**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe fiscal year ended December 31, 2004**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe transition period from                  to                  **

**Commissionfile number 0-24557**

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrantas specified in its charter)
| **Virginia**                                                     | **54-1874630**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **8270 Greensboro Drive, Suite 500  McLean, Virginia**      | **22102**                             |
| (Address of  principal executive offices)                        | (Zip Code)                            |

 

Registrant’s telephonenumber, including area code**: (703) 584-3400**

Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, par value$1.00 per share**

(Title of class)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes   x   No   o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.    o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act). Yes   x   No   o

The aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold as of June 30, 2004 was$153,495,900.

The number of shares outstanding of Common Stock, asof February 28, 2005, was 18,529,344.

**DOCUMENTS INCORPORATED BY REFERENCE**

Portionsof the registrant’s definitive Proxy Statement for the Annual Meeting ofShareholders to be held on April 22, 2005 are incorporated by reference into Part IIIof this Form 10-K. With the exception of the portions of the ProxyStatement specifically incorporated herein by reference, the Proxy Statement isnot deemed to be filed as part of this Form 10-K.

 

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**TABLE OF CONTENTS**
|            | ** **                                                                                                           | ** ** | **Page** | ** ** |
|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|       | **PART I**                                                                                                           | ** ** |
| Item 1.    | Business                                                                                                             | 3          |
| Item 2.    | Properties                                                                                                           | 19         |
| Item 3.    | Legal  Proceedings                                                                                                   | 20         |
| Item 4.    | Submission  of Matters to a Vote of Security Holders                                                                 | 20         |
| ** ** | **PART II**                                                                                                     | ** ** |
| Item 5.    | Market  for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases  of Equity Securities | 21         |
| Item 6.    | Selected  Financial Data                                                                                             | 22         |
| Item 7.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operation                      | 23         |
| Item 7A.   | Quantitative  and Qualitative Disclosures About Market Risk                                                          | 55         |
| Item  8.   | Financial  Statements and Supplementary Data                                                                         | 56         |
| Item 9.    | Changes  in and Disagreements with Accountants on Accounting and Financial  Disclosure                          | 94         |
| Item 9A.   | Controls  and Procedures                                                                                             | 94         |
| Item 9B.   | Other Information                                                                                                    | 95         |
| ** ** | **PART III**                                                                                                    | ** ** |
| Item 10.   | Directors  and Executive Officers of the Registrant                                                                  | 96         |
| Item 11.   | Executive  Compensation                                                                                              | 96         |
| Item 12.   | Security  Ownership of Certain Beneficial Owners and Management                                                      | 96         |
| Item 13.   | Certain  Relationships and Related Transactions                                                                      | 96         |
| Item 14.   | Principal  Accounting Fees and Services                                                                              | 96         |
| ** ** | **Part IV**                                                                                                     | ** ** |
| Item 15.   | Exhibits,  Financial Statement Schedules                                                                             | 97         |

 

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**PART I**

**Item 1.        Business**

**Overview**

We own Cardinal Bank, aVirginia state-chartered community bank headquartered in Tysons Corner,Virginia. Cardinal Bank has offices in Alexandria, Annandale, Arlington,Clifton, Fairfax, Fredericksburg, Herndon, Leesburg, Manassas, McLean,Purcellville, Reston, Stafford, Sterling, Sterling Park, Tysons Corner, andWoodbridge, Virginia. We conduct virtually all of our business through CardinalBank, Cardinal Wealth Services, Inc., and George Mason Mortgage, LLC.

**History**

Cardinal Financial Corporation was formed in late 1997as a Virginia corporation, principally in response to opportunities resultingfrom the consolidation of several Virginia based banks with regional bankholding companies. In our market area, these bank consolidations had beenaccompanied by the dissolution of local boards of directors and relocation ortermination of management and customer service professionals.

We organized Cardinal Bank, N.A. as a wholly ownedsubsidiary that commenced operations as a nationally chartered community bankon June 8, 1998. Subsequently, we organized two additional wholly-ownedbank subsidiaries: Cardinal Bank—Manassas/Prince William, N.A., headquarteredin Manassas, Virginia, that commenced operations on July 26, 1999; and CardinalBank—Dulles, N.A., headquartered in Reston, Virginia, that commenced operationson August 2, 1999. In addition to the banks that we organized de novo, in September 2000,we acquired The Heritage Bank through a merger with Heritage Bancorp, Inc.The Heritage Bank was renamed Cardinal Bank—Potomac as a result of the merger. EffectiveMarch 1, 2002, we reorganized these four banking subsidiaries into asingle bank, Cardinal Bank, N.A. In December 2004, Cardinal Bank, N.A.converted to a state-chartered bank and changed its name to Cardinal Bank.

Cardinal Bank and Cardinal Wealth Services, Inc.provide brokerage and investment services through a contract with Raymond JamesFinancial Services, Inc. Under this contract, financial advisors can offerour customers an extensive range of financial products and services, includingestate planning, qualified retirement plans, mutual funds, annuities, lifeinsurance, fixed income and equity securities and equity research andrecommendations.

On July 7, 2004, Cardinal Bank purchased GeorgeMason Mortgage, LLC (George Mason) for $17.0 million in cash. George Mason,based in Fairfax, Virginia, engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis. George Mason conducts its business with eight brancheslocated throughout the metropolitan Washington, D.C. region. George Mason hasapproximately 200 employees and does business in eight states and the Districtof Columbia. George Mason is one of the largest residential mortgageoriginators in the greater Washington, D.C. metropolitan area, reporting loanclosings of over $3.5 billion in 2004 and $4.5 billion in 2003. George Mason’sprimary sources of revenue include net interest income earned on loans held forsale, gains on the sale of loans and management fees related to servicesprovided to other mortgage companies owned by local home builders.

In July 2004, weformed a wholly-owned subsidiary, Cardinal Statutory Trust I for the purpose ofissuing $20.0 million of floating rate junior subordinated deferrable interestdebentures (“trust preferred securities”). These trust preferred securities aredue in 2034 and have an interest rate of LIBOR (London Interbank Offered Rate)plus 2.40%, which adjusts quarterly.

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**Growth Strategy**

We believe that both the strong demographiccharacteristics of our markets and the ongoing bank consolidation within thegreater Washington, D.C. and Northern Virginia metropolitan areas provides asignificant opportunity to continue building a successful community-focusedbanking franchise. We intend to continue to expand our business throughinternal growth as well as selective geographic expansion while maintainingstrong asset quality and achieving sustained profitability. The strategy forachieving these objectives includes the following:

**Expand our footprint through branchexpansion.  **We intend to continue to expand ourfootprint by establishing new branches and potentially acquiring existingbranches or other financial institutions in communities that present attractivegrowth opportunities within Northern Virginia and other markets in the greaterWashington, D.C. metropolitan area. During 2004, we opened seven branch bankingoffices, one in the first quarter of the year, one in the second quarter, twoin the third quarter, and three in the fourth quarter. The branch bankingoffices opened during 2004 were in Annandale, Clifton, Fairfax, Fredericksburg,Herndon, Purcellville, and Stafford, Virginia. Six of the seven branches thatwe opened in 2004 were previously branch locations of other financialinstitutions. In January 2005, we opened a branch in Sterling Park whichalso was previously a branch of another financial institution.

As a result of the recent consolidation of banks inour market, we expect to continue to have opportunities to acquire or leaseformer branch sites from other financial institutions. As we have done in thepast, we may acquire additional sites prior to planned branch openings when webelieve the sites are attractive and are available on favorable terms. At thepresent time, we have a first right of refusal that gives us the option topurchase two branch facilities if the financial institution now operating theselocations chooses to close or move its operations anytime before January 2010.We are also currently in negotiations to purchase or lease additional branchsites located in Northern Virginia, although there can be no assurance that wewill be successful in acquiring any of them. Our current plans, which aresubject to change, contemplate that we will add as many as five new branches bythe end of 2005. We have purchased real estate in Woodbridge where, uponobtaining regulatory approval, we will construct a new branch. Because theopening of each new branch increases our operating expenses, we intend to stagenew branch openings in an effort to take into account the impact of theseexpenses on our results of operations.

**Capitalize on the continued bankconsolidation in our market.  **Recently announced or completed mergers of larger regional andnational banks will result in further consolidation in our target market overthe coming months. We intend to capitalize on the dislocation of customersresulting from this continuing bank consolidation who are seeking morepersonalized service from a local institution. We believe this consolidationcreates opportunities for us to further expand our branch network to attractiveretail sites, as discussed above, as well as to increase our market share ofbank deposits within our target market. As a local banking organization, webelieve we can compete effectively by providing a high level of personalizedservice in a retail-oriented branch system.

Although we are not at this time engaged in negotiationswith any specific bank acquisition targets, we will continue to explore thepossibility of further growth through acquisition in Virginia and themetropolitan Washington, D.C. market.

**Expand our lending activities.  **Wehave substantially increased our legal lending limit to $13.9 million as of December 31,2004 as a result of the completion of our secondary common stock offering in December 2003,including the additional capital raised in January 2004 when theunderwriters exercised their over allotment option, and earnings retained inthe business. The increase in our legal lending limit allows us to furtherexpand our commercial and real estate lending activities. It also improves ourability to serve larger residential homebuilders and allows us to seek businessfrom larger government contractors in the greater Washington, D.C. area. Governmentprocurement in the greater Washington region exceeded $42 billion in 2003, andwe believe there are unique growth opportunities in this sector of our regional

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economy. Our goal is toaggressively grow our loan portfolio while maintaining superior asset qualitythrough conservative underwriting practices. During significant periods ofgrowth in our loan portfolio, our earnings could be impacted by additional provisionsto our allowance for loan losses to reflect the resultant increase in loanbalances.

**Continue to recruit experiencedbankers.  **We have been successful in recruiting seniorbankers with experience in and knowledge of our markets who have been displacedor have grown dissatisfied as a result of the bank consolidation in our market. We intend to continue our efforts torecruit experienced bankers, particularly experienced lenders within our marketwho can have an immediate impact on generating additional loan volume throughexisting relationships.

**Focus on specialized lending services.  **Wehave expanded certain existing product lines, including government contractreceivables lending, SBA guaranteed lending, and retail lending. Our goal is tocreate a diversified, community-focused banking franchise, balanced betweenretail, commercial and real estate transactions and services.

**Offer additional financial products and services.  **GeorgeMason will increase our fee income and will allow us to offer our existingcustomer base a far greater array of mortgage loan products. In addition, wewill aggressively market our traditional banking and wealth management productsto the George Mason customer base. Our focus at George Mason will be to buildand maintain relationships with local and national homebuilders in an attemptto reduce reliance on the cyclical refinancing market. Building relationshipswith larger homebuilders will also assist us in our efforts to increase ourcommercial real estate lending activities.

We plan to further developand expand the investment services we offer through our wealth managementsubsidiary. We believe we have opportunities to cross-sell additional servicesto both our traditional banking customers and George Mason’s customers. Wefurther believe we will be able to attract new customers by offering a broaderarray of financial products and services.

**Business Segment Operations**

In 2003 and for the first six months of 2004, weoperated and reported in two business segments, commercial banking andinvestment services. As of July 7, 2004, we began operating in a third businesssegment, mortgage banking, with the completion of our acquisition of GeorgeMason. The commercial banking segment includes both commercial and consumerlending and provides customers such products as commercial loans, real estateloans, and other business financing and consumer loans. In addition, thissegment also provides customers with several choices of deposit productsincluding demand deposit accounts, savings accounts and certificates of deposit.The mortgage banking segment engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis. The investment services segment provides advisory servicesto businesses and individuals, including financial planning and retirement/estateplanning.

For financial informationabout the reportable segments, see “Business Segment Operations” in Item 7below and note 19 to the notes to the consolidated financial statements in Item8 below.

**Market Area**

We consider ourtarget market to be the greater Washington metropolitan area, which includesthe District of Columbia, the Northern Virginia counties of Arlington, Fairfax,Fauquier, Loudoun, Prince William, Spotsylvania and Stafford, the NorthernVirginia cities of Alexandria, Fairfax, Falls Church, Fredericksburg, andManassas, and the Maryland counties of Frederick, Montgomery and PrinceGeorges.

According to 2000 U.S. census data, the population ofthe greater Washington metropolitan area was approximately 4.7 million people. Theaverage of the median family income figures reported in the 

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2000 U.S. census forour target market was approximately $64,000, compared to a national medianhousehold income of approximately $42,000. Based on estimates released by theBureau of Labor Statistics of the U.S. Department of Labor for December 2004,the unemployment rate for the greater Washington metropolitan area wasapproximately 2.9%, compared to a national unemployment rate of 5.1%. Accordingto 2000 U.S. census figures, approximately 44% of adults at least 25 years oldin this area have a bachelor’s degree or higher, compared to approximately 24%nationally. As of June 30, 2004, total deposits in this area wereapproximately $120 billion as reported by the Federal Deposit InsuranceCorporation (“FDIC”).

Our headquarters islocated approximately seven miles west of Washington, D.C. in Fairfax County,Virginia. The 2000 U.S. census data indicates that Fairfax County is the mostpopulous county in Virginia with a population of approximately one million peopleand a median household income of over $81,000. Based on estimates released bythe Bureau of Statistics of the U.S. Department of Labor for October 2004,the unemployment rate in Fairfax County was 1.8%. The 2000 U.S. census datashows that over 54% of Fairfax County adults at least 25 years old have abachelor’s degree or higher.

**Competition**

The greater Washington region is dominated by branchesof large regional or national banks headquartered outside of the region. Ourmarket area is a highly competitive, highly branched banking market. We competeas a financial intermediary with other commercial banks, savings and loanassociations, credit unions, mortgage banking firms, consumer financecompanies, securities brokerage firms, insurance companies, money market mutualfunds and other types of financial institutions. George Mason faces significantcompetition from both traditional financial institutions and other national andlocal mortgage banking operations.

Competition for deposits and in providing lending andmortgage banking products and services to small businesses and professionals inthe market area is intense, and pricing is important. Many of our competitorshave substantially greater resources and lending limits than we do. Inaddition, many competitors offer more extensive branch networks than wecurrently have. Moreover, larger institutions operating in the greaterWashington market have access to borrowed funds at lower costs than areavailable to us. However, we have succeeded in competing in this environmentdue to an emphasis on a high level of personalized customer service, localizedand more responsive decision making, and community involvement.

With over 1,500 bankbranches in the greater Washington region, deposit competition among institutionsin the market area is also very strong. However, of the $120 billion inbank deposits in the greater Washington region at June 30, 2004,approximately 75% were held by banks that are either based outside of thegreater Washington region or are operating wholesale banks drawing depositsnationally (E*TRADE Bank, Capital One Bank and Treasury Bank). In just over sixyears, we have grown to the seventh largest financial institution headquarteredin the greater Washington region measured by total deposits. By providingcompetitive products and more personalized service, and being actively involvedin our local communities, we believe we can continue to increase our share ofthis banking deposit market.

**Customers**

We believe that the recent and ongoing bankconsolidation within Northern Virginia and the greater Washington regionprovides a significant opportunity to build a successful, locally-orientedbanking franchise. We also believe that many of the larger financialinstitutions in our area do not emphasize a high level of personalized serviceto small and medium-sized commercial businesses and professional or individualretail customers. Our commercial relationship managers focus their marketingefforts on 

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attracting small andmedium-sized businesses as well as commercial real estate developers andbuilders and professionals, such as physicians, accountants and attorneys.

Although we expect tocontinue serving the business and professional market with experiencedcommercial relationship managers, we have increased our retail marketingefforts through the expansion of our branch network and development ofadditional retail products and services. We expanded our deposit market sharethrough aggressive marketing of our President’s Club relationship product andour Totally Free Checking product. In addition, during the second quarter of2002, we organized our retail lending group which specializes in consumerlending products, and in 2003 we established a small business lending group anda government contract lending group.

**Banking Products and Services**

The principal business of the bank is to acceptdeposits from the public and to make loans and other investments. The principalsources of funds for the bank’s loans and investments are demand, time, savingsand other deposits, repayment of loans, and borrowings. The principal source ofincome for the bank is interest collected on loans and other investments. Theprincipal expenses of the bank are interest paid on savings and other deposits,employee compensation, office expenses, and other overhead expenses. The bankdoes not currently offer trust or fiduciary services.

The principal business of George Mason, the bank’smortgage banking subsidiary, is to originate residential loans for sale intothe secondary market on a best efforts basis. These loans are closed andserviced by George Mason on an interim basis pending their ultimate sale to apermanent investor in the secondary market. The mortgage subsidiary funds theseloans through a line of credit from Cardinal Bank, lines of credit throughthird party lenders and cash available to George Mason through its ownoperations. George Mason’s income on these loans is generated from the upfrontfees it charges its customers, the gain it recognizes upon the sale of theloans and the interest income it earns while the loans are being serviced bythe company. Costs associated with these loans are primarily comprised ofsalaries and commissions paid to loan originators and support personnel,interest expense incurred while the loan is being serviced by George Mason, andoperational expenses associated with the origination of the loans. In addition,George Mason generates management fee income by providing specific services toother mortgage banking companies owned by local home builders.

George Mason also offers a construction-to-permanentloan program. This program provides financing for customers to construct theirresidence. Once the home has been completed, the loan converts to permanentfinancing and is sold into the secondary market. Theseconstruction-to-permanent loans generate fee income as well as net interestincome for George Mason.

Both Cardinal Bank and George Mason are committed toproviding high quality products and services to their customers, and have madea significant investment in its core informational technology systems. Thesesystems provide the technology that fully automates the branches, processesbank transactions, mortgage originations and tracking, other loans andelectronic banking, conducts database and direct response marketing, providescash management solutions, streamlined reporting and reconciliation support aswell as sales support.

With this investment in technology, the bank offersinternet-based delivery of products for both consumers and commercial customers.Customers can open accounts, apply for loans, check balances, check accounthistory, transfer funds, pay bills, download account transactions into QuickenTM and Microsoft MoneyTM, use interactivecalculators and correspond via e-mail with the bank over the internet. Theinternet provides an inexpensive way for the bank to expand its geographicborders and branch activities while providing the kind of services one wouldexpect from larger banks.

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We offer a broad array ofproducts and services to our customers. A description of products and servicesis set forth below.

*Lending*

We offer a full range of short- to long-termcommercial, real estate and consumer lending products and services, which are describedin further detail below. We have established pre-determined target ranges forthe diversification of our loan portfolio. Commercial and industrial loans,real estate-commercial loans, real estate-construction loans, realestate-residential loans, home equity loans, and consumer loans account forapproximately 12%, 45%, 14%, 16%, 12% and 1%, respectively of our loanportfolio at December 31, 2004. We may adjust these levels from time totime as the credit demands of the community change and as our business evolves.

*Commercial and Industrial Loans*.   We make commercial loans toqualified businesses in our market area. Our commercial lending portfolioconsists primarily of commercial and industrial loans for the financing ofaccounts receivable, inventory, property, plant and equipment. Our government contractlending group provides secured lending to government contract firms andbusinesses based primarily on receivables from the federal government. We alsooffer Small Business Administration (SBA) guaranteed loans and asset-basedlending arrangements to certain of our customers. In 2003, we became certifiedas a preferred lender by the SBA, which provides us with much more flexibilityin approving loans guaranteed under the SBA’s various loan guaranty programs.

Commercial and industrial loans generally have ahigher degree of risk than residential mortgage loans, but have commensuratelyhigher yields. Residential mortgage loans generally are made on the basis ofthe borrower’s ability to repay the loan from his or her salary and otherincome and are secured by residential real estate, the value of which generallyis readily ascertainable. In contrast, commercial loans typically are made onthe basis of the borrower’s ability to repay the loan from the cash flow fromits business and are secured by business assets, such as commercial realestate, accounts receivable, equipment and inventory. As a result, theavailability of funds for the repayment of commercial loans may besubstantially dependent on the success of the business itself. Further, thecollateral for commercial loans may depreciate over time and generally cannotbe appraised with as much precision as residential real estate.

To manage these risks, our policy is to secure thecommercial loans we make with both the assets of the borrowing business andother additional collateral and guarantees that may be available. In addition,we actively monitor certain measures of the borrower, including advance rate,cash flow, collateral value and other appropriate credit factors.

*Commercial Mortgage Loans*.   Wealso originate commercial mortgage loans. These loans are primarily secured byvarious types of commercial real estate, including office, retail, warehouse,industrial and other non-residential types of properties and are made to theowners and/or occupiers of such property. The majority of these loans havematurities generally ranging from one to ten years.

Commercial mortgage lending entails significantadditional risk compared with residential mortgage lending. Commercial mortgageloans typically involve larger loan balances concentrated with single borrowersor groups of related borrowers. Additionally, the repayment of loans secured byincome-producing properties is typically dependent on the successful operationof a business or a real estate project and thus may be subject, to a greaterextent than is the case with residential mortgage loans, to adverse conditionsin the commercial real estate market or in the general economy. Our commercialreal estate loan underwriting criteria require an examination of debt servicecoverage ratios, the borrower’s creditworthiness and prior credit history andreputation, and we generally require personal guarantees or endorsements withrespect to these loans. In the loan underwriting process, we also carefullyconsider the location of the property that will be collateral for the loan.

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Loan-to-value ratios for commercial mortgage loansgenerally do not exceed 75%. We permit loan-to-value ratios of up to 80% if theproperty is owner occupied and the borrower has unusually strong liquidity, networth and cash flow.

*Residential Mortgage Loans*.   Residentialmortgage loans are originated by both Cardinal Bank and George Mason. Ourresidential mortgage loans consist of residential first and second mortgageloans, residential construction loans and home equity lines of credit and termloans secured by first and second mortgages on the residences of borrowers. Secondmortgage and home equity lines of credit are used for home improvements,education and other personal expenditures. We make mortgage loans with avariety of terms, including fixed, floating and variable interest rates and avariety of loan maturities.

Residential mortgage loans generally are made on thebasis of the borrower’s ability to repay the loan from his or her salary andother income and are secured by residential real estate, the value of which isgenerally readily ascertainable. These loans are made consistent with ourappraisal and real estate lending policies, which detail maximum loan-to-valueratios and maturities. Residential mortgage loans and home equity lines ofcredit secured by owner-occupied property generally are made with aloan-to-value ratio of up to 80%. Loan-to-value ratios of up to 90% may beallowed on residential owner-occupied property if the borrower exhibitsunusually strong liquidity, net worth and cash flow.

*Construction Loans*.   Ourconstruction loan portfolio consists of single-family residential properties,multi-family properties and commercial projects. Construction lending entailssignificant additional risks compared with residential mortgage lending. Constructionloans often involve larger loan balances concentrated with single borrowers orgroups of related borrowers. Construction loans also involve additional riskssince funds are advanced while the property is under construction, whichproperty has uncertain value prior to the completion of construction. Thus, itis more difficult to evaluate accurately the total loan funds required tocomplete a project and related loan-to-value ratios. To minimize the risksassociated with construction lending, we limit loan-to-value ratios for owneroccupied residential or commercial properties to 80%, and for investor-ownedresidential or commercial properties to 75% of when-completed appraised values.We expect that the loan-to-value ratios will be sufficient to compensate forfluctuations in the real estate market to minimize the risk of loss. Maturitiesfor construction loans generally range from six to 12 months for residentialproperty and from 12 to 24 months for non-residential and multi-familyproperties.

*Consumer Loans*.   Ourconsumer loans consist primarily of installment loans made to individuals forpersonal, family and household purposes. The specific types of consumer loanswe make include home improvement loans, automobile loans, debt consolidationloans and general consumer lending.

Consumer loans may entail greater risk thanresidential mortgage loans, particularly in the case of consumer loans that areunsecured, such as lines of credit, or secured by rapidly depreciable assets,such as automobiles. In such cases, any repossessed collateral for a defaultedconsumer loan may not provide an adequate source of repayment of theoutstanding loan balance as a result of the greater likelihood of damage, lossor depreciation. The remaining deficiency often does not warrant furthersubstantial collection efforts against the borrower. In addition, consumer loancollections are dependent on the borrower’s continuing financial stability, andthus are more likely to be adversely affected by job loss, divorce, illness orpersonal bankruptcy. Furthermore, the application of various federal and statelaws, including federal and state bankruptcy and insolvency laws, may limit theamount that can be recovered on such loans. A loan may also give rise to claimsand defenses by a consumer loan borrower against an assignee of such loan, suchas the bank, and a borrower may be able to assert against such assignee claimsand defenses that it has against the seller of the underlying collateral.

Our policy for consumer loans is to accept moderaterisk while minimizing losses, primarily through a careful credit and financialanalysis of the borrower. In evaluating consumer loans, we require our lendingofficers to review the borrower’s level and stability of income, past credithistory, amount of debt currently 

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outstanding and the impactof these factors on the ability of the borrower to repay the loan in a timelymanner. In addition, we require our banking officers to maintain an appropriatemargin between the loan amount and collateral value.

We also issue credit cardsto certain of our customers. In determining to whom we will issue credit cards,we evaluate the borrower’s level and stability of income, past credit historyand other factors. Finally, we make additional loans that are not classified inone of the above categories. In making such loans, we attempt to ensure thatthe borrower meets our loan underwriting standards.

*Loan Participations*

From time to time wepurchase and sell commercial loan participations to or from other banks withinour market area. All loan participations purchased have been underwritten usingthe bank’s standard and customary underwriting criteria and are in goodstanding.

*Deposits*

We offer a broad range ofinterest-bearing and non-interest-bearing deposit accounts, includingcommercial and retail checking accounts, money market accounts, individualretirement accounts, regular interest-bearing savings accounts and certificatesof deposit with a range of maturity date options. The primary sources ofdeposits are small and medium-sized businesses and individuals within ourtarget market. Senior management has the authority to set rates withinspecified parameters in order to remain competitive with other financialinstitutions in our market area. All deposits are insured by the FederalDeposit Insurance Corporation up to the maximum amount permitted by law. Wehave a service charge fee schedule, which is competitive with other financialinstitutions in our market, covering such matters as maintenance fees onchecking accounts, per item processing fees on checking accounts, returnedcheck charges and other similar fees.

*Courier Services*

We offer courier servicesto our business customers. Courier services permit us to provide theconvenience and personalized service that our customers require by schedulingpick-ups of deposits and other banking transactions.

*Telephone andInternet Banking*

We believe that there is astrong demand within our market for telephone banking and internet banking. Theseservices allow both commercial and retail customers to access detailed accountinformation and execute a wide variety of the banking transactions, includingbalance transfers and bill payment. We believe that these services areparticularly attractive to our customers, as it enables them to conduct theirbanking business and monitor their bank accounts from remote locations and atanytime. Telephone and internet banking assist us in attracting and retainingcustomers and encourages our existing customers to consider Cardinal for all oftheir banking and financial needs.

*Automatic TellerMachines*

We have an ATM at each ofour branch offices and we make other financial institutions’ ATMs available toour customers.

*Other Products andServices*

We offer otherbanking-related specialized products and services to our customers, such astravelers’ checks and safe deposit services. We issue letters of credit andstandby letters of credit for some of our 

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commercialcustomers, most of which are related to real estate construction loans. Neitherthe Bank nor George Mason has engaged in any securitizations of loans.

**Credit Policies**

Our senior lending officers and chief credit officerare primarily responsible for maintaining both a quality loan portfolio and astrong credit culture throughout the organization. The chief credit officer isresponsible for developing and updating our credit policies and procedures,which are approved by the board of directors. Senior lending officers may makeexceptions to these credit policies and procedures as appropriate, but any suchexception must be approved by the chief credit officer, documented and made forsound business reasons.

Credit quality is controlled by the chief creditofficer through compliance with our credit policies and procedures. Ourrisk-decision process is actively managed in a disciplined fashion to maintainan acceptable risk profile characterized by soundness, diversity, quality,prudence, balance and accountability. Our credit approval process consists ofspecific authorities granted to the lending officers and combinations of loanofficers. Loans exceeding a particular lending officer’s level of authority, orthe combined limit of several officers, are reviewed and considered forapproval by an officers’ loan committee and, when above a specified amount, bya committee of the bank’s board of directors. All loans of $500,000 or morerequire committee approval. In addition, the chief credit officer works closelywith each lending officer at the bank level to ensure that the business beingsolicited is of the quality and structure that fits our desired risk profile.

Under our credit policies, we monitor ourconcentration of credit risk. We have established concentration guidelinelimits for any individual or entity, any group of borrowers related as to thesource of repayment, or any specific industry. Furthermore, the bank hasestablished limits on the total amount of the bank’s outstanding loans to oneborrower, all of which are set below legal lending limits.

Loans closed by GeorgeMason are underwritten in accordance with guidelines established by the variousinvestors to whom George Mason sells its loans to in the secondary market.

**Brokerage and Investment Services**

We provide brokerage andinvestment services through an arrangement with Raymond James FinancialServices, Inc. Under this arrangement, financial advisors can offer ourcustomers an extensive range of investment products and services, including estateplanning, qualified retirement plans, mutual funds, annuities, life insurance,fixed income and equity securities and equity research and recommendations.

**Employees**

At December 31, 2004,we had 385 full-time equivalent employees. None of our employees arerepresented by any collective bargaining unit. We believe our relations withour employees are good.

**GovernmentSupervision and Regulation**

*General*

As a financial holding company, we are subject toregulation under the Bank Holding Company Act of 1956, as amended, and theexamination and reporting requirements of the Board of Governors of the FederalReserve System. Other federal and state laws govern the activities of our banksubsidiary, including the activities in which it may engage, the investmentsthat it makes, the aggregate amount of loans that it may grant to one borrower,and the dividends it may declare. Our bank subsidiary is also subject tovarious consumer and compliance laws. As a state chartered bank, Cardinal Bankis subject to 

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primary regulation,supervision and examination by the Bureau of Financial Institutions of theVirginia State Corporation Commission. Our bank subsidiary also is subject toregulation, supervision and examination by the Federal Deposit InsuranceCorporation. As part of our bank subsidiary, George Mason is subject to thesame regulations as the bank.

The following descriptionsummarizes the significant federal and state laws applicable to us. To theextent that statutory or regulatory provisions are described, the descriptionis qualified in its entirety by reference to that particular statutory orregulatory provision.

*The Bank HoldingCompany Act*

Under the BankHolding Company Act, we are subject to periodic examination by the FederalReserve and required to file periodic reports regarding our operations and anyadditional information that the Federal Reserve may require. Our activities atthe bank holding company level are limited to:

·       banking,managing or controlling banks;

·       furnishingservices to or performing services for our subsidiaries; and

·       engagingin other activities that the Federal Reserve has determined by regulation ororder to be so closely related to banking as to be a proper incident to theseactivities.

Some of the activities that the Federal Reserve Boardhas determined by regulation to be closely related to the business of a bankholding company include making or servicing loans and specific types of leases,performing specific data processing services and acting in some circumstancesas a fiduciary or investment or financial adviser.

With some limitedexceptions, the Bank Holding Company Act requires every bank holding company toobtain the prior approval of the Federal Reserve before:

·       acquiringsubstantially all the assets of any bank; and

·       acquiringdirect or indirect ownership or control of any voting shares of any bank ifafter such acquisition it would own or control more than 5% of the votingshares of such bank (unless it already owns or controls the majority of suchshares), or merging or consolidating with another bank holding company.

In addition, and subject to some exceptions, the BankHolding Company Act and the Change in Bank Control Act, together with theirregulations, require Federal Reserve approval prior to any person or companyacquiring “control” of a bank holding company. Control is conclusively presumedto exist if an individual or company acquires 25% or more of any class ofvoting securities of the bank holding company. Control is rebuttably presumedto exist if a person acquires 10% or more, but less than 25%, of any class ofvoting securities and if the institution has registered securities under Section 12of the Securities Exchange Act of 1934 or no other person owns a greaterpercentage of that class of voting securities immediately after the transaction.The regulations provide a procedure for challenging this rebuttable controlpresumption.

In November 1999,Congress enacted the Gramm-Leach-Bliley Act (“GLBA”), which made substantialrevisions to the statutory restrictions separating banking activities fromother financial activities. Under the GLBA, bank holding companies that arewell-capitalized and well-managed and meet other conditions can elect to become“financial holding companies.” As financial holding companies, they and theirsubsidiaries are permitted to acquire or engage in certain activities in whichbank holding companies are not permitted to engage, such as insuranceunderwriting and securities underwriting and distribution. In addition,financial holding companies may also acquire or engage in travel agencyactivities, insurance agency activities, merchant banking and other activitiesthat the Federal Reserve determines to 

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befinancial in nature or complementary to these activities. Financial holding companiescontinue to be subject to the overall oversight and supervision of the FederalReserve, but the GLBA applies the concept of functional regulation to theactivities conducted by subsidiaries. For example, insurance activities wouldbe subject to supervision and regulation by state insurance authorities. Webecame a financial holding company in 2004.

*Payment ofDividends*

We are a legal entity separate and distinct fromCardinal Bank, Cardinal Wealth Services, Inc., and Cardinal StatutoryTrust I. Virtually all of our revenues will result from dividends paid to us byour bank subsidiary and interest earned on short term investments. Our banksubsidiary is subject to laws and regulations that limit the amount ofdividends that it can pay. Under Virginia law, a bank may not declare adividend in excess of its undivided profits, which means that our banksubsidiary must recover any start-up losses before it may pay a dividend to us.Additionally, our bank subsidiary may not declare a dividend if the total amountof all dividends, including the proposed dividend, declared by the bank in anycalendar year exceeds the total of the bank’s retained net income of that yearto date, combined with its retained net income of the two preceding years,unless the dividend is approved by the FDIC. Our bank subsidiary may notdeclare or pay any dividend if, after making the dividend, the bank would be “undercapitalized,”as defined in the banking regulations.

The FDIC and the state have the general authority tolimit the dividends paid by insured banks if the payment is deemed an unsafeand unsound practice. Both the state and the FDIC have indicated that payingdividends that deplete a bank’s capital base to an inadequate level would be anunsound and unsafe banking practice.

In addition, we aresubject to certain regulatory requirements to maintain capital at or aboveregulatory minimums. These regulatory requirements regarding capital affect ourdividend policies. Banking regulators have indicated that banking organizationsshould generally pay dividends only if the organization’s net income availableto common shareholders over the past year has been sufficient to fully fund thedividends, and the prospective rate of earnings retention appears consistentwith the organization’s capital needs, asset quality and overall financialcondition.

*Insurance ofAccounts, Assessments and Regulation by the FDIC*

The deposits of our bank subsidiary are insured by theFDIC up to the limits set forth under applicable law. The deposits of our banksubsidiary are subject to the deposit insurance assessments of the BankInsurance Fund, or “BIF”, of the FDIC.

The FDIC has implemented a risk-based depositinsurance assessment system under which the assessment rate for an insuredinstitution may vary according to regulatory capital levels of the institutionand other factors, including supervisory evaluations. For example, depositoryinstitutions insured by the BIF that are “well capitalized” and that presentfew or no supervisory concerns are required to pay only the statutory minimumassessment of $2,000 annually for deposit insurance, while all other banks arerequired to pay premiums ranging from 0.03% to 0.27% of domestic deposits. Theserate schedules are subject to future adjustments by the FDIC. In addition tobeing influenced by the risk profile of the particular depository institution,FDIC premiums are also influenced by the size of the FDIC insurance fund inrelation to total deposits in FDIC insured banks. The FDIC has authority to imposespecial assessments from time to time.

The FDIC is authorized toprohibit any BIF-insured institution from engaging in any activity that theFDIC determines by regulation or order to pose a serious threat to theinsurance fund. Also, the FDIC may initiate enforcement actions against banks,after first giving the institution’s primary regulatory authority anopportunity to take such action. The FDIC may terminate the deposit insuranceof any 

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depositoryinstitution if it determines, after a hearing, that the institution has engagedor is engaging in unsafe or unsound practices, is in an unsafe or unsoundcondition to continue operations, or has violated any applicable law,regulation, order or any condition imposed in writing by the FDIC. It also maysuspend deposit insurance temporarily during the hearing process for thepermanent termination of insurance, if the institution has no tangible capital.If deposit insurance is terminated, the deposits at the institution at the timeof termination, less subsequent withdrawals, shall continue to be insured for aperiod from six months to two years, as determined by the FDIC. We are unawareof any existing circumstances that could result in termination of any of ourbank subsidiary’s deposit insurance.

*Capital Requirements*

Each of the FDICand the Federal Reserve Board has issued risk-based and leverage capitalguidelines applicable to banking organizations that it supervises. Under therisk-based capital requirements, we and our bank subsidiary are each generallyrequired to maintain a minimum ratio of total capital to risk-weighted assets(including specific off-balance sheet activities, such as standby letters ofcredit) of 8%. At least half of the total capital must be composed of “Tier 1Capital”, which is defined as common equity, retained earnings, qualifyingperpetual preferred stock and minority interests in common equity accounts ofconsolidated subsidiaries, less certain intangibles. The remainder may consistof “Tier 2 Capital”, which is defined as specific subordinated debt, somehybrid capital instruments and other qualifying preferred stock and a limitedamount of the loan loss allowance and pretax net unrealized holding gains oncertain equity securities. In addition, each of the federal banking regulatoryagencies has established minimum leverage capital requirements for bankingorganizations. Under these requirements, banking organizations must maintain aminimum ratio of Tier 1 capital to adjusted average quarterly assets equal to3% to 5%, subject to federal bank regulatory evaluation of an organization’soverall safety and soundness. In summary, the capital measures used by thefederal banking regulators are:

·       TotalRisk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital andTier 2 Capital

·       Tier1 Risk-Based Capital ratio, and

·       theleverage ratio.

Under these regulations, a bank will be:

·  “wellcapitalized” if it has a Total Risk-Based Capital ratio of 10% or greater, aTier 1 Risk-Based Capital ratio of 6% or greater, a leverage ratio of 5% orgreater, and is not subject to any written agreement, order, capital directive,or prompt corrective action directive by a federal bank regulatory agency tomeet and maintain a specific capital level for any capital measure

·       “adequatelycapitalized” if it has a Total Risk-Based Capital ratio of 8% or greater, aTier 1 Risk-Based Capital ratio of 4% or greater, and a leverage ratio of4% or greater (or 3% in certain circumstances) and is not well capitalized

·       “undercapitalized”if it has a Total Risk-Based Capital ratio of less than 8%, a Tier 1Risk-Based Capital ratio of less than 4% (or 3% in certain circumstances), or aleverage ratio of less than 4% (or 3% in certain circumstances)

·       “significantlyundercapitalized” if it has a Total Risk-Based Capital ratio of less than 6%, aTier 1 Risk-Based Capital ratio of less than 3%, or a leverage ratio ofless than 3%, or

·       “criticallyundercapitalized” if its tangible equity is equal to or less than 2% oftangible assets.

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The risk-based capital standards of each of the FDICand the Federal Reserve Board explicitly identify concentrations of credit riskand the risk arising from non-traditional activities, as well as an institution’sability to manage these risks, as important factors to be taken into account bythe agency in assessing an institution’s overall capital adequacy. The capitalguidelines also provide that an institution’s exposure to a decline in theeconomic value of its capital due to changes in interest rates be considered bythe agency as a factor in evaluating a banking organization’s capital adequacy.

The FDIC may take variouscorrective actions against any undercapitalized bank and any bank that fails tosubmit an acceptable capital restoration plan or fails to implement a planacceptable to the FDIC. These powers include, but are not limited to, requiringthe institution to be recapitalized, prohibiting asset growth, restrictinginterest rates paid, requiring prior approval of capital distributions by any bankholding company that controls the institution, requiring divestiture by theinstitution of its subsidiaries or by the holding company of the institutionitself, requiring new election of directors, and requiring the dismissal ofdirectors and officers. Our bank subsidiary presently maintains sufficientcapital to remain in compliance with capital requirements.

*OtherSafety and Soundness Regulations*

There are a number ofobligations and restrictions imposed on bank holding companies and theirdepository institution subsidiaries by federal law and regulatory policy thatare designed to reduce potential loss exposure to the depositors of suchdepository institutions and to the FDIC insurance fund in the event that thedepository institution is insolvent or is in danger of becoming insolvent. Theseobligations and restrictions are not for the benefit of investors. Regulatorsmay pursue an administrative action against any bank holding company or bankwhich violates the law, engages in an unsafe or unsound banking practice, orwhich is about to engage in an unsafe and unsound banking practice. Theadministrative action could take the form of a cease and desist proceeding, aremoval action against the responsible individuals or, in the case of aviolation of law or unsafe and unsound banking practice, a civil penalty action.A cease and desist order, in addition to prohibiting certain action, could alsorequire that certain action be undertaken. Under the policies of the FederalReserve Board, we are required to serve as a source of financial strength toour subsidiary depository institution and to commit resources to support thebank in circumstances where we might not do so otherwise.

*The Bank SecrecyAct*

Under the Bank Secrecy Act(“BSA”), a financial institution is required to have systems in place to detectcertain transactions, based on the size and nature of the transaction. Financialinstitutions are generally required to report cash transactions involving morethan $10,000 to the United States Treasury. In addition, financial institutionsare required to file suspicious activity reports for transactions that involvemore than $5,000 and which the financial institution knows, suspects or hasreason to suspect, involves illegal funds, is designed to evade therequirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001,enacted in response to the September 11, 2001 terrorist attacks, requiresbank regulators to consider a financial institution’s compliance with the BSAwhen reviewing applications from a financial institution. As part of its BSAprogram, the USA PATRIOT Act also requires a financial institution to followrecently implemented customer identification procedures when opening accountsfor new customers and to review lists of individuals and entities who areprohibited from opening accounts at financial institutions.

*Interstate Banking and Branching*

Current federal lawauthorizes interstate acquisitions of banks and bank holding companies withoutgeographic limitation. Effective June 1, 1997, a bank headquartered in onestate is authorized to merge with a bank headquartered in another state, aslong as neither of the states had opted out of such interstate 

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mergerauthority prior to such date. For example, as a bank headquartered in Virginia,we may acquire a bank or branch in Maryland, but we cannot simply establish abranch in Maryland. After a bank has acquired a branch in a state through aninterstate merger transaction, the bank may establish and acquire additionalbranches at any location in the state where a bank headquartered in that statecould have established or acquired branches under applicable federal or statelaw.

*Monetary Policy*

The commercial bankingbusiness is affected not only by general economic conditions but also by themonetary policies of the Federal Reserve Board. The instruments of monetarypolicy employed by the Federal Reserve Board include open market operations inUnited States government securities, changes in the discount rate on memberbank borrowing and changes in reserve requirements against deposits held by allfederally insured banks. The Federal Reserve Board’s monetary policies have hada significant effect on the operating results of commercial banks in the pastand are expected to continue to do so in the future. In view of changingconditions in the national and international economy and in the money markets,as well as the effect of actions by monetary fiscal authorities, including theFederal Reserve System, no prediction can be made as to possible future changesin interest rates, deposit levels, loan demand or the business and earnings ofour bank subsidiary.

*Federal Reserve System*

In 1980, Congress enactedlegislation that imposed reserve requirements on all depository institutionsthat maintain transaction accounts or non-personal time deposits. NOW accountsand demand deposit accounts that permit payments or transfers to third partiesfall within the definition of transaction accounts and are subject to thesereserve requirements. For net transaction accounts in 2005, the first $7.0million will be exempt from reserve requirements. A 3% reserve ratio will beassessed on net transaction accounts over $7.0 million to and including $47.6million. A 10% reserve ratio will be applied to amounts in net transactionaccounts in excess of $47.6 million. These percentages are subject toadjustment by the Federal Reserve Board. Because required reserves must bemaintained in the form of vault cash or in a non-interest-bearing accountat, or on behalf of, a Federal Reserve Bank, the effect of the reserverequirement is to reduce the amount of the institution’s interest-earningassets.

*Transactions with Affiliates*

Transactions between banksand their affiliates are governed by Sections 23A and 23B of the FederalReserve Act. An affiliate of a bank is any bank or entity that controls, iscontrolled by or is under common control with such bank. Generally, Sections23A and 23B (i) limit the extent to which the bank or its subsidiaries mayengage in “covered transactions” with any one affiliate to an amount equal to10% of such institution’s capital stock and surplus, and maintain an aggregatelimit on all such transactions with affiliates to an amount equal to 20% ofsuch capital stock and surplus, and (ii) require that all suchtransactions be on terms substantially the same, or at least as favorable, tothe bank as those provided to a non-affiliate. The term “covered transaction”includes the making of loans, purchase of assets, issuance of a guarantee andsimilar other types of transactions. Section 23B applies to “coveredtransactions” as well as sales of assets and payments of money to an affiliate.These transactions must also be conducted on terms substantially the same as,or at least favorable, to the bank as those provided to non-affiliates.

*Loans to Insiders*

The Federal Reserve Actand related regulations impose specific restrictions on loans to directors,executive officers and principal shareholders of banks. Under Section 22(h) ofthe Federal Reserve Act, loans to a director, an executive officer and to aprincipal shareholder of a bank, and to entities controlled by any of theforegoing, may not exceed, together with all other outstanding loans to suchperson and 

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entitiescontrolled by such person, the bank’s loan-to-one borrower limit. Loans in theaggregate to insiders and their related interests as a class may not exceed twotimes the bank’s unimpaired capital and unimpaired surplus until the bank’stotal assets equal or exceed $100,000,000, at which time the aggregate islimited to the bank’s unimpaired capital and unimpaired surplus. Section 22(h) alsoprohibits loans above amounts prescribed by the appropriate federal bankingagency to directors, executive officers and principal shareholders of a bank orbank holding company, and to entities controlled by such persons, unless suchloan is approved in advance by a majority of the board of directors of the bankwith any “interested” director not participating in the voting. The FDIC hasprescribed the loan amount, which includes all other outstanding loans to suchperson, as to which such prior board of director approval is required, as beingthe greater of $25,000 or 5% of capital and surplus (up to $500,000).Section 22(h) requires that loans to directors, executive officersand principal shareholders be made on terms and underwriting standardssubstantially the same as offered in comparable transactions to other persons.

*Community Reinvestment Act*

Under the Community Reinvestment Act and relatedregulations, depository institutions have an affirmative obligation to assistin meeting the credit needs of their market areas, including low andmoderate-income areas, consistent with safe and sound banking practice. TheCommunity Reinvestment Act requires the adoption by each institution of aCommunity Reinvestment Act statement for each of its market areas describingthe depository institution’s efforts to assist in its community’s credit needs.Depository institutions are periodically examined for compliance with theCommunity Reinvestment Act and are periodically assigned ratings in this regard.Banking regulators consider a depository institution’s Community ReinvestmentAct rating when reviewing applications to establish new branches, undertake newlines of business, and/or acquire part or all of another depository institution.An unsatisfactory rating can significantly delay or even prohibit regulatoryapproval of a proposed transaction by a bank holding company or its depositoryinstitution subsidiaries.

The Gramm-Leach-Bliley Actand federal bank regulators have made various changes to the CommunityReinvestment Act. Among other changes, Community Reinvestment Act agreementswith private parties must be disclosed and annual reports must be made to abank’s primary federal regulator. A bank holding company will not be permittedto become a financial holding company and no new activities authorized underthe GLBA may be commenced by an existing financial holding company or by itssubsidiaries if any bank subsidiary received less than a “satisfactory” ratingin its latest Community Reinvestment Act examination.

*Fair Lending; Consumer Laws*

In addition to the Community Reinvestment Act, otherfederal and state laws regulate various lending and consumer aspects of thebanking business. Governmental agencies, including the Department of Housingand Urban Development, the Federal Trade Commission and the Department ofJustice, have become concerned that prospective borrowers may experiencediscrimination in their efforts to obtain loans from depository and otherlending institutions. These agencies have brought litigation against depositoryinstitutions alleging discrimination against borrowers. Many of these suitshave been settled, in some cases for material sums, short of a full trial.

These governmental agencies have clarified what theyconsider to be lending discrimination and have specified various factors thatthey will use to determine the existence of lending discrimination under theEqual Credit Opportunity Act and the Fair Housing Act, including evidence thata lender discriminated on a prohibited basis, evidence that a lender treatedapplicants differently based on prohibited factors in the absence of evidencethat the treatment was the result of prejudice or a conscious intention todiscriminate, and evidence that a lender applied an otherwise neutralnon-discriminatory policy uniformly to all 

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applicants, but thepractice had a discriminatory effect, unless the practice could be justified asa business necessity.

Banks and other depositoryinstitutions also are subject to numerous consumer-oriented laws andregulations. These laws, which include the Truth in Lending Act, the Truth inSavings Act, the Real Estate Settlement Procedures Act, the Electronic FundsTransfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act,require compliance by depository institutions with various disclosurerequirements and requirements regulating the availability of funds afterdeposit or the making of some loans to customers.

*Gramm-Leach-BlileyAct of 1999*

The Gramm-Leach-Bliley Act of 1999 was signed into lawon November 12, 1999. The GLBA covers a broad range of issues, including arepeal of most of the restrictions on affiliations among depositoryinstitutions, securities firms and insurance companies. The followingdescription summarizes some of its significant provisions.

The GLBA repeals sections 20 and 32 of the Glass-SteagallAct, thus permitting unrestricted affiliations between banks and securitiesfirms. It also permits bank holding companies to elect to become financialholding companies. A financial holding company may engage in or acquirecompanies that engage in a broad range of financial services, includingsecurities activities such as underwriting, dealing, investment, merchantbanking, insurance underwriting, sales and brokerage activities. In order tobecome a financial holding company, the bank holding company and all of itsaffiliated depository institutions must be well-capitalized, well-managed andhave at least a satisfactory Community Reinvestment Act rating. We became afinancial holding company in 2004.

The GLBA provides that the states continue to have theauthority to regulate insurance activities, but prohibits the states in mostinstances from preventing or significantly interfering with the ability of abank, directly or through an affiliate, to engage in insurance sales,solicitations or cross-marketing activities. Although the states generally mustregulate bank insurance activities in a nondiscriminatory manner, the statesmay continue to adopt and enforce rules that specifically regulate bankinsurance activities in areas identified under the law. Under the new law, thefederal bank regulatory agencies adopted insurance consumer protectionregulations that apply to sales practices, solicitations, advertising anddisclosures.

The GLBA adopts a system of functional regulationunder which the Federal Reserve Board is designated as the umbrella regulatorfor financial holding companies, but financial holding company affiliates areprincipally regulated by functional regulators such as the FDIC for bankaffiliates, the Securities and Exchange Commission for securities affiliates,and state insurance regulators for insurance affiliates. It repeals the broadexemption of banks from the definitions of “broker” and “dealer” for purposesof the Securities Exchange Act of 1934, as amended. It also identifies a set ofspecific activities, including traditional bank trust and fiduciary activities,in which a bank may engage without being deemed a “broker,” and a set ofactivities in which a bank may engage without being deemed a “dealer.”Additionally, GLBA makes conforming changes in the definitions of “broker” and “dealer”for purposes of the Investment Company Act of 1940, as amended, and theInvestment Advisers Act of 1940, as amended.

The GLBA containsextensive customer privacy protection provisions. Under these provisions, afinancial institution must provide to its customers, both at the inception ofthe customer relationship and on an annual basis, the institution’s policiesand procedures regarding the handling of customers’ nonpublic personalfinancial information. The law provides that, except for specific limitedexceptions, an institution may not provide such personal information tounaffiliated third parties unless the institution discloses to the customerthat such information may be so provided and the customer is given theopportunity to opt out of such disclosure. An institution may not disclose to anon-affiliated third party, other than to a consumer reporting agency, customeraccount numbers or other similar account identifiers 

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formarketing purposes. The GLBA also provides that the states may adopt customerprivacy protections that are stricter than those contained in the act.

*Future RegulatoryUncertainty*

Because federal and stateregulation of financial institutions changes regularly and is the subject ofconstant legislative debate, we cannot forecast how federal and state regulationof financial institutions may change in the future and impact our operations. AlthoughCongress and the state legislature in recent years have sought to reduce theregulatory burden on financial institutions with respect to the approval ofspecific transactions, we fully expect that the financial institution industrywill remain heavily regulated in the near future and that additional laws orregulations may be adopted further regulating specific banking practices.

*AdditionalInformation*

We file annual, quarterly and current reports, proxystatements, and other documents with the Securities and Exchange Commission (“SEC”)under the Exchange Act of 1934, as amended (the “Exchange Act”). The public mayread and copy any materials that we file with the SEC at the SEC’s PublicReference Room: 450 Fifth Street, NW, Washington, D.C. 20549. The public mayobtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330. Also, the SEC maintains aninternet website that contains reports, proxy and information statements andother information regarding registrants, including us, that file electronicallywith the SEC. The public can obtain any documents that we file at *http:*//*www.sec.gov*.

We also make availablefree of charge on or through our internet website (*www.CardinalBank.com*)our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and, if applicable, amendments to thosereports filed or furnished pursuant to Section 13(a) of the ExchangeAct as soon as reasonably practicable after we electronically file suchmaterials with, or furnish them to, the SEC.

**Item 2.**                        Properties

Cardinal Bank, excluding its George Mason subsidiary,conducts its business from nineteen branch banking offices. Seven of thesefacilities are owned and twelve are leased. Leased branch banking facilitiesrange in size from 1,000 square feet to 11,182 square feet. Our leases on thesefacilities expire at various dates through 2014, but all our leases haverenewal options. Thirteen of our branch banking locations have drive-up bankingcapabilities and all have ATMs.

Cardinal Wealth Services, Inc. conducts itsbusiness from three of Cardinal Bank’s branch facilities.

George Mason conducts its business from eight leasedfacilities which range in size from 1,428 square feet to 22,056 square feet. Theleases have various expiration dates through 2008 and generally do not haverenewal options.

Our headquarters facility in Tysons Corner, Virginiacomprises 31,880 square feet of leased office space. This lease expires in January 2010but has renewal options. In addition to housing various administrativefunctions—including accounting, data processing, compliance, treasury,marketing, deposit and loan operations—our commercial and industrial andcommercial real estate lending functions are located there.

We believe that all of ourproperties are maintained in good operating condition and are suitable andadequate for our operational needs.

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**Item 3.**                        LegalProceedings

In the ordinary course ofour operations, we may become party to legal proceedings. Currently, we are notparty to any material proceedings and no such proceedings are, to management’sknowledge, threatened against us.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

No matters were submitted to a vote of securityholders, through the solicitation of proxies or otherwise, during the fourthquarter of 2004.

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**PART II**

**Item 5.        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities**

Our common stock is currently listed for quotation onthe Nasdaq National Market under the symbol “CFNL.” Prior to December 17,2003, our common stock was listed for quotation on the Nasdaq SmallCap Marketunder the same symbol. As of December 31, 2004, our common stock was heldby 691 shareholders of record. In addition, we estimate that there were 4,800beneficial owners of our common stock who own their shares through brokers orbanks.

Thehigh and low sale prices per share for our common stock for each quarter of2004 and 2003 as reported on the Nasdaq National Market and, prior to December 17,2003, on the Nasdaq SmallCap Market, were as follows:
| **Periods Ended** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------|------------|------------|------------|----------|------------|---------|------------|
| 2004                   |       |       |       |     |       |
| First Quarter          |       | $          | 9.80       |     | $          | 8.15    |       |
| Second Quarter         |       | 9.92       |       | 8.49     |       |
| Third Quarter          |       | 9.64       |       | 8.40     |       |
| Fourth Quarter         |       | 11.42      |       | 9.21     |       |
| 2003                   |       |       |       |     |       |
| First Quarter          |       | $          | 5.45       |     | $          | 4.30    |       |
| Second Quarter         |       | 7.01       |       | 5.13     |       |
| Third Quarter          |       | 7.08       |       | 6.10     |       |
| Fourth Quarter         |       | 8.68       |       | 6.40     |       |

 

We have not declared or distributed any cash dividendsto the holders of our common shares, and we have no current intentions todeclare a cash dividend in the foreseeable future. Our board of directorsintends to follow a policy of retaining any earnings to provide funds tooperate and expand our business. Our future dividend policy is subject to thediscretion of the board of directors and will depend upon a number of factors,including future earnings, financial condition, cash requirements, and generalbusiness conditions.

Our ability to distributecash dividends will depend primarily on the ability of our subsidiaries to paydividends to us. Cardinal Bank is subject to legal limitations on the amount ofdividends it is permitted to pay. Furthermore, neither Cardinal Bank nor we maydeclare or pay a cash dividend on any of our capital stock if we are insolventor if the payment of the dividend would render us insolvent or unable to payour obligations as they become due in the ordinary course of business. Foradditional information on these limitations, see “Government Regulation andSupervision—Payment of Dividends” in Item 1 above.

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**Item 6.        SelectedFinancial Data**

**Selected FinancialData**(In thousands, except per share data)
| ** **                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Income Statement Data:**                             |       |                                        |       |   |   |   |   |   |   |   |   |
| Interest income                                                  |       | $                                           | 40,522     |   | $ | 24,602 |   | $ | 20,242 |   | $ | 16,577 |   | $ | 11,150 |   |
| Interest expense                                                 |       | 15,969                                      |       | 9,429 |   | 9,586 |   | 7,500 |   | 4,740 |   |
| Net interest  income                                             |       | 24,553                                      |       | 15,173 |   | 10,656 |   | 9,077 |   | 6,410 |   |
| Provision for loan  losses                                       |       | 1,626                                       |       | 1,001 |   | 444 |   | 1,202 |   | 753 |   |
| Net interest  income after provision for loan losses             |       | 22,927                                      |       | 14,172 |   | 10,212 |   | 7,875 |   | 5,657 |   |
| Non-interest  income                                             |       | 9,409                                       |       | 3,829 |   | 2,864 |   | 3,157 |   | 2,098 |   |
| Non-interest  expense                                            |       | 27,154                                      |       | 15,355 |   | 13,605 |   | 23,756 |   | 11,726 |   |
| Net income (loss)  before income taxes                           |       | 5,182                                       |       | 2,646 |   | (529 | ) | (12,724 | ) | (3,971 | ) |
| Provision  (benefit) for income taxes                            |       | 1,713                                       |       | (3,508 | ) | — |   | — |   | — |   |
| Net income (loss)                                                |       | 3,469                                       |       | 6,154 |   | (529 | ) | (12,724 | ) | (3,971 | ) |
| Dividends to  preferred shareholders                             |       | —                                      |       | 495 |   | 495 |   | 503 |   | 171 |   |
| Net income (loss)  to common shareholders                        |       | $                                           | 3,469      |   | $ | 5,659 |   | $ | (1,024 | ) | $ | (13,227 | ) | $ | (4,142 | ) |
| **Balance Sheet Data:**                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Total assets                                                     |       | $                                           | 1,211,576  |   | $ | 636,248 |   | $ | 486,323 |   | $ | 279,584 |   | $ | 207,048 |   |
| Loans receivable,  net of deferred fees and costs                |       | 489,896                                     |       | 336,002 |   | 249,106 |   | 200,911 |   | 154,271 |   |
| Allowance for loan  losses                                       |       | 5,878                                       |       | 4,344 |   | 3,372 |   | 3,104 |   | 1,900 |   |
| Loans held for  sale, at lower of cost or market, net            |       | 365,454                                     |       | — |   | — |   | — |   | — |   |
| Total investment  securities                                     |       | 289,507                                     |       | 273,614 |   | 163,665 |   | 34,147 |   | 6,935 |   |
| Total deposits                                                   |       | 824,210                                     |       | 474,129 |   | 423,479 |   | 246,024 |   | 163,371 |   |
| Other borrowed  funds                                            |       | 201,085                                     |       | 74,457 |   | 2,000 |   | 9,824 |   | 7,287 |   |
| Total  shareholders’ equity                                 |       | 95,105                                      |       | 85,412 |   | 40,712 |   | 20,624 |   | 34,112 |   |
| Preferred shares  outstanding                                    |       | —                                      |       | 1,364 |   | 1,365 |   | 1,365 |   | 1,411 |   |
| Common shares  outstanding                                       |       | 18,463                                      |       | 16,377 |   | 10,044 |   | 4,294 |   | 4,253 |   |
| **Per Common Share Data:**                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic net income  (loss)                                         |       | $                                           | 0.19       |   | $ | 0.55 |   | $ | (0.13 | ) | $ | (3.11 | ) | $ | (0.98 | ) |
| Fully diluted net  income (loss)                                 |       | 0.19                                        |       | 0.54 |   | (0.13 | ) | (3.11 | ) | (0.98 | ) |
| Book value                                                       |       | 5.15                                        |       | 4.80 |   | 3.37 |   | 3.21 |   | 6.36 |   |
| Tangible book  value                                             |       | 4.36                                        |       | 4.80 |   | 3.31 |   | 3.06 |   | 4.11 |   |
| **Performance Ratios:**                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Return on average  assets                                        |       | 0.37                                        | %          | 1.18 | % | (0.14 | )% | (5.24 | )% | (2.72 | )% |
| Return on average  equity                                        |       | 3.69                                        |       | 13.84 |   | (1.61 | ) | (39.14 | ) | (12.72 | ) |
| Net interest  margin(1)                                          |       | 2.72                                        |       | 3.00 |   | 2.92 |   | 4.17 |   | 4.82 |   |
| Efficiency  ratio(2)                                             |       | 83.97                                       |       | 85.30 |   | 104.05 |   | 215.34 |   | 151.21 |   |
| Non-interest  income to average assets                           |       | 1.00                                        |       | 0.73 |   | 0.74 |   | 1.30 |   | 1.44 |   |
| Non-interest  expense to average assets                          |       | 2.90                                        |       | 2.94 |   | 3.50 |   | 9.79 |   | 8.03 |   |
| Loans receivable,  net of fees to total deposits                 |       | 59.44                                       |       | 70.87 |   | 58.82 |   | 81.66 |   | 94.43 |   |
| **Asset Quality Ratios:**                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Net charge-offs to  average loans receivable, net of fees        |       | 0.02                                        | %          | 0.01 | % | 0.05 | % | — | % | — | % |
| Non-performing  loans to loans receivable, net of fees           |       | 0.11                                        |       | 0.12 |   | 0.39 |   | 0.46 |   | 0.38 |   |
| Non-performing  loans to total assets                            |       | 0.05                                        |       | 0.06 |   | 0.20 |   | 0.33 |   | 0.28 |   |
| Allowance for loan  losses to nonperforming loans                |       | 1,074.60                                    |       | 1,102.54 |   | 345.49 |   | 334.84 |   | 323.68 |   |
| Allowance for loan  losses to loan receivable, net of fees       |       | 1.20                                        |       | 1.29 |   | 1.35 |   | 1.54 |   | 1.23 |   |
| **Capital Ratios:**                                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Tier 1 risk-based  capital                                       |       | 12.65                                       | %          | 19.66 | % | 12.25 | % | 9.04 | % | 18.89 | % |
| Total risk-based  capital                                        |       | 13.40                                       |       | 20.66 |   | 13.35 |   | 10.42 |   | 19.94 |   |
| Leverage capital  ratio                                          |       | 8.83                                        |       | 15.45 |   | 8.97 |   | 8.57 |   | 17.39 |   |
| **Other:**                                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Average  shareholders’ equity to average total assets       |       | 10.05                                       | %          | 7.84 | % | 8.45 | % | 13.39 | % | 21.37 | % |
| Average loans  receivable, net of fees to average total deposits |       | 59.97                                       | %          | 63.02 | % | 59.36 | % | 91.69 | % | 97.03 | % |
| Average common shares  outstanding:                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                            |       | 18,448                                      |       | 10,218 |   | 7,949 |   | 4,258 |   | 4,246 |   |
| Diluted                                                          |       | 18,705                                      |       | 11,468 |   | 7,949 |   | 4,258 |   | 4,246 |   |

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(1)             Net interest margin is calculated as net interestincome divided by total average earning assets.

(2)             Efficiency ratio is calculated as total non-interestexpense divided by the total of net interest income after provision for loanlosses and non-interest income.

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**Item 7.        Management’sDiscussion and Analysis of Financial Condition and Results of Operation**

The following presentsmanagement’s discussion and analysis of our consolidated financial condition atDecember 31, 2004 and 2003 and the results of our operations for the yearsended December 31, 2004, 2003 and 2002. The discussion should be read inconjunction with the consolidated financial statements and related notesincluded in this report.

**Overview**

Cardinal Financial Corporation (“Cardinal”), a locallyowned and managed financial holding company headquartered in Tysons Corner,Virginia, is committed to providing superior customer service, a diversifiedmix of financial products and services, and convenient banking to our retailand business consumers. We own Cardinal Bank, a state-chartered community bank,and Cardinal Wealth Services, Inc., an investment services subsidiary. Throughthese two subsidiaries and George Mason, a subsidiary of Cardinal Bank, weoffer a wide range of banking products and services to both our commercial andretail customers. Our commercial relationship managers focus on attracting loanand depository relationships with small and medium-sized businesses as well ascommercial real estate developers, builders, and professionals such as physicians,accountants and attorneys. We have nineteen retail branch locations and providecompetitive retail products and services. We complement our core bankingoperations by offering investment products and services to our customersthrough our third-party brokerage relationship with Raymond James FinancialServices, Inc.

On July 7, 2004, we acquired George Mason fromUnited Bank—Virginia, a wholly owned subsidiary of United Bankshares, Inc.in a cash transaction for $17.0 million. This transaction resulted in therecognition of $12.9 million of goodwill. This transaction was accounted for asa purchase, and George Mason’s assets and liabilities were recorded at fairvalue as of the purchase date. George Mason’s operating results are included inthe consolidated results since the date of the acquisition. George Mason, basedin Fairfax, Virginia, engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis through nine branches located throughout the metropolitan Washingtonregion. George Mason has approximately 200 employees and does business in eightstates, including Virginia, Maryland and the District of Columbia. George Masonis one of the significant residential mortgage originators in the greaterWashington metropolitan area, reporting originations of over $4.5 billion in2003 and $3.2 billion in 2002. George Mason’s primary sources of revenueinclude net interest income earned on loans held for sale, gain on the sale ofloans held for sale and contractual management fees earned relating to themanagement of other entities’ activities. Loans are made pursuant to purchasecommitments and are sold servicing released.

In July 2004, the Company formed a wholly-ownedsubsidiary, Cardinal Statutory Trust I, for the purpose of issuing $20.0million of floating rate junior subordinated deferrable interest debentures (“trustpreferred securities”). These trust preferred securities are due in 2034 andhave an interest rate of LIBOR (London Interbank Offered Rate) plus 2.40%,which adjusts quarterly. These securities are redeemable at a premium through March 2008and at par thereafter. The Company has guaranteed payment of these securities. The$20.6 million payable by the Company to Cardinal Statutory Trust I is includedin other borrowed funds in the Consolidated Statements of Condition sinceCardinal Statutory Trust I is an unconsolidated subsidiary as the Company isnot the primary beneficiary of this entity. The Company utilized the proceedsfrom the issuance of the trust preferred securities to make a capitalcontribution into the Bank.

Net interest income is our primary source of revenue.We define revenue as net interest income plus non-interest income. As discussedfurther in the interest rate sensitivity section, we manage our balance sheetand interest rate risk to maximize, and concurrently stabilize, net interestincome. We do this by monitoring the spread between the interest rates earnedon interest earning assets and the interest rate 

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paid on interest bearingliabilities. We attempt to minimize our exposure to interest rate risk, but areunable to eliminate it.  In addition tomanagement of interest rate risk, we analyze our loan portfolio for exposure tocredit risk. Risk of loan defaults and foreclosures are unavoidable in thebanking industry, and we try to limit our exposure to this risk by carefullyunderwriting and monitoring our extensions of credit. In addition to netinterest income, non-interest income is an increasingly important source ofincome for us and includes service charges on deposits and loans, investmentfee income, gains on sales on investment securities available-for-sale, gainson sale of loans held for sale and management fee income. Our acquisition of GeorgeMason in July 2004 has resulted in non-interest income becoming a largercomponent of our total revenues.

Netinterest income and non-interest income represented the following percentagesof total revenue for the three years ended December 31, 2004:
| ** ** | ** ** | **Net Interest  Income** | ** ** | **Non-Interest   Income** | ** ** |
|------------|------------|-------------------------------|------------|--------------------------------|------------|
| 2004       |       |                          | 72.3       | %                              |       |   | 27.7 | % |   |
| 2003       |       |                          | 79.8       | %                              |       |   | 20.2 | % |   |
| 2002       |       |                          | 78.8       | %                              |       |   | 21.2 | % |   |

 

We anticipate that non-interest income will be alarger percentage of our total revenue in 2005 than it was in 2004 since wewill have owned George Mason for a full year in 2005 compared to a half year in2004.

Our business strategy isto grow through geographic expansion while maintaining strong asset quality andachieving sustained profitability. We completed a secondary common stockoffering that raised $41.7 million in capital in December 2003 and anadditional $6.3 million in capital following the exercise of the underwriters’over allotment option in January 2004. This capital is being used tosupport the continuing expansion of our branch office network and balance sheetgrowth. As a result of this increased capital and retained earnings, weincreased our legal lending limit to $13.9 million as of December 31,2004, which allows us to more quickly expand our commercial and real estatelending loan portfolios. We expect to increase our loan-to-deposit ratio andshift the mix of our earning assets to higher yielding loans. We used $17.0million of the cash that was raised in December 2003 and January 2004to acquire George Mason. George Mason adds to our plans to increase ourselection of banking products and financial services and diversify our revenuebase, increase fee income, and strengthen customer relationships.

**Risks Factors**

***We have operated at a cumulative loss since our inception.***

We have operated at acumulative loss since our organization in 1997. While we reported net income of$3.5 million in 2004 and $5.7 million in 2003, we cannot assure you that wewill be able to continue to operate at a profit as we continue to grow.

***We may not be able to successfully manage our growthor implement our growth strategies, which may adversely affect our results ofoperations and financial condition.***

During the lastfive years, we have experienced significant growth, and a key aspect of ourbusiness strategy is our continued growth and expansion. Our ability tocontinue to grow depends, in part, upon our ability to:

·  open new branch offices or acquire existingbranches or other financial institutions;

·  attract deposits to those locations; and

·  identify attractive loan and investmentopportunities.

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We may not be able to successfully implement ourgrowth strategy if we are unable to identify attractive markets, locations oropportunities to expand in the future. Our ability to manage our growthsuccessfully also will depend on whether we can maintain capital levelsadequate to support our growth and maintain cost controls and asset quality.

As we continue toimplement our growth strategy by opening new branches or acquiring branches orother banks, we expect to incur increased personnel, occupancy and otheroperating expenses. In the case of new branches, we must absorb those higherexpenses while we begin to generate new deposits, and there is a further timelag involved in redeploying new deposits into attractively priced loans andother higher yielding earning assets. Thus, our plans to branch aggressivelycould depress our earnings in the short run, even if we efficiently execute ourbranching strategy.

***We rely heavily on our management team and theunexpected loss of any of those personnel could adversely affect ouroperations; we depend on our ability to attract and retain key personnel.***

We are a customer-focused and relationship-drivenorganization. We expect our future growth to be driven in a large part by therelationships maintained with our customers by our Chairman, President andChief Executive Officer, Bernard H. Clineburg, and our other executive andsenior lending officers. We have entered into employment agreements with Mr. Clineburgand three other executive officers. The existence of such agreements, however,does not necessarily assure that we will be able to continue to retain theirservices. The unexpected loss of Mr. Clineburg or other key employeescould have a material adverse effect on our business and possibly result inreduced revenues and earnings. We do not maintain key man life insurancepolicies on any of our executives.

The implementation of ourbusiness strategy will also require us to continue to attract, hire, motivateand retain skilled personnel to develop new customer relationships as well asnew financial products and services. Many experienced banking professionalsemployed by our competitors are covered by agreements not to compete or solicittheir existing customers if they were to leave their current employment. Theseagreements make the recruitment of these professionals more difficult. Themarket for these people is competitive, and we cannot assure you that we willbe successful in attracting, hiring, motivating or retaining them.

***We may incur losses if we are unable to successfullymanage interest rate risk.***

Our profitability willdepend in substantial part upon the spread between the interest rates earned oninvestments and loans and interest rates paid on deposits and otherinterest-bearing liabilities. We may pay above-market rates to attract depositsas we have done in some of our marketing promotions in the past. Changes ininterest rates will affect our operating performance and financial condition indiverse ways. We attempt to minimize our exposure to interest rate risk, but wewill be unable to eliminate it. Our net interest spread will depend on manyfactors that are partly or entirely outside our control, including competition,federal economic, monetary and fiscal policies, and economic conditionsgenerally.

***We may be adversely affected by economic conditions inour market area.***

We are headquartered in northern Virginia, and ourmarket includes the greater Washington, D.C. metropolitan area. Because ourlending is concentrated in this market, we will be affected by the generaleconomic conditions in the greater Washington area, which may be impacted bythe level of federal government spending. Changes in the economy, andgovernment spending in particular, may influence the growth rate of our loansand deposits, the quality of the loan portfolio and loan and deposit pricing. Asignificant decline in general economic conditions caused by inflation,recession, unemployment or other factors beyond our control would impact theselocal economic conditions and the demand for banking products and servicesgenerally could negatively affect our financial condition and performance.

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In recent years, there hasbeen a proliferation of technology and communications businesses in our marketarea. The recent economic recession and the downturn in those industries havehad a significant adverse impact on a number of those businesses. Although wedo not have significant credit exposure to these businesses, the downturn inthese industries could have a negative impact on local economic conditions andreal estate collateral values generally, which could negatively affect ourprofitability.

***Our concentration in loans secured by real estate mayincrease our credit losses, which would negatively affect our financialresults.***

We offer a variety ofsecured loans, including commercial lines of credit, commercial term loans,real estate, construction, home equity, consumer and other loans. Many of ourloans are secured by real estate (both residential and commercial) in ourmarket area. A major change in the real estate market, such as a deteriorationin the value of this collateral, or in the local or national economy, couldadversely affect our customers’ ability to pay these loans, which in turn couldimpact us. Risk of loan defaults and foreclosures are unavoidable in thebanking industry, and we try to limit our exposure to this risk by monitoringour extensions of credit carefully. We cannot fully eliminate credit risk, andas a result credit losses may occur in the future.

***If our allowance for loan losses becomes inadequate,our results of operations may be adversely affected.***

We maintain an allowance for loan losses that webelieve is a reasonable estimate of known and inherent losses in our loanportfolio. Through a periodic review and consideration of the loan portfolio,management determines the amount of the allowance for loan losses byconsidering general market conditions, credit quality of the loan portfolio,the collateral supporting the loans and performance of our customers relativeto their financial obligations with us. The amount of future losses issusceptible to changes in economic, operating and other conditions, includingchanges in interest rates, that may be beyond our control, and these losses mayexceed our current estimates. Rapidly growing loan portfolios are, by theirnature, unseasoned. As a result, estimating loan loss allowances is moredifficult, and may be more susceptible to changes in estimates, and to lossesexceeding estimates, than more seasoned portfolios. Although we believe theallowance for loan losses is a reasonable estimate of known and inherent lossesin our loan portfolio, we cannot fully predict such losses or that our loanloss allowance will be adequate in the future. Excessive loan losses could havea material impact on our financial performance.

Federal and stateregulators periodically review our allowance for loan losses and may require usto increase our provision for loan losses or recognize further loancharge-offs, based on judgments different than those of our management. Anyincrease in the amount of our provision or loans charged-off as required bythese regulatory agencies could have a negative effect on our operating results.

***Our future success is dependent on our ability tocompete effectively in the highly competitive banking industry.***

We face vigorouscompetition from other banks and other financial institutions, includingsavings and loan associates, savings banks, finance companies and credit unionsfor deposits, loans and other financial services in our market area. A numberof these banks and other financial institutions are significantly larger thanwe are and have substantially greater access to capital and other resources, aswell as larger lending limits and branch systems, and offer a wider array ofbanking services. To a limited extent, we also compete with other providers offinancial services, such as money market mutual funds, brokerage firms,consumer finance companies, insurance companies and governmental organizationswhich may offer more favorable financing than we can. Many of our nonbankcompetitors are not subject to the same extensive regulations that govern us.As a result, these nonbank competitors have advantages over us in providingcertain services. This competition may reduce or limit our margins and ourmarket share and may adversely affect our results of operations and financialcondition.

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***Our profitability and the value of your investment maysuffer because of rapid and unpredictable changes in the highly regulatedenvironment in which we operate.***

We are subject toextensive supervision by several governmental regulatory agencies at thefederal and state levels. Recently enacted, proposed and future bankinglegislation and regulations have had, and will continue to have, or may have asignificant impact on the financial services industry. These regulations, whichare intended to protect depositors and not our shareholders, and the interpretationand application of them by federal and state regulators, are beyond ourcontrol, may change rapidly and unpredictably and can be expected to influenceour earnings and growth. Our success depends on our continued ability tomaintain compliance with these regulations. Some of these regulations mayincrease our costs and thus place other financial institutions who are notsubject to similar regulation in stronger, more favorable competitivepositions.

***If we need additional capital in the future tocontinue our growth, we may not be able to obtain it on terms that arefavorable. This could negatively affect our performance and the value of ourcommon stock.***

Our business strategycalls for continued growth. We anticipate that we will be able to support thisgrowth through the generation of additional deposits at new branch locations aswell as investment opportunities. However, we may need to raise additionalcapital in the future to support our continued growth and to maintain ourcapital levels. Our ability to raise capital through the sale of additionalsecurities will depend primarily upon our financial condition and the conditionof financial markets at that time. We may not be able to obtain additionalcapital in the amounts or on terms satisfactory to us. Our growth may beconstrained if we are unable to raise additional capital as needed.

***Off Balance Sheet Risks***

In the normal course ofbusiness we issue loan commitments, stand-by letters of credit and enter intoguarantees which are not reflected in the consolidated statements of condition.Such arrangements could expose us to additional risk of loss. See Note 20 tothe consolidated financial statements for additional information.

**CautionAbout Forward Looking Statements**

We make certain forward looking statements in this Form 10-Kthat are subject to risks and uncertainties. These forward looking statementsinclude statements regarding our profitability, liquidity, allowance for loanlosses, interest rate sensitivity, market risk, growth strategy, and financialand other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,”“contemplates,” “anticipates,” “forecasts,” “intends,” or other similar wordsor terms are intended to identify forward looking statements.

These forwardlooking statements are subject to significant uncertainties because they arebased upon or are affected by factors including:

·       theability to successfully manage our growth or implement our growth strategies ifwe are unable to identify attractive markets, locations or opportunities toexpand in the future;

·       changesin interest rates and their policies;

·       risksinherent in making loans such as repayment risks and fluctuating collateralvalues;

·       thesuccessful management of interest rate risk;

·       maintainingcost controls and asset quality as we open or acquire new branches;

·       maintainingcapital levels adequate to support our growth;

·       relianceon our management team, including our ability to attract and retain keypersonnel;

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·       competitionwith other banks and financial institutions, and companies outside of thebanking industry, including those companies that have substantially greateraccess to capital and other resources;

·       changesin general economic and business conditions in our market area;

·       demand,development and acceptance of new products and services;

·       problemswith technology utilized by us;

·       changingtrends in customer profiles and behavior;

·       changesin banking, other laws and regulations applicable to us; and

·       otherfactors discussed in “Risk Factors” above.

Because of theseuncertainties, our actual future results may be materially different from theresults indicated by these forward-looking statements. In addition, our pastresults of operations do not necessarily indicate our future results.

**Financial Developments**

Prior to March 2002, Cardinal was a multi-bankorganization. In 2002, we completed the consolidation of our original fourbanking subsidiaries into a single bank in order to reduce costs and streamlineoperations and decision-making.

As a result of the bank consolidation noted above, wereduced staffing levels during the fourth quarter of 2001. We reduced ournumber of employees from 138 on June 30, 2001 to 105 as of December 31,2001. Most of the staff reductions were made in the commercial lending area ofthe bank, which had become overstaffed in light of the shift in strategy fromfour banks to one. We also made significant reductions in staff in ourcentralized administration areas, including accounting, deposit operations andcredit administration. We have grown our branch banking network from sevenlocations at the end of 2001 to eighteen locations at the end of 2004. Thisgrowth, combined with the acquisition of George Mason, has resulted in thenumber of our employees increasing from 105 at the beginning of 2002 to 385 atthe end of 2004.

Our 2001 restructuring resulted in significant savingsin operating costs during 2002. However, an other than temporary write down of$1.7 million on a WorldCom bond recorded in the second quarter of 2002, createda reported net loss to common shareholders of $1.0 million for the year ended December 31,2002.

The year ended December 31, 2003 was our firstfull year of profitability. We reported net income of $5.7 million or $0.54 perdiluted common share in 2003. Included in this net income was an income taxbenefit of $3.5 million attributable to the recognition of deferred tax assetssince we determined that it was more likely than not that these assets would beutilized. The pretax profit to common shareholders in 2003 was $2.6 million,which was achieved through continued growth in our earning assets, as well asincreases in non-interest income, primarily attributable to $1.4 million ofrealized gains on sales of investment securities available-for-sale. Thesesales were from our mortgage-backed investment securities available-for-saleportfolio, which had accelerated prepayment speeds as a result of the lowmortgage rate environment experienced during 2003. We sold these securitieswith realized gains and reinvested the funds in our loan and investmentsecurities portfolio. We do not have plans to record such gains in the future,although we may sell portions of our available-for-sale investment securitiesportfolio as needed for liquidity or interest rate risk management purposes.

The year ended December 31,2004 was our second full year of profitability. For the year, we reported netincome of $3.5 million. George Mason is included in our operating results sinceJuly 7, 2004 and 

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contributedapproximately $1.4 million to consolidated net income during 2004. The decreasein net income from the prior year is the result of the one-time income taxbenefit recorded in 2003. Pretax income in 2004 was $5.2 million compared to$2.6 million in 2003. Total assets increased by $575.3 million in 2004, from$636.2 million at December 31, 2003, to $1.21 billion at December 31,2004. Total deposits increased by $350.1 million in 2004, from $474.1 millionat December 31, 2003, to $824.2 million at December 31, 2004.

**Critical Accounting Policies**

*General*

U.S generally accepted accounting principles arecomplex and require management to apply significant judgment to variousaccounting, reporting, and disclosure matters. Management must use assumptionsand estimates to apply these principles where actual measurements are notpossible or practical. These policies are critical because they are highlydependent upon subjective or complex judgments, assumptions and estimates. Changesin such judgments, assumptions or estimates may have a significant impact onthe consolidated financial statements. Actual results could differ from thoseestimates.

The accounting policies weview as critical are those relating to judgments, assumptions and estimatesregarding the accounting for business combinations, the determination of theallowance for loan losses, accounting for economic hedging activities, and thevaluation allowance for deferred tax assets.

*Accounting forBusiness Combinations*

We account foracquisitions of other businesses in accordance with Financial AccountingStandards Board (“FASB”) Statement No. 141, *BusinessCombinations*. This statement mandates the use of purchase accountingand, accordingly, assets and liabilities, including previously unrecordedassets and liabilities, are recorded at fair values as of the acquisition date.We utilize a variety of valuation methods to estimate fair value of acquiredassets and liabilities. These methodologies are often based upon assumptionsand estimates which may change at a future date and require that the carryingamount of assets and liabilities acquired be adjusted. To reduce thepossibility of future adjustments, we have utilized independent consultants toidentify and value identifiable purchased intangibles. The difference betweenthe fair value of assets acquired less the fair value of liabilities acquiredis recorded as goodwill. Goodwill and any other intangible assets are accountedfor in accordance with FASB Statement No. 142, *Goodwill andOther Intangible Assets*. In accordance with this statement, goodwillwill not be amortized but will be tested on at least an annual basis forimpairment.

*Allowance for LoanLosses*

We maintain the allowance for loan losses at a levelthat represents management’s best estimate of known and inherent losses in theloan portfolio. Both the amount of the provision expense and the level of theallowance for loan losses are impacted by many factors, including generaleconomic conditions, actual and expected credit losses, historical trends andspecific conditions of the individual borrowers. As a part of our analysis, weuse comparative peer group data, duration factors and qualitative factors suchas levels of and trends in delinquencies and non-accrual loans, national andlocal economic trends and conditions and concentrations of loans exhibitingsimilar risk profiles to support our estimates.

Credit losses are an inherent part of our businessand, although we believe the methodologies for determining the allowance forloan losses and the current level of the allowance are adequate, it is possiblethat there may be unidentified losses in the portfolio that may become evidentat a future date pursuant to additional analysis or regulatory comment. Additionalprovisions for such losses, if necessary, would be 

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recorded in the commercialbanking or mortgage banking segment, as appropriate, and would negativelyimpact earnings.

For purposes of ouranalysis, we categorize our loans into one of five categories: commercial andindustrial, commercial real estate (including construction), home equity linesof credit, residential mortgages, and consumer loans. Peer group annual lossfactors (in the absence of historical results) are applied to all categoriesand are adjusted by the projected duration of the loan category and by thequalitative factors mentioned above. The indicated loss factors resulting fromthis analysis are applied to each of the loan categories to determine a reservelevel for each of the five categories of loans. In addition, we individuallyassign loss factors to all loans that have been identified as having lossattributes, as indicated by deterioration in the financial condition of theborrower or a decline in underlying collateral values. Since we have limitedhistorical data on which to base loss factors for classified loans, we apply,in accordance with regulatory guidelines, a 5% loss factor to all specialmention loans, a 15% loss factor to all substandard loans and a 50% loss factorto all loans classified as doubtful. Loans classified as loss loans are fullyreserved or charged off.

*Hedging*

We account for our derivatives and hedging activitiesin accordance with FASB Statement No. 133, *Accountingfor Derivative Instruments and Hedging Activity* (“SFAS No. 133),as amended by FASB Statement No. 138, *Accounting for CertainDerivative Instruments and Certain Hedging Activities,*and FASBStatement No. 149*, Amendment of Statement133 on Derivative Instruments and Hedging Activities.*

In the normal course of business, we enter intocontractual commitments, including loan commitments and rate lock commitmentsto extend credit to finance residential mortgages. These commitments, whichcontain fixed expiration dates, offer the borrower an interest rate guaranteeprovided the loan meets underwriting guidelines and closes within the timeframe established by us. Interest rate risk arises on these commitments andsubsequently closed loans if interest rates move between the time of theinterest rate lock and the delivery of the loan to the investor. Loancommitments related to mortgage loans that are intended to be sold areconsidered derivatives in accordance with the guidance of SEC Staff AccountingBulletin No. 105, *Application of AccountingPrinciples to Loan Commitments*. Accordingly, the fair value of thesederivatives at the end of the reporting period has been determined through ananalysis of changes in market interest rates from the interest rate lock dateand loan closing date.

To mitigate the effect of the interest rate risk inherentin providing rate lock commitments, we economically hedge our commitments byentering into best efforts delivery forward loan sale contracts. These forwardcontracts are marked to market through earnings and are not designated asaccounting hedges under Statement No. 133. The change in the fair value ofloan commitments and the change in the fair value of forward sales contractsgenerally move in opposite directions and, accordingly, impact of changes inthese valuations on net income during the loan commitments period is generallyinconsequential.

Although the forward loansale contracts also serve as an economic hedge of loans held for sale, forwardcontracts have not been designated as accounting hedges under Statement No. 133and, accordingly, loans held for sale are accounted for at the lower of cost ormarket in accordance with Statement No. 65, *Accountingfor Certain Mortgage Banking Activities.*

*Valuation ofDeferred Tax Assets*

We record a provision forincome tax expense based on the amounts of current taxes payable (orrefundable) and the change in net deferred tax assets or liabilities during theyear. Deferred tax assets and liabilities are recognized for the tax effects ofdiffering carrying values of assets and liabilities for tax and financialstatement purposes that will reverse in future periods. When substantialuncertainty exists 

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concerningthe recoverability of a deferred tax asset, the carrying value of the asset isreduced by a valuation allowance. The amount of any valuation allowanceestablished is based upon an estimate of the deferred tax asset that isprobable of recovery. The establishment of a valuation allowance increases theprovision for income taxes.

**New Financial Accounting Standards**

In March 2004, the FASB issued Emerging IssuesTask Force Issue No. 03-1 (“EITF 03-1”), *The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments.*EITF03-1 provided guidance for evaluating whether an investment in debt andequity securities is other-than-temporarily impaired and was effective forother than-temporary impairment evaluations made in reporting periods beginningafter June 15, 2004. According to EITF 03-1, a security is impairedwhen its fair value is less than its carrying value, and an impairment isother-than-temporary if the investor does not have the “ability and intent” tohold the investment until a forecasted recovery of its carrying amount. EITF 03-1requires that once an investment is determined to be impaired, the impairmentmust be assessed using the ability-and-intent-to-hold criterion regardless ofthe severity or amount of the impairment. If the impairment is determined to beother-than-temporary, an impairment loss should be recognized in earnings. TheFASB staff subsequently issued FSP EITF 03-1-1, which deferred theapplication of measurement provisions of EITF 03-1. The FASB determinedthat a delay in the effective date of those provisions was necessary until itcan issue additional guidance on the application of EITF 03-1. Thedisclosure provisions of EITF 3-01 remain effective.

In December 2004, theFASB issued FASB Statement No. 123R, *Share-Based Payments:  an Amendment of FASB Statements 123 and 95.*Thisstatement requires that companies recognize to the income statement the grant-datefair value of stock options and other equity-based compensation. This statementrequires that stock awards be classified as either an equity award or aliability award. Equity classified awards are valued as of the grant date usingeither an observable market price or a valuation methodology. Liabilityclassified awards are valued at fair value as of each reporting date. Thisstatement is effective for the Company in the third quarter of 2005. Weestimate that this new standard will result in an increase in pretax expense ofapproximately $138,000 in the second half of 2005 compared to the first sixmonths of 2005.

**Financial Overview**

***2004 Compared to 2003***

At December 31, 2004, total assets were $1.21billion, an increase of 90.4% or $575.3 million, compared to $636.2 million at December 31,2003. Total loans receivable, net of deferred fees and costs, increased 45.8%or $153.9 million, to $489.9 million at December 31, 2004, compared to$336.0 million at December 31, 2003. Total investment securities increasedby $15.9 million or 5.8%, to $289.5 million at December 31, 2004, comparedto $273.6 million at December 31, 2003. Total deposits increased 73.8% or$350.1 million, to $824.2 million at December 31, 2004, compared to$474.1 million at December 31, 2003. Other borrowed funds, which primarilyinclude repurchase agreements, FHLB advances and our payable to CardinalStatutory Trust I, increased $126.6 million to $201.1 million at December 31,2004, compared to $74.5 million at December 31, 2003. During 2003, weintroduced repurchase agreements to our customers, which totaled $25.5 millionat December 31, 2003 and $30.4 million at December 31, 2004. Advancesfrom the Federal Home Loan Bank of Atlanta were $49.0 million at December 31,2003, and $137.0 million at December 31, 2004.

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Shareholders’ equity at December 31,2004 was $95.1 million, an increase of $9.7 million, compared to $85.4 millionat December 31, 2003. The increase in shareholders’ equity was primarilyattributable to $6.3 million of additional equity raised as a result of theunderwriters exercising in January 2004 their over allotment option inconnection with our 2003 stock offering and net income of $3.5 million. Totalshareholders’ equity to total assets at December 31, 2004 and 2003 were7.9% and 13.4%, respectively. Book value per share at December 31, 2004and 2003 was $5.15 and $4.80, respectively. Total risk based capital to riskweighted assets was 13.40% at December 31, 2004 compared to 20.66% at December 31,2003. Accordingly, the Company was considered “well capitalized” for regulatorypurposes at December 31, 2004. Risk based capital to risk weighted assetsdeclined from 2003 to 2004 despite our issuance of $20.0 million of trustpreferred securities, which is included as a component of regulatory capital, becauseof our growth during 2004 and the fact that goodwill and intangibles, whichincreased by $14.7 million as a result of the George Mason acquisition, areexcluded from regulatory capital.

We recorded net income of$3.5 million, or $0.19 per diluted common share, for the year ended December 31,2004, compared to net income of $5.7 million or $0.54 per diluted common share,for the comparable period in 2003. As previously noted, 2003’s net incomeincluded an income tax benefit of $3.5 million attributable to the recognitionof prior periods’ net operating loss carryforwards. We recorded pretax incomeof $5.2 million for the year ended December 31, 2004, compared to $2.6million for year ended December 31, 2003. The 2003 results included theeffect of preferred stock dividends of $495,000. All outstanding shares of thepreferred stock were converted into shares of our common stock in March 2004.

The return on averageassets for the years ended December 31, 2004 and 2003 was 0.37% and 1.18%,respectively. The return on average equity for the years ended December 31,2004 and 2003 was 3.69% and 13.84%, respectively.

***2003 Compared to 2002***

Our net income for the year ended December 31,2003 was $5.7 million or $0.54 per diluted common share, compared with a lossof $1.0 million or $0.13 per diluted common share for the same period of 2002. The2002 loss included an other than temporary impairment of $1.7 million of aninvestment in a WorldCom bond that we recorded in the second quarter of 2002. Ifthe impact of the WorldCom impairment was excluded, we would have reported netincome of $636,000, or $0.08 per diluted common share, for the year ended December 31,2002. Table 1 shows a reconciliation of GAAP to Non-GAAP financial measures,which we believe appropriately compares our operating results for 2004, 2003and 2002 by excluding the other than temporary impairment. Results arepresented after the effect of dividends paid to preferred shareholders of$495,000 during each of 2003 and 2002. The return on average assets for theyears ended December 31, 2003 and 2002 were 1.18% and (0.14)%,respectively. The return on average equity for the years ended December 31,2003 and 2002 were 13.84% and (1.61)%, respectively.

Total assets increased $149.9 million, or 30.8%, to$636.2 million at December 31, 2003, compared to $486.3 million at December 31,2002. Asset growth was funded primarily by a $72.5 million increase in otherborrowed funds to $74.5 million at December 31, 2003, a $44.7 millionincrease in equity capital which was primarily the result of our secondarystock offering in December 2003, and an increase in deposits of $50.7million to $474.1 million at December 31, 2003. The strong growthexperienced during 2003 is attributed to aggressive promotion of our productsthrough advertising and direct mail in addition to the opening of threebranches in 2003.

As noted above, totalshareholders’ equity increased $44.7 million to $85.4 million at December 31,2003 compared to $40.7 million at December 31, 2002. This increase wasprimarily a result of the completion of our secondary common stock offering in December 2003,which raised $41.7 million of additional capital. Book value per common shareincreased to $4.80 at December 31, 2003 compared to $3.37 at December 31,2002. The ratio of risk-based capital to risk-based assets increased to 20.66%at 

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December 31,2003 compared to 13.35% at December 31, 2002. Total shareholders’ equityto total assets at December 31, 2003 and 2002 were 13.4% and 8.4%,respectively.

**Table1.**

**Reconciliationof GAAP to Non-GAAP Financial MeasuresYears ended December 31, 2004, 2003 and 2002 (Dollars in thousands, except per share data)**
| ** **                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Reported net income  (loss) to common shareholders   |       | $        | 3,469      |     | $          | 5,659    |       | $ | (1,024 | ) |
| Less impairments:                                    |       |     |       |     |       |     |       |
| Other than temporary  impairment of WorldCom bond    |       | —   |       | —   |       | 1,660    |       |
| Net income (loss)  without impairments               |       | $        | 3,469      |     | $          | 5,659    |       | $ | 636 |   |
| Reported net income  (loss) per common share         |       | $        | 0.19       |     | $          | 0.55     |       | $ | (0.13 | ) |
| Less impairments:                                    |       |     |       |     |       |     |       |
| Other than temporary  impairment of WorldCom bond    |       | —   |       | —   |       | 0.21     |       |
| Earnings (loss) per common share without impairments |       | $        | 0.19       |     | $          | 0.55     |       | $ | 0.08 |   |

 

**Statements of Operations**

***Net Interest Income/Margin***

Net interest income is our primary source of revenue,representing the difference between interest and fees earned oninterest-bearing assets and the interest paid on deposits and otherinterest-bearing liabilities. The level of net interest income is affectedprimarily by variations in the volume and mix of these assets and liabilities,as well as changes in interest rates. During 2002 and continuing in 2003, weexperienced a weakened economy that had entered into a recessionary phase earlyin 2001. During 2001, the Federal Reserve lowered rates eleven times in orderto generate economic growth. During the fourth quarter of 2002, in response tothis weakening economy and the lack of any inflationary pressures, the FederalReserve lowered rates an additional 50 basis points. During the second quarterof 2003, the Federal Reserve again decreased interest rates another 25 basispoints. At the end of 2003, the prime lending rate was at 4.00%, its lowestlevel in over forty years. During 2004 and into 2005 as economic activity hasincreased, the Federal Reserve raised the key federal funds rate six times to2.50%. The prime lending rate increased from 4.00% at the end of 2003 to 5.50%at the end of 2004. See “Interest Rate Sensitivity” for further information.

Net interest income for the year ended December 31,2004 was $24.6 million, compared to $15.2 million for the year ended December 31,2003, an increase of $9.4 million, or 61.8%. The increase in net interestincome is a result of increases in average volume of investment securities,loans held for sale and loans receivable, net of the impact of decreased yieldsduring 2004, compared with the same period of 2003. These net increases werefunded through the increases in total deposits and other borrowed funds.

Our net interest margin for the years ended December 31,2004 and 2003 was 2.72% and 3.00%, respectively, as a result of earning assetyields declining more quickly than the cost of interest-bearing liabilities. Theaverage yield on interest earning assets decreased to 4.49% in 2004 from 4.86%in 2003 and our cost of interest-bearing liabilities decreased to 2.17% in 2004from 2.31% in 2003. The yield on other borrowed funds, which generally areshorter term fundings and which we utilized to a greater extent in 2004 than2003 as a result of the George Mason acquisition, increased 50 basis points to2.18% for 2004 compared to 1.68% for 2003.

Total earning assetsincreased by 88.3% to $1.16 billion at December 31, 2004, compared to$616.7 million at December 31, 2003. This resulted primarily from a $365.5million increase in loans held for sale 

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as aresult of our George Mason acquisition and a $153.9 million increase in loansreceivable. These increases were funded by deposit growth of $350.1 million, or73.8%, and other borrowed funds and warehouse financing growth of $156.9million over December 31, 2003 balances. In addition, other borrowed fundsincreased by $126.6 million during 2004 to $201.1 million at December 31,2004, compared to $74.5 million at December 31, 2003.

Average loans receivableincreased $118.7 million to $391.4 million during 2004 from $272.8 million in2003. Average balances of nonperforming assets, which consist of non-accrualloans, are included in the net interest margin calculation and did not have amaterial impact on our net interest margin in 2004 and 2003. Additionalinterest income of approximately $25,000 for 2004 and $39,000 for 2003 wouldhave been realized had all nonperforming assets performed as originallyexpected. Nonperforming assets exclude loans that are both past due 90 days ormore and still accruing interest due to an assessment of collectibility.

Average total depositsincreased $219.9 million to $652.7 million in 2004 from $432.8 million in 2003.The largest increase in average deposit balances was experienced incertificates of deposit, an increase of $194.8 million compared to 2003, aresult of our branch expansion and increased advertising of our rates oncertificates of deposit. In addition, to assist in the funding of George Mason’sloans held-for-sale, we began using the brokered certificates of deposit marketduring 2004. At December 31, 2004, we had $86.7 million of brokeredcertificates of deposit. Our utilization of the brokered certificates ofdeposit market averaged $52.3 million in 2004.

Net interest income was$15.2 million for the year ended December 31, 2003, up $4.5 million or42.3% from 2002. The increase was primarily due to the increase in loans andinvestment securities available-for-sale during 2003, funded through theincrease in total deposits and shareholders’ equity.

Our net interest marginfor the years ended December 31, 2003 and 2002 was 3.00% and 2.92%,respectively. The increase in the net interest margin was a result of thedecrease in the cost of interest-bearing liabilities offset slightly by the decreasein the yield on average earning assets. The average yield on interest earningassets decreased to 4.86% in 2003 from 5.54% in 2002 and our cost ofinterest-bearing liabilities decreased to 2.31% in 2003 from 3.27% in 2002. Thedecrease in our cost of interest-bearing deposits is primarily the result ofour decreasing the rate on our President’s Club relationship product to 1.51%,down from 2.00% at December 31, 2002. In addition, the yield on otherborrowed funds decreased 231 basis points to 1.68% at December 31, 2003compared to December 31, 2002.

Total earning assetsincreased by 37.0% to $616.7 million at December 31, 2003, compared to$450.3 million at December 31, 2002. This increase consisted mainly of an$86.9 million, or 34.9% increase in loans receivable, net of fees and a $109.9million, or 67.2% increase in total investment securities. These increases werefunded by deposit growth of $50.7 million, or 12.0%, and other borrowed fundsgrowth of $72.5 million over December 31, 2002 balances. In addition,proceeds from our secondary common stock offering of $41.7 million funded ourearning asset growth as of December 31, 2003.

Average total loansincreased $66.1 million to $272.8 million during 2003 from $206.7 million in2002. Average balances of non-performing assets, which consist of non-accrualloans, are included in the net interest margin calculation and did not have amaterial impact on our net interest margin in 2003 and 2002. Additionalinterest income of approximately $39,000 for 2003 and $37,000 for 2002 wouldhave been realized had all non-performing assets performed as originallyexpected. Nonperforming assets exclude loans that are both past due 90 days ormore and still accruing interest due to an assessment of collectibility.

Average total deposits increased $84.7 million to$432.8 million in 2003 from $348.1 million in 2002. The largest increase inaverage deposit balances was experienced in certificates of deposit, anincrease of $42.9 million compared to 2002 and a result of our branch expansionand increased advertising of our rates on certificates of deposit.

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The following is a summaryof our average earning and non-earning assets and interest-bearing andnon-interest-bearing liabilities for the three years ended December 31,2004 and the resulting yields and cost of funding for those years.

**Table2.**

**AverageBalance Sheets and Interest Rates on Earning Assets and Interest-BearingLiabilitiesYears Ended December 31, 2004, 2003 and 2002**
| ** **                                               | ** ** | **2004**                             | ** ** | **2003**                 | ** ** | **2002**   | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|------------|------------|
| ** **                                               | ** ** | ** **                           | ** ** | ** Interest ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** Interest ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** Interest ** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Average**                          | ** ** | ** Income/ **  | ** ** | ** ** | ** ** | **Average** | ** ** | ** Income/ ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** Income/ ** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Balance**                          | ** ** | ** Expense **  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | ** Expense ** | ** ** | **Rate** | ** ** | **Balance** | ** ** | ** Expense ** | ** ** | **Rate** | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)** | ** ** |
| **Assets**                                               | ** ** | ** **                           |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans(1):                                                |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $                                    | 58,293     |                     |       | $          | 3,046      |   |   | 5.23 | % | $ | 50,188 |   |   | $ | 3,101 |   |   | 6.18 | % | $ | 52,960 |   |   | $ | 3,696 |   |   | 6.98 | % |
| Real estate—commercial                              |       | 170,730                              |       |                     | 10,617     |       |       | 6.22 | % | 121,345 |   |   | 8,422 |   |   | 6.94 | % | 91,289 |   |   | 7,276 |   |   | 7.97 | % |
| Real estate—construction                            |       | 52,459                               |       |                     | 3,024      |       |       | 5.76 | % | 20,427 |   |   | 1,131 |   |   | 5.54 | % | 6,156 |   |   | 375 |   |   | 6.09 | % |
| Real estate—residential                             |       | 49,057                               |       |                     | 2,780      |       |       | 5.67 | % | 38,059 |   |   | 2,414 |   |   | 6.34 | % | 20,139 |   |   | 1,534 |   |   | 7.62 | % |
| Home equity lines                                        |       | 52,221                               |       |                     | 1,856      |       |       | 3.55 | % | 33,720 |   |   | 1,121 |   |   | 3.32 | % | 23,711 |   |   | 993 |   |   | 4.19 | % |
| Consumer                                                 |       | 8,665                                |       |                     | 552        |       |       | 6.37 | % | 9,026 |   |   | 662 |   |   | 7.33 | % | 12,399 |   |   | 924 |   |   | 7.45 | % |
| Total loans                                              |       | 391,425                              |       |                     | 21,875     |       |       | 5.59 | % | 272,765 |   |   | 16,851 |   |   | 6.18 | % | 206,654 |   |   | 14,798 |   |   | 7.16 | % |
| Loans held for  sale, net                                |       | 181,700                              |       |                     | 6,814      |       |       | 3.75 | % | — |   |   | — |   |   | 0.00 | % | — |   |   | — |   |   | 0.00 | % |
| Investment  securities available-for-  sale              |       | 161,741                              |       |                     | 5,830      |       |       | 3.60 | % | 152,915 |   |   | 5,026 |   |   | 3.29 | % | 101,589 |   |   | 4,501 |   |   | 4.43 | % |
| Investment  securities held-to-  maturity                |       | 151,286                              |       |                     | 5,622      |       |       | 3.72 | % | 67,685 |   |   | 2,483 |   |   | 3.67 | % | — |   |   | — |   |   | 0.00 | % |
| Other investments                                        |       | 6,139                                |       |                     | 251        |       |       | 4.09 | % | 2,906 |   |   | 135 |   |   | 4.65 | % | 1,253 |   |   | 72 |   |   | 5.75 | % |
| Federal funds sold                                       |       | 10,473                               |       |                     | 130        |       |       | 1.24 | % | 9,753 |   |   | 107 |   |   | 1.10 | % | 55,773 |   |   | 871 |   |   | 1.56 | % |
| Total  interest-earning assets and interest income       |       | 902,764                              |       |                     | 40,522     |       |       | 4.49 | % | 506,024 |   |   | 24,602 |   |   | 4.86 | % | 365,269 |   |   | 20,242 |   |   | 5.54 | % |
| Non-interest-earning assets:                             | ** ** | ** **                           |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | 11,015                               |       |                     |       |       |       |   |   | 10,291 |   |   |   |   |   |   |   | 18,595 |   |   |   |   |   |   |   |
| Premises and  equipment, net                             |       | 11,229                               |       |                     |       |       |       |   |   | 5,249 |   |   |   |   |   |   |   | 4,820 |   |   |   |   |   |   |   |
| Goodwill and other  intangibles                          |       | 7,515                                |       |                     |       |       |       |   |   | 646 |   |   |   |   |   |   |   | 651 |   |   |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 8,533                                |       |                     |       |       |       |   |   | 3,265 |   |   |   |   |   |   |   | 2,551 |   |   |   |   |   |   |   |
| Allowance for loan  losses                               |       | (4,759                               | )          |                     |       |       |       |   |   | (3,652 | ) |   |   |   |   |   |   | (3,060 | ) |   |   |   |   |   |   |
| Total assets                                             |       | $                                    | 936,297    |                     |       |       |       |   |   |   | $ | 521,823 |   |   |   |   |   |   |   | $ | 388,826 |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**            |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                            |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                              |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 151,727                              |       |                     | 2,016      |       |       | 1.33 | % | 147,746 |   |   | 2,375 |   |   | 1.61 | % | 114,350 |   |   | 3,073 |   |   | 2.69 | % |
| Money markets                                            |       | 26,304                               |       |                     | 155        |       |       | 0.59 | % | 26,722 |   |   | 208 |   |   | 0.78 | % | 28,667 |   |   | 525 |   |   | 1.83 | % |
| Statement savings                                        |       | 7,806                                |       |                     | 58         |       |       | 0.74 | % | 5,389 |   |   | 35 |   |   | 0.65 | % | 4,305 |   |   | 52 |   |   | 1.21 | % |
| Certificates of  deposit                                 |       | 377,770                              |       |                     | 10,465     |       |       | 2.77 | % | 182,922 |   |   | 6,038 |   |   | 3.30 | % | 140,033 |   |   | 5,714 |   |   | 4.08 | % |
| Total interest-bearing  deposits                         |       | 563,607                              |       |                     | 12,694     |       |       | 2.25 | % | 362,779 |   |   | 8,656 |   |   | 2.39 | % | 287,355 |   |   | 9,364 |   |   | 3.26 | % |
| Other borrowed  funds                                    |       | 139,637                              |       |                     | 3,047      |       |       | 2.18 | % | 46,069 |   |   | 773 |   |   | 1.68 | % | 5,564 |   |   | 222 |   |   | 3.99 | % |
| Warehouse  financing                                     |       | 31,981                               |       |                     | 228        |       |       | 0.71 | % | — |   |   | — |   |   | 0.00 | % | — |   |   | — |   |   | 0.00 | % |
| Total  interest-bearing liabilities and interest expense |       | 735,225                              |       |                     | 15,969     |       |       | 2.17 | % | 408,848 |   |   | 9,429 |   |   | 2.31 | % | 292,919 |   |   | 9,586 |   |   | 3.27 | % |
| Non-interest-bearing liabilities:                        |       |                                 |       |                     |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 89,114                               |       |                     |       |       |       |   |   | 70,030 |   |   |   |   |   |   |   | 60,786 |   |   |   |   |   |   |   |
| Other liabilities                                        |       | 17,847                               |       |                     |       |       |       |   |   | 2,043 |   |   |   |   |   |   |   | 2,282 |   |   |   |   |   |   |   |
| Preferred  shareholders’ equity                     |       | 1,589                                |       |                     |       |       |       |   |   | 6,824 |   |   |   |   |   |   |   | 6,825 |   |   |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 92,522                               |       |                     |       |       |       |   |   | 34,078 |   |   |   |   |   |   |   | 26,014 |   |   |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $                                    | 936,297    |                     |       |       |       |   |   |   | $ | 521,823 |   |   |   |   |   |   |   | $ | 388,826 |   |   |   |   |   |   |   |
| Net interest  income and net interest margin(2)          |       |                                 |       |                     | $          | 24,553     |       |   | 2.72 | % |   |   |   | $ | 15,173 |   |   | 3.00 | % |   |   |   | $ | 10,656 |   |   | 2.92 | % |

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(1)                Non-accrual loans are included in average balances and donot have a material effect on the average yield. Interest income onnon-accruing loans was not material for years presented.

(2)                We do not have investments that have tax benefitattributes; therefore, there are no tax equivalent adjustments to our net interestincome.

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**Table3.**

**Rateand Volume AnalysisYears Ended December 31, 2004, 2003 and 2002(Dollars in thousands)**
| ** **                                | ** ** | **2004 Compared to 2003** | ** ** | **2003 Compared to 2002** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **Average**                              | ** ** | **Average**                              | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume**                               | ** ** | **Rate**                                 | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest income:**                      |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans(1):                                 |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                 |       | $                                        | 501        |                                     | $          | (556 | ) |   | $ | (55 | ) |   | $ | (193 | ) | $ | (402 | ) |   | $ | (595 | ) |   |
| Real estate—commercial               |       | 3,428                                    |       | (1,233                                   | )          |   | 2,195 |   |   | 2,396 |   | (1,250 | ) |   | 1,146 |   |   |
| Real estate—construction             |       | 1,774                                    |       | 119                                      |       |   | 1,893 |   |   | 869 |   | (113 | ) |   | 756 |   |   |
| Real estate—residential              |       | 698                                      |       | (332                                     | )          |   | 366 |   |   | 1,365 |   | (485 | ) |   | 880 |   |   |
| Home equity lines                         |       | 615                                      |       | 120                                      |       |   | 735 |   |   | 419 |   | (291 | ) |   | 128 |   |   |
| Consumer                                  |       | (26                                      | )          | (84                                      | )          |   | (110 | ) |   | (251 | ) | (11 | ) |   | (262 | ) |   |
| Total loans                               |       | 6,990                                    |       | (1,966                                   | )          |   | 5,024 |   |   | 4,605 |   | (2,552 | ) |   | 2,053 |   |   |
| Loans held for sale, net                  |       | 6,814                                    |       | —                                   |       |   | 6,814 |   |   | — |   | — |   |   | — |   |   |
| Investment  securities available-for-sale |       | 290                                      |       | 514                                      |       |   | 804 |   |   | 2,274 |   | (1,749 | ) |   | 525 |   |   |
| Investment  securities held-to-maturity   |       | 3,067                                    |       | 72                                       |       |   | 3,139 |   |   | 2,483 |   | — |   |   | 2,483 |   |   |
| Other investments                         |       | 150                                      |       | (34                                      | )          |   | 116 |   |   | 95 |   | (32 | ) |   | 63 |   |   |
| Federal funds  sold                       |       | 8                                        |       | 15                                       |       |   | 23 |   |   | (719 | ) | (45 | ) |   | (764 | ) |   |
| Total interest income                     |       | 17,319                                   |       | (1,399                                   | )          |   | 15,920 |   |   | 8,738 |   | (4,378 | ) |   | 4,360 |   |   |
| **Interest  expense:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                         |       | 64                                       |       | (423                                     | )          |   | (359 | ) |   | 897 |   | (1,595 | ) |   | (698 | ) |   |
| Money markets                             |       | (3                                       | )          | (50                                      | )          |   | (53 | ) |   | (36 | ) | (281 | ) |   | (317 | ) |   |
| Statement savings                         |       | 16                                       |       | 7                                        |       |   | 23 |   |   | 13 |   | (30 | ) |   | (17 | ) |   |
| Certificates of deposit                   |       | 6,432                                    |       | (2,005                                   | )          |   | 4,427 |   |   | 1,750 |   | (1,426 | ) |   | 324 |   |   |
| Total interest-bearing deposits           |       | 6,509                                    |       | (2,471                                   | )          |   | 4,038 |   |   | 2,624 |   | (3,332 | ) |   | (708 | ) |   |
| Other borrowed funds                      |       | 1,570                                    |       | 704                                      |       |   | 2,274 |   |   | 1,616 |   | (1,065 | ) |   | 551 |   |   |
| Warehouse  financing                      |       | 228                                      |       | —                                   |       |   | 228 |   |   | — |   | — |   |   | — |   |   |
| Total interest expense                    |       | 8,307                                    |       | (1,767                                   | )          |   | 6,540 |   |   | 4,240 |   | (4,397 | ) |   | (157 | ) |   |
| Net interest  income(2)                   |       | $                                        | 9,012      |                                     | $          | 368 |   |   | $ | 9,380 |   |   | $ | 4,498 |   | $ | 19 |   |   | $ | 4,517 |   |   |

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(1)          Non-accrual loans areincluded in average balances and do not have a material effect on the averageyield. Interest income on non-accruing loans was not material for yearspresented.

(2)          Wedo not have investments that have tax benefit attributes; therefore, there areno tax equivalent adjustments to our net interest income.

**Interest Rate Sensitivity**

We are exposed to various business risks includinginterest rate risk. Our goal is to maximize net interest income withoutincurring excessive interest rate risk. Management of net interest income andinterest rate risk must be consistent with the level of capital and liquiditythat we maintain. We manage interest rate risk through an asset and liabilitycommittee (“ALCO”). ALCO is responsible for managing the interest rate risk forthe company in conjunction with liquidity and capital management.

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In managing interest rate sensitivity, the ALCOcommittee until the third quarter of 2004 primarily used gap analysis. Gapanalysis attempts to determine the volume of interest sensitive assets lessinterest sensitive liabilities in various time intervals. The difference is theinterest sensitivity gap which indicates how future changes in interest ratesmay affect net interest income. At December 31, 2003, we were liabilitysensitive within a one year time horizon, which means that rising rates had anadverse impact on net interest income. A negative gap, or liability sensitiveposition exists when we have more interest sensitive liabilities maturingwithin a certain time frame than interest sensitive assets.

Based on gap analysis, we could then simulate howchanges in interest rates would impact net interest income. We maintainedguidelines on both the level of acceptable gaps as well as guidelines fornegative variances of net interest income given certain interest rate changes.

Beginning with the interest rate sensitivity analysisfor the third quarter of 2004, we hired an independent consulting firm to modelthe interest rate sensitivity of the company. Instead of gap analysis, we beganusing a net interest income simulation model as our primary tool to measureinterest rate sensitivity. Many assumptions are developed based on expectedactivity in the balance sheet. For maturing assets, assumptions are created forthe redeployment of these assets. For maturing liabilities, assumptions aredeveloped for the replacement of these funding sources. Assumptions are alsodeveloped for assets and liabilities that could reprice during the modeled timeperiod. These assumptions also cover how we expect rates to change onnon-maturity deposits such as NOW, Money Market and savings accounts. Based oninputs that include the current balance sheet, the current level of interestrates and the developed assumptions, the model then produces an expected levelof net interest income assuming that market rates remain unchanged. This isconsidered the base case. Next, the model determines what net interest incomewould be given changes in interest rates. The rate simulations performedinclude a ramped rate change of down 100 basis points and up 200 basis pointsover a two year time period. In the ramped rate change, the model moves ratesgradually down 100 basis points over the first year and then rates remain flatin the second year. For the up 200 basis point scenario, rates are graduallymoved up 200 basis points in the first year and then rates remain flat in thesecond year. In both the up and down scenarios, the model assumes a parallelshift in the yield curve. The results of these simulations are then compared tothe base case.

At December 31, 2004,we were asset sensitive. Asset sensitive means that we had more assets maturingand repricing than liabilities. We have a significant portion of our assets asfloating rate assets and we have taken a significant amount of term fundingthrough fixed rate, fixed term, certificates of deposit. In a rising rateenvironment, net interest income should grow for an asset sensitive bank. Inthe up 200 basis point scenario for one year, net interest income improves bynot more than 10% compared to the base case and by not more than 15% over thetwo year time horizon. Being asset sensitive, net interest income declinescompared to the base case in the down 100 basis point scenario. At December 31,2004, net interest income has a negative variance to the base case of less than6% for the one year period and a negative variance of less than 10% over thecumulative two year period.

**ProvisionExpense and Allowance for Loan Losses**

Our policy is to maintain the allowance for loanlosses at a level that represents our best estimate of known and inherentlosses in the loan portfolio. Both the amount of the provision and the level ofthe allowance for loan losses are impacted by many factors, including generaleconomic conditions, actual and expected credit losses, historical trends andspecific conditions of the individual borrower.

The provision for loan losses was $1.6 million and$1.0 million for the years ended December 31, 2004 and 2003, respectively.The allowance for loan losses at December 31, 2004 was $5.9 millioncompared to $4.3 million at December 31, 2003. Our allowance for loan lossratio at December 31, 2004 was 1.20% compared to 1.29% at December 31,2003. The decrease in the allowance for loan loss ratio is primarily reflectiveof the shift in the loan mix in our portfolio and a slight improvement inoverall loan quality. Our 

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growth in the loanportfolio was mostly comprised of increases in our residential and commercialreal estate loans and home equity loan portfolios, which require lower reservecoverage than other portions of the loan portfolio. We continued to experiencestrong loan quality with annualized net charged-off loans equal to 0.02% toaverage loans receivable for the year ended December 31, 2004, andnon-performing loans equal to 0.11% of total loans as of December 31,2004.

Provision for loan losses was $444,000 for 2002. Thegrowth in loans during 2002 was comprised primarily of increases in ourresidential and home equity loan portfolios, which require lower reserveamounts than the remainder of the loan portfolio.

See “Critical Accounting Policies” above for moreinformation on our allowance for loan losses methodology.

The following tablescontain additional information pertaining to the calculation and allocation ofthe allowance for loan losses by loan type and the percentage of the loan typeto the total loan portfolio.

**Table4.**

**Allowancefor Loan LossesYears Ended December 31, 2004, 2003, 2002, 2001 and 2000(Dollars in thousands)**
| ** **                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1                                                 |       | $        | 4,344      |     | $          | 3,372    |       | $        | 3,104      |     | $          | 1,900 |   | $ | 726 |   |
| Provision for loan losses                                                          |       | 1,626    |       | 1,001    |       | 444      |       | 1,202    |       | 753      |       |
| Transfer to liability on unfunded commitments                                      |       | —   |       | —   |       | (74      | )          | —   |       | —   |       |
| Assumed allowance for loan losses from acquisition  of Heritage Bancorp, Inc. |       | —   |       | —   |       | —   |       | —   |       | 421      |       |
| Loans charged  off:                                                                |       |     |       |     |       |     |       |     |       |     |       |
| Commercial and industrial                                                          |       | (100     | )          | (74      | )          | (63      | )          | —   |       | —   |       |
| Consumer                                                                           |       | (8       | )          | (6       | )          | (54      | )          | —   |       | —   |       |
| Total loans charged off                                                            |       | (108     | )          | (80      | )          | (117     | )          | —   |       | —   |       |
| Recoveries:                                                                        |       |     |       |     |       |     |       |     |       |     |       |
| Commercial and industrial                                                          |       | 14       |       | 43       |       | 12       |       | 2        |       | —   |       |
| Consumer                                                                           |       | 2        |       | 8        |       | 3        |       | —   |       | —   |       |
| Total recoveries                                                                   |       | 16       |       | 51       |       | 15       |       | 2        |       | —   |       |
| Net (charge offs) recoveries                                                       |       | (92      | )          | (29      | )          | (102     | )          | 2        |       | —   |       |
| Ending balance,  December 31,                                                 |       | $        | 5,878      |     | $          | 4,344    |       | $        | 3,372      |     | $          | 3,104 |   | $ | 1,900 |   |

 
| ** **                                                  | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**   | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Loans:                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at year end                                         |       | $          | 489,896    |       | $          | 336,002    |       | $          | 249,106    |       | $          | 200,911 |   | $ | 154,271 |   |
| Allowance for loan losses to loans receivable, net  of fees |       | 1.20       | %          | 1.29       | %          | 1.35       | %          | 1.54       | %          | 1.23       | %          |
| Net charge-offs  to average loans receivable           |       | 0.02       | %          | 0.01       | %          | 0.05       | %          | 0.00       | %          | 0.00       | %          |
|                                                             |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |

 

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**Table5.**

**Allocationof the Allowance for Loan LossesAt December 31, 2004, 2003, 2002, 2001 and 2000(Dollars in thousands)**
| ** **                       | ** ** | **2004**       | ** ** | **2003**                  | ** ** | **2002**       | ** ** |
|----------------------------------|------------|----------------|------------|---------------------------|------------|----------------|------------|
| ** **                       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       |           | $          | 963                       |       |           |       | 11.53 | % |   |   | $ | 1,046 |   |   |   | 17.21 | % |   |   | $ | 1,301 |   |   |   | 23.40 | % |   |
| Real estate—commercial      |       |           | 2,732      |                      |       |           | 44.88      | % |   |   | 1,662 |   |   |   | 41.56 | % |   |   | 1,386 |   |   |   | 46.63 | % |   |
| Real estate—construction    |       |           | 768        |                      |       |           | 14.18      | % |   |   | 497 |   |   |   | 12.57 | % |   |   | 19 |   |   |   | 2.32 | % |   |
| Real estate—residential     |       |           | 692        |                      |       |           | 15.69      | % |   |   | 418 |   |   |   | 12.64 | % |   |   | 241 |   |   |   | 12.77 | % |   |
| Home equity lines                |       |           | 612        |                      |       |           | 12.32      | % |   |   | 486 |   |   |   | 12.84 | % |   |   | 201 |   |   |   | 10.77 | % |   |
| Consumer                         |       |           | 111        |                      |       |           | 1.40       | % |   |   | 235 |   |   |   | 3.18 | % |   |   | 224 |   |   |   | 4.11 | % |   |
| Total allowance for loan  losses |       |           | $          | 5,878                     |       |           |       | 100.00 | % |   |   | $ | 4,344 |   |   |   | 100.00 | % |   |   | $ | 3,372 |   |   |   | 100.00 | % |   |

 
| ** **                       | ** ** | **2001**       | ** ** | **2000**                  | ** ** |
|----------------------------------|------------|----------------|------------|---------------------------|------------|
| ** **                       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       |           | $          | 1,149                     |       |   |   | 28.71 | % |   |   | $ | 612 |   |   |   | 32.22 | % |   |
| Real estate—commercial      |       |           | 1,270      |                      |       |   | 43.37 | % |   |   | 678 |   |   |   | 37.05 | % |   |
| Real estate—construction    |       |           | 34         |                      |       |   | 3.18 | % |   |   | 50 |   |   |   | 2.65 | % |   |
| Real estate—residential     |       |           | 98         |                      |       |   | 7.20 | % |   |   | 181 |   |   |   | 11.51 | % |   |
| Home equity lines                |       |           | 176        |                      |       |   | 10.60 | % |   |   | 126 |   |   |   | 9.65 | % |   |
| Consumer                         |       |           | 377        |                      |       |   | 6.94 | % |   |   | 253 |   |   |   | 6.92 | % |   |
| Total allowance for loan  losses |       |           | $          | 3,104                     |       |   |   | 100.00 | % |   |   | $ | 1,900 |   |   |   | 100.00 | % |   |

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*                    Percentageof loan type to the total loan portfolio.

***Non-Interest Income***

Non-interest income includes service charges ondeposits and loans, gains on the sale of loans held for sale, investment feeincome, management fee income and gains on sales of investment securitiesavailable-for-sale, and continues to be an important factor in our operatingresults. Non-interest income for the years ended December 31, 2004 and2003 was $9.4 million and $3.8 million, respectively. The increase innon-interest income for the year ended December 31, 2004, compared to thesame period of 2003, is primarily the result of increased gains on the sale ofloans held for sale of $4.4 million as a result of our acquisition of GeorgeMason in July 2004. Also contributing to the increase in non-interestincome, and also as a direct result of the George Mason acquisition, managementfee income rose by $1.7 million from 2003 to 2004. Offsetting these increaseswas a $1.1 million decrease in gains on sales of investment securitiesavailable-for-sale from 2003 to 2004. Management fees represent the incomeearned for services provided to other mortgage companies owned by local homebuilders. The 2003 gains on the sale of investment securitiesavailable-for-sale were recorded on sales of mortgage-backed securities withaccelerated prepayment speeds, a result of the lower interest rate environmentexperienced during 2003. Service charges on deposit accounts increased andinvestment fees decreased slightly from 2003 levels. Deposit service chargesincreased primarily as a result of an increased number of transaction accountsand investment fees decreased primarily as a result of reduced finders feesearned by Cardinal Wealth Services. Loan service charges increased by $576,000from 2003 to 2004.

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Non-interest income increased by $965,000 from 2002 to2003. As previously noted, due to the interest rate condition, we recordedgains on investment securities available-for-sale during 2003. In 2003, thesegains were $840,000 greater than in 2002. In addition, gains on the sale ofloans held for sale increased by $208,000 from 2002 to 2003. These gains, alongwith a $66,000 increase in service charges on deposit accounts, were partiallyoffset by a $155,000 reduction in investment fee income.

The following tableprovides additional detail on non-interest income for the years ended December 31,2004, 2003, and 2002.

**Table6.**

**Non-InterestIncomeYears Ended December 31, 2004, 2003 and 2002(Dollars in thousands)**
| ** **                                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Insufficient  funds fee income                                 |       | $        | 540        |     | $          | 400      |       | $ | 305 |   |
| Service charges  on deposit accounts                           |       | 202      |       | 231      |       | 206      |       |
| Other fee income  on deposit accounts                          |       | 101      |       | 134      |       | 195      |       |
| ATM transaction  fees                                          |       | 205      |       | 107      |       | 100      |       |
| Loan service  charges                                          |       | 958      |       | 382      |       | 392      |       |
| Investment fee  income                                         |       | 657      |       | 785      |       | 940      |       |
| Net gain on sales  of loans                                    |       | 4,696    |       | 282      |       | 74       |       |
| Management fee  income                                         |       | 1,749    |       | —   |       | —   |       |
| Net realized gain  on investment securities available-for-sale |       | 245      |       | 1,364    |       | 524      |       |
| Net gain (loss)  on sales of assets                            |       | (1       | )          | —   |       | 39       |       |
| Credit card fees                                               |       | 41       |       | 46       |       | 46       |       |
| Other income                                                   |       | 16       |       | 98       |       | 43       |       |
| **Total non-interest income**                                  |       | $        | 9,409      |     | $          | 3,829    |       | $ | 2,864 |   |

 

***Non-Interest Expense***

Non-interest expense includes salaries and benefits,occupancy, professional fees, depreciation, data processing, telecommunicationsand miscellaneous expenses. Non-interest expense was $27.2 million and $15.4million for the years ended December 31, 2004 and 2003, respectively, anincrease of $11.8 million, or 76.8%. The increase in non-interest expense forthe year ended December 31, 2004, compared to 2003, is primarily theresult of our George Mason acquisition and the branch expansion that hasoccurred over the past twelve months. Expenses related to the branch expansionare represented in the increases in our salaries and benefits expense andoccupancy expense. Expenses have also increased in professional fees, marketingand advertising, and loan expenses to support our branch openings and strongasset growth over the past year. We expect non-interest expense to continue toincrease going forward as we continue our branch expansion in 2005. We openedour 19th office in Sterling, Virginia in January 2005.

Non-interest expense was $15.4 million and $13.6million for the years ended December 31, 2003 and 2002, respectively. Theincrease in non-interest expense was $1.8 million, or 12.9% for 2003 comparedto 2002. During the second quarter of 2002, we recorded an other than temporaryimpairment of $1.7 million on an investment in a WorldCom bond. Increasesin substantially all components of non-interest expense from 2002 to 2003 morethan offset the year-to-year decrease attributable to the WorldCom bond, withsalaries and benefits increasing $1.1 million or 18.9%, a $587,000 or 60.4%increase in occupancy costs, and a $294,000 or 39.9% increase in depreciation.

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The following tablereflects the components of non-interest expense for the years ended December 31,2004, 2003 and 2002.

**Table7.**

**Non-InterestExpenseYears Ended December 31, 2004, 2003 and 2002(Dollars in thousands)**
| ** **                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Salary and benefits            |       | $        | 13,354     |     | $          | 6,797    |       | $ | 5,715 |   |
| Occupancy                      |       | 2,897    |       | 1,559    |       | 972      |       |
| Professional fees              |       | 1,610    |       | 1,113    |       | 1,011    |       |
| Depreciation                   |       | 1,838    |       | 1,030    |       | 736      |       |
| Amortization of  intangibles   |       | 49       |       | —   |       | 22       |       |
| Writedown on  corporate bond   |       | —   |       | —   |       | 1,660    |       |
| Data processing                |       | 969      |       | 835      |       | 759      |       |
| Stationary and  supplies       |       | 965      |       | 387      |       | 317      |       |
| Advertising and  marketing     |       | 1,613    |       | 913      |       | 540      |       |
| Telecommunications             |       | 611      |       | 396      |       | 276      |       |
| Other taxes                    |       | 548      |       | 390      |       | 248      |       |
| Travel and  entertainment      |       | 427      |       | 138      |       | 127      |       |
| Bank operations                |       | 676      |       | 635      |       | 411      |       |
| Premises and equipment         |       | 800      |       | 351      |       | 365      |       |
| Miscellaneous                  |       | 797      |       | 811      |       | 446      |       |
| **Total non-interest expense** |       | $        | 27,154     |     | $          | 15,355   |       | $ | 13,605 |   |

 

**Income Taxes**

We recorded a provision for income tax expense of $1.7million for the year ended December 31, 2004. Our effective tax rate forthe year ended December 31, 2004 was 33.0%

We recorded an income taxbenefit of $3.5 million in the fourth quarter of 2003 primarily attributable tothe recognition of deferred tax assets related to the net operating losscarryforwards. The benefit of our deferred tax asset was recognized based on adetailed assessment indicating that it is more likely than not that the benefitof these net operating losses and other deferred tax assets would be realized. Factorsthat were considered in our decision to record our income tax benefit were 2003profitability, future projections of continued profitability and the completionof our common stock offering in December 2003. For more information, see “CriticalAccounting Policies” earlier in this discussion. In addition, Note 12 to theNotes to Consolidated Financial Statements provides additional information withrespect to the deferred tax accounts and the net operating loss carryforward.

**Statements ofCondition**

**Loans Receivable,Net**

Total loans receivable,net of fees, were $489.9 million at December 31, 2004, an increase of$153.9 million, or 45.8%, compared to December 31, 2003. We achievedgrowth in all our loan categories with the exception of our commercial andindustrial loans, and consumer loans. Commercial and industrial loans decreased$1.3 million as a result of experiencing more loan payoffs than fundings inthis loan category. Consumer loans declined $3.9 million, or 36.2%, from December 31,2003 to December 31, 2004, primarily as a result of repayments of boatloan participations that were purchased in 1999. As a result of our GeorgeMason acquisition, we had $365.5 million of loans held for sale at December 31,2004.

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Loans receivable accountedfor on a non-accrual basis at December 31, 2004 and December 31, 2003were $547,000 and $390,000, respectively. Accruing loans, which arecontractually past due 90 days or more as to principal or interest payments asof December 31, 2004 and December 31, 2003, were $0 and $4,000,respectively. There are no loans as of December 31, 2004 and December 31,2003 which are “troubled debt restructurings” as defined in FASB Statement No. 15,*Accounting by Debtors and Creditors forTroubled Debt Restructurings.*

Interest income onnon-accrual loans, if recognized, is recorded using the cash basis method ofaccounting. When a loan is placed on non-accrual, unpaid interest is reversedagainst interest income if it was accrued in the current year and is charged tothe allowance for loan losses if it was accrued in prior years. While onnon-accrual, the collection of interest is recorded as interest income onlyafter all principal has been collected. When all past contractual obligationsare collected and, in our opinion, the borrower has demonstrated the ability toremain current, the loan is returned to an accruing status. Gross interestincome that would have been recorded if the non-accrual loans had been currentwith their original terms and had been outstanding throughout the period orsince origination if held for part of the period for the years ended December 31,2004 and 2003 were $25,000 and $39,000, respectively. The interest incomerealized prior to the loans being placed on non-accrual status for the yearsended December 31, 2004 and 2003 were $21,000 and $1,000, respectively.

Total loans receivable,net of fees, increased $86.9 million to $336.0 million at December 31,2003, as compared to December 31, 2002. The strongest growth was incommercial real estate loans, residential real estate loans and real estateconstruction loans.

Loans receivable accountedfor on a non-accrual basis at December 31, 2002 was $917,000. Accruingloans, which are contractually past due 90 days or more as to principal orinterest payments as of December 31, 2002 was $59,000. There are no loansas of December 31, 2002 which are “troubled debt restructurings” asdefined in FASB Statement No. 15, *Accountingby Debtors and Creditors for Troubled Debt Restructurings.*Grossinterest income that would have been recorded if the non-accrual loans had beencurrent with their original terms and had been outstanding throughout theperiod, or since origination if held for part of the period for 2002 was$37,000.

The ratio ofnon-performing loans to total loans was 0.11%, 0.12% and 0.39% at December 31,2004, 2003 and 2002, respectively.

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The following tables represent the composition of our loans receivableportfolio at the end of each of the five years ended December 31, 2004with additional information on non-performing loans receivable.

**Table8.**

**LoansReceivable At December 31, 2004, 2003, 2002, 2001 and 2000(Dollars in thousands)**
| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Commercial and  industrial       |       | $        | 56,512     |     | 11.53      | %        | $          | 57,854 |   | 17.21 | % | $ | 58,292 |   | 23.40 | % |
| Real estate—commercial      |       | 220,012  |       | 44.88    | %          | 139,725  |       | 41.56 | % | 116,135 |   | 46.63 | % |
| Real estate—construction    |       | 69,535   |       | 14.18    | %          | 42,243   |       | 12.57 | % | 5,781 |   | 2.32 | % |
| Real estate—residential     |       | 76,932   |       | 15.69    | %          | 42,495   |       | 12.64 | % | 31,808 |   | 12.77 | % |
| Home equity lines                |       | 60,408   |       | 12.32    | %          | 43,176   |       | 12.84 | % | 26,831 |   | 10.77 | % |
| Consumer                         |       | 6,816    |       | 1.40     | %          | 10,690   |       | 3.18 | % | 10,235 |   | 4.11 | % |
| Gross loans                      |       | $        | 490,215    |     | 100.00     | %        | $          | 336,183 |   | 100.00 | % | $ | 249,082 |   | 100.00 | % |
| Add: net deferred  (fees) costs  |       | (319     | )          |     |       | (181     | )          |   |   | 24 |   |   |   |
| Less: allowance  for loan losses |       | (5,878   | )          |     |       | (4,344   | )          |   |   | (3,372 | ) |   |   |
| Loans receivable,  net           |       | $        | 484,018    |     |       |     | $          | 331,658 |   |   |   | $ | 245,734 |   |   |   |

 
| ** **                       | ** ** | **2001** | ** ** | **2000** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Commercial and  industrial       |       | $        | 57,665     |     | 28.71      | % | $ | 49,646 |   | 32.22 | % |
| Real estate—commercial      |       | 87,116   |       | 43.37    | %          | 57,083 |   | 37.05 | % |
| Real estate—construction    |       | 6,397    |       | 3.18     | %          | 4,088 |   | 2.65 | % |
| Real estate—residential     |       | 14,469   |       | 7.20     | %          | 17,729 |   | 11.51 | % |
| Home equity lines                |       | 21,299   |       | 10.60    | %          | 14,867 |   | 9.65 | % |
| Consumer                         |       | 13,941   |       | 6.94     | %          | 10,665 |   | 6.92 | % |
| Gross loans                      |       | $        | 200,887    |     | 100.00     | % | $ | 154,078 |   | 100.00 | % |
| Add: net deferred (fees) costs   |       | 24       |       |     |       | 193 |   |   |   |
| Less: allowance  for loan losses |       | (3,104   | )          |     |       | (1,900 | ) |   |   |
| Loans receivable, net            |       | $        | 197,807    |     |       |   | $ | 152,371 |   |   |   |

 

**Table9.**

**Non-PerformingLoans Receivable At December 31, 2004, 2003, 2002, 2001, and 2000(Dollars in thousands)**
| ** **                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Nonaccruing loans                            |       | $547     |       | $390     |       | $917     |       | $361     |       | $585     |       |
| Loans contractually past-due 90 days or more |       | —   |       | 4        |       | 59       |       | 566      |       | 2        |       |
| Total non-performing  loans receivable       |       | $547     |       | $394     |       | $976     |       | $927     |       | $587     |       |

 

43

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Thefollowing table presents information on loan maturities and interest ratesensitivity.

**Table10.**

**LoanMaturities and Interest Rate SensitivityAt December 31, 2004(Dollars in thousands)**
| ** **                    | ** ** | **One Year  or Less** | ** ** | **Between  One and   Five Years ** | ** ** | **After  Five Years** | ** ** | **Total** | ** ** |
|-------------------------------|------------|---------------------------------|------------|--------------------------------------------------------|------------|----------------------------|------------|-----------|------------|
| Commercial and  industrial    |       | $                               | 25,701     |                                                   |       | $                          | 21,280     |      |       | $ | 9,531 |   | $ | 56,512 |   |
| Real estate—commercial   |       | 5,993                           |       |                                                   | 45,625     |                       |       | 168,394   |       | 220,012 |   |
| Real estate—construction |       | 47,676                          |       |                                                   | 19,791     |                       |       | 2,068     |       | 69,535 |   |
| Real estate—residential  |       | 2,546                           |       |                                                   | 2,714      |                       |       | 71,672    |       | 76,932 |   |
| Home equity lines             |       | —                          |       |                                                   | 3,298      |                       |       | 57,110    |       | 60,408 |   |
| Consumer                      |       | 659                             |       |                                                   | 4,315      |                       |       | 1,842     |       | 6,816 |   |
| **Total  loans receivable**   |       | $                               | 82,575     |                                                   |       | $                          | 97,023     |      |       | $ | 310,617 |   | $ | 490,215 |   |
| Fixed-rate loans              |       |                            |       |                                                   | $          | 34,463                     |       |      | $          | 78,449 |   | $ | 112,912 |   |
| Floating-rate  loans          |       |                            |       |                                                   | 62,560     |                       |       | 232,168   |       | 294,728 |   |
| **Total loans receivable**    |       |                            |       |                                                   | $          | 97,023                     |       |      | $          | 310,617 |   | $ | 407,640 |   |

 

**Investment Securities**

Our investment securities portfolio is used as asource of income and liquidity. Investment securities were $289.5 million at December 31,2004, an increase of $15.9 million or 5.8%, compared to investment securitiesat December 31, 2003.

During the third quarter of 2003, we transferred aportion of the available-for-sale investment securities portfolio to theheld-to-maturity investment securities portfolio. Of the $289.5 millioninvestment portfolio at December 31, 2004, $138.0 million were classifiedas held-to-maturity and $151.6 million were classified as available-for-sale. AtDecember 31, 2004, the yield on the available-for-sale investmentportfolio was 3.94% and the yield on the held-to-maturity portfolio was 3.98%.

Also, during the third quarter of 2003, we implementeda $25.0 million leverage strategy that allowed us to take advantage of theavailability of low cost funds through advances from the Federal Home Loan Bankof Atlanta and purchase mortgage-backed investment securities. The impact ofthis strategy is an increase of approximately $100,000 in net interest incomeon a quarterly basis.

Total investment securities increased to $273.6million at December 31, 2003, compared to $163.7 million at December 31,2002. Strong deposit growth during 2003 made more funds available forinvestments. The portfolio yield decreased from 4.33% as of December 31,2002 to 3.96% as of December 31, 2003 due to higher yielding investmentshaving matured, been called or sold for a net realized gain and purchases ofadditional investments during 2003 yielding lower rates. The amount ofinvestment securities available-for-sale decreased from December 31, 2002to December 31, 2003 as a result of the previously mentionedreclassification of securities available-for-sale into the securities held-to-maturitycategory during the third quarter of 2003.

44

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Thefollowing table reflects the composition of the investment portfolio at December 31,2004, 2003, and 2002.

**Table11.**

**InvestmentSecurities At December 31, 2004, 2003 and 2002(Dollars in thousands)**
| **Available-for-sale at December 31, 2004**    | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S.  government-sponsored agencies and enterprises |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 3,000      |                | $          | 2,947           |       |               | 3.33       | % |   |
| Five to ten years                                                  |       | 3,000      |       | 3,009               |       |            | 4.46       | %                  |       |
| Total U.S. government-sponsored agencies                           |       | $          | 6,000      |                | $          | 5,956           |       |               | 3.89       | % |   |
| Mortgage-backed  securities*                                       |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 2,161      |                | $          | 2,131           |       |               | 3.59       | % |   |
| Five to ten years                                                  |       | 14,662     |       | 14,603              |       |            | 3.96       | %                  |       |
| After ten years                                                    |       | 128,477    |       | 126,846             |       |            | 3.97       | %                  |       |
| Total mortgage-backed securities                                   |       | $          | 145,300    |                | $          | 143,580         |       |               | 3.96       | % |   |
| Treasury bonds                                                     |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 2,031      |                | $          | 2,018           |       |               | 2.63       | % |   |
| Total treasury bonds                                               |       | $          | 2,031      |                | $          | 2,018           |       |               | 2.63       | % |   |
| Total investment securities available-for-sale                     |       | $          | 153,331    |                | $          | 151,554         |       |               | 3.94       | % |   |

 
| **Held-to-maturity  at December 31, 2004**                    | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S.  government-sponsored agencies and enterprises |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 6,500      |                | $          | 6,427           |       |               | 3.36       | % |   |
| Five to ten years                                                  |       | 16,018     |       | 15,901              |       |            | 4.28       | %                  |       |
| After ten years                                                    |       | 2,999      |       | 2,962               |       |            | 4.22       | %                  |       |
| Total U.S. government-sponsored agencies                           |       | $          | 25,517     |                | $          | 25,290          |       |               | 4.03       | % |   |
| Mortgage-backed  securities*                                       |       |       |       |                |       |            |       |               |       |
| Five to ten years                                                  |       | $          | 10,392     |                | $          | 10,406          |       |               | 3.83       | % |   |
| After ten years                                                    |       | 94,039     |       | 92,990              |       |            | 4.04       | %                  |       |
| Total mortgage-backed securities                                   |       | $          | 104,431    |                | $          | 103,396         |       |               | 4.02       | % |   |
| Corporate bonds                                                    |       |       |       |                |       |            |       |               |       |
| After ten years                                                    |       | $          | 8,000      |                | $          | 7,923           |       |               | 4.21       | % |   |
| Total corporate bonds                                              |       | $          | 8,000      |                | $          | 7,923           |       |               | 4.21       | % |   |
| Total investment securities held-to-maturity                       |       | $          | 137,953    |                | $          | 136,609         |       |               | 4.03       | % |   |
| Total investment securities                                        |       | $          | 291,284    |                | $          | 288,163         |       |               | 3.98       | % |   |

 

45

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| **Available-for-sale  at December 31, 2003**                  | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S.  government-sponsored agencies and enterprises |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 3,000      |                | $          | 3,016           |       |               | 3.92       | % |   |
| Five to ten years                                                  |       | 2,000      |       | 1,986               |       |            | 4.23       | %                  |       |
| After ten years                                                    |       | 1,000      |       | 1,027               |       |            | 5.79       | %                  |       |
| Total U.S. government-sponsored agencies                           |       | $          | 6,000      |                | $          | 6,029           |       |               | 4.33       | % |   |
| Mortgage-backed  securities*                                       |       |       |       |                |       |            |       |               |       |
| Five to ten years                                                  |       | $          | 15,615     |                | $          | 15,630          |       |               | 3.92       | % |   |
| After ten years                                                    |       | 97,865     |       | 97,041              |       |            | 4.02       | %                  |       |
| Total mortgage-backed securities                                   |       | $          | 113,480    |                | $          | 112,671         |       |               | 4.00       | % |   |
| Corporate bonds                                                    |       |       |       |                |       |            |       |               |       |
| After ten years                                                    |       | $          | 10,000     |                | $          | 9,995           |       |               | 2.41       | % |   |
| Total corporate bonds                                              |       | $          | 10,000     |                | $          | 9,995           |       |               | 2.41       | % |   |
| Treasury bonds                                                     |       |       |       |                |       |            |       |               |       |
| One to five years                                                  |       | $          | 2,047      |                | $          | 2,067           |       |               | 2.64       | % |   |
| Total treasury bonds                                               |       | $          | 2,047      |                | $          | 2,067           |       |               | 2.64       | % |   |
| Total investment securities available-for-sale                     |       | $          | 131,527    |                | $          | 130,762         |       |               | 3.87       | % |   |

 
| **Held-to-maturity  at December 31, 2003**                    | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S.  government-sponsored agencies and enterprises |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 4,000      |                | $          | 3,951           |       |               | 3.39       | % |   |
| Five to ten years                                                  |       | 9,993      |       | 9,884               |       |            | 4.65       | %                  |       |
| After ten years                                                    |       | 2,999      |       | 2,950               |       |            | 4.20       | %                  |       |
| Total U.S. government-sponsored agencies                           |       | $          | 16,992     |                | $          | 16,785          |       |               | 4.27       | % |   |
| Mortgage-backed  securities*                                       |       |       |       |                |       |            |       |               |       |
| Five to ten years                                                  |       | $          | 9,476      |                | $          | 9,450           |       |               | 3.70       | % |   |
| After ten years                                                    |       | 108,384    |       | 107,547             |       |            | 4.01       | %                  |       |
| Total mortgage-backed securities                                   |       | $          | 117,860    |                | $          | 116,997         |       |               | 3.98       | % |   |
| Corporate bonds                                                    |       |       |       |                |       |            |       |               |       |
| After ten years                                                    |       | $          | 8,000      |                | $          | 7,848           |       |               | 4.21       | % |   |
| Total corporate bonds                                              |       | $          | 8,000      |                | $          | 7,848           |       |               | 4.21       | % |   |
| Total investment securities held-to-maturity                       |       | $          | 142,852    |                | $          | 141,630         |       |               | 4.03       | % |   |
| Total investment securities                                        |       | $          | 274,379    |                | $          | 272,392         |       |               | 3.96       | % |   |

 

46

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| **Available-for-sale  at December 31, 2002**                  | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S.  government-sponsored agencies and enterprises |       |       |       |                |       |            |       | *** ***       |       |
| One to five years                                                  |       | $          | 26,739     |                | $          | 26,988          |       |               | 3.47       | % |   |
| Five to ten years                                                  |       | 12,048     |       | 12,048              |       |            | 3.68       | %                  |       |
| Total U.S. government-sponsored agencies                           |       | $          | 38,787     |                | $          | 39,036          |       |               | 3.53       | % |   |
| Mortgage-backed  securities*                                       |       |       |       |                |       |            |       |               |       |
| Within one year                                                    |       | $          | 15,478     |                | $          | 15,750          |       |               | 3.61       | % |   |
| One to five years                                                  |       | 70,552     |       | 72,342              |       |            | 4.82       | %                  |       |
| Five to ten years                                                  |       | 13,695     |       | 13,686              |       |            | 4.43       | %                  |       |
| After ten years                                                    |       | 15,301     |       | 15,301              |       |            | 5.20       | %                  |       |
| Total mortgage-backed securities                                   |       | $          | 115,026    |                | $          | 117,079         |       |               | 4.66       | % |   |
| Corporate bonds                                                    |       |       |       |                |       |            |       |               |       |
| After ten years                                                    |       | $          | 5,000      |                | $          | 5,000           |       |               | 3.39       | % |   |
| Total corporate bonds                                              |       | $          | 5,000      |                | $          | 5,000           |       |               | 3.39       | % |   |
| Treasury bonds                                                     |       |       |       |                |       |            |       |               |       |
| One to five years                                                  |       | $          | 2,507      |                | $          | 2,550           |       |               | 2.67       | % |   |
| Total treasury bonds                                               |       | $          | 2,507      |                | $          | 2,550           |       |               | 2.67       | % |   |
| Total investment securities available-for-sale                     |       | $          | 161,320    |                | $          | 163,665         |       |               | 4.33       | % |   |

----

*                    Basedon contractual maturities.

**Deposits and Other Borrowed Funds**

Total deposits were $824.2 million at December 31,2004, an increase of $350.1 million, or 73.8%, compared to December 31,2003. This growth is primarily attributable to the opening of seven branchoffices during 2004. In addition, to assist in the funding of George Mason’sloans held-for-sale, we began using the brokered certificates of deposit marketduring 2004. At December 31, 2004, we had $86.7 million of brokeredcertificates of deposit at an average rate of 2.16%. Our utilization of thebrokered certificates of deposit market averaged $52.3 million in 2004.

Other borrowed funds, which primarily includerepurchase agreements, FHLB advances and our payable to Cardinal StatutoryTrust I, were $201.1 million at December 31, 2004, an increase of $126.6million, compared to December 31, 2003. During the second quarter of 2003,we introduced a repurchase agreement program for those commercial customersthat leave larger balances in their demand deposit accounts, allowing them toearn interest on balances deposited in this program. Repurchase agreements at December 31,2004 were $30.4 million compared to $25.5 million at December 31, 2003.

The primary reason for the increase in other borrowedfunds at December 31, 2004 were advances from the Federal Home Loan Bankof Atlanta. Due to interest rates on these advances being at their lowestlevels in several years, we borrowed $47.0 million during the year ended December 31,2003. We further utilized the Federal Home Loan Bank of Atlanta during 2004 andended that year with $137.0 million of advances that had a composite rate of2.68%. Advances taken during 2004 were utilized primarily to leverage some ofour larger commercial real estate fundings and to assist in financing theGeorge Mason inventory of loans held-for-sale. In addition, included in otherborrowed funds at December 31, 2004, was $20.6 million payable to CardinalStatutory Trust I, the issuer of our trust preferred securities. This debt hadan interest rate of 4.89% at December 31, 2004. In accordance with FIN 46,*Consolidation of Variable Interest Entities,*CardinalStatutory Trust I is an unconsolidated entity as we are not the primarybeneficiary of the trust. At December 31, 2004, other borrowed funds alsoincluded $7.0 million of federal funds purchased and $6.2 million borrowedunder the Federal Reserve TT&L note option.

47

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The following tablereflects the short-term borrowings outstanding as of December 31, 2004.

**Table12.**

**Short-TermBorrowings**

**At December 31, 2004**(Dollars in thousands)

 
| ** **                                                 | ** ** | **Original** | ** ** | **Date Amount**          | ** ** | ** ** | ** ** | ** **             | ** ** |
|------------------------------------------------------------|------------|--------------|------------|-------------------------------|------------|------------|------------|------------------------|------------|
| **Advance Date**                                      | ** ** | ** **   | ** ** | **Term of Advance** | ** ** | **Due**    | ** ** | **Interest Rate** | ** ** | **Outstanding** | ** ** |
| Jan-04                                                     |       |         | 12 months  |                          |       |       | Jan-05     |                   |       |   | 1.56 | % |   |   | $ | 5,000 |   |   |
| Jan-04                                                     |       |         | 18 months  |                          |       |       | Jul-05     |                   |       |   | 1.83 | % |   |   | 5,000 |   |   |
| Mar-03                                                     |       |         | 24 months  |                          |       |       | Mar-05     |                   |       |   | 1.82 | % |   |   | 1,000 |   |   |
| Jul-04                                                     |       |         | 12 months  |                          |       |       | Jul-05     |                   |       |   | 2.44 | % |   |   | 55,000 |   |   |
| **Total  short-term borrowings and weighted average rate** | ** ** |         |       |                          |       |       |       |                   | ** ** | ** ** | **2.32** | **%** | ** ** | ** ** | **$** | **66,000** |   |   |
| All other borrowed funds                                   |       |         |       |                          |       |       |       |                   |       |   | 2.18 | % |   |   | 135,085 |   |   |
| **Total  other borrowed funds**                            | ** ** |         |       |                          |       |       |       |                   | ** ** | ** ** | **2.23** | **%** | ** ** | ** ** | **$** | **201,085** |   |   |
|                                                            |            |              |            |                               |            |            |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |

 

Total deposits at December 31, 2003 were $474.1million compared to $423.5 million at December 31, 2002, an increase of$50.7 million, or 12.0%. Other borrowed funds increased $72.5 million to $74.5million at December 31, 2003, compared to $2.0 million at December 31,2002.

Thefollowing table reflects the maturities of the certificates of deposit of$100,000 or more as of December 31, 2004, 2003 and 2002.

**Table13.**

**Certificatesof Deposit of $100,000 or More**At December 31, 2004, 2003 and 2002 (Dollars in thousands) 
| ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Maturities:**                        |       |     |       |     |       |     |       |
| Three months or  less                  |       | $        | 7,283      |     | $          | 19,467   |       | $ | 10,759 |   |
| Over three months  through six months  |       | 8,373    |       | 11,463   |       | 8,716    |       |
| Over six months  through twelve months |       | 34,150   |       | 38,107   |       | 15,523   |       |
| Over twelve  months                    |       | 175,496  |       | 34,563   |       | 45,214   |       |
|                                   |       | $        | 225,302    |     | $          | 103,600  |       | $ | 80,212 |   |

 

**Business Segment Operations**

In 2003 and for the first six months of 2004, weoperated and reported in two business segments, commercial banking andinvestment services. As of July 7, 2004, we began operating in a thirdbusiness segment, mortgage banking, with the completion of our acquisition ofGeorge Mason. The commercial banking segment includes both commercial andconsumer lending and provides customers such products as commercial loans, realestate loans, and other business financing and consumer loans. In addition,this segment also provides customers with several choices of deposit productsincluding demand deposit accounts, savings accounts and certificates of deposit.The mortgage banking segment engages primarily in the origination and acquisitionof residential mortgages for sale into the secondary market on a best effortsbasis. The investment services segment provides advisory services to businessesand individuals, including financial planning and retirement/estate planning.

48

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Information about thereportable segments, and reconciliation of this information to the consolidatedfinancial statements at December 31, 2004, 2003 and 2002 follows.

**Table14.**

**As ofand for the Year Ended December 31, 2004:**
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **Investment** | ** ** | **Intersegment** | ** ** | ** ** | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|----------------|------------|------------------|------------|------------|------------|------------------|------------|
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Services**   | ** ** | **Elimination**  | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       | $              | 21,753     |         | $          | 3,057          |       |             | $          | —     |       |             | $          | — |   |   | $ | (257 | ) |   | $ | 24,553 |   |
| Provision for  loan losses  |       | 1,626          |       | —       |       |           | —     |             |       | —     |       |             | —     |   |   | 1,626 |   |
| Non-interest  income        |       | 1,804          |       | 6,953        |       |           | 645        |             |       | —     |       |             | 7          |   |   | 9,409 |   |
| Non-interest  expense       |       | 17,065         |       | 7,889        |       |           | 800        |             |       | —     |       |             | 1,400      |   |   | 27,154 |   |
| Provision for  income taxes |       | 1,628          |       | 698          |       |           | (52        | )                |       | —     |       |             | (561       | ) |   | 1,713 |   |
| Net income (loss)           |       | $              | 3,238      |         | $          | 1,423          |       |             | $          | (103       | )          |             | $          | — |   |   | $ | (1,089 | ) |   | $ | 3,469 |   |
| Total Assets                |       | $              | 1,123,868  |         | $          | 392,241        |       |             | $          | 685        |       |             | $          | (421,203 | ) |   | $ | 115,985 |   |   | $ | 1,211,576 |   |

 

**As ofand for the Year Ended December 31, 2003:**
| ** **                  | ** ** | **Commercial** | ** ** | **Investment** | ** ** | **Intersegment** | ** ** | ** ** | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------|------------|------------------|------------|
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**    | ** ** | **Elimination**  | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       |           | $          | 15,077         |       |             |       | $          | —     |             |       |   | $ | — |   |   | $ | 96 |   |   | $ | 15,173 |   |   |
| Provision for  loan losses  |       |           | 1,001      |           |       |             | —     |       |       |             | —     |   |   | — |   |   | 1,001 |   |   |
| Non-interest  income        |       |           | 2,954      |           |       |             | 843        |       |       |             | —     |   |   | 32 |   |   | 3,829 |   |   |
| Non-interest  expense       |       |           | 13,265     |           |       |             | 820        |       |       |             | —     |   |   | 1,270 |   |   | 15,355 |   |   |
| Provision for  income taxes |       |           | (464       | )              |       |             | (443       | )          |       |             | —     |   |   | (2,601 | ) |   | (3,508 | ) |   |
| Net income (loss)           |       |           | $          | 4,229          |       |             |       | $          | 466        |             |       |   | $ | — |   |   | $ | 1,459 |   |   | $ | 6,154 |   |   |
| Total Assets                |       |           | $          | 630,415        |       |             |       | $          | 776        |             |       |   | $ | (80,903 | ) |   | $ | 85,960 |   |   | $ | 636,248 |   |   |

 

**As ofand for the Year Ended December 31, 2002:**
| ** **                 | ** ** | **Commercial** | ** ** | **Investment** | ** ** | **Intersegment** | ** ** | ** ** | ** ** | ** **       | ** ** |
|----------------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------|------------|------------------|------------|
| ** **                 | ** ** | **Banking**    | ** ** | **Services**   | ** ** | **Elimination**  | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income       |       |           | $          | 10,575         |       |             |       | $          | —     |             |       |   | $ | — |   |   | $ | 81 |   |   | $ | 10,656 |   |   |
| Provision for  loan losses |       |           | 444        |           |       |             | —     |       |       |             | —     |   |   | — |   |   | 444 |   |   |
| Non-interest  income       |       |           | 1,848      |           |       |             | 942        |       |       |             | —     |   |   | 74 |   |   | 2,864 |   |   |
| Non-interest  expense      |       |           | 11,995     |           |       |             | 1,147      |       |       |             | —     |   |   | 463 |   |   | 13,605 |   |   |
| Net income (loss)          |       |           | $          | (16            | )          |             |       | $          | (205       | )                |       |   | $ | — |   |   | $ | (308 | ) |   | $ | (529 | ) |   |
| Total Assets               |       |           | $          | 483,135        |       |             |       | $          | 274        |             |       |   | $ | (38,245 | ) |   | $ | 41,159 |   |   | $ | 486,323 |   |   |

 

**Capital Resources**

Capital adequacy is an important measure of financialstability and performance. Our objectives are to maintain a level ofcapitalization that is sufficient to sustain asset growth and promote depositorand investor confidence.

Regulatory agencies measure capital adequacy utilizinga formula that takes into account the individual risk profile of a financialinstitution. The guidelines define capital as both Tier 1 (primarily commonshareholders’ equity, defined to include certain debt obligations) and Tier 2(to include certain other debt obligations and a portion of the allowance forloan losses and 45% of unrealized gains in equity securities).

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Shareholders’ equity at December 31, 2004 was$95.1 million, an increase of $9.7 million, compared to $85.4 million at December 31,2003. The increase in shareholders’ equity was primarily attributable to $6.3million of additional equity raised as a result of the underwriters exercisingin January 2004 their over allotment option in connection with our 2003stock offering and net income of $3.5 million. Total shareholders’ equity tototal assets at December 31, 2004 and 2003 were 7.9% and 13.4%,respectively. Book value per share at December 31, 2004 and 2003 was $5.15and $4.80, respectively. Total risk based capital to risk weighted assets was13.40% at December 31, 2004 compared to 20.66% at December 31, 2003. Accordingly,the Company was considered “well capitalized” for regulatory purposes at December 31,2004. Risk based capital to risk weighted assets declined from 2003 to 2004despite our issuance of $20.0 million of trust preferred securities, which isincluded as a component of regulatory capital, because of our growth during2004 and the fact that goodwill and intangibles, which increased by $14.7million as a result of the George Mason acquisition, are excluded fromregulatory capital.

At December 31, 2003, shareholders’ equity was$85.4 million compared to $40.7 million at December 31, 2002, an increaseof $44.7 million. This increase in shareholders’ equity was primarily driven byour completion of a secondary common stock offering that raised $41.7 millionof equity capital in December 2003. In addition, we recorded net income tocommon shareholders of $5.7 million for the year ended December 31, 2003. Theseincreases were offset by an unfavorable mark-to-market adjustment of $2.9million in our investment securities available-for-sale portfolio. Book valueper common share at December 31, 2003 was $4.80, compared to $3.37 at December 31,2002. Tangible book value per common share at December 31, 2003 was $4.80,compared to $3.31 at December 31, 2002. At December 31, 2003, ourtier 1 and total risk-based capital ratios were 19.7% and 20.7%, respectively. AtDecember 31, 2002, our tier 1 and total risk-based capital ratios were12.3% and 13.4%, respectively. Our regulatory capital levels for the bank andbank holding company exceeded the minimum ratios established forwell-capitalized institutions.

Our regulatory capital levels for the bank and bankholding company meet those established for well-capitalized institutions. Whilewe are currently considered well-capitalized, we may from time-to-time find itnecessary to access the capital markets to meet our growth objectives orcapitalize on specific business opportunities.

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Thefollowing table shows the minimum capital requirement and our capital positionat December 31, 2004, 2003, and 2002 for the consolidated bank holdingcompany.

**Table15.**

**Capital Components**At December 31, 2004, 2003 and 2002(Dollars in thousands)
| ** **                                                       | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **To Be Well**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|------------|------------|----------------------------|------------|
| ** **                                                       | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **Capitalized Under** | ** ** |
| ** **                                                       | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                       | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                       | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | ** **                 | ** ** | **Ratio**  | ** ** | **Amount**                 | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| **At  December 31, 2004**                                   |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| Total risk based  capital/ Total capital to risk-weighted assets |       | $          | 107,660    |                       | 13.40      | %                          | $          | 64,294                     |       | >       |       | 8.00                       | %          | $ | 80,368 |   | > |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 101,670    |       | 12.65                      | %          | 32,147                     |       | >                       |       | 4.00       | %          | 48,221                     |       | > |   | 6.00 | % |
| Total risk based  capital/ Total capital to average assets       |       | 107,660    |       | 8.83                       | %          | 46,075                     |       | >                       |       | 4.00       | %          | 57,594                     |       | > |   | 5.00 | % |
| **At December 31, 2003**                                    |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| Total risk based  capital/ Total capital to risk-weighted assets |       | $          | 90,239     |                       | 20.66      | %                          | $          | 34,951                     |       | >       |       | 8.00                       | %          | $ | 43,688 |   | > |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 85,896     |       | 19.66                      | %          | 17,475                     |       | >                       |       | 4.00       | %          | 26,213                     |       | > |   | 6.00 | % |
| Total risk based  capital/ Total capital to average assets       |       | 90,239     |       | 15.45                      | %          | 23,365                     |       | >                       |       | 4.00       | %          | 29,206                     |       | > |   | 5.00 | % |
| **At December 31, 2002**                                    |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| Total risk based  capital/ Total capital to risk-weighted assets |       | $          | 41,093     |                       | 13.35      | %                          | $          | 24,625                     |       | >       |       | 8.00                       | %          | $ | 30,781 |   | > |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 37,721     |       | 12.25                      | %          | 12,313                     |       | >                       |       | 4.00       | %          | 18,469                     |       | > |   | 6.00 | % |
| Total risk based  capital/ Total capital to average assets       |       | 41,093     |       | 8.97                       | %          | 18,330                     |       | >                       |       | 4.00       | %          | 15,391                     |       | > |   | 5.00 | % |

 

**Liquidity**

Liquidity in the banking industry is defined as theability to meet the demand for funds of both depositors and borrowers. We mustbe able to meet these needs with cash on hand by obtaining funding from depositorsor other lenders or by converting non-cash items to cash. The objective of ourliquidity management program is to ensure that we always have sufficient liquidresources to meet the demands of our depositors and borrowers. Stable coredeposits and a strong capital position provide the base for our liquidityposition. In addition, we have demonstrated our ability to attract retaildeposits because of our convenient branch locations, personal service andpricing.

In addition to retail deposits, we have access to thedifferent wholesale funding markets. These markets include the brokered CDmarket, the repurchase agreement market and the federal funds market. Inaddition, we maintain secured lines of credit with the Federal Reserve Bank ofRichmond and the Federal Home Loan Bank of Atlanta. Having diverse fundingalternatives reduces our reliance on any one source for funding.

 

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Cash flow from amortizing assets or maturing assetscan also provide funding to meet the needs of depositors and borrowers.

We have established a formal liquidity contingencyplan which establishes a liquidity management team and provides guidelines forliquidity management. For our liquidity management program, we first determineour current liquidity position. Liquidity is then forecasted based onforecasted changes in the balance sheet. The bank expects to maintain a certainliquidity cushion throughout the forecast period. In addition to the forecast,we also stress test our liquidity position under several different stressscenarios. Guidelines for the forecasted liquidity cushion and for liquiditycushions for each stress scenario have been established. In addition, onestress test combines all other stress tests to see how liquidity would react toseveral negative scenarios occurring at the same time. We believe that we havesufficient resources to meet our liquidity needs.

In September 2004, George Mason and the CardinalBank entered into a one year $150 million floating rate revolving credit andsecurity agreement with a third party. The purpose of this credit facility isto fund residential mortgage loans at George Mason prior to their sale into thesecondary market. The credit facility requires, among other things, that GeorgeMason and the Bank have positive quarterly net income and maintain specifiedminimum tangible and regulatory net worth levels. The Company has guaranteedrepayment of this debt. The interest rate on this credit facility is LIBOR plusbetween 1.50% and 1.875%. At December 31, 2004, $0 of this line wasutilized.

In addition to this facility, this same lender hasalso provided a $100 million facility that is utilized by George Mason towarehouse residential mortgage loans held for sale to this lender. The terms ofthis facility are substantially the same as the above-referenced revolvingcredit and security agreement and the cost of this facility is netted againstinterest earned on the loans pending settlement with the lender. At December 31,2004, $0 of this line was utilized.

George Mason also had a $60.0 million line of creditwith an unaffiliated party, which it uses to warehouse loans pending sale. Thisline matured on March 1, 2005 and had an interest rate of LIBOR plus 1.50%.At December 31, 2004, $30.2 million of this line was utilized and the ratewas 3.89%.

Liquid assets, whichinclude cash and due from banks, federal funds sold and investment securitiesavailable for sale totaled $175.0 million at December 31, 2004 or 14.4% oftotal assets. We held investments that are classified as held-to-maturity inthe amount of $138.0 million at December 31, 2004. To maintain readyaccess to the bank’s secured lines of credit, the bank has pledged the majorityof its securities to the Federal Home Loan Bank of Atlanta with additionalsecurities pledged to the Federal Reserve Bank of Richmond. Additionalborrowing capacity at the Federal Home Loan Bank of Atlanta at December 31,2004 was approximately $117 million. Borrowing capacity with the FederalReserve Bank of Richmond was approximately $46.5 million at December 31,2004. GMM has $310 million of lines of credit available to it. We are committedto maintaining liquidity at a level sufficient to protect depositors, providefor reasonable growth and fully comply with all regulatory requirements.

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**Contractual Obligations**

Wehave entered into a number of long-term contractual obligations to support ourongoing activities. These contractual obligations will be funded throughoperating revenues and liquidity sources held or available to us. The requiredpayments under such obligations were as follows:

**Table16.**

**ContractualObligationsAt December 31, 2004(Dollars in thousands)**
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | **Total**                                 | ** ** | ** Less than 1   Year** | ** ** | ** 1 - 3 Years ** | ** ** | **3 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
| Certificates of  deposit of $100,000 or more              |       | $                                         | 225,302    |   |   | $ | 49,806 |   |   |   | $ | 9,939 |   |   | $ | 164,874 |   |   | $ | 683 |   |   |
| Brokered  certificates of deposits                        |       | 86,708                                    |       |   | 84,858 |   |   |   | 1,850 |   |   | — |   |   | — |   |   |
| Advances from the  Federal Home Loan Bank of Atlanta |       | 136,958                                   |       |   | 66,000 |   |   |   | 9,250 |   |   | 41,708 |   |   | 20,000 |   |   |
| Trust preferred  securities                               |       | 20,000                                    |       |   | — |   |   |   | — |   |   | — |   |   | 20,000 |   |   |
| Operating lease  obligations                              |       | 16,256                                    |       |   | 3,888 |   |   |   | 3,889 |   |   | 7,013 |   |   | 1,466 |   |   |
| Total                                                     |       | $                                         | 485,224    |   |   | $ | 204,552 |   |   |   | $ | 24,928 |   |   | $ | 213,595 |   |   | $ | 42,149 |   |   |

 

**Financial Instruments with Off-Balance-Sheet Risk andCredit Risk**

We are a party to financial instruments with off-balance-sheetrisk in the normal course of business to meet the financing needs of ourcustomers. These financial instruments include commitments to extend credit andstandby letters of credit. Those instruments involve, to varying degrees,elements of credit risk in excess of the amount recognized in the balance sheet.

The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of those instruments. The Bank uses the same credit policiesin making commitments and conditional obligations as it does for on-balance-sheetinstruments.

Asummary of the contract amount of the Bank’s exposure to off-balance-sheetrisk as of December 31, 2004 and 2003, is as follows:
| ** **                                                                     | ** ** | **2004**                | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                     | ** ** | **(In thousands)** | ** ** |
| Financial  instruments whose contract amounts represent potential credit risk: |       |                    |       |     |       |
| Commitments to extend credit                                                   |       | $                       | 324,786    |     | $          | 111,182 |   |
| Standby letters  of credit                                                     |       | 5,159                   |       | 3,330    |       |
|                                                                                |            |                         |            |          |            |  |  |

 

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract. Commitments generally have fixed expiration dates or othertermination clauses and may require payment of a fee. Since many of thecommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements. Weevaluate each customer’s credit worthiness on a case-by-case basis.The amount of collateral obtained is based on management’s credit evaluation ofthe counterparty. Collateral held varies but may include accounts receivable,inventory, property and equipment, and income-producing commercialproperties.

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Unfunded commitments under lines of credit arecommitments for possible future extensions of credit to existing customers. Thoselines of credit may not be drawn upon to the total extent to which we havecommitted.

Standby letters of creditare conditional commitments we issued to guarantee the performance of acustomer to a third party. Those guarantees are primarily issued to supportpublic and private borrowing arrangements, including commercial paper, bondfinancing, and similar transactions. The credit risk involved in issuingletters of credit is essentially the same as that involved in extending loanfacilities to customers. We hold certificates of deposit, deposit accounts, andreal estate as collateral supporting those commitments for which collateral isdeemed necessary. 

**Quarterly Data**

The following tableprovides quarterly data for the years ended December 31, 2004 and 2003. Quarterlyper share results may not calculate to the year-end per share results due torounding.

**Table17.**

**Quarterly DataYears ended December 31, 2004 and 2003(Dollars in thousands, except per share data)**
| ** **                                          | ** ** | **2004**    | ** ** |
|-----------------------------------------------------|------------|-------------|------------|
| ** **                                          | ** ** | **Fourth**  | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** |
| ** **                                          | ** ** | **Quarter** | ** ** | **Quarter*** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Interest income                                     |       | $           | 12,952     |   | $ | 12,189 |   | $ | 7,967 |   | $ | 7,414 |   |
| Interest expense                                    |       | 5,424       |       | 4,995 |   | 2,969 |   | 2,581 |   |
| Net interest income                                 |       | 7,528       |       | 7,194 |   | 4,998 |   | 4,833 |   |
| Provision for  loan losses                          |       | (709        | )          | (529 | ) | (314 | ) | (74 | ) |
| Net interest income after provision for loan losses |       | 6,819       |       | 6,665 |   | 4,684 |   | 4,759 |   |
| Non-interest  income                                |       | 5,097       |       | 2,784 |   | 564 |   | 964 |   |
| Non-interest  expense                               |       | 9,321       |       | 8,893 |   | 4,298 |   | 4,642 |   |
| Net income before income taxes                      |       | 2,595       |       | 556 |   | 950 |   | 1,081 |   |
| Provision for  income taxes                         |       | 863         |       | 172 |   | 316 |   | 362 |   |
| Net income                                          |       | $           | 1,732      |   | $ | 384 |   | $ | 634 |   | $ | 719 |   |
| Dividends to  preferred shareholders                |       | —      |       | — |   | — |   | — |   |
| Net income to  common shareholders                  |       | $           | 1,732      |   | $ | 384 |   | $ | 634 |   | $ | 719 |   |
| Earnings per  common share, basic                   |       | $           | 0.09       |   | $ | 0.02 |   | $ | 0.03 |   | $ | 0.04 |   |
| Earnings per common  share, diluted                 |       | $           | 0.09       |   | $ | 0.02 |   | $ | 0.03 |   | $ | 0.04 |   |

----

*       As restated.

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| ** **                                          | ** ** | **2003**    | ** ** |
|-----------------------------------------------------|------------|-------------|------------|
| ** **                                          | ** ** | **Fourth**  | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** |
| ** **                                          | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Interest income                           |       | $           | 6,864      |   | $ | 6,179 |   | $ | 5,787 |   | $ | 5,772 |   |
| Interest expense                                    |       | 2,432       |       | 2,341 |   | 2,343 |   | 2,313 |   |
| Net interest income                                 |       | 4,432       |       | 3,838 |   | 3,444 |   | 3,459 |   |
| Provision for  loan losses                          |       | (399        | )          | (356 | ) | (166 | ) | (80 | ) |
| Net interest income after provision for loan losses |       | 4,033       |       | 3,482 |   | 3,278 |   | 3,379 |   |
| Non-interest  income                                |       | 833         |       | 971 |   | 1,049 |   | 976 |   |
| Non-interest  expense                               |       | 4,148       |       | 3,684 |   | 3,658 |   | 3,865 |   |
| Net income before income taxes                      |       | 718         |       | 769 |   | 669 |   | 490 |   |
| Income tax  benefit                                 |       | (3,508      | )          | — |   | — |   | — |   |
| Net income                                          |       | $           | 4,226      |   | $ | 769 |   | $ | 669 |   | $ | 490 |   |
| Dividends to  preferred shareholders                |       | 123         |       | 124 |   | 124 |   | 124 |   |
| Net income to  common shareholders                  |       | $           | 4,103      |   | $ | 645 |   | $ | 545 |   | $ | 366 |   |
| Earnings per  common share, basic                   |       | $           | 0.38       |   | $ | 0.06 |   | $ | 0.05 |   | $ | 0.04 |   |
| Earnings per common  share, diluted                 |       | $           | 0.37       |   | $ | 0.06 |   | $ | 0.05 |   | $ | 0.04 |   |

 

**Item 7A.     Quantitativeand Qualitative Disclosures About Market Risk**

See “Interest Rate Sensitivity” in Item 7 for adiscussion of our sensitivity to interest rate risk and the steps we take tomanage this risk.

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**Item8. Financial Statements and Supplementary Data**

**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors andStockholdersCardinal Financial Corporation and subsidiaries:

We have audited the accompanying consolidatedstatements of condition of Cardinal Financial Corporation and subsidiaries (theCompany) as of December 31, 2004 and 2003, and the related consolidatedstatements of operations, comprehensive income, changes in shareholders’equity, and cash flows for each of the years in the three-year period ended December 31,2004. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of the Company as of December 31, 2004 and 2003, and the resultsof their operations and their cash flows for each of the years in thethree-year period ended December 31, 2004, in conformity with U.S.generally accepted accounting principles.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2004, based on criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), and our report dated March 11, 2005 expressed an unqualifiedopinion on management’s assessment of, and an adverse opinion on the effectiveoperation of, internal control over financial reporting. The Company acquiredGeorge Mason Mortgage, LLC (GMM) during 2004, and management excluded from itsassessment of the effectiveness of the Company’s internal control over financialreporting as of December 31, 2004, GMM’s internal control over financialreporting associated with total assets of $392.2 million and pre-tax income of$2.1 million included in the consolidated financial statements of the Companyas of and for the year ended December 31, 2004. Our audit of internal controlover financial reporting of the Company also excluded an evaluation of theinternal control over financial reporting of George Mason Mortgage, LLC.
| /s/ KPMG LLP        |
|---------------------|
| McLean, Virginia    |
| March 11, 2005 |

 

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**Report ofIndependent Registered Public Accounting Firm**

The Board ofDirectors and StockholdersCardinal Financial Corporation and subsidiaries:

We have audited management’s assessment, included inthe accompanying *Management’s Report onInternal Control Over Financial Reporting*, that Cardinal FinancialCorporation and subsidiaries (the Company) did not maintain effective internalcontrol over financial reporting as of December 31, 2004, because of theeffect of the material weakness identified in management’s assessment withrespect to the accounting for non-routine transactions, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesshas been identified and included in management’s assessment:**As of December 31, 2004, the Company’saccounting personnel lacked sufficient resources and expertise to properlyaccount for certain non-routine transactions; the Company’s policies andprocedures did not provide for timely review of significant non-routinetransactions and related accounting entries; and the Company did not maintainsufficient documentation related to the application of U.S. generally acceptedaccounting principles to significant non-routine transactions. As a result ofthis material weakness in internal control over financial reporting, CardinalFinancial Corporation and Subsidiaries’ consolidated financial statements werematerially misstated as of and for the three-month and nine-month periods endedSeptember 30, 2004, due to the Company’s incorrect accounting for certainnon-routine transactions. These material misstatements resulted in theoverstatement of goodwill and the 

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allowance for loan losses,and the understatement of loans held for sale, net, loans receivable, net,accrued interest receivable and other assets, and accrued interest payable andother liabilities, and an overstatement of net income as of and for the periodended September 30, 2004.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated statements of condition of the Company as of December 31,2004 and 2003, and the related consolidated statements of operations,comprehensive income, changes in shareholders’ equity, and cash flows for eachof the years in the three-year period ended December 31, 2004. Theaforementioned material weakness was considered in determining the nature,timing, and extent of audit tests applied in our audit of the 2004 consolidatedfinancial statements, and this report does not affect our report dated March 11,2005, which expressed an unqualified opinion on those consolidated financialstatements.

In our opinion, management’s assessment that theCompany did not maintain effective internal control over financial reporting asof December 31, 2004, is fairly stated, in all material respects, based oncriteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, becauseof the effect of the material weakness described above on the achievement ofthe objectives of the control criteria, the Company has not maintainedeffective internal control over financial reporting as of December 31,2004, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

The Company acquiredGeorge Mason Mortgage, LLC (GMM) during 2004, and management excluded from itsassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2004, GMM’s internal control overfinancial reporting associated with total assets of $392.2 million and pre-taxincome of $2.1 million included in the consolidated financial statements of theCompany as of and for the year ended December 31, 2004.Our audit of internalcontrol over financial reporting of the Company also excluded an evaluation ofthe internal control over financial reporting of George Mason Mortgage, LLC.
| /s/ KPMG LLP        |
|---------------------|
| McLean, Virginia    |
| March 11, 2005 |

 

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**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CONDITIONDecember 31, 2004 and 2003(Dollars in thousands, except share data)**
| ** **                                                                                                                                                                               | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Assets**                                                                                                                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and due from banks                                                                                                                                                                  |       | $          | 15,205     |       | $          | 9,555 |   |
| Federal funds sold                                                                                                                                                                       |       | 8,203      |       | 3,528      |       |
| Total cash and cash  equivalents                                                                                                                                                         |       | 23,408     |       | 13,083     |       |
| Investment securities  available-for-sale                                                                                                                                                |       | 151,554    |       | 130,762    |       |
| Investment securities  held-to-maturity (market value of $136,609 and $141,630 at December 31,  2004 and 2003, respectively)                                                        |       | 137,953    |       | 142,852    |       |
| Total investment  securities                                                                                                                                                             |       | 289,507    |       | 273,614    |       |
| Other investments                                                                                                                                                                        |       | 8,110      |       | 3,517      |       |
| Loans held for sale, net                                                                                                                                                                 |       | 365,454    |       | —     |       |
| Loans receivable, net of  deferred fees and costs                                                                                                                                        |       | 489,896    |       | 336,002    |       |
| Allowance for loan  losses                                                                                                                                                               |       | (5,878     | )          | (4,344     | )          |
| Loans receivable, net                                                                                                                                                                    |       | 484,018    |       | 331,658    |       |
| Premises and equipment,  net                                                                                                                                                             |       | 15,531     |       | 6,707      |       |
| Deferred tax asset                                                                                                                                                                       |       | 3,238      |       | 4,473      |       |
| Goodwill and  intangibles, net                                                                                                                                                           |       | 14,694     |       | 22         |       |
| Accrued interest  receivable and other assets                                                                                                                                            |       | 7,616      |       | 3,174      |       |
| Total assets                                                                                                                                                                             |       | $          | 1,211,576  |       | $          | 636,248 |   |
| **Liabilities  and Shareholders’ Equity**                                                                                                                                           |       |       |       |       |       |
| Deposits                                                                                                                                                                                 |       | $          | 824,210    |       | $          | 474,129 |   |
| Other borrowed funds                                                                                                                                                                     |       | 201,085    |       | 74,457     |       |
| Warehouse financing                                                                                                                                                                      |       | 30,245     |       | —     |       |
| Mortgage funding checks                                                                                                                                                                  |       | 46,392     |       | —     |       |
| Escrow liabilities                                                                                                                                                                       |       | 3,020      |       | —     |       |
| Accrued interest payable  and other liabilities                                                                                                                                          |       | 11,519     |       | 2,250      |       |
| Total liabilities                                                                                                                                                                        |       | 1,116,471  |       | 550,836    |       |
| Preferred stock, $1 par  value, 10,000,000 shares authorized; Series A preferred stock,  cumulative convertible, 0 and 1,364,062 shares outstanding in 2004 and 2003,  respectively |       | —     |       | 1,364      |       |
| Common stock, $1 par value                                                                                                                                                               | **2004**   | ** ** | **2003**   |       |       |   |   |   |   |
| Authorized                                                                                                                                                                               | 50,000,000 |       | 50,000,000 |       |       |   |   |   |   |
| Issued and outstanding                                                                                                                                                                   | 18,462,597 |       | 16,377,337 |       |       | 18,463 |   | 16,377 |   |
| Additional paid-in  capital                                                                                                                                                              |       | 92,868     |       | 86,790     |       |
| Accumulated deficit                                                                                                                                                                      |       | (15,145    | )          | (18,614    | )          |
| Accumulated other  comprehensive loss                                                                                                                                                    |       | (1,081     | )          | (505       | )          |
| Total shareholders’  equity                                                                                                                                                         |       | 95,105     |       | 85,412     |       |
| Total liabilities and shareholders’ equity                                                                                                                                          |       | $          | 1,211,576  |       | $          | 636,248 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF OPERATIONSYears ended December 31, 2004, 2003 and 2002(In thousands, except per share data)
| ** **                                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income:                                               |       |     |       |     |       |     |       |
| Loans receivable                                               |       | $        | 21,875     |     | $          | 16,851   |       | $ | 14,798 |   |
| Loans held for sale                                            |       | 6,814    |       | —   |       | —   |       |
| Federal funds sold                                             |       | 130      |       | 107      |       | 871      |       |
| Investment securities  available-for-sale                      |       | 5,830    |       | 5,026    |       | 4,501    |       |
| Investment securities  held-to-maturity                        |       | 5,622    |       | 2,483    |       | —   |       |
| Other investments                                              |       | 251      |       | 135      |       | 72       |       |
| Total interest income                                          |       | 40,522   |       | 24,602   |       | 20,242   |       |
| Interest expense:                                              |       |     |       |     |       |     |       |
| Deposits                                                       |       | 12,694   |       | 8,656    |       | 9,364    |       |
| Other borrowed funds                                           |       | 3,047    |       | 773      |       | 222      |       |
| Warehouse financing                                            |       | 228      |       | —   |       | —   |       |
| Total interest expense                                         |       | 15,969   |       | 9,429    |       | 9,586    |       |
| Net interest income                                            |       | 24,553   |       | 15,173   |       | 10,656   |       |
| Provision for loan  losses                                     |       | 1,626    |       | 1,001    |       | 444      |       |
| Net interest income  after provision for loan losses           |       | 22,927   |       | 14,172   |       | 10,212   |       |
| Non-interest income:                                           |       |     |       |     |       |     |       |
| Service charges on  deposit accounts                           |       | 1,089    |       | 918      |       | 852      |       |
| Loan service charges                                           |       | 958      |       | 382      |       | 392      |       |
| Investment fee income                                          |       | 657      |       | 785      |       | 940      |       |
| Net gain on sales of  loans                                    |       | 4,696    |       | 282      |       | 74       |       |
| Net realized gain on  investment securities available-for-sale |       | 245      |       | 1,364    |       | 524      |       |
| Net gain (loss) on sales  of assets                            |       | (1       | )          | —   |       | 39       |       |
| Management fee income                                          |       | 1,749    |       | —   |       | —   |       |
| Other income                                                   |       | 16       |       | 98       |       | 43       |       |
| Total non-interest  income                                     |       | 9,409    |       | 3,829    |       | 2,864    |       |
| Non-interest expense:                                          |       |     |       |     |       |     |       |
| Salary and benefits                                            |       | 13,354   |       | 6,797    |       | 5,715    |       |
| Occupancy                                                      |       | 2,897    |       | 1,559    |       | 972      |       |
| Professional fees                                              |       | 1,610    |       | 1,113    |       | 1,011    |       |
| Depreciation                                                   |       | 1,838    |       | 1,030    |       | 736      |       |
| Data Processing                                                |       | 969      |       | 835      |       | 759      |       |
| Telecommunications                                             |       | 611      |       | 396      |       | 276      |       |
| Writedown on corporate  bond                                   |       | —   |       | —   |       | 1,660    |       |
| Amortization of  intangibles                                   |       | 49       |       | —   |       | 22       |       |
| Other operating expenses                                       |       | 5,826    |       | 3,625    |       | 2,454    |       |
| Total non-interest  expense                                    |       | 27,154   |       | 15,355   |       | 13,605   |       |
| Net income (loss) before  income taxes                         |       | 5,182    |       | 2,646    |       | (529     | )          |
| Provision (benefit) for  income taxes                          |       | 1,713    |       | (3,508   | )          | —   |       |
| Net income (loss)                                              |       | $        | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |
| Dividends to preferred  shareholders                           |       | —   |       | 495      |       | 495      |       |
| Net income (loss) to common  shareholders                      |       | $        | 3,469      |     | $          | 5,659    |       | $ | (1,024 | ) |
| Earnings (loss) per  common share—basic                   |       | $        | 0.19       |     | $          | 0.55     |       | $ | (0.13 | ) |
| Earnings (loss) per  common share—diluted                 |       | $        | 0.19       |     | $          | 0.54     |       | $ | (0.13 | ) |
| Weighted-average common  shares outstanding—basic         |       | 18,448   |       | 10,218   |       | 7,949    |       |
| Weighted-average common shares outstanding—diluted        |       | 18,705   |       | 11,468   |       | 7,949    |       |

 

See accompanying notes to consolidated financial statements.

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOMEYears ended December 31, 2004, 2003 and 2002(Dollars in thousands)
| ** **                                                                                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss)                                                                          |       | $        | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |
| Other comprehensive  income:                                                               |       |     |       |     |       |     |       |
| Unrealized loss  on available-for-sale investment securities:                              |       |     |       |     |       |     |       |
| Unrealized holding loss arising during the year, net  of tax                               |       | (412     | )          | (1,950   | )          | 3,143    |       |
| Less: reclassification adjustment forgains included  in net income (loss), net of tax |       | 164      |       | 900      |       | 524      |       |
| Comprehensive  income                                                                      |       | $        | 2,893      |     | $          | 3,304    |       | $ | 2,090 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYYears ended December 31, 2004, 2003 and 2002(In thousands)
| ** **                                                                                                     | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | ** Common   Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------------------|------------|----------------------------------|------------|--------------------------|------------|-----------------------------------------------------------|------------|-----------|------------|
| **Balance,  December 31, 2001**                                                                      |       |                  | 1,365      |                 |       |               | $          | 1,365                         |       |                             |       | 4,294                    |       |                                                      |       | $         | 4,294      |   |   |   | $ | 38,488 |   |   |   | $ | (23,249 | ) |   |   | $ | (274 | ) |   | $ | 20,624 |   |
| Rights offering  shares issued                                                                                 |       |                  | —     |                 |       |               | —     |                          |       |                             | 2,437      |                     |       |                                                      | 2,437      |      |       |   | 5,462 |   |   |   | — |   |   |   | — |   |   | 7,899 |   |
| Public offering  shares issued                                                                                 |       |                  | —     |                 |       |               | —     |                          |       |                             | 3,313      |                     |       |                                                      | 3,313      |      |       |   | 7,281 |   |   |   | — |   |   |   | — |   |   | 10,594 |   |
| Dividends on  preferred stock                                                                                  |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | (495 | ) |   |   | — |   |   | (495 | ) |
| Change in  unrealized gain (loss) on investment securities available-for-sale                             |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | — |   |   |   | 2,619 |   |   | 2,619 |   |
| Net loss                                                                                                       |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | (529 | ) |   |   | — |   |   | (529 | ) |
| **Balance,  December 31, 2002**                                                                      |       |                  | 1,365      |                 |       |               | $          | 1,365                         |       |                             |       | 10,044                   |       |                                                      |       | $         | 10,044     |   |   |   | $ | 51,231 |   |   |   | $ | (24,273 | ) |   |   | $ | 2,345 |   |   | $ | 40,712 |   |
| Stock options  exercised                                                                                       |       |                  | —     |                 |       |               | —     |                          |       |                             | 32         |                     |       |                                                      | 32         |      |       |   | 112 |   |   |   | — |   |   |   | — |   |   | 144 |   |
| Preferred stock  converted to common stock                                                           |       |                  | (1         | )                    |       |               | (1         | )                             |       |                             | 1          |                     |       |                                                      | 1          |      |       |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Public offering  shares issued                                                                                 |       |                  | —     |                 |       |               | —     |                          |       |                             | 6,300      |                     |       |                                                      | 6,300      |      |       |   | 35,447 |   |   |   | — |   |   |   | — |   |   | 41,747 |   |
| Dividends on  preferred stock                                                                                  |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | (495 | ) |   |   | — |   |   | (495 | ) |
| Change in  unrealized gain (loss) on investment securities  available-for-sale,net of tax       |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | — |   |   |   | (2,850 | ) |   | (2,850 | ) |
| Net income                                                                                                     |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | 6,154 |   |   |   | — |   |   | 6,154 |   |
| **Balance,  December 31, 2003**                                                                      |       |                  | 1,364      |                 |       |               | $          | 1,364                         |       |                             |       | 16,377                   |       |                                                      |       | $         | 16,377     |   |   |   | $ | 86,790 |   |   |   | $ | (18,614 | ) |   |   | $ | (505 | ) |   | $ | 85,412 |   |
| Stock options  exercised                                                                                       |       |                  | —     |                 |       |               | —     |                          |       |                             | 115        |                     |       |                                                      | 115        |      |       |   | 383 |   |   |   | — |   |   |   | — |   |   | 498 |   |
| Public offering  shares issued                                                                                 |       |                  | —     |                 |       |               | —     |                          |       |                             | 945        |                     |       |                                                      | 945        |      |       |   | 5,357 |   |   |   | — |   |   |   | — |   |   | 6,302 |   |
| Preferred stock  converted to common stock                                                           |       |                  | (1,364     | )                    |       |               | (1,364     | )                             |       |                             | 1,026      |                     |       |                                                      | 1,026      |      |       |   | 338 |   |   |   | — |   |   |   | — |   |   | — |   |
| Change in  unrealized gain (loss) on investment securities available-for-sale,  net of tax |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | — |   |   |   | (576 | ) |   | (576 | ) |
| Net income                                                                                                     |       |                  | —     |                 |       |               | —     |                          |       |                             | —     |                     |       |                                                      | —     |      |       |   | — |   |   |   | 3,469 |   |   |   | — |   |   | 3,469 |   |
| **Balance,  December 31, 2004**                                                                      |       |                  | —     |                 |       |               | $          | —                        |       |                             |       | 18,463                   |       |                                                      |       | $         | 18,463     |   |   |   | $ | 92,868 |   |   |   | $ | (15,145 | ) |   |   | $ | (1,081 | ) |   | $ | 95,105 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CASH FLOWSYears ended December 31, 2004, 2003 and 2002(Dollars in thousands)
| ** **                                                                                                                                                                                                | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Cash flows from operating  activities:**                                                                                                                                                                |       |       |       |     |       |     |       |
| Net income (loss)                                                                                                                                                                                         |       | $          | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities:                                                                                                       |       |       |       |     |       |     |       |
| Depreciation                                                                                                                                                                                              |       | 1,838      |       | 1,030    |       | 736      |       |
| Amortization of  premiums, discounts and intangibles                                                                                                                                                      |       | 2,025      |       | 2,137    |       | 1,120    |       |
| Provision for loan  losses                                                                                                                                                                                |       | 1,626      |       | 1,001    |       | 444      |       |
| Loans held for  sale originated and acquired                                                                                                                                                              |       | (2,181,655 | )          | (32,697  | )          | (4,369   | )          |
| Proceeds from the  sale of loans held for sale                                                                                                                                                            |       | 1,820,897  |       | 32,979   |       | 9,175    |       |
| Gain on sale of  loans held for sale                                                                                                                                                                      |       | (4,696     | )          | (282     | )          | (74      | )          |
| Writedown on corporate  bond                                                                                                                                                                              |       | —     |       | —   |       | 1,660    |       |
| Gain on sale of  investment securities available-for-sale                                                                                                                                                 |       | (245       | )          | (1,364   | )          | (524     | )          |
| Gain on sale of  other assets                                                                                                                                                                             |       | (1         | )          | —   |       | (39      | )          |
| (Increase)  decrease in goodwill and intangibles, net                                                                                                                                                     |       | (14,672    | )          | 624      |       | —   |       |
| Increase in  accrued interest receivable, other assets, and deferred tax asset                                                                                                                            |       | (3,207     | )          | (1,297   | )          | (4,924   | )          |
| (Increase)  decrease in accrued interest payable, escrow liabilities and other  liabilities                                                                                                               |       | 12,289     |       | (17,882  | )          | 17,020   |       |
| Net cash provided by  (used in) operating activities                                                                                                                                                      |       | (362,332   | )          | (9,597   | )          | 19,696   |       |
| **Cash flows from investing activities:**                                                                                                                                                                 |       |       |       |     |       |     |       |
| Purchase of premises and  equipment                                                                                                                                                                       |       | (10,666    | )          | (2,795   | )          | (601     | )          |
| Proceeds from sale,  maturity and call of investment securities available-for-sale                                                                                                                        |       | 14,000     |       | 50,666   |       | 21,928   |       |
| Proceeds from sale,  maturity and call of mortgage-backed securities available-for-sale                                                                                                                   |       | 9,719      |       | 46,948   |       | 20,106   |       |
| Proceeds from maturity  and call of investment securities held-to-maturity                                                                                                                                |       | 9,985      |       | —   |       | —   |       |
| Proceeds from sale of  other investments                                                                                                                                                                  |       | 9,558      |       | 1,831    |       | 188      |       |
| Purchase of investment  securities available-for-sale                                                                                                                                                     |       | (6,000     | )          | (43,066  | )          | (58,087  | )          |
| Purchase of  mortgage-backed securities available-for-sale                                                                                                                                                |       | (72,959    | )          | (223,505 | )          | (139,168 | )          |
| Purchase of investment  securities held-to-maturity                                                                                                                                                       |       | (16,472    | )          | (2,998   | )          | —   |       |
| Purchase of  mortgage-backed securities held-to-maturity                                                                                                                                                  |       | (14,042    | )          | (5,023   | )          | —   |       |
| Purchase of other  investments                                                                                                                                                                            |       | (13,528    | )          | (3,733   | )          | (535     | )          |
| Redemptions of investment  securities available-for-sale                                                                                                                                                  |       | 30,525     |       | 41,805   |       | 25,564   |       |
| Redemptions of investment  securities held-to-maturity                                                                                                                                                    |       | 26,452     |       | 21,340   |       | —   |       |
| Net cash acquired in  acquisition                                                                                                                                                                         |       | 1,778      |       | —   |       | —   |       |
| Net increase in loans  receivable                                                                                                                                                                         |       | (155,219   | )          | (86,664  | )          | (47,808  | )          |
| Net cash used in  investing activities                                                                                                                                                                    |       | (186,869   | )          | (205,194 | )          | (178,413 | )          |
| **Cash flows from financing activities:**                                                                                                                                                                 |       |       |       |     |       |     |       |
| Net increase in deposits                                                                                                                                                                                  |       | 350,081    |       | 50,650   |       | 177,455  |       |
| Net increase (decrease)  in other borrowed funds                                                                                                                                                          |       | 62,008     |       | 25,499   |       | (24      | )          |
| Net increase in warehouse  financing                                                                                                                                                                      |       | 30,245     |       | —   |       | —   |       |
| Net increase in mortgage  funding checks                                                                                                                                                                  |       | 46,392     |       | —   |       | —   |       |
| Proceeds from FHLB  advances—long term                                                                                                                                                               |       | 52,500     |       | 59,000   |       | 1,000    |       |
| Repayments of FHLB  advances—long term                                                                                                                                                               |       | (8,500     | )          | (12,042  | )          | (8,800   | )          |
| Proceeds from rights  offering                                                                                                                                                                            |       | —     |       | —   |       | 7,899    |       |
| Proceeds from public  offering                                                                                                                                                                            |       | 6,302      |       | 41,747   |       | 10,594   |       |
| Proceeds from trust  preferred issuance                                                                                                                                                                   |       | 20,000     |       | —   |       | —   |       |
| Stock options exercised                                                                                                                                                                                   |       | 498        |       | 144      |       | —   |       |
| Dividends on preferred  stock                                                                                                                                                                             |       | —     |       | (495     | )          | (495     | )          |
| Net cash provided by  financing activities                                                                                                                                                                |       | 559,526    |       | 164,503  |       | 187,629  |       |
| Net increase  (decrease) in cash and cash equivalents                                                                                                                                                     |       | 10,325     |       | (50,288  | )          | 28,912   |       |
| Cash and cash  equivalents at beginning of year                                                                                                                                                           |       | 13,083     |       | 63,371   |       | 34,459   |       |
| Cash and cash  equivalents at end of year                                                                                                                                                                 |       | $          | 23,408     |     | $          | 13,083   |       | $ | 63,371 |   |
| **Supplemental disclosure of cash flow information:**                                                                                                                                                     |       |       |       |     |       |     |       |
| Cash paid during year for  interest                                                                                                                                                                       |       | $          | 15,124     |     | $          | 9,380    |       | $ | 9,491 |   |
| Cash paid for income  taxes                                                                                                                                                                               |       | 135        |       | 80       |       | —   |       |
| **Supplemental schedule of non-cash investing and  financing activities:**                                                                                                                                |       |       |       |     |       |     |       |
| The Company acquired all of the issued and  outstanding membership interests of George Mason Mortgage, LLC for $17.0  million. In conjunction with the acquisition, liabilities were assumed as  follows: |       |       |       |     |       |     |       |
| Fair value of  assets acquired                                                                                                                                                                            |       | $          | 355,232    |     |       |     |       |   |
| Goodwill and  intangibles                                                                                                                                                                                 |       | 14,703     |       |     |       |     |       |
| Cash paid                                                                                                                                                                                                 |       | (17,000    | )          |     |       |     |       |
| Fair value of  liabilities assumed                                                                                                                                                                        |       | $          | 352,935    |     |       |     |       |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIALCORPORATIONNotes to Consolidated Financial Statements**

(1)        Organization

Cardinal Financial Corporation (the ”Company”)was incorporated November 24, 1997 under the laws of the Commonwealth ofVirginia as a holding company whose activities consist of investment in itswholly-owned subsidiaries. The Company opened Cardinal Bank, N.A. (the “Bank”)in 1998 and Cardinal Wealth Services, Inc., an investment servicessubsidiary, in 1999. In 1999, the Company opened two additional banking subsidiariesand, in late 2000, completed an acquisition of Heritage Bancorp, Inc. andits banking subsidiary, The Heritage Bank (“Heritage”). These bankingsubsidiaries were consolidated into the Bank as of March 1, 2002. On April 15,2004, the Company received approval from the Federal Reserve Bank of Richmondto be a financial holding company. Effective July 7, 2004, the Bankacquired George Mason Mortgage, LLC (“GMM”) from United Bank—Virginia, a whollyowned subsidiary of United Bankshares, Inc. In December 2004,Cardinal Bank, N.A. converted to a state chartered institution and changed itsname to Cardinal Bank.

On July 7, 2004, the Bank acquired George MasonMortgage LLC (“George Mason” or “GMM”) in a cash transaction for $17.0 million.This transaction resulted in the recognition of $12.8 million of goodwill and$1.7 million of other intangibles. This transaction was accounted for as apurchase, and GMM’s assets and liabilities were recorded at fair value as ofthe purchase date. GMM’s operating results are included in the consolidatedresults since the date of the acquisition. GMM, based in Fairfax, Virginia,engages primarily in the origination and acquisition of residential mortgagesfor sale into the secondary market on a best efforts basis through eight brancheslocated throughout the metropolitan Washington region. GMM has approximately200 employees and does business in eight states, including Virginia, Marylandand the District of Columbia. GMM’s primary sources of revenue include netinterest income earned on loans held for sale, gain on the sale of loans heldfor sale and contractual management fees earned relating to the management ofother entities’ activities. Loans are made pursuant to purchase commitments andare sold servicing released.

In July 2004,the Company formed a wholly-owned subsidiary, Cardinal Statutory Trust I, forthe purpose of issuing $20.0 million of floating rate junior subordinateddeferrable interest debentures (“trust preferred securities”). These trustpreferred securities are due in 2034 and have an interest rate of LIBOR (LondonInterbank Offered Rate) plus 2.40%, which adjusts quarterly. These securitiesare redeemable at a premium through March 2008 and at par thereafter. TheCompany has guaranteed payment of these securities. The $20.6 million payableby the Company to Cardinal Statutory Trust I is included in other borrowedfunds in the Consolidated Statements of Condition since Cardinal StatutoryTrust I is an unconsolidated subsidiary as the Company is not the primary beneficiaryof this entity. The Company utilized the proceeds from the issuance of thetrust preferred securities to make a capital contribution into the Bank.

(2)        Summaryof Significant Accounting Policies

***(a)***    Useof Estimates

U.S. generally acceptedaccounting principles are complex and require management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and contingent liabilities at the date of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates. The accounting policies the Company views as critical are thoserelating to judgments, assumptions and estimates regarding the accounting forbusiness combinations, the 

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determination ofthe allowance for loan losses, accounting for economic hedging activities, andthe valuation allowance for deferred tax assets.

***(b)***     Principlesof Consolidation

The consolidated financialstatements include the accounts of the Company and its subsidiaries. Allsignificant intercompany transactions and balances have been eliminated inconsolidation.

***(c)***      Accountingfor Business Combinations

The acquisition of GMM wasaccounted for as a purchase as required by SFAS No. 141, *Business Combinations*. The purchase accounting methodrequires that the cost of an acquired entity be allocated to the assetsacquired and liabilities assumed based on their estimated fair values at thedate of acquisition. The difference between the fair values and the purchaseprice is recorded as goodwill. In addition, SFAS No. 141 requires thatidentified intangible assets acquired in a business combination must beseparately valued and recognized on the balance sheet if they meet certainrequirements.

***(d)***     Cashand Cash Equivalents

For the purpose ofpresentation in the consolidated statements of cash flows, the Company hasdefined cash and cash equivalents as those amounts included in cash, due frombanks, and federal funds sold.

***(e)***      InvestmentSecurities

The Company classifies its debt and marketable equitysecurities in one of two categories: available-for-sale or held-to-maturity.Held-to-maturity securities are those securities for which theCompany has the ability and intent to hold until maturity. All other securitiesare classified as available-for-sale.

Held to maturity securities are carried at amortizedcost. Available-for-sale securities are carried at fair value. Unrealizedgains and losses, net of tax if applicable, on available-for-salesecurities are reported in other comprehensive income (loss).

Gains and losses on the sale of securities aredetermined using the specific identification method. Declines in the fair valueof individual held-to-maturity and available-for-salesecurities below their cost that are deemed other than temporary are charged toearnings as realized losses, resulting in the establishment of a new cost basisfor the security.

Premiums and discounts arerecognized in interest income using the effective interest method over theperiod to maturity. Prepayment of the mortgages securing the mortgage-backedsecurities may affect the maturity date and yield to maturity. The Company usesactual principal prepayment experience and estimates of future principalprepayments in calculating the yield necessary to apply the effective interestmethod.

***(f)***       LoansHeld for Sale

Loans originated andintended for sale into the secondary market are carried at the lower of cost orestimated fair value on an aggregate loan basis as determined by outstandingcommitments from investors and changes in fair value due to changes in interestrates. Net unrealized losses, if any, are recognized through a valuationallowance by charges to operations. Carrying amount includes unpaid principalbalances, valuation allowances, origination premiums or discounts, andorigination fees and direct costs that are deferred at the time of origination.

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***(g)***     LoansReceivable and Allowance for Loan Losses

Loans receivable thatmanagement has the intent and ability to hold for the foreseeable future oruntil maturity or pay-off are reported at their outstanding principal balanceadjusted for any charge-offs, and net of the allowance for loan lossesand any deferred fees or costs. Loan origination fees and certain directorigination costs are capitalized and amortized as an adjustment of the yieldusing the payment terms required by the loan contract.

Loans are placed innonaccrual status when they are past-due 90 days as to either principal orinterest or when, in the opinion of management, the collection of principal andinterest is in doubt. A loan remains in nonaccrual status until the loan iscurrent as to payment of both principal and interest or past-due less than90 days, and the borrower demonstrates the ability to pay and remaincurrent. Loans are charged-off when a loan or a portion thereof is considereduncollectible. When cash payments are received, they are applied to principalfirst, then to accrued interest. It is the Company’s policy not to recordinterest income on nonaccrual loans until principal is current.

The Company determines andrecognizes impairment of certain loans when, based on current information andevents, it is probable that the Company will be unable to collect all amountsdue according to the contractual terms of the loan agreement. A loan is notconsidered impaired during a period of delay in payment if the Company expectsto collect all amounts due, including past-due interest. An impaired loanis measured at the present value of its expected future cash flows discountedat the loan’s coupon rate, or at the loan’s observable market price or fairvalue of the collateral if the loan is collateral dependent.

The allowance for loanlosses is increased by provisions for loan losses and decreased by charge-offs(net of recoveries). Management’s periodic determination of the allowance isbased on the Company’s past loan loss experience, adverse situations that mayaffect the borrower’s ability to repay, the estimated value of any underlyingcollateral, and current economic conditions. In addition, various regulatoryagencies, as an integral part of their examination process, periodically reviewthe Company’s allowance for loan losses. Such agencies may require the Companyto recognize additions to the allowance based on their judgments aboutinformation available to them at the time of their examination. Managementbelieves that the current allowance for loan losses is a reasonable estimate ofknown and inherent losses in the current loan portfolio.

***(h)***    Premisesand Equipment

Land is carried at cost. Premises,furniture, equipment, and leasehold improvements are carried at cost, lessaccumulated depreciation and amortization. Depreciation of premises, furnitureand equipment is computed using the straight-line method over estimated usefullives from 3 to 25 years. Amortization of leasehold improvements is computedusing the straight-line method over the useful lives of the improvementsor the lease term, whichever is shorter.

***(i)***       Goodwilland Other Intangibles

Goodwill, which representsthe excess of purchase price over fair value of net assets acquired, is notamortized but is evaluated at least annually for impairment by comparing itsfair value with its recorded amount and is written-down when appropriate. Inaddition to goodwill, the Company has amortizable intangible assets as a resultof the GMM acquisition. These intangible assets are being amortized on astraight-line basis over their estimated lives. Additional information on theCompany’s goodwill and intangible assets can be found in Note 23.

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***(j)***        Gainon Sale of Loans

Gains or losses on thesale of loans are recognized at the date of settlement and are based on thedifference between the selling price and the carrying value of the relatedloans sold. Fees and direct costs originally deferred that are associated withthe origination of the loans held for sale are recognized as an adjustment tothe gain on sale when the loans are sold.

***(k)***     ManagementFee Income

Management fee incomerepresents income earned for the management and operational support provided byGMM to other mortgage banking companies (the “managed companies”). Therelationship of GMM to these managed companies is solely as a mortgage bankingadvisor. There are no fiduciary or other special relationships with regard toeach of the managed companies. Fees earned by GMM are accrued based oncontractual arrangements with each of the managed companies.

***(l)***        InvestmentFee Income

Investmentfee income represents commissions paid by customers of Cardinal Wealth Services, Inc.for investment transactions. Fees are generally recognized in income as theyare earned.

***(m) Income Taxes***

Deferred tax assets andliabilities are reflected at currently enacted income tax rates applicable tothe period in which the deferred tax assets or liabilities are expected to berealized or settled. As changes in tax laws or rates are enacted, deferred taxassets and liabilities are adjusted through the provision for income taxes.

***(n)***    Earnings(Loss) Per Common Share

Basic earnings (loss) percommon share is computed by dividing net income (loss) by the weighted-averagenumber of shares of common stock outstanding during the periods. Dilutedearnings per share reflects the impact of dilutive potential common shares thatwould have been outstanding if common stock equivalents had been issued, aswell as any adjustment to income that would result from the assumed issuance. Commonstock equivalents that may be issued by the Company relate solely tooutstanding stock options, and the dilutive potential common shares resultingfrom outstanding stock options are determined using the treasury stock method. Commonstock equivalents outstanding at December 31, 2002 were antidilutive andconsequently, not included in the loss per common share calculation.

***(o)***     Derivativesand Hedging Activities

The Company accounts for its derivatives and hedgingactivities in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 133, *Accounting for Derivative Instruments andHedging Activity,*as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities*and SFAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities.*

In the normal course of business, the Company entersinto contractual commitments, including loan commitments and rate lockcommitments to finance residential mortgages. These commitments, which containfixed expiration dates, offer the borrower an interest rate guarantee providedthe loan meets underwriting guidelines and closes within the timeframeestablished by the Company. Interest rate risk arises on these commitments andsubsequently closed loans if interest rates move between the time of theinterest rate lock and the delivery of the loan to the investor. Loancommitments 

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related to mortgage loansthat are intended to be sold are considered derivatives in accordance with theguidance of SEC Staff Accounting Bulletin No. 105, *Applicationof Accounting Principles to Loan Commitments.*Accordingly, the fairvalue of these derivatives at the end of the reporting period has beendetermined through an analysis of changes in market interest rates from theinterest rate lock date and the loan closing date.

To mitigate the effect of the interest rate riskinherent in providing loan commitments, the Company economically hedges itscommitments by entering into best efforts delivery forward loan sale contracts.These forward contracts are marked to market through earnings and are notdesignated as accounting hedges under SFAS No. 133. The change in the fairvalue of loan commitments and the change in the fair value of forward salescontracts generally move in opposite directions and, accordingly, the impact ofchanges in these valuations on net income during the loan commitment period isgenerally inconsequential.

Although the forward loansale contracts also serve as an economic hedge of loans held for sale, forwardcontracts have not been designated as accounting hedges under SFAS No. 133and, accordingly, loans held for sale are accounted for at the lower of cost ormarket in accordance with SFAS No. 65, *Accounting for CertainMortgage Banking Activities.*

***(p)***     StockOption Plans

The Company applies theintrinsic value-based method of accounting prescribed by Accounting PrinciplesBoard (“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations, in accounting forits fixed plan stock options. As such, compensation expense is recorded only ifthe current market price of the underlying stock exceeded the exercise price onthe date of grant.

***(q)***     StockBased Compensation

At December 31, 2004,the Company had two stock-based employee compensation plans, which aredescribed more fully in Footnote 16. As permitted under SFAS No. 148, *Accounting for Stock-Based Compensation—Transition and Disclosure*,which amended SFAS No. 123, *Accounting for Stock-BasedCompensation*, the Company has elected to continue to follow theintrinsic value method in accounting for its stock-based employee compensationarrangement as defined by Accounting Principles Board Opinion (“APB”) No. 25,*Accounting for Stock Issued to Employees*,and related interpretations including *Financial AccountingStandards Board Interpretation No. 44, Accounting for Certain Transactionsinvolving Stock Compensation*, an interpretation of APB No. 25. Thefollowing table illustrates the effect on net income (loss) and earnings (loss)per common share if the Company 

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had applied the fair value recognition provisions ofSFAS No. 123 to stock-based employee compensation.
|                                                       | ** **                    | **Years ended December 31,**                                                  | ** ** |
|-------------------------------------------------------|-------------------------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** **                    | **       2004       ** | ** ** | **       2003       ** | ** ** | **       2002       ** | ** ** |
| ** **                                            | ** **                    | **(Dollars in thousands, except per share data)**              | ** ** |
| Net income (loss) to common  shareholders as reported |                          |                                                                                         | $          | 3,469 |   |   |   | $ | 5,659 |   |   |   | $ | (1,024 | ) |   |
| Deduct:                                               | Total stock based  employee   |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
|                                                  | compensation  expense         |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
|                                                  | determined under  fair value- |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
|                                                  | based method for  all awards  |                                                                                         |       | (1,427 | ) |   |   | (547 | ) |   |   | (265 | ) |   |
| Pro forma net income (loss)                           |                          |                                                                                         | $          | 2,042 |   |   |   | $ | 5,112 |   |   |   | $ | (1,289 | ) |   |
| Earnings (loss)  per common share:                    |                          |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
|                                                       | Basic—as reported        |                                                                                         |       | $ | 0.19 |   |   |   | $ | 0.55 |   |   |   | $ | (0.13 | ) |   |
|                                                  | Basic—pro forma          |                                                                                         |       | 0.11 |   |   |   | 0.50 |   |   |   | (0.16 | ) |   |
|                                                       | Diluted—as  reported     |                                                                                         |       | 0.19 |   |   |   | 0.54 |   |   |   | (0.13 | ) |   |
|                                                  | Diluted—pro forma        |                                                                                         |       | 0.11 |   |   |   | 0.45 |   |   |   | (0.16 | ) |   |

 

Theweighted average per share fair values of grants made in 2004, 2003 and 2002were $3.11, $2.13 and $2.12, respectively. The fair values of the optionsgranted were estimated on the grant date using the Black-Scholes option-pricingmodel based on the following weighted-average assumptions:
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Estimated option life    |       | 10 years |       | 10 years |       | 10 years |       |
| Risk free  interest rate |       | 4.07     | %          | 3.98     | %          | 4.25     | %          |
| Expected  volatility     |       | 11.8     | %          | 11.8     | %          | 20.4     | %          |
| Expected dividend yield  |       | 0.00     | %          | 0.00     | %          | 0.00     | %          |

 

***(r)***      Reclassifications

Certain amounts for 2003and 2002 have been reclassified to conform to the presentation for 2004.

(3)        Business Combinations

Effective July 7, 2004, the Bank completed itsacquisition of GMM from United Bank—Virginia, a wholly owned subsidiary ofUnited Bankshares, Inc. GMM was acquired in a cash transaction for $17.0million and is operating as a subsidiary of the Bank. This transaction wasaccounted for as a purchase and GMM’s assets and liabilities were recorded atfair value as of the purchase date. GMM’s operating results are included in theconsolidated results since the date of acquisition. This transaction resultedin the recognition of $12.9 million of goodwill and $1.7 million of otherintangible assets. During the fourth quarter of 2004, the Company reallocated apart of goodwill as previously reported to other intangible assets as a resultof a study by an independent valuation consultant. GMM’s primary sources ofrevenue include net interest income earned on loans held for sale, gain on saleof loans and management fees earned. Loans are made pursuant to purchasecommitments and are sold servicing released. The Bank purchased GMM primarilyto diversify its sources of income, increase non-interest income and to be asource of residential loans for its portfolio.

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The following presents thecondensed statement of condition of George Mason Mortgage, LLC at July 7,2004, the date of acquisition:

**CONDENSEDCONSOLIDATED STATEMENT OF CONDITION(Dollars in thousands)**
| **Assets**                                |   |   |                     |   |   |
|-------------------------------------------|--------|--------|--------------------------|--------|--------|
| Cash and cash  equivalents                |   |   | $   1,778 |   |   |
| Loans held for  sale, net                 |   |   | 339,643                  |   |   |
| Loans receivable,  net                    |   |   | 429                      |   |   |
| Premises and  equipment, net              |   |   | 2,289                    |   |   |
| Other assets                              |   |   | 7,784                    |   |   |
| Total assets                              |   |   | $ 351,923           |   |   |
| **Liabilities  and Shareholder Equity**   |   |   |                     |   |   |
| Warehouse financing                       |   |   | $ 335,584           |   |   |
| Other liabilities                         |   |   | 16,339                   |   |   |
| Total liabilities                         |   |   | 351,923                  |   |   |
| Total shareholder equity                  |   |   | —                   |   |   |
| Total liabilities  and shareholder equity |   |   | $ 351,923           |   |   |

 

Thefollowing unaudited pro forma condensed combined financial information presentsthe results of operations of the Company as if GMM had been acquired on January 1,2003.
| ** **                                               | ** ** | **For the Years Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **December 31,**                  | ** ** |
| ** **                                               | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| ** **                                               | ** ** | **(Dollars in thousands)**   | ** ** |
| Net interest  income                                     |       | $ 28,674                          |       | $ 27,506 |   |
| Non-interest  income                                     |       | 28,254                                 |       | 33,275 |   |
| Provision for  loan losses                               |       | 1,627                                  |       | 1,000 |   |
| Non-interest  expense                                    |       | 45,019                                 |       | 36,701 |   |
| Net income before  income taxes                          |       | 10,282                                 |       | 23,080 |   |
| Provision for  income taxes                              |       | 3,228                                  |       | 2,237 |   |
| Net income                                               |       | $ 7,054                           |       | $ 20,843 |   |
| Earnings per common share—basic                     |       | $   0.38                |       | $   2.04 |   |
| Earnings per  common share—diluted                  |       | $   0.38                |       | $   1.82 |   |
| Weighted-average  common shares outstanding—basic   |       | 18,448                                 |       | 10,218 |   |
| Weighted-average common  shares outstanding—diluted |       | 18,705                                 |       | 11,468 |   |

 

The 2003 proforma tax expense of $2.2 million includesthe impact of a $3.5 million tax benefit associated with Cardinal FinancialCorporation’s recognition of deferred tax assets since the Company determinedthat it was more than likely than not that these assets would be utilized. SeeNote 12 for additional information.

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Thefollowing table provides a reconciliation of the excess cost of the acquisitionto the Company over the fair value of net assets acquired from GMM
| ** **                                                   | ** ** | **(Dollars in thousands)** | ** **    |
|--------------------------------------------------------------|------------|--------------------------------------|---------------|
| Cash paid by the  Company                                    |       |                                 | $ 17,000 |   |   |
| Identifiable  intangible assets                              |       |                                 | (1,781        | ) |   |
| Fair value of  loans held for sale                           |       |                                 | (1,204        | ) |   |
| Fair value of  construction to permanent loans held for sale |       |                                 | (235          | ) |   |
| Fair value of  unfunded commitments                          |       |                                 | (455          | ) |   |
| Fair value of  reserve for loan losses                       |       |                                 | (397          | ) |   |
| Fair value of  management fee accrual                        |       |                                 | (130          | ) |   |
| Merger costs                                                 |       |                                 | 143           |   |   |
| Goodwill                                                     |       |                                 | $ 12,941 |   |   |

 

Goodwillwill be deductible for federal income tax purposes over a fifteen year period. Thefederal income tax deduction attributable to goodwill in each of the next fiveyears will be $863,000.

(4)                       InvestmentSecurities and Other Investments

Thefair value and amortized cost of investment securities at December 31,2004 and 2003 are shown below.
| ** **                                                         | ** ** | **2004**                             | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                         | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                         | ** ** | **cost**                             | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| ** **                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| *Investment Securities  Available-for-Sale*                        | ** ** | ** **                           | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Obligations of U.S. government-sponsored agencies  and enterprises |       | $   6,000             |       |   | $   9 | ** ** |   |   | $    (53 | ) |   | $   5,956 |   |
| Mortgage-backed  securities                                        |       | 145,300                              |       |   | 121 | ** ** |   |   | (1,841 | ) |   | 143,580 |   |
| Treasury bonds                                                     |       | 2,031                                |       |   | — | ** ** |   |   | (13 | ) |   | 2,018 |   |
| Total                                                              |       | $ 153,331                       |       |   | $ 130 | ** ** |   |   | $ (1,907 | ) |   | $ 151,554 |   |
| *Investment  Securities Held-to-Maturity*                          | ** ** | ** **                           | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | ** ** | ** ** |
| Obligations of U.S. government-sponsored agencies  and enterprises |       | $ 25,517                        |       |   | $ 21 | ** ** |   |   | $  (248 | ) |   | $ 25,290 |   |
| Mortgage-backed  securities                                        |       | 104,431                              |       |   | 222 | ** ** |   |   | (1,256 | ) |   | 103,397 |   |
| Corporate bonds                                                    |       | 8,005                                |       |   | 5 | ** ** |   |   | (88 | ) |   | 7,922 |   |
| Total                                                              |       | $ 137,953                       |       |   | $ 248 | ** ** |   |   | $ (1,592 | ) |   | $ 136,609 |   |

 

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| ** **                                                         | ** ** | **2003**                             | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                         | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                         | ** ** | **cost**                             | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| ** **                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| *Investment Securities  Available-for-Sale*                        | ** ** | ** **                           | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Obligations of U.S. government-sponsored agencies  and enterprises |       | $   6,000             |       |   | $ 66 | ** ** |   |   | $    (37 | ) |   | $   6,029 |   |
| Mortgage-backed  securities                                        |       | 113,480                              |       |   | 304 | ** ** |   |   | (1,113 | ) |   | 112,671 |   |
| Corporate bonds                                                    |       | 10,000                               |       |   | — | ** ** |   |   | (5 | ) |   | 9,995 |   |
| Treasury bonds                                                     |       | 2,047                                |       |   | 20 | ** ** |   |   | — |   |   | 2,067 |   |
| Total                                                              |       | $ 131,527                       |       |   | $ 390 | ** ** |   |   | $ (1,155 | ) |   | $ 130,762 |   |
| *Investment  Securities Held-to-Maturity*                          | ** ** | ** **                           | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | ** ** | ** ** |
| Obligations of U.S. government-sponsored agencies  and enterprises |       | $ 16,992                        |       |   | $   9 | ** ** |   |   | $  (216 | ) |   | $ 16,785 |   |
| Mortgage-backed  securities                                        |       | 117,860                              |       |   | 266 | ** ** |   |   | (1,129 | ) |   | 116,997 |   |
| Corporate bonds                                                    |       | 8,000                                |       |   | — | ** ** |   |   | (152 | ) |   | 7,848 |   |
| Total                                                              |       | $ 142,852                       |       |   | $ 275 | ** ** |   |   | $ (1,497 | ) |   | $ 141,630 |   |

 

Thefair value and amortized cost of available-for-sale securities bycontractual maturity at December 31, 2004 is shown below. Expectedmaturities may differ from contractual maturities because many issuers have theright to call or prepay obligations with or without call or prepaymentpenalties.
| ** **                         | ** ** | **Available-for-Sale**               | ** ** | **Held-to-Maturity**     | ** ** |
|------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|
| ** **                         | ** ** | **Amortized**                        | ** ** | **Fair**                 | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                         | ** ** | **cost**                             | ** ** | **Value**                | ** ** | **cost** | ** ** | **Value** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| After 1 year but  within 5 years   |       | $   5,031             |       | $   4,965 |       | $   6,500 |   | $   6,427 |   |
| After 5 years but  within 10 years |       | 3,000                                |       | 3,009                    |       | 16,018 |   | 15,901 |   |
| After 10 years                     |       | —                               |       | —                   |       | 11,004 |   | 10,884 |   |
| Mortgage-backed  securities        |       | 145,300                              |       | 143,580                  |       | 104,431 |   | 103,397 |   |
| Total                              |       | $ 153,331                       |       | $ 151,554           |       | $ 137,953 |   | $ 136,609 |   |

 

For the years ended December 31, 2004, 2003, and2002, proceeds from sales of investment securities available-for-sale amountedto approximately $25.0 million, $68.9 million, and $31.3 million, respectively.Gross realized gains in 2004, 2003 and 2002 amounted to approximately $250,000,$1.4 million and $544,000, respectively. Gross realized losses during 2004,2003 and 2002 amounted to approximately $5,000, $0, and $20,000, respectively.

The table below shows theCompany’s investment securities’ gross unrealized losses and their fair value,aggregated by investment category and length of time that individual securitieshave been in a continuous unrealized loss position, at December 31, 2004.

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| **Investment Securities**                                          | ** ** | ** **                 | ** **    | **Less than 12 months** | ** ** | **12 months or more** | ** **                   | **Total**                       | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|---------------|----------------------------------------|------------|--------------------------------------|------------------------------|---------------------------------|------------|
| **Available-for-Sale **                                            | ** ** | ** **                 | ** **    | ** Fair Value **        | ** ** | **Unrealized loss**             | ** **                   | ** Fair Value ** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** **    |
| Obligations of  U.S. government-sponsored agencies and enterprises |       |                       | $ 1,979  |                                   |       |                                 | $    (21 | )                               |       |   | $    967 |   |   |   | $ (33 | ) |   | $   2,946 |   |   | $    (54 | ) |   |
| Mortgage-backed  securities                                             |       |                       | 87,862        |                                   |       |                                 | (1,024                       | )                               |       |   | 37,720 |   |   |   | (816 | ) |   | 125,582 |   |   | (1,840 | ) |   |
| Treasury bonds                                                          |       |                       | 2,018         |                                   |       |                                 | (13                          | )                               |       |   | — |   |   |   | — |   |   | 2,018 |   |   | (13 | ) |   |
| Total temporarily  impaired securities                                  |       |                       | $ 91,859 |                                   |       |                                 | $ (1,058                | )                               |       |   | $ 38,687 |   |   |   | $ (849 | ) |   | $ 130,546 |   |   | $ (1,907 | ) |   |
|                                                                         |            |                            |               |                                        |            |                                      |                              |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Investment Securities**                                     | ** ** | **Less than 12 months** | ** **    | **12 months or more** | ** ** | **Total**                | ** **  |
|--------------------------------------------------------------------|------------|----------------------------------------|---------------|--------------------------------------|------------|--------------------------|-------------|
| **Held-to-Maturity**                                               | ** ** | ** **                             | ** **    | ** Fair Value **      | ** ** | **Unrealized loss** | ** **  | ** Fair Value ** | ** ** | **Unrealized loss** | ** ** | ** Fair Value ** | ** ** | **Unrealized loss** | ** ** |
| ** **                                                         | ** ** | **(Dollars in thousands)**   | ** **    |
| Obligations of  U.S. government-sponsored agencies and enterprises |       |                                   | $ 14,844 |                                 |       |                     | $ (155 | ) |   |   | $ 3,906 |   |   |   | $    (93 | ) |   |   | $ 18,750 |   |   |   | $  (248 | ) |   |
| Mortgage-backed  securities                                        |       |                                   | 33,993        |                                 |       |                     | (335        | ) |   |   | 38,236 |   |   |   | (922 | ) |   |   | 72,229 |   |   |   | (1,257 | ) |   |
| Corporate bonds                                                    |       |                                   | 3,980         |                                 |       |                     | (20         | ) |   |   | 1,933 |   |   |   | (67 | ) |   |   | 5,913 |   |   |   | (87 | ) |   |
| Total temporarily  impaired securities                             |       |                                   | $ 52,817 |                                 |       |                     | $ (510 | ) |   |   | $ 44,075 |   |   |   | $ (1,082 | ) |   |   | $ 96,892 |   |   |   | $ (1,592 | ) |   |
|                                                                    |            |                                        |               |                                      |            |                          |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Investment securities with unrealized losses are allinvestment grade and the unrealized losses are a result of the economicenvironment of 2004. Investment securities with unrealized losses have interestrates that are less than the current interest rate environment and not a resultof impairment. Mortgage-backed investment securities, which reflect most of theunrealized losses in the investment securities portfolio, are primarilycomprised of bonds issued by the Federal National Mortgage Association (FNMA),Federal Home Loan Mortgage Corporation (FHLMC) and Government National MortgageAssociation (GNMA), and are supported by pools of residential mortgage loans.

Investmentsecurities that were pledged to secure outstanding other borrowed funds andavailable to secure future borrowings at December 31, 2004 and 2003 hadcarrying value of $279.0 million and $177.5 million, respectively, and are usedto secure the following:
| ** **                                    | ** ** | **2004**                             | ** ** | **2003**       | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|----------------|------------|
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| FHLB advances                                 |       | $ 169,133                       |       | $ 70,100  |       |
| Repurchase agreements                         |       | 42,099                               |       | 102,404        |       |
| Debtor in possession and  public deposits     |       |                                 |       |           |       |
| and TT&L payments                         |       | 18,953                               |       | 5,000          |       |
| FRB discount  window and TT&L note option |       | 47,063                               |       | —         |       |
|                                          |       | $ 277,248                       |       | $ 177,504 |       |

 

Otherinvestments at December 31, 2004 include $7.4 million of Federal Home LoanBank stock, and $63,000 of Community Bankers’ Bank stock. As a member of theFederal Home Loan Bank of Atlanta, the Company’s banking subsidiary is requiredto hold stock in this entity. Stock membership in Community Bankers’ Bank allowsthe Company to participate in loan purchases or sales including participations.In addition, included in other investments is the Company’s $619,000 investmentin Cardinal Statutory Trust I. These investments are carried at cost sinceno active trading markets exist.

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(5)                       LoansReceivable

Theloan portfolio at December 31, 2004 and 2003 consisted of the following:
| ** **                          | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial and  industrial          |       | $                                    | 56,512     |     | $          | 57,854 |   |
| Real estate––commercial   |       | 220,012                              |       | 139,725  |       |
| Real estate––construction |       | 69,535                               |       | 42,243   |       |
| Real estate––residential  |       | 76,932                               |       | 42,495   |       |
| Home equity lines                   |       | 60,408                               |       | 43,176   |       |
| Consumer                            |       | 6,816                                |       | 10,690   |       |
|                                |       | 490,215                              |       | 336,183  |       |
| Net deferred fees                   |       | (319                                 | )          | (181     | )          |
| Loans receivable, net of fees       |       | 489,896                              |       | 336,002  |       |
| Allowance for  loan losses          |       | (5,878                               | )          | (4,344   | )          |
| Loans receivable,  net              |       | $                                    | 484,018    |     | $          | 331,658 |   |

 

Most of the Company’s loans, commitments and standbyletters of credit have been granted to customers located in the Washington,D.C. metropolitan area. The concentrations of credit by type of loan are setforth above. As a matter of regulatory restriction, the Company’s bankingsubsidiary limits the amount of credit extended to any single borrower or groupof related borrowers. Loans in process at December 31, 2004 and 2003 were$423,000 and $172,000, respectively.

Ananalysis of the change in the allowance for loan losses follows:
| ** **                                     | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|----------|------------|----------|------------|
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Balance,  beginning of year                    |       | $                                    | 4,344      |     | $          | 3,372    |       | $ | 3,104 |   |
| Provision for  loan losses                     |       | 1,626                                |       | 1,001    |       | 444      |       |
| Transfer to  liability on unfunded commitments |       | —                               |       | —   |       | (74      | )          |
| Loans charged off                              |       | (108                                 | )          | (80      | )          | (117     | )          |
| Recoveries                                     |       | 16                                   |       | 51       |       | 15       |       |
| Balance, end of year                           |       | $                                    | 5,878      |     | $          | 4,344    |       | $ | 3,372 |   |

 

At December 31, 2004 and 2003, the Company hadimpaired loans of $547,000 and $390,000, respectively, which were on nonaccrualstatus. These impairments had valuation allowances of $207,000 and $166,000 asof December 31, 2004 and 2003, respectively. The average balance ofimpaired loans was $298,000, $654,000 and $568,000 for 2004, 2003 and 2002,respectively. Interest income that would have been recorded had these loansbeen performing was $25,000 for 2004, $39,000 for 2003 and $37,000 for 2002. Theinterest income realized prior to the loans being placed on non-accrual statusfor the years ended December 31, 2004, 2003 and 2002 was $21,000, $1,000and $28,000, respectively.

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(6)                       LoansHeld for Sale, Net

Theloans held for sale portfolio at December 31, 2004 consisted of thefollowing:
| ** **                | ** ** | **2004**                             | ** ** |
|---------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **(Dollars in thousands)** | ** ** |
| Residential               |       |                                 | $          | 293,739 |   |   |
| Construction-to-permanent |       |                                 | 69,507     |   |   |
|                      |       |                                 | 363,246    |   |   |
| Net deferred  costs       |       |                                 | 2,208      |   |   |
|                      |       |                                 | $          | 365,454 |   |   |

 

Therewere no loans held for sale at December 31, 2003. At December 31,2004, GMM maintained a $75,000 reserve for loans sold that paid off within acontractual agreed upon period, thereby requiring that GMM refund part of thepurchase price.

(7)                       Premisesand Equipment

Componentsof premises and equipment at December 31, 2004 and 2003 were as follows:
| ** **                                      | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                                      | ** ** | **(Dollars in thousands)** | ** ** |
| Land                                            |       | $                                    | 2,748      |     | $          | 1,024 |   |
| Building                                        |       | 4,725                                |       | 1,472    |       |
| Furniture and  equipment                        |       | 9,648                                |       | 5,322    |       |
| Leasehold  improvements                         |       | 3,908                                |       | 2,618    |       |
| Total cost                                      |       | 21,029                               |       | 10,436   |       |
| Less accumulated  depreciation and amortization |       | 5,498                                |       | 3,729    |       |
| Premises and  equipment, net                    |       | $                                    | 15,531     |     | $          | 6,707 |   |

 

Depreciation expense for the years ended December 31,2004, 2003 and 2002 was $1.8 million, $1.0 million, and $736,000, respectively.

The Company has entered into leases for office spaceover various terms. The leases are subject to annual increases as well asallocations of real estate taxes and certain operating expenses.

Minimumfuture rental payments under the noncancelable operating leases, as of December 31,2004 were as follows:
| **Year ending December 31,** | ** ** | ** **                           | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| 2005                                        |       |                                 | $          | 3,887      |       |   |
| 2006                                        |       |                                 | 3,889      |       |       |
| 2007                                        |       |                                 | 3,158      |       |       |
| 2008                                        |       |                                 | 2,201      |       |       |
| 2009                                        |       |                                 | 1,654      |       |       |
| Thereafter                                  |       |                                 | 1,467      |       |       |
|                                        |       |                                 | $          | 16,256     |       |   |

 

The total rent expense was $3.2 million, $1.9 millionand $1.3 million in 2004, 2003 and 2002, respectively.

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TheCompany has entered into contracts as sublessor for excess office space. Futureminimum lease payment receivables under noncancellable leasing arrangements asof December 31, 2004 were as follows:
| **Year ending December 31,** | ** ** | ** **                           | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| 2005                                        |       |                                 | $          | 635        |       |   |
| 2006                                        |       |                                 | 551        |       |       |
| 2007                                        |       |                                 | 274        |       |       |
| 2008                                        |       |                                 | 142        |       |       |
| 2009                                        |       |                                 | 94         |       |       |
| Thereafter                                  |       |                                 | 486        |       |       |
|                                        |       |                                 | $          | 2,182      |       |   |

 

The total rentincome was $573,000, $453,000 and $409,000 in 2004, 2003 and 2002,respectively.

(8)                       Deposits

Depositsconsisted of the following at December 31, 2004 and 2003:
| ** **                           | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Non-interest-bearing  deposits:      |       |                                 |       |     |       |
| Demand deposits                      |       | $                                    | 105,424    |     | $          | 70,998 |   |
| Total  non-interest-bearing deposits |       | 105,424                              |       | 70,998   |       |
| Interest-bearing  deposits:          |       |                                 |       |     |       |
| Interest checking                    |       | 150,112                              |       | 152,656  |       |
| Money market and statement savings   |       | 29,790                               |       | 30,139   |       |
| Certificates of deposit              |       | 538,884                              |       | 220,336  |       |
| Total  interest-bearing deposits     |       | 718,786                              |       | 403,131  |       |
| Total deposits                       |       | $                                    | 824,210    |     | $          | 474,129 |   |

 

Brokered certificates of deposit at December 31,2004 were $86.7 million. We had no brokered certificates of deposit at December 31,2003.

Interestexpense by deposit categories were as follows for the years indicated:
| ** **                          | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|----------|------------|----------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Interest checking                   |       | $                                    | 2,016      |     | $          | 2,375    |       | $ | 3,073 |   |
| Money market and  statement savings |       | 213                                  |       | 243      |       | 577      |       |
| Certificates of  deposit            |       | 10,465                               |       | 6,038    |       | 5,714    |       |
|                                |       | $                                    | 12,694     |     | $          | 8,656    |       | $ | 9,364 |   |

 

The aggregate amount of time deposits, each with aminimum denomination of $100,000, was $225.3 million and $103.6 million at December 31,2004 and 2003, respectively.

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At December 31,2004, the scheduled maturities of certificates of deposit were as follows:
| ** **           | ** ** | **(Dollars in thousands)** | ** ** |
|----------------------|------------|--------------------------------------|------------|
| 2005                 |       |                                 | $          | 202,068 |   |   |
| 2006                 |       |                                 | 30,376     |   |   |
| 2007                 |       |                                 | 250,007    |   |   |
| 2008                 |       |                                 | 45,587     |   |   |
| 2009 and  thereafter |       |                                 | 10,846     |   |   |
|                 |       |                                 | $          | 538,884 |   |   |

 

(9)                       OtherBorrowed Funds

At December 31,2004 and 2003, other borrowed funds consisted of the following:
| ** **                            | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                            | ** ** | **(Dollars in thousands)** | ** ** |
| Fixed rate  advances from the FHLB    |       | $                                    | 81,958     |     | $          | 43,958 |   |
| Variable rate  advances from the FHLB |       | 55,000                               |       | 5,000    |       |
| Repurchase  agreements                |       | 30,357                               |       | 25,499   |       |
| Payable to  Statutory Trust I         |       | 20,619                               |       | —   |       |
| Fed funds  purchased                  |       | 7,000                                |       | —   |       |
| TT&L note  option                 |       | 6,151                                |       | —   |       |
|                                  |       | $                                    | 201,085    |     | $          | 74,457 |   |

 

The Company has fixed rate advances from the FederalHome Loan Bank of Atlanta (FHLB) of $82.0 million at December 31, 2004. Theseadvances mature through 2014 and have interest rates ranging from 1.56% to3.59%. At December 31, 2003, the Company had $44.0 million in fixed advancesfrom the Federal Home Loan Bank of Atlanta with maturities through 2008 andinterest rates ranging from 1.31% to 2.81%.

The Company has also a variable rate advance from theFederal Home Loan Bank of Atlanta of $55.0 million at December 31, 2004,which matures in 2005. The variable rate is based on the federal fundspurchased rate and reprices daily. At December 31, 2004, the variableinterest rate was 2.44%. At December 31, 2003, the Company had anadjustable rate advance of $5.0 million which matured during 2004. Theadjustable rate was based on the three month London Interbank Offered Rate(LIBOR).

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The contractualmaturities of the fixed and variable rate advances were as follows:

**At December 31, 200**4
| **Type of Advance** | ** ** | ** **                           | ** ** | **Interest Rate** | ** ** | **Advance Term** | ** ** | **Maturity Date** | ** ** | **Balance** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|------------------------|------------|-----------------------|------------|------------------------|------------|-------------|------------|
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** |
| Fixed Rate Credit             |       |                                 | 1.56       | %                      |       |                  | 12 months  |                   |       |        | Jan-05     |   |   | $ | 5,000 |   |
| Fixed Rate Credit             |       |                                 | 1.82       | %                      |       |                  | 24 months  |                   |       |        | Mar-05     |   |   | 1,000 |   |
| Daily Rate Credit             |       |                                 | 2.44       | %                      |       |                  | 12 months  |                   |       |        | Jul-05     |   |   | 55,000 |   |
| Fixed Rate Credit             |       |                                 | 1.83       | %                      |       |                  | 18 months  |                   |       |        | Jul-05     |   |   | 5,000 |   |
| Fixed Rate Credit             |       |                                 | 2.33       | %                      |       |                  | 36 months  |                   |       |        | Mar-06     |   |   | 1,000 |   |
| Fixed Rate Credit             |       |                                 | 2.58       | %                      |       |                  | 24 months  |                   |       |        | May-06     |   |   | 2,000 |   |
| Fixed Rate Credit             |       |                                 | 2.07       | %                      |       |                  | 36 months  |                   |       |        | Jul-06     |   |   | 6,250 |   |
| Fixed Rate Credit             |       |                                 | 2.81       | %                      |       |                  | 48 months  |                   |       |        | Mar-07     |   |   | 1,000 |   |
| Fixed Rate Credit             |       |                                 | 3.15       | %                      |       |                  | 36 months  |                   |       |        | Apr-07     |   |   | 3,000 |   |
| Fixed Rate Credit             |       |                                 | 2.63       | %                      |       |                  | 48 months  |                   |       |        | Jul-07     |   |   | 6,250 |   |
| Fixed Rate Credit             |       |                                 | 3.59       | %                      |       |                  | 36 months  |                   |       |        | Dec-07     |   |   | 7,500 |   |
| Principal  Reducing Credit    |       |                                 | 2.29       | %                      |       |                  | 60 months  |                   |       |        | Jul-08     |   |   | 8,958 |   |
| Convertible                   |       |                                 | 2.91       | %                      |       |                  | 60 months  |                   |       |        | May-09     |   |   | 5,000 |   |
| Convertible                   |       |                                 | 3.50       | %                      |       |                  | 60 months  |                   |       |        | May-09     |   |   | 10,000 |   |
| Convertible                   |       |                                 | 3.33       | %                      |       |                  | 10 years   |                   |       |        | Apr-14     |   |   | 10,000 |   |
| Convertible                   |       |                                 | 3.47       | %                      |       |                  | 10 years   |                   |       |        | May-14     |   |   | 10,000 |   |
| **Total FHLB Advances**       | ** ** | ** **                           | **2.68**   | **%**                  | ** ** |                  |       |                   |       |        |       |   |   | **$** | **136,958** |   |

 

**At December 31, 2003**
| **Type of Advance**         | ** ** | ** ** | ** ** | **Interest Rate** | ** ** | **Advance Term** | ** ** | **Maturity Date** | ** ** | **Balance** | ** ** |
|---------------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|------------------------|------------|-------------|------------|
| Fixed Rate Credit                     |       |       | 1.31       | %                      |       |                  | 5 months   |                   |       |        | Jan-04     |   |   | $ | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.63       | %                      |       |                  | 12 months  |                   |       |        | Jan-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.72       | %                      |       |                  | 12 months  |                   |       |        | Jan-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.36       | %                      |       |                  | 6 months   |                   |       |        | Feb-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.54       | %                      |       |                  | 12 months  |                   |       |        | Mar-04     |   |   | 1,000 |   |
| Fixed Rate Credit                     |       |       | 1.65       | %                      |       |                  | 12 months  |                   |       |        | Mar-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.81       | %                      |       |                  | 18 months  |                   |       |        | Jul-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.96       | %                      |       |                  | 18 months  |                   |       |        | Jul-04     |   |   | 2,000 |   |
| Fixed Rate Credit                     |       |       | 1.77       | %                      |       |                  | 18 months  |                   |       |        | Sep-04     |   |   | 1,000 |   |
| Fixed Rate Credit                     |       |       | 1.86       | %                      |       |                  | 18 months  |                   |       |        | Sep-04     |   |   | 1,000 |   |
| Adjustable Rate  Credit               |       |       | 1.23       | %                      |       |                  | 12 months  |                   |       |        | Dec-04     |   |   | 5,000 |   |
| Fixed Rate Credit                     |       |       | 1.82       | %                      |       |                  | 24 months  |                   |       |        | Mar-05     |   |   | 1,000 |   |
| Fixed Rate Credit                     |       |       | 2.33       | %                      |       |                  | 36 months  |                   |       |        | Mar-06     |   |   | 1,000 |   |
| Fixed Rate Credit                     |       |       | 2.07       | %                      |       |                  | 36 months  |                   |       |        | Jul-06     |   |   | 6,250 |   |
| Fixed Rate Credit                     |       |       | 2.81       | %                      |       |                  | 48 months  |                   |       |        | Mar-07     |   |   | 1,000 |   |
| Fixed Rate Credit                     |       |       | 2.63       | %                      |       |                  | 48 months  |                   |       |        | Jul-07     |   |   | 6,250 |   |
| Principal  Reducing Fixed Rate Credit |       |       | 2.29       | %                      |       |                  | 60 months  |                   |       |        | Jul-08     |   |   | 11,458 |   |
| **Total FHLB Advances**               | ** ** | ** ** | **1.98**   | **%**                  |       |                  |       |                   |       |        |       |   | ** ** | **$** | **48,958** |   |

 

The average balances of FHLB advances for the yearsended December 31, 2004 and 2003 were $94.8 million and $33.5 million,respectively. The maximum amount outstanding at any month-end during the yearsended December 31, 2004 and 2003 was $137.0 million and $56.8 million,respectively. Total interest expense on FHLB advances for the years ended December 31,2004, 2003 and 2002 was $2.3 million, $654,000, and $222,000, respectively.

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Securities sold under agreements to repurchase, whichare classified as other borrowed funds, generally mature within one to fourdays from the transaction date. Securities sold under agreements to repurchaseare reflected at the amount of cash received in connection with the transaction.The Company is required to provide collateral based on the fair value of theunderlying securities.

At December 31, 2004 and 2003 the Company hadrepurchase agreements of $30.4 million and $25.5 million, respectively. Theinterest rate of the repurchase agreements was 0.75% at December 31, 2004and 2003. The average balances of the repurchase agreements for 2004 and 2003were $27.3 million and $9.2 million, respectively, and the maximum amountoutstanding at any month-end during 2004 and 2003 were $45.1 million and $26.1million, respectively.  Interest expenseon repurchase agreements for 2004, 2003 and 2002 was $180,000, $72,000, and $0,respectively.

Occasionally, the Company purchases fed funds. At December 31,2004 and 2003, the Company had outstanding purchases in fed funds of $7.0million and $0, respectively. Interest expense related to fed funds purchasedfor 2004, 2003 and 2002 was $114,000, $47,000 and $0. The Company also has aTT&L Note Option with the Federal Reserve. At December 31, 2004 and2003, the outstanding balance in the TT&L Note Option was $6.2 million and$0, respectively. Interest expense related to the TT&L Note Option for 2004was $23,000. There was no interest expense for the TT&L Note Option in 2003and 2002. The Company has a line of credit at the Federal Reserve discountwindow in the amount of $46.5 million. At December 31, 2004, theoutstanding balance at the Federal Reserve discount window was $0. Interestexpense related to the discount window for 2004 and 2003 was $28,000 and $0,respectively.

In July 2004, the Company formed a newwholly-owned subsidiary, Cardinal Statutory Trust I (the “Trust”), for thepurpose of issuing $20.0 million of floating rate junior subordinated deferrableinterest debentures (“trust preferred securities”). These trust preferredsecurities are due in 2034 and have an interest rate of LIBOR (London InterbankOffered Rate) plus 2.40%, which adjusts quarterly. These securities areredeemable at a premium through March 2008 and at par thereafter. TheCompany has guaranteed payment of these securities. The $20.6 million payableby the Company to the Trust is included in other borrowed funds. The Trust isan unconsolidated subsidiary since the Company is not the primary beneficiaryof this entity under FIN 46R. The additional $619,000 that is payable by theCompany to the Trust relates to the capital of the Trust. The Company utilizedthe proceeds from the issuance of the trust preferred securities to make acapital contribution into the Bank. Interest expense on trust preferredsecurities was $382,000 for the year ended December 31, 2004.

Thescheduled maturities of other borrowed funds at December 31, 2004 were asfollows:
| ** **             | ** ** | **2005**                             | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009 and  thereafter** | ** ** |
|------------------------|------------|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|
| ** **             | ** ** | **(Dollars in thousands)** | ** ** |
| FHLB advances          |       | $                                    | 66,000     |     | $          | 9,250    |       | $        | 17,750     |                          | $          | 8,958 |   | $ | 35,000 |   |
| Repurchase  agreements |       | 30,357                               |       | —   |       | —   |       | —   |       | —                        |       |
| Statutory Trust I      |       | —                               |       | —   |       | —   |       | —   |       | 20,619                        |       |
| Fed funds  purchased   |       | 7,000                                |       | —   |       | —   |       | —   |       | —                        |       |
| TT&L note  option  |       | 6,151                                |       | —   |       | —   |       | —   |       | —                        |       |
|                   |       | $                                    | 109,508    |     | $          | 9,250    |       | $        | 17,750     |                          | $          | 8,958 |   | $ | 55,619 |   |

 

(10)                WarehouseFinancing

In September 2004, GMM and the Bank entered intoa one year $150 million floating rate revolving credit and security agreementwith a third party. The purpose of this credit facility is to fund residentialmortgage loans at GMM prior to their sale into the secondary market. The creditfacility requires, among other things, that GMM and the Bank have positivequarterly net income and maintain specified minimum tangible and regulatory networth requirements. The Company has guaranteed repayment of this debt. The 

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interest rate on thiscredit facility is LIBOR plus between 1.50% and 1.875%. At December 31,2004, $0 of this line was utilized.

In addition to this facility, this same lender hasalso provided a $100 million facility that is utilized by GMM to warehouseresidential mortgage loans held for sale to this lender. The terms of thisfacility are substantially the same as the above-referenced revolving creditand security agreement and the cost of this facility is netted against interestearned on the loans pending settlement with the lender. At December 31,2004, $0 of this line was utilized.

GMM also has a $60.0 million line of credit with anunaffiliated party, which it uses to warehouse loans pending sale. This linematures on March 1, 2005 and has an interest rate of LIBOR plus 1.50%. At December 31,2004, $30.2 million of this line was utilized and the rate was 3.89%.

Interest expense relatedto GMM’s warehouse financing was $228,000 for the year ended December 31,2004.

(11)                PreferredStock

In connection with the acquisition of Heritage Bancorp, Inc.on September 1, 2000, the Company issued 1,411,268 shares of 7.25%Cumulative Convertible Preferred Stock, Series A. Shares of the PreferredStock outstanding at December 31, 2003 and 2002 were 1,364,062 and1,364,684, respectively. The Series A Preferred Stock has a par value of$1.00 per share and a liquidation preference of $5.00 per share. The terms ofthe preferred stock call for automatic conversion into the Company’s commonstock if the common stock trades at a price above $8.65 for 20 consecutivetrading days beginning at anytime on or after March 1, 2004. Dividends onthe Series A Preferred Stock are payable quarterly for a cumulative annualdividend of $0.3625 or 7.25% of the $5.00 liquidation amount, before anydividend is paid on any Cardinal common stock.

On March 29, 2004,these 1,364,062 preferred shares automatically converted into 1,025,997 sharesof common stock and there are no preferred shares outstanding at December 31,2004.

(12)                Income Taxes

The Company and its subsidiaries file consolidated federaltax returns on a calendar-year basis. The Company recorded income taxexpense of $1.7 million for the year ended December 31, 2004 and a benefitof $3.5 million during the year ended December 31, 2003 and had noprovision for income taxes for the year ended December 31, 2002.

Theprovision for income tax expense (benefit) is reconciled to the amount computedby applying the federal corporate tax rate to income before taxes and were asfollows for the years indicated:
| ** **                                      | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|----------|------------|----------|------------|
| ** **                                      | ** ** | **(Dollars in thousands)** | ** ** |
| Income tax  (benefit) at federal corporate rate |       | $                                    | 1,762      |     | $          | 900      |       | $ | (180 | ) |
| Expected state tax  benefit                     |       | (97                                  | )          | —   |       | —   |       |
| Nondeductible  expenses/ other expenses         |       | (49                                  | )          | 7        |       | 7        |       |
| Change in  valuation allowance                  |       | 97                                   |       | (4,415   | )          | 173      |       |
|                                            |       | $                                    | 1,713      |     | $          | (3,508   | )          | $ | — |   |

 

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Thecomponents of income tax expense follow:
| ** **                                                                                     | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Included in net income                                                          |       |                                 |       |     |       |     |       |
| Current                                                                                        |       |                                 |       |     |       |     |       |
| Federal                                                                                        |       | $                                    | 134        |     | $          | —   |       | $ | — |   |
| State                                                                                          |       | —                               |       | —   |       | —   |       |
| Total current                                                                                  |       | 134                                  |       | —   |       | —   |       |
| Deferred                                                                                       |       |                                 |       |     |       |     |       |
| Federal                                                                                        |       | 1,579                                |       | (3,508   | )          | —   |       |
| State                                                                                          |       | —                               |       | —   |       | —   |       |
| Total deferred                                                                                 |       | 1,579                                |       | (3,508   | )          | —   |       |
| Total included in net income                                                                   |       | $                                    | 1,713      |     | $          | (3,508   | )          | $ | — |   |
| Included in shareholders’ equity                                                          |       |                                 |       |     |       |     |       |
| Deferred tax expense (benefit) related to the change  in the net unrealized gain on securities |       | $                                    | (344       | )        | $          | 1,057    |       | $ | — |   |
| Total included in  shareholders’ equity                                                   |       | $                                    | (344       | )        | $          | 1,057    |       | $ | — |   |

 

The taxbenefits of temporary differences between the financial reporting basis andincome tax basis of assets and liabilities relate to the following:
| ** **                                                    | ** ** | **2004**                         | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|----------|------------|
| ** **                                                    | ** ** | **(Dollars in  thousands)** | ** ** |
| Deferred tax  assets:                                         |       |                             |       |     |       |
| Allowance for loan losses                                     |       | $                                | 1,944      |     | $          | 1,391 |   |
| Net operating loss carryforwards                              |       | 2,120                            |       | 3,606    |       |
| Unrealized losses on investment securities available-for-sale |       | 604                              |       | 260      |       |
| Other                                                         |       | 279                              |       | 126      |       |
| Total gross deferred assets                                   |       | 4,947                            |       | 5,383    |       |
| Less valuation allowance                                      |       | (765                             | )          | (668     | )          |
| Net deferred tax assets                                       |       | 4,182                            |       | 4,715    |       |
| Deferred tax liabilities:                                     |       |                             |       |     |       |
| Prepaid expenses                                              |       | (86                              | )          | (51      | )          |
| Depreciation                                                  |       | (650                             | )          | (121     | )          |
| Loan origination costs                                        |       | (208                             | )          | (70      | )          |
| Total gross deferred tax liabilities                          |       | (944                             | )          | (242     | )          |
| Net deferred tax  asset                                       |       | $                                | 3,238      |     | $          | 4,473 |   |

 

Deferred tax assets and liabilities are recognized forthe tax effects of differing carrying values of assets and liabilities for taxand financial statement purposes that will reverse in future periods. Whensubstantial uncertainty exists concerning the recoverability of a deferred taxasset, the carrying value of the asset is reduced by a valuation allowance. Avaluation allowance in the amount of $765,000 at December 31, 2004 hasbeen established for deferred tax assets. This valuation allowance relatesprimarily to the state portion of the net operating losses for the ParentCompany and Cardinal Wealth Services, Inc. as realization is dependentupon generating future taxable income within those entities.

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TheCompany has net operating loss carryforwards of approximately $4.6 million at December 31, 2004,which are available to offset tax payments on future taxable income. TheCompany’s net operating loss carryforwards expire as follows: $1.9 million in 2020and $2.7 million in 2021.

(13)                Derivatives

The Company utilizes forward sale commitments toeconomically hedge the interest rate risk inherent in entering into interestrate lock loan commitments and originating fixed-rate closed loans for sale. Asof December 31, 2004, the fair value of interest rate lock loancommitments with a notional value of $119 million was $(63,000), and the fairvalue of forward sale commitments with a notional value of $438 million was$587,000. These derivatives are recorded in other assets and other liabilitieson the consolidated statement of condition at their fair values. In addition tothese market adjustments for open interest rate lock loan commitments andforward sale commitments, at December 31, 2004, a basis adjustment of($351,000) has been recorded related to the closed loans held for sale which isincluded in mortgage loans held for sale, net in the consolidated statement ofcondition.

TheCompany had no derivative instruments at December 31, 2003.

(14)                Regulatory Matters

The Company’s banking subsidiary, Cardinal Bank, as astate-chartered bank, is subject to the dividend restrictions established bythe State Corporation Commission of the Commonwealth of Virginia. Under suchrestrictions, the Bank may not, without the prior approval of the Bank’sprimary regulator, declare dividends in excess of the sum of the current year’searnings (as defined) plus the retained earnings (as defined) from the priortwo years. At December 31, 2004, there were no earnings against whichdividends could be paid.

The Bank is required to maintain a minimum averagereserve balance with the Federal Reserve Bank. The average amount of therequired reserve was $100,000 for 2004.

The Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”) requires the regulators to stratify institutions intofive quality tiers based upon their relative capital strengths and to increaseprogressively the degree of regulation over the weaker institutions, limits thepass through deposit insurance treatment of certain types of accounts, adopts a“truth in savings” program, calls for the adoption of risk-based premiums ondeposit insurance and requires the Bank to observe insider credit underwritingproducts no less strict than those applied to comparable noninsidertransactions.

At December 31,2004 and 2003, the Company and the Bank met all regulatory capital requirements.The key measures of capital are: (1) total capital (Tier I capital plus theallowance for loan losses up to certain limitations) as a percent of total risk-weightedassets, (2) Tier I capital (as defined) as a percent of total risk-weightedassets (as defined), and (3) Tier I capital (as defined) as a percent oftotal assets (as defined).
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **To Be Well**   | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **Capitalized Under** | ** ** |
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                              | ** ** | **Actual**                           | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **At December 31, 2004** | ** ** | ** **                           | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | ** ** | ** ** | **Ratio**                  | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                                    | 107,660    |                       | 13.40      | %                          | $          | 64,294                     |       | >       |       | 8.00                       | %          | $ | 80,368 |   | > |   | 10.00 | % |
| Tier I capital to  risk weighted assets |       | 101,670                              |       | 12.65                      | %          | 32,147                     |       | >                       |       | 4.00       | %          | 48,221                     |       | > |   | 6.00 | % |
| Tier I capital to  average assets       |       | 107,660                              |       | 8.83                       | %          | 46,075                     |       | >                       |       | 4.00       | %          | 57,594                     |       | > |   | 5.00 | % |
|                                         |            |                                      |            |                            |            |                            |            |                            |            |            |            |                            |            |  |  |  |  |  |  |  |  |  |

 

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| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **To Be Well**   | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** | **Capitalized Under** | ** ** |
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                              | ** ** | **Actual**                           | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **At December 31, 2003** | ** ** | ** **                           | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | ** ** | ** ** | **Ratio**                  | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                                    | 90,239     |                       | 20.66      | %                          | $          | 34,951                     |       | >       |       | 8.00                       | %          | $ | 43,688 |   | > |   | 10.00 | % |
| Tier I capital to  risk weighted assets |       | 85,896                               |       | 19.66                      | %          | 17,475                     |       | >                       |       | 4.00       | %          | 26,213                     |       | > |   | 6.00 | % |
| Tier I capital to  average assets       |       | 85,896                               |       | 15.45                      | %          | 23,365                     |       | >                       |       | 4.00       | %          | 29,206                     |       | > |   | 5.00 | % |
|                                         |            |                                      |            |                            |            |                            |            |                            |            |            |            |                            |            |  |  |  |  |  |  |  |  |  |

 

GeorgeMason is required to maintain defined capital levels under Department ofHousing and Urban Development guidelines. At December 31, 2004, GMMmaintained capital in excess of these required guidelines.

(15)                Related-PartyTransactions

Officers, directors, employees and their relatedbusiness interests are loan customers in the ordinary course of business. Inmanagement’s opinion, these loans are made on substantially the same terms,including interest rates and collateral, as those prevailing at the time forcomparable loans with other persons and do not involve more than normal risk ofcollectibility or present other unfavorable features.

Analysisof activity for loans to related parties were as follows for the yearsindicated:
| ** **                   | ** ** | **2004**                         | ** ** | **2003** | ** ** |
|------------------------------|------------|----------------------------------|------------|----------|------------|
| ** **                   | ** ** | **(Dollars in  thousands)** | ** ** |
| Balance,  beginning of year  |       | $                                | 4,491      |     | $          | 4,752 |   |
| New loans                    |       | 20,000                           |       | 2,242    |       |
| Loans paid off or  paid down |       | (2,415                           | )          | (2,503   | )          |
| Balance, end of year         |       | $                                | 22,076     |     | $          | 4,491 |   |

 

(16)                Earnings (Loss)Per Common Share

The following is the calculation of basic and dilutedearnings (loss) per common share. Because the Company had a net loss in 2002,outstanding stock options had an anti-dilutive effect and, therefore, wereexcluded from the loss per common share calculation.

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At December 31,2004 and 2003, the dilutive potential common shares resulting from outstandingstock options added to the weighted average shares for the diluted earnings percommon share calculation were 257,000 and 227,000. At December 31, 2004,there were no outstanding stock options excluded from the weighted averageshares outstanding for the diluted earnings per share calculation as thesestock options have exercise prices that were greater than the average marketprice of the Company’s common stock for the years ended December 31, 2004.At December 31, 2003, 9,000 outstanding stock options were excluded fromthe weighted average shares outstanding for the diluted earnings per sharecalculation as these stock options have exercise prices that were greater thanthe average market price of the Company’s common stock for the years ended December 31,2003.
| ** **                                | ** ** | **2004**                                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                | ** ** | **(Dollars and shares in thousands)** | ** ** |
| Net income (loss)                         |       | $                                                         | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |
| Dividends to  preferred shareholders      |       | —                                                    |       | 495      |       | 495      |       |
| Net income (loss)  to common shareholders |       | $                                                         | 3,469      |     | $          | 5,659    |       | $ | (1,024 | ) |
| Weighted average  shares for basic        |       | 18,448                                                    |       | 10,218   |       | 7,949    |       |
| Weighted average  shares for diluted      |       | 18,705                                                    |       | 11,468   |       | 7,949    |       |
| Basic earnings  (loss) per common share   |       | $                                                         | 0.19       |     | $          | 0.55     |       | $ | (0.13 | ) |
| Diluted earnings (loss)  per common share |       | $                                                         | 0.19       |     | $          | 0.54     |       | $ | (0.13 | ) |

 

(17)                Employee BenefitPlan

TheCompany established a 401(k) plan in 1998 for all eligible employees. TheCompany began to match a portion of employee contributions beginning January 1,1999. The Company’s match for December 31, 2004, 2003 and 2002 was$286,000, $106,000, and $102,000, respectively.

(18)                Director andEmployee Stock Compensation Plans

In 1998, the Company adopted a stock option plan(the “Plan”) pursuant to which the Company may grant stock options toemployees and members of the Company’s and its’ subsidiaries’ Boards ofDirectors. 625,000 options to purchase shares of the Company’s common stock areauthorized under this plan as of December 31, 2004.

During 2004, the shareholders approved the Company’sAmended and Restated 2002 Equity Compensation Plan (the “Equity Plan”). TheEquity Plan authorizes the granting of options, which may either be incentivestock options, non-qualified stock options, stock appreciation rights,restricted stock awards, phantom stock awards and performance share awards todirectors, eligible officers and key employees of the Company. The Equity Planauthorizes the issuance of options and other equity instruments equivalent to1,450,000 shares of common stock.

Stock options are granted with an exercise price equalto the stock’s fair market value at the date of grant. Director stock optionshave ten year terms and vest and become fully exercisable immediately. Certainemployee stock options have ten year terms and vest and become fullyexercisable after 3 years. Other employee stock options have ten year terms andvest and become fully exercisable in 20% increments beginning as of the grantdate. In addition, the Company has granted stock options to employees of theCompany that have ten year terms and vest and become fully exercisable in 20%increments beginning after their first year of vesting.

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Stockoption activity during the years indicated were as follows:
| ** **                         | ** ** | ** **         | ** ** | **Weighted** | ** ** |
|------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                         | ** ** | ** **         | ** ** | **Average**  | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| ** **                         | ** ** | **Shares**         | ** ** | **Price**    | ** ** |
| Balance at  December 31, 2001 |       | 368,028            |       |         | $          | 5.23 |   |   |
| Granted                            |       | 265,530            |       |         | 3.27       |   |   |
| Forfeited                          |       | (90,665            | )          |         | 5.48       |   |   |
| Balance at  December 31, 2002 |       | 542,893            |       |         | $          | 4.22 |   |   |
| Granted                            |       | 376,000            |       |         | 5.07       |   |   |
| Exercised                          |       | (32,523            | )          |         | 4.44       |   |   |
| Forfeited                          |       | (38,933            | )          |         | 4.90       |   |   |
| Balance at  December 31, 2003 |       | 847,437            |       |         | $          | 4.57 |   |   |
| Granted                            |       | 537,018            |       |         | 8.71       |   |   |
| Exercised                          |       | (114,663           | )          |         | 4.36       |   |   |
| Forfeited                          |       | (39,304            | )          |         | 6.29       |   |   |
| Balance at  December 31, 2004 |       | 1,230,488          |       |         | $          | 6.34 |   |   |

 

Information pertaining tostock options outstanding at December 31, 2004 and 2003 is as follows:

**At December 31, 2004**
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | ** **                   | ** ** | **Weighed Average**          | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
| **Range of  Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Remaining  Contractual Life** | ** ** | **Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Exercise  Price** | ** ** |
| $2.41 - $3.56                           |       | 247,756                      |       |                         | 7.1 years  |   |   |   | $ | 3.26 |   |   |   | 143,888 |   |   |   | $ | 3.27 |   |   |
| $3.95 - $5.50                           |       | 362,748                      |       |                         | 7.8 years  |   |   |   | 4.91 |   |   |   | 178,562 |   |   |   | 4.88 |   |   |
| $6.38 - $7.25                           |       | 100,857                      |       |                         | 2.5 years  |   |   |   | 6.84 |   |   |   | 87,657 |   |   |   | 6.84 |   |   |
| $8.28 - $11.15                          |       | 519,127                      |       |                         | 9.3 years  |   |   |   | 8.72 |   |   |   | 303,556 |   |   |   | 8.63 |   |   |
| Outstanding at  year end                |       | 1,230,488                    |       |                         | 7.9 years  |   |   |   | $ | 6.34 |   |   |   | 713,663 |   |   |   | $ | 6.39 |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**At December 31,2003**
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | ** **                   | ** ** | **Weighed Average**          | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
| **Range of  Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Remaining  Contractual Life** | ** ** | **Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Exercise  Price** | ** ** |
| $2.41 - $3.56                           |       | 305,999                      |       |                         | 7.8 years  |   |   |   | $ | 3.27 |   |   |   | 163,455 |   |   |   | $ | 3.36 |   |   |
| $3.95 - $5.50                           |       | 415,241                      |       |                         | 8.8 years  |   |   |   | 4.86 |   |   |   | 128,211 |   |   |   | 4.83 |   |   |
| $6.38 - $7.25                           |       | 126,197                      |       |                         | 6.1 years  |   |   |   | 6.79 |   |   |   | 103,447 |   |   |   | 6.77 |   |   |
| Outstanding at year end                 |       | 847,437                      |       |                         | 8.0 years  |   |   |   | $ | 4.57 |   |   |   | 395,113 |   |   |   | $ | 4.73 |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31,2004 and 2003, additional shares available for grant under both stock optionplans were 687,858 and 477,563, respectively.

(19)                Segment Reporting

In 2002 and 2003, the Company operated and reported intwo business segments, commercial banking and investment services. As of July 7,2004, the Company began operating in a third business segment, mortgagebanking, with the completion of its acquisition of GMM. The commercial bankingsegment includes both commercial and consumer lending and provides customerssuch products as commercial 

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loans, real estate loans,and other business financing and consumer loans. In addition, this segment alsoprovides customers with several choices of deposit products including demanddeposit accounts, savings accounts and certificates of deposit. The mortgagebanking segment engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis. The investment services segment provides advisory services to businessesand individuals including financial planning and retirement/estate planning.

Informationabout reportable segments, and reconciliation of such information to theconsolidated financial statements as of and for the years ended December 31,2004, 2003 and 2002 follows:

**Atand for the Year Ended December 31, 2004:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment    Elimination  ** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 21,753     |                  | $          | 3,057                    |       |                                                  | $          | —    |       |             |       | $ | — |   |   | $ | (257 | ) | $ | 24,553 |   |
| Provision for  loan losses  |       | 1,626                   |       | —                |       |                     | —     |                                                  |       |      | —     |             |       | — |   | 1,626 |   |
| Non-interest  income        |       | 1,804                   |       | 6,953                 |       |                     | 645        |                                                  |       |      | —     |             |       | 7 |   | 9,409 |   |
| Non-interest  expense       |       | 17,065                  |       | 7,889                 |       |                     | 800        |                                                  |       |      | —     |             |       | 1,400 |   | 27,154 |   |
| Provision for  income taxes |       | 1,628                   |       | 698                   |       |                     | (52        | )                                                     |       |      | —     |             |       | (561 | ) | 1,713 |   |
| Net income (loss)           |       | $                       | 3,238      |                  | $          | 1,423                    |       |                                                  | $          | (103      | )          |             |       | $ | — |   |   | $ | (1,089 | ) | $ | 3,469 |   |
| Total Assets                |       | $                       | 1,123,868  |                  | $          | 392,241                  |       |                                                  | $          | 685       |       |             |       | $ | (421,203 | ) |   | $ | 115,985 |   | $ | 1,211,576 |   |

 

**At and for the Year Ended December 31, 2003:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       |                    | $          | 15,077                   |       |                          |       | $         | —     |             |       |   | $ | — |   |   | $ | 96 |   |   | $ | 15,173 |   |   |
| Provision for  loan losses  |       |                    | 1,001      |                     |       |                          | —     |      |       |             | —     |   |   | — |   |   | 1,001 |   |   |
| Non-interest  income        |       |                    | 2,954      |                     |       |                          | 843        |      |       |             | —     |   |   | 32 |   |   | 3,829 |   |   |
| Non-interest  expense       |       |                    | 13,265     |                     |       |                          | 820        |      |       |             | —     |   |   | 1,270 |   |   | 15,355 |   |   |
| Provision for  income taxes |       |                    | (464       | )                        |       |                          | (443       | )         |       |             | —     |   |   | (2,601 | ) |   | (3,508 | ) |   |
| Net income (loss)           |       |                    | $          | 4,229                    |       |                          |       | $         | 466        |             |       |   | $ | — |   |   | $ | 1,459 |   |   | $ | 6,154 |   |   |
| Total Assets                |       |                    | $          | 630,415                  |       |                          |       | $         | 776        |             |       |   | $ | (80,903 | ) |   | $ | 85,960 |   |   | $ | 636,248 |   |   |

 

**At and for the Year Ended December 31, 2002:**
| ** **                 | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income       |       |                    | $          | 10,575                   |       |                          |       | $         | —     |             |       |   | $ | — |   |   | $ | 81 |   |   | $ | 10,656 |   |   |
| Provision for  loan losses |       |                    | 444        |                     |       |                          | —     |      |       |             | —     |   |   | — |   |   | 444 |   |   |
| Non-interest  income       |       |                    | 1,848      |                     |       |                          | 942        |      |       |             | —     |   |   | 74 |   |   | 2,864 |   |   |
| Non-interest  expense      |       |                    | 11,995     |                     |       |                          | 1,147      |      |       |             | —     |   |   | 463 |   |   | 13,605 |   |   |
| Net income (loss)          |       |                    | $          | (16                      | )          |                          |       | $         | (205       | )                |       |   | $ | — |   |   | $ | (308 | ) |   | $ | (529 | ) |   |
| Total Assets               |       |                    | $          | 483,135                  |       |                          |       | $         | 274        |             |       |   | $ | (38,245 | ) |   | $ | 41,159 |   |   | $ | 486,323 |   |   |

 

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TheCompany does not have operating segments other than those reported. ParentCompany financial information is included in the “Other” category andrepresents an overhead function rather than an operating segment. The parentcompany’s most significant assets are its net investments in its operatingsubsidiaries. The parent company’s net interest income is comprised of interestincome from short-term investments and interest expense on trust preferredsecurities.

(20)                FinancialInstruments with Off Balance Sheet Risk

The Company is a party to financial instruments withoff-balance-sheet risk in the normal course of business to meet thefinancing needs of its customers. These financial instruments includecommitments to extend credit, standby letters of credit and financialguarantees. Commitments to extend credit are agreements to lend to a customerso long as there is no violation of any condition established in the contract. Commitmentsusually have fixed expiration dates up to one year or other termination clausesand may require payment of a fee. Since many of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements.

Standby letters of credit are conditional commitmentsissued by the Company to guarantee the performance of the contractualobligations by a customer to a third party. The majority of these guaranteesextend until satisfactory completion of the customer’s contractual obligations.All standby letters of credit outstanding at December 31, 2004 arecollateralized.

These instruments represent obligations of the Companyto extend credit or guarantee borrowings and are not recorded on theconsolidated statements of financial condition. The rates and terms of theseinstruments are competitive with others in the market in which the Companyoperates. Commitments to extend credit of $128.7 million are related to GeorgeMason’s pipeline and are of a short term nature. Commitments to extend creditof $196.1 million primarily have floating rates as of December 31, 2004.

Thoseinstruments may involve, to varying degrees, elements of credit and interestrate risk in excess of the amount recognized in the consolidated statements offinancial condition. Credit risk is defined as the possibility of sustaining aloss because the other parties to a financial instrument fail to perform inaccordance with the terms of the contract. The Company’s maximum exposure tocredit loss under standby letters of credit and commitments to extend credit isrepresented by the contractual amounts of those instruments.
| ** **                                                                     | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Financial instruments  whose contract amounts represent potential credit risk: |       |                                 |       |     |       |
| Commitments to extend credit                                                   |       | $                                    | 324,786    |     | $          | 111,182 |   |
| Standby letters  of credit                                                     |       | 5,159                                |       | 3,330    |       |
|                                                                                |            |                                      |            |          |            |  |  |

 

The Company had recorded no liability associated withstandby letters of credit at December 31, 2004 and 2003 as such amountswere immaterial.

At December 31, 2004, GMM maintained a $75,000reserve for loans sold that paid off within a contractual agreed upon period,thereby requiring that GMM refund part of the purchase price.

The Company uses the same credit policies in makingcommitments and conditional obligations as it does for on-balance-sheetinstruments. The Company evaluates each customer’s creditworthiness on a case-by-casebasis and requires collateral to support financial instruments when deemednecessary. The amount of collateral obtained upon extension of credit is basedon management’s evaluation of the counterparty. Collateral held varies but mayinclude deposits held by the Company, marketable securities, accountsreceivable, inventory, property, plant and equipment, and income-producingcommercial properties.

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TheCompany has guaranteed payment of the $20.0 million debt of Statutory Trust Iand has also guaranteed repayment of any borrowing under GMM’s $150 millionline of credit.

(21)     Disclosures of Fair Valueof Financial Instruments

The assumptions used and the estimates disclosedrepresent management’s best judgment of appropriate valuation methods. Theseestimates are based on pertinent information available to management at thevaluation date. In certain cases, fair values are not subject to precisequantification or verification and may change as economic and market factorsand management’s evaluation of those factors change.

Although management usesits best judgment in estimating the fair value of these financial instruments,there are inherent limitations in any estimation technique. Therefore, thesefair value estimates are not necessarily indicative of the amounts the Companywould realize in a market transaction. Because of the wide range of valuationtechniques and the numerous estimates which must be made, it may be difficultto make reasonable comparisons of the Company’s fair value information to thatof other financial institutions. It is important that the many uncertaintiesdiscussed above be considered when using the estimated fair value disclosuresand that, because of these uncertainties, the aggregate fair value amountshould not be construed as representative of the underlying value of theCompany.

*Fair Value ofFinancial Instruments*

The following summarizesthe significant methodologies and assumptions used in estimating the fairvalues presented in the accompanying table.

*Cash and CashEquivalents*

The carrying amount ofcash and cash equivalents is used as a reasonable estimate of fair value.

*Derivatives*

Derivative assets andliabilities are valued at fair value as determined primarily by changes inmarket interest rates.

*InvestmentSecurities and Other Investments*

Fair values for investmentsecurities are based on quoted market prices or prices quoted for similarfinancial instruments. Fair value for other investments is estimated at theircost since no active trading markets exist.

*Loans Held forSale, Net*

Loans held for sale arecarried at the lower of cost or market. The estimated fair value is based uponthe related purchase price commitment from secondary market investors.

*Loans Receivable,Net*

In order to determine thefair market value for loans receivable, the loan portfolio was segmented basedon loan type, credit quality and maturities. For certain variable rate loanswith no significant credit concerns and frequent repricings, estimated fairvalues are based on current carrying amounts. The fair values of other loansare estimated using discounted cash flow analyses, using interest ratescurrently being offered for loans with similar terms to borrowers of similarcredit quality.

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*Deposits*

The fair values disclosedfor demand deposits are, by definition, equal to the amount payable on demandat the reporting date (that is, their carrying amounts). The carrying amountsof variable rate, fixed-term money market accounts and certificates of deposit(CDs) approximate their fair value at the reporting date. Fair values for fixed-rateCDs are estimated using a discounted cash flow calculation that appliesinterest rates currently being offered on CDs to a schedule of aggregatedexpected monthly maturities on time deposits.

*Other BorrowedFunds*

The fair value of otherborrowed funds is estimated using a discounted cash flow calculation that appliesinterest rates currently available with similar terms.

*Commitments toExtend Credit*

The fair value of thesefinancial instruments is based on the credit quality and relationship, fees,interest rates, probability of funding, compensating balance and othercovenants or requirements. These commitments generally have fixed expirationdates expiring within one year. Many commitments are expected to, and typicallydo, expire without being drawn upon. The rates and terms of these instrumentsare competitive with others in the market in which the Company operates. Thecarrying amounts are reasonable estimates of the fair value of these financialinstruments. The carrying amounts of these instruments are zero at December 31,2004 and 2003.

*Accrued Interest*

The carrying amounts of accrued interest approximatetheir fair values.

Fairvalue of financial instruments as of December 31, 2004 and 2003 was asfollows:
| ** **                                  | ** ** | **December 31, 2004**      | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **Carrying  Amount**                 | ** ** | **Estimated  Fair Value** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Financial assets:                           |       |                                 |       |   |   |
| Cash and cash equivalents                   |       | $                                    | 23,408     |   | $ | 23,408 |   |
| Investment securities and other investments |       | 297,617                              |       | 296,273 |   |
| Loans held for sale, net                    |       | 365,454                              |       | 367,824 |   |
| Loans receivable, net                       |       | 489,896                              |       | 491,868 |   |
| Accrued interest receivable                 |       | 2,542                                |       | 2,542 |   |
| Derivative asset                            |       | 587                                  |       | 587 |   |
| Financial  liabilities:                     |       |                                 |       |   |   |
| Demand deposits                             |       | $                                    | 105,424    |   | $ | 105,424 |   |
| Interest checking                           |       | 150,112                              |       | 150,112 |   |
| Money market and statement savings          |       | 29,790                               |       | 29,790 |   |
| Certificates of deposit                     |       | 538,884                              |       | 534,090 |   |
| Other borrowed funds                        |       | 201,085                              |       | 197,532 |   |
| Warehouse financing                         |       | 30,245                               |       | 30,245 |   |
| Mortgage funding checks                     |       | 46,392                               |       | 46,392 |   |
| Accrued interest payable                    |       | 1,038                                |       | 1,038 |   |
| Derivative liability                        |       | 64                                   |       | 64 |   |
| Other:                                      |       |                                 |       |   |   |
| Commitments to  extend credit               |       | $                                    | —     |   | $ | — |   |

 

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| ** **                                  | ** ** | **December 31, 2003**      | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **Carrying  Amount**                 | ** ** | **Estimated  Fair Value** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Financial assets:                           |       |                                 |       |   |   |
| Cash and cash equivalents                   |       | $                                    | 13,083     |   | $ | 13,083 |   |
| Investment securities and other investments |       | 277,131                              |       | 275,909 |   |
| Loans receivable, net                       |       | 331,658                              |       | 327,087 |   |
| Accrued interest receivable                 |       | 2,082                                |       | 2,082 |   |
| Financial  liabilities:                     |       |                                 |       |   |   |
| Demand deposits                             |       | $                                    | 70,998     |   | $ | 70,998 |   |
| Interest checking                           |       | 152,656                              |       | 152,656 |   |
| Money market and statement savings          |       | 30,139                               |       | 30,139 |   |
| Certificates of deposit                     |       | 220,336                              |       | 227,871 |   |
| Other borrowed funds                        |       | 74,457                               |       | 73,967 |   |
| Accrued interest payable                    |       | 164                                  |       | 164 |   |
| Other:                                      |       |                                 |       |   |   |
| Commitments to  extend credit               |       | $                                    | —     |   | $ | — |   |

 

(22)     Parent Company OnlyFinancial Statements

The Cardinal Financial Corporation (Parent Companyonly) condensed financial statements are as follows:

**PARENTCOMPANY ONLY CONDENSED STATEMENTS OF CONDITIONDecember 31, 2004 and 2003(Dollars in thousands)**
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                       |       |     |       |     |       |
| Cash and cash  equivalents                       |       | $        | 10,557     |     | $          | 45,516 |   |
| Other investments                                |       | 63       |       | 63       |       |
| Investment in  subsidiaries                      |       | 99,905   |       | 35,318   |       |
| Premises and  equipment, net                     |       | 1,308    |       | 1,552    |       |
| Goodwill                                         |       | 22       |       | 22       |       |
| Other assets                                     |       | 4,130    |       | 3,489    |       |
| Total assets                                     |       | $        | 115,985    |     | $          | 85,960 |   |
| **Liabilities and Shareholders’  Equity**   |       |     |       |     |       |
| Debt to Cardinal  Statutory Trust I              |       | $        | 20,619     |     | $          | — |   |
| Other liabilities                                |       | 261      |       | 548      |       |
| Total liabilities                                |       | 20,880   |       | 548      |       |
| Total  shareholders’ equity                 |       | $        | 95,105     |     | $          | 85,412 |   |
| Total liabilities  and shareholders’ equity |       | $        | 115,985    |     | $          | 85,960 |   |

 

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**PARENT COMPANY ONLYCONDENSED STATEMENTS OF OPERATIONS**

**Years Ended December 31,2004, 2003 and 2002**

**(Dollarsin thousands)**
| ** **                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income:                                                                            |       |     |       |     |       |     |       |
| Net interest  income                                                               |       | $        | (257       | )        | $          | 96       |       | $ | 81 |   |
| Other income                                                                       |       | 7        |       | 32       |       | 74       |       |
| Total income                                                                       |       | (250     | )          | 128      |       | 155      |       |
| Expense—General  and administrative                                           |       | 1,400    |       | 1,270    |       | 463      |       |
| Net loss before income taxes and equity in  undistributed earnings of subsidiaries |       | (1,650   | )          | (1,142   | )          | (308     | )          |
| Income tax  benefit                                                                |       | (561     | )          | (2,601   | )          | —   |       |
| Equity in  undistributed earnings of subsidiaries                                  |       | 4,558    |       | 4,695    |       | (221     | )          |
| Net income (loss)                                                                  |       | $        | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |

 

**PARENT COMPANY ONLYCONDENSED STATEMENTS OF CASH FLOWS**

**Years ended December 31,2004, 2003 and 2002**

**(Dollarsin thousands)**
| ** **                                                                                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                                              |       |     |       |     |       |     |       |
| Net income (loss)                                                                                   |       | $        | 3,469      |     | $          | 6,154    |       | $ | (529 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |     |       |     |       |     |       |
| Equity in undistributed earnings of subsidiaries                                                    |       | (4,558   | )          | (4,695   | )          | 221      |       |
| Depreciation                                                                                        |       | 240      |       | 261      |       | 238      |       |
| Increase in other assets, liabilities and goodwill                                                  |       | (914     | )          | (2,600   | )          | (2,413   | )          |
| Net cash used in operating activities                                                               |       | (1,763   | )          | (880     | )          | (2,483   | )          |
| Cash flows from  investing activities:                                                              |       |     |       |     |       |     |       |
| Capital infusion into subsidiary                                                                    |       | (60,000  | )          | (1,000   | )          | (12,275  | )          |
| Net change in premises and equipment                                                                |       | 4        |       | 11       |       | 161      |       |
| Proceeds from sale of other investments                                                             |       | —   |       | —   |       | 4        |       |
| Net cash used in investing activities                                                               |       | (59,996  | )          | (989     | )          | (12,110  | )          |
| Cash flows from  financing activities:                                                              |       |     |       |     |       |     |       |
| Proceeds from rights and secondary offerings                                                        |       | 6,302    |       | 41,747   |       | 18,493   |       |
| Proceeds from trust preferred issuance                                                              |       | 20,000   |       | —   |       | —   |       |
| Dividends declared on preferred stock                                                               |       | —   |       | (495     | )          | (495     | )          |
| Stock options exercised                                                                             |       | 498      |       | 144      |       | —   |       |
| Net cash provided by financing activities                                                           |       | 26,800   |       | 41,396   |       | 17,998   |       |
| Net increase  (decrease) in cash and cash equivalents                                               |       | (34,959  | )          | 39,527   |       | 3,405    |       |
| Cash and cash  equivalents at beginning of year                                                     |       | 45,516   |       | 5,989    |       | 2,584    |       |
| Cash and cash  equivalents at end of year                                                           |       | $        | 10,557     |     | $          | 45,516   |       | $ | 5,989 |   |

 

(23)                Goodwill and OtherIntangible Assets

Effective July 7,2004, the Bank completed its acquisition of GMM in a cash transaction of $17.0million. This transaction was accounted for as a purchase and GMM’s assets andliabilities were recorded 

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atfair value as of the purchase date. This transaction resulted in therecognition of $12.9 million of goodwill and amortizable other intangibleassets of $1.7 million.

The Company adopted SFAS No. 142 as of January 1,2002, and, therefore, discontinued the amortization of goodwill on January 1,2002. The Company has evaluated impairment of goodwill under SFAS No. 142.The evaluation of goodwill under this statement did not result in impairment ofthe Company’s goodwill as of the annual evaluation date.

Informationconcerning amortizable intangibles at December 31, 2004 is as follows:
| ** **              | ** ** | **Gross   Carrying   Amount** | ** ** | ** Accumulated   Amortization** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **(Dollars in thousands)**    | ** ** |
| Customer  relationships |       |                                    | $          | 1,781                                     |       |   |   | $ | 49 |   |   |
|                         |            |                                         |            |                                           |            |  |  |  |  |  |  |

 

Theaggregate amortization expense for 2004 was $49,000 and the estimatedamortization expense for the next five years is as follows:
| ** ** | ** ** | **(Dollars in thousands)** | ** ** |
|------------|------------|--------------------------------------|------------|
| 2005       |       |                                 | $          | 198 |   |   |
| 2006       |       |                                 | 198        |   |   |
| 2007       |       |                                 | 198        |   |   |
| 2008       |       |                                 | 198        |   |   |
| 2009       |       |                                 | 198        |   |   |

 

Thechanges in the carrying amount of goodwill for the year ended December 31,2004 were as follows:
| ** **                                | ** ** | **Commercial  Banking**              | ** ** | **Mortgage  Banking** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                | ** ** | **(Dollars in thousands)** | ** ** |
| Balance at  December 31, 2003        |       |                                 | $          | 22                    |       |      | $          | — |   | $ | 22 |   |
| Goodwill  attributable to GMM acquisition |       |                                 | —     |                  |       | 12,941    |       | 12,941 |   |
| Balance at  December 31, 2004        |       |                                 | $          | 22                    |       |      | $          | 12,941 |   | $ | 12,963 |   |

 

(24)                Other OperatingExpenses

Thefollowing shows the composition of other operating expenses for the years endedDecember 31, 2004, 2003 and 2002:
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stationary and  supplies        |       | 965      |       | 387      |       | 317      |       |
| Advertising and  marketing      |       | 1,613    |       | 913      |       | 540      |       |
| Other taxes                     |       | 548      |       | 390      |       | 248      |       |
| Travel and  entertainment       |       | 427      |       | 138      |       | 127      |       |
| Bank operations                 |       | 676      |       | 608      |       | 505      |       |
| Premises and  equipment         |       | 800      |       | 351      |       | 271      |       |
| Miscellaneous                   |       | 797      |       | 838      |       | 446      |       |
| Total other operating  expenses |       | $        | 5,826      |     | $          | 3,625    |       | $ | 2,454 |   |
|                                 |            |          |            |          |            |          |            |  |  |  |

 

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(25)     SubsequentEvents

In January 2005, the Company began deferredcompensation plans for its directors and certain employees. Under the directors’plan, a director may elect to defer all or a portion of any director relatedfees including fees for serving on board committees. Under the employees’ plan,certain employees may defer all or a portion of their compensation includingany bonus or commission compensation. Director and employee deferrals, otherthan employees of George Mason, are matched 50% by the Company. Deferrals madeby employees of George Mason are not eligible for the Company match. The amountof the Company match is deemed invested in Cardinal Financial Corporationcommon stock which vests immediately for the directors and after four years foremployees. The maximum Company match per employee is $50,000 per year.

In February 2005, theCompany awarded 457,235 stock options to its officers at an exercise price of$10.78, the market value on the grant date. These options fully vested on theaward date.

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**Item 9.**                        Changes inand Disagreements with Accountants on Accounting and Financial Disclosure

No changes in the Company’sindependent accountants or disagreements on accounting and financial disclosurerequired to be reported hereunder have taken place.

**Item 9A.**                Controls andProcedures

**Disclosure Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed by us in thereports that we file or submit under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), is recorded, processed, summarized and reportedwithin the time periods required by the Securities and Exchange Commission,including, without limitation, those controls and procedures designed to ensurethat such information is accumulated and communicated to our management toallow timely decisions regarding required disclosures.

As of the end of theperiod covered by this report, an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures was carried out underthe supervision and with the participation of our management, including thechief executive officer and chief financial officer. Based on and as of thedate of such evaluation, these officers concluded that our disclosure controlsand procedures were not effective due to corrections or errors related to ouraccounting adjustments applied to the acquisition of George Mason in a cashtransaction for $17.0 million on July 7, 2004, as described below. Theseofficers believe that the corrections have been handled as contemplated by therequirement for disclosure controls and procedures under the Exchange Act.

**Management’sReport on Internal Control over Financial Reporting**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act). Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2004 andidentified the material weakness described below, which resulted in materialmisstatements that caused us to restate our consolidated financial statements includedon our Quarterly Report on Form 10-Q as of and for the periods ended September30, 2004. Subsequent to the initial filing of the aforementioned Form 10-Q, weidentified these errors related to our accounting for the acquisition of GeorgeMason. The errors were related to the fair value estimates associated withacquired loans held for sale and the acquired pipeline of unfunded loancommitments and various other adjustments primarily related to the George Masonacquisition. These material misstatements resulted in the overstatement ofgoodwill and the allowance for loan losses; the understatement of loans heldfor sale, net, loans receivable, net, accrued interest receivable and otherassets, and accrued interest payable and other liabilities; and anoverstatement of net income as of and for the periods ended September 30, 2004.

During the evaluation of these accounting errors, weconcluded that they were the result of a material weakness in our internalcontrol over financial reporting with respect to the accounting for non-routinetransactions. A material weakness is a significant deficiency (as defined inthe Public Company Accounting Oversight Board’s Auditing Standard No. 2),or combination of significant deficiencies, that results in there being morethan a remote likelihood that a material misstatement in the annual or interimfinancial statements will not be prevented or detected on a timely basis byemployees in the normal course of their work. Specifically, our accountingpersonnel lacked sufficient resources and expertise to properly account 

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for certain non-routinetransactions; our policies and procedures did not provide for timely review ofsignificant non-routine transactions and related accounting entries; and we didnot maintain sufficient documentation related to the application of U.S.generally accepted accounting principles to significant non-routinetransactions.

In making the assessment set forth above, as ofDecember 31, 2004, our management used the criteria established in the *Internal Control-Integrated Framework* established by theCommittee of Sponsoring Organizations of the Treadway Commission. The scope ofmanagement’s assessment of the effectiveness of internal control over financialreporting, however, did not include an assessment of the internal control overfinancial reporting at George Mason, which we acquired on July 7, 2004. Forthe year ended December 31, 2004, we had $5.2 million in income beforeincome taxes, of which George Mason accounted for $2.1 million, and $3.5million in net income, of which George Mason accounted for $1.4 million. Inaddition, at December 31, 2004, we had $1.21 billion in total assets, ofwhich George Mason accounted for $392.2 million.

Because of the material weakness described above,management believes that, as of December 31, 2004, our internal controlover financial reporting was not effective based on the aforementionedcriteria.

Our independent registeredpublic accountants have issued an audit report on our assessment of ourinternal control over financial reporting. That report appears in Item 8 above.

**RemediationSteps to Address Material Weakness**

As a result of these corrections, we restated certainfinancial statements included in our Quarterly Report on Form 10-Qfor the period ended September 30, 2004.  The corrections occurred as a result of themiscalculations of accounting entries and misapplication of certain financialaccounting standards and did not result from any fraudulent activities. Thecorrections related to purchase accounting were nonrecurring and noncash innature. We appointed a new chief financial officer and hired a new senioraccountant in October 2004. We believe these appointments havestrengthened the internal control structure of the organization. We continue toevaluate our financial accounting staff levels and expertise and areimplementing appropriate oversight and review procedures. We believe that weare taking the necessary corrective actions to eliminate the material weakness.

Except as described above,there were no changes in our internal control over financial reportingidentified in connection with our evaluation of it that occurred during ourlast fiscal quarter that materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

**Item 9B.**               Other Information

None.

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**PART III**

**Item10.**                 Directorsand Executive Officers of the Registrant

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained in “The Boardof Directors” section and under the headings “Executive Officers andSignificant Employees,” “The Committees of the Board of Directors—AuditCommittee” (only with respect to the designation of James D. Russo as an auditcommittee financial expert), “Code of Ethics” and “Section 16(a) BeneficialOwnership Reporting Compliance” in the Company’s Proxy Statement for the 2005Annual Meeting of Shareholders is incorporated herein by reference.

**Item 11.**                 ExecutiveCompensation

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained under theheadings “Director Compensation,” “Executive Officer Compensation,” “StockOptions,” “Employment Agreements” and “Compensation Committee Interlocks andInsider Participation” in the Company’s Proxy Statement for the 2005 AnnualMeeting of Shareholders is incorporated herein by reference.

**Item12.**                 SecurityOwnership of Certain Beneficial Owners and Management

*SecurityOwnership of Certain Beneficial Owners and Management.  *Pursuantto General Instruction G(3) of Form 10-K, the information containedunder the headings “Security Ownership of Directors and Executive Officers” and“Security Ownership of Certain Beneficial Owners” in the Company’s ProxyStatement for the 2005 Annual Meeting of Shareholders is incorporated herein byreference.

*Equity Compensation Plan Information.  *Thefollowing table sets forth information as of December 31, 2004, withrespect to compensation plans under which shares of our Common Stock areauthorized for issuance.
| **Plan Category**                                     | ** ** | ** ** | ** ** | **Number of Securities to  Be Issued upon Exercise  of Outstanding Options,  Warrants and Rights** | ** ** | **Weighted Average  Exercise Price of   Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available  for Future Issuance  Under Equity  Compensation Plans(1)** | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity Compensation Plans Approved by Shareholders         |       |       |       |                                                                                                                                                 |       |                                                                                                                   |       |                                                                                                                                       |       |   |   |   |   |
| 1999 Stock Plan                                            |       |       | 473,251    |                                                                                                                                                 |       |                                                                                                                   | $          | 4.91                                                                                                                                       |       |   |   | 2,058 |   |   |
| 2002 Equity Compensation  Plan                             |       |       | 757,237    |                                                                                                                                                 |       |                                                                                                                   | $          | 7.24                                                                                                                                       |       |   |   | 685,800 |   |   |
| Equity Compensation  Plans Not Approved by Shareholders(2) |       |       | —     |                                                                                                                                                 |       |                                                                                                                   | —     |                                                                                                                                       |       |   | — |   |   |
| **Total**                                                  |       |       | 1,230,488  |                                                                                                                                                 |       |                                                                                                                   | $          | 6.34                                                                                                                                       |       |   |   | 687,858 |   |   |

 

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(1)   Amounts exclude any securities to be issued upon exercise ofoutstanding options, warrants and rights.

(2)          TheCompany does not have any equity compensation plans that have not been approvedby shareholders.

**Item13.**                 CertainRelationships and Related Transactions

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained underthe heading “Certain Relationships and Related Transactions” in the Company’sProxy Statement for the 2005 Annual Meeting of Shareholders is incorporated hereinby reference.

**Item 14.**                 PrincipalAccounting Fees and Services

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained underthe headings “Fees of Independent Public Accountants” and “Audit CommitteePre-Approval Policies and Procedures,” in the Company’s Proxy Statement for the2005 Annual Meeting of Shareholders is incorporated herein by reference.

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**Part IV**

**Item15.**                 Exhibits,Financial Statement Schedules

(a)           (1) and(2) The response to this portion of Item 15 is included in Item 8 below.

(3)   Exhibits
|        | 3.1  | Articles  of Incorporation of Cardinal Financial Corporation (incorporated by reference  to Exhibit 3.1 to the Registration Statement on Form SB-2,  Registration No. 333-82946 (the “Form SB-2”)).                                     |
|--------|------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3.2  | Articles of Amendment to the Articles of  Incorporation of Cardinal Financial Corporation, setting forth the  designation for the Series A Preferred Stock (incorporated by reference  to Exhibit 3.2 to the Form SB-2).                               |
|   | 3.3  | Bylaws of Cardinal Financial Corporation (restated  in electronic format to reflect all amendments through April 21, 2004)  (incorporated by reference to Exhibit 3.1 to the Quarterly Report on  Form 10-Q for the period ended March 31, 2004). |
|   | 4.1  | Form of Common Stock Certificate (incorporated  by reference to Exhibit 4.1 to the Form SB-2).                                                                                                                                                         |
|   | 10.1 | Employment Agreement, dated as of February 12,  2002, between Cardinal Financial Corporation and Bernard H. Clineburg  (incorporated by reference to Exhibit 10.1 to the Form SB-2).                                                                   |
|   | 10.2 | Executive Employment Agreement, dated as of  February 12, 2002, between Cardinal Financial Corporation and Carl E.  Dodson (incorporated by reference to Exhibit 10.2 to the Form SB-2).                                                               |
|   | 10.3 | Executive Employment Agreement, dated as of  February 12, 2002 between Cardinal Financial Corporation and F. Kevin  Reynolds (incorporated by reference to Exhibit 10.4 to the Form SB-2).                                                             |
|   | 10.4 | Executive Employment Agreement, dated as of  February 12, 2002, between Cardinal Financial Corporation and  Christopher W. Bergstrom (incorporated by reference to Exhibit 10.5 to  the Form SB-2).                                                    |
|   | 10.5 | Cardinal Financial Corporation 1999 Stock Option  Plan, as amended (incorporated by reference to Exhibit 10.7 to the  Form SB-2).                                                                                                                           |
|   | 10.6 | Cardinal Financial Corporation 2002 Equity  Compensation Plan, as amended and restated (incorporated by reference to  Exhibit A to the Proxy Statement for the 2004 Annual Meeting of  Shareholders).                                                            |
|   | 21   | Subsidiaries of Cardinal Financial Corporation.                                                                                                                                                                                                                       |
|   | 23   | Consent of KPMG LLP                                                                                                                                                                                                                                                   |
|   | 31.1 | Rule 13a-14(a) Certification of  Chief Executive Officer                                                                                                                                                                                                    |
|   | 31.2 | Rule 13a-14(a) Certification of  Chief Financial Officer                                                                                                                                                                                                    |
|   | 31.3 | Rule 13a-14(a) Certification of Controller                                                                                                                                                                                                                  |
|   | 32.1 | Statement of Chief Executive Officer Pursuant to 18  U.S.C. § 1350.                                                                                                                                                                                              |
|   | 32.2 | Statement of Chief Financial Officer Pursuant to 18  U.S.C. § 1350.                                                                                                                                                                                              |
|   | 32.3 | Statement of Controller Pursuant to 18 U.S.C. §  1350.                                                                                                                                                                                                           |

 

(b)          Exhibits

SeeItem 15(a)(3) above.

(c)           Financial Statement Schedules

SeeItem 15(a)(2) above.

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**SIGNATURES**

Pursuantto the requirements of Section 13 and 15 (d) of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|                     | CARDINAL FINANCIAL  CORPORATION |
|---------------------|---------------------------------|
| March 11, 2005 | By:                             | /s/ BERNARD H. CLINEBURG |
|                | Name:                           | Bernard H. Clineburg |
|                | Title:                          | *Chairman, President and Chief Executive Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, this reporthas been signed below by the following persons on behalf of the registrant andin the capacities indicated on March 11, 2005.
|                             | **Signatures** | ** **                                            | ** ** | ** ** | **Titles** | ** ** |
|-----------------------------|----------------|-------------------------------------------------------|------------|------------|------------|------------|
| /s/  BERNARD H. CLINEBURG   |           | Chairman, President and  Chief Executive Officer      |
| Name: Bernard H.  Clineburg |           | (Principal Executive Officer)                         |
| /s/  ROBERT A. CERN         |           | Executive Vice President  and Chief Financial Officer |
| Name: Robert A.  Cern       |           | (Principal Financial Officer)                         |
| /s/  JENNIFER L. DEACON     |           | Senior Vice President  and Controller                 |
| Name: Jennifer L.  Deacon   |           | (Principal Accounting Officer)                        |
| /s/  B.G. BECK              |           | Director                                              |
| Name: B. G. Beck            |           | ** **                                            |
| /s/  WAYNE W. BROADWATER    |           | Director                                              |
| Name: Wayne W.  Broadwater  |           | ** **                                            |
| /s/  WILLIAM G. BUCK        |           | Director                                              |
| Name: William G.  Buck      |           | ** **                                            |
| /s/  SIDNEY O. DEWBERRY     |           | Director                                              |
| Name: Sidney O.  Dewberry   |           | ** **                                            |
| /s/  JOHN W. FISHER         |           | Director                                              |
| Name: John W.  Fisher       |           | ** **                                            |
| /s/  MICHAEL A. GARCIA      |           | Director                                              |
| Name: Michael A.  Garcia    |           | ** **                                            |
| /s/  J. HAMILTON LAMBERT    |           | Director                                              |
| Name: J. Hamilton  Lambert  |           | ** **                                            |

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| /s/ WILLIAM  E. PETERSON      |   | Director   |
|-------------------------------|--------|------------|
| Name: William E.  Peterson    |   | ** ** |
| /s/  JAMES D. RUSSO           |   | Director   |
| Name: James D.  Russo         |   | ** ** |
| /s/  JOHN H. RUST, JR.   |   | Director   |
| Name: John H.  Rust, Jr. |   | ** ** |
| /s/  GEORGE P. SHAFRAN        |   | Director   |
| Name: George P.  Shafran      |   | ** ** |
|                          |   | Director   |
| Name: Alice M.  Starr         |   | ** ** |

 

 

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**EXHIBIT INDEX**
| Number | ** ** | ** **                                                                                                                                                                                                                                                            | ** ** | **Description** |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1    |       | Articles  of Incorporation of Cardinal Financial Corporation (incorporated by reference  to Exhibit 3.1 to the Registration Statement on Form SB-2,  Registration No. 333-82946 (the “Form SB-2”)).                                     |       |
| 3.2    |       | Articles of Amendment to the Articles of  Incorporation of Cardinal Financial Corporation, setting forth the  designation for the Series A Preferred Stock (incorporated by reference  to Exhibit 3.2 to the Form SB-2).                               |       |
| 3.3    |       | Bylaws of Cardinal Financial Corporation (restated  in electronic format to reflect all amendments through April 21, 2004)  (incorporated by reference to Exhibit 3.1 to the Quarterly Report on  Form 10-Q for the period ended March 31, 2004). |       |
| 4.1    |       | Form of Common Stock Certificate (incorporated  by reference to Exhibit 4.1 to the Form SB-2).                                                                                                                                                         |       |
| 10.1   |       | Employment Agreement, dated as of February 12,  2002, between Cardinal Financial Corporation and Bernard H. Clineburg  (incorporated by reference to Exhibit 10.1 to the Form SB-2).                                                                   |       |
| 10.2   |       | Executive Employment Agreement, dated as of  February 12, 2002, between Cardinal Financial Corporation and Carl E.  Dodson (incorporated by reference to Exhibit 10.2 to the Form SB-2).                                                               |       |
| 10.3   |       | Executive Employment Agreement, dated as of  February 12, 2002 between Cardinal Financial Corporation and F. Kevin  Reynolds (incorporated by reference to Exhibit 10.4 to the Form SB-2).                                                             |       |
| 10.4   |       | Executive Employment Agreement, dated as of  February 12, 2002, between Cardinal Financial Corporation and  Christopher W. Bergstrom (incorporated by reference to Exhibit 10.5 to  the Form SB-2).                                                    |       |
| 10.5   |       | Cardinal Financial Corporation 1999 Stock Option  Plan, as amended (incorporated by reference to Exhibit 10.7 to the  Form SB-2).                                                                                                                           |       |
| 10.6   |       | Cardinal Financial Corporation 2002 Equity  Compensation Plan, as amended and restated (incorporated by reference to  Exhibit A to the Proxy Statement for the 2004 Annual Meeting of Shareholders).                                                             |       |
| 21     |       | Subsidiaries of Cardinal Financial Corporation.                                                                                                                                                                                                                       |       |
| 23     |       | Consent of KPMG LLP                                                                                                                                                                                                                                                   |       |
| 31.1   |       | Rule 13a-14(a) Certification of  Chief Executive Officer                                                                                                                                                                                                    |       |
| 31.2   |       | Rule 13a-14(a) Certification of  Chief Financial Officer                                                                                                                                                                                                    |       |
| 31.3   |       | Rule 13a-14(a) Certification of Controller                                                                                                                                                                                                                            |       |
| 32.1   |       | Statement of Chief Executive Officer Pursuant to 18  U.S.C. § 1350.                                                                                                                                                                                              |       |
| 32.2   |       | Statement of  Chief Financial Officer Pursuant to 18 U.S.C. § 1350.                                                                                                                                                                                              |       |
| 32.3   |       | Statement of  Controller Pursuant to 18 U.S.C. § 1350.                                                                                                                                                                                                           |       |
|        |            |                                                                                                                                                                                                                                                                       |            |                 |  |  |  |

 

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