED INSTRUCTIONS WILL BE MAILED SOON AFTER THE MERGER IS
COMPLETED.

                                       36


EFFECTIVE TIME OF THE MERGER

       If the merger agreement is approved by the Harbor shareholders, the
merger will close as soon as practicable after the Annual Meeting, provided that
all other conditions to the merger have been satisfied or waived. After all of
the conditions to the merger have been satisfied or waived, articles of merger
will be filed with the Maryland Department of Assessment and Taxation. The
merger will become effective on the date and at the time specified on the
certificate of merger.

DIRECTORS AND OFFICERS

       The merger agreement provides that the Directors and executive officers
of Harbor immediately prior to the merger will be the Directors and executive
officers of Harbor, as the surviving corporation, immediately after the merger.

ARTICLES OF INCORPORATION AND BYLAWS

       The merger agreement provides that the articles of incorporation and
bylaws of Harbor in effect immediately prior to the merger will be the articles
of incorporation and bylaws of Harbor, as the surviving corporation, immediately
after the merger.

REPRESENTATIONS AND WARRANTIES

       The merger agreement contains customary representations and warranties
made by Harbor and merger subsidiary regarding various matters, including
representations by them as to the enforceability of the merger agreement.

CONDITIONS TO THE COMPLETION OF THE MERGER

       The obligations of Harbor and merger subsidiary to complete the merger
are subject to the satisfaction or waiver of all of the following conditions:

                    o Approval of the merger agreement by the holders of at
                      least two-thirds (2/3) of the outstanding shares of Harbor
                      common stock which cannot be waived;

                    o All requisite regulatory approvals relating to the Merger,
                      if any, shall have been obtained and continue to be in
                      full force and effect, and all waiting and notice periods
                      under applicable law shall have expired.

                    o The aggregate number of shares of Common Stock owned by
                      those shareholders of Harbor who will receive merger
                      consideration or have perfected and are entitled to
                      exercise their objecting shareholders' rights shall not
                      exceed 1.0% of the issued and outstanding shares of Common
                      Stock.

                    o No injunction, restraining order, stop order, or other
                      order or action of any Federal or state court or agency in
                      the United States which prohibits, restricts, or makes
                      illegal the consummation of the transactions contemplated
                      by the merger agreement shall be in effect, and no action,
                      suit or other proceeding seeking such shall have been
                      instituted or threatened, and no statue, rule, or
                      regulation shall have been enacted, issued, or promulgated
                      by and state or Federal government or government agency
                      which prohibits, restricts, or makes illegal the
                      consummation of those transactions.


       As set forth above, the merger agreement includes a provision designed to
protect Harbor in the event that the aggregate of the number of shares to be
cashed-out in the merger plus the number of shares held by shareholders who
object to the merger pursuant to the provisions of the MGCL exceeds 1% of the
total number of outstanding shares of Harbor common stock. The purpose of this
provision is to provide Harbor with the opportunity to terminate the merger
agreement prior to consummation of the transaction in the event that the total
consideration to be paid to Harbor shareholders in connection with the merger
exceeds approximately $386,818. Based upon the list of beneficial shareholders
on October __, 2006, it is expected that the number of shares of Harbor common
stock to be cashed-out in the merger will be approximately 12,478, and Harbor
is prepared to waive the condition to the merger agreement and consummate the
transaction. Further, the merger agreement provides that it may be terminated at
any time by either Harbor or merger subsidiary prior to consummation of the
merger.


                                       37


TERMINATION OF MERGER AGREEMENT

       The merger agreement may be terminated by either Harbor or merger
subsidiary at any time prior to the effective time of the merger.

                                       38


                 PROPOSAL II--ADJOURNMENT OF THE ANNUAL MEETING

       If Harbor does not receive a sufficient number of votes to approve
Proposal I, Harbor may propose to adjourn the Annual Meeting, if a quorum is
present, from time to time for a period of not more than 120 days after the
record date, with the approval of a majority of shares present in person or by
proxy and entitled to vote. Harbor currently does not intend to propose an
adjournment of the Annual Meeting if there are sufficient votes to approve the
merger agreement.

       Harbor's Board of Directors and each Filing Person and Affiliate has
determined and believes that the Proposal to adjourn the Annual Meeting, if
necessary to solicit additional proxies if there are not sufficient votes in
favor of Proposal I is advisable and procedurally fair to, and in the bests
interests of Harbor and its shareholders, including unaffiliated shareholders,
and has approval and adopted the proposal. Accordingly, the Harbor Board of
Directors recommends that shareholders vote FOR Proposal II for adjournment of
the Annual Meeting.

                       PROPOSAL III--ELECTION OF DIRECTORS

       The charter and by-laws of the Company provide that the Directors shall
be classified into three classes as equal in number as possible, with each
Director serving a three-year term. Currently, the Board of Directors is
composed of 13 members with Classes I and II each consisting of four member and
Class III consisting of five members. The Board of Directors currently also has
three open Board seats which will remain open until suitable candidates are
located. The terms of the Class II Directors are scheduled to expire at the 2006
annual meeting or until their respective successors have been duly elected and
qualified.

       Directors are elected by a plurality of the votes cast by the holders of
shares of Common Stock present in person or represented by proxy.

       DIRECTORS TO BE ELECTED AT THE 2006 ANNUAL MEETING TO SERVE UNTIL THE
2008 ANNUAL MEETING (CLASS II)

Nathaniel Higgs                    Reverend Higgs is 75 years old and has served
                                   as a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1981.
                                   From December 1966 to December 2002, he
                                   served as the Pastor of Southern Baptist
                                   Church and has now retired.

Delores G. Kelley                  Dr. Kelley is 69 years old and has served as
                                   a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1980.
                                   She is a retired educator and Senator in the
                                   Maryland State Senate.

Erich March                        Mr. March is 54 years old and has served as a
                                   Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1981.
                                   He is Vice President of March Funeral Homes,
                                   Inc.

Stanley W. Tucker                  Mr. Tucker is 58 years old and has served as
                                   a Director of the Corporation and of the Bank
                                   since 1996. He is President of Meridian
                                   management Company, Inc., which is the
                                   managing general partner of MMG Ventures,
                                   L.P., an investment management company.

CONTINUING DIRECTORS

       The following information is provided with respect Directors who will
continue to serve as Directors of the Company until the expiration of their
terms at the times indicated.

       DIRECTORS CONTINUING TO SERVE UNTIL 2007 ANNUAL MEETING (CLASS III)

John Paterakis                     Mr. Paterakis is 77 years old and has served
                                   as a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1982.
                                   He is President and Chief Executive Officer
                                   of H & S Bakery, Inc. and Northeast Foods,
                                   Inc.

James Scott, Jr.                   Mr. Scott is 48 years old and has served as a
                                   Director of the Corporation and the Bank
                                   since November 2000. He is a principal of
                                   Pennan & Scott P.C., an accounting firm. Mr.
                                   Scott is a certified public accountant.

Edward St. John                    Mr. St. John is 68 years old and has served
                                   as a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1990.
                                   He is President and Chief Executive Officer
                                   of M.I.E. Investment Company, a real estate
                                   development company.

                                       39


Walter S. Thomas                   Pastor Thomas is 55 years old and has served
                                   as a Director of the Corporation and the Bank
                                   since November 2000. He is the Pastor of New
                                   Psalmist Church.

George F. Vaeth, Jr.               Mr. Vaeth is 72 years old and has served as a
                                   Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1981.
                                   He has served as Secretary of the Company
                                   since its formation and of the Bank since
                                   1986. He is an architect with G.V.A., an
                                   architectural and interior design firm.

        DIRECTORS CONTINUING TO SERVE UNTIL 2008 ANNUAL MEETING (CLASS I)

James H. DeGraffereidt, Jr.        Mr. DeGraffereidt is 52 years old and has
                                   served as a Director of the Corporation and
                                   of the Bank since 1996. He is Chairman and
                                   Chief Executive Officer of WGL Holdings,
                                   Inc., distributors of natural gas.

Louis J. Grasmick                  Mr. Grasmick is 76 years old and has served
                                   as a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1982.
                                   He is Chief Executive Officer of Louis J.
                                   Grasmick Lumber Company, Inc.

Joseph Haskins, Jr.                Mr. Haskins is 58 years old and has served as
                                   a Director of the Corporation since its
                                   formation in 1992 and of the Bank since 1980.
                                   He has served as Chief Executive Officer of
                                   the Company since its formation in 1992,
                                   Chairman of the Board of the Company Bank
                                   since 1995 and Chief Executive Officer of the
                                   Bank since 1987.

John D. Ryder                      Mr. Ryder is 58 years old and has served as a
                                   Director of the Corporation and the Bank
                                   since January 2000. He was President and
                                   Chief Operating Officer of Metro Food
                                   Markets, a supermarket chain, until 2000. He
                                   was President of AXS Technologies, a software
                                   company, until July 2003. Currently, he is
                                   President of Tree Top Kids, Inc.

                          COMPANY CORPORATE GOVERNANCE

GENERAL

       The Corporation's business is managed under the direction of its Board of
Directors. The Board of Directors seeks to increase shareholder value and
promote the Corporation's long-term growth. The Board of Directors establishes
Corporation policies and strategies and regularly monitors the effectiveness of
the Corporation's management in carrying out these policies and strategies. As
part of the Board of Director's commitment to these principles, the Board of
Directors regularly reviews the Corporation's corporate governance policies and
practices. This review includes comparing the Corporation's current policies and
practices to the policies and practices suggest by various groups and
authorities active in corporate governance and policies and practices of public
companies in general. The Board of Directors will continue to consider the
adoption of changes, as appropriate, to enhance the Corporation's corporate
governance policies and practices, and to comply with any rule changes made by
the SEC.

BOARD ORGANIZATION AND OPERATION

       Members of the Board of Directors are kept informed of the Corporation
business through discussions with key member of the Corporation's management
team, by reviewing materials provided to the Board of Directors and by
participating in meetings of the Board and its committees.

       The Board of Directors has adopted standards for Director independence
that are in accordance with the standards adopted by the National Association of
Securities Dealers, Inc. (the "NASD") and utilized by companies with securities
quoted on Nasdaq. The Board of Directors is not required to adhere to the
independence standards adopted by the NASD because the common Stock is not
quoted or listed on NASDAQ or any other quotation system or exchange. The Board
of Directors believes, however, that a Board with at least a majority of
independent Directors is an important part of good corporate governance
principles. Based on the Board of Directors' adopted standards, the Board of
Directors has determined that none of its members has a material relationship
with the Corporation and that all of its members are independent Directors,
except for Messrs. Haskins and Paterakis who are not independent Directors
because each is an executive officer of the Corporation. As a result, a
significant majority of the members of the Board of Directors is independent.

                                       40


       During 2005, the Board of Directors met 12 times. Each of the nominees
and the other Directors attended at least 75% of the total Board of Directors
meetings and meetings of the Board committees on which he or she served, with
the exception of Mr. Thomas who attended 60% of these meetings. When necessary
or appropriate, the Corporation's independent Directors meet in executive
sessions without the presence of the Corporation's management. This gives the
independent Directors the opportunity to discuss management's performance and
any other matter that one or more independent Directors would like to discuss.

BOARD COMMITTEES

       Each Director who serves on the Board of Directors is also a Director on
the Bank's Board of Directors. The Board of Directors has one standing
committee: the Audit Committee (the "Audit Committee"). The Bank's Board of
Directors has a Compensation Committee (the "Compensation Committee") and an
Executive Committee (the "Executive Committee")

       Audit Committee. The Audit Committee responsibilities include the
appointment of the Corporation's independent accountants, the preapproval of all
audit services and permitted non-audit services provided to the Corporation by
the Corporation's independent accountants, reviews of the independence of the
Corporation's independent accountants, and review of the adequacy of internal
accounting and disclosure controls of the Corporation. The Audit Committee
operates under a written charter adopted by the Board of Directors. In 2005, the
Audit Committee met four times. The current members of the Audit Committee are:
Messrs. Vaeth, Chair, Higgs, March, Scott and Tucker. Each member of the Audit
Committee is an independent Director as defined by the current NASD rules. Mr.
Scott has the professional experience deemed necessary o qualify as an audit
committee financial expert under the SEC's rules and regulations.

       Compensation Committee. The Compensation Committee structures the
compensation of the Corporation's executive officers and administers the
Corporation's employee benefit plans. The Compensation Committee currently does
not operate under written charter. The Compensation Committee met once in 2005.
The current members of the Compensation Committee are: Messrs. Grasmick, Chair,
DeGraffereidt, and St. John. Each member of the Compensation Committee is an
independent Director as defined by the current NASD rules.

       Executive Committee. The Executive Committee generally has the authority
to exercise all of the power of the Bank's Board of Director in the management
and direction of the business affairs of the Bank, subject to specific
directions of the Bank's Board of Directors and the limitation of Maryland law.
The Executive Committee met 13 times in 2005. The current members of the
Executive Committee are: Messrs. Paterakis, Chair, Haskins, DeGraffereidt,
Grasmick, March, Vaeth and Dr. Kelley. A majority of the members of the
Executive Committee is independent as defined by the current NASD rules.

NOMINATION PROCESS

       The Board of Directors does not have a nominating committee. The full
Board of Directors performs the functions of a nominating committee. The Board
of Directors does not believe it needs a separate nominating committee because
the full Board is comprised predominantly of independent Directors and has the
time and resources to perform the function of selecting Board nominees. When the
Board of Directors performs nominating function, the Board of Directors acts in
accordance with the Corporation's corporate charter and bylaws but does not have
a separate charter related to the nomination process. Under the Corporation's
charter, nominations for Director may be made by the Board of Directors or by a
shareholder of record who delivers notice along with the additional information
and materials required by the Corporation's charter to the Corporation Corporate
Secretary not less then 30 days and no more than 60 days before the annual
meeting date. For the Corporation's annual meeting in 2007, the Corporation must
receive this notice on or after February 18, 2007 and on or before March 20,
2007. The Corporation's shareholders may obtain a copy of the Corporation
charter by writing to the Corporation Corporate Secretary, Harbor Bankshares
Corporation, 25 West Fayette Street, Baltimore, Maryland 21201.

                                       41


       The Corporation's Directors have a critical role in guiding the
Corporation's strategic direction and in overseeing the Corporation's
management. The Board of Directors considers candidates for the Board based upon
several criteria, including their broad-based business and professional skills
and experiences, concern for the long-term interests of shareholders, and
personal integrity and judgment. Candidates should have reputations, both
personal and professional, consistent with the Corporation's image and
reputation. Because diversity is important, the Board of Directors seeks to
ensure that its Directors reflect the gender and ethnic diversity of the
Corporation's community. The majority of Directors on the Board of Directors
should be "independent," not only as that term may be legally defined, but also
without the appearance of any conflict in serving as a Director. In addition,
Directors must have time available to devote to Board activities and to enhance
their knowledge of the banking industry. Accordingly, the Board of Directors
seeks to attract and retain highly qualified Directors who have sufficient time
to attend to their substantial duties and responsibilities to the Corporation.

       The Board of Directors utilizes the following process for identifying and
evaluating nominees to the Board. In the case of incumbent Directors whose terms
of office are set to expire, the Board of Directors review such Directors'
overall service to the company during their term, including the number of
meetings attended, level of participation and quality of performance. In the
case of new Director candidates, the Directors on the Board of Directors are
polled for suggestions as to potential candidates that may meet the criteria
above, discuss candidates suggested by the Corporation's shareholders and may
also engage, if the Board of Directors deems appropriate, a professional search
firm. To date, the Board of Directors has not engaged professional search firms
to identify or evaluate potential nominees but may do so in the future, if
necessary. The Board of Directors then meets to discuss and consider these
candidates' qualifications and then chooses a candidate by a majority vote.

DIRECTOR ATTENDANCE AT THE CORPORATION ANNUAL MEETING

       The Corporation does not have a formal policy regarding attendance by
members of the Board of Director at the Corporation's annual meetings of
shareholders. The Corporation has always encouraged its Directors to attend its
annual meetings of shareholders and expects to continue this policy. In 2005, 13
Corporation Directors attended the Corporation's annual meeting of shareholders.

SHAREHOLDER COMMUNICATION WITH THE BOARD

       The Corporation does not have a formal process for shareholder
communications with the Board of Directors. The Corporation has made an effort
to ensure that the Board of Directors or individual Directors, as applicable,
hear the views of Corporation's shareholders. The Corporation believes that it
has been responsive regarding conveying shareholder communications to the Board
of Directors.

SHAREHOLDER PROPOSALS

        Under the proxy rules established by the SEC and currently applicable to
Harbor, shareholder proposals intended to be presented at the 2007 Annual
Meeting of Shareholders may be eligible for inclusion in Bancorp's proxy
materials for that Annual Meeting if received by Bancorp at its executive
offices not later than __________________, 200_ unless the date of the 2007
annual meeting is more than 30 days from_________________, 2007, in which case
the deadline is a reasonable time before Bancorp begins to print and mail proxy
materials.

       In addition, Bancorp's Bylaws require that to be properly brought before
an annual meeting, shareholder proposals for new business must be delivered to
or mailed and received by Bancorp not less than thirty nor more than sixty days
prior to the date of the meeting; provided, however, that if less than
thirty-one days notice of the date of the meeting is given to shareholders, such
notice by a shareholder must be received not later than the tenth day following
the date on which notice of the date of the meeting was mailed to shareholders.
Each such notice given by a shareholder must set forth certain information
specified in the Bylaws concerning the shareholder and the business proposed to
be brought before the meeting.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.

       Based solely on the Corporation's review of the copies of initial
statements of beneficial ownership on Form 3 and reports of changes in
beneficial ownership on Form 4 that it has received in the past year, annual
statements of changes in beneficial ownership on Form 5 with respect to the last
fiscal year, and written representations that no such annual statement of change
in beneficial ownership was required, all Directors, executive officers, and
beneficial owners of more than 10% of its common stock have timely filed those
reports with respect to 2005. The Corporation makes no representation regarding
persons who have not identified themselves as being subject to the reporting
requirements of Section 16(a) of the Securities Exchange Act of 1934, or as to
the appropriateness of disclaimers of beneficial ownership.

                                       42


CODE OF ETHICS AND BUSINESS CONDUCT

       For years the Corporation has had policies regarding conflicts of
interest and securities law compliance. The Corporation has adopted a Code of
Ethics and Business Conduct that reflects these longstanding policies and
contains additional policy initiatives. The Corporation requires all its
Directors, executive officers, and employees to adhere to the Code of Ethics and
Business Conduct in addressing the legal and ethical issues encountered in
conducting their work. The Code of Ethics and Business Conduct requires that the
Corporation's Directors, executive officers and employees avoid conflict of
interest, comply with securities laws and other legal requirements and conduct
business in an honest and ethical manner. The Corporation conveys to its
Directors, executive officers, and employees both their obligations and
responsibilities under and the importance of the Code of Ethics and Business
Conduct.

       Directors, executive officers, and employees are required to report any
conduct that they believe in good faith to be an actual or apparent violation of
the Code of Ethics and Business Conduct. The Corporation has established
procedures for receiving, retaining and treating complaints received regarding
accounting, internal accounting controls or auditing matters and for the
confidential and anonymous submission by employees of concerns regarding
questionable accounting or auditing matters. The Corporation's shareholders may
obtain a copy of the Code of Ethics and Business conduct by writing to the
Corporation's Corporate Secretary, Harbor Bankshares Corporation, 25 West
Fayette Street, Baltimore, Maryland 21201. A Copy of the Code of Ethics and
Business Conduct has been filed with the SEC as an exhibit to the Corporation's
Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004.

                  OWNERS OF MORE THAN 5% OF HARBOR COMMON STOCK


       Beneficial owners of more than 5% of the common stock are required to
file certain ownership reports under the federal securities laws. The following
table shows the common stock beneficially owned by persons who have filed these
reports reporting beneficial ownership that exceeds 5% of Harbor's outstanding
common stock at June 30, 2006.


                                                  Amount and Nature                         Percentage
                                                    of Beneficial                            of Shares
Name                                                Ownership (1)                         Outstanding (2)
----                                                -------------                         ---------------
Joseph Haskins, Jr.                                    95,538  (3)                                13.79%
John Paterakis                                         58,789  (4)                                 9.16%
Joe Louis Gladney.                                     50,312  (5)                                 7.84%
--------------------
(1)      Beneficial ownership is defined by rules of the Securities and Exchange
         Commission, and includes shares that the person has or shares voting or
         investment power. A decision to disclaim beneficial ownership or to
         include shares held by others is made by the shareholder, not by
         Southwest.
(2)      Calculated by Southwest based upon shares reported as beneficially
         owned by the listed persons and shares of Southwest common stock
         outstanding at March 3, 2006.
(3)      The address of Mr. Haskins is 25 West Fayette Street, Baltimore, MD
         21201.
(4)      The address of Mr. Paterakis is 601 S. Carolina Street, Baltimore,
         Maryland. Includes shares owned by J&B Associates, Inc., H&S Bakery,
         Inc., and Northeast Foods, Inc., companies controlled by Mr. Paterakis.
(5)      The address of Mr. Gladney is 2301 Sinclair Lane, Baltimore, MD 21213
         Includes shares owned by 2301 Incorporated and New Life LLC, companies
         controlled by Mr. Gladney.


                COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

SUMMARY COMPENSATION TABLE

       The following table shows compensation paid to certain executive officers
of the Corporation for the three-year period ended December 31, 2005. No other
executive officer of the Corporation received total annual compensation in
excess of $100,000 during such period.

                                       43


                                                ANNUAL COMPENSATION
                                                -------------------
                                                                              ALL OTHER
NAME AND POSITION                   YEAR       SALARY          BONUS        COMPENSATION
-----------------                   ----       ------          -----        ------------
Joseph Haskins, Jr. (1)(2)           2005     $213,383        170,706          $6,191
 Chairman, President and             2004      207,168        165,734           6,191
 Chief Executive Officer             2003      203,105        182,795           6,191

Teodoro J. Hernandez                 2005       99,548         14,955               --
 Vice President and Treasurer        2004       91,781          9,179               --
                                     2003       90,000         17,000               --

Darius L. Davis                      2005      101,904         15,000               --
 Executive Vice President/Bank       2004       86,797          8,680               --

(6) Bonus paid pursuant to the terms of Mr. Haskins' employment agreement.
(7) All other compensation represents premiums for term life benefit paid by the
Corporation.

OPTION GRANTS IN LAST FISCAL YEAR

       The Corporation has adopted stock option plans, pursuant to which it has
reserved 226,886 shares of its Common Stock for the issuance of options. The
following table sets forth information regarding the options granted to the
named executive officers during 2005.

                             NUMBER OF           PERCENT OF TOTAL      EXERCISE OR      MARKET PRICE PER
                         SHARES UNDERLYING      OPTIONS GRANTED TO      BASE PRICE       SHARE ON DATE
NAME                      OPTIONS GRANTED    EMPLOYEES IN FISCAL YEAR   PER SHARE           OF GRANT          EXPIRATION DATE
----                      ---------------    ------------------------   ---------           --------          ---------------
Joseph Haskins, Jr.           2,560              42.3%                   $25.00              $25.00               1/1/2016
Teodoro J. Hernandez.           796              13.2                     25.00               25.00               1/1/2016
Darius L. Davis               1,223              20.2                     25.00               25.00               1/1/2016

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR END VALUE OF OPTIONS

       The following table set for the aggregated option exercises in 2005 and
the option values at December 31, 2005, based upon a market value for Company
Common Stock of $25.00 per share:

                             NUMBER OF                        NUMBER OF             VALUE OF UNEXERCISED
                          SHARES ACQUIRED     VALUE      UNEXERCISED OPTIONS        IN-THE-MONEY OPTIONS
NAME                        ON EXERCISE     REALIZED    AT FISCAL YEAR-END(1)        AT FISCAL YEAR-END
----                        -----------     --------   ----------------------        ------------------
Joseph Haskins, Jr.           4,053          41,330             50,938                     $345,989
Teodoro J. Hernandez             --              --              8,775                       59,085
Darius L. Davis                  --              --              3,048                        5,024

---------
(1) Currently exercisable options.

COMPENSATION OF DIRECTORS

       Directors of the Corporation receive a fee of $533 for each Board meeting
attended ($1,066 if the Director is a member of the Corporation's Executive
Committee), but do not receive a fee for attendance at the committee meetings.
Mr. Vaeth received an additional fee of 4,340 for acting as secretary at each of
the Board and Board committee meetings. Total fees paid to Directors of the
Corporation during 2005 were $104,605. Directors who are not employed by the
Corporation or the Bank are permitted to elect whether to receive their fees in
the form of cash or in the form of options to purchase Common Stock of the
Corporation under the 1995 Director Stock Option Plan which has been approved by
the Corporation's shareholders. The exercise prices of the options will equal
the market price of the Common Stock on the date of grant. The Corporation did
not grant any options to its Directors in 2005.

                                       44


MR. HASKINS' EMPLOYMENT AGREEMENT AND RETIREMENT BENEFIT

       Joseph Haskins, Jr. has an employment agreement with the Corporation and
the Bank for a four-year term commencing as of January 1, 2000, which term may
be automatically renewed for additional three-year terms unless earlier
terminated. The employment agreement provides that Mr. Haskins will serve as
Chairman of the Board, President and Chief Executive Officer of the Corporation
and Chairman of the Board and Chief Executive Officer of the Bank at an annual
salary of $182,330, subject to annual increases approved by the Corporation and
the Bank. Under the employment agreement, Mr. Haskins may also receive an annual
incentive bonus based upon the attainment of goals and objectives set by the
Corporation's Board of Directors. If the minimum level of such goals and
objectives is not met, Mr. Haskins will not be entitled to an incentive bonus.
If the Corporation's Board of Directors awards Mr. Haskins an incentive bonus,
the amount of the bonus will range from 60% to 100% of Mr. Haskins's then
current salary, as determined by the Board of Directors. In addition to the
benefit programs, plans, and arrangements of the Corporation and the Bank
generally available to their employees and the normal perquisites provided to
their senior executive officers, the employment agreement provides that Mr.
Haskins will receive long-term disability insurance, life insurance, and an
automobile allowance. Further, the Corporation must maintain a key man life
insurance policy on the life of Mr. Haskins in order to provide the funds
necessary to buy his shares of Corporation Common Stock from his estate or his
heirs.

       If the Corporation terminates Mr. Haskins' employment because he becomes
disabled, the Corporation will continue to provide Mr. Haskins with long-term
disability insurance and medical and group life insurance until he attains age
65. Upon termination without cause or resignation with good reason (as those
terms are used in the employment agreement), Mr. Haskins would be entitled to
(1) severance pay equal to three times his base salary at the time of
termination, payable in three equal annual installments, the first of which is
due within 30 day of termination, (2) a pro rated bonus based upon the bonus
paid in the year prior to termination or resignation, and (3) immediate vesting
of his outstanding options. If Mr. Haskins voluntarily resigns without good
reason or if the Corporation terminates his employment for cause, the
Corporation would not have any further obligations to Mr. Haskins under his
employment agreement.

       The Corporation must pay a change of control benefit to Mr. Haskins if
either (1) within 12 months after a change of control of the Corporation, the
Corporation terminates Mr. Haskins' employment without cause or Mr. Haskins
terminate his employment for good reason or (2) within 30 days after the
expiration of six month after the change in control, Mr. Haskins' terminates his
employment for any reason. The change of control benefit would equal the greater
of (1) 2.99 times the average of Mr. Haskins' gross compensation from the
Corporation over the five-year period before the termination or (2) the amount
Mr. Haskins would receive if he was terminated without cause, as described in
the prior paragraph. Further, in such event, Mr. Haskins would be entitled to
the immediate vesting of his options.

       Mr. Haskins may be entitled to receive a retirement benefit under an
executive supplemental retirement plan. Mr. Haskins will receive 15 annual
payments of the greater of (1) 63% of his final base salary or (2) $200,000,
payable at the time of retirement, if he retires at or after age 62. Mr. Haskins
will receive 15 annual payments, each payment being equal to 63% of his final
base salary, payable at the time of retirement or termination (or in the case of
a disability, at the age of 65), if before age 62:

                    o Mr. Haskins terminates his employment for good reason or,
                      within 30 days after the expiration of six months after a
                      change of control of the Corporation, Mr. Haskins
                      terminates his employment with or without good reason; or

                    o the Corporation terminates Mr. Haskins' employment without
                      cause or because of a disability.

       If Mr. Haskins terminates his employment before age 62 without good
reason, Mr. Haskins will be entitled to a prorated amount of 63% of his final
base salary based upon the number of years he provided services to the
Corporation from the year 2000 until such time has he retires. However, if the
Corporation terminates Mr. Haskins' employment for cause, Mr. Haskins will
forfeit his retirement benefit. In the event of Mr. Haskins' death, Mr. Haskins'
beneficiaries would be entitled to receive the reminder of the retirement
benefit should he die before receipt of the full retirement benefit.

INFORMATION REGARDING MR. HERNANDEZ

       Mr. Hernandez is 61 years old and has served as Vice President and
Cashier of the Bank since 1982 and Vice President and Treasurer of the
Corporation since its formation in 1992. He became a Senior Vice President of
the Bank in 1998.

                                       45


       Mr. Hernandez may be entitled to receive a retirement benefit under an
executive supplemental retirement plan. Mr. Hernandez will receive 15 annual
payments of $40,000, payable at the time of retirement, if he retires at or
after age 65. Mr. Hernandez will receive 15 annual payments, in amounts ranging
from $5,309 to $40,000, if Mr. Hernandez retires before age 65. In the event of
a change of control of the Bank, if Mr. Hernandez's employment is terminated for
any reason (other than a Bank-approved leave of absence), Mr. Hernandez will be
entitled to receive the same benefit as if he retired at or after age 65. Mr.
Hernandez's beneficiaries would be entitled to receive the remainder of the
retirement benefit should he die before receipt of the full retirement benefit.
In the event of Mr. Hernandez's death while in active services of the Bank, Mr.
Hernandez's beneficiaries would be entitled to receive a lump sum payment
ranging from $38,676 to $396,987, depending upon the year of his death. However,
if the Board of Directors terminates Mr. Hernandez's employment for cause, Mr.
Hernandez will forfeit his retirement benefit.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

       During the past year the Bank has had loan transactions in the ordinary
course of its banking business with Directors and executive officers of the Bank
and with their affiliates. Loans to such persons were made in the ordinary
course of business and did not and do not currently involve more than the normal
risk of collectibility or present other unfavorable features. All such loans
were made on substantially the same terms including interest rates and
collateral requirements, as those prevailing at the time for comparable
transactions with non-affiliates. The bank expects to enter into such
transaction in the future. As of December 31, 2005, loans to Directors and
executive officers of the Bank, and their affiliates, including loans guaranteed
by such persons and unfunded commitments made in 2005, aggregated $13,466,000 or
approximately 63.2% of tangible shareholders' equity of the Bank.

       Since May 1997, the Bank has leased approximately 2,600 square feet from
Harbor East - Office, LLC for one of the Bank's branch offices located in
Baltimore, Maryland. A majority of the outstanding membership interests of
Harbor East - Office, LLC is beneficially owned by John Paterakis, who serves as
a Director of the Company and the Bank and as Chairman of the Executive
Committee of the Bank's Board of Directors. In 2005, the Bank's monthly lease
payments for these premises were approximately $6,333. The current lease term
expires in May 2007, and the Bank has two five-year options to renew. The
Company believes that this lease is on terms no less favorable to the Bank than
those that would be available to the Bank in an arm's length transaction with a
third party.

                         INDEPENDENT PUBLIC ACCOUNTANTS

GENERAL

       The Audit Committee has retained Stegman & Company as independent public
accountants to audit the Corporation's 2006 consolidated financial statements.
Stegman & Company also audited the Corporation's consolidated financial
statements for 2004 and 2005. A representative of Stegman & Company is expected
to be present at the Annual Meeting, with the opportunity to make a statement if
he or she decides, and will respond to appropriate questions.

AUDIT AND NON-AUDIT FEES


                                         2005              2004
                                         ----              ----
      Audit Fees                      $60,500           $59,950
      Audit-Related Fees                1,950             2,250
      Tax Fees                         10,425            10,725
      All Other Fees                       --                --
                                   -----------        ----------
           Total                      $72,875           $72,925
                                   ===========        ==========

         Fees that the Corporation paid to Stegman & Company in 2004 and 2005
are set forth in the above table. Audit fees are fees the Corporation paid
Stegman & Company for the audit and quarterly reviews of the Corporation's
consolidated financial statements, assistance with the review of documents filed
with the SEC, consent procedures and accounting consultation related to
transaction and the adoption of new accounting pronouncements. Audit-related
fees are fees for services that are reasonably related to the performance of the
audit or the review of the Corporation's consolidated financial statements and
principally included consultation concerning financial accounting and reporting
standards. Tax fee primarily included tax compliance services. Stegman & Company
did not provide any other services to the Corporation in 2004 and 2005.

                                       46


POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDI AND NON-AUDIT SERVICES

         The Audit committee's policy is to pre-approve all audit and non-audit
services proved by the independent public accountants. These services may
include audit services, and audit-related services, tax services and other
services. Pre-approval is generally provided for up to one year and any
pre-approval is derailed as to the particular service or category of services
and is generally subject to a specific budget. The Audit Committee has delegated
pre-approval authority to its Chair when expedition of services is necessary.
The Chair is required to report any decision to pre-approve such services to the
full Audit Committee at its next meeting. The independent public accountants and
management are required to periodically report to the full Audit Committee
regarding the extent of services provided by the independent public accountants
in accordance with this pre-approval, and the fees for the services performed to
date.

                               THE ANNUAL MEETING

PURPOSE

       This proxy statement is furnished to shareholders of Harbor in connection
with the solicitation of proxies by Harbor's Board of Directors for use at the
Annual Meeting.

DATE, PLACE AND TIME OF ANNUAL MEETING


       The Annual Meeting of Harbor's shareholders will be held at Harbor's main
office at 25 West Fayette Street, Baltimore, Maryland 21201 on Wednesday,
November __, 2006, at 12:00 noon Eastern Time.


SHARES ENTITLED TO VOTE; QUORUM AND VOTE REQUIRED


       The holders of record of the outstanding shares of Harbor voting common
stock at the close of business on October __, 2006, will be entitled to notice
of and to vote at the Annual Meeting and any adjournment or postponement of the
Annual Meeting. At the close of business on that date, there were 641,784 shares
of Harbor common stock issued and outstanding and entitled to vote at the Annual
Meeting.


       At the Annual Meeting Harbor shareholders will be entitled to one vote
for each share of Harbor common stock owned of record on the record date. The
holders of a majority of the Harbor common stock must be present, either in
person or by proxy, to constitute a quorum at the meeting. Shares of Harbor
common stock present in person or represented by proxy, including shares whose
holders abstain or do not vote and shares held of record by a broker or nominee
that are voted on any matter, will be counted for purposes of determining
whether a quorum exists at the Annual Meeting.

       The affirmative vote of at least two-thirds (2/3) of the issued and
outstanding Harbor voting common stock is required to approve the merger
agreement. Directors are elected by a plurality of the votes cast by the holders
of shares of common stock present in person or represented by proxy at the
Annual Meeting with a quorum present. Abstentions and broker non-votes are not
considered to be votes cast. The affirmative vote of at least a majority of the
Harbor common stock present at the meeting, either in person or by proxy, is
required to approve an adjournment of the Annual Meeting and any other matters
that may be properly presented at the meeting.

       The proposal to approve the merger agreement and the proposal for
adjournment are "non-discretionary" items, meaning that brokers and banks who
hold shares in an account for customers who are the beneficial owners of such
shares may not give a proxy to vote those shares on those items without specific
instructions from their customers. Any abstentions and broker non-votes will
have the same effect as votes against approval of the merger agreement.
Accordingly, the Harbor Board of Directors encourages you to complete, date and
sign the accompanying proxy card and return it promptly in the enclosed
postage-paid envelope.

       On the record date, the Directors and executive officers of Harbor and
the Bank (16 persons) were entitled to vote, in the aggregate, 193,177 shares of
Harbor common stock, or approximately 30.1% of the outstanding shares of Harbor
voting common stock. These shares are expected to be voted FOR approval of the
merger agreement. If these shares are voted in favor of the merger agreement,
then shareholders owning an additional 234,679 shares would be required to vote
in favor of the merger in order for the proposal to receive approval by
two-thirds (2/3) of the outstanding shares of Harbor common stock.

                                       47


       A list of shareholders will be available for examination by holders of
the Harbor common stock for any purpose related to the Annual Meeting at the
Annual Meeting and during the 10 days prior to the Annual Meeting at our offices
at 25 West Fayette Street, Baltimore, MD 21201.

VOTING PROCEDURES AND REVOCATION OF PROXIES

       Proxies, in the form enclosed, which are properly executed by the
shareholders and returned to Harbor and not subsequently revoked, will be voted
in accordance with the instructions indicated on the proxies. Any properly
executed proxy on which voting instructions are not specified will be voted FOR
the proposal to approve the merger agreement, FOR the propose to adjourn the
Annual Meeting, if necessary, and FOR the election of the four nominated Class
II Directors. The proxy also grants authority to the persons designated in the
proxy to vote in accordance with their own judgment if an unscheduled matter is
properly brought before the meeting.

       If you are the record holder of your shares, you may revoke any proxy
given pursuant to this solicitation by the Harbor Board of Directors at any time
before it is voted at the Annual Meeting by:

                    o Giving written notice to the Secretary of Harbor;

                    o Executing a proxy bearing a later date filed with the
                      Secretary of Harbor at or before the meeting; or

                    o Attending and voting in person at the meeting. Attendance
                      without voting at the Annual Meeting will not in and of
                      itself constitute revocation of a proxy.

       All written notices of revocation and other communications with respect
to revocation or proxies should be sent to: Harbor Bankshares Corporation, 25
West Fayette Street, Baltimore, MD 21201 Attention: Teodoro J. Hernandez, Vice
President and Treasurer. If you hold your shares in street name with a bank or
broker, you must contact the bank or broker if you wish to revoke your proxy.

ATTENDING THE ANNUAL MEETING

       All of our shareholders are invited to attend the Annual Meeting. If you
are a beneficial owner of Harbor common stock held by a broker, bank or other
nominee (i.e., in "street name"), you will need proof of ownership to be
admitted to the Annual Meeting. A recent brokerage statement or a letter from a
bank or broker are examples of proof of ownership. If you want to vote your
shares of Harbor common stock held in street name in person at the Annual
Meeting, you will have to get a written proxy in your name from the broker,
bank, or other nominee who holds your shares.

ANNUAL REPORT


       Our Annual Report to the SEC on Form 10-KSB for the fiscal year ended
December 31, 2005, and our Quarterly Report on Form 10-QSB for the period ended
June 30, 2006, are attached to this proxy statement as Appendixes D, E, and F,
and are incorporated herein by reference. See "Where You Can Find More
Information" and "Documents Incorporated by Reference."


OTHER MATTERS TO BE CONSIDERED

       Our Board of Directors is not aware of any business or matter other than
the proposal to approve the merger agreement. If, however, any matter properly
comes before the Annual Meeting, the proxy holders will vote on these matters in
their discretion.

SOLICITATION OF PROXIES AND EXPENSES

       This proxy solicitation is made by the Board of Directors of Harbor.
Harbor is responsible for its expenses incurred in preparing, assembling,
printing, and mailing this proxy statement. Proxies will be solicited through
the mail. Additionally, Directors, officers and other employees of Harbor or its
subsidiaries may solicit proxies personally, by telephone or other means of
communications. None of these people will receive any special compensation for
solicitation activities. Harbor will reimburse banks, brokers and other
custodians, nominees and fiduciaries for their reasonable expenses in forwarding
the proxy materials to beneficial owners.

                                  OTHER MATTERS

       Management of Harbor knows of no other business to be presented at the
Annual Meeting, other than procedural matters relating to the conduct of the
Annual Meeting, but if other matters do properly come before the Annual Meeting,
unless otherwise instructed, it is intended that the persons named in the proxy
card will vote shares according to their best judgment.

                                       48


                       WHERE YOU CAN FIND MORE INFORMATION

       Harbor files reports, proxy statements and other information with the SEC
under the Exchange Act. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference rooms. You may read and copy, at the
prescribed rates, this information at the SEC's Public Reference Room, 100 F
Street, N.E., Washington, D.C. 20549. The SEC also maintains an Internet world
wide web site that contains reports, proxy statements and other information
about issuers, including Harbor, who file electronically with the SEC. The
address of that site is http://www.sec.gov.


       Harbor and the merger subsidiary have filed with the SEC a Rule 13e-3
Transaction Statement on Schedule 13E-3 in respect of the merger. As permitted
by the SEC, this proxy statement omits certain information contained in the
Schedule 13E-3. The Schedule 13E-3, including any amendments and exhibits filed
or incorporated by reference as a part thereof, is available for inspection or
copying as set forth above or is available electronically at the SEC's website.


                       DOCUMENTS INCORPORATED BY REFERENCE

       The SEC allows Harbor to "incorporate by reference" information into this
document. This means that we can disclose important information to you be
referring you to another document filed separately with the SEC. The information
incorporated by reference is considered to be a part of this document, except
for any information that is superseded by information that is included directly
in this document or in any other subsequently filed document that also is
incorporated by reference herein.

       This document incorporates by reference the documents listed below that
Harbor has filed previously with the SEC. They contain important information
about Harbor and its financial condition:


                    o Harbor's Annual Report on Form 10-KSB for the year ended
                      December 31, 2005; and

                    o Harbor's Quarterly Report on Form 10-QSB for the quarter
                      ended June 30, 2006.


       We also incorporate by reference any additional documents that we may
file with the SEC under Section 13(a), 13(c), 14, or 15(d) of the Exchange Act,
between the date of this document and the date of Harbor's Annual Meeting.

       We will provide, without charge, to each person to whom this proxy
statement is delivered, upon written or oral request of such person and by first
class mail or other equally prompt means within one business day of receipt of
such request, a copy of any and all information that has been incorporated by
reference, without exhibits unless such exhibits are also incorporated by
reference in this proxy statement. You may obtain a copy of these documents and
any amendments thereto by writing to Teodoro J. Hernandez, Vice President and
Treasurer at the following address: Harbor Bankshares Corporation, 25 West
Fayette Street, Baltimore, MD 21201.

       These documents are also included in our SEC filings, which you can
access electronically at the SEC's website at http://www.sec.gov.

       We have not authorized anyone to give any information or make any
representation about the merger or us that differs from, or adds to, the
information in this proxy statement or in our documents that are publicly filed
with the SEC. If anyone does give you different or additional information, you
should not rely on it.


                                      By Order of the Board of Directors

                                      Joseph Haskins, Jr.
                                      Chairman, President, and Chief Executive
                                               Officer

                                       49



                                   APPENDIX A

                          AGREEMENT AND PLAN OF MERGER



                                   APPENDIX A

                          AGREEMENT AND PLAN OF MERGER

       This AGREEMENT AND PLAN OF MERGER (this "Agreement") dated as of
_________, 2006 is by and between HARBOR BANKSHARES CORPORATION ("Harbor"), a
Maryland corporation, and HARBOR MERGER CORPORATION ("Merger Corp"), a Maryland
corporation.

                              W I T N E S S E T H:

       WHEREAS, Merger Corp has been formed in order to effect the merger that
is the subject of this Agreement.

       WHEREAS, the Boards of Directors of Harbor and Merger Corp have approved
this Agreement and the transactions proposed herein, pursuant to which Merger
Corp will be merged with and into Harbor.

       NOW THEREFORE, IN CONSIDERATION of the premises and the mutual covenants
and agreements contained in this Agreement, and for other good and valuable
consideration the receipt and sufficiency of which is hereby acknowledged, the
parties hereto, intending legally to be bound, agree and covenant as follows:

                              ARTICLE I--THE MERGER

1.1      MERGER.

       Upon the terms and subject to the conditions of this Agreement, and in
accordance with the Maryland General Corporation Law (the "MGCL"), at the
Effective Time, Merger Corp shall be merged with and into Harbor and the
separate existence of Merger Corp shall thereupon cease, and Harbor (the
"Surviving Corporation"), shall by virtue of the merger continue its corporate
existence under the laws of the State of Maryland (the "Merger") under the name
Harbor Bankshares, Inc.

1.2      EFFECTIVE TIME OF THE MERGER.

       The Merger shall become effective at the date and time (the "Effective
Time") when subject to the terms and conditions of this Agreement, the parties
file articles of merger with the Secretary of State of the State of Maryland in
accordance with the MGCL, following fulfillment of the conditions set forth in
Articles VI and VII hereof.

1.3      THE SURVIVING CORPORATION.

         (a)      The Certificate of Incorporation of Harbor in effect at the
                  Effective Time shall be the certificate of incorporation of
                  the Surviving Corporation, until further amended in accordance
                  with its terms and as provided by law.

         (b)      The bylaws of Harbor as in effect at the Effective Time shall
                  be the bylaws of the Surviving Corporation, until further
                  amended in accordance with their terms and as provided by law.

         (c)      The directors of Harbor immediately prior to the Effective
                  Time shall be the directors of the Surviving Corporation and
                  the officers of Harbor immediately prior to the Effective Time
                  shall be the officers of the Surviving Corporation, in each
                  case as of the Effective Time until their respective
                  successors are duly elected and qualified.

         (d)      The Merger shall have the effects set forth in the MGCL.

         (e)      All options for Harbor common stock outstanding at the
                  Effective Time shall remain outstanding without change.

1.4      MERGER CONSIDERATION.

       At the Effective Time, by virtue of the Merger and without any action
on the part of the holders thereof,

         (a)      All outstanding shares of Common Stock (other than Objecting
                  Shares) held of record by a shareholder holding 100 or fewer
                  shares of Common Stock immediately prior to the Effective Time
                  shall, without any action on the part of the shareholder
                  thereof, be canceled and converted into the right to receive,
                  upon the surrender of the certificate representing such
                  shares, $31.00 in cash per share of Common Stock without
                  interest thereon, (the "Merger Consideration").

         (b)      Each share of Common Stock held in the treasury of Harbor and
                  each share of Common Stock owned by any direct or indirect
                  wholly-owned subsidiary of Harbor immediately prior to the
                  Effective Time shall be cancelled without any conversion and
                  no payment or distribution shall be made with respect thereto;

                                      A-1


         (c)      All outstanding shares of Common Stock other than those
                  described in paragraphs (a) and (b) as being converted into
                  the right to receive the Merger Consideration shall remain
                  outstanding with all rights, privileges, and powers existing
                  immediately prior to the Effective Time; and

         (d)      The outstanding shares of Merger Corp Stock shall, without any
                  action on the part of the holder thereof, be canceled.

         (e)      Except as provided in Section 1.6 with respect to Objecting
                  Shares, in no event shall any shareholder holding of record
                  immediately prior to the Effective Time more than 100 shares
                  of Common Stock in the aggregate be entitled to receive any
                  Merger Consideration with respect to the shares of Common
                  Stock so held.

         (f)      For purposes hereof, the term "Cash-Out Shares" shall mean any
                  shares of Common Stock that are converted into the right to
                  receive the Merger Consideration pursuant to this Section 1.4.

1.5      MANNER OF CALCULATING SHARES HELD OF RECORD.

         (a)      Subject to Sections 1.5 (b) through (d), below, calculations
                  of shares held of record shall be made in accordance with
                  Securities and Exchange Commission Rule 12g5-1, and
                  accordingly:

                  (i)     The number of shares held of record will be calculated
                          by adding all shares registered in the same manner;

                  (ii)    Shares held in street name beneficially owned by a
                          shareholder will not be aggregated with shares
                          registered in such shareholder's own name, and

                  (iii)   Shares owned by related persons or in different
                          capacities will not be aggregated.

         (b)      For purposes of this Section 1.5, Harbor may in its sole
                  discretion, but shall not have any obligation to do so, (i)
                  presume that any shares of Common Stock held in a discrete
                  account (whether record or beneficial) are held by a person
                  distinct from any other person, notwithstanding that the
                  registered or beneficial holder of a separate discrete account
                  has the same or a similar name as the holder of a separate
                  discrete account; and (ii) aggregate the shares of Common
                  Stock held (whether of record or beneficially) by any person
                  or persons that Harbor determines to constitute a single
                  shareholder for purposes of determining the number of shares
                  of Common Stock held by such shareholder.

         (c)      Harbor will presume that all shares held in street name are
                  held by shareholders holding more than 100 shares of Common
                  Stock immediately prior to the Effective Time unless Harbor
                  determines, or a beneficial owner of shares held in street
                  name is able to demonstrate to Harbor's satisfaction, that
                  such shares are held beneficially by a shareholder holding 100
                  or fewer shares of Common Stock immediately prior to the
                  Effective Time, in which case such shares will be deemed to be
                  Cash-Out shares.

         (d)      Harbor (and any other person or entity to which it may
                  delegate or assign any responsibility or task with respect
                  thereto) shall make all decisions regarding the application of
                  this section in good faith and in accordance with the
                  principles of Securities and Exchange Commission Rule 12g5-1
                  and sections 1.5(b) and (c). Harbor shall have full discretion
                  and exclusive authority (subject to its right and power to so
                  delegate or assign such authority) to (i) make such inquiries,
                  whether of any shareholder(s) or otherwise, as it may deem
                  appropriate for purposes of this Section 1.5 and (ii) resolve
                  and determine all ambiguities, questions of fact, and
                  interpretive and other matters relating to this Section All
                  such determinations by Harbor under this Section 1.5 shall be
                  final..

1.6      OBJECTING SHARES.

         (a)      Each share of Common Stock issued and outstanding immediately
                  prior to the Effective Time, the shareholder of which has not
                  voted in favor of the Merger and who has delivered a written
                  demand for payment of the fair value of such shares within the
                  time and in the manner provided in Title 3, Subtitle 2 of the
                  MGCL, is referred to herein as a "Objecting Share."

                                      A-2


         (b)      Notwithstanding anything in this Agreement to the contrary,
                  Objecting Shares shall not be converted into or represent the
                  right to receive the Merger Consideration pursuant to Section
                  1.5 hereof unless and until such shareholder shall have failed
                  to perfect or shall have effectively withdrawn or lost his
                  right to appraisal and payment under the MGCL. If any such
                  shareholder shall have so failed to perfect or shall have
                  effectively withdrawn or lost such right, such shareholder's
                  Objecting Shares shall thereupon be deemed to have been
                  converted into and to have become exchangeable for, at the
                  Effective Time, the right to receive the Merger Consideration
                  without any interest thereon.

1.7      EXCHANGE OF SHARES.

         (a)      Harbor shall deposit or cause to be deposited prior to the
                  Effective Time cash, an aggregate amount necessary to pay the
                  Merger Consideration to Cash-Out Shareholders and to make
                  appropriate cash payments to shareholders of Objecting Shares
                  pursuant to Section 1.6 hereof, if any, (such amounts being
                  hereinafter referred to as (the "Exchange Fund").

         (b)      As soon as practicable after the Effective Time, the Exchange
                  Agent selected by Harbor in its discretion shall mail to each
                  shareholder of record of an outstanding certificate or
                  certificates which represent shares of Common Stock (the
                  "Certificates"), a form letter of transmittal which will
                  specify that delivery shall be effected, and risk of loss and
                  title to the Certificates shall pass, only upon proper
                  delivery of the Certificates to the Exchange Agent and contain
                  instructions for use in effecting the surrender of the
                  Certificates for payment therefor. At and after the Closing
                  (as defined herein) and upon surrender to the Exchange Agent
                  of a Certificate, together with such letter of transmittal
                  duly executed, the holder of such Certificate shall be
                  entitled to receive in exchange therefor the amount of cash
                  provided in Section 1.4 hereof and such Certificate shall
                  forthwith be canceled. The Exchange Agent shall, upon
                  surrender of Certificates representing shares of Common Stock,
                  promptly deliver the Merger Consideration with respect to such
                  shares of Common Stock formerly represented by such
                  Certificate. No interest will be paid or accrued on the Merger
                  Consideration payable upon surrender of the Certificates. If
                  payment of cash is to be made to a person other than the
                  person in whose name the Certificate surrendered is
                  registered, it shall be a condition of payment that the
                  Certificate so surrendered shall be properly endorsed or
                  otherwise in proper form for transfer and that the person
                  requesting such payment shall pay any transfer or other taxes
                  required by reason of the payment to a person other than the
                  registered holder of the Certificate surrendered or
                  established to the satisfaction of Harbor that such tax has
                  been paid or is not applicable. Until surrendered in
                  accordance with the provisions of this Section 1.7, each
                  Certificate (other than Certificates representing Objecting
                  Shares) shall represent for all purposes the right to receive
                  the Merger Consideration without any interest thereon.

         (c)      Any portion of the Exchange Fund (including the proceeds of
                  any investments thereof) that remains unclaimed by the
                  shareholders of Harbor for six months after the Exchange Agent
                  mails the letter of transmittal pursuant to this Section 1.7
                  shall be returned to Harbor upon demand, and the holders of
                  shares of Common Stock who have not theretofore complied with
                  the exchange procedures in this Section 1.7 shall look to
                  Harbor only, and not the Exchange Agent, for the payment of
                  any of the Merger Consideration in respect of such shares.

         (d)      None of Harbor, Merger Corp, the Exchange Agent or any other
                  person shall be liable to any former holder of shares of
                  Common Stock for any cash properly delivered to a public
                  official pursuant to applicable abandoned property, escheat,
                  or similar laws.

         (e)      In the event any Certificate shall have been lost, stolen or
                  destroyed, upon the making of an affidavit of that fact by the
                  person claiming such Certificate to be lost, stolen or
                  destroyed and, if required by Harbor or the Exchange Agent,
                  the posting by such person of a bond in such amount as Harbor
                  or the Exchange Agent may direct as indemnity against any
                  claim that may be made against it with respect to such
                  Certificate, the Exchange Agent will issue in exchange for
                  such lost, stolen or destroyed Certificate the Merger
                  Consideration deliverable in respect thereof pursuant to this
                  Agreement.

1.8      APPROVAL BY SHAREHOLDERS.

       This Agreement shall be submitted to the shareholders of Harbor and
Merger Corp in accordance with applicable provisions of law and the Articles of
Incorporation and Bylaws of Harbor and Merger Corp. Harbor and Merger Corp shall
proceed expeditiously and cooperate fully in the procurement of any other
consents and approvals and the taking of any other actions in satisfaction of
all other requirements prescribed by law or otherwise necessary for consummation
of the Merger on the terms herein provided, including, without limitation, the
preparation and submission of all necessary filings, requests for waivers, and
certificates with the regulatory authorities, if any.

                                      A-3


              ARTICLE II--REPRESENTATIONS AND WARRANTIES OF HARBOR

       Harbor hereby represents and warrants to Merger Corp as follows:

2.1      ORGANIZATION AND AUTHORITY.

       Harbor is a corporation duly organized, validly existing and in good
standing under the laws of the State of Maryland, is a registered bank holding
company under the Bank Holding Company Act of 1956, as amended, and has full
corporate power to own its properties, to carry on its business, and to enter
into this Agreement.

2.2      CAPITAL STRUCTURE.

       The authorized capital stock of Harbor is 10,000,000 shares of Common
Stock, 641,784 shares of which are validly issued and outstanding, fully paid
and nonassessable.

2.3      AUTHORIZATION.

         (a)      The Board of Directors of Harbor has approved this Agreement
                  and the transactions contemplated hereby, subject to the
                  approval by the shareholders of Harbor as required by law.
                  This Agreement has been duly executed and delivered by Harbor
                  and when executed by Harbor and duly approved by the
                  shareholders of Harbor, it will be a binding agreement of
                  Harbor enforceable against it in accordance with its terms.

         (b)      Subject to the receipt of all required regulatory approvals
                  and compliance with all applicable federal and state
                  securities laws, the execution, delivery and performance of
                  this Agreement and the transactions contemplated hereby and
                  thereby will not violate any provision of, or constitute a
                  default under any order, writ, injunction or decree of any
                  court or other governmental agency, or any contract, agreement
                  or instrument to which Harbor is a party or by which it is
                  bound, or constitute an event which with the lapse of time or
                  action by a third party could result in any default under any
                  of the foregoing or result in the creation of any lien, charge
                  or encumbrance upon any of the assets or properties of Harbor
                  or upon shares of Common Stock.

           ARTICLE III--REPRESENTATIONS AND WARRANTIES OF MERGER CORP

       Merger Corp hereby represents and warrants to Harbor as follows:

3.1      ORGANIZATION.

       Merger Corp is a Maryland corporation duly organized, validly existing
and in good standing under the laws of Maryland, and has full corporate power
and authority to own its properties, and to enter into this Agreement. Merger
Corp does not have any subsidiaries.

3.2      CAPITAL STRUCTURE.

       The authorized capital stock of Merger Corp consists of 1,000 shares of
common stock, $1.00 par value (the "Merger Corp Stock"), all of which are issued
and outstanding. All such shares are validly issued, fully paid, and
nonassessable. There are no existing options, warrants, calls, or commitments of
any kind obligating Merger Corp to issue any of its authorized and unissued
capital stock.

3.3      AUTHORIZATION.

         (a)      The Board of Directors of Merger Corp has approved this
                  Agreement and the transactions contemplated hereby, subject to
                  the approval thereof by the shareholders of the Merger Corp as
                  required by law. This Agreement has been duly executed and
                  delivered by Merger Corp and when executed by Harbor and duly
                  approved by the shareholders of Merger Corp, it will be a
                  binding agreement of Merger Corp enforceable against it in
                  accordance with its terms.

         (b)      No Conflict with Other Instruments. Subject to the receipt of
                  all required regulatory approvals and compliance with all
                  applicable federal and state securities laws, the execution,
                  delivery and performance of this Agreement and the
                  transactions contemplated hereby and thereby will not violate
                  any provision of, or constitute a default under, any order,
                  writ, injunction or decree of any court or other governmental
                  agency, or any contract, agreement or instrument to which
                  Merger Corp is a party or by which it is bound, or constitute
                  an event which with the lapse of time or action by a third
                  party could result in any default under any of the foregoing
                  or result in the creation of any lien, charge or encumbrance
                  upon any of the assets or properties of Merger Corp or upon
                  shares of capital stock of Merger Corp.

                                      A-4


                         ARTICLE IV--COVENANTS OF HARBOR

       Harbor hereby covenants to and with Merger Corp as follows:

4.1      ACTIONS.

       Harbor will use its best efforts to take or cause to be taken all actions
necessary, proper, or advisable to consummate this Agreement, including such
actions Merger Corp may reasonably consider necessary, proper, or advisable in
connection with filing applications and other instruments with, or obtaining
approvals of, governmental bodies to the transactions contemplated by this
Agreement.

4.2      CONDUCT.

       From and after the date of this Agreement to the Effective Time of the
Merger, Harbor will maintain its corporate existence, will not (i) amend its
articles of incorporation by-laws, (ii) will not issue any securities, and (iii)
will not declare or make any dividend or other distribution with respect to the
outstanding shares of the Common Stock without written consent of Merger Corp.

4.3      PAYMENTS.

       Harbor will deliver, when and if required by the provisions of this
Agreement, such amounts of cash into which certain shares of Common Stock are to
be converted pursuant to this Agreement.

                       ARTICLE V--COVENANTS OF MERGER CORP

       Merger Corp hereby covenants to and with Harbor as follows:

5.1      ACTIONS.

       Merger Corp will use its best efforts to take or cause to be taken all
other actions necessary, proper or advisable to consummate this Agreement,
including such actions as Harbor may reasonably consider necessary, proper or
advisable in connection with filing applications and other instruments with, or
obtaining approvals of, governmental bodies to the transactions contemplated by
this Agreement.

5.2      CONDUCT.

       From and after the date of this Agreement to the Effective Time, Merger
Corp (i) will maintain its corporate existence; (ii) will not amend its charter
or bylaws; and (iii) will not issue any securities.

               ARTICLE VI--CONDITIONS TO THE OBLIGATIONS OF HARBOR

       The obligation of Harbor to effect the Merger shall be subject to the
satisfaction prior to the Effective Time of the Merger of the following
conditions:

6.1      SHAREHOLDER APPROVAL.

       The shareholders of Harbor shall have voted affirmatively to approve the
Merger by not less than two-thirds of the outstanding voting stock of Harbor.

6.2      OTHER APPROVALS.

       All requisite regulatory approvals relating to the Merger, if any, shall
have been obtained and continue to be in full force and effect, and all waiting
and notice periods under applicable law shall have expired.

6.3      RIGHTS OF OBJECTING SHAREHOLDERS AND OTHER SHAREHOLDERS RECEIVING CASH.

       The aggregate number of shares of Common Stock owned by those
shareholders of Harbor who (i) have perfected and shall be entitled to exercise
their objecting shareholders' rights pursuant to the MGCL, or (ii) are
shareholders of Cash-Out Shares (as defined in Section 1.4 herein) shall not
exceed 1.0% of the issued and outstanding shares of Common Stock.

                                      A-5


6.4      NO INJUNCTIONS OR RESTRAINTS; ILLEGALITY.

       No injunction, restraining order, stop order, or other order or action of
any Federal or state court or agency in the United States which prohibits,
restricts, or makes illegal the consummation of the transactions contemplated
hereby shall be in effect, and no action, suit or other proceeding seeking such
shall have been instituted or threatened, and no statue, rule, or regulation
shall have been enacted, issued, or promulgated by and state or Federal
government or government agency which prohibits, restricts, or makes illegal the
consummation of the transactions contemplated hereby.

            ARTICLE VII--CONDITIONS TO THE OBLIGATIONS OF MERGER CORP

       The obligation of Merger Corp to effect the Merger shall be subject to
the satisfaction prior to the Effective Time of the Merger of the following
conditions:

7.1      SHAREHOLDER APPROVAL.

       The sole shareholder of Merger Corp shall have voted affirmatively to
approve the Merger by not less than two-thirds of the outstanding voting stock
of Merger Corp.

7.2      OTHER APPROVALS.

       All requisite regulatory approvals relating to the Merger, if any, shall
have been obtained and continue to be in full force and effect, and all waiting
and notice periods under applicable law shall have expired.

7.3      RIGHTS OF OBJECTING SHAREHOLDERS AND OTHER SHAREHOLDERS RECEIVING CASH.

       The aggregate number of shares of Common Stock owned by those
shareholders of Harbor who (i) have perfected and shall be entitled to exercise
their objecting shareholders' rights pursuant to the MGCL, or (ii) are
shareholders of Cash-Out Shares (as defined in Section 1.4 herein) shall not
exceed 1.0% of the issued and outstanding shares of Common Stock.

7.4      NO INJUNCTIONS OR RESTRAINTS; ILLEGALITY.

       No injunction, restraining order, stop order, or other order or action of
any Federal or state court or agency in the United States which prohibits,
restricts, or makes illegal the consummation of the transactions contemplated
hereby shall be in effect, and no action, suit or other proceeding seeking such
shall have been instituted or threatened, and no statue, rule, or regulation
shall have been enacted, issued, or promulgated by and state or Federal
government or government agency which prohibits, restricts, or makes illegal the
consummation of the transactions contemplated hereby.

                     ARTICLE VIII--TERMINATION AND AMENDMENT

8.1      TERMINATION.

       This Agreement may be terminated at anytime prior to the Effective Time
by the Boards of Directors of either Merger Corp or Harbor.

8.2      EFFECT OF TERMINATION.

       In the event of termination of this Agreement as provided in this Article
VIII hereof, this Agreement shall forthwith become void and there shall be no
liability or obligation on the part of Merger Corp or Harbor or their respective
officers, directors or shareholders.


8.3      AMENDMENT.

       This Agreement may be amended by the parties hereto by action taken or
authorized by their respective Boards of Directors. This Agreement may not be
amended except by an instrument in writing signed on behalf of each of the
parties hereto.

                        ARTICLE IX--GENERAL PROVISIONS

9.1      NONSURVIVAL OF AGREEMENTS.

       None of the agreements in this Agreement or in any instrument delivered
pursuant to this Agreement shall survive the Effective Time of the Merger.

                                      A-6


9.2      NOTICES.

       All notices and other communications hereunder shall be in writing and
shall be deemed given if delivered personally, telecopied (with confirmation),
or mailed by registered or certified mail (return receipt requested) to Harbor
or Merger Corp, respectively, at the following addresses:

(a) If to Harbor:

                  Joseph Haskins, Jr.
                  Chairman, President and CEO
                  Harbor Bancorp, Inc.
                   25 West Fayette Street
                  Baltimore, MD 21201

(b) If to Merger Sub:

                  Teodoro J. Hernandez
                  Vice President, Secretary, and Treasurer
                  Harbor Bancorp, Inc.,
                  25 West Fayette Street
                  Baltimore, MD 21201

9.3      INTERPRETATION.

       When a reference is made in this Agreement to Sections, such reference
shall be to a Section of this Agreement unless otherwise indicated. The headings
contained in this Agreement are for reference purposes only and shall not affect
in any way the meaning or interpretation of this Agreement. Whenever the words
"include," "includes" or "including" are used in this Agreement, they shall be
deemed to be followed by the words "without limitation."

9.4      COUNTERPARTS.

       This Agreement may be executed in two counterparts, both of which shall
be considered one and the same agreement and shall become effective when both
counterparts have been signed by each of the parties and delivered to the other
party, it being understood that both parties need not sign the same counterpart.

9.5      ENTIRE AGREEMENT.

       This Agreement (including the documents and the instruments referred to
herein) constitutes the entire agreement and supersedes all prior agreements and
understandings, both written and oral, among the parties with respect to the
subject matter hereof.

9.6      ASSIGNMENT.

       Neither this Agreement nor any of the rights, interests or obligations
hereunder shall be assigned by any of the parties hereto (whether by operation
of law or otherwise) without the prior written consent of the other party.

9.7      GOVERNING LAW.

       This Agreement shall be governed by and construed in accordance with the
laws of the State of Maryland applicable to agreements made and entirely to be
performed within such jurisdiction.

       [Signature Page Follows]



                                      A-7


       IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first above written.



ATTEST:           [SEAL]         HARBOR BANKSHARES CORPORATION



____________________________     By:  ______________________________
                                      Joseph Haskins, Jr.
                                      Chairman, President, and CEO


ATTEST:           [SEAL]         HARBOR MERGER CORPORATION



____________________________     By  :______________________________
                                      Teodoro J. Hernandez
                                      Vice President, Secretary, and Treasurer



                                      A-8


                                   APPENDIX B

                                FAIRNESS OPINION





                          HARBOR BANKSHARES CORPORATION
                               BALTIMORE, MARYLAND
                                FAIRNESS OPINION
                              AS OF AUGUST 29, 2006

         Set forth herein is Danielson Associates Inc.'s ("Danielson
Associates") updated independent appraisal of the "fair" market value of the
common stock of Harbor Bankshares Corporation ("Harbor" or "the Bank") of
Baltimore, Maryland as of August 29, 2006. The original opinion was dated
December 8, 2005. Market value is defined as the price at which the common stock
would change hands between a willing seller and a willing buyer, each having
reasonable knowledge of relevant facts and assuming a significant amount of
stock changing hands daily to assure a true reflection of market forces.

         This fairness opinion is based on data supplied by Harbor to Danielson
Associates and its regulators, but it also relies on some public information.
All information received is believed to be reliable, but the accuracy or
completeness of such information cannot be guaranteed. In particular, this
fairness opinion assumes that there are no significant loan quality problems
beyond what has been stated in Harbor's quarterly reports to the Federal Deposit
Insurance Corporation ("FDIC").


         In determining the fair value of the common stock of Harbor, primary
emphasis has been given to the stock prices of banks that have comparable
financial, market and structural characteristics, and the relationship of these
prices to earnings.


         Based on these updated comparisons, an analysis of Harbor's past
performance and future potential and by applying discounts for market, stock
liquidity and its minority ownership, it has been established that the fair
value of its common stock as of August 29, 2006 is between $30.53 and $32.17 per
share with the midpoint being $31.35 per share. Any price in this range would be
fair to current shareholders.


                                            Respectfully submitted,


                                            /s/ David G. Danielson
                                            David G. Danielson, President
                                            Danielson Associates Inc.





                                   APPENDIX C

                        RIGHTS OF OBJECTING SHAREHOLDERS




                   APPENDIX C-RIGHTS OF OBJECTING SHAREHOLDERS

     TITLE 3. CORPORATIONS IN GENERAL--EXTRAORDINARY ACTIONS
       SUBTITLE 2. RIGHTS OF OBJECTING STOCKHOLDERS

         --->SS. 3-201. DEFINITION OF SUCCESSOR

 (a) In this subtitle, except as provided in subsection (b) of this section,
"successor" includes a corporation which amends its charter in a way which
alters the contract rights, as expressly set forth in the charter, of any
outstanding stock, unless the right to do so is reserved by the charter of the
corporation.

(b) When used with reference to a share exchange, "successor" means the
corporation the stock of which was acquired in the share exchange.

         --->SS. 3-202. FAIR VALUE, RIGHT TO FROM SUCCESSORS

 (a) Except as provided in subsection (c) of this section, a stockholder of a
Maryland corporation has the right to demand and receive payment of the fair
value of the stockholder's stock from the successor if:

   (1) The corporation consolidates or merges with another corporation;

   (2) The stockholder's stock is to be acquired in a share exchange;

   (3) The corporation transfers its assets in a manner requiring action under

   ss. 3-105(e) of this title;

   (4) The corporation amends its charter in a way which alters the contract
   rights, as expressly set forth in the charter, of any outstanding stock and
   substantially adversely affects the stockholder's rights, unless the right to
   do so is reserved by the charter of the corporation; or

   (5) The transaction is governed by ss. 3-602 of this title or exempted by ss.
   3-603(b) of this title.

(b)(1) Fair value is determined as of the close of business:

     (i) With respect to a merger under ss. 3-106 of this title of a 90 percent
     or more owned subsidiary with or into its parent corporation, on the day
     notice is given or waived under ss. 3-106; or

     (ii) With respect to any other transaction, on the day the stockholders
     voted on the transaction objected to.

   (2) Except as provided in paragraph (3) of this subsection, fair value may
   not include any appreciation or depreciation which directly or indirectly
   results from the transaction objected to or from its proposal.

   (3) In any transaction governed by ss. 3-602 of this title or exempted by ss.
   3-603(b) of this title, fair value shall be value determined in accordance
   with the requirements of ss. 3-603(b) of this title.

(c) Unless the transaction is governed by ss. 3-602 of this title or is exempted
by ss. 3-603(b) of this title, a stockholder may not demand the fair value of
the stockholder's stock and is bound by the terms of the transaction if:

   (1) The stock is listed on a national securities exchange, is designated as a
   national market system security on an interdealer quotation system by the
   National Association of Securities Dealers, Inc., or is designated for
   trading on the NASDAQ Small Cap Market:

     (i) With respect to a merger under ss. 3-106 of this title of a 90 percent
     or more owned subsidiary with or into its parent corporation, on the date
     notice is given or waived under ss. 3-106; or

     (ii) With respect to any other transaction, on the record date for
     determining stockholders entitled to vote on the transaction objected to;

                                      C-1


   (2) The stock is that of the successor in a merger, unless:

     (i) The merger alters the contract rights of the stock as expressly set
     forth in the charter, and the charter does not reserve the right to do so;
     or

     (ii) The stock is to be changed or converted in whole or in part in the
     merger into something other than either stock in the successor or cash,
     scrip, or other rights or interests arising out of provisions for the
     treatment of fractional shares of stock in the successor;

   (3) The stock is not entitled, other than solely because of ss. 3-106 of this
   title, to be voted on the transaction or the stockholder did not own the
   shares of stock on the record date for determining stockholders entitled to
   vote on the transaction;

   (4) The charter provides that the holders of the stock are not entitled to
   exercise the rights of an objecting stockholder under this subtitle; or

   (5) The stock is that of an open-end investment company registered with the
   Securities and Exchange Commission under the Investment Company Act of 1940
   and the value placed on the stock in the transaction is its net asset value.

         --->SS. 3-203. DUTIES OF OBJECTING STOCKHOLDERS

 (a) A stockholder of a corporation who desires to receive payment of the fair
value of the stockholder's stock under this subtitle:

   (1) Shall file with the corporation a written objection to the proposed
transaction:

     (i) With respect to a merger under ss. 3-106 of this title of a 90 percent
     or more owned subsidiary with or into its parent corporation, within 30
     days after notice is given or waived under ss. 3-106; or

     (ii) With respect to any other transaction, at or before the stockholders'
     meeting at which the transaction will be considered or, in the case of
     action taken under ss. 2-505(b) of this article, within 10 days after the
     corporation gives the notice required by ss. 2-505(b) of this article;

   (2) May not vote in favor of the transaction; and

   (3) Within 20 days after the Department accepts the articles for record,
   shall make a written demand on the successor for payment for the
   stockholder's stock, stating the number and class of shares for which the
   stockholder demands payment.

(b) A stockholder who fails to comply with this section is bound by the terms of
the consolidation, merger, share exchange, transfer of assets, or charter
amendment.


         --->SS. 3-204. EFFECT OF DEMAND

A stockholder who demands payment for his stock under this subtitle:

   (1) Has no right to receive any dividends or distributions payable to holders
   of record of that stock on a record date after the close of business on the
   day as at which fair value is to be determined under ss. 3-202 of this
   subtitle; and

   (2) Ceases to have any rights of a stockholder with respect to that stock,
   except the right to receive payment of its fair value.

                                      C-2


         --->SS. 3-205. CONSENT TO DEMAND WITHDRAWAL

A demand for payment may be withdrawn only with the consent of the successor.

         --->SS. 3-206. RESTORATION OF STOCKHOLDER RIGHTS

 (a) The rights of a stockholder who demands payment are restored in full, if:

   (1) The demand for payment is withdrawn;

   (2) A petition for an appraisal is not filed within the time required by this
subtitle;

   (3) A court determines that the stockholder is not entitled to relief; or

   (4) The transaction objected to is abandoned or rescinded.

(b) The restoration of a stockholder's rights entitles him to receive the
dividends, distributions, and other rights he would have received if he had not
demanded payment for his stock. However, the restoration does not prejudice any
corporate proceedings taken before the restoration.

         --->SS. 3-207. SUCCESSOR'S DUTY, NOTICE AND OFFER

 (a)(1) The successor promptly shall notify each objecting stockholder in
writing of the date the articles are accepted for record by the Department.

   (2) The successor also may send a written offer to pay the objecting
   stockholder what it considers to be the fair value of his stock. Each offer
   shall be accompanied by the following information relating to the corporation
   which issued the stock:

     (i) A balance sheet as of a date not more than six months before the date
of the offer;

     (ii) A profit and loss statement for the 12 months ending on the date of
the balance sheet; and

     (iii) Any other information the successor considers pertinent.

(b) The successor shall deliver the notice and offer to each objecting
stockholder personally or mail them to him by certified mail, return receipt
requested, bearing a postmark from the United States Postal Service, at the
address he gives the successor in writing, or, if none, at his address as it
appears on the records of the corporation which issued the stock.


         --->SS. 3-208. PETITION FOR APPRAISAL

 (a) Within 50 days after the Department accepts the articles for record, the
successor or an objecting stockholder who has not received payment for his stock
may petition a court of equity in the county where the principal office of the
successor is located or, if it does not have a principal office in this State,
where the resident agent of the successor is located, for an appraisal to
determine the fair value of the stock.

(b)(1) If more than one appraisal proceeding is instituted, the court shall
direct the consolidation of all the proceedings on terms and conditions it
considers proper.

   (2) Two or more objecting stockholders may join or be joined in an appraisal
proceeding.

                                      C-3


         --->SS. 3-209. SUBMISSION OF CERTIFICATE FOR NOTATION

 (a) At any time after a petition for appraisal is filed, the court may require
the objecting stockholders parties to the proceeding to submit their stock
certificates to the clerk of the court for notation on them that the appraisal
proceeding is pending. If a stockholder fails to comply with the order, the
court may dismiss the proceeding as to him or grant other appropriate relief.

(b) If any stock represented by a certificate which bears a notation is
subsequently transferred, the new certificate issued for the stock shall bear a
similar notation and the name of the original objecting stockholder. The
transferee of this stock does not acquire rights of any character with respect
to the stock other than the rights of the original objecting stockholder.

         --->SS. 3-210. REPORT OF APPRAISERS

 (a) If the court finds that the objecting stockholder is entitled to an
appraisal of his stock, it shall appoint three disinterested appraisers to
determine the fair value of the stock on terms and conditions the court
considers proper. Each appraiser shall take an oath to discharge his duties
honestly and faithfully.

(b) Within 60 days after their appointment, unless the court sets a longer time,
the appraisers shall determine the fair value of the stock as of the appropriate
date and file a report stating the conclusion of the majority as to the fair
value of the stock.

(c) The report shall state the reasons for the conclusion and shall include a
transcript of all testimony and exhibits offered.

(d)(1) On the same day that the report is filed, the appraisers shall mail a
copy of it to each party to the proceedings.

   (2) Within 15 days after the report is filed, any party may object to it and
request a hearing.

         --->SS. 3-211. COURT ORDER UPON APPRAISERS REPORT

 (a) The court shall consider the report and, on motion of any party to the
proceeding, enter an order which:

   (1) Confirms, modifies, or rejects it; and

   (2) If appropriate, sets the time for payment to the stockholder.

(b)(1) If the appraisers' report is confirmed or modified by the order, judgment
shall be entered against the successor and in favor of each objecting
stockholder party to the proceeding for the appraised fair value of his stock.

   (2) If the appraisers' report is rejected, the court may:

     (i) Determine the fair value of the stock and enter judgment for the
stockholder; or

     (ii) Remit the proceedings to the same or other appraisers on terms and
conditions it considers proper.

(c)(1) Except as provided in paragraph (2) of this subsection, a judgment for
the stockholder shall award the value of the stock and interest from the date as
at which fair value is to be determined under ss. 3-202 of this subtitle.

   (2) The court may not allow interest if it finds that the failure of the
   stockholder to accept an offer for the stock made under ss. 3-207 of this
   subtitle was arbitrary and vexatious or not in good faith. In making this
   finding, the court shall consider:

     (i) The price which the successor offered for the stock;

     (ii) The financial statements and other information furnished to the
stockholder; and

                                      C-4


     (iii) Any other circumstances it considers relevant.

(d)(1) The costs of the proceedings, including reasonable compensation and
expenses of the appraisers, shall be set by the court and assessed against the
successor. However, the court may direct the costs to be apportioned and
assessed against any objecting stockholder if the court finds that the failure
of the stockholder to accept an offer for the stock made under ss. 3-207 of this
subtitle was arbitrary and vexatious or not in good faith. In making this
finding, the court shall consider:

     (i) The price which the successor offered for the stock;

     (ii) The financial statements and other information furnished to the
stockholder; and

     (iii) Any other circumstances it considers relevant.


   (2) Costs may not include attorney's fees or expenses. The reasonable fees
   and expenses of experts may be included only if:

     (i) The successor did not make an offer for the stock under ss. 3-207 of
     this subtitle; or

     (ii) The value of the stock determined in the proceeding materially exceeds
     the amount offered by the successor.

(e) The judgment is final and conclusive on all parties and has the same force
and effect as other decrees in equity. The judgment constitutes a lien on the
assets of the successor with priority over any mortgage or other lien attaching
on or after the effective date of the consolidation, merger, transfer, or
charter amendment.

         --->SS. 3-212. SURRENDER OF STOCK TO SUCCESSOR

The successor is not required to pay for the stock of an objecting stockholder
or to pay a judgment rendered against it in a proceeding for an appraisal
unless, simultaneously with payment:

   (1) The certificates representing the stock are surrendered to it, indorsed
   in blank, and in proper form for transfer; or

   (2) Satisfactory evidence of the loss or destruction of the certificates and
   sufficient indemnity bond are furnished.

         SS. 3-213. RIGHTS OF SUCCESSOR

 (a) A successor which acquires the stock of an objecting stockholder is
entitled to any dividends or distributions payable to holders of record of that
stock on a record date after the close of business on the day as at which fair
value is to be determined under ss. 3-202 of this subtitle.

(b) After acquiring the stock of an objecting stockholder, a successor in a
transfer of assets may exercise all the rights of an owner of the stock.

(c) Unless the articles provide otherwise, stock in the successor of a
consolidation, merger, or share exchange otherwise deliverable in exchange for
the stock of an objecting stockholder has the status of authorized but unissued
stock of the successor. However, a proceeding for reduction of the capital of
the successor is not necessary to retire the stock or to reduce the capital of
the successor represented by the stock.


                                      C-5






Appendix D

Form 10-KSB
 



                                   FORM 10-KSB
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                  ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 2005

                         Commission File Number: 0-20990

                          HARBOR BANKSHARES CORPORATION
             (Exact name of registrant as specified in its charter)

          Maryland                                         52-1786341
 (State or other jurisdiction of               (IRS Employer Identification No.)
 incorporation or organization)

 25 West Fayette Street                                       21201
 Baltimore, Maryland                                       (Zip Code)
 (Address of principal executive officer)

       Registrant's telephone number, including area code: (410) 528-1800

        Securities registered pursuant to Section 12(b) of the Act: None.

           Securities registered pursuant to Section 12(g) of the Act:

                     Common Stock, par value $0.01 per share
                                (Title of Class)

Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act.                                                |_|

Check whether the issuer (1 filed all reports required to be filed by Section 13
or 15(d) of the Exchange Act during the past 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 |_|

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.                                               |_|

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
                                                                  Yes |_| No |X|
Issuer's revenues for its most recent fiscal year:

As of March 3, 2006, the registrant had 675,579 shares of Common Stock issued
and outstanding, including 33,795 non-voting shares. The aggregate market value
of shares held by nonaffiliates on such date was $12,060,050 based on the
average of the bid and asked price of $25.00 per share of the Registrant's
Common Stock on that date. For purposes of this calculation, it is assumed that
the 193,177 shares held by directors and executive officers of the Registrant,
are shares held by affiliates.

Documents Incorporated by Reference: Portions of the Registrant's Annual Report
to Stockholders for the year ended December 31, 2005.

Transitional small business disclosure format (check one):        Yes |_| No |X|




                          HARBOR BANKSHARES CORPORATION

                  ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                       SECURITIES AND EXCHANGE COMMISSION
                                   FORM 10-KSB

TABLE OF CONTENTS

PART I
Item 1. Description of Business.....................................................................1
Item 2. Description of Property....................................................................18
Item 3. Legal Proceedings..........................................................................18
Item 4. Submission of Matters to a Vote of Security Holders........................................18

PART II
Item 5. Market for Common Equity and Related Stockholder Matters...................................19
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations......20
Item 7. Financial Statements.......................................................................27
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......56
Item 8A. Controls and Procedures...................................................................56
Item 8B. Other Information.........................................................................56

PART III
Item 9. Directors, and Executive Officers and Control Persons; Compliance
     with Section 16(a) of the Exchange Act........................................................56
Item 10. Executive Compensation....................................................................60
Item 11. Security Ownership of Certain Beneficial Owners and Management
     and Related Stockholder Matters...............................................................63
Item 12. Certain Relationships and Related Transactions............................................64
Item 13. Exhibits..................................................................................64
Item 15. Principal Accountant Fees and Services....................................................65

SIGNATURES.........................................................................................66


EXHIBITS

                                       ii


PART I

Forward Looking Statements

         Harbor Bankshares Corporation (the "Corporation") makes forward-looking
statements in this Annual Report on Form 10-KSB that are subject to risks and
uncertainties. These forward-looking statements include: statements of the
Corporation's goals, intentions, and expectations; estimates of risks and of
future costs and benefits; expectations regarding future financial performance
of the Corporation; assessments of loan quality, probable loan losses, and the
amount and timing of loan payoffs; liquidity, contractual obligations,
off-balance sheet risk, and market or interest rate risk; and statements of the
Corporation's ability to achieve financial and other goals. These
forward-looking statements are subject to significant uncertainties because they
are based upon: the amount and timing of future changes in interest rates,
market behavior, and other economic conditions; future laws, regulations and
accounting principles; and a variety of other matters. Because of these
uncertainties, the actual future results may be materially different from the
results indicated by these forward-looking statements. In addition, the
Corporation's past growth and performance do not necessarily indicate its future
results.

Item 1.  Description of Business

Harbor Bankshares Corporation

         Harbor Bankshares Corporation (the "Corporation") is a bank holding
company with one bank subsidiary and two Community Development financial
subsidiaries, one for profit, The Harbor Bank of Baltimore LLC and a non-profit,
The Harbor Bank CDC. Both were established during 2002. The Corporation has no
investment in either subsidiary as of December 31, 2004. The Corporation was
organized under the laws of the State of Maryland in 1992. On November 2, 1992,
Harbor Bankshares Corporation acquired all outstanding stock of The Harbor Bank
of Maryland (the "Bank"), headquartered in Baltimore, Maryland.

The Harbor Bank of Maryland

         The Bank is a Maryland chartered commercial bank headquartered in
Baltimore, Maryland. The Bank was opened on September 13, 1982. The deposits of
the Bank are insured by the Federal Deposit Insurance Corporation.

         The Bank conducts general banking business in seven (7) locations and
serves primarily the Baltimore Metropolitan area. It offers checking, savings
and time deposits, commercial, real estate, personal, home improvement,
automobile and other installment loans, credit cards and term loans. The Bank is
also a member of a local and national ATM network. The retail nature of the Bank
allows for diversification of deposits and borrowers so it is not dependent upon
a single or a few customers.

         Harbor Financial Services, a company dealing with the sale of mutual
funds, stocks, insurance, etc., was established as a subsidiary of the Bank
during May 1997 in order to compete with that expanding market.

Competition

         The Corporation's subsidiary, The Harbor Bank of Maryland, competes
with virtually all banks and savings institutions that offer services in its
market area. The Bank directly competes with branches of most of the State's
largest banks, each of which has greater financial and other resources to
conduct large advertising campaigns and to allocate their investment assets to
regions of higher yield and demand. To attract business in this competitive
environment, the Bank relies heavily on local promotional activities and
personal contact by its officers and directors and by its ability to provide
personalized services.

Supervision and Regulation

         Following is a brief summary of certain statutes and regulations that
significantly affect the Corporation and the Bank. A number of other statutes
and regulations affect the Corporation and the Bank but are not summarized
below.

         Bank Holding Company Regulation. The Corporation is registered as a
bank holding company under the Holding Company Act and, as such, is subject to
supervision and regulation by the Board of Governors of the Federal Reserve
System (the "Federal Reserve"). As a bank holding company, the Corporation is
required to furnish to the Federal Reserve regular reports of its operations and
additional information and reports. The Corporation is also subject to regular
examination by the Federal Reserve.

                                       1


         Under the Holding Company Act, a bank holding company must obtain the
prior approval of the Federal Reserve before (1) acquiring direct or indirect
ownership or control of any class of voting securities of any bank or bank
holding company if, after the acquisition, the bank holding company would
directly or indirectly own or control more than 5% of the class; (2) acquiring
all or substantially all of the assets of another bank or bank holding company;
or (3) merging or consolidating with another bank holding company.

         Under the Holding Company Act, any company must obtain approval of the
Federal Reserve prior to acquiring control of the Corporation or the Bank. For
purposes of the Holding Company Act, "control" is defined as ownership of 25% or
more of any class of voting securities of the Corporation or the Bank, the
ability to control the election of a majority of the directors, or the exercise
of a controlling influence over management or policies of the Corporation or the
Bank.

         The Change in Bank Control Act and the related regulations of the
Federal Reserve require any person or persons acting in concert (except for
companies required to make application under the Holding Company Act), to file a
written notice with the Federal Reserve before the person or persons acquire
control of the Corporation or the Bank. The Change in Bank Control Act defines
"control" as the direct or indirect power to vote 25% or more of any class of
voting securities or to direct the management or policies of a bank holding
company or an insured bank.

         The Holding Company Act also limits the investments and activities of
bank holding companies. In general, a bank holding company is prohibited from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of a company that is not a bank or a bank holding company or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, providing services for its subsidiaries, non-bank
activities that are closely related to banking, and other financially related
activities. The activities of the Corporation are subject to these legal and
regulatory limitations under the Holding Company Act and Federal Reserve
regulations.

         In general, bank holding companies that qualify as financial holding
companies under federal banking law may engage in an expanded list of non-bank
activities. Non-bank and financially related activities of bank holding
companies, including companies that become financial holding companies, also may
be subject to regulation and oversight by regulators other than the Federal
Reserve.

         The Federal Reserve has the power to order a holding company or its
subsidiaries to terminate any activity, or to terminate its ownership or control
of any subsidiary, when it has reasonable cause to believe that the continuation
of such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness, or stability of any bank subsidiary of that holding
company.

         The Federal Reserve has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets. See "Regulatory Capital Requirements."

         The Federal Reserve has the power to prohibit dividends by bank holding
companies if their actions constitute unsafe or unsound practices. The Federal
Reserve has issued a policy statement on the payment of cash dividends by bank
holding companies, which expresses the Federal Reserve's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earnings retention that is consistent with the company's capital
needs, asset quality, and overall financial condition.

         Bank Regulation. The Bank is subject to supervision by the Federal
Deposit Insurance Corporation (`FDIC") and the State of Maryland. Deposits of
the Bank are insured by the FDIC to the legal maximum of $100,000 for each
insured depositor. Deposits, reserves, investments, loans, consumer law
compliance, issuance of securities, payment of dividends, establishment of
branches, mergers and acquisitions, corporate activities, changes in control,
electronic funds transfers, responsiveness to community needs, management
practices, compensation policies, and other aspects of operations are subject to
regulation by the appropriate federal and state supervisory authorities. In
addition, the Bank is subject to numerous federal, state and local laws and
regulations which set forth specific restrictions and procedural requirements
with respect to extensions of credit (including to insiders), credit practices,
disclosure of credit terms and discrimination in credit transactions.

         The FDIC regularly examines the operations and condition of the Bank,
including, but not limited to, its capital adequacy, reserves, loans,
investments, and management practices. These examinations are for the protection
of the Bank's depositors and the FDIC's insurance fund. In addition, the Bank is
required to furnish quarterly and annual reports to the FDIC. The FDIC's
enforcement authority includes the power to remove officers and directors and
the authority to issue cease-and-desist orders to prevent a bank from engaging
in unsafe or unsound practices or violating laws or regulations governing its
business.

         The FDIC has adopted regulations regarding the capital adequacy, which
require FDIC supervised banks to maintain specified minimum ratios of capital to
total assets and capital to risk-weighted assets. See "Regulatory Capital
Requirements." Regulations limit the amount of dividends that the Bank may pay
to the Corporation. See Note 15 "Regulatory Matters" on page 22 of the Audited
Consolidated Financial Statements section of the Corporation's Annual Report to
Shareholders.

                                       2


         The Bank is subject to restrictions under federal law which limit the
transfer of funds by the Bank to the Corporation and its non-banking
subsidiaries, whether in the form of loans, extensions of credit, investments,
asset purchases, or otherwise. Such transfers by the Bank to the Corporation or
any of the Corporation 's non-banking subsidiaries are limited in amount to 10%
of the Bank's capital and surplus and, with respect to the Corporation and all
such non-banking subsidiaries, to an aggregate of 20% of the Bank's capital and
surplus. Furthermore, such loans and extensions of credit are required to be
secured in specified amounts.


         The Bank is subject to restrictions imposed by federal law on
extensions of credit to, and certain other transactions with, the Corporation
and other affiliates, and on investments in their stock or other securities.
These restrictions prevent the Corporation and the Bank's other affiliates from
borrowing from the Bank unless the loans are secured by specified collateral,
and require those transactions to have terms comparable to terms of arms-length
transactions with third persons. In addition, secured loans and other
transactions and investments by the Bank are generally limited in amount as to
the Corporation and as to any other affiliate to 10% of the Bank's capital and
surplus and as to the Corporation and all other affiliates together to an
aggregate of 20% of the Bank's capital and surplus. Certain exemptions to these
limitations apply to extensions of credit and other transactions between the
Bank and its subsidiaries. These regulations and restrictions may limit the
Corporation's ability to obtain funds from the Bank for its cash needs,
including funds for acquisitions and for payment of dividends, interest, and
operating expenses.

         Under Federal bank regulations, banks must adopt and maintain written
policies that establish appropriate limits and standards for extensions of
credit secured by liens or interests in real estate or are made for the purpose
of financing permanent improvements to real estate. These policies must
establish loan portfolio diversification standards; prudent underwriting
standards, including loan-to-value limits, that are clear and measurable; loan
administration procedures; and documentation, approval, and reporting
requirements. A bank's real estate lending policy must reflect consideration of
the Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") adopted by the federal bank regulators. The Interagency Guidelines,
among other things, call for internal loan-to-value limits for real estate loans
that are not in excess of the limits specified in the Guidelines. The
Interagency Guidelines state, however, that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits.

         The FDIC has established a risk-based deposit insurance premium
assessment system for insured depository institutions. Under the system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, based upon the
institution's capital level and supervisory evaluations. Institutions are
assigned to one of three capital groups -- well-capitalized, adequately
capitalized, or undercapitalized -- based on the data reported to regulators.
Well-capitalized institutions are institutions satisfying the following capital
ratio standards: (i) total risk-based capital ratio of 10% or greater; (ii) Tier
1 risk-based capital ratio of 6% or greater; and (iii) Tier 1 leverage ratio of
5% or greater. Adequately capitalized institutions are institutions that do not
meet the standards for well-capitalized institutions but that satisfy the
following capital ratio standards: (i) total risk-based capital ratio of 8% or
greater; (ii) Tier 1 risk-based capital ratio of 4% or greater; and (iii) Tier 1
leverage ratio of 4% or greater. Institutions that do not qualify as either
well-capitalized or adequately capitalized are deemed to be undercapitalized.
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk it poses to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions with demonstrated
weaknesses that, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
Deposit insurance rates may be increased during 2006 or later years.

         Regulatory Capital Requirements. The Federal bank regulators have
established guidelines for maintenance of appropriate levels of capital by bank
holding companies and banks. 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.

         The regulations require bank holding companies and banks to maintain a
minimum leverage ratio of "Tier 1 capital" (as defined in the risk-based capital
guidelines discussed in the following paragraphs) to total assets of 3.0%. The
capital regulations state, however, that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near this minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary regulator. A bank or bank holding company experiencing
or anticipating significant growth is expected to maintain capital well above
the minimum levels. In addition, the bank regulators have indicated that they
also may consider the level of an organization's ratio of tangible Tier 1
capital (after deducting all intangibles) to total assets in making an overall
assessment of capital.

                                       3


         The risk-based capital rules require bank holding companies and member
banks to maintain minimum regulatory capital levels based upon a weighting of
their assets and off-balance sheet obligations according to risk. The risk-based
capital rules have two basic components: a core capital (Tier 1) requirement and
a supplementary capital (Tier 2) requirement. Core capital consists primarily of
common stockholders' equity, certain perpetual preferred stock (noncumulative
perpetual preferred stock with respect to banks), and minority interests in the
equity accounts of consolidated subsidiaries; less all intangible assets, except
for certain mortgage servicing rights and purchased credit card relationships.
Supplementary capital elements include, subject to certain limitations, the
allowance for losses on loans and leases; perpetual preferred stock that does
not qualify as Tier 1 capital; long-term preferred stock with an original
maturity of at least 20 years from issuance; hybrid capital instruments,
including perpetual debt and mandatory convertible securities; subordinated
debt, intermediate-term preferred stock, and up to 45% of pre-tax net unrealized
gains on available-for-sale equity securities.

            In 2003, the Corporation, through its subsidiary, Harbor Bankshares
Corporation Capital Trust, issued $7.2 million in trust preferred securities in
a private placement. These securities are shown as junior subordinated
debentures on the Consolidated Balance Sheets of the Corporation. These trust
preferred securities issued are believed to meet the Federal Reserve's
regulatory criteria for Tier 1 capital, subject to Federal Reserve guidelines
that limit the amount of trust preferred securities (and any cumulative
perpetual preferred stock) that may be included in Tier 1 capital to an
aggregate of 25% of Tier 1 capital. Any excess may be included as supplementary
capital. See Note 12 "Junior Subordinated Debentures" on page 20 of the Audited
Consolidated Financial Statements section of the Corporation's Annual Report to
Shareholders.

         The risk-based capital regulations assign balance sheet assets and
credit equivalent amounts of off-balance sheet obligations to one of four broad
risk categories based principally on the degree of credit risk associated with
the obligor. The assets and off-balance sheet items in the four risk categories
are weighted at 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets.

         The risk-based capital regulations require all commercial banks and
bank holding companies to maintain a minimum ratio of total capital to total
risk-weighted assets of 8%, with at least 4% as core capital. For the purpose of
calculating these ratios: (i) supplementary capital is limited to no more than
100% of core capital; and (ii) the aggregate amount of certain types of
supplementary capital is limited. In addition, the risk-based capital
regulations limit the allowance for credit losses that may be included in
capital to 1.25% of total risk-weighted assets.

         The federal bank regulatory agencies have established a joint policy
regarding the evaluation of commercial banks' capital adequacy for interest rate
risk. Under the policy, the Federal Reserve's assessment of a bank's capital
adequacy includes an assessment of the bank's exposure to adverse changes in
interest rates. The Federal Reserve has determined to rely on its examination
process for such evaluations rather than on standardized measurement systems or
formulas. The Federal Reserve may require banks that are found to have a high
level of interest rate risk exposure or weak interest rate risk management
systems to take corrective actions. Management believes its interest rate risk
management systems and its capital relative to its interest rate risk are
adequate.

         Federal banking regulations also require banks with significant trading
assets or liabilities to maintain supplemental risk-based capital based upon
their levels of market risk. The Bank did not have significant levels of trading
assets or liabilities during 2004, and was not required to maintain such
supplemental capital.

         Well-capitalized institutions are not subject to limitations on
brokered deposits, while an adequately capitalized institution is able to
accept, renew, or rollover brokered deposits only with a waiver from the FDIC
and subject to certain restrictions on the yield paid on such deposits.
Undercapitalized institutions are not permitted to accept brokered deposits.

         The Federal bank regulators have established regulations that classify
banks by capital levels and provide for the Federal Reserve to take various
"prompt corrective actions" to resolve the problems of any bank that fails to
satisfy the capital standards. Under these regulations, a well-capitalized bank
is one that is not subject to any regulatory order or directive to meet any
specific capital level and that has a total risk-based capital ratio of 10% or
more, a Tier 1 risk-based capital ratio of 6% or more, and a leverage ratio of
5% or more. An adequately capitalized bank is one that does not qualify as
well-capitalized but meets or exceeds the following capital requirements: a
total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%,
and a leverage ratio of either (i) 4% or (ii) 3% if the bank has the highest
composite examination rating. A bank that does not meet these standards is
categorized as undercapitalized, significantly undercapitalized, or critically
undercapitalized, depending on its capital levels. A bank that falls within any
of the three undercapitalized categories established by the prompt corrective
action regulation is subject to severe regulatory sanctions. As of December 31,
2005, the Bank was well-capitalized as defined in the regulations.

                                        4


         For information regarding the Corporation's and the Bank's compliance
with their respective regulatory capital requirements, see note 16 "Regulatory
Matters" on page 22 of the Audited Consolidated Financial Statements section of
the Corporation's Annual Report to Shareholders.

Community Reinvestment

         Under the Community Reinvestment Act ("CRA"), a financial institution
has a continuing and affirmative obligation to help meet the credit needs of its
entire community, including low- and moderate-income neighborhoods. The CRA does
not establish specific lending requirements or programs for financial
institutions, or limit an institution's discretion to develop the types of
products and services that it believes are best suited to its particular
community. However, institutions are rated on their performance in meeting the
needs of their communities. Performance is tested in three areas: (a) lending,
to evaluate the institution's record of making loans in its assessment areas;
(b) investment, to evaluate the institution's record of investing in community
development projects, affordable housing, and programs benefiting low or
moderate income individuals and business; and (c) service, to evaluate the
institution's delivery of services through its branches, ATMs and other offices.
The CRA requires each federal banking agency, in connection with its examination
of a financial institution, to assess and assign one of four ratings to the
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by the
institution, including applications for charters, branches and other deposit
facilities, relocations, mergers, consolidations, acquisitions of assets or
assumptions of liabilities, and savings and loan holding company acquisitions.
The CRA also requires that all institutions make public disclosure of their CRA
ratings. The Bank was assigned an "outstanding" rating as a result of its last
CRA examination.

Bank Secrecy Act

Under the Bank Secrecy Act ("BSA"), a financial institution is required to have
systems in place to detect certain transactions, based on the size and nature of
the transaction. Financial institutions are generally required to report cash
transactions involving more than $10,000 to the United States Treasury. In
addition, financial institutions are required to file suspicious activity
reports for transactions that involve more than $5,000 and which the financial
institution knows, suspects, or has reason to suspect involves illegal funds, is
designed to evade the requirements of the BSA, or has no lawful purpose. The
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act, commonly referred to as the "USA Patriot
Act" or the "Patriot Act", enacted in response to the September 11, 2001,
terrorist attacks, enacted prohibitions against specified financial transactions
and account relationships, as well as enhanced due diligence standards intended
to prevent the use of the United States financial system for money laundering
and terrorist financing activities. The Patriot Act requires banks and other
depository institutions, brokers, dealers and certain other businesses involved
in the transfer of money to establish anti-money laundering programs, including
employee training and independent audit requirements meeting minimum standards
specified by the act, to follow standards for customer identification and
maintenance of customer identification records, and to compare customer lists
against lists of suspected terrorists, terrorist organizations and money
launderers. The Patriot Act also requires federal bank regulators to evaluate
the effectiveness of an applicant in combating money laundering in determining
whether to approve a proposed bank acquisition... On May 18, 2005, the Bank
executed a memorandum of understanding with the FDIC and the Maryland
Commissioner of Financial Regulation, in which it agreed to take certain steps
to improve its Bank Secrecy Act and anti-money laundering compliance programs,
including independent testing of compliance. Management believes that the Bank
is fully in compliance with the terms of the memorandum.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") established a broad range of
corporate governance and accounting measures intended to increase corporate
responsibility and protect investors by improving the accuracy and reliability
of disclosures under federal securities laws. The Corporation is subject to
Sarbanes-Oxley because it is required to file periodic reports with the SEC
under the Securities and Exchange Act of 1934. Among other things,
Sarbanes-Oxley, its implementing regulations have established new membership
requirements and additional responsibilities for the Corporation's audit
committee, imposed restrictions on the relationship between the Corporation and
its outside auditors (including restrictions on the types of non-audit services
our auditors may provide to us), imposed additional financial statement
certification responsibilities for the Company's chief executive officer and
chief financial officer, expanded the disclosure requirements for corporate
insiders, and require management to evaluate the Corporation's disclosure
controls and procedures and report material changes in the Corporation's
internal control over financial reporting. Under current regulations, in future
periods, Sarbanes-Oxley will require the management to evaluate the
Corporation's internal control over financial reporting and will require
Corporation's auditors to issue a report on the Corporation's internal control
over financial reporting.

                                       5


Other Laws and Regulations

Some of the aspects of the lending and deposit business of the Bank that are
subject to regulation by the FDIC include reserve requirements and disclosure
requirements in connection with personal and mortgage loans and deposit
accounts. In addition, the Bank is subject to numerous federal and state laws
and regulations that include specific restrictions and procedural requirements
with respect to the establishment of branches, investments, interest rates on
loans, credit practices, the disclosure of credit terms, and discrimination in
credit transactions.

Enforcement Actions
Federal statutes and regulations provide financial institution regulatory
agencies with great flexibility to undertake an enforcement action against an
institution that fails to comply with regulatory requirements. Possible
enforcement actions range from the imposition of a capital plan and capital
directive to civil money penalties, cease and desist orders, receivership,
conservatorship, or the termination of deposit insurance.

Governmental Monetary Policies and Economic Controls

         The earnings and growth of the banking industry and ultimately of The
Harbor Bank of Maryland, Harbor Bankshares Corporation's sole subsidiary, are
affected by the credit policies of monetary authorities including the Federal
Reserve System. An important function of the Federal Reserve System is to
regulate the national supply of bank credit in order to control recessionary and
inflationary pressures. Among the instruments of monetary policy used by the
Federal Reserve to implement these objectives are open market operations in U.S.
Government securities, changes in the discount rate of member bank borrowings,
and changes in reserve requirements against member bank deposits. These means
are used in varying combinations to influence overall growth of bank loans and
investments and deposits, and may also affect interest rates charged on loans or
paid for deposits. The monetary policies of the Federal Reserve authorities have
had a significant effect on the operating results of commercial banks in the
past and are expected to continue to have such an effect in the future.

         In view of changing conditions in the national economy and in the money
markets, as well as the effect of actions by monetary and fiscal authorities,
including the Federal Reserve System, no prediction can be made as to possible
future changes in interest rates, deposit levels, and loan demand, or their
effect on the business and earnings of the Corporation and its subsidiary.

                                       6


Employees

         At December 31, 2005, Harbor Bankshares Corporation and its
subsidiaries employed 77 individuals, of which 27 were officers and 50 were
full-time employees.

Executive Officers

         Information concerning executive officers of the Corporation is listed
below:

                                       Age         Position

         Joseph Haskins, Jr.           58          Chairman, President and Chief Executive Officer of
                                                   the Bank and Corporation

         John Paterakis                77          Chairman of the Executive Committee of the
                                                   Corporation and the Bank

         Teodoro J. Hernandez          60          Treasurer of the Corporation and Senior Vice
                                                   President and Cashier of the Bank

         Each of the executive officer has been employed in his current capacity
for more than five years.

                                       7


Tabular Information

         The information in this description of business should be read in
conjunction with the information provided in the Management's Discussion and
Analysis of Financial Condition and Operations, which is incorporated herein
from the Annual Report...

                 Consolidated Five-Years Selected Financial Data
                      (In thousands, except per share data)

                                                                   Year ended December 31,
                                                       2005          2004          2003           2002           2001
                                                       ----          ----          ----           ----           ----
OPERATING DATA
Interest Income                                     $15,014       $12,648       $11,886        $11,647        $13,609
Interest Expense                                      3,787         2,283         2,411          3,402          5,973
                                                    -------       -------       -------        -------        -------
Net Interest Income                                  11,227        10,365         9,475          8,245          7,636
Provision for Loan Losses                               410           360           755            340            400
Non-Interest Income                                   1,771         1,514         2,506          2,220          2,329
Non-Interest Expenses                                 9,638         9,295         8,610          8,575          8,526
                                                    -------       -------       -------        -------        -------
Income Before Taxes                                   2,950         2,224         2,616          1,550          1,039
Income Taxes                                          1,067           762           831            473            309
                                                    -------       -------       -------        -------        -------
Net Income                                          $ 1,883       $ 1,462       $ 1,785        $ 1,077        $   730
                                                    =======       =======       =======        =======        =======

PER SHARE DATA
Net Income - Basic                                    $2.73         $2.07         $2.46          $1.47          $1.02
Net Income - Diluted                                   2.55          1.93          2.36           1.43           0.99
Cash and Stock Dividends                               0.40          0.35          0.25           0.25             --
Book Value                                           $24.73        $23.04        $21.69         $19.23         $16.72

BALANCE SHEET DATA
Total Assets                                       $256,636      $235,464      $219,547       $210,234       $186,586
Deposits                                            229,845       210,224       195,901        193,294        171,531
Total Net Loans                                     188,936       172,205       149,729        120,523        105,847
Total Stockholder's Equity                           16,954        16,240        15,274         14,149         12,241
Return on Average Assets                              0.78%         0.63%         0.84%          0.54%          0.37%
Return on Average Equity                             11.57%         9.33%        12.23%          8.20%          6.20%
Tier 1 Regulatory Capital to Average Assets           7.31%         7.36%         7.46%          5.20%          5.40%
Average Equity to Average Assets                      6.74%         7.27%         6.48%          5.24%          4.77%
Dividend Paid to
Diluted Net Income                                   15.69%        18.13%        10.59%         17.48%             --

                                       8


                Average Balances, Yields/Rates and Income/Expense

Years ended December 31,                       2005                            2004                             2003
                                   Average  Yields/   Income      Average   Yields/     Income     Average   Yields/    Income
                                  Balances    Rates   Expense    Balances     Rates    Expense    Balances     Rates   Expense
                                  --------    -----   -------    --------     -----    -------    --------     -----   -------
ASSETS
U. S. Treasury Securities        $     --       --%   $    --    $    836      3.11%   $    26     $ 3,048      2.79%  $    85
U.S. Government Agencies           27,230     3.11        848      35,824      3.08      1,104      39,878      3.39     1,354
Interest-Bearing Deposits
 with Other Banks                     562     3.20         18       1,510      2.91         44       2,100      3.24        68
FHLB Stock and Other
 Securities                           507     4.14         21         550      3.82         21       1,051      3.61        38
Federal Funds Sold                  6,440     3.35        216       7,776      1.21         94       9,397      1.03        97
                                 --------             -------    --------              -------     -------             -------
                                   34,739     3.18%     1,103      46,496      2.77%     1,289      55,474      2.96%    1,642
                                 --------             -------    --------              -------     -------             -------
Loans
Commercial Loans                   75,390     8.70      6,556      64,090      7.37      4,725      44,887      7.03     3,156
Real Estate Loans                 102,932     6.67      6,863      91,544      6.68      6,113      85,226      7.16     6,102
Consumer Loans                      6,052     8.11        491       8,032      6.49        521      10,263      9.61       986
                                 --------             -------    --------              -------    --------             -------
Loans Net of Unearned Income      184,374     7.54     13,910     163,666      6.94     11,359     140,376      7.30    10,244
                                                      -------    --------              -------    --------             -------
Total Earning Assets              219,113     6.85%   $15,013     210,162      6.02%   $12,648     195,850      6.07%  $11,886
                                                      =======                          =======                         =======
Allowance for Possible Losses      (2,059)                         (1,543)                          (1,488)
Other Assets                       24,183                          23,461                           18,909
                                 --------                        --------                         --------
   TOTAL ASSETS                  $241,237                        $232,080                         $213,271
                                 ========                        ========                         ========

LIABILITIES AND STOCKHOLDERS'
EQUITY
Non-Interest Bearing Deposits    $ 47,933       --%  $     --    $ 40,646        --%   $    --    $ 31,641        --%  $    --

Interest-Bearing Transaction
  Accounts                         26,020      .22         57      24,370       .18         43      23,515       .16        38
Savings                            81,048     1.74      1,409      85,059       .79        670      84,715       .82       696
Time - $100,000 or more            28,268     2.35        664      22,627      2.02        456      25,172      2.63       662
Other Time                         32,208     3.70      1,192      34,968      2.24        782      29,831      2.81       840
                                 --------             -------    --------              -------    --------             -------
Savings and Time Deposits         167,544     1.98%     3,322     167,024      1.17%     1,951     163,233      1.37%    2,236
                                 --------                        --------                         --------
   TOTAL Deposits                 215,477                         207,670                          194,874
     Junior Subordinated
      Debentures                    7,217     6.15%       444       7,217      4.41%       318       1,611      4.40%       71
Other Borrowed Money                  611     3.44         21         720      1.94         14          --        --        --
Notes payable                          --       --         --          --        --         --       1,310      7.00       104
Other Liabilities                   1,661                             795                              871
                                 --------                        --------                         --------
         TOTAL Liabilities        224,966     2.15%   $ 3,787     216,402      1.30%   $ 2,283     198,666      1.45%  $ 2,411
                                                      =======                          =======                         =======
STOCKHOLDERS' EQUITY               16,271                          15,678                           14,605
                                 --------                        --------                         --------
TOTAL LIABILITIES AND
  STOCKHOLDERS' EQUITY           $241,237                        $232,080                         $213,271
                                 ========                        ========                         ========



Net Yield on Interest
  Earning Assets                              4.70%                            4.72%                            4.62%
Benefit of Non-Interest
  Bearing Funds                                .45%                             .25%                             .22%
Net Interest Margin                           5.15%                            4.97%                            4.84%

Nonaccrual loans are included in the
appropriate loan categories, above.

                                       9


                           Interest Variance Analysis
                             (dollars in thousands)

                                                             2005 Compared to 2004                   2004 Compared to 2003
                                                          Increase (Decrease) Due to:             Increase (Decrease) Due to:
                                                      ---------------------------------         ---------------------------------

                                                      Volume          Rate          Net         Volume         Rate           Net
                                                      ------          ----          ---         ------         ----           ---
         INTEREST INCOME

              Loans                                   $ 1,437       $ 1,114       $ 2,551       $ 1,700       $  (585)      $ 1,115

      Investment Securities                              (266)          (16)         (282)         (227)          (99)         (326)

       Federal Funds Sold                                 (16)          138           122           (17)           14            (3)

Other Interest Bearing Assets (1)                         (25)           --           (25)          (21)           (3)          (24)
                                                      -------       -------       -------       -------       -------       -------

      TOTAL Interest Income                           $ 1,130       $ 1,236       $ 2,366       $ 1,435       $  (673)      $   762
                                                      =======       =======       =======       =======       =======       =======


        INTEREST EXPENSE

  Interest-Bearing Transaction
            Accounts                                  $     3       $    11       $    14       $     1       $     4       $     5

             Savings                                      (32)          771           739             3           (29)          (26)

     Time - $100,000 or more                              114            94           208           (67)         (139)         (206)

           Other Time                                     (62)          472           410           144          (202)          (58)

      Other Borrowed Money                                 (2)            9             7            14            --            14

     Subordinate Debentures                                --           126           126           246             2           248

          Notes Payable                                    --            --            --          (104)           --          (104)
                                                      -------       -------       -------       -------       -------       -------

     TOTAL Interest Expense                           $    21       $ 1,483       $ 1,504       $   237       $  (364)      $  (127)
                                                      =======       =======       =======       =======       =======       =======

       NET INTEREST INCOME                            $ 1,108       $  (247)      $   862       $ 1,198       $  (309)      $   889
                                                      =======       =======       =======       =======       =======       =======

Note:  Loan fees, which were included in interest income, were $981 in 2005,
       $1,024 in 2004, and $814 in 2003. A change in Rate/Volume has been
       allocated to the change in rate.

(1) Certificates of Deposit with other financial institutions.


Maturity Distribution of Investment Securities (dollars in thousands)
----------------------------------------------

                                                                       U.S Treasuries   U.S Agencies   Other Securities      TOTAL
                                                                       --------------   ------------   ----------------      -----
Maturing Within One Year                                                  $    --          $ 2,438          $    --          $ 2,438
Maturing After One But Within Five Years                                       --           23,544               --           23,544
Maturing After Five But Within Ten Years                                       --               --               --               --
Maturing After Ten Years                                                       --              135               30              165
                                                                          -------          -------          -------          -------
TOTAL                                                                     $    --          $26,117          $    30          $26,147
                                                                          =======          =======          =======          =======

                                       10


Weighted Average Interest Rates of Investment Securities at December 31, 2005
-----------------------------------------------------------------------------

                                                                                  U.S  Government          Other
                                                                 U.S Treasuries          Agencies     Securities               TOTAL
                                                                 --------------          --------     ----------               -----
Maturing Within One Year                                                    --%             2.22%             --%             2.22%
Maturing After One But Within Five Years                                    --%             3.07%             --%             3.07%
Maturing After Five But Within Ten Years                                    --%               --%             --%               --%
Maturing After Ten Years                                                    --%             5.15%           7.25%             6.20%
 TOTAL                                                                      --%             3.48%           7.25%             3.83%

Amortized cost and the fair value of Investment Securities at 2005 , 2004
and 2003 (dollars in thousands)
-------------------------------

                                                                     2005                     2004                      2003
                                                            --------------------      --------------------      --------------------
                                                            Amortized    Fair         Amortized    Fair         Amortized    Fair
                                                            Cost         Value        Cost         Value        Cost         Value
                                                            ----         -----        ----         -----        ----         -----
U.S. Treasuries, Government Agencies
and Mortgage Backed Securities                              $26,979      $26,117      $28,988      $28,606      $37,258      $37,369
Other Securities                                                 30           30           36           36          548          549
                                                            -------      -------      -------      -------      -------      -------
TOTAL                                                       $27,009      $26,147      $29,024      $28,642      $37,806      $37,918
                                                            =======      =======      =======      =======      =======      =======

                                       11


Loan Distribution

Five-Year Loan Distribution at December 31, 2005 (dollars in thousands)

                                                 2005               2004              2003               2002              2001
                                                 ----               ----              ----               ----              ----
Commercial Loans                             $ 82,845           $ 72,414          $ 55,184           $ 30,964          $ 23,126
Real Estate Loans                             102,404             94,204            87,228             78,856            71,962
Consumer Loans                                  5,746              7,198             8,806             11,751            11,718
                                    ------------------------------------------------------- ------------------------------------
TOTAL                                        $190,995           $173,816          $151,218           $121,571          $106,806
                                    ======================================================= ====================================

Five-Year Loan Distribution at December 31 (expressed as percentages)

                                                 2005               2004              2003               2002              2001
                                                 ----               ----              ----               ----              ----
Commercial Loans                               43.37%             38.87%            36.49%             25.47%            21.65%
Real Estate Loans                              53.62%             56.90%            57.69%             64.86%            67.38%
Consumer Loans                                  3.01%              4.23%             5.82%              9.67%            10.97%
                                    ------------------------------------------------------- ------------------------------------
TOTAL                                         100.00%            100.00%           100.00%            100.00%           100.00%
                                    ======================================================= ====================================

Maturity and Repricing of Loans at December 31, 2005 (dollars in thousands)
---------------------------------------------------------------------------

                                                  Commercial             Real Estate            Consumer
                                                  Loans                  Loans                  Loans                   TOTAL
                                                  -----                  -----                  -----                   -----
Within One Year                                         $44,970                $23,325                 $1,043           $69,338
After One Year But Within Five Years                     37,131                 22,516                  3,068           $62,715
After Five Years                                            744                 56,563                  1,635           $58,942
                                                  -------------          -------------          -------------      ------------
TOTAL                                                   $82,845               $102,404                 $5,746          $190,995
                                                  =============          =============          =============      ============

Loans Classified by Sensitivity to Changes in Interest Rates
(dollars in thousands)
----------------------

                                                                                         Adjustable
                                                           Fixed Rate                 Interest Rate
                                                                Loans                          Loans                   TOTAL
                                                                -----                          -----                   -----
Within One Year                                               $18,221                        $51,742                 $69,963
After One Year But Within Five Years                           62,719                             --                 $62,719
After Five Years                                               58,313                             --                 $58,313
                                                    ------------------            -------------------           -------------
TOTAL                                                        $139,253                        $51,742                $190,995
                                                    ==================            ===================           =============

The total amount of Real Estate Construction and Mortgage loans due after one
year included above are $2,600 and $2,441 respectively.

Asset Quality

           One of the Corporation's main objectives has been and continues to be
the achievement of a high level of asset quality. We maintain a large portion of
loans secured by residential one-to four- family properties and commercial
properties. As of December 31, 2005, those loans totaled $89 million or 46.35
percent of total outstanding loans. We set sound credit standards for new loan
originations, and follow careful loan administration procedures. We strengthened
our focus on credit risk by having independent reviews of all major credits with
detailed reports to management.

         Delinquent Loans and Foreclosed Assets: The Corporation policies
require that management continuously monitor the status of the loan portfolio
and report to the Board of Directors on a monthly basis. These reports include
information on delinquent loans and foreclosed real estate, and actions and
plans to cure the delinquent status of the loans and to dispose of the
foreclosed properties.

                                       12




Interest on Non-accrual Loans. (dollars in thousands)
-----------------------------------------------------

                                                                                   2005            2004
                                                                                   ----            ----
      Interest Income that Would Have Been Recorded Under Original Terms        $     27         $    52
                                                                               ---------         -------
      Interest Income Recorded during the Period                                $     --         $    --
                                                                               ---------         -------

      It is the policy of the Corporation to place a loan on non-accrual status
whenever there is substantial doubt about the ability of a borrower to pay
principal or interest on any outstanding credit. Management considers such
factors as payment history, the nature of the collateral securing the loan, and
the overall economic situation of the borrower when making a non-accrual
decision. Non-accrual loans are closely monitored by management. A non-accruing
loan is restored to accrual status when principal and interest payments have
been brought current or it becomes well-secured or is in the process of
collection and the prospects of future contractual payments are no longer in
doubt.

      We generally stop accruing income when interest or principal payments are
90 days in arrears. We may stop accruing income on such loans earlier than 90
days when we consider the timely collectibility of interest or principal payment
to be doubtful.

      When we designate non-accrual loans, we reverse all outstanding interest
that we had previously credited. If we receive a payment on a non-accrual loan,
we may recognize a portion of that payment as interest income if we determine
that the ultimate collectibility of principal is no longer in doubt. However,
such loans may remain in non-accrual status.

Impaired Loans

      At December 31, 2005, the Corporation had $576 thousand of impaired loans
for which the borrowers were experiencing financial difficulties. Those loans
are subject to constant management attention and their classification is
reviewed monthly. Impaired loans are individually assessed to determine whether
the carrying value exceeds the fair value of the collateral.

Foreclosed Real Estate

      Foreclosed real estate consists of property we have acquired through
foreclosed or deed in lieu of foreclosure. Foreclosed real estate properties are
initially recorded at the lower of the recorded investment in the loan or fair
value. At December 31, 2005 and 2004 we had no foreclosed real estate.

Potential Nonperforming Loans

         Those performing loans considered potential nonperforming loans, loans
which are not included in the past due, nonaccrual or restructured categories,
but for which known information about possible credit problems cause management
to be uncertain as to the ability of the borrowers to comply with the present
loan repayment terms over the next six months, amounted to approximately $7,149
thousand at December 31, 2005, compared to $3,716 thousand at December 31, 2004,
and $3,502 thousand at December 31, 2003. These loans are subject to continuing
management attention and are considered by management in determining the level
of the allowance for loan losses.


                                       13


Allowance for Loan Losses

         The Corporation's allowance for loan loss methodology is a loan
classification-based system, based on the required allowance on a percentage of
the loan balance for each type of loan and classification level. Allowance
percentages are 3.0% and 5.0% for watch loans, 10.0% for special mention, 15.0%
and 20.0% for substandard and 50.0% for doubtful loans. Allowance percentages
are based on each individual lending program, its loss history and underwriting
characteristics such as: loan to value, credit score, debt coverage, collateral,
and capacity to service debt. This analysis is used to validate the loan loss
allowance matrix as well as to assist in establishing overall lending direction.

While management considers the Corporation's allowance for loan losses to be
adequate based on information currently available, future adjustments to the
allowance may be necessary due to changes in economic conditions, management's
assumptions as to future delinquencies or loss rates, and management's intent
with regard to asset disposition options. In addition, the Corporation's
allowance for loan losses is periodically reviewed by the bank regulatory
agencies and an independent external loan review as an integral part of their
examination process. Based on their reviews, the agencies may require the
Corporation to adjust the allowance.


                                       14


                            Allowance for Loan Losses
                             (dollars in thousands)

Year ended December 31,                             2005          2004         2003         2002        2001
                                                    ----          ----         ----         ----        ----

Balance at Beginning of Period                   $   1,612     $   1,488    $   1,049    $     959    $     732

Loans Charged Off:
      Commercial Loans                                  --           108           71          109           65
      Real Estate Loans                                 --            10           11           26           70
      Consumer Loans                                    91           295          341          178          111
                                                 ---------     ---------    ---------    ---------    ---------
      TOTAL Loans Charged Off                           91           413          423          313          246
                                                 ---------     ---------    ---------    ---------    ---------

Recoveries of Loans:
      Commercial Loans                                  45            13           22           42           39
      Real Estate Loans                                 --             1           22           11           22
      Consumer Loans                                    83           163           63           10           12
                                                               ---------    ---------    ---------    ---------
      TOTAL Loans Recovered                            128           177          107           63           73
                                                 ---------     ---------    ---------    ---------    ---------
Net Loans Charged Off (Recovered)                      (37)          236          316          250          173
                                                 ---------     ---------    ---------    ---------    ---------

Provisions Charged to Operations                       410           360          755          340          400
                                                 ---------     ---------    ---------    ---------    ---------

Balance at End of Period                         $   2,059     $   1,612    $   1,488    $   1,049    $     959
                                                 =========     =========    =========    =========    =========

Daily Average Amount of Loans                    $ 184,374     $ 163,656    $ 140,376    $ 110,293    $ 105,067
                                                 =========     =========    =========    =========    =========

Allowance for Possible Loan Losses to
Loans Outstanding                                     1.08%         .93%         .98%         .86%          .90%
                                                 =========     =========    =========    =========    =========

Net Charge Offs (Recoveries) to Average
Loans Outstanding                                     (.02%)        .14%         .22%         .22%          .16%
                                                 =========     =========    =========    =========    =========

      A breakdown of the Allowance is provided in the table below; however,
management does not believe that the Allowance can be segregated y category with
precision. The breakdown of the Allowance is based primarily on hose factors
discussed previously in evaluating the Allowance as a whole. Since all of those
factors are subject to change, the breakdown is not necessarily indicative of
the category of actual or realized credit losses. The following table presents
the allocation of the Allowance among the various loan categories at December
31:

                     Allocation of Allowance for Loan Losses
                             (dollars in thousands)

As of December 31,           2005     %        2004     %        2003     %       2002    %       2001    %
                             ----     -        ----     -        ----     -       ----    -       ----    -

Commercial Loans             $573   45.1%              44.7%     $825    36.9%    $555   25.4%    $557   21.7%
                                               $406
Real Estate Loans             702   52.8        746    54.1       151    57.3      138   64.9      110   67.4
Consumer Loans                 65    2.2         83     3.7        35     5.2       76    8.9       80    9.9
Credit Cards                   38     .4         41      .5        47      .6       46     .8       55    1.0
Unallocated                   681     --        336      --       430      --      234     --      157     --
                          -------   ----    -------    ----   -------    ----   ------   ----    -----   ----
TOTAL Allowance for
Loan Losses               $ 2,059    100%   $ 1,612     100%  $ 1,488     100%  $1,049    100%   $ 959    100%
                          =======   ====    =======    ====   =======    ====   ======   ====    =====   ====

                                       15



Maturities of Time Certificates of Deposit of $100,000 or More Outstanding at
December 31, 2005 and 2004 (dollars in thousands)

                                            2005                   2004
                                            ----                   ----
              Three months or less        $7,145                 $5,804
              Three to six months          2,111                  2,746
              Six to twelve months        13,315                  8,187
              Over twelve months          10,239                  8,662
                                         --------            -----------
              TOTAL                      $32,810                $25,399
                                         ========            ===========

Long And Short Term Borrowings

Junior Subordinated Debt Security

      On October 9, 2003, Harbor Bankshares Corporation issued a Floating Rate
Junior Subordinated Debt Securities due 2033 in the amount of $7.2 million. The
Debt Security was issued by the Corporation pursuant to an Indenture, dated as
of October 9, 2003, between the Corporation and Wilmington Trust Company. The
Capital Securities were issued by Harbor Bankshares Corporation Capital Trust
pursuant to a Purchase Agreement dated September 18, 2003, among the
Corporation, the Trust and Citigroup Global Markets Inc. Upon receipt of the
funds, the corporation paid off its long-term debt to the National Community
Investment Fund ("NCIF") in the amount of $1.8 million and placed the remaining
funds in its subsidiary, The Harbor Bank of Maryland, increasing the Bank's Tier
One capital. This capital infusion increased the Bank's lending limit and
allowed for future growth.





                                       16


Borrowings for the Years Ended December 31, 2005 and 2004
(dollars in thousands)

                                                               2005      2004
                                                               ----      ----
         Amount outstanding at period-end:
         Subordinated Debt Securities                         7,217     7,217


         Average outstanding:
         Subordinated Debt Securities                         7,217     7,217


         Weighted average interest rate during the period:
         Subordinated Debt Securities                         6.15%     4.41%


Off-Balance Sheet Arrangements

         Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank holds collateral
supporting those commitments for which collateral is deemed necessary. The
Harbor Bank of Maryland has not been required to perform on any financial
guarantees and has not incurred any losses on its commitments. The issuance of
letters of credit is not a significant activity of the Bank.

         Commitments to extend credit are agreements to lend funds to customers
as long as there are no violations of any condition established in the loan
contracts. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Bank evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if it is deemed necessary by the Bank upon
extension of credit, is based on credit evaluation by management. Collateral
held varies but may include accounts receivable, inventory, property, plant and
equipment as well as income producing properties. We believe that we have
adequate resources to fund all loan commitments.

         The Bank has entered into leases for some of its branches, most of
which contain renewal options.

         For additional information regarding off-balance sheet arrangements,
please see Notes 7 and 17 to the Consolidated Financial Statements and the
discussion of the Debt Security in "Long and Short Term Borrowings," above.

Critical Accounting Policies

           The Corporation's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States
and follow general practices within the industries in which it operates.
Application of these principles requires management to make estimates,
assumptions and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions and judgments. Certain policies inherently have
a greater reliance on the use of estimates, assumptions and judgments and as
such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.


                                       17


        The most significant accounting policies followed by the Corporation are
presented in Note 2 to the consolidated financial statements. These policies,
along with the disclosures presented in the other financial statement notes and
in this discussion, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions and estimates underlying
those amounts, management has identified the determination of the allowance for
loan losses as the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.

        The Corporation believes it 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 Corporation's assessments may be
affected in future periods by changes in economic conditions, the impact of
regulatory examinations, and the discovery of information with respect to
borrowers which is not known to management at the time of the issuance of the
consolidated financial statements. For additional discussion concerning the
Corporation's allowance for loan losses and related matters, see "Provision for
Loan Losses and Asset Quality" above and Note 2 to the Consolidated Financial
Statements.

Item 2.  Description of Property

         The Corporation's Headquarters is located at 25 West Fayette Street,
Baltimore, Maryland 21201. This location is approximately 60,000 square feet and
was bought by the Corporation during September 2003 for $2.9 million. The
renovation of the building is completed.

         The Bank also maintains another six (6) branch offices, five (5) are
leased; three (3) located in Baltimore City, 1000 Lancaster Street Baltimore,
Maryland 21202, 5000 Park Heights Avenue Baltimore, Maryland 21215 and 800 West
Baltimore Street, Baltimore, Maryland 21201, one (1) located in Prince George's
County, Maryland at 6820 Riverdale Road Riverdale, Maryland 20737 and one (1)
located in Baltimore County, Maryland at 3825 Liberty Plaza Randallstown,
Maryland 21133. The Bank owns another branch facility in Baltimore City located
at 3240 Belair Road Baltimore, Maryland 21213.

Item 3.  Legal Proceedings

     In the normal course of business, the Corporation is at all times subject
to various pending and threatened legal actions. The relief or damages sought in
some of these actions may be substantial. After reviewing pending and threatened
actions with counsel, management considers that the outcome of such actions will
not have a material adverse effect on the Corporation's financial position;
however, the Corporation is not able to predict whether the outcome of such
actions may or may not have a material adverse effect on results of operations
in a particular future period as the timing and amount of any resolution of such
actions and relationship to the future results of operations are not known.

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

         None



                                       18


PART II

Item 5.  Market for Common Equity and Related Stockholder Matters.

         Harbor Bankshares Corporation is traded privately and is not listed on
any exchange. During 2005 and 2004, there was little trading activity in the
stock. The bid and ask price during 2005 and 2004 was $25.00 per share. On
December 31, 2005 the Corporation had 626 common stockholders of record.

         A cash dividend of $.40 per share was paid during the first quarter of
2005.

         The following table presents disclosure regarding equity compensation
plans in existence at December 31, 2005, consisting only of the stock option
plan arrangements described further under the caption "Stock Options" in Note 14
to the consolidated financial statements.


                                            Equity Compensation Plan Information
------------------------------- ---------------------------- ---------------------------- ----------------------------
Plan Category                   Number of securities to be   Weighted average exercise    Number of securities
                                issued upon exercise of      price of outstanding         remaining available for
                                outstanding options,         options, warrants and        future issuance under
                                warrants and rights          rights                       equity compensation plans
                                        (a)                           (b)                 excluding securities
                                                                                          reflected in column (a)
                                                                                                  (c)
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans                   --                           --                           --
approved by security holders
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans not             132,741                      $18.80                       94,145
approved by security holders
------------------------------- ---------------------------- ---------------------------- ----------------------------
            Total                         132,741                      $18.80                       94,145
------------------------------- ---------------------------- ---------------------------- ----------------------------




                                       19


Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations

This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with Item 1. Business, and Item 7,
Financial Statements, of this Report.

OVERVIEW - 2005 COMPARED TO 2004

All references to Harbor Bankshares Corporation (the "Corporation") should be
interpreted to include The Harbor Bank of Maryland (the "Bank") whenever
appropriate, except when specifically noted otherwise.

The Corporation earnings increased for the year 2005 when compared to the prior
year. Earnings for the year were $1.9 million in comparison to $1.5 million
earned during 2004, an increase of $421 thousand or 28.8 %. The 2005 earnings
did not include any securities gains or Federal agency awards. The earnings for
2004 reflected only $17 thousand of securities gains and no awards.

The Harbor Bank of Maryland, the Corporation's subsidiary, achieved earnings of
$2.5 million in comparison to $1.9 million for the prior year, an increase of
$564 thousand or 29.0%.

Returns on average assets (ROAA) and average equity (ROAE) for the Corporation
in 2005 were .78% and 11.57%, respectively, compared to the .63% and 9.33%
achieved during the prior year. The return on average assets for the Bank in
2005 was 1.04%, compared to .84% for the prior year.

NET-INTEREST INCOME

Net interest income is the difference between interest income and related fees
on earning assets and the interest expense incurred on deposits and other
borrowings. Net interest income continues to be the Corporation's main source of
earnings. Net interest income for 2005 increased by $862 thousand or 8.3 %. The
increase reflects the growth of the loan portfolio during 2005, mainly in the
commercial and commercial real estate categories.

Total interest income increased by $2.4 million or 18.7% to $15.0 million for
2005 in comparison to the $12.7 million earned during 2004. As stated above, the
growth of the loan portfolio combined with higher rates were the main reasons
for the increase.

Total interest expense increased by $1.5 million or 6.6 % to $3.8 million in
2005 from $2.3 million in 2004. Higher interest rates combined with interest
bearing deposit increases resulted in the increase.

Net interest margin for 2005 was 5.15% compared to 4.97% for 2004.

PROVISION FOR LOAN LOSSES AND ASSET QUALITY

For the year 2005, the Corporation recorded a $410 thousand provision for loan
losses, compared to $360 for the year 2004. Gross charge-offs totaled $91
thousand for the year ended December 31, 2005, compared to the prior year total
of $413 thousand. These charge-offs in 2004 primarily relate to credit card,
consumer and commercial loans.

The allowance for loan losses as of December 31, 2005, was 1.08% of total loans
and .93% at the end of the comparable 2004 period.

Future provisions for loan losses will continue to be based upon our assessment
of the overall loan portfolio and its underlying collateral, the mix of loans
within the portfolio, delinquency trends, economic conditions, current and
prospective trends in real estate values, and other relevant factors.


                                       20


The table below shows the non-performing assets for a five-year period:
Non-Performing Assets (in thousands except percentages)

                                         2005    2004     2003     2002   2001
                                         ----    ----     ----     ----   ----
Non-accrual Loans                        $558    $799    $ 220     $409   $620
Accruing Loans past due 90 days
  or more                                  18       9      506      746    135
Foreclosed Real Estate                      -       -        -       70     14
Total Non-performing Assets and          ----    ----     ----   ------   ----
  past due Loans                         $576    $808     $726   $1,225   $769
                                         ====    ====     ====   ======   ====
Total Non-performing Assets and
  past due Loans to year-end Assets      .22%    .34%     .33%     .58%   .41%
Total Non-performing Loans to
  year-end Loans                         .30%    .46%     .48%    1.01%   .72%

The Corporation's allowance for loan loss methodology is a loan
classification-based system, based on the required allowance on a percentage of
the loan balance for each type of loan and classification level. Allowance
percentages are 3.0% and 5.0% for watch loans, 10.0% for special mention, 15.0%
and 20.0% for substandard and 50.0% for doubtful loans. Allowance percentages
are based on each individual lending program, its loss history and underwriting
characteristics such as: loan to value, credit score, debt coverage, collateral,
and capacity to service debt. This analysis is used to validate the loan loss
allowance matrix as well as to assist in establishing overall lending direction.

While management considers the Corporation's allowance for loan losses to be
adequate based on information currently available, future adjustments to the
allowance may be necessary due to changes in economic conditions, management's
assumptions as to future delinquencies or loss rates, and management's intent
with regard to asset disposition options. In addition, the Corporation's
allowance for loan losses is periodically reviewed by the bank regulatory
agencies and an independent external loan review as an integral part of their
examination process. Based on their reviews, the agencies may require the
Corporation to adjust the allowance.

NON-INTEREST INCOME

Non-interest income increased by $257 thousand or 17.0% to $1.8 million in 2005.
Included in the 2004 non-interest income were $6 thousand in gain on sale of
loans, $17 thousand in securities gains and no Community Development Financial
Institution Fund ("CDFI") awards. In 2005, there were no gains on the sale of
securities or loans, and no CDFI awards. Service charges on deposit accounts
increased by $98 thousand or 12.2% and other non-interest income by $152
thousand or 31.9%. Included in other non-interest income are fees in the amount
of $82 thousand for reimbursement for services and expenses incurred by the Bank
in the formation of one of the Holding Company unconsolidated subsidiaries in
2002.

Non-Interest Income Summary (in thousands)

                                         2005     2004     2003     2002    2001
                                         ----     ----     ----     ----    ----

Service charges on deposit accounts      $900     $802     $855     $910    $965
ATM fees                                  224      195      216      274     166
Awards & Grants                            --       --      664      214     229
Gain on sale of real estate                --       --       --       --      --
Gain on sale of loans                      --        6       51       54      45
Gain on sale of securities                 --       17      225      226     197
Servicing fees                             18       17       16       26      27
Other non-interest income                 629      477      479      517     700
                                       ------   ------   ------   ------  ------
Total non-interest income              $1,771   $1,514   $2,506   $2,221  $2,329
                                       ======   ======   ======   ======  ======



                                       21


NON-INTEREST EXPENSES

Non-interest expenses of $9.6 million in 2005 increased by $343 thousand or 3.7
% when compared to the prior year. Salaries and benefits of $4.4 million in 2005
reflected a decrease of $85 thousand or 1.9% when compared to the prior year
salaries and benefits cost. Advertising expenses increased by $69 thousand or
23.0%. Occupancy expense increased by $414 thousand or 61.0% due to the
renovation of the Corporation's Headquarters building and the opening of a new
branch facility. Equipment expense decreased by $32 thousand or 9.0% due to
lower depreciation. Professional fees, which include legal expenses, decreased
by $98 thousand or 19.0%. In 2005, the Bank settled its claims against third
parties in connection with a 2004 ATM cash shortage upon payment to the Bank of
$575,000. The Bank recorded losses of $225,000 in 2005 and $275,000 in 2004
relating to this cash shortage. The amortization expense in 2002 through 2005
includes amortization of core deposit intangibles recorded in the purchase of a
branch facility during 2002. Amortization in 2001 and 2002 reflects amortization
of goodwill. Other non-interest expenses increased by $46 thousand or 3.0 %.

Non-Interest Expenses Summary (In thousands)


                                           2005     2004      2003      2002      2001
                                           ----     ----      ----      ----      ----
Salaries and Employee Benefits           $4,425   $4,510    $4,368   $ 4,230   $ 3,989
Occupancy Expense, net                    1,093      679       720       785       778
Advertising                                 369      300       344       287       115
Equipment Expenses                          324      356       386       478       654
Data Processing Fees                      1,110    1,031       973       976       918
Professional Fees                           420      518       303       399       327
Amortization of Intangible Assets            81       81        81        47       331
Amortization
ATM Loss                                    225      275        --        --        --
Other Non-Interest Expense                1,590    1,544     1,435     1,373     1,414
                                         ------   ------   -------   -------   -------
Total Non-Interest Expense               $9,637   $9,294   $ 8,610   $ 8,575   $ 8,526
                                         ======   ======   =======   =======   =======


APPLICABLE INCOME TAXES

Applicable income taxes include current and deferred portions, which are
detailed in Note 10 of the audited consolidated financial statements. Taxes for
2005 were $1,067 thousand compared to $762 thousand for 2004. The effective tax
rate for the year 2005 was 36.2% compared to 34.3% for the year 2004.

CREDIT RISK ANALYSIS

The Corporation, through its subsidiary, The Harbor Bank of Maryland, has in
place credit policies and procedures designed to control and monitor credit
risk. Credit analysis and loan review functions have provided a check and
balance system for assessing initial and on-going risk associated with the
lending process.

Credit risk is mitigated through portfolio diversification, limiting exposure to
any single industry or customer, requiring collateral and employing standard
lending policies and underwriting criteria across the Corporation. Independent
third party credit reviews are performed quarterly. During 2005, 70.0% of the
loan portfolio was analyzed. During these reviews, any weaknesses are brought to
management's attention for corrective action. Note 2 to the consolidated
financial statements describes the Corporation's accounting policies related to
nonperforming loans and charge-offs and describes the methodologies used to
develop the allowance, including both the allocated and unallocated components.
The Corporation's policies are consistent with regulatory standards.



                                       22


ASSET AND LIABILITY MANAGEMENT

INTRODUCTION

The Investment Committee of the Corporation reviews policies regarding the
sources and uses of funds, maturity distribution, and associated interest rate
sensitivities. This effort is aimed at minimizing risks associated with
fluctuating interest rates, as well as maintaining sufficient liquidity.

LIQUIDITY


Liquidity describes the ability of the Corporation to meet financial
obligations, including lending commitments and contingencies that arise during
the normal course of business. Liquidity is primarily needed to meet the
borrowing and deposit withdrawal requirements of the customers of the
Corporation, as well as to meet current and planned expenditures. The
Corporation, through the Bank, is required to maintain adequate sources of cash
in order to meet its financial commitments in an organized manner without
incurring substantial losses. These commitments relate principally to changes in
the Bank's deposit base through withdrawals and changes in funds required to
meet normal and seasonal loan demands. The Bank, and thereby the Corporation,
derives liquidity through the maturity distribution of the investment portfolio,
loan repayments and income from earning assets. The Bank maintains a portion of
its investment portfolio as a liquidity reserve, which can be converted to cash
on an immediate basis.

The Bank has also established secured lines of credit with the Federal Home Loan
Bank as an additional source of liquidity. Collateral must be pledged to the
FHLB before advances can be obtained. At December 31, 2005, the Corporation had
sufficient collateral in order to borrow up to an aggregate of $25.7 million
from the FHLB under the established lines of credit, if necessary. Liquidity is
also provided through the Corporation's portfolio of liquid assets, consisting
of cash and due from banks, interest-bearing deposits in other banks and
investment securities available for sale. Such assets totaled $49.1 million or
19.1% of total assets at December 31, 2005.

The Corporation derives its cash from a combination of operating activities,
investing activities and financing activities as disclosed in the consolidated
statement of cash flows. Cash flows from operating activities consist of
interest income collected on loans and investments, interest expense paid on
deposits and other borrowings, other income collected, such as cash received
relating to service charges, and cash payments for other operating expenses
including income taxes.

Cash flows from investing activities include the purchase, sale and maturity of
investments and interest bearing deposits in other banks, the net decrease in
the level of loans, and purchases of premises and equipment. Cash flows from
financing activities consist of movements in the level of deposits and other
borrowings, and proceeds from the issuance of stock.

For the year ended December 31, 2005, net cash provided by operating activities
totaled $4.6 million. Net cash used by investing activities totaled $16.5
million resulting primarily from a net increase in loans of $16.7 million and
net purchases of premises and equipment of $3.1 million, offset in part by the
proceeds of maturities and principal payments of investment securities of $2.0
million and a decrease in deposits at other banks of $1.3 million. Net cash
provided by financing activities totaled $18.7 million, mainly resulting from
the net increase in total deposits of $19.6 million.

INTEREST RATE SENSITIVITY

The Corporation's net income is largely dependent on its net interest income.
The Corporation seeks to maximize its net interest margin within an acceptable
level of interest rate risk. Interest rate risk can be defined as the amount of
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities. Net
interest income is also affected by changes in the portion of interest-earning
assets that are funded by interest-bearing liabilities rather than by other
sources of funds, such as noninterest-bearing deposits and stockholders' equity.

The Corporation attempts to manage interest rate risk while enhancing net
interest margin by adjusting its asset/liability position. At times, depending
on the level of general interest rates, the relationship between long-term and
short-term interest rates, market conditions and competitive factors, the
Corporation may determine to increase its interest rate risk position somewhat
in order to increase its net interest margin. The Corporation monitors interest
rate risk and adjust the composition of its interest-related assets and
liabilities in order to limit its exposure to changes in interest rates on net
interest income over time. The Corporation's Investment Committee reviews its
interest rate risk position and profitability, and recommends adjustments. The
Investment Committee also reviews the securities portfolio, formulates
investment strategies, and oversees the timing and implementation of
transactions. Notwithstanding The Corporation's interest rate risk management
activities, the potential for changing interest rates is an uncertainty that can
have an adverse effect on net income.


                                       23


The Bank also analyzes interest rate risk based upon quantitative measures of
the percentage changes in fair value of equity capital resulting from a
hypothetical immediate change (or shock) of plus or minus 100 and 200 basis
points in interest rate levels. This analysis is based upon models, which are
based upon a number of significant assumptions regarding reactions of interest
rates. These models also provide an analysis of interest rate shock effects on
net interest income. The maximum decrease of net interest income, based upon the
Bank's December 31, 2005 asset/liability position, was 1.3% from a 200 basis
point rate shock.

One measure of interest rate sensitivity is the difference between interest
sensitive assets and interest sensitive liabilities called the "interest
sensitivity gap." The following table shows an analysis of the Corporation's
cumulative interest sensitivity gap position.


         Cumulative Interest Sensitivity Gap

                                                           1 YEAR

         Interest sensitive assets                        $    28.5
         Interest sensitive liabilities                        12.4
                                                          ---------
         Interest sensitivity gap                         $    16.1
                                                          =========
         Gap to total assets                                   6.3%
                                                          =========


LONG AND SHORT TERM BORROWINGS

On October 9, 2003, Harbor Bankshares Corporation issued a Floating Rate Junior
Subordinated Debt Security due 2033 in the amount of $7.2 million. The Debt
Security was issued by the Corporation pursuant to an Indenture, dated as of
October 9, 2003, between the Corporation and Wilmington Trust Company. The
Capital Securities were issued by Harbor Bankshares Corporation Capital Trust
pursuant to a Purchase Agreement dated September 18, 2003, among the
Corporation, the Trust and Citigroup Global Markets Inc. Upon the receipt of the
funds, the Corporation paid off its long-term debt to National Community
Investment Fund in the amount of $1.9 million and placed the remaining funds in
the amount of $4.9 million in its subsidiary, The Harbor Bank of Maryland,
increasing the Bank's Tier One capital. There were no other borrowings as of
December 31, 2005.



                                       24



CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE
SHEET ARRANGEMENTS

Contractual Obligations: The following table presents, as of December 31, 2005,
significant fixed and determinable contractual obligations to third parties by
payment date.


       (In thousands)             One Year or Less      One to Three Years     Three to Five Years    Over Five Years
                                  ----------------      ------------------     -------------------    ---------------
Deposits without a stated
  maturity                               $163,495                 $    --                  $   --             $   --
Certificates of deposit                    43,038                  19,814                   3,498                 --
Operating leases                              203                     311                     227                506
Junior
Subordinated Debentures                        --                      --                      --              7,217
                                         --------                 -------                  ------             ------
Total                                    $206,736                 $20,125                  $3,725             $7,723
                                         ========                 =======                  ======             ======

Off-Balance Sheet Arrangements: Standby letters of credit are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank holds collateral supporting those commitments for which collateral is
deemed necessary. The Bank has not been required to perform on any financial
guarantees and has not incurred any losses on its commitments. The issuance of
letters of credit is not a significant activity of the Bank.

Commitments to extend credit are agreements to lend funds to customers as long
as there are no violations of any condition established in the loan contracts.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if it is
deemed necessary by the Bank upon extension of credit, is based on credit
evaluation by management. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment as well as income producing
properties. We believe that we have adequate resources to fund all loan
commitments.

The Bank has entered into leases for its branch and office space, most of which
contain renewal options. For additional information regarding off-balance sheet
arrangements, please see Notes 7, 11 and 17 to the Consolidated Financial
Statements.

CAPITAL RESOURCES

Stockholders' equity increased by $714 thousand or 4.4% to $16.9 million. This
increase was mainly due to net income of $1.9 million, and proceeds from the
sale of common stock of $172 thousand, offset by the unrealized loss of
securities held for sale, which was $522 thousand at December 31, 2005, compared
to a loss of $238 thousand for 2004 and retirement of common stock of $775
thousand. As of year-end, based on borrowing arrangements with the Federal Home
Loan Bank with unused credit availability of $25.6 million, the Corporation had
sufficient liquidity to withstand any unusual demand of funds without
liquidating its investment securities. Stockholders' equity was 6.6% of total
assets as of the year-end. The Tier 1 capital ratio as of December 31, 2005, was
7.3%, and the risk-based capital ratio was 11.67%. The minimum requirements
established by regulators are 4.0% for Tier 1 capital and 8.0% for total
risk-based capital. The book value of each share of common stock was $24.73 as
of December 31, 2005.

The Tier I capital ratio for the Corporation's subsidiary, The Harbor Bank of
Maryland as of December 31, 2005, was 8.8% and the risk-based total capital
ratio was 11.6%, both above the established regulatory requirements.

CHANGES IN FINANCIAL POSITION

The Corporation, through its subsidiary, The Harbor Bank of Maryland, continued
its growth during 2005. Total assets increased by $21.1 million or 9.0 %.



                                       25


Deposits increased from $210.2 million in 2004 to $229.8 million in 2005, an
increase of $19.6 million or 9.3%. Net loans reached to $188.9 million in 2005
from $172.2 million in 2004, an increase of $16.7 million or 8.8%.

The Corporation plans to continue its expansion through marketing efforts by its
Management and Board of Directors.

OTHER INFORMATION

The Harbor Bank Community Development Corporation ("CDC") and The Harbor Bank of
Baltimore LLC ("LLC") were established in 2003. The CDC is a non-profit company
established with the purpose of bringing financial assistance to underserved
areas in the City of Baltimore. The Corporation has no investments in this
company. The Harbor Bank of Maryland, one of the Corporation's subsidiaries has
a $1.8 million loan to the CDC. As of December 31, 2005, the CDC had earnings of
$3.0 thousand and a $28 thousand accumulated deficit since inception. These
numbers exclude any tax benefit that may be available.

The Harbor Bank of Baltimore LLC was established with the purpose of taking
advantage of the New Markets Tax Credit program offered by the U.S. Treasury
Department for the development of certain targeted markets in the country. In
the case of the LLC, the targeted market is the City of Baltimore. The LLC
received a $50 million New Market Tax Credit award in September 2004, and has
written commitments from various investors in the amount of $64 million. The
Corporation has no investment in this company. The financial data from these
companies is not included in the Corporation's financial statements, in
accordance with FIN 46 (R) "Consolidation of Variable Interest Entities."

For a complete discussion of recent accounting pronouncements and their effect
on the Corporation's financial statements, please refer to Note 3 of the
Corporation's audited consolidated financial statements.




                                       26




ITEM 7. FINANCIAL STATEMENTS


                          HARBOR BANKSHARES CORPORATION
                                AND SUBSIDIARIES

                               REPORT ON AUDITS OF
                              FINANCIAL STATEMENTS

                               FOR THE YEARS ENDED
                           DECEMBER 31, 2005 AND 2004

















   No extracts from this report may be published without our written consent.

                                Stegman & Company


                                       27


                                TABLE OF CONTENTS






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



CONSOLIDATED FINANCIAL STATEMENTS                                    Page
                                                                     ----


           Balance Sheets                                           30 - 31


           Statements of Income                                        32


           Statements of Changes in Stockholders' Equity               33


           Statements of Cash Flows                                 34 - 35



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                          36 - 55

                                       28


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




Audit Committee of the
  Board of Directors and Stockholders
  of Harbor Bankshares Corporation


           We have audited the accompanying consolidated balance sheets of
Harbor Bankshares Corporation and subsidiaries as of December 31, 2005 and 2004
and the related consolidated statements of income, changes in stockholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the management of Harbor Bankshares Corporation. Our
responsibility is to express an opinion on these financial statements based on
our audits.

           We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

           In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Harbor
Bankshares Corporation and subsidiaries as of December 31, 2005 and 2004 and the
results of their operations and cash flows for the years then ended in
conformity with U.S. generally accepted accounting principles.


Stegman & Company

Baltimore, Maryland
February 18, 2006

                                       29


                 HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 2005 AND 2004

                                     ASSETS

                                                                                   2005                    2004
                                                                               --------------          --------------
Cash and due from banks                                                        $    7,259,358          $    6,867,063

Federal funds sold                                                                 15,624,890               9,845,813

Interest bearing deposits in other banks                                               74,996               1,352,791

Investment securities:
   Available for sale - at fair value                                              26,116,631              26,600,079

   Held to maturity - at amortized cost (fair value of
     $30,402 in 2005 and $2,042,147 in 2004)                                           30,402               2,036,622
                                                                               --------------          --------------

           Total investment securities                                             26,147,033              28,636,701
                                                                               --------------          --------------

Loans                                                                             190,994,929             173,816,465

Allowance for loan losses                                                          (2,058,561)             (1,611,880)
                                                                               --------------          --------------

           Net loans                                                              188,936,368             172,204,585
                                                                               --------------          --------------

Premises and equipment, net                                                         7,526,340               5,137,720

Federal Home Loan Bank of Atlanta stock - at cost                                     470,000                 438,200

Goodwill                                                                            2,506,226               2,506,226


Other intangible assets                                                               462,667                 547,040

Bank-owned life insurance                                                           4,178,774               4,023,808

Other assets                                                                        3,449,790               3,903,752
                                                                               --------------          --------------

           TOTAL ASSETS                                                          $256,636,442            $235,463,699
                                                                               ==============          ==============



See accompanying notes.


                                       30


                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                                                                   2005                   2004
                                                                                -------------          -------------
LIABILITIES:
   Deposits:
     Noninterest bearing demand                                                 $  50,433,169          $  49,342,950
     Interest bearing transaction accounts                                         25,562,641             22,981,734
     Savings                                                                       87,498,709             78,610,482
     Time, $100,000 or more                                                        32,810,327             25,339,116
     Other time                                                                    33,539,740             33,949,621
                                                                                -------------          -------------
           Total deposits                                                         229,844,586            210,223,903
   Accrued interest payable                                                           683,762                356,184
   Junior subordinated debentures                                                   7,217,000              7,217,000
   Other liabilities                                                                1,937,184              1,426,651
                                                                                -------------          -------------


           Total liabilities                                                      239,682,532            219,223,738
                                                                                -------------          -------------




STOCKHOLDERS' EQUITY:
   Common stock (par value $0.01):
     Authorized 10,000,000 shares; issued 685,579 and
       704,934, including 33,795 common nonvoting
       at December 31, 2005 and 2004, respectively                                      6,856                  7,049
     Additional paid-in capital                                                     6,615,906              7,218,340
     Retained earnings                                                             10,853,086              9,252,307
     Accumulated other comprehensive loss                                            (521,938)              (237,735)
                                                                                -------------          -------------


           Total stockholders' equity                                              16,953,910             16,239,961
                                                                                -------------          -------------


           TOTAL LIABILITIES AND STOCKHOLDERS'
              EQUITY                                                             $256,636,442           $235,463,699
                                                                                =============          =============


                                       31


                 HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF INCOME
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004


                                                                                        2005                     2004
                                                                                 --------------          ---------------
INTEREST INCOME:
   Interest and fees on loans                                                       $13,909,841              $11,359,107
   Interest on investments - taxable                                                    850,262                1,135,744
   Interest on deposits in other banks                                                   18,200                   44,488
   Interest on federal funds sold                                                       216,379                   93,993
   Other interest income                                                                 19,164                   14,528
                                                                                 --------------           --------------

           Total interest income                                                     15,013,846               12,647,860
                                                                                 --------------          ---------------

INTEREST EXPENSE:
   Interest bearing transaction accounts                                                 57,097                   43,147
   Savings                                                                            1,408,670                  669,696
   Time, $100,000 or more                                                               664,051                  456,056
   Other time                                                                         1,192,439                  783,198
   Interest on junior subordinated debentures                                           443,779                  317,690
   Federal funds purchased                                                               20,738                   13,095
                                                                                 --------------          ---------------

           Total interest expense                                                     3,786,774                2,282,882
                                                                                 --------------          ---------------

NET INTEREST INCOME                                                                  11,227,072               10,364,978

PROVISION FOR LOAN LOSSES                                                               410,000                  360,000
                                                                                 --------------          ---------------

NET INTEREST INCOME AFTER PROVISION
   FOR LOAN LOSSES                                                                   10,817,072               10,004,978
                                                                                 --------------          ---------------

NONINTEREST INCOME:
   Service charges on deposit accounts                                                  899,883                  802,192
   Other service charges                                                                455,230                  279,464
   Gain on sale of securities                                                            -                        16,733
   Gain on sales of loans                                                                -                         6,027
   Cash surrender value life insurance                                                  175,547                  197,900
   Loan servicing fees                                                                    9,747                   16,729
   Other income                                                                         230,696                  195,095
                                                                                 --------------          ---------------

           Total noninterest income                                                   1,771,103                1,514,140
                                                                                 --------------          ---------------

NONINTEREST EXPENSES:
   Salaries and employee benefits                                                     4,425,478                4,510,208
   Advertising                                                                          368,689                  300,130
   Occupancy expense of premises                                                      1,093,193                  679,386
   Equipment expense                                                                    323,747                  355,698
   Data processing fees                                                               1,110,060                1,031,317
   Professional fees                                                                    420,564                  518,180
   Amortization of intangible assets                                                     80,460                   80,460
   ATM loss                                                                             225,000                  275,000
   Other expenses                                                                     1,590,433                1,544,358
                                                                                 --------------          ---------------

           Total noninterest expense                                                  9,637,624                9,294,737
                                                                                 --------------          ---------------

INCOME BEFORE INCOME TAXES                                                            2,950,551                2,224,381

APPLICABLE INCOME TAXES                                                               1,067,377                  762,326
                                                                                 --------------          ---------------

NET INCOME                                                                           $1,883,174             $  1,462,055
                                                                                 ==============          ===============

BASIC EARNINGS PER SHARE                                                                $2.73                     $2.07
                                                                                        =====                     =====

DILUTED EARNINGS PER SHARE                                                              $2.55                     $1.93
                                                                                        =====                     =====

See accompanying notes.


                                       32


                 HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004



                                                                                             Accumulated
                                                                                               Other
                                                              Additional                    Comprehensive           Total
                                               Common          Paid-in       Retained          Income           Stockholders'
                                                Stock          Capital       Earnings          (Loss)              Equity
                                             -----------    -------------  ------------  ------------------    ---------------
Balance at January 1, 2004                      $7,041        $7,210,178      $8,036,714      $   20,835        $15,274,768

Comprehensive income:
   Net income                                        -                 -       1,462,055               -          1,462,055
   Reclassification adjustment,
     net of taxes of $6,462                          -                 -          -              (10,271)           (10,271)
   Unrealized losses on securities
     available-for-sale, net of taxes
     of $156,228                                     -                 -          -             (248,299)          (248,299)
                                                                                                                -----------

           Total comprehensive income                                                                             1,203,485

   Payment of cash dividends
     $0.35 per share                                 -                 -        (246,462)              -           (246,462)
   Stock options exercised                           8             8,162               -               -              8,170
                                                ------        ----------     -----------       ---------        -----------

Balance at December 31, 2004                     7,049         7,218,340       9,252,307        (237,735)        16,239,961

Comprehensive income:
   Net income                                        -                 -       1,883,174               -          1,883,174
   Unrealized losses on securities
     available-for-sale, net of taxes
     of $112,260                                     -                 -               -        (284,203)          (284,203)
                                                                                                               ------------

           Total comprehensive income                                                                             1,598,971

     Retirement of stock                          (310)         (774,690)              -              -            (775,000)
     Payment of cash dividends
       $.40 per share                                -                 -        (282,395)             -            (282,395)
     Stock options exercised                       117           172,256              -               -             172,373
                                                ------        ----------     -----------       ---------        -----------

Balance at December 31, 2005                    $6,856        $6,615,906     $10,853,086       $(521,938)       $16,953,910
                                                ======        ==========     ===========       =========        ===========



See accompanying notes.


                                       33


                 HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004


                                                                                          2005                      2004
                                                                                      -----------               -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                                                        $  1,883,174              $  1,462,055
   Adjustments to reconcile net income to net
      cash provided by operating activities:
     Depreciation and amortization                                                        761,363                   492,332
     Provision for loan losses                                                            410,000                   360,000
     Deferred income taxes                                                               (323,885)                   40,388
     Increase in cash surrender value of life insurance                                  (154,966)                 (165,183)
     Gains on sales of loans                                                               -                         (6,027)
     Gain on sale securities                                                               -                        (16,733)
     Origination of loans held for sale                                                    -                     (2,802,440)
     Proceeds from sales of loans held for sale                                            -                      2,808,467
     Increase in accrued interest receivable and other assets                             718,666                  (285,590)
     Increase in accrued interest payable and other liabilities                           838,111                   629,267
                                                                                      -----------               -----------

           Net cash provided by operating activities                                    4,132,463                 2,516,536
                                                                                      -----------               -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Net decrease in deposits at other banks                                              1,277,795                   547,209
   Purchases of investment securities available-for-sale                                   -                    (13,999,000)
   Proceeds from calls, maturities and principal payments of
     investment securities available-for-sale                                           2,008,765                15,694,410
   Proceeds from sales of securities available-for-sale                                    -                      7,032,625
   Net increase in loans                                                              (16,298,793)              (22,475,090)
   Purchases of premises and equipment - net                                           (3,069,523)               (1,829,589)
                                                                                      -----------               -----------

           Net cash used in investing activities                                      (16,081,756)              (15,029,435)
                                                                                      -----------               -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Net increase in deposits                                                            19,620,683                14,322,479
   Proceeds from sale of common stock                                                     172,373                     8,170
   Cash dividends paid                                                                   (282,395)                 (246,462)
   Retirement of stock                                                                   (775,000)                  -
                                                                                      -----------               -----------


           Net cash provided by financing activities                                   18,735,661                14,084,187
                                                                                      -----------               -----------

INCREASE IN CASH AND CASH EQUIVALENTS                                                   6,786,368                 1,571,288

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                         16,172,876                15,141,588
                                                                                      -----------               -----------

CASH AND CASH EQUIVALENTS AT END OF YEAR                                              $22,959,244               $16,712,876
                                                                                      ===========               ===========



                                       34



HARBOR BANKSHARES CORPORATION

Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2005 and 2004





                                                                                           2005                     2004
                                                                                        ----------             ------------
Supplemental disclosure of cash flows information:

   Cash paid for income taxes                                                           $1,075,000             $    825,000
                                                                                        ==========             ============


   Cash paid for interest                                                               $3,459,196               $2,160,463
                                                                                        ==========               ==========


See accompanying notes.


                                       35


                 HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004





1. NATURE OF OPERATIONS

             Harbor Bankshares Corporation (the "Corporation") is a bank holding
company organized under the laws of the State of Maryland in 1992. The
Corporation owns all of the outstanding stock of the Harbor Bank of Maryland
(the "Bank") which owns all of the outstanding stock of the Bank's subsidiary,
Harbor Financial Services.

             The Bank is a commercial bank headquartered in Baltimore, Maryland.
The deposits of the Bank are insured by the Federal Deposit Insurance
Corporation. The Bank conducts general banking business in six locations and
primarily serves the Baltimore, Maryland metropolitan area. The Bank also has a
branch in Riverdale, Prince George's County, Maryland. It offers checking,
savings and time deposits, commercial real estate, personal, home improvement,
automobile, and other installment and term loans. The Bank is also a member of a
national ATM network. The retail nature of the Bank allows for diversification
of depositors and borrowers so it is not dependent upon a single or a few
customers.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

             The accounting and reporting policies of the Corporation and its
subsidiary conform to U.S. generally accepted accounting principles. Certain
reclassifications have been made to amounts previously reported to conform to
the classifications made in 2005. The following is a summary of the more
significant accounting policies:

             Use of Estimates

                  The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.

             Cash and Cash Equivalents

                  For purposes of the consolidated statements of cash flows, the
Corporation considers all highly liquid debt instruments with original
maturities of three months or less and money market funds to be cash
equivalents.


                                       36


             Investment Securities

                  Debt securities that the Corporation has the positive intent
and ability to hold to maturity are classified as held to maturity and recorded
at amortized cost. Debt and equity securities are classified as trading
securities if bought and held principally for the purpose of selling them in the
near term. Trading securities are reported at estimated fair value, with
unrealized gains and losses included in earnings. Debt securities not classified
as held to maturity and debt and equity securities not classified as trading
securities are considered available for sale and are reported at estimated fair
value, with unrealized gains and losses excluded from earnings and reported as a
separate component of stockholders' equity, net of tax effects, in accumulated
other comprehensive income.

                  The Corporation designates securities into one of the three
categories at the time of purchase. If a decline in value of an individual
security classified as held to maturity or available for sale is judged to be
other than temporary, the cost basis of that security is reduced to its fair
value and the amount of the write-down is reflected in earnings. Estimated fair
value is determined based on bid prices published in financial newspapers or bid
quotations received from securities dealers. Gains or losses on the sales of
investments are calculated using a specific identification basis and are
determined on a trade-date basis. Premiums and discounts on investment and
mortgage-backed securities are amortized over the term of the security using
methods that approximate the interest method.

             Loans Held for Sale

                  The Corporation engages in sales of residential mortgage loans
originated by the Bank. Loans held for sale are carried at the lower of
aggregate cost or fair value. Gains and losses on sales of these loans are
recorded as a component of non-interest income in the accompanying consolidated
statements of income. The amount of loans held for sale as of December 31, 2005
and 2004 was not considered material.

             Loans

                  Loans are stated at their principal balance outstanding net of
any deferred fees and costs. Interest income on loans is accrued at the
contractual rate based on the principal outstanding. The Corporation places
loans, on non-accrual when any portion of the principal or interest is ninety
days past due and collateral is insufficient to discharge the debt in full.
Interest accrual may also be discontinued earlier if, in management's opinion,
collection is unlikely.

                  Loans are considered impaired when, based on current
information, it is probable that the Corporation will not collect all principal
and interest payments according to contractual terms. Generally, loans are
considered impaired once principal or interest payments become ninety days or
more past due and they are placed on non-accrual. Management also considers the

financial condition of the borrower, cash flows of the loan and the value of the
related collateral. Impaired loans do not include large groups of smaller
balance homogeneous credits such as residential real estate and consumer
installment loans, which are evaluated collectively for impairment. Loans
specifically reviewed for impairment are not considered impaired during periods
of "minimal delay" in payment


                                       37


(ninety days or less) provided eventual collection of all amounts due is
expected. The impairment of a loan is measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate, or
the fair value of the collateral if repayment is expected to be provided by the
collateral. Generally, the Corporation's impairment on such loans is measured by
reference to the fair value of the collateral. Income on impaired loans is
recognized on the cash basis and is first applied against the principal balance
outstanding.

                  Discounts and premiums on purchased loans are amortized to
income using the interest method over the remaining period to contractual
maturity, adjusted for anticipated prepayments.

             Allowance for Loan Losses

                  The allowance for loan losses represents an amount which, in
management's judgment, will be adequate to absorb probable losses on existing
loans that may become uncollectible. The allowance for loan losses consists of
an allocated component and an unallocated component. The components of the
allowance for loan losses represent an estimation done pursuant to either
Statement of Financial Accounting Standards ("SFAS") No. 5, Accounting for
Contingencies, or SFAS No. 114, Accounting by Creditors for Impairment of a
Loan. The adequacy of the allowance for loan losses is determined through
careful and continuous review and evaluation of the loan portfolio and involves
the balancing of a number of factors as outlined below to establish a prudent
level. Loans deemed uncollectible are charged against, while recoveries are
credited to, the allowance. Management adjusts the level of the allowance
through the provision for loan losses, which is recorded as a current period
operating expense. The Corporation's methodology for assessing the
appropriateness of the allowance consists of several key elements, which include
the formula allowance, specific allowances and the unallocated allowance.

                  The formula allowance is calculated by applying loss factors
to corresponding categories of outstanding loans. Loss factors are based on the
Corporation's historical loss experience. The use of these loss factors is
intended to reduce the difference between estimated losses inherent in the
portfolio and observed losses.

                  Specific allowances are established in cases where management
has identified significant conditions or circumstances related to a loan that
management believes indicate the probability that a loss may be incurred in an
amount different from the amount determined by application of the formula
allowance. For other problem graded credits, allowances are established
according to the application of credit risk factors. These factors are set by
management to reflect its assessment of the relative level of risk inherent in
each grade.

                  The unallocated allowance is based upon management's
evaluation of various conditions that are not directly measured in the
determination of the formula and specific allowances. Such conditions include
general economic and business conditions affecting key lending areas, credit
quality trends (including trends in delinquencies and nonperforming loans
expected to result from existing conditions), loan volumes and concentrations,
specific industry conditions within portfolio categories, recent loss experience
in particular loan categories, duration of the current business cycle, bank
regulatory examination results, findings of internal loan examiners, and
management's judgment with respect to various other conditions including loan
administration and management and the quality of risk identification systems.
Executive management reviews these conditions quarterly.


                                       38


                  Management believes that the allowance for loan losses is
adequate. However, the determination of the allowance requires significant
judgment, and estimates of probable losses inherent in the loan portfolio can
vary significantly from the amounts actually observed. While management uses
available information to recognize probable losses, future additions to the
allowance may be necessary based on changes in the loans comprising the loan
portfolio and changes in the financial condition of borrowers, such as may
result from changes in economic conditions. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's loan portfolio and allowance for loan losses. Such review may result
in recognition of additions to the allowance based on their judgments of
information available to them at the time of their examination.

             Premises and Equipment

                  Premises and equipment are stated at cost less accumulated
depreciation and amortization computed using the straight-line method. Premises
and equipment are depreciated over the useful lives of the assets, except for
leasehold improvements which are amortized over the terms of the respective
leases or the estimated useful lives of the improvements, whichever is shorter.
Useful lives range from three to seven years for furniture, fixtures and
equipment and forty years for buildings. The costs of major renewals and
betterments are capitalized, while the costs of ordinary maintenance and repairs
are expensed as incurred.

             Federal Home Loan Bank of Atlanta Stock

                  The Bank, as a member of the Federal Home Loan Bank System, is
required to maintain an investment in capital stock of the Federal Home Loan
Bank of Atlanta ("FHLB") in varying amounts based on balances of outstanding
home loans and on amounts borrowed from the FHLB. Because no ready market exists
for this stock and it has no quoted market value, the Bank's investment in this
stock is carried at cost.

             Other Real Estate Owned (OREO)

                  OREO comprises properties acquired in partial or total
satisfaction of problem loans. The properties are recorded at the lower of cost
or fair value at the date acquired. Losses arising at the time of acquisition of
such properties are charged against the allowance for loan losses. Subsequent
write-downs that may be required are added to a valuation reserve. Gains and
losses realized from the sale of OREO, as well as valuation adjustments, are
included in noninterest income. Expenses of operation are included in
noninterest expense. There was no OREO as of December 31, 2005 and 2004.

             Goodwill

                  Goodwill represents the excess of the cost of assets acquired
in business combinations accounted for under the purchase method over the fair
value of the net assets at dates of acquisition and is annually tested for
impairment in accordance with SFAS No. 142.


                                       39


             Core Deposit Intangibles

                  Upon acquiring the branches of another financial institution,
the Bank engages an independent third party of experts to analyze and prepare a
core deposit study. This study reflects the cumulative present value benefit of
acquiring deposits versus an alternative source of funding. Based upon this
analysis, the amount of the premium related to the core deposits of the business
purchased is calculated along with the estimated life of the acquired deposits.
The core deposit intangible is being amortized over an approximate life of 9
years.

             Loan Servicing

                  The cost of mortgage servicing rights is amortized in
proportion to, and over the period of, estimated net servicing revenue.
Impairment of mortgage servicing rights is assessed based on the fair value of
those rights. Fair values are estimated using discounted cash flows based on a
current market interest rate. The amount of impairment recognized is the amount
by which the capitalized mortgage servicing rights exceed their fair value.

                  When participating interests in loans sold have an average
contractual interest rate, adjusted for normal servicing fees, that differs from
the agreed yield to the purchaser, gains or losses are recognized equal to the
present value of such differential over the estimated remaining life of such
loans. The resulting "excess servicing receivable" or "deferred servicing
revenue" is amortized over the estimated life using a method approximating the
interest method.

                  Quoted market prices are not available for the excess
servicing receivables. Thus, the excess servicing receivables and the
amortization thereon are periodically evaluated in relation to estimated future
servicing revenue, taking into consideration changes in interest rates, current
repayment rates, and expected future cash flows. The Corporation evaluates the
carrying value of the excess servicing receivables by estimating the future
servicing income of the excess servicing receivables based on management's best
estimate of remaining loan lives and discounted at the original discount rate.

             Bank-Owned Life Insurance

                  The Bank is the beneficiary of insurance policies on the lives
of certain officers of the Bank. The Bank has recognized the amount that could
be realized under the insurance policies as an asset in the consolidated balance
sheets. Appreciation in the value of the insurance policies is classified in
non-interest income.

             Income Taxes

                  Income tax expense is based on the results of operations,
adjusted for permanent differences between items of income or expense reported
in the financial statements and those reported for tax purposes. Under the
liability method, deferred income taxes are determined based on the differences
between the financial statement carrying amounts and the income tax basis of
assets and liabilities and are measured at the enacted tax rates that will be in
effect when these differences reverse.


                                       40


             Earnings Per Share

                  Basic earnings per share is computed by dividing net income by
the weighted-average number of shares outstanding during the period. Diluted
earnings per share is determined using the weighted-average number of shares
outstanding during the period, adjusted for the dilutive effect of common stock
equivalents, consisting of shares that might be issued upon exercise of common
stock options.

             Stock Based Compensation

                  The Corporation's stock-based compensation plan is accounted
for based on the intrinsic value method set forth in Accounting Principles Board
Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Compensation expense for stock options is generally not
recognized if the exercise price of the option equals or exceeds the fair market
value of the stock on the date of grant.

                  The following table illustrates the effect on net income and
earnings per share if the Corporation had applied the fair value recognition
provisions of SFAS No. 123 to all stock option awards.

                                                                                          For the Year Ended
                                                                                    ---------------------------------
                                                                                       2005                   2004
                                                                                    ----------             ----------
             Net income, as reported                                                $1,883,174             $1,462,055
             Less:  total option expense determined under
               fair value method for all option awards, net
               of related tax effects                                                  (10,937)              (103,150)
                                                                                    ----------             ----------

             Pro forma net income                                                   $1,872,237             $1,358,905
                                                                                    ==========             ==========

             Pro forma net income per share:
               Basic - as reported                                                    $2.73                 $2.07
                                                                                      =====                 =====
               Basic - pro forma                                                      $2.72                 $1.93
                                                                                      =====                 =====
               Diluted - as reported                                                  $2.55                 $1.93
                                                                                      =====                 =====
               Diluted - pro forma                                                    $2.53                 $1.80
                                                                                      =====                 =====

                  The fair values of stock options granted were estimated at the
date of grant using the Black-Scholes option pricing model. The Black-Scholes
option pricing model was originally developed for use in estimating the fair
value of traded options, which have different characteristics from the
Corporation's employee stock options. The model is also sensitive to changes in
assumptions, which can materially affect the fair value estimate. The following
weighted-average assumptions were used to determine the fair value of options
granted on the Corporation's common stock:

                                                                                                For the Year Ended
                                                                                       -----------------------------------
                                                                                          2005                   2004
                                                                                       ----------             ----------
             Risk-free interest rate                                                      4.23%                   5.0%
             Expected volatility                                                            20%                    20%
             Expected life (in years)                                                       10                     10
             Expected dividend yield                                                      1.50%                  1.50%


                                       41


                  The Corporation expects to adopt the provisions of SFAS No.
123(R), Share-Based Payment (Revised 2005), on January 1, 2006. Among other
things, SFAS 123(R) eliminates the ability to account for stock-based
compensation using APB No. 25 and requires that such transactions be recognized
as compensation cost in the income statement based on their fair values on the
date of the grant.

             Advertising

                  Advertising costs are expensed as incurred. Advertising
expense was $368,689 and $300,130 for the years ended December 31, 2005 and
2004, respectively.

             Awards and Grants

                  Income from awards and grants represents awards from the
Community Development Financial Institution Fund and is recognized when a
definitive commitment from the federal government agency is received. There were
no awards or grants in 2005 or 2004.

             Business Segments

                  The Corporation has determined that its current business and
operations  consist of one business segment.

3. RECENT ACCOUNTING PRONOUNCEMENTS

             In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement No. 123(R), Share-Based Payment. This statement replaces SFAS
No. 123, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees. SFAS 123(R) will require compensation costs related to share-based
payment transactions to be recognized in the financial statements (with limited
exceptions). The amount of compensation cost will be measured based on the
grant-date fair value of the equity or liability instruments issued.
Compensation cost will be recognized over the period that an employee provides
service in exchange for the award. The Company is evaluating the requirements of
implementation and plans to adopt the provisions under the prospective method
beginning January 1, 2006. The impact of this Statement on the Corporation in
2006 and beyond will depend upon various factors, among them being the
Corporation's future compensation strategy. As of December 31, 2005, all stock
options outstanding are fully vested.

             In May 2005, the Financial Accounting Standards Board ("FASB")
issued Statement No. 154, ("SFAS No. 154") Accounting Changes and Error
Corrections - a Replacement of APB Opinion No. 20 and FASB Statement No. 3. This
new standard replaces Accounting Principles Board ("APB") Opinion No. 20,
Accounting Changes, and FASB Statement No. 3 Reporting Accounting Changes in
Interim Financial Statements. Among other changes, SFAS No. 154 requires that a
voluntary change in accounting principle be applied retrospectively with all
prior period financial statements presented on the new accounting principle,
unless it is impracticable to do so. SFAS No. 154 also provides that (1) a
change in method of depreciating or amortizing a long-lived nonfinancial asset
be accounted for as a change in estimate (prospectively) that was effected by a
change in accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement". The new standard
is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. The Corporation does not anticipate
this revision will have a material effect on its financial statements.


                                       42


             On November 3, 2005, the FASB issued FSP Nos. FAS 115-1 and FAS
124-1 to address the determination as to when an investment is considered
impaired, whether that impairment is other than temporary, and the measurement
of the impairment loss. The FSPs also includes guidance on the accounting
subsequent to the recognition of an other-than-temporary impairment and requires
additional disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance in this FAS amends FASB
Statements No. 115 Accounting for Certain Investments in Debt and Equity
Securities. The guidance in this FSP shall be applied to reporting periods
beginning after December 15, 2005. This revision will not have a material effect
on the Corporation's financial statements.

4. RESTRICTIONS ON CASH AND DUE FROM BANKS

             The Bank is required by the Federal Reserve to maintain a reserve
balance based principally on deposit liabilities. The balance maintained is
included in cash and due from banks. The reserve balances kept at the Federal
Reserve Bank as of December 31, 2005 were $25,000.

5. INVESTMENT SECURITIES

             The amortized cost and estimated fair values of investments
securities are as follows:

                                                                           Gross            Gross
                                                     Amortized           Unrealized       Unrealized         Estimated
                                                       Cost                 Gains           Losses          Fair Value
                                                   ------------         ----------        ---------         -----------
Balance at December 31, 2005:
   Available-for-sale:
     U.S. Treasury and government agencies         $ 26,847,870         $  -              $(865,740)        $25,982,130
     Mortgage-backed securities                         131,468              3,033           -                  134,501
                                                   ------------         ----------        ---------         -----------

       Total                                       $ 26,979,338         $    3,033        $(865,740)        $26,116,631
                                                   ============         ==========        =========         ===========

   Held-to-maturity:
     Other                                         $     30,402         $   -             $  -              $    30,402
                                                   ============         ==========        =========         ===========


                                                                           Gross            Gross
                                                     Amortized           Unrealized       Unrealized          Estimated
                                                       Cost                 Gains           Losses          Fair Value
                                                   ------------         ----------        ---------         -----------
Balance at December 31, 2004:
   Available-for-sale:
     U.S. Treasury and government agencies         $ 26,847,162         $   -             $(390,740)        $26,456,422
     Mortgage-backed securities                         140,233              3,424           -                  143,657
     State and political subdivisions                    -                  -                -                  -
                                                   ------------         ----------        ---------         -----------

       Total                                       $ 26,987,395         $    3,424        $(390,740)        $26,600,079
                                                   ============         ==========        =========         ===========

   Held-to-maturity:
     U.S. Government agencies                         2,000,735              5,525           -                2,006,260
     Other                                               35,887             -                -                   35,887
                                                   ------------         ----------        ---------         -----------

       Total                                       $  2,036,622        $     5,525        $  -              $ 2,042,147
                                                   ============         ==========        =========         ===========


                                       43


             Securities, with unrealized losses segregated by length of
impairment, were as follows:

                                  Less than 12 Months            More than 12 Months                        Total
                             ----------------------------   ----------------------------    -------------------------------
                              Estimated        Unrealized    Estimated        Unrealized     Estimated       Unrealized
                              Fair Value         Losses      Fair Value         Losses       Fair Value        Losses
                             ------------    -------------  ------------    -------------   ------------    --------------
Available-for-sale:
  U.S. Government
   agencies and
   corporations                $2,438,275       $(61,725)     $23,543,855     $(804,015)     $26,982,130      $(865,740)
                               ==========       ========      ===========     =========      ===========      =========

             Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. In estimating
other-than-temporary impairment losses, management considers, among other
things, (i) the length of time and the extent to which the fair value has been
less than cost, (ii) the financial condition and near-term prospects of the
issuer, and (iii) the intent and ability of the Corporation to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.

             Management has the ability and intent to hold the securities
classified as held-to-maturity until they mature, at which time the Corporation
will receive full value for the securities. Furthermore, as of December 31,
2005, management also had the ability and intent to hold the securities
classified as available-for-sale for a period of time sufficient for a recovery
of cost. The unrealized losses are largely due to increases in market interest
rates over the yields available at the time the underlying securities were
purchased. The fair value is expected to recover as the bonds approach their
maturity date or repricing date or if market yields for such investments
decline. Management does not believe any of the securities are impaired due to
reasons of credit quality. Accordingly, as of December 31, 2005, management
believes the impairments detailed in the table above are temporary and no
impairment loss has been realized in the Corporation's consolidated statement of
income.

             The amortized cost and estimated fair value of debt securities at
December 31, 2005, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because borrowers have the right to call
or repay obligations without call or prepayment penalties.

                                                                                                        Estimated
                                                                          Amortized                        Fair
                                                                             Cost                         Value
                                                                       ----------------              ---------------
Available-for-sale:
   Due after one year through five years                                 $26,847,870                    $25,982,130
   Due after five years through ten years                                    -                               -
   Mortgage-backed securities                                                131,468                        134,501
                                                                         -----------                    -----------

       Total                                                             $26,979,338                    $26,116,631
                                                                         ===========                    ===========

Held-to-maturity:
   Due after one year through five years                                 $   -                          $    -
   Due after ten years                                                        30,402                         30,402
                                                                         -----------                    -----------

       Total                                                             $    30,402                    $   30,402
                                                                         ===========                    ===========


                                       44


             During the year ended December 31, 2005 no available-for-sale
securities were sold. During 2004, the gross proceeds for the sale of available
securities were $7,032,625 and gains of $16,733.

             Securities with a fair value of $14,975,010 at December 31, 2005
have been pledged as collateral for money market and certificate of deposit
accounts.

             The only investments to a single issuer that exceeds 10% of
stockholders' equity are to government sponsored entities.

6. LOANS AND ALLOWANCE FOR LOAN LOSSES

             The composition of loans, net of unearned income at December 31 is
as follows:

                                                                            2005                         2004
                                                                       ------------                 ------------
       Real estate                                                     $102,404,253                $  94,543,110
       Commercial                                                        82,844,979                   72,075,164
       Consumer                                                           4,980,479                    6,368,380
       Credit card loans                                                    765,218                      829,811
                                                                       ------------                 ------------

                                                                       $190,994,929                 $173,816,465
                                                                       ============                 ============

             Transactions in the allowance for loan losses are summarized as
follows:

                                                                            2005                          2004
                                                                        -----------                  -----------
       Balance at January 1                                             $ 1,611,880                  $ 1,488,212
                                                                        -----------                  -----------
       Provision charged to operating expense                               410,000                      360,000
                                                                        -----------                  -----------
       Loans charged-off                                                    (91,302)                    (413,390)
       Recovery on loans previously charged-off                             127,983                      177,058
                                                                        -----------                  -----------

             Net recovery (charged-off)                                      36,681                     (236,332)
                                                                        -----------                  -----------

       Balance at December 31                                           $ 2,058,561                  $ 1,611,880
                                                                        ===========                  ===========

             Information with respect to impaired loans at December 31, 2005 and
2004 and for the years then ended is as follows:

                                                                            2005                        2004
                                                                        -----------                  -----------
       Impaired loans with a valuation allowance                        $   558,128                  $   749,794
       Impaired loans without a valuation allowance                          17,805                       49,355
                                                                        -----------                  -----------

             Total impaired loans                                       $   575,933                  $   799,149
                                                                        ===========                  ===========

       Allowance for loan losses related to impaired loans              $    50,808                  $   102,127
       Allowance for loan losses related to other than
         impaired loans                                                   2,007,753                    1,509,753
                                                                        -----------                  -----------

             Total allowance for loan losses                            $ 2,058,561                  $ 1,611,880
                                                                        ===========                  ===========

       Average impaired loans for the year                              $   752,271                  $   746,909
                                                                        ===========                  ===========


                                       45


             Approximately $34,700 and $9,157 of interest income was recognized
on impaired loans for the years ended December 31, 2005 and 2004, respectively.
Interest income recognized on impaired loans on a cash basis during 2005 and
2004 was not considered material.

             The Bank has sold certain real estate mortgage loans without
recourse and in some cases retained the related servicing rights. The principal
balances of these serviced loans, which are not included in the accompanying
consolidated balance sheets, totaled $4,331,326 and $4,988,951 at December 31,
2005 and 2004, respectively. There were $716,000 of loans held for sale at
December 31, 2005 and $1,149,000 at December 31, 2004.

             At December 31, 2005 and 2004 the net carrying amount of mortgage
servicing rights was $-0- and $3,913, respectively, which approximated fair
value and are included in other assets.

             The Bank has granted loans to certain officers and directors of the
Bank and their associates. Related party loans are made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with unrelated persons and do not involve more
than the normal risk of collectibility. The aggregate dollar amount of these
loans was $13,465,670 and $11,508,543 at December 31, 2005 and 2004,
respectively. During 2005, $7,851,906 of new loans were made while repayments
totaled $5,894,779. During 2004, $5,116,420 of new loans were made while
repayments totaled $2,306,545. The 2004 numbers for loans to officers and
directors include two directors that no longer serve on the Board. As of
December 31, 2005 and 2004, the Bank had outstanding loans to the Harbor Bank of
Maryland Community Development Corporation amounting to $1,795,444 and
$2,000,000, respectively.

7. PREMISES AND EQUIPMENT

             The major classes of premises and equipment at December 31 are
summarized as follows:

                                                                                      2005                  2004
                                                                                  ------------           -----------
             Land                                                                 $    661,900            $  661,900
             Buildings                                                               2,400,196             3,947,253
             Furniture, fixtures and equipment                                       2,575,067             2,111,982
             Leasehold improvements                                                  4,778,883               625,877
                                                                                  ------------           -----------
                                                                                    10,416,046             7,347,012
               Less accumulated depreciation and amortization                        2,889,706             2,209,292
                                                                                  ------------            ----------

                      Total                                                       $  7,526,340            $5,137,720
                                                                                  ============            ==========

             Depreciation expense was $680,903 and $427,497 for the years ended
December 31, 2005 and 2004.

             The Bank leases branch and office facilities. The lease agreements
provide for the payment of utilities and taxes by the lessee. Future minimum
payments for each of the five succeeding years under noncancelable operating
leases consisted of the following at December 31, 2005:

                                    2006                            $203,216
                                    2007                             196,999
                                    2008                             113,542
                                    2009                             113,542
                                    2010                             113,542
                                    Thereafter                       506,572

                                       46


             Total rental expense under operating leases amounted to $212,914
and $168,096 for the years ended December 31, 2005 and 2004, respectively.

8. CORE DEPOSIT INTANGIBLE

             The Corporation has a finite-lived core deposit intangible asset
created in 2002 which is being amortized over a 9-year period beginning in 2002.
Annual amortization expense related to this intangible is expected to be $80,460
per year through 2010 and $60,367 in 2011.

9. TIME DEPOSITS

             At December 31, 2005, time deposits with a remaining maturity of
one year or more amounted to $21,924,052. Maturities of all time deposits are as
follows:

                           2007                                  $10,071,533
                           2008                                    9,742,793
                           2009                                    1,398,195
                           2010                                      482,009
                           2011                                      229,522

             Deposits are the Corporation's primary funding source for loans and
investment securities. The mix and repricing alternatives can significantly
affect the cost of this source of funds and, therefore, impact the margin.

10. INCOME TAX

             The Corporation's provision for income taxes for the years ended
December 31, is summarized as follows:

                                                                                  2005                        2004
                                                                                ----------                   --------
             Taxes currently payable                                            $1,205,592                   $868,436
             Deferred taxes                                                       (138,225)                  (106,110)
                                                                                ----------                   --------

             Income tax expense for the year                                    $1,067,367                   $762,326
                                                                                ==========                   ========

             A reconcilement of the difference between the statutory federal
income tax rate and the effective tax rate for the Corporation is as follows:

                                                                                     2005                   2004
                                                                                   --------                --------
             Federal income tax rate                                                34.00%                  34.00%
             State income taxes, net of federal income tax effect                    4.02                    2.30
             Increase (decrease) resulting from:
               Increase in value of bank-owned life insurance                       (2.50)                  (2.50)
               Other                                                                 0.65                     .50
                                                                                   ------                  -------

             Effective tax rate                                                     36.17%                  34.30%
                                                                                   ======                  =======


                                       47


             Significant components of the Corporation's deferred tax
liabilities and assets at December 31 are as follows:

                                                                                   2005                      2004
                                                                               -----------                 ---------
             Deferred tax liabilities -
               Goodwill                                                        $   511,749                  $383,812
                                                                               -----------                 ---------

             Deferred tax assets:
               Accrued liability                                                    -                        106,205
               Allowance for loan losses                                           598,506                   440,988
               Deferred loan origination fees                                       -                         14,457
               Depreciation                                                        120,884                    19,189
               Deferred compensation                                               333,716                   237,865
               Deposit premium                                                      90,121                    63,890
                                                                               -----------                 ---------

                  Total gross deferred tax assets                                1,143,227                   882,594
                                                                               -----------                 ---------

             Net deferred tax assets attributable to operations                    631,478                   498,782
             Unrealized loss (gain) on investments charged
               to other comprehensive income                                       340,769                   149,581
                                                                               -----------                 ---------

                  Net deferred income tax assets                               $   972,247                  $648,363
                                                                               ===========                  ========

11. SHORT-TERM BORROWINGS

             As of December 31, 2005, the Bank had an unused available
line-of-credit from the Federal Home Loan Bank of Atlanta ("FHLB") of
$25,610,000.

12. JUNIOR SUBORDINATED DEBENTURES

             On October 9, 2004, the Corporation issued floating rate junior
subordinated debt securities due 2033 in the amount of $7.2 million. The debt
security was issued by the Corporation pursuant to an indenture, dated as of
October 9, 2004, between the Corporation and Wilmington Trust Company. The
capital securities will be issued by Harbor Bankshares Corporation Capital Trust
(the "Trust") pursuant to a purchase agreement dated September 18, 2004, among
the Corporation, the Trust and Citigroup Global Markets Inc. Upon the receipt of
the funds, the Corporation paid off its long-term debt in the amount of $1.8
million and invested the remaining funds in the amount of $4.9 million as
capital in the Bank, increasing the Bank's tier one capital. The interest rate
on the debentures was 7.25% at December 31, 2005.

13. EMPLOYEE BENEFIT PLANS

             Stock Options

                  The Corporation has stock option award arrangements which
provide for the granting of options to acquire common stock by directors and key
employees. Option prices are equal to or greater than the estimated fair market
value of the common stock at the date of the grant. Options are generally
exercisable immediately after the date of the grant.


                                       48


                  A summary of the Corporation's stock options as of December
31, 2005 and 2004 and changes during the years ended on those dates is presented
below:

                                                                         2005                            2004
                                                               ------------------------        -------------------------
                                                                             Weighted                          Weighted
                                                                              Average                           Average
                                                                             Exercise                          Exercise
                                                                Shares         Price            Shares           Price
                                                               ---------     ----------        --------        ---------
       Outstanding at the beginning of the year                   150,826        $15.93           151,843       $15.49
       Granted                                                      4,891         23.04             9,820        21.69
       Exercised                                                  (11,645)        14.80              (758)       11.61
       Forfeited                                                  (11,331)        14.80           (10,079)       15.76
                                                                ---------                        --------
       Outstanding at end of year                                 132,741         16.24           150,826        15.93
                                                                  =======                         =======

       Options exercisable at year-end                            132,741        $16.24           150,826       $15.93
                                                                  =======        ======           =======       ======

       Weighted average fair value of options
         granted during the year                                   $6.78                          $10.50
                                                                   =====                          ======

                  The following table summarizes information about stock options
outstanding at December 31, 2005:

                                                 Options Outstanding and Exercisable
                                                 -----------------------------------

                                                                        Weighted-         Weighted-
                                                Remaining                Average           Average
                             Exercise              Number                  Life           Exercise
                           Price Range          Outstanding              (Years)             Price
                          -------------         -----------           ------------       ------------------
                        $15.24 - $23.04          132,741                   3.6              $16.24
                        ===============          =======                   ===              ======

             Profit Sharing Retirement Savings Plan

                  The Corporation has established a defined contribution plan
covering employees meeting certain age and service eligibility requirements. The
plan provides for cash deferrals qualifying under Section 401(k). Matching
contributions made by the Corporation totaled $67,169 and $77,324 for the years
ended December 31, 2005 and 2004, respectively.

             Deferred Compensation

                  The Bank has entered into deferred compensation agreements
with two of its executive officers. Under the agreements, the Bank is obligated
to provide for the officer or his beneficiaries, during a period of fifteen
years after the employee's death, disability or retirement, annual benefits
ranging from $40,000 to $200,000. The estimated present value of future benefits
to be paid is being accrued over the period from the effective date of the
agreements until the full eligibility dates of the participants. The expense
incurred for this plan for the years ended December 31, 2005 and 2004 was
$248,190 and $225,411, respectively. The Bank is the beneficiary of life
insurance policies, with aggregate cash surrender value of $4,178,774 at
December 31, 2005, that was purchased as a method of partially financing
benefits under this plan.


                                       49


14. CONCENTRATIONS OF CREDIT RISK

             Real estate loans comprise $102,903,065 and $94,543,110 of the
total loan portfolio at December 31, 2005 and 2004, respectively. All real
estate mortgage loans are collateralized by real property and/or other assets.

15. REGULATORY MATTERS

             The Corporation and the Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Corporation's and the Bank'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 classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.

             Quantitative measures established by regulation to ensure capital
adequacy require the Corporation and the Bank to maintain amounts and ratios
(set forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). As of December 31, 2005, the capital
levels of the Corporation and the Bank exceed all minimum capital adequacy
requirements to which they are subject. There are no conditions or events since
December 31, 2005 that management believes have changed the Bank's capital
rating.

             The Corporation's and the Bank's actual capital amounts and ratios
are also presented in the table: (in thousands)

                                                                                                        To Be Well
                                                                                                     Capitalized Under
                                                                              For Capital           Prompt Corrective
                                                         Actual            Adequacy Purposes         Action Provisions
                                                   -----------------    ------------------------   ---------------------
                                                                         Minimum      Required      Minimum   Required
                                                   Amount      Ratio      Amount        Ratio        Amount     Ratio
                                                   ------      -----    ---------    -----------   --------  -----------
As of December 31, 2005:
    Total Capital (to risk-weighted total assets)
       Harbor Bankshares Corporation                $23,566    11.67%      $16,154      8.0%         $20,192       10.0%
       Harbor Bank of Maryland                       23,356    11.59%       16,119      8.0%          20,150       10.0%

    Tier 1 Capital (to risk weighted assets)
       Harbor Bankshares Corporation                $18,321     9.07%      $ 8,077      4.0%         $12,116        6.0%
       Harbor Bank of Maryland                       21,297     9.47%        8,060      4.0%          12,080        6.0%

    Tier 1 Capital (to average assets)
       Harbor Bankshares Corporation                $18,321     7.31%      $ 9,666      4.0%         $12,083        5.0%
       Harbor Bank of Maryland                       21,297     8.83%        9,649      4.0%          12,062        5.0%


                                       50


                                                                                                       To Be Well
                                                                                                    Capitalized Under
                                                                             For Capital            Prompt Corrective
                                                         Actual           Adequacy Purposes         Action Provisions
                                                   ------------------    ---------------------     --------------------
                                                                          Minimum   Required       Minimum    Required
                                                    Amount     Ratio       Amount     Ratio         Amount     Ratio
                                                   --------   -------    ---------- ----------     --------- ----------
As of December 31, 2004:
    Total Capital (to risk-weighted total assets)
       Harbor Bankshares Corporation                $22,040    12.10%      $14,535      8.0%         $18,169       10.0%
       Harbor Bank of Maryland                       21,830    12.01%       14,535      8.0%          18,169       10.0%

    Tier 1 Capital (to risk weighted assets)
       Harbor Bankshares Corporation                $17,242     9.47%      $ 7,267      4.0%         $10,901        6.0%
       Harbor Bank of Maryland                       20,218     9.47%        7,267      4.0%          10,901        6.0%

    Tier 1 Capital (to average assets)
       Harbor Bankshares Corporation                $17,242     7.36%       $9,365      4.0%         $11,707        5.0%
       Harbor Bank of Maryland                       20,218     8.63%        9,365      4.0%          11,707        5.0%

             Bank and holding company regulations, as well as Maryland law,
impose certain restrictions on dividend payments by the Bank, as well as
restricting extensions of credit and transfers of assets between the Bank and
the Company. At December 31, 2005, the Bank could have paid additional dividends
of $10,008,477 to its parent company without regulatory approval.

16. EARNINGS PER SHARE

             Basic and diluted earnings per common share calculations for the
years ended December 31, 2005 and 2004 are as follows:

                                                                                     2005                  2004
                                                                                  ----------            ----------
       BASIC:
         Net income                                                               $1,883,174            $1,462,055
                                                                                  ----------            ----------

         Average common shares outstanding                                           689,134               704,602
                                                                                  ----------            ----------

         Earnings per common share - basic                                           $2.73                 $2.07
                                                                                     =====                 =====

       DILUTED:
         Net income                                                               $1,883,174            $1,462,055
                                                                                  ----------            ----------

         Average common shares outstanding                                           689,134               704,569

         Stock option adjustment                                                      49,488                51,654
                                                                                  ----------            ----------

         Average common shares outstanding - diluted                                 738,622               756,223
                                                                                  ----------            ----------

         Earnings per common share - diluted                                         $2.55                 $1.93
                                                                                     =====                 =====

             Basic earnings per common share is calculated by dividing net
income by the weighted- average number of common shares outstanding for the
period.


                                       51


             Diluted earnings per common shares takes into consideration the pro
forma dilution assuming the Corporation's outstanding in-the-money stock options
were converted or exercised into common shares. The average price of the
Corporation's common stock for the period is used to determine the dilutive
effect of outstanding stock options. As of December 31, 2005 none of the
Corporation's 132,741 outstanding stock options were excluded from the
computation of diluted earnings per share.

17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

             In the normal course of business, the Corporation has various
outstanding credit commitments which are properly not reflected in the financial
statements. These commitments are made to satisfy the financing needs of the
Corporation's clients. The associated credit risk is controlled by subjecting
such activity to the same credit and quality controls as exist for the
Corporation's lending and investing activities. The commitments are generally
variable rate and involve diverse business and consumer customers and are
generally well collateralized. Management does not anticipate that losses, if
any, which may occur as a result of these commitments would materially affect
the stockholders' equity of the Corporation. Since a portion of the commitments
have some likelihood of not being exercised, the amounts do not necessarily
represent future cash requirements.

             Loan and credit line commitments, totaled $27,913,000 at December
31, 2005 and $24,301,000 at December 31, 2004. These commitments are contingent
upon continuing customer compliance with the terms of the agreement.

             Commercial letters of credit, totaling $907,810 at December 31,
2005 and $1,744,640 at December 31, 2004, are obligations to make payments under
certain conditions to meet contingencies related to customers' contractual
agreements. They are primarily used to guarantee a customer's contractual and/or
financial performance, and are seldom exercised.

18. FAIR VALUE OF FINANCIAL INSTRUMENTS

             SFAS No. 107, Disclosure About Fair Value of Financial Instruments
requires the Corporation to disclose fair value information about financial
instruments for which it is practicable to estimate, whether or not such fair
values are reflected in the consolidated balance sheets. Estimated fair value
amounts have been determined using available market information and other
valuation methodologies. However, considerable judgment is required to interpret
market data in developing the estimates of fair value. Accordingly, the
estimates presented are not necessarily indicative of the amount that could be
realized in a current market exchange. The use of different market assumptions
and estimation methodologies may have a material effect on the estimated fair
value amounts.

             Cash and Due from Banks and Federal Funds Sold

                  The carrying amount approximated fair value.

             Interest-Bearing Deposits in Other Banks

                  Due to their short-term nature, the carrying amount
approximated fair value.


                                       52


             Investment Securities

                  The fair values of securities are based upon quoted market
prices when available. If quoted market prices are not available, fair values
are based upon quoted market prices of comparable instruments.

             Loans

                  The fair values of variable-rate loans and fixed-rate loans
that reprice within one year, with no significant credit risk, are based upon
their carrying amounts. The fair values of all other loans are estimated using
discounted cash flow analysis, which utilizes interest rates currently being
offered for loans with similar terms to borrowers of similar credit quality. The
reserve for possible loan losses is allocated to the various components of the
loan portfolio in determining the fair value.

             FHLB of Atlanta Stock

                  Due to its restrictive nature, the fair value of FHLB of
Atlanta Stock approximates its carrying value.

             Accrued Interest Receivable

                  The carrying amount reported in the consolidated balance
sheets is a reasonable estimate of fair value.

             Bank-Owned Life Insurance

                  The carrying amount reported in the consolidated balance
sheets represents cash to be received on the surrender value of life insurance
policies and is a reasonable estimate of value.

             Deposits

                  The fair value for demand deposits is, by definition, equal to
the amount payable on demand at the reporting date. The carrying amounts for
variable rate deposits and fixed-rate certificates of deposit that reprice
within one year approximate their fair values at the reporting date. Fair values
for longer-term fixed-rate certificates of deposit are estimated using
discounted cash flow analysis that applies interest rates currently being
offered on certificates.

             Accrued Interest Payable

                  Accrued interest payable includes interest expensed but not
yet paid for deposits and notes payable. The carrying amount approximates its
fair value.

             Long-Term Debt

                  Long-term debt is discounted on a cash flow approach based on
market rates as of December 31, 2005 and 2004.

             Off-Balance Sheet Financial Instruments

                  The fair value of loan commitments and letters of credit was
estimated based upon the estimated amount of unamortized fees collected or paid
incident to granting or receiving the commitment.


                                       53


                  The carrying values and estimated fair values of the
Corporation's financial assets and liabilities are as follows:

                                                  December 31, 2005                        December 31, 2004
                                           --------------------------------        -------------------------------
                                                               Estimated                                 Estimated
                                             Carrying              Fair              Carrying                Fair
                                                Value             Value                 Value               Value
                                           ----------------   -------------       ------------------   -----------
Financial assets:
   Cash and due from banks                   $   7,259,358    $   7,259,358        $    6,867,063     $    6,867,063
   Federal funds sold                           15,624,890       15,624,890             9,845,813          9,845,813
   Interest bearing deposits
     in other banks                                 74,996           74,996             1,352,791          1,352,791
   Investment securities                        26,147,033       26,147,033            28,636,701         28,642,226
   Loans, net of reserves                      188,936,368      190,388,999           172,204,585        172,904,585
   FHLB of Atlanta stock                           470,000          470,000               438,200            438,200
   Accrued interest receivable                   1,101,742        1,101,742             1,034,913          1,034,913
   Bank-owned life insurance                     4,178,774        4,178,774             4,023,808          4,023,808

Financial liabilities:
   Deposits                                    229,844,586       229,843,382          210,223,903        210,030,821
   Accrued interest payable                        683,762           683,762              356,184            356,184
   Junior subordinated debentures                7,217,000         7,217,000            7,217,000          7,217,000

             Off-Balance Sheet Financial Assets

                                                         2005                                    2004
                                           --------------------------------         --------------------------------
                                              Estimated         Estimated            Estimated          Estimated
                                              Amount            Fair Value             Amount           Fair Value
                                           -------------       ------------         -----------        -------------
Commitments to extend credit                   $25,585,000       $27,913,000          $24,301,000        $24,301,000
Other unused commitments                         2,328,000         2,328,000            3,886,000          3,886,000
Commercial letters of credit                       907,810           907,810            1,744,640          1,744,640

19. PARENT COMPANY ONLY FINANCIAL STATEMENTS

                            CONDENSED BALANCE SHEETS

                                                                                            December 31
                                                                                 ----------------------------------
                                                                                   2005                  2004
                                                                                 -----------            -----------
       Assets:
         Balance with subsidiary                                                 $    95,867            $    66,968
         Investment in bank subsidiary                                            23,960,910             23,245,961
         Prepaid placement fee                                                       193,665                201,666
                                                                                 -----------            -----------

             Total assets                                                        $24,250,442            $23,514,595
                                                                                 ===========            ===========

       Liabilities:
         Accrued interest payable                                                $    79,532            $    57,634
         Junior subordinated debentures                                            7,217,000              7,217,000

       Stockholders' equity                                                       16,953,910             16,239,961
                                                                                 -----------            -----------

             Total liabilities and stockholders' equity                          $24,250,442            $23,514,595
                                                                                 ===========            ===========


                                       54


                          CONDENSED STATEMENT OF INCOME


                                                                                     Years Ended December 31
                                                                                  2005                     2004
                                                                               -----------               ----------
       Dividend from subsidiary                                                 $1,681,445               $  731,715
       Interest and other expenses                                                (625,052)                (485,838)
       Income tax benefit                                                          212,518                  165,802
       Equity in undistributed income of subsidiary                                614,263                1,050,376
                                                                               -----------               ----------

             Net income                                                         $1,883,174               $1,462,055
                                                                                ==========               ==========

                       CONDENSED STATEMENTS OF CASH FLOWS

                                                                                       Years Ended December 31
                                                                                      2005                 2004
                                                                                 ------------          -------------
Operating activities:
   Net income                                                                    $  1,883,174          $   1,462,055
   Adjustment to reconcile net income to net
     cash provided by operating activities
   Change in other assets and liabilities, net                                       (354,990)              (176,979)
   Equity in undistributed income of subsidiary                                      (614,263)            (1,050,376)
                                                                                 ------------          -------------

         Net cash provided by operating activities                                    913,921                234,700
                                                                                 ------------          -------------

Investing activities - Investment in subsidiary                                        -                      -
                                                                                 ------------          -------------


Financing activities:
   Retirement of stock                                                               (775,000)                -
   Proceeds from sale of common stock                                                 172,373                  8,170
   Payments of cash dividends                                                        (282,395)              (246,462)
                                                                                 ------------          -------------

        Net cash (used) provided by financing activities                             (885,022)              (238,292)
                                                                                 ------------          -------------

Change in cash and cash equivalents                                                    28,899                 (3,592)

Cash and cash equivalents at beginning of year                                         66,968                 70,560
                                                                                 ------------          -------------

Cash and cash equivalents at end of year                                         $     95,867          $      66,968
                                                                                 ============          =============


                                       55



Item 8. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure

         None

Item 8A. Controls and Procedures

         The Corporation's management, under the supervision and with the
participation of it Chief Executive Officer and the Chief Financial Officer,
evaluated as of the last day of the period covered by this report, the
effectiveness of the design and operation of the Corporation's disclosure
controls and procedures, as defined in Rule 13a-15 under the Securities Exchange
Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Corporation's disclosure controls and
procedures were adequate. There were no significant changes in the Corporation's
internal controls over financial reporting (as defined in Rule 13a-15 under the
Securities Act of 1934) during the quarter ended December 31, 2005, that have
materially effected, or are reasonably likely to materially affect, the
Corporation's internal control over financial reporting.

Item 8B. Other Information.

         Not applicable.

PART III

Item 9. Directors, Executive Officers and Control Persons; Compliance with
Section 16(a) of the Exchange Act

Information required by this item is listed below and on page 7 of this report
under the caption of "Executive Officers" of the Registrant.

         The charter and by-laws of the Company provide that the directors shall
be classified into three classes as equal in number as possible, with each
director serving a three-year term. Currently, the Board of Directors is
composed of 13 members with Classes I and II each consisting of four member and
Class III consisting of five members. The Board of Directors currently also has
three open board seats which will remain open until suitable candidates are
located. The terms of the Class II directors are scheduled to expire at the 2006
annual meeting or until their respective successors have been duly elected and
qualified.

         Directors are elected by a plurality of the votes cast by the holders
of shares of Common Stock present in person or represent

NAME OF NOMINEES             INFORMATION REGARDING CLASS II DIRECTORS
----------------             ----------------------------------------

Nathaniel Higgs              Reverend Higgs is 75 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1981. From December 1966
                             to December 2002, he served as the Pastor of
                             Southern Baptist Church and has now retired.

Delores G. Kelley            Dr. Kelley is 69 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1980. She is a retired
                             educator and Senator in the Maryland State Senate.

Erich March                  Mr. March is 54 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1981. His is Vice
                             President of March Funeral Homes, Inc.

Stanley W. Tucker            Mr. Tucker is 58 years old and has served as a
                             director of the Corporation and of the Bank since
                             1996. He is President of Meridian management
                             Company, Inc., which is the managing general
                             partner of MMG Ventures, L.P., an investment
                             management company.


                                       56



Directors to serve until 2007 Annual Meeting (Class III)

NAME OF CLASS III DIRECTORS  INFORMATION REGARDING CLASS III DIRECTORS
---------------------------  -----------------------------------------

John Paterakis               Mr. Paterakis is 77 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1982. He is President
                             and Chief Executive Officer of H & S Bakery, Inc.
                             and Northeast Foods, Inc.

James Scott, Jr.             Mr. Scott is 48 years old and has served a s
                             director of the Corporation and the Bank since
                             November 2000. He is a principal of Pennan & Scott
                             P.C., an accounting firm. Mr. Scott is a certified
                             public accountant.

Edward St. John              Mr. St. John is 68 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1990. He is President
                             and Chief Executive Officer of M.I.E. Investment
                             Company, a real estate development company.

Walter S. Thomas             Pastor Thomas is 55 years old and has served as a
                             director of the Corporation and the Bank since
                             November 2000. He is the Pastor of New Psalmist
                             Church.

George F. Vaeth, Jr.         Mr. Vaeth is 72 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1981. He has served as
                             Secretary of the Company since its formation and of
                             the Bank since 1986. He is an architect with
                             G.V.A., an architectural and interior design firm.

2008 Annual Meeting (Class I)

NAME OF CLASS I DIRECTORS    INFORMATION REGARDING CLASS I DIRECTORS
-------------------------    ---------------------------------------

James H. Degraffereidt, Jr.  Mr. Degraffenreidt is 52 years old and has served
                             as a director of the Corporation and of the Bank
                             since 1996. He is Chairman and Chief Executive
                             Officer of WGL Holdings, Inc., distributors of
                             natural gas.

Louis J. Grasmick            Mr. Grasmick is 76 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1982. He is Chief
                             Executive Officer of Louis J. Grasmick Lumber
                             Company, Inc.

Joseph Haskins, Jr.          Mr. Haskins is 58 years old and has served as a
                             director of the Corporation since its formation in
                             1992 and of the Bank since 1980. He has served as
                             Chief Executive Officer of the Company since its
                             formation in 1992, Chairman of the Board of the
                             Company Bank since 1995 and Chief Executive Officer
                             of the Bank since 1987.

John D. Ryder                Mr. Ryder is 58 years old and has served as a
                             director of the Corporation and the Bank since
                             January 2000. He was President and Chief Operating
                             Officer of Metro Food Markets, a supermarket chain,
                             until 2000. He was President of AXS Technologies, a
                             software company, until July 2003. Currently, he is
                             President of Tree Top Kids, Inc.


                                       57


CONTINUING DIRECTORS

         The following information is provided with respect directors who will
continue to serve as directors of the Company until the expiration of their
terms at the times indicated.

                          COMPANY CORPORATE GOVERNANCE
GENERAL

         The Corporation's business is managed under the direction of its Board
of Directors. The Board of Directors seeks to increase stockholder value and
promote the Corporation's long-term growth. The Board of Directors establishes
Corporation policies and strategies and regularly monitors the effectiveness of
the Corporation's management in carrying out these policies and strategies. As
part of the Board of Director's commitment to these principles, the Board of
Directors regularly reviews the Corporation's corporate governance policies and
practices. This review includes comparing the Corporation's current policies and
practices to the policies and practices suggest by various groups and
authorities active in corporate governance and policies and practices of public
companies in general. The Board of Directors will continue to consider the
adoption of changes, as appropriate, to enhance the Corporation's corporate
governance policies and practices and to comply with any rule changes made by
the SEC.

BOARD ORGANIZATION AND OPERATION

         Members of the Board of Directors are kept informed of the Corporation
business through discussions with key member of the Corporation's management
team, by reviewing materials provided to the Board of Directors and by
participating in meetings of the Board and its committees.

         The Board of Directors has adopted standards for director independence
that are in accordance with the standards adopted by the National Association of
Securities Dealers, Inc. (the "NASD") and utilized by companies with securities
quoted on Nasdaq. The Board of Directors is not required to adhere to the
independence standards adopted by the NASD because the common Stock is not
quoted or listed on Nasdaq or any other quotation system or exchange. The Board
of Directors believes, however, that a board with at least a majority of
independent directors is an important part of good corporate governance
principles. Based on the Board of Directors' adopted standards, the Board of
Directors has determined that none of its members has a material relationship
with the Corporation and that all of its members are independent directors,
except for Messrs. Haskins and Paterakis who are not independent directors
because each is an executive officer of the Corporation. As a result, a
significant majority of the members of the Board of Directors is independent.

         During 2005, the Board of Directors met 12 times. Each of the nominees
and the other directors attended at least 75% of the total Board of Directors
meetings and meetings of the board committees on which he or she served, with
the exception of Mr. Thomas who attended 60% of these meetings. When necessary
or appropriate, the Corporation's independent directors meet in executive
sessions without the presence of the Corporation's management. This gives the
independent directors the opportunity to discuss management's performance and
any other matter that one or more independent directors would like to discuss.

BOARD COMMITTEES

         Each director who serves on the Board of Directors is also a director
on the Bank's Board of Directors. The Board of Directors has one standing
committee: the Audit Committee (the "Audit Committee"). The Bank's Board of
Directors has a Compensation Committee (the "Compensation Committee") and an
Executive Committee (the "Executive Committee")

         Audit Committee. The Audit Committee responsibilities include the
appointment of the Corporation's independent accountants, the preapproval of all
audit services and permitted non-audit services provided to the Corporation by
the Corporation's independent accountants, reviews of the independence of the
Corporation's independent accountants, and review of the adequacy of internal
accounting and disclosure controls of the Corporation. The Audit Committee
operates under a written charter adopted by the Board of Directors. In 2005, the
Audit Committee met four times. The current members of the Audit Committee are:
Messrs. Vaeth, Chair, Higgs, March, Scott and Tucker. Each member of the Audit
Committee is an independent director as defined by the current NASD rules. Mr.
Scott has the professional experience deemed necessary o qualify as an audit
committee financial expert under the SEC's rules and regulations.

         Compensation Committee. The Compensation Committee structures the
compensation of the Corporation's executive officers and administers the
Corporation's employee benefit plans. The Compensation Committee currently does
not operate under written charter. The Compensation Committee met once in 2005.
The current members of the Compensation Committee are: Messrs. Grasmick, Chair,
DeGraffenreidt and St. John. Each member of the Compensation Committee is an
independent director as defined by the current NASD rules.


                                       58


         Executive Committee. The Executive Committee generally has the
authority to exercise all of the power of the Bank's Board of Director in the
management and direction of the business affairs of the Bank, subject to
specific directions of the Bank's Board of Directors and the limitation of
Maryland law. The Executive Committee met 13 times in 2005. The current members
of the Executive Committee are: Messrs. Paterakis, Chair, Haskins,
Degraffenreidt, Grasmick, March, Vaeth and Dr. Kelley. A majority of the members
of the Executive Committee is independent as defined by the current NASD rules.

NOMINATION PROCESS

         The Board of Directors does not have a nominating committee. The full
Board of Directors performs the functions of a nominating committee. The Board
of Directors does not believe it needs a separate nominating committee because
the full Board is comprised predominantly of independent directors and has the
time and resources to perform the function of selecting board nominees. When the
Board of Directors performs nominating function, the Board of Directors acts in
accordance with the Corporation's corporate charter and bylaws but does not have
a separate charter related to the nomination process. Under the Corporation's
charter, nominations for director may be made by the Board of Directors or by a
stockholder of record who delivers notice along with the additional information
and materials required by the Corporation's charter to the Corporation Corporate
Secretary not less then 30 days and no more than 60 days before the annual
meeting date. For the Corporation's annual meeting in 2007, the Corporation must
receive this notice on or after February 18, 2007 and on or before March 20,
2007. The Corporation's stockholders may obtain a copy of the Corporation
charter by writing to the Corporation Corporate Secretary, Harbor Bankshares
Corporation, 25 West Fayette Street, Baltimore, Maryland 21201.

         The Corporation's directors have a critical role in guiding the
Corporation's strategic direction and in overseeing the Corporation's
management. The Board of Directors considers candidates for the Board based upon
several criteria, including their broad-based business and professional skills
and experiences, concern for the long-term interests of stockholders, and
personal integrity and judgment. Candidates should have reputations, both
personal and professional, consistent with the Corporation's image and
reputation. Because diversity is important, the Board of Directors seeks to
ensure that its directors reflect the gender and ethnic diversity of the
Corporation's community. The majority of directors on the Board of Directors
should be "independent," not only as that term may be legally defined, but also
without the appearance of any conflict in serving as a director. In addition,
directors must have time available to devote to Board activities and to enhance
their knowledge of the banking industry. Accordingly, the Board of Directors
seeks to attract and retain highly qualified directors who have sufficient time
to attend to their substantial duties and responsibilities to the Corporation.

         The Board of Directors utilizes the following process for identifying
and evaluating nominees to the Board. In the case of incumbent directors whose
terms of office are set to expire, the Board of Directors review such directors'
overall service to the company during their term, including the number of
meetings attended, level of participation and quality of performance. In the
case of new director candidates, the directors on the Board of Directors are
polled for suggestions as to potential candidates that may meet the criteria
above, discuss candidates suggested by the Corporation's stockholders and may
also engage, if the Board of Directors deems appropriate, a professional search
firm. To date, the Board of Directors has not engaged professional search firms
to identify or evaluate potential nominees but may do so in the future, if
necessary. The Board of Directors then meets to discuss and consider these
candidates' qualifications and then chooses a candidate by a majority vote.

DIRECTOR ATTENDANCE AT THE CORPORATION ANNUAL MEETING

         The Corporation does not have a formal policy regarding attendance by
members of the Board of Director at the Corporation's annual meetings of
stockholders. The Corporation has always encouraged its directors to attend its
annual meetings of stockholders and expects to continue this policy. In 2005, 13
Corporation directors attended the Corporation's annual meeting of stockholders.

STOCKHOLDER COMMUNICATION WITH THE BOARD

         The Corporation does not have a formal process for stockholder
communications with the Board of Directors. The Corporation has made an effort
to ensure that the Board of Directors or individual directors, as applicable,
hear the views of Corporation's stockholders. The Corporation believes that it
has been responsive regarding conveying stockholder communications to the Board
of Directors.


                                       59


SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.

Based solely on the Corporation's review of the copies of initial statements of
beneficial ownership on Form 3 and reports of changes in beneficial ownership on
Form 4 that it has received in the past year, annual statements of changes in
beneficial ownership on Form 5 with respect to the last fiscal year, and written
representations that no such annual statement of change in beneficial ownership
was required, all directors, executive officers, and beneficial owners of more
than 10% of its common stock have timely filed those reports with respect to
2005, except for a Form 4 reporting acquisition of shares upon option exercise
by Director Grasmick, which was inadvertently filed 1 day late. . The
Corporation makes no representation regarding persons who have not identified
themselves as being subject to the reporting requirements of Section 16(a) of
the Securities Exchange Act of 1934, or as to the appropriateness of disclaimers
of beneficial ownership.

Item 10. Executive Compensation

         Information required by this item is listed below.

CODE OF ETHICS AND BUSINESS CONDUCT

         For years the Corporation has had policies regarding conflicts of
interest and securities law compliance. The Corporation has adopted a Code of
Ethics and Business Conduct that reflects these longstanding policies and
contains additional policy initiatives. The Corporation requires all its
directors, executive officers and employees to adhere to the Code of Ethics and
Business Conduct in addressing the legal and ethical issues encountered in
conducting their work. The Code of Ethics and Business Conduct requires that the
Corporation's directors, executive officers and employees avoid conflict of
interest, comply with securities laws and other legal requirements and conduct
business in an honest and ethical manner. The Corporation conveys to its
directors, executive officers and employees both their obligations and
responsibilities under and the importance of the Code of Ethics and Business
Conduct.
         Directors, executive officers and employees are required to report any
conduct that they believe in good faith to be an actual or apparent violation of
the Code of Ethics and Business Conduct. The Corporation has established
procedures for receiving, retaining and treating complaints received regarding
accounting, internal accounting controls or auditing matters and for the
confidential and anonymous submission by employees of concerns regarding
questionable accounting or auditing matters. The Corporation's stockholders may
obtain a copy of the Code of Ethics and Business conduct by writing to the
Corporation's Corporate Secretary, Harbor Bankshares Corporation, 25 West
Fayette Street, Baltimore, Maryland 21201. A Copy of the Code of Ethics and
Business Conduct has been filed with the SEC as an exhibit to the Corporation's
Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004.

COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

SUMMARY COMPENSATION TABLE

         The following table shows compensation paid to certain executive
officers of the Corporation for the three-year period ended December 31, 2005.
No other executive officer of the Corporation received total annual compensation
in excess of $100,000 during such period.


                                                            ANNUAL COMPENSATION
                                                      ------------------------------
                                                                                          ALL OTHER
NAME AND POSITION                                     YEAR      SALARY       BONUS       COMPENSATION
-----------------                                     ----     ---------    -------      ------------
Joseph Haskins, Jr. (1)(2)                            2005     $213,383     170,706        $6,191
 Chairman, President and                              2004      207,168     165,734         6,191
 Chief Executive Officer                              2003      203,105     182,795         6,191

Teodoro J. Hernandez                                  2005       99,548      14,955            --
 Vice President and Treasurer                         2004       91,781       9,179            --
                                                      2003       90,000      17,000            --

Darius L. Davis                                       2005      101,904      15,000            --
 Executive Vice President/Bank                        2004       86,797      15,000            --


(1) Bonus paid pursuant to the terms of Mr. Haskins' employment agreement.

(2) All other compensation represents premiums for term life benefit paid by the
Corporation.


                                       60


                        OPTION GRANTS IN LAST FISCAL YEAR

         The Corporation has adopted stock option plans, pursuant to which it
has reserved 226,886 shares of its Common Stock for the issuance of options. The
following table sets forth information regarding the options granted to the
named executive officers during 2005.


                                   NUMBER OF           PERCENT OF TOTAL       EXERCISE OR      MARKET PRICE PER
                               SHARES UNDERLYING      OPTIONS GRANTED TO      BASE PRICE         SHARE ON DATE
NAME                            OPTIONS GRANTED    EMPLOYEES IN FISCAL YEAR   PER SHARE             OF GRANT       EXPIRATION DATE
----                            ---------------    ------------------------   ---------             --------       ---------------
Joseph Haskins, Jr. ......          2,560                    42.3%              $25.00                $25.00           1/1/2016
Teodoro J. Hernandez......            796                    13.2                25.00                 25.00           1/1/2016
Darius L. Davis...........          1,223                    20.2                25.00                 25.00           1/1/2016


                 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                          AND YEAR END VALUE OF OPTIONS

         The following table set for the aggregated option exercises in 2005 and
the option values at December 31, 2005, based upon a market value for Company
Common Stock of $25.00 per share:


                                     NUMBER OF                            NUMBER OF          VALUE OF UNEXERCISE
                                  SHARES ACQUIRED       VALUE       UNEXERCISED OPTIONS     IN-THE-MONEY OPTIONS
NAME                                ON EXERCISE        REALIZED     AT FISCAL YEAR-END(1)    AT FISCAL YEAR-END
----                                -----------        --------     ---------------------    ------------------
Joseph Haskins, Jr. .........         4,053             41,330             50,938                  $345,989
Teodoro J. Hernandez ........            --                 --              8,775                    59,085
Daruius L. Davis.............            --                 --              3,048                     5,024


-----------------
(1) Currently exercisable options.

COMPENSATION OF DIRECTORS

         Directors of the Corporation receive a fee of $533 for each board
meeting attended ($1,066 if the director is a member of the Corporation's
Executive Committee), but do not receive a fee for attendance at the committee
meetings. Mr. Vaeth received an additional fee of 4,340 for acting as secretary
at each of the board and board committee meetings. Total fees paid to directors
of the Corporation during 2005 were $104,605. Directors who are not employed by
the Corporation or the Bank are permitted to elect whether to receive their fees
in the form of cash or in the form of options to purchase Common Stock of the
Corporation under the 1995 Director Stock Option Plan which has been approved by
the Corporation's stockholders. The exercise prices of the options will equal
the market price of the Common Stock on the date of grant. The Corporation did
not grant any options to its directors in 2005.

MR. HASKINS' EMPLOYMENT AGREEMENT AND RETIREMENT BENEFIT

         Joseph Haskins, Jr. has an employment agreement with the Corporation
and the Bank for a four-year term commencing as of January 1, 2000, which term
may be automatically renewed for additional three-year terms unless earlier
terminated. The employment agreement provides that Mr. Haskins will serve as
Chairman of the Board, President and Chief Executive Officer of the Corporation
and Chairman of the Board and Chief Executive Officer of the Bank at an annual
salary of $182,330, subject to annual increases approved by the Corporation and
the Bank. Under the employment agreement, Mr. Haskins may also receive an annual
incentive bonus based upon the attainment of goals and objectives set by the
Corporation's Board of Directors. If the minimum level of such goals and
objectives is not met, Mr. Haskins will not be entitled to an incentive bonus.
If the Corporation's Board of Directors awards Mr. Haskins an incentive bonus,
the amount of the bonus will range from 60% to 100% of Mr. Haskins's then
current salary, as determined by the Board of Directors. In addition to the
benefit programs, plans, and arrangements of the Corporation and the Bank
generally available to their employees and the normal perquisites provided to
their senior executive officers, the employment agreement provides that Mr.
Haskins will receive long-term disability insurance, life insurance, and an
automobile allowance. Further, the Corporation must maintain a key man life
insurance policy on the life of Mr. Haskins in order to provide the funds
necessary to buy his shares of Corporation Common Stock from his estate or his
heirs.


                                       61


         If the Corporation terminates Mr. Haskins' employment because he
becomes disabled, the Corporation will continue to provide Mr. Haskins with
long-term disability insurance and medical and group life insurance until he
attains age 65. Upon termination without cause or resignation with good reason
(as those terms are used in the employment agreement), Mr. Haskins would be
entitled to (1) severance pay equal to three times his base salary at the time
of termination, payable in three equal annual installments, the first of which
is due within 30 day of termination, (2) a pro rated bonus based upon the bonus
paid in the year prior to termination or resignation, and (3) immediate vesting
of his outstanding options. If Mr. Haskins voluntarily resigns without good
reason or if the Corporation terminates his employment for cause, the
Corporation would not have any further obligations to Mr. Haskins under his
employment agreement.

         The Corporation must pay a change of control benefit to Mr. Haskins if
either (1) within 12 months after a change of control of the Corporation, the
Corporation terminates Mr. Haskins' employment without cause or Mr. Haskins
terminate his employment for good reason or (2) within 30 days after the
expiration of six month after the change in control, Mr. Haskins' terminates his
employment for any reason. The change of control benefit would equal the greater
of (1) 2.99 times the average of Mr. Haskins' gross compensation from the
Corporation over the five-year period before the termination or (2) the amount
Mr. Haskins would receive if he was terminated without cause, as described in
the prior paragraph. Further, in such event, Mr. Haskins would be entitled to
the immediate vesting of his options.

         Mr. Haskins may be entitled to receive a retirement benefit under an
executive supplemental retirement plan. Mr. Haskins will receive 15 annual
payment of the greater of (1) 63% of his final base salary or (2) $200,000,
payable at the time of retirement, if he retires at or after age 62. Mr. Haskins
will receive 15 annual payments, each payment being equal to 63% of his final
base salary, payable at the time of retirement or termination (or in the case of
a disability, at the age of 65), if before age 62:

             o  Mr. Haskins terminates his employment for good reason or, within
                30 days after the expiration of six months after a change of
                control of the Corporation, Mr. Haskins terminates his
                employment with or without good reason; or

             o  the Corporation terminates Mr. Haskins' employment without cause
                or because of a disability.

         If Mr. Haskins terminates his employment before age 62 without good
         reason, Mr. Haskins will be entitled to a prorated amount of 63% of his
         final base salary based upon the number of years he provided services
         to the Corporation from the year 2000 until such time has he retires.
         However, if the Corporation terminates Mr. Haskins' employment for
         cause, Mr. Haskins will forfeit his retirement benefit. In the event of
         Mr. Haskins' death, Mr. Haskins' beneficiaries would be entitled to
         receive the reminder of the retirement benefit should he die before
         receipt of the full retirement benefit.

INFORMATION REGARDING MR. HERNANDEZ

         Mr. Hernandez is 61 years old and has served as Vice President and
Cashier of the Bank since 1982 and Vice President and Treasurer of the
Corporation since its formation in 1992. He became a Senior Vice President of
the Bank in 1998.

         Mr. Hernandez may be entitled to receive a retirement benefit under an
executive supplemental retirement plan. Mr. Hernandez will receive 15 annual
payments of $40,000, payable at the time of retirement, if he retires at or
after age 65. Mr. Hernandez will receive 15 annual payments, in amounts ranging
from $5,309 to $40,000, if Mr. Hernandez retires before age 65. In the event of
a change of control of the Bank, if Mr. Hernandez's employment is terminated for
any reason (other than a Bank-approved leave of absence), Mr. Hernandez will be
entitled to receive the same benefit as if he retired at or after age 65. Mr.
Hernandez's beneficiaries would be entitled to receive the remainder of the
retirement benefit should he die before receipt of the full retirement benefit.
In the event of Mr. Hernandez's death while in active services of the Bank, Mr.
Hernandez's beneficiaries would be entitled to receive a lump sum payment
ranging from $38,676 to $396,987, depending upon the year of his death. However,
if the Board of Directors terminates Mr. Hernandez's employment for cause, Mr.
Hernandez will forfeit his retirement benefit.


                                       62


Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

         Information required by this item is listed below:

                                 STOCK OWNERSHIP

         There were 641,784 shares of the Common Stock issued and outstanding on
March 3, 2006. The following table shows the beneficial ownership of the Common
Stock as of this dates by: (1) each of the Corporation's current named executive
officers and directors and (2) all of the Corporation's current directors and
executive officers as a group.

                                                                 NUMBER OF SHARES
                                                                   BENEFICIALLY      PERCENTAGE OF SHARES
NAME OF BENEFICIAL OWNER(1)(2)                                       OWNED(3)          BENEFICIALLY OWNED
------------------------------                                   -----------------   --------------------
Joseph Haskins, Jr. (4) ..................................            95,538                13.79%
Teodoro J. Hernandez (5) .................................             8,775                 1.35%
James H. Degraffereidt, Jr. (6) ..........................            13,928                 2.13%
Louis J. Grasmick (7) ....................................            23,227                 3.42%
Nathaniel Higgs (8) ......................................             9,545                 1.47%
Delores G. Kelley (9) ....................................            16,923                 2.60%
Erich March (10) .........................................            26,093                 4.00%
John Paterakis (11) ......................................            58,789                 9.16%
John D. Ryder ............................................             3,219                   *
James Scott, Jr. (12) ....................................             3,747                   *
Edward St. John ..........................................            13,488                 2.10%
Walter S. Thomas (13) ....................................               228                   *
Stanley W. Tucker (14) ...................................            13,268                 2.07%
George F. Vaeth, Jr. (15) ................................            20,725                 3.18%

All directors and executive officers
As a group (14 persons) (16) .............................           307,493                40.40%

----------------
*      Less Than 1%

(1)    Unless otherwise specified, the address of these persons is c/o Harbor
       Bankshares Corporation, 25 West Fayette Street, Baltimore, Maryland
       21201.

(2)    The Corporation uses the SEC's definition of beneficial ownership. This
       means that the person named in this table have sole or shared voting
       and/or investment power over the shares shown. Beneficial ownership also
       includes shares underlying options currently exercisable or exercisable
       within 60 days.

(3)    Unless otherwise specified, the number of shares shown represents shares
       of Common Stock.

(4)    Represents 44,600 shares of Common Stock and 50,938 shares of Common
       Stock issuable upon the exercise of options.

(5)    Represents 8,775 shares of Common Stock issuable upon the exercise of
       options.

(6)    Represents 4,325 hares of Common Stock and 9,603 shares of Common Stock
       issuable upon the exercise of options.

(7)    Represents 13,227 shares of Common Stock (including 3,848 shares jointly
       owned with Mr. Grasmick and his son and 8,780 shares jointly owned by Mr.
       Grasmick and his wife) and 10,000 shares of Common Stock issuable upon
       the exercise of options.

(8)    Represents 4,545 shares of Common Stock (including 4,175 shares jointly
       owned by Reverend Higgs and his wife) and 5,000 shares of Common Stock
       issuable upon the exercise of options.

(9)    Represents 6,923 shares of Common Stock (including 619 shares jointly
       owned by Dr. Kelley and her husband) and 10,000 shares of Common Stock
       issuable upon the exercise options.

(10)   Represents 16,093 shares of Common Stock (including 15,435 shares owned
       by a corporation over which Mr. March has the power to vote) and 10,000
       shares of Common Stock issuable upon the exercise of options.

(11)   Includes 32,874 shares of Common Stock owned by three corporations
       controlled by Mr. Paterakis (J and B Associates, Inc. - 16,437 shares; H
       & S Bakery, Inc. - 6,164 shares; Northeast Food, Inc. 10,273 shares) and
       11,300 shares of Common Stock owned by Paterakis Limited Partnership,
       LLP.

(12)   Includes 3,430 shares of Common Stock jointly owned by Mr. Scott and his
       wife.

(13)   The number of shares of Common Stock owned does not include 3,757 shares
       owned by a religious organization over which Pastor Thomas has the power
       to vote.

(14)   Includes 13,234 shares of Common Stock owned by MMG ventures L.P. over
       which Mr. Tucker has authority to vote.

(15)   Represents 10,725 shares of Common Stock and 10,000 shares of Common
       Stock issuable upon the exercise of options.

(16)   Represents 193,177 shares of Common Stock and 114,316 shares of Common
       Stock issuable upon the exercise of options.

                                       63


Item 12.  Certain Relationships and Related Transactions

         During the past year the Bank has had loan transactions in the ordinary
course of its banking business with directors and executive officers of the Bank
and with their affiliates. Loans to such persons were made in the ordinary
course of business and did not and do not currently involve more than the normal
risk of collectibility or present other unfavorable features. All such loans
were made on substantially the same terms including interest rates and
collateral requirements, as those prevailing at the time for comparable
transactions with non-affiliates. The bank expects to enter into such
transaction in the future. As of December 31, 2005, loans to directors and
executive officers of the Bank, and their affiliates, including loans guaranteed
by such persons and unfunded commitments made in 2005, aggregated $13,468,000 or
approximately 63.2% of tangible stockholders' equity of the Bank.

Item 13.  Exhibits

 The following is a list of exhibits filed as part of this Annual Report on Form
10-KSB.

No.               Exhibit

3.1         Articles of Incorporation of Harbor Bankshares Corporation
            (incorporated by reference to Exhibit 3(a) to Registration Statement
            on Form S-4 filed July 17, 1992.

3.2         Bylaws of Harbor Bankshares Corporation (incorporated by reference
            to Exhibit 3(b) to Registration Statement on Form S-4 filed July 17,
            1992.

10.1*       Harbor Bankshares Corporation Stock Option Plan (incorporated by
            reference to Exhibit 10(b) to Registration Statement on Form S-4
            filed July 17, 1992.

10.2*       Employment Agreement by and between Joseph Haskins, Jr., Harbor
            Bankshares Corporation, and the Harbor Bank of Maryland effective
            January 1, 2000.

10.3        1995 Directors Stock Option Plan

10.4,10.5   Deferred Compensation Agreements.

13          Portions of the Annual Report to Shareholders for the Year Ended
            December 31, 2005

14          Code of Ethics

23          Consent of Independent Registered Public Accounting Firm

31(a),(b)   Rule 13a-14(a)/15d-14(a) Certifications

32(a),(b)   18 U.S.C. Section 1350 Certifications

*           Management contract or compensatory plan or arrangement.

The Corporation will furnish copies of the exhibits to this report upon request
of its stockholders upon payment of a reasonable fee upon request to Teodoro J.
Hernandez, Treasurer, Harbor Bankshares Corporation, 25 West Fayette Street,
Baltimore, Maryland 21201.

                                       64


Item 15. Principal Accountant Fees and Services

GENERAL

         The Audit Committee has retained Stegman & Company as independent
public accountants to audit the Corporation's 2006 consolidated financial
statements. Stegman & Company also audited the Corporation's consolidated
financial statements for 2004 and 2005. A representative of Stegman & Company is
expected to be present at the Annual Meeting, with the opportunity to make a
statement if he or she decides, and will respond to appropriate questions.

AUDIT AND NON-AUDIT FEES

                                        2005        2004
                                        ----        ----
Audit Fees                           $60,500     $59,950
Audit-Related Fees                     1,950       2,250
Tax Fees                              10,425      10,725
All Other Fees                            --          --
     Total                           $72,875     $72,925


           Fees that the Corporation paid to Stegman & Company in 2004 and 2005
are set forth in the above table. Audit fees are fees the Corporation paid
Stegman & Company for the audit and quarterly reviews of the Corporation's
consolidated financial statements, assistance with the review of documents filed
with the SEC, consent procedures and accounting consultation related to
transaction and the adoption of new accounting pronouncements. Audit-related
fees are fees for services that are reasonably related to the performance of the
audit or the review of the Corporation's consolidated financial statements and
principally included consultation concerning financial accounting and reporting
standards. Tax fee primarily included tax compliance services. Stegman & Company
did not provide any other services to the Corporation in 2004 and 2005.

POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDI AND NON-AUDIT SERVICES

           The Audit committee's policy is to pre-approve all audit and
non-audit services proved by the independent public accountants. These services
may include audit services, and audit-related services, tax services and other
services. Pre-approval is generally provided for up to one year and any
pre-approval is derailed as to the particular service or category of services
and is generally subject to a specific budget. The Audit Committee has delegated
pre-approval authority to its Chair when expedition of services is necessary.
The Chair is required to report any decision to pre-approve such services to the
full Audit Committee at its next meeting. The independent public accountants and
management are required to periodically report to the full Audit Committee
regarding the extent of services provided by the independent public accountants
in accordance with this pre-approval, and the fees for the services performed to
date.


                                       65



SIGNATURES

           In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.


       HARBOR BANKSHARES CORPORATION

By:    /s/ Teodoro J. Hernandez
Title: Vice President and Treasurer
Date:  March 8, 2006

           In accordance with Section 13 or 15(d) of the Exchange Act, this
report has been signed by the following persons on behalf of the Registrant, and
in the capacities, and on the dates indicated:

By:    /s/ Joseph Haskins, Jr.
Title: Chairman of the Board, President, and Chief Executive
       Officer
Date:  March 8, 2006
---------------------------------------

By:    /s/ Nathaniel Higgs                    By:    /s/ James H. DeGraffenreidt
Title: Director                               Title: Director
Date:  March 8, 2006                          Date:  March 8, 2006
---------------------------------------       ----------------------------------

By:    /s/ George F. Vaeth, Jr.               By:    /s/ Louis Grasmick
Title: Director                               Title: Director
Date:  March 8, 2006                          Date:  March 8, 2006
---------------------------------------       ----------------------------------
By:    /s/ Stanley W. Tucker                  By:    /s/ John D. Ryder
Title: Director                               Title: Director
Date:  March 8, 2006                          Date:  March 8, 2006
---------------------------------------       ----------------------------------
By:    James Scott, Jr.                       By:    /s/ Erich W. March
Title: Director                               Title: Director
Date:  March 8, 2006                          Date:  March 8, 2006
---------------------------------------       ----------------------------------
By:    /s/ John Paterakis                     By:    /s/ Edward St. John
Title: Director                               Title: Director
Date:  March 8, 2006                          Date:  March 8, 2006
---------------------------------------
By:    /s/ Walter S. Thomas, Sr.
Title: Director
Date:  March 8, 2006
---------------------------------------
By:    /s/ Delores J. Kelly
Title: Director
Date:  March 8, 2006
---------------------------------------


                                       66

Appendix E
Form 10-QSB

 

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-QSB

	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2006.

OR

	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                                to

	Commission File Number 0-20990

	HARBOR BANKSHARES CORPORATION
	(Exact name of registrant as specified in its charter)

Maryland		52-1786341
(State of other jurisdiction of incorporation or organization)		(IRS Employer identification No.)
25 W. Fayette Street, Baltimore, Maryland		21201
(Address of principal executive office)		(Zip code)

Registrants' telephone number, including area code:		(410) 528-1800

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.

Yes No

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act.

Yes No

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common stock, non-voting, $.01 Par value – 33,795 shares as of August 9, 2006.

Common stock, $.01 Par value –641,784 shares as of August 9, 2006.

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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INDEX

PART I	FINANCIAL INFORMATION
	Item 1	Financial Statements
		Consolidated Statements of Financial Condition – June 30, 2006 (Unaudited) and December 31, 2005
		Consolidated Statements of Income, (Unaudited) – Three months Ended June 30, 2006 and 2005
		Consolidated Statement of Income, (Unaudited) Six months Ended June 30, 2006 and 2005.
		Consolidated Statement of Cash Flows (Unaudited) -Six months Ended June 30, 2006 and 2005
		Notes to Unaudited Consolidated Financial Statements
	Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations
	Item 3	Controls and Procedures
PART II	OTHER INFORMATION
SIGNATURES

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CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

		June 30, 2006			December 31, 2005
		(Unaudited)
		Dollars in Thousands
ASSETS
Cash and Due from Banks		$	6,665		$	7,334
Federal Funds Sold			2,255			15,625
Investment Securities:
Held to maturity at amortized cost (fair value of $23 as of June 30, 2006 and $30 as of December 31, 2005)			23			30
Available for Sale, at fair value			26,006			26,117
Total Investment Securities			26,029			26,147
Loans Held for Sale			—			716
Loans			205,605			190,279
Allowance for Loan Losses			(2,145	)		(2,059	)
Net Loans			203,460			188,220
Property and Equipment – Net			7,518			7,526
Goodwill			2,506			2,506
Intangible Assets			423			463
Bank-owned Life Insurance			4,257			4,179
Accrued Interest Receivable and Other Assets			5,061			3,920
TOTAL ASSETS		$	258,174		$	256,636
LIABILITIES AND STOCKHOLDER'S EQUITY
Deposits:
Non-Interest Bearing Demand		$	46,770		$	50,433
Interest Bearing Transaction Accounts			23,587			25,562
Savings			81,861			87,499
Time, $100,000 or more			42,558			32,810
Other Time			33,699			33,540
Total Deposits			228,475			229,844
Short Term Borrowings			3,000
Junior Subordinated Debentures			7,217			7,217
Accrued Interest and Other Liabilities			2,252			2,621
TOTAL LIABILITIES			240,944			239,682
STOCKHOLDERS' EQUITY
Common stock, – par value $.01 per share:
Authorized 10,000,000 shares; issued and outstanding 641,784 at June 30, 2006 and 651,784 at December 31, 2005 and 33,795 common non-voting at June 30, 2006 and December 31, 2005			6			7
Paid-in Capital			6,405			6,616
Retained Earnings			11,405			10,853
Accumulated other comprehensive loss			(586	)		(522	)
TOTAL STOCKHOLDERS' EQUITY			17,230			16,954
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY		$	258,174		$	256,636

See Notes to Unaudited Consolidated Financial Statements

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CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended June 30
		2006			2005
		(Unaudited) Dollars in Thousands Except Per Share Data
INTEREST INCOME
Interest and Fees on Loans		$	4,047		$	3,393
Interest on Investment Securities (Taxable)			209			209
Interest on Deposits in Other Banks			—			9
Interest on Federal Funds Sold			27			20
Other Interest Income			9			3
TOTAL INTEREST INCOME			4,292			3,634
INTEREST EXPENSE
Interest on Deposits:
Savings			614			316
Interest Bearing Transaction Accounts			13			13
Time $100,000 or More			316			150
Other Time			344			281
Interest Other Borrowed Money			40			9
Interest on Junior Subordinated Debentures			141			106
TOTAL INTEREST EXPENSE			1,468			875
NET INTEREST INCOME			2,824			2,759
Provision for Loan Losses			80			120
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			2,744			2,639
NON-INTEREST INCOME
Service Charges on Deposit Accounts			188			249
Other Income			221			198
TOTAL NON-INTEREST INCOME			409			447
NON-INTEREST EXPENSE
Salaries and Employee Benefits			1,158			1,077
Advertising			107			109
Occupancy Expense of Premises			319			246
Equipment Expense			84			79
Professional Cost			74			53
Data Processing Expense			275			265
Other Expenses			448			398
TOTAL NON-INTEREST EXPENSES			2,465			2,227
INCOME BEFORE INCOME TAXES			688			859
Applicable Income Taxes			240			321
NET INCOME		$	448		$	538
BASIC EARNINGS PER SHARE		$	0.66		$	0.78
DILUTED EARNINGS PER SHARE		$	0.62		$	0.72
Dividends Declared per Share			—			—

See notes to unaudited consolidated Financial Statements

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CONSOLIDATED STATEMENTS OF INCOME

		Six Months Ended June 30
		2006			2005
		(Unaudited) Dollars in Thousands Except Per Share Data
INTEREST INCOME
Interest and Fees on Loans		$	7,824		$	6,560
Interest on Investment Securities (Taxable)			416			428
Interest on Deposits in Other Banks			1			18
Interest on Federal Funds Sold			178			46
Other Interest Income			17			10
TOTAL INTEREST INCOME			8,436			7,062
INTEREST EXPENSE
Interest on Deposits:
Savings			1,223			579
Interest Bearing Transaction Accounts			26			27
Time $100,000 or More			575			285
Other Time			678			511
Interest Other Borrowed Money			41			13
Interest on Junior Subordinated Debentures			271			203
TOTAL INTEREST EXPENSE			2,814			1,618
NET INTEREST INCOME			5,622			5,444
Provision for Loan Losses			135			240
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			5,487			5,204
NON-INTEREST INCOME
Service Charges on Deposit Accounts			356			487
Other Income			430			452
Loss on Sale of Loans			(2	)		—
TOTAL NON-INTEREST INCOME			784			939
NON-INTEREST EXPENSE
Salaries and Employee Benefits			2,344			2,198
Advertising			196			196
Occupancy Expense of Premises			649			460
Equipment Expense			170			166
Professional Cost			129			241
Data Processing Expense			549			526
ATM Loss			—			225
Other Expenses			843			813
TOTAL NON-INTEREST EXPENSES			4,880			4,825
INCOME BEFORE INCOME TAXES			1,391			1,318
Applicable Income Taxes			496			486
NET INCOME		$	895		$	832
BASIC EARNINGS PER SHARE		$	1.32		$	1.20
DILUTED EARNINGS PER SHARE		$	1.24		$	1.11
Dividends Declared per Share		$	0.50		$	0.40

See notes to unaudited consolidated Financial Statements

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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CONSOLIDATED STATEMENTS OF CASH FLOWS

		Six Months Ended June 30
		2006			2005
		(Unaudited) Dollars in Thousands
OPERATING ACTIVITIES
Net Income		$	895		$	832
Adjustments to Reconcile Net Income to Net Cash
And Cash Equivalents Provided by Operating
Activities:
Origination of Loans Held for Sale			—			(152	)
Proceeds from the Sale of Loans Held for Sale			714			—
Increase in bank-owned life insurance policies			(78	)		(78	)
Loss on sale of loans			2			—
Provisions for loan losses			135			240
Depreciation and Amortization			480			330
(Increase) Decrease in Interest Receivable and Other Assets			(1,171	)		1,214
(Decrease) Increase in Interest Payable and Other Liabilities			(369	)		322
Net Cash Provided by Operating Activities			608			2,708
INVESTING ACTIVITIES
Net decrease in Deposits at Other Banks			—			1,294
Proceeds from Matured Securities and Principal Payments			12			2,005
Net Increase in Loans			(15,265	)		(8,224	)
Purchase of Premises and Equipment			(432	)		(1,885	)
Net Cash Used in Investing Activities			(15,685	)		(6,810	)
FINANCING ACTIVITIES
Net (Decrease) Increase in Non-Interest Bearing
Transaction Accounts			(3,663	)		1,440
Net (Decrease) Increase in Interest Bearing
Transaction Accounts			(1,975	)		4,827
Net Decrease in Savings Deposits			(5,638	)		(1,938	)
Net Increase in Time Deposits			9,907			3,352
Short Term Borrowings			3,000			—
Payment of Cash Dividends			(343	)		(282	)
Retirement of Common Stock			(250	)		(525	)
Proceeds from the Sale of Common Stock			—			63
Net Cash Provided by Financing Activities			1,038			6,937
(Decrease) Increase in Cash and Cash Equivalents			(14,039	)		2,835
Cash and Cash Equivalents at Beginning of Period			22,959			16,714
Cash and Cash Equivalents at End of Period		$	8,920		$	19,549

See notes to unaudited consolidated Financial Statements

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Notes to Unaudited Consolidated Financial Statements
For the Three Months and Six Months Ended June 30, 2006

Note A:	Basis of Presentation
		The accompanying unaudited consolidated financial statements of Harbor Bankshares Corporation and subsidiaries (The "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10 – QSB. Accordingly, they do not include all the information required for complete financial statements. In the opinion of management, all adjustments and reclassifications considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature. Operating results for the three month and six month periods ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The enclosed unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto incorporated by reference in the Company’s Annual Report on Form 10 – KSB for the year ended December 31, 2005. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2006.

Note B:	Comprehensive Income

		The Company’s comprehensive income consists of its net income and unrealized holding losses on its available for sale securities, net of taxes.

		Presented below is a reconciliation of net income to comprehensive income.

		Three Months Ended March 31						Six Months Ended June 30
		2006			2005			2006			2005
Net Income		$	448		$	538		$	895		$	832
Unrealized (loss) gains on securities
Available-for-sale			(35	)		164			(106	)		(524	)
Related Income Tax (benefit) expense			(14	)		65			(42	)		(207	)
			(21	)		99			(64	)		(317	)
Total Comprehensive Income		$	427		$	637		$	831		$	515

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EARNINGS PER SHARE

Note C:		Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Basic earnings per share does not include the effect of potentially dilutive transactions or conversions. The computation of diluted earnings per share reflects the potential dilution of earnings per share under the treasury stock method, which could occur if contracts to issue common stock, such as stock options, were exercised and shared in corporate earnings. At June 30, 2006 and 2005, there were no antidilutive options to purchase common shares.

The following table presents a summary of per share data and amounts for the period indicated:

(amount in thousands except per-share data)

		Three Months Ended June 30						Six Months Ended June 30
		2006			2005			2006			2005
Basic:
Net income applicable to common stock		$	448		$	538		$	895		$	832
Average common shares outstanding			675			691			678			694
Basic earnings per share		$	.66		$	.78		$	1.32		$	1.20
Diluted:
Net income applicable to common stock		$	448		$	538		$	895		$	832
Average common shares outstanding			675			691			678			694
Stock option adjustment			41			55			41			55
Diluted average common shares outstanding			716			746			719			749
Diluted earnings per share		$	.62		$	.72		$	1.24		$	1.11

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Note D:

EMPLOYEE STOCK-BASED COMPENSATION

Effective on January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, "Share-Based Payment" (Statement 123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company accounted for stock-based compensation plans and the employee stock purchase plan in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations and provided the required pro forma disclosures of Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation". The Company elected to adopt the modified prospective-transition method as provided by Statement 123R. Under this transition method, compensation cost recognized during 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006 based on the grant-date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123R. The effect of applying Statement 123R was a decrease in net income of $17 and $26 thousand net of taxes for the three and six month period ended June 30, 2006, or $0.02 and $0.04 per basic and diluted share respectively. Results for prior periods have not been restated.

The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of Statement 123R to stock-based employee compensation for the period ended June 30, 2005:

		Three months Ended June 30, 2005			Six Months Ended June 30, 2005
Net income, as reported		$	538		$	832
Add: Stock-based compensation cost included in net loss, net of taxes			—
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of taxes			(12	)		(24	)
Pro forma net income attributable to common stockholders		$	526		$	808
Net income attributable to common stockholders:
Basic – as reported		$	0.78		$	1.20
Diluted – as reported		$	0.76		$	1.16
Basic – pro forma		$	0.72		$	1.11
Diluted – pro forma		$	0.71		$	1.08

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The following are the assumptions made in computing the fair value of stock-based awards:

		Three months ended June 30,						Six months ended June 30,
		2006			2005			2006			2005
Average risk-free interest rate		4.36	%		5.00	%		4.36	%		5.00	%
Dividend yield		1.50	%		1.50	%		1.50	%		1.50	%
Expected term		10			10			10			10
Average expected volatility		20	%		20	%		20	%		20	%
Weighted average fair value of granted options		7.44			6.78			7.44			6.78

Expected volatilities are based on historical volatility of the Company’s stock. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of stock option activity during the six months ended June 30, 2006 and related information is included in the table below:

			Options			Weighted- Average Exercise Price		Aggregate Intrinsic Value
Outstanding at January 1, 2006			132,741			16.24		$	2,159,300
Granted			6,043			25.00			151,075
Exercised			—
Forfeited			(15,500	)		16.19			(250,945	)
Outstanding at June 30, 2006			123,284			16.70			2,059,430
Exercisable at June 30, 2006			123,284			16.70			2,059,430
Weighted-average remaining contractual life			7.6

The weighted average grant date fair value of options granted during the six month period ended June 30, 2006 was $25.00 per share. All options granted have an exercise price equal to the fair value of the Company’s common stock on the date of grant. Exercise prices for options outstanding as of June 30, 2006 ranged from $15.24 to $25.00 as follows:

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	Range of Exercise Prices		Options Outstanding		Weighted Average Exercise Prices of Options Outstanding				Weighted Average Remaining Contractual Life of Options Outstanding
	$15.24 – $17.35		99,853		$	15.45			5.35
	$18.00 – $21.69		12,497		$	20.24			7.65
	$23.04 – $25.00		10,934		$	24.44			9.73
			123,284

Note E:

NEW ACCOUNTING PRONOUNCEMENTS

SFAS No. 154, "Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. Previously, most changes in accounting principle were recognized by including the cumulative effect of changing to the new account principle in net income of the period of the change. Under SFAS 154, retrospective application requires (i) the cumulative effect of the change to the new accounting principle on periods prior to those presented to be reflected in the carrying amounts of assets and liabilities as of the beginning of the first year presented, (ii) an offsetting adjustment, if any, to be made to the opening balance of retained earnings (or other appropriate complements of equity) for that period, and (iii) financial statements for each individual prior period presented to be adjusted to reflect the direct period-specific effects of applying the new accounting principle. Special retroactive application rules apply in situation where it is impracticable to determine either the period – specific effects or the cumulative effect of the change. Indirect effects of a change in accounting principle are required to be reported in the period in which the accounting change is made. SFAS 154 carries forward the guidance in APB Opinion 20 "Accounting Changes," requiring justification of a change in accounting principle on the basis of preferability. SFAS 154 also carries forward without change the guidance contained in APB Opinion 20, for reporting the correction of an error in previously issued financial statements and for a change in an accounting estimate. SFAS is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 did not significantly impact the Company's financial statements.

In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments", an amendment of SFAS No. 133 and SFAS No. 140. This statement permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. It establishes a requirement to evaluate interests in securitized financial assets to identify interest that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. In addition, SFAS 155 clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133. It also clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS 155 amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement 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 evaluating the impact, if any, of the adoption of this Statement on its financial results.

In March 2006, the FASB issued SFAS No. 156 "Accounting for Servicing of Financial Assets": This Statement amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", and requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivative to qualify for hedge account treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. This Statement is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is evaluating the impact, if any, of the adoption of this Statement on its financial results.

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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Part I.  FINANCIAL INFORMATION

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

Forward-Looking Statements. This management’s discussion and analysis of financial condition and results of operations and other portions of this report include forward-looking statements such as: statements of the Company’s goals, intentions, and expectations; estimates of risks and of future costs and benefits; assessments of loan quality, and probable loan losses, liquidity, and interest risk; and statements of the Company’s ability to achieve financial and other goals. These forward-looking statements are subject to significant uncertainties because they are based upon: the amount and timing of future changes in interest rates, market behaviors, and other economic conditions; future laws and regulations; and a variety of other matters. Because of these uncertainties, the actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Company’s past growth and performance do not necessarily indicate its future results.

Harbor Bankshares Corporation earnings for the second quarter of 2006 totaled $448 thousand, a decrease of $90 thousand or 16.7 percent when compared to the second quarter of 2005. Net interest income increased by $65 thousand or 2.4 percent. Non-interest income decreased by $38 thousand or 8.5 percent and non-interest expenses increased by $238 thousand or 10.7 percent. The provisions for loan losses decreased by $40 thousand or 33.3 percent.

Year to date earning as of June 30, 2006 were $895 thousand, reflecting an increase of $63 thousand or 7.6 percent when compared to the first six months of 2005. The annualized return on average assets (ROAA) and average stockholders equity (ROAE) were .70 percent and 10.6 percent respectively, compared to .71 percent and 10.3 percent achieved during the first six months of 2005.

For the first six months of 2006, net interest income increased by $178 thousand or 3.3 percent. Interest and fees on loans increased by $1.2 million or 19.3 percent as a result of the growth in the portfolio and interest rate increases. Investment income decreased by $12 thousand or 2.8 percent. Interest on federal funds sold increased by $132 thousand or 74.2 percent resulting from higher balances and rates. Interest expense increased by $1.2 million or 73.9 percent. Interest on time deposits increased by $457 thousand or 57.4 percent. Interest expense on saving accounts increased by $644 thousand or 111.2 percent. Time deposits increased by $9.9 million or 14.9 percent when compared to December 31, 2005. This increase, combined with higher rates for both, time and savings deposits were the main reason for overall increase in interest expense. The interest expense on borrowed funds was $41 thousand. The interest expense for the junior subordinated floating rate debentures increased by $68 thousand or 33.5 percent due to higher interest rates.

For the second quarter of 2006, when compared to the same period for 2005, net interest income increased by $65 thousand or 2.4 percent. Interest and fees on loans increased by $654 thousand or 19.3 percent resulting from portfolio growth and rate increases. Investment income at $209 thousand remained the same for both periods. Federal fund sold income increased by $7 thousand or 35.0 percent. Interest expense increased by $593 thousand or 67.8 percent mainly due to higher rates on time and savings deposits. Interest expense on time deposits increased by $229 thousand or 53.1 percent due to higher rates and increased balances. Interest expense on savings accounts increased by $298 thousand or 94.3 percent mainly due to higher interest rates. The interest expense on borrowed funds for the period was $40 thousand. The interest expense for the junior subordinated debentures increased by $35 thousand or 33.0 percent due to higher interest rates.

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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As of June 30, 2006, the provision for loan losses was $135 thousand compared to $240 thousand for the same period in 2005. Charge-offs totaled $58 thousand reflecting an increase of $24 thousand when compared to the $34 thousand charged-off during the same period in 2005. Recoveries for the period were $9 thousand, compared to $72 thousand recovered during the first six months of 2005.

Future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and its underlying collateral, the mix of loans within the portfolio, delinquency trends, economic conditions, current and prospective trends in real estate values, and other relevant factors under our allowance methodology.

Our allowance for loan loss methodology is a loan classification-based system. We base the required allowance on a percentage of the loan balance for each type of loan classification level. Allowance percentages are based on each individual lending program, its loss history and underwriting characteristics including loan value, credit score, debt coverage, collateral, and capacity to service debt.

This analysis is used to validate the loan loss reserve matrix as well as assist in establishing overall lending direction. In Management’s opinion, the allowance for loan losses as of June 30, 2006 is adequate. There were no changes in estimation methods or assumptions that affected the methodology for assessing the appropriateness of the allowance during the period.

Non-performing assets consist of non-accruing loans, loans past due 90 days or more but still accruing, restructured loans, and foreclosed real estate.

The following table shows the non-performing assets as of June 30, 2006 compared to December 31, 2005.

		June 30, 2006			December 31, 2005
		(In Thousands)
Non-accruing Loans		$	349		$	558
Past Due 90 days or more			21			18
Restructured loans			—			—
Total non-performing loans			370			576
Foreclosed real estate			—			—
Total non-performing assets		$	370		$	576
Non-performing loans to total loans			0.18	%		0.30	%
Non-performing assets to total assets			0.14	%		0.22	%
Allowance for loan losses to non-performing loans			579.73	%		357.50	%

Non-interest income decreased by $155 thousand or 16.5 percent. Service charges on deposit accounts decreased by $131 thousand or 26.9 percent, mainly related to decreases in the returned check fees charges. Other income decreased by $22 thousand or 4.9 percent. There was a loss of $2 thousand on the sale of loans. Salary and employee benefits at $2.3 million increased by $146 thousand or 6.6 percent when compared to the same period of 2005. Advertising cost of $196 thousand remained the same for both periods. Occupancy expense increased by $189 thousand or 41.1 percent reflecting the cost associated with the renovation of the Company's headquarters building and the opening of a new branch facility in October, 2005. Equipment expenses increased by $4 thousand or 2.4 percent. Professional costs decreased by $112 thousand or 46.5 percent. Data processing fees increased by $23 thousand or 4.4 percent. Included in this non-interest expense for 2005, is a loss of $255 thousand resulting from the final settlement of the ATM shortage matter.

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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For the second quarter of 2006, when compared to the same period for 2005, non-interest income decreased by $38 thousand or 8.5 percent. Service charges on deposit accounts decreased by $61 thousand or 24.5 percent mainly related to the returned check fees charges. Other income increased by $23 thousand or 11.6 percent. Salary and employee benefits increased by $81 thousand or 7.5 percent and advertising cost decreased by $2 thousand or 1.8 percent. Occupancy expenses increased by $73 thousand or 29.7 percent reflecting the cost associated with renovation expenses and branch expansion. Equipment expenses increased by $5 thousand or 6.3 percent. Professional costs increased by $21 thousand or 39.6 percent. Data processing expense increased by $10 thousand or 3.8 percent and other expenses increased by $50 thousand or 12.6 percent.

As of June 30, 2006, total deposits were $228.5 million, reflecting a decrease of $1.3 million when compared to deposits as of December 31, 2005. Non-interest bearing deposits decreased by $3.7 million or 7.3 percent. Interest bearing transaction accounts decreased by $2.0 million or 7.7 percent. Savings accounts which included money market accounts decreased by $5.6 million or 6.4 percent and time deposits increased by $9.9 million or 14.9 percent. There was a $3.0 million short term borrowing from the Federal Home Loan Bank as of June 30, 2006.

Total loans, including loans held for sale, increased by $15.2 million or 8.1 percent. The increase was mainly the result of growth in the commercial loans and commercial real estate categories. Stockholders' equity increased by $276 thousand, resulting from earnings of $895 thousand offset by an increase of $64 thousand of unrealized losses on available-for-sale securities, cash dividend paid in the amount of $343 thousand, and the retirement of 10,000 shares or $250 thousand of common stock. Primary and risk based capital were 7.4 percent and 11.1 percent, respectively.

As of June 30, 2006, based on borrowing arrangements with the Federal Home Loan Bank there was unused credit availability of $22.8 million, the Company has sufficient liquidity to withstand any unusual demand for funds without the liquidation of its securities.

The Harbor Bank CDC ("CDC") and The Harbor Bank of Baltimore LLC ("LLC") were established in 2003. The Harbor Bank CDC is a non-profit company established for the purpose of bringing financial assistance to underserved areas in the City of Baltimore. The Corporation has no investments in this company. The Harbor Bank of Maryland, one of the Company's subsidiaries has a $1.3 million loan to the CDC. As of June 30, 2006, the CDC had $9 thousand in operating income and a $25 thousand loss since inception. These numbers exclude any tax benefit that may be available.

The Harbor Bank of Baltimore LLC was established for the purpose of taking advantage of the New Markets Tax Credit program offered by the U.S. Treasury Department for the development of certain targeted markets in the country. In the case of the LLC, the targeted market is the City of Baltimore. The LLC received a $50 million New Market Tax Credit award in September 2004. The LLC funded a $25.0 million loan through a partnership with General Motors Corporation. The Corporation has no investment in this company.

The financial data from these companies is not included in the Company's financial statements.

The Corporation's stock is traded from time to time over the counter, but is not listed on Nasdaq or any exchange or quoted on the OTC Bulletin Board. The last trade of which the Corporation is aware was on June 14, 2006 at a price of $28.00. During the first six months of 2006, other trades are believed to have been made at prices ranging from $25.00 to $29.73.

ITEM 3 Controls and Procedures

The Company’s management, under the supervision and with the participation of its Chief Executive Officer and the Chief Financial Officer, evaluated as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a – 15 under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Treasurer concluded that the Company’s disclosure controls and procedures were effective. There were no significant changes in the Company’s internal controls over financial reporting (as defined in Rule 13a – 15 under the Securities Act of 1934) for the period ending June 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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Part II.  OTHER INFORMATION

	Item 1.		Legal Proceedings
			The Company and its Bank subsidiary, at times and in the ordinary course of business, are subject to various pending and threatened legal actions. The relief or damages sought in some of these actions may be substantial. Management considers that the outcome of such actions will not have a material adverse effect on the Company's financial position; however, the Company is not able to predict whether the outcome of such actions may or may not have a material adverse effect on results of operations in a particular future period as the timing and amount of any resolution of such actions and relationship to the future results of operations are not known.

	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
			None
	Item 5.		Other Information
			None
	Item 6.		Exhibits
			Exhibit 31(a),(b), Rule 13a-14(a)/15d-14(a) Certifications
			Exhibit 32(a), (b), 18 U.S.C Section 1350 Certifications

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HARBOR BANKSHARES CORPORATION AND SUBSIDIARIES

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

HARBOR BANKSHARES CORPORATION

Date:	August 9, 2006		/s/Joseph Haskins, Jr.
			Joseph Haskins, Jr.
			Chairman and Chief Executive Officer
Date:	August 9, 2006		/s/Teodoro J. Hernandez
			Teodoro J. Hernandez
			Vice President and Treasurer

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                                   PRELIMINARY
                                 -FORM OF PROXY-

                                 REVOCABLE PROXY
                          HARBOR BANKSHARES CORPORATION
                         ANNUAL MEETING OF SHAREHOLDERS
                              ______________, 2006

       The undersigned hereby constitutes and appoints Joseph Haskins, Jr. and
George F. Vaeth, Jr. and each of them the proxies of the undersigned, with full
power of substitution, to attend the annual meeting of shareholders (the "Annual
Meeting") of Harbor Bankshares Corporation (the "Company") to be held at the
offices of the Company at 25 West Fayette Street, Baltimore, Maryland 21201 on
Wednesday,________ 2006, at 12:00 noon Eastern Time, or at any adjournment
thereof, and to vote all the shares of stock of the Company that the undersigned
may be entitled to vote, upon the following matters:

     THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR' APPROVAL OF THE AGREEMENT
     AND PLAN OF MERGER, "FOR" ADJOURNMENT OF THE ANNUAL MEETING IF NECESSARY TO
     SOLICIT ADDITIONAL VOTES FOR APPROVAL OF THE AGREEMENT AND PLAN OF MERGER,
     AND "FOR" THE ELECTION OF ALL DIRECTOR NOMINEES. PLEASE SIGN, DATE AND
     RETURN PROMPTLY IN THE ENCLOSED ENVELOPE. PLEASE MARK YOUR VOTE IN BLUE OR
     BLACK INK

     1.  Approval of the Agreement and Plan of Merger, dated as of ________,
         2006, by and between Harbor Bankshares Corporation and Harbor Merger
         Corporation, a Maryland corporation and wholly-owned subsidiary of
         Harbor Bankshares Corporation (the "merger subsidiary"), pursuant to
         which the merger subsidiary will merge with and into Harbor Bankshares
         Corporation, with Harbor Bankshares Corporation being the surviving
         corporation.

     FOR          AGAINST          ABSTAIN


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     2.  The adjournment of the Annual Meeting to solicit additional votes for
         approval of the Agreement and Plan of Merger, if necessary.

     FOR          AGAINST          ABSTAIN


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     3. The election of four Class II Directors, each to serve for a three-year
term.

     _____   For all nominees listed below (except as marked to the
             contrary below).

     _____   Withhold authority to vote for all nominees listed below.



     Nominees:   Nathaniel Higgs, Delores G. Kelley, Erich March,
                 and Stanley W. Tucker

     (TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, STRIKE OUT THE
NOMINEE'S NAME.)

     4. The transaction of such other matters as may properly come before the
     Annual Meeting or any adjournments or postponements thereof.

THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE INSTRUCTIONS MARKED HEREIN. IF
NO INSTRUCTIONS TO THE CONTRARY ARE MARKED HEREIN, THIS PROXY WILL BE VOTED FOR
APPROVAL OF THE AGREEMENT AND PLAN OF MERGER, FOR ADJOURNMENT OF THE ANNUAL
MEETING, IF NECESSARY, AND FOR THE ELECTION OF DIRECTORS, AND AS DETERMINED BY A
MAJORITY OF THE BOARD OF DIRECTORS AS TO OTHER MATTERS.



THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS.

The undersigned shareholder hereby acknowledges receipt of a copy of the
accompanying Notice of Annual Meeting of Shareholders and Proxy Statement and
hereby revokes any proxy or proxies previously given. This proxy may be revoked
at any time prior to its exercise.

PLEASE COMPLETE, DATE, SIGN, AND MAIL THIS PROXY PROMPTLY IN THE ENCLOSED
POSTAGE-PREPAID ENVELOPE.

To change the address on your account, please check the box at right and
indicate your new address in the address space above. Please note that changes
to the registered name(s) on the account may not be submitted via this method.

Signature of Shareholder                          Date:

Signature of Shareholder                          Date:

Note: Please sign exactly as your name or names appear on this Proxy. When
shares are held jointly, each holder should sign. When signing as executor,
administrator, attorney, trustee, or guardian, please give full title as such.
If the signer is a corporation, please sign full corporate name by duly
authorized officer, giving full title as such. If signer is a partnership,
please sign in partnership name by authorized person.

 

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