**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

(MarkOne)

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

**Forthe fiscal year ended December 31, 2006**

**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**

**CARDINALFINANCIAL CORPORATION**

(Exact name of registrantas specified in its charter)

| **Virginia**                              |   | **54-1874630**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction             |   | (I.R.S. Employer     |
| of incorporation  or organization)        |   | 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:

| Title of each class                          |   | Name of each  exchange on which registered |
|----------------------------------------------|--------|--------------------------------------------|
| **Common  Stock, par value $1.00 per share** |   | **The  Nasdaq Stock Market**               |

 

Securitiesregistered pursuant to Section 12(g) of the Act: None

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o   No x

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler o      Accelerated filer x      Non-accelerated filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o   No x

State the aggregate marketvalue of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was last sold asof June 30, 2006: $260,988,221.

Thenumber of shares outstanding of Common Stock, as of March 5, 2007, was24,466,428.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’sdefinitive Proxy Statement for the 2007 Annual Meeting of Shareholders areincorporated by reference into Part III of this Form 10-K. Withthe exception of the portions of the Proxy Statement specifically incorporatedherein by reference, the Proxy Statement is not deemed to be filed as part ofthis Form 10-K.

 

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**TABLEOF CONTENTS**
|                   | ** ** | ** **                                                                                                               | ** ** | **Page** | ** ** |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I**   |       |                                                                                                                     |
| Item 1.           |       | Business                                                                                                                 |       |     | 3          |   |   |
| Item 1A.          |       | Risk Factors                                                                                                             |       |     | 21         |   |   |
| Item 1B.          |       | Unresolved Staff  Comments                                                                                               |       |     | 25         |   |   |
| Item 2.           |       | Properties                                                                                                               |       |     | 25         |   |   |
| Item 3.           |       | Legal Proceedings                                                                                                        |       |     | 25         |   |   |
| Item 4.           |       | Submission of  Matters to a Vote of Security Holders                                                                     |       |     | 25         |   |   |
| **PART II**  |       |                                                                                                                     |
| Item 5.           |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and  Issuer Purchases of Equity Securities |       |     | 26         |   |   |
| Item 6.           |       | Selected Financial  Data                                                                                                 |       |     | 28         |   |   |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and  Results of Operations                   |       |     | 29         |   |   |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                              |       |     | 64         |   |   |
| Item 8.           |       | Financial  Statements and Supplementary Data                                                                             |       |     | 64         |   |   |
| Item 9.           |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure      |       |     | 114        |   |   |
| Item 9A.          |       | Controls and  Procedures.                                                                                                |       |     | 114        |   |   |
| Item 9B.          |       | Other Information                                                                                                        |       |     | 114        |   |   |
| **PART III** |       |                                                                                                                     |
| Item 10.          |       | Directors,  Executive Officers and Corporate Governance                                                                  |       |     | 115        |   |   |
| Item 11.          |       | Executive  Compensation                                                                                                  |       |     | 115        |   |   |
| Item 12.          |       | Security  Ownership of Certain Beneficial Owners and Management and  Related Stockholder Matters     |       |     | 115        |   |   |
| Item 13.          |       | Certain  Relationships and Related Transactions, and Director Independence                                               |       |     | 115        |   |   |
| Item 14.          |       | Principal  Accounting Fees and Services                                                                                  |       |     | 115        |   |   |
| **PART IV**  |       |                                                                                                                     |
| Item 15.          |       | Exhibits,  Financial Statement Schedules                                                                                 |       |     | 116        |   |   |

 

This Annual Report on Form 10-K has notbeen reviewed, or confirmed for accuracy or relevance, by the Federal DepositInsurance Corporation.

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**PART I**

**Item 1.**                        Business

**Overview**

Cardinal Financial Corporation, a financial holdingcompany, was formed in late 1997 as a Virginia corporation, principally inresponse to opportunities resulting from the consolidation of severalVirginia-based banks with regional bank holding companies. In our market area,these bank consolidations had been accompanied by the dissolution of localboards of directors and relocation or termination of management and customerservice professionals.

We own Cardinal Bank, a Virginia state-charteredcommunity bank headquartered in Tysons Corner, Virginia. Cardinal Bank hasoffices in Alexandria, Annandale, Arlington, Chantilly, Clifton, Fairfax,Fredericksburg, Herndon, Leesburg, Manassas, McLean, Purcellville, Reston,Stafford, Sterling, Sterling Park, Tysons Corner, and Woodbridge, Virginia,Washington, D.C. and Bethesda, Maryland. We conduct all of our business throughCardinal Bank (the “Bank”), our principal operating unit, its subsidiary GeorgeMason Mortgage, LLC (“George Mason”), Cardinal Wealth Services, Inc. (“CWS”),and Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”).

Cardinal Bank****offers a widerange of traditional bank loan and deposit products and services to both ourcommercial and retail customers. Our commercial relationship managers focus onattracting small and medium sized businesses as well as government contractors,commercial real estate developers and builders and professionals, such asphysicians, accountants and attorneys. We have 25 branch office locations andprovide competitive products and services.

George Mason engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis through seven branches located throughout the metropolitanWashington, D.C. region. George Mason is one of the largest residentialmortgage originators in the greater Washington metropolitan area, generatingoriginations of approximately $3.0 billion in 2006 and $4.3 billion in 2005,excluding advances on construction loans and including loans purchased fromother mortgage banking companies owned by local home builders but managed byGeorge Mason.

CWS provides brokerage and investment services througha contract with Raymond James Financial Services, Inc. Under thiscontract, financial advisors can offer our customers an extensive range offinancial products and services, including estate planning, qualifiedretirement plans, mutual funds, annuities, life insurance, fixed income andequity securities and equity research and recommendations. CWS’s principalsource of revenue is the net commissions it earns on the purchases and sales ofinvestment products to its customers.

Wilson/Bennettprovides professional investment management of financial assets withasset preservation as the primary goal. Clients include individuals, pensionplans and medium sized corporations. Wilson/Bennett utilizes a value orientedinvestment approach and focuses on large capitalization stocks. Wilson/Bennettearns fees based upon the market value of its clients’ portfolios.

**Recent Developments**

On February 9, 2006, Cardinal Bank acquiredcertain fiduciary and other assets and assumed certain liabilities of FBRNational Trust Company, formerly a subsidiary of Friedman, Billings, RamseyGroup, Inc. As a result of this transaction, the Bank acts as trustee orcustodian for assets under management in excess of $6 billion as of February 28,2007. This transaction diversifies the Bank’s sources of non-interest incomeand allows it to provide additional services to its customers.

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On June 9, 2005, weacquired Wilson/Bennett for a total consideration of $6.5 million, whichconsisted of a payment of $1.5 million in cash and the issuance of 611,111shares of our common stock, which we valued at $4.9 million. We believe thatthe Wilson/Bennett acquisition furthers our strategies of enhancing fee income,and diversifying our revenue stream and the services we deliver to ourcustomers.

**Growth Strategy**

We believe that the strong demographic characteristicsof our market, the ongoing bank consolidation, and the vibrant economy in themetropolitan Washington, D.C. area, particularly in Northern Virginia, providea significant 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 increasing profitability. The strategy forachieving these objectives includes the following:

**Expandour footprint through branch expansion.****  **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 the second quarter of 2006, weopened two branch banking offices, one in Chantilly, Virginia and the second inWashington, D.C. On January 31, 2007, we opened our first branch bankingoffice in Bethesda, Maryland, and on March 9, 2007, we opened a secondlocation in Arlington, Virginia.

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 one branch facility if the financial institution now operating thislocation chooses to close or move its operations anytime before January 2010.Our current plans, which are subject to change, contemplate that we will add nonew branches in 2007 other than those described above. Because the opening ofeach new branch increases our operating expenses, we intend to stage futurebranch openings in an effort to minimize the impact of these expenses on ourresults of operations.

**Capitalizeon the continued bank consolidation in our market.****  **We anticipate that recently announced or completed bank mergerswill result in further consolidation in our target market and intend tocapitalize on the dislocation of customers resulting from this consolidation. Webelieve this consolidation creates opportunities for us to further expand ourbranch network, 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 service-oriented and customer-centric branch system.

Although we are not at this time engaged innegotiations with any specific bank acquisition targets, we will continue toexplore the possibility of further growth through acquisition in Virginia, themetropolitan Washington, D.C. market, or other areas if we believe that suchexpansion will strengthen the Company by diversifying its customer base andsources of revenue and be accretive to earnings within a reasonable time frame.

**Expandour lending activities.****  **We have substantially increased our legal lending limitto $21.3 million as of December 31, 2006 as a result of the completion ofour secondary common stock offering in May 2005, 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. Federal government spending in the greaterWashington region was approximately $107 billion in 2004, and we believe thereare unique growth opportunities in this sector of our regional economy. Ourgoal is to 

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aggressively grow our loanportfolio while maintaining superior asset quality through conservativeunderwriting practices. During periods of growth in our loan portfolio, ourearnings could be adversely impacted by provisions to our allowance for loanlosses as a result of increases in loan balances.

**Continueto recruit experienced bankers.****  **We have been successful inrecruiting senior bankers with experience in and knowledge of our market whohave been displaced or have grown dissatisfied as a result of the previouslymentioned bank consolidation. We intend to continue our efforts to recruitexperienced bankers, particularly experienced lenders, who can immediatelygenerate additional loan volume through their existing credit relationships.

**Focuson specialized lending services.****  **We have expanded certain existingproduct lines, including government contract receivables lending, SBAguaranteed lending, and retail lending. Our commercial relationship managersfocus on attracting small and medium sized businesses, including commercialreal estate developers, builders and professionals such as physicians,accountants and attorneys. Our goal is to create a diversified,community-focused banking franchise, balanced between retail, commercial andreal estate transactions and services.

**Offeradditional financial products and services.****  **George Mason has increased our fee income and hasallowed us to offer our existing customer base a far greater array of mortgageloan products. In addition, we aggressively market our traditional banking,trust and wealth management products to the George Mason customer base. Ourfocus at George Mason is to build and maintain relationships with local andnational homebuilders in an attempt to reduce reliance on the cyclicalrefinancing market. Building relationships with larger homebuilders assists usin our efforts to increase our commercial real estate lending activities.

We plan to further developand expand the investment services we offer through CWS and the addition of ourtrust services department and Wilson/Bennett, which has recently begun to offeran attractive cash management product. We believe we have opportunities tocross-sell additional services to both our traditional banking customers andGeorge Mason’s customers. We further believe we will be able to attract newcustomers by offering a broader array of financial products and services.

**Business SegmentOperations**

In 2003 and for the first six months of 2004, weoperated and reported in two business segments, Commercial Banking and Wealth ManagementServices. 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 provides customers with several choices of deposit products, includingdemand deposit 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 Wealth Management Services segment, which became the WealthManagement and Trust Services segment as a result of our 2006 acquisition ofcertain assets and assumed liabilities from FBR National Trust Company,provides investment and financial advisory services to businesses andindividuals, including financial planning, retirement/estate planning, trust,estates, custody, investment management, escrows, and retirement plans.

Wilson/Bennett has been included in the WealthManagement and Trust Services segment since the date of acquisition, June 9,2005. Results related to the assets acquired and liabilities assumed from FBRNational Trust Company have been reflected in the Wealth Management and TrustServices segment since the date of their acquisition and assumption, February 9,2006.

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

**Market Area**

We consider ourprimary target 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 Prince Georges.We will, however, consider expansion into other areas if we believe suchexpansion will strengthen the Company by diversifying its customer base andsources of revenue and be accretive to earnings within a reasonable time frame.

Based on estimates released by the U.S. Census Bureau,the population of the greater Washington metropolitan area was approximately5.2 million people in 2005, the eighth largest market in the country. Themedian annual household income for this area in 2006 was approximately $73,000,the wealthiest region in the country. Based on estimates released by the Bureauof Labor Statistics of the U.S. Department of Labor for December 2006, theunemployment rate for the greater Washington metropolitan area wasapproximately 2.9%, compared to a national unemployment rate of 4.6%. As of June 30,2006, total deposits in this area were approximately $144 billion as reportedby the Federal Deposit Insurance Corporation (“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 over one million people. In2005, Fairfax County had a median household income of approximately $100,800. Basedon estimates released by the Bureau of Statistics of the U.S. Department ofLabor for December 2005, the unemployment rate in Fairfax County was 2.1%.

**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. Wecompete as a financial intermediary with other commercial banks, savings andloan associations, savings banks, credit unions, mortgage banking firms,consumer finance companies, securities brokerage firms, insurance companies,mutual fund groups and other types of financial institutions. George Masonfaces significant competition from both traditional financial institutions andother national and local mortgage banking operations.

The competition to acquire deposits and to generateloans, including mortgage banking loans, is intense, and pricing is important. Manyof our competitors are larger and have substantially greater resources andlending limits than we do. In addition, many competitors offer more extensivebranch and ATM networks than we currently have. Larger institutions operatingin the greater Washington market have access to funding sources at lower coststhan are available to us since they have larger and more diverse fundgenerating capabilities. However, we believe that we have and will continue tobe successful in competing in this environment due to an emphasis on a highlevel of personalized customer service, localized and more responsive decisionmaking, and community involvement.

Of the $144 billionin bank deposits in the greater Washington region at June 30, 2006,approximately 76% were held by banks that are either based outside of thegreater Washington region or are operating wholesale banks that generatedeposits nationally. In just over eight years, excluding deposits held byinstitutions based outside our region, we have grown to the seventh largestfinancial institution headquartered in the greater Washington region asmeasured by total deposits. By providing competitive 

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productsand more personalized service and being actively involved in our localcommunities, we believe we can continue to increase our share of this depositmarket.

**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 the high level of personalizedservice to small and medium-sized commercial businesses, professionals orindividual retail customers that we emphasize.

We expect to continueserving these business and professional markets with experienced commercialrelationship managers, and we have increased our retail marketing effortsthrough the expansion of our branch network and development of additionalretail products and services. We expanded our deposit market share throughaggressive marketing of our President’s Club, Chairman’s Club, Simply Savingsand Monster Money Market relationship products and our Totally Free Checkingproduct.

**Banking Productsand Services**

Our principal business is to accept deposits from thepublic and to make loans and other investments. The principal sources of fundsfor the Bank’s loans and investments are demand, time, savings and otherdeposits, repayments of existing loans, and borrowings. Our principal source ofincome is interest collected on loans, investment securities and otherinvestments. Non-interest income, which includes among other things deposit andloan fees and service charges, gains on sales of loans, investment fee income andmanagement fee income, is the next largest component of our revenues. Ourprincipal expenses are interest expense on deposits and borrowings, employeecompensation and benefits, occupancy-related expenses, and other overheadexpenses.

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. The mortgage subsidiary funds these loans through a line ofcredit from Cardinal Bank, lines of credit through third party lenders and cashavailable through its own operations. George Mason’s income on these loans isgenerated from the fees it charges its customers, the gains it recognizes uponthe sales of the loans and the interest income it earns while the loans arebeing serviced. Costs associated with these loans are primarily comprised ofsalaries and commissions paid to loan originators and support personnel,interest expense incurred while the loans are held pending sale and otherexpenses associated with the origination of the loans. In addition, GeorgeMason generates management fee income by providing specific services to othermortgage banking companies owned by local home builders.

George Mason also offers a construction-to-permanentloan program. This program provides variable rate financing for customers toconstruct their residences. Once the home has been completed, the loan convertsto fixed rate financing and is sold into the secondary market. Theseconstruction-to-permanent loans generate fee income as well as net interestincome for George Mason and are classified as loans held for sale.

George Mason’s business is both cyclical and seasonal.The cyclical nature of its business is influenced by, among other things, thelevels of and trends in mortgage interest rates, national and local economicconditions and consumer confidence in the economy. Historically, George Masonhas its lowest levels of quarterly loan closings during the first quarter ofthe year.

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Both Cardinal Bank and George Mason are committed toproviding high quality products and services to their customers, and have madea significant investment in their core information technology systems. Thesesystems provide the technology that fully automates the branches, processesbank transactions, mortgage originations, other loans and electronic banking,conducts database and direct response marketing, provides cash managementsolutions, streamlined reporting and reconciliation support.

With this investment in technology, the bank offersinternet-based delivery of products for both individuals and commercialcustomers. Customers can open accounts, apply for loans, check balances, checkaccount history, transfer funds, pay bills, download account transactions intoQuickenTM and Microsoft MoneyTM, and correspond via e-mail with the Bank over theinternet. The internet provides an inexpensive way for the bank to expand itsgeographic borders and branch activities while providing services offered bylarger banks.

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 aredescribed in further detail below. We have established target percentage goalsfor each type of loan to insure adequate diversification of our loan portfolio.These goals, however, may change from time to time as a result of competition,market conditions, employee expertise, and other factors. Commercial andindustrial loans, real estate-commercial loans, real estate-construction loans,real estate-residential loans, home equity loans, and consumer loans accountfor approximately 12%, 37%, 18%, 24%, 8% and 1%, respectively of our loanportfolio at December 31, 2006. At December 31, 2006, approximately 2%of our total loan portfolio is unsecured.

*Commercialand Industrial Loans.*   We make commercial loans to qualified businesses in ourmarket area. Our commercial lending portfolio consists primarily of commercialand industrial loans for the financing of accounts receivable, inventory,property, plant and equipment. Our government contract lending group providessecured lending to government contracting firms and businesses based primarilyon receivables from the federal government. We also offer Small BusinessAdministration (SBA) guaranteed loans and asset-based lending arrangements toour customers. We are certified as a preferred lender by the SBA, whichprovides us with much more flexibility in approving loans guaranteed under theSBA’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, the values of which maydecline over time and generally cannot be appraised with as much precision asresidential real estate. As a result, the availability of funds for therepayment of commercial loans may be substantially dependent upon thecommercial success of the business itself.

To manage these risks, our policy is to secure thecommercial loans we make with both the assets of the business, which aresubject to the risks described above, and other additional collateral andguarantees that may be available. In addition, we actively monitor certainattributes of the borrower and the credit facility, including advance rate,cash flow, collateral value and other credit factors that we considerappropriate.

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*Commercial Mortgage Loans.*   Weoriginate 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. These loans generally have maturitiesranging from one to ten years.

Commercialmortgage lending entails significant additional risk compared with traditionalresidential mortgage lending. Commercial mortgage loans typically involvelarger loan balances concentrated with single borrowers or groups of relatedborrowers. Additionally, the repayment of loans secured by income-producingproperties is typically dependent upon the successful operation of a businessor real estate project and thus may be subject, to a greater extent than is thecase with residential mortgage loans, to adverse conditions in the commercialreal estate market or in the general economy. Our commercial real estate loanunderwriting criteria require an examination of debt service coverage ratios,the borrower’s creditworthiness and prior credit history and reputation, and wegenerally require personal guarantees or endorsements with respect to theseloans. In the loan underwriting process, we also carefully consider thelocation of the property that will be collateral for the loan.

Loan-to-valueratios for commercial mortgage loans generally do not exceed 80%. We permitloan-to-value ratios of up to 80% if the borrower has appropriate liquidity,net worth 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 the residences of borrowers. Second mortgage and home equitylines of credit are used for home improvements, education and other personalexpenditures. We make mortgage loans with a variety of terms, including fixed,floating and variable interest rates, with maturities ranging from three monthsto thirty years.

Residentialmortgage loans generally are made on the basis of the borrower’s ability torepay the loan from his or her salary and other income and are secured byresidential real estate, the value of which is generally readily ascertainable.These loans are made consistent with our appraisal and real estate lendingpolicies, which detail maximum loan-to-value ratios and maturities. Residentialmortgage loans and home equity lines of credit secured by owner-occupiedproperty generally are made with a loan-to-value ratio of up to 80%. Loan-to-valueratios of up to 95% may be allowed on residential owner-occupied property ifthe borrower exhibits unusually strong creditworthiness. We do not make residentialloans which, at the time of inception, have loan-to-value ratios in excess of95%.

*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 reduce 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 these loan-to-value ratios will provide sufficient protectionagainst fluctuations in the real estate market to limit the risk of loss. Maturitiesfor construction loans generally range from 12 to 24 months for residential,non-residential and multi-family properties.

*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.

Consumerloans may entail greater risk than residential mortgage loans, particularly inthe case of consumer loans that are unsecured, such as lines of credit, orsecured by rapidly depreciable assets, such as automobiles. In such cases, anyrepossessed collateral for a defaulted consumer loan may not provide an 

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adequate source of repayment of the outstanding loanbalance as a result of the greater likelihood of damage, loss or depreciation. Theremaining deficiency often does not warrant further substantial collectionefforts against the borrower. In addition, consumer loan collections aredependent on the borrower’s continuing financial stability, and thus are morelikely to be adversely affected by job loss, divorce, illness or personalbankruptcy. Furthermore, the application of various federal and state laws,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.

Ourpolicy for consumer loans is to accept moderate risk while minimizing losses,primarily through a careful credit and financial analysis of the borrower. Inevaluating consumer loans, we require our lending officers to review the borrower’slevel and stability of income, past credit history, amount of debt currentlyoutstanding and the impact of these factors on the ability of the borrower torepay the loan in a timely manner. In addition, we require our banking officersto maintain an appropriate differential between the loan amount and collateralvalue.

We also issue credit cards to certain of our customers.In determining to whom we will issue credit cards, we evaluate the borrower’slevel and stability of income, past credit history and other factors. Finally,we make additional loans that are not classified in one of the above categories.In making such loans, we attempt to ensure that the borrower meets our loanunderwriting standards.

*Loan Participations*

From time to time we purchase and sell commercial loanparticipations to or from other banks within our market area. All loanparticipations purchased have been underwritten using the bank’s standard andcustomary underwriting criteria and are in good standing.

*Deposits*

We offer a broad range of interest-bearing andnon-interest-bearing deposit accounts, including commercial and retail checkingaccounts, money market accounts, individual retirement accounts, regularinterest-bearing savings accounts and certificates of deposit with a range ofmaturity date options. The primary sources of deposits are small andmedium-sized businesses and individuals within our target market. Seniormanagement has the authority to set rates within specified parameters in orderto remain competitive with other financial institutions in our market area. Alldeposits are insured by the FDIC up to the maximum amount permitted by law. Wehave a service charge fee schedule, which is generally competitive with otherfinancial institutions in our market, covering such matters as maintenance feesand per item processing fees on checking accounts, returned check charges andother similar fees.

*Courier Services*

We offer courier services to our business customers. Courierservices permit us to provide the convenience and personalized service that ourcustomers require by scheduling pick-ups of deposits and other bankingtransactions.

*Deposit on Demand*

*Weprovide our commercial banking customers electronic deposit capability throughour Deposit on Demand product. Business customers who sign up for this servicecan scan their deposits and send electronic batches of their deposits to thebank. This product reduces or eliminates the need for businesses with dailydeposits and high check volume to visit the bank and provides fasteravailability of funds and the benefit of viewing images of deposited checks.*

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*Telephone and InternetBanking*

We believe that there is a strong demand within ourmarket for telephone banking and internet banking. These services allow bothcommercial and retail customers to access detailed account information andexecute a wide variety of the banking transactions, including balance transfersand bill payment. We believe that these services are particularly attractive toour customers, as it enables them at any time to conduct their banking businessand monitor their accounts. Telephone and internet banking assist us inattracting and retaining customers and encourages our existing customers toconsider Cardinal for all of their banking and financial needs.

*Automatic Teller Machines*

We have an ATM at each of our branch offices and wemake other financial institutions’ ATMs available to our customers.

*Other Products andServices*

We offer other banking-related specialized productsand services to our customers, such as travelers’ checks, coin counters, wireservices, and safe deposit box services. We issue letters of credit and standbyletters of credit for some of our commercial customers, most of which arerelated to real estate construction loans. We have not engaged in anysecuritizations of loans.

**Credit Policies**

Ourchief credit officer and senior lending officers are primarily responsible formaintaining both a quality loan portfolio and a strong credit culture throughoutthe organization. The chief credit officer is responsible for developing andupdating our credit policies and procedures, which are approved by the board ofdirectors. Senior lending officers may make exceptions to these credit policiesand procedures as appropriate, but any such exception must be documented andmade for sound business reasons, and, if the loan is in excess of the officer’slending limit, be approved by the chief credit officer.

Creditquality is controlled by the chief credit officer through compliance with ourcredit policies and procedures. Our risk-decision process is actively managedin a disciplined fashion to maintain an acceptable risk profile characterizedby soundness, diversity, quality, prudence, balance and accountability. Ourcredit approval process consists of specific authorities granted to the lendingofficers and combinations of lending officers. Loans exceeding a particularlending officer’s level of authority, or the combined limit of severalofficers, are reviewed and considered for approval by an officers’ loancommittee and, when above a specified amount, by a committee of the Bank’sboard of directors. Generally, loans of $1,500,000 or more require committeeapproval. Our policy allows exceptions for very specific conditions, such asloans secured by deposits at our Bank. 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.

Underour credit policies, we monitor our concentration of credit risk. We haveestablished credit concentration guideline limits for any individual or entity,any group of borrowers related as to the source of repayment, or any specificindustry. Furthermore, the Bank has established limits on the total amount ofthe Bank’s outstanding loans to one borrower, all of which are set below legallending limits.

Loans closed by George Mason are underwritten inaccordance with guidelines established by the various secondary marketinvestors to which George Mason sells its loans. George Mason may originatenon-traditional loans, such as negative amortization loans, for theseinvestors.

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**Brokerage and AssetManagement Services**

CWS provides brokerage and investment services throughan arrangement with Raymond James Financial Services, Inc. Under thisarrangement, financial advisors can offer our customers an extensive range ofinvestment products and services, including estate planning, qualifiedretirement plans, mutual funds, annuities, life insurance, fixed income andequity securities and equity research and recommendations. With the addition ofWilson/Bennett in June 2005, we also offer asset management services tocustomers using a value-oriented approach that focuses on large capitalizationstocks.

On February 9, 2006,the Bank acquired certain fiduciary and other assets and assumed certainliabilities of FBR National Trust Company, formerly a subsidiary of Friedman,Billings, Ramsey Group, Inc. As a result of this transaction, the Bankacts as trustee or custodian for assets under management in excess of $6billion as of February 28, 2007. This acquisition allowed us to create atrust division, and services provided by our trust division include trust,estates, custody, investment management, escrows, and retirement plans. Theaddition of trust services diversifies the Bank’s sources of non-interestincome and allows us to provide additional services to our customers.

**Employees**

At December 31, 2006,we had 406 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 bank subsidiary,including the activities in which it may engage, the investments that it makes,the aggregate amount of loans that it may grant to one borrower, and thedividends it may declare and pay to us. Our bank subsidiary is also subject tovarious consumer and compliance laws. As a state-chartered bank, the Bank isprimarily subject to regulation, supervision and examination by the Bureau ofFinancial Institutions of the Virginia State Corporation Commission. Our banksubsidiary also is subject to regulation, supervision and examination by theFederal Deposit Insurance Corporation. As part of our bank subsidiary, GeorgeMason is subject to the same regulations as the Bank.

The following descriptionsummarizes the more 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.

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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 voting sharesof such bank (unless it already owns or controls the majority of such shares),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 previously impermissibleactivities, such as insurance underwriting and securities underwriting anddistribution. In addition, financial holding companies may also acquire orengage in certain activities in which bank holding companies are not permittedto engage in, such as travel agency activities, insurance agency activities,merchant banking and other activities that the Federal Reserve determines to befinancial in nature or complementary to these activities. Financial holdingcompanies continue to be subject to the overall oversight and supervision ofthe Federal Reserve, but the GLBA applies the concept of functional regulationto the activities conducted by subsidiaries. For example, insurance activitieswould be subject to supervision and regulation by state insurance authorities. Webecame a financial holding company in 2004.

*Payment of Dividends*

We are a legal entity separate and distinct fromCardinal Bank, CWS, Wilson/Bennett, and Cardinal Statutory Trust I. Virtuallyall of our cash revenues will result from dividends paid to us by our banksubsidiary and interest earned on short term investments. Our bank subsidiaryis subject to laws and regulations that limit the amount of dividends that itcan pay. Under Virginia law, a bank may not declare a dividend in excess of itsaccumulated retained earnings. Additionally, our bank subsidiary may notdeclare a dividend if the total amount of all dividends, including the proposeddividend, declared by the bank in any calendar year exceeds the total of thebank’s retained net income of that year to date, combined with its retained netincome of the two preceding years, unless the dividend is approved by the FDIC.Our bank subsidiary may not declare or pay any dividend if, after making thedividend, the bank would be “undercapitalized,” as defined in the bankingregulations.

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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. Regulators have indicated that financial holding companiesshould 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. In addition to beinginfluenced by the risk profile of the particular depository institution, FDIC premiumsare also influenced by the size of the FDIC insurance fund in relation to totaldeposits in FDIC insured banks. The FDIC has authority to impose specialassessments.

In February 2006, The Federal Deposit InsuranceReform Act of 2005 and The Federal Deposit Insurance Reform ConformingAmendments Act of 2005 (collectively, “The Reform Act”) was signed into law.This legislation contained technical and conforming changes to implementdeposit insurance reform, as well as a number of study and survey requirements.

The Reform Act provides for the following changes:

·       Mergingthe Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund(“SAIF”) into a new fund, the Deposit Insurance Fund (“DIF”). This change wasmade effective March 31, 2006.

·       Increasingthe coverage limit for retirement accounts to $250,000 and indexing thecoverage limit for retirement accounts to inflation as with the general depositinsurance coverage limit. This change was made effective April 1, 2006.

·       Establishinga range of 1.15 percent to 1.50 percent within which the FDIC Board ofDirectors may set the Designated Reserve Ratio (“DRR”).

·       Allowingthe FDIC to manage the pace at which the reserve ratio varies within thisrange.

1.                 If the reserveratio falls below 1.15 percent—or is expected to within 6 months—the FDIC mustadopt a restoration plan that provides that the DIF will return to 1.15 percentgenerally within 5 years.

2.                 If the reserveratio exceeds 1.35 percent, the FDIC must generally dividend to DIF membershalf of the amount above the amount necessary to maintain the DIF at 1.35percent, unless the FDIC Board, considering statutory factors, suspends thedividends.

3.                 If the reserveratio exceeds 1.5 percent, the FDIC must generally dividend to DIF members allamounts above the amount necessary to maintain the DIF at 1.5 percent.

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·       Eliminating therestrictions on premium rates based on the DRR and granting the FDIC Board thediscretion to price deposit insurance according to risk for all insuredinstitutions regardless of the level of the reserve ratio.

·       Granting a one-time initialassessment credit (of approximately $4.7 billion) to recognize institutions’past contributions to the fund.

·       Requiring the FDIC toconduct studies of three issues: (1) further potential changes to thedeposit insurance system, (2) the appropriate deposit base in designatingthe reserve ratio, and (3) the Corporation’s contingent loss reservingmethodology and accounting for losses.

·       Requiring the ComptrollerGeneral to conduct studies of (1) federal bank regulators’ administrationof the prompt corrective action program and recent changes to the FDIC depositinsurance system, and (2) the organizational structure of the FDIC.

The FDIC is authorized to prohibit any insuredinstitution from engaging in any activity that the FDIC determines byregulation or order to pose a serious threat to the DIF. Also, the FDIC mayinitiate enforcement actions against banks, after first giving the institution’sprimary regulatory authority an opportunity to take such action. The FDIC mayterminate the deposit insurance of any depository institution if it determines,after a hearing, that the institution has engaged or is engaging in unsafe orunsound practices, is in an unsafe or unsound condition to continue operations,or has violated any applicable law, regulation, order or any condition imposedin writing by the FDIC. It also may suspend deposit insurance temporarilyduring the hearing process for the permanent termination of insurance, if theinstitution has no tangible capital. If deposit insurance is terminated, thedeposits at the institution at the time of termination, less subsequentwithdrawals, shall continue to be insured for a period from six months to twoyears, as determined by the FDIC. We are unaware of any existing circumstancesthat could result in termination of any of our bank subsidiary’s depositinsurance.

*Capital Requirements*

Each of the FDIC and the Federal Reserve Board hasissued risk-based and leverage capital guidelines applicable to bankingorganizations that it supervises. Under the risk-based capital requirements, weand our bank subsidiary are each generally required to maintain a minimum ratioof total capital to risk-weighted assets (including specific off-balance sheetactivities, such as standby letters of credit) of 8%. At least half of thetotal capital must be composed of “Tier 1 Capital,” which is defined as commonequity, retained earnings, qualifying perpetual preferred stock and minorityinterests in common equity accounts of consolidated subsidiaries, less certainintangibles. The remainder may consist of “Tier 2 Capital”, which is defined asspecific subordinated debt, some hybrid capital instruments and otherqualifying preferred stock and a limited amount of the loan loss allowance andpretax net unrealized holding gains on certain equity securities. In addition,each of the federal banking regulatory agencies has established minimumleverage capital requirements for banking organizations. Under theserequirements, banking organizations must maintain a minimum ratio of Tier 1capital to adjusted average quarterly assets equal to 3% to 5%, subject tofederal bank regulatory evaluation of an organization’s overall safety andsoundness. In summary, the capital measures used by the federal bankingregulators are:

·       Total Risk-Based Capitalratio, which is the total of Tier 1 Risk-Based Capital (which includes commonshareholders’ equity, trust preferred securities, minority interests andqualifying preferred stock, less goodwill and other adjustments) and Tier 2Capital (which includes preferred stock not qualifying as Tier 1 capital,mandatory convertible debt, limited amounts of subordinated debt, otherqualifying term debt and the allowance for loan losses up to 1.25 percent ofrisk-weighted assets and other adjustments) as a percentage of totalrisk-weighted assets

·       Tier 1 Risk-Based Capitalratio (Tier 1 capital divided by total risk-weighted assets), and

·       the Leverage ratio (Tier 1capital divided by adjusted average total assets)

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Under theseregulations, 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.

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 anyfinancial holding company that controls the institution, requiring divestitureby the institution of its subsidiaries or by the holding company of theinstitution itself, requiring new election of directors, and requiring thedismissal of directors and officers. We are considered “well-capitalized” at December 31,2006 and, in addition, our bank subsidiary maintains sufficient capital toremain in compliance with capital requirements and is considered “well-capitalized”at December 31, 2006.

*Other Safety andSoundness Regulations*

There are significantobligations and restrictions imposed on financial 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 financial holding company orbank which violates the law, engages in an unsafe or unsound banking practice,or which is about to engage in an unsafe or 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 monetarypenalty action. A cease and desist order, in addition to prohibiting certainaction, could also require that certain actions be undertaken. Under thepolicies of the Federal Reserve Board, we are required to serve as a source offinancial strength to our subsidiary depository institution and to commitresources to support the bank in circumstances where we might not do sootherwise.

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*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 of 2001 also requires a financial institution tofollow recently implemented customer identification procedures when openingaccounts for new customers and to review U.S. government-maintained lists ofindividuals and entities that are prohibited from opening accounts at financialinstitutions.

*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 borrowings and changes in reserve requirements against deposits held byfederally 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 and fiscal authorities, includingthe Federal Reserve System, no prediction can be made as to possible futurechanges in interest rates, deposit levels, loan demand or the business andearnings of our bank subsidiary, its subsidiary, or any of our othersubsidiaries.

*Federal ReserveSystem*

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 these reserverequirements. For net transaction accounts in 2007, the first $8.5 million ofbalances will be exempt from reserve requirements. A 3% reserve ratio will beassessed on net transaction account balances over $8.5 million to and including$45.8 million. A 10% reserve ratio will be applied to amounts in nettransaction account balances in excess of $45.8 million. These percentages aresubject to adjustment by the Federal Reserve Board. Because required reservesmust be maintained in the form of vault cash or in a non-interest-bearingaccount at, or on behalf of, a Federal Reserve Bank, the effect of the reserverequirement is to reduce the amount of our interest-earning assets.

*Transactions withAffiliates*

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% of suchcapital stock and surplus, and (ii) require that all such transactions beon terms substantially the same as, or at least as favorable to those that, thebank has provided to a non-affiliate. The term “covered transaction” includesthe making of loans, purchase of assets, issuance of a guarantee and similarother types of transactions. Section 23B applies to “covered 

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transactions”as well as sales of assets and payments of money to an affiliate. Thesetransactions must also be conducted on terms substantially the same as, or atleast favorable to those that, the bank has 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 entities controlled by such person, the bank’s loan-to-one borrowerlimit. Loans in the aggregate to insiders and their related interests as aclass may not exceed two times the bank’s unimpaired capital and unimpairedsurplus until the bank’s total assets equal or exceed $100,000,000, at whichtime the aggregate is limited to the bank’s unimpaired capital and unimpairedsurplus. Section 22(h) also prohibits loans above amounts prescribedby the appropriate federal banking agency to directors, executive officers andprincipal shareholders of a bank or bank holding company, and to entitiescontrolled by such persons, unless such loan is approved in advance by amajority of the board of directors of the bank with any “interested” directornot participating in the voting. The FDIC has prescribed the loan amount, whichincludes all other outstanding loans to such person, as to which such priorboard of director approval is required, as being the greater of $25,000 or 5%of capital and surplus (up to $500,000). Section 22(h) requires thatloans to directors, executive officers and principal shareholders be made onterms and underwriting standards substantially the same as offered incomparable transactions to other persons.

*Community ReinvestmentAct*

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 financial holding company or itsdepository institution 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 financial holding company or any of itssubsidiaries will not be permitted to engage in new activities authorized underthe GLBA if any bank subsidiary received less than a “satisfactory” rating inits latest Community Reinvestment Act examination.

*Consumer LawsRegarding Fair Lending*

In addition to the Community Reinvestment Actdescribed above, other federal and state laws regulate various lending andconsumer aspects of our business. Governmental agencies, including theDepartment of Housing and Urban Development, the Federal Trade Commission andthe Department of Justice, have become concerned that prospective borrowers mayexperience discrimination in their efforts to obtain loans from depository andother lending institutions. These agencies have brought litigation 

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against depositoryinstitutions alleging discrimination against borrowers. Many of these suitshave been settled, in some cases for material sums of money, short of a fulltrial.

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 applicants, but the practice had adiscriminatory effect, unless the practice could be justified as a businessnecessity.

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 covers a broadrange of issues, including a repeal of most of the restrictions on affiliationsamong depository institutions, securities firms and insurance companies. Thefollowing description 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 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.

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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 credit reporting agency,customer account numbers or other similar account identifiers for marketingpurposes. The GLBA also provides that the states may adopt customer privacyprotections 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 stateregulation of financial institutions may change in the future and, as a result,impact our operations. Although Congress and the state legislature in recentyears have sought to reduce the regulatory burden on financial institutionswith respect to the approval of specific transactions, we fully expect that thefinancial institution industry will remain heavily regulated in the near futureand that additional laws or regulations may be adopted further regulatingspecific banking practices.

*AdditionalInformation*

We file with or furnish to the Securities and ExchangeCommission (“SEC”) annual, quarterly and current reports, proxy statements, andvarious other documents under the Securities Exchange Act of 1934, as amended(the “Exchange Act”). The public may read and copy any materials that we file withor furnish to the SEC at the SEC’s Public Reference Room, which is located at100 F Street, NE, Washington, D.C. 20549. The public may obtain information onthe operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.Also, the SEC maintains an internet website at www.sec.gov that containsreports, proxy and information statements and other information regardingregistrants, including us, that file or furnish documents electronically withthe SEC.

We also make available free of charge on or throughour internet website (www.cardinalbank.com) our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-Kand, if applicable, amendments to those reports as filed or furnished pursuantto Section 13(a) of the Exchange Act as soon as reasonablypracticable after we electronically file such materials with, or furnish themto, the SEC.

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**Item 1A.**                RiskFactors

Our operations are subjectto many risks that could adversely affect our future financial condition andperformance and, therefore, the market value of our securities. The riskfactors applicable to us are the following:

***Our mortgage bankingrevenue is sensitive to changes in economic conditions, decreased economicactivity, a slowdown in the housing market or higher interest rates and mayadversely impact our profits.***

Our Mortgage Bankingsegment is a significant portion of our consolidated business and maintainingour revenue stream in this segment is dependent upon our ability to originateloans and sell them to investors. Loan production levels are sensitive tochanges in economic conditions and can suffer from decreased economic activity,a slowdown in the housing market or higher interest rates. Generally, anysustained period of decreased economic activity or higher interest rates couldadversely affect our mortgage originations and, consequently, reduce our incomefrom mortgage banking activities. As a result, these conditions may adverselyaffect our net income.

***We have goodwill and other intangibles that may becomeimpaired, and thus result in a charge against earnings.***

At December 31, 2006, we had $12.9 million and$2.7 million of goodwill related to the George Mason and Wilson/Bennettacquisitions, respectively. In addition, we have identified and recorded otherintangible assets, such as customer relationships and trade names, as of theacquisition dates of both George Mason and Wilson/Bennett. The carrying amountsof these intangibles at December 31, 2006 was $1.3 million at George Masonand $217,000 at Wilson/Bennett. Goodwill and other intangibles are tested forimpairment on an annual basis or when facts and circumstances indicate thatimpairment may have occurred.

As noted above, our Mortgage Banking segment issensitive to changes in economic conditions, decreased economic activity, aslowdown in the housing market and higher interest rates. In addition todirectly impacting our revenues and net income, these conditions, if sustained,may result in an impairment charge related to the goodwill and otherintangibles at George Mason if we determine the carrying value of the goodwilland other intangible assets is greater than their fair value.

When we acquired Wilson/Bennett, it had approximately$225.0 million of assets under management. In July 2006, we announced theretirement of John W. Fisher, Wilson/Bennett’s founder, Chief Executive Officerand President, from Wilson/Bennett and as a member of our board of directors asof September 30, 2006. During the third quarter of 2006 and as Mr. Fishertransitioned out of his involvement with Wilson/Bennett, several significantclients unexpectedly either terminated or advised us that they intended toterminate their asset management contracts, and this triggered an evaluation ofour goodwill and intangible assets. Accordingly, we updated our analysis of thefair value of the goodwill and intangible assets associated with our acquisitionof Wilson/Bennett. The updated analysis indicated an impairment to the goodwilland certain customer relationships and Mr. Fisher’s employment agreement. Werecorded a non-cash impairment loss totaling $2.9 million pretax, and $1.9million after tax, during the quarter ended September 30, 2006.

As of December 31,2006, assets under management were approximately $114.1 million. Significantfurther declines of the assets managed by Wilson/Bennett as a result ofadditional losses in its client base, may result in an impairment condition,which would require a charge against future earnings.

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

We are headquartered inNorthern Virginia, and our market is the greater Washington, D.C. metropolitanarea. Because our lending and deposit-gathering activities are concentrated inthis market, we will be affected by the general economic conditions in thegreater Washington area, which may, among other factors, be impacted by thelevel of federal government spending. Changes in the economy, and governmentspending in particular, may influence the growth rate of our loans anddeposits, 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 which are beyond our control wouldimpact these local economic conditions and the demand for banking products andservices generally, and could negatively affect our financial condition and performance.

***We may not be ableto successfully manage our growth or implement our growth strategies, which mayadversely affect our results of operations 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:

·       opennew branch offices or acquire existing branches or other financialinstitutions;

·       attractdeposits to those locations and cross-sell new and existing depositorsadditional products and services; and

·       identifyattractive loan and investment opportunities.

We may not be able to successfully implement ourgrowth strategy if we are unable to identify attractive markets, locations oropportunities to expand. Our ability to successfully manage our growth willalso depend upon our ability to maintain capital levels sufficient to supportthis growth, maintain effective cost controls and adequate asset quality such thatearnings are not adversely impacted to a material degree.

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 onour management team and the unexpected loss of any of those personnel couldadversely affect our operations; we depend on our ability to attract and retainkey 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 and Chief ExecutiveOfficer, Bernard H. Clineburg, and our other executive and senior lendingofficers. We have entered into employment agreements with Mr. Clineburgand three other executive officers. The existence of such agreements, however,does not necessarily assure us that we will be able to continue to retain theirservices. The unexpected loss of Mr. Clineburg or other key employeescould have a significant adverse effect on our business and possibly result inreduced revenues and earnings. We maintain bank owned life insurance policieson all of our corporate 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 asdevelop new financial products and services. Many experienced bankingprofessionals employed by our competitors are covered 

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byagreements not to compete or solicit their existing customers if they were toleave their current employment. These agreements make the recruitment of theseprofessionals more difficult. While we have been recently successful inacquiring what we consider to be talented banking professionals, the market fortalented people is competitive and we may not continue to be successful in attracting,hiring, motivating or retaining experienced banking professionals.

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

Our future profitabilitywill substantially depend upon our ability to maintain or increase the spreadbetween the interest rates earned on investments and loans and interest ratespaid on deposits and other interest-bearing liabilities. Changes in interestrates will affect our operating performance and financial condition. Beingliability sensitive as of December 31, 2006, the Bank’s net interestincome should improve in a decreasing rate environment. The shape of the yieldcurve can also impact net interest income. Changing rates will impact how fastour mortgage loans and mortgage backed securities will have the principalrepaid. Rate changes can also impact the behavior of our depositors, especiallydepositors in non-maturity deposits such as demand, interest checking, savingsand money market accounts. While we attempt to minimize our exposure to interestrate risk, we are unable to eliminate it as it is an inherent part of ourbusiness. Our net interest spread will depend on many factors that are partlyor entirely outside our control, including competition, federal economic,monetary and fiscal policies, and industry-specific conditions and economicconditions generally.

***Our concentrationin loans secured by real estate may increase our future credit losses, whichwould negatively affect our financial results.***

We offer a variety ofsecured loans, including commercial lines of credit, commercial term loans,real estate, construction, home equity, consumer and other loans. Approximately90% of our loans are secured by real estate, both residential and commercial,substantially all of which are located in our market area. A major change inthe region’s real estate market, resulting in a deterioration in real estatevalues, or in the local or national economy, including changes caused byraising interest rates, could adversely affect our customers’ ability to paythese loans, which in turn could adversely impact us. Risk of loan defaults andforeclosures are inherent in the banking industry, and we try to limit ourexposure to this risk by carefully underwriting and monitoring our extensionsof credit. We cannot fully eliminate credit risk, and as a result credit lossesmay 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 analysis of the loan portfolio,management determines the adequacy of the allowance for loan losses byconsidering such factors as general and industry-specific market conditions,credit quality of the loan portfolio, the collateral supporting the loans andfinancial performance of our loan customers relative to their financialobligations to us. The amount of future losses is impacted by changes in economic,operating and other conditions, including changes in interest rates, which maybe beyond our control. Actual losses may exceed our current estimates. Rapidlygrowing loan portfolios are, by their nature, unseasoned. Estimating loan lossallowances for an unseasoned portfolio is more difficult than with seasonedportfolios, and may be more susceptible to changes in estimates and to lossesexceeding estimates. Although we believe the allowance for loan losses is areasonable estimate of known and inherent losses in our loan portfolio, wecannot fully predict such losses or assert that our loan loss allowance will beadequate in the future. Future loan losses that are greater than currentestimates could have a material impact on our future financial performance.

Banking regulatorsperiodically review our allowance for loan losses and may require us toincrease our allowance for loan losses or recognize additional loan charge-offs,based on credit judgments different 

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thanthose of our management. Any increase in the amount of our allowance or loanscharged-off as required by these regulatory agencies could have a negativeeffect on our operating results.

***Our future successis dependent on our ability to compete effectively in the highly competitivebanking and financial services industry.***

We face vigorouscompetition from other commercial banks, savings and loan associations, savingsbanks, credit unions, mortgage banking firms, consumer finance companies,securities brokerage firms, insurance companies, money market funds and othertypes of financial institutions for deposits, loans and other financialservices in our market area. A number of these banks and other financial institutionsare significantly larger than we are and have substantially greater access tocapital and other resources, as well as larger lending limits and branchsystems, and offer a wider array of banking services. 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.

***Our profitabilityand the value of any equity investment in us may suffer because of rapid andunpredictable changes in the highly regulated environment in which we operate.***

We are subject toextensive supervision by several governmental regulatory agencies at thefederal and state levels. Recently enacted, proposed and future banking andother legislation and regulations have had, and will continue to have, or mayhave a significant impact on the financial services industry. Theseregulations, which are generally intended to protect depositors and not ourshareholders, and the interpretation and application of them by federal andstate regulators, are beyond our control, may change rapidly and unpredictably,and can be expected to influence our earnings and growth. Our success dependson our continued ability to maintain compliance with these regulations. Many ofthese regulations increase our costs and thus place other financialinstitutions that may not be subject to similar regulation in stronger, morefavorable competitive positions.

***If we needadditional capital in the future to continue our growth, we may not be able toobtain it on terms that are favorable. This could negatively affect ourperformance and the value of our common stock.***

Our business strategycalls for continued growth. We anticipate that we will be able to support thisgrowth through the generation of additional deposits at existing and new branchlocations, as well as expanded loan and other investment opportunities.However, we may need to raise additional capital in the future to support ourcontinued growth and to maintain desired capital levels. Our ability to raisecapital through the sale of additional equity securities or the placement of financialinstruments that qualify as regulatory capital will depend primarily upon ourfinancial condition and the condition of financial markets at that time. We maynot be able to obtain additional capital in the amounts or on termssatisfactory to us. Our growth may be constrained if we are unable to raiseadditional capital as needed.

***We have extendedoff-balance sheet commitments to borrowers which could expose us to credit andinterest rate risk.***

We enter into certainoff-balance sheet arrangements in the normal course of business to meet thefinancing needs of our customers. These off-balance sheet arrangements includecommitments to extend credit, standby letters of credit and guarantees whichwould impact our liquidity and capital resources to the extent customers acceptor use these commitments. These instruments involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized inthe balance sheet. Our exposure to credit loss in the event of nonperformance bythe other party to the financial instrument for commitments to extend creditand standby letters of credit and guarantees written is represented by the 

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contractualor notional amount of those instruments. We use the same credit policies inmaking commitments and conditional obligations as we do for on-balance-sheetinstruments.

**Item 1B.**               UnresolvedStaff Comments

None.

**Item 2.**                        Properties

Cardinal Bank, excluding its George Mason subsidiary,conducts its business from 25 branch offices. Nine of these facilities areowned and 16 are leased. Leased branch banking facilities range in size from457 square feet to 11,182 square feet. Our leases on these facilities expire atvarious dates through 2016, and all but one of our leases have renewal options.The branch that does not have a renewal option is located at the headquarterslocation of George Mason (see below for additional lease information for GeorgeMason). Fifteen 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 seven leasedfacilities which range in size from 1,428 square feet to 22,056 square feet. Theleases have various expiration dates through 2010 and generally do not haverenewal options. George Mason is currently in the process of negotiating athree year lease renewal of its headquarters location which expires onJune 30, 2007.

Wilson/Bennett conducts its business from office spacelocated in our Tysons Corner, Virginia headquarters facility.

Our headquarters facility in Tysons Corner, Virginiacomprises 41,818 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 and various other departments arelocated there.

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

**Item 3.**                        LegalProceedings

In the ordinary course ofour operations, we become party to various legal proceedings. Currently, we arenot party to any material legal proceedings, and no such proceedings are, tomanagement’s knowledge, 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 2006.

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**PART II**

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

*MarketPrice for Common Stock and Dividends.**  *Our common stock is currently listed for quotation onthe Nasdaq Global Select Market under the symbol “CFNL.”  Our common stock had traded on the NasdaqNational Market under the same symbol until July 3, 2006. As of December 31,2006, our common stock was held by 646 shareholders of record. In addition, weestimate that there were 5,235 beneficial owners of our common stock who owntheir shares through brokers or banks.

Thehigh and low sale prices per share for our common stock for each quarter of2006 and 2005 as reported on the market at the time and dividends declaredduring those periods were as follows:

| **Periods Ended** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|------------------------|------------|------------|------------|----------|------------|---------|------------|---------------|------------|
| 2006                   |       |       |       |     |       |    |       |          |       |
| First Quarter          |       | $          | 13.54      |     | $          | 10.62   |       |          | $          | 0.01 |   |   |
| Second Quarter         |       | 13.68      |       | 10.63    |       |    | 0.01       |          |       |
| Third Quarter          |       | 12.01      |       | 10.21    |       |    | 0.01       |          |       |
| Fourth Quarter         |       | 11.17      |       | 9.71     |       |    | 0.01       |          |       |
| 2005                   |       |       |       |     |       |    |       |          |       |
| First Quarter          |       | $          | 11.45      |     | $          | 9.01    |       |          | $          | — |   |   |
| Second Quarter         |       | 9.50       |       | 7.75     |       |    | —     |          |       |
| Third Quarter          |       | 10.60      |       | 8.81     |       |    | —     |          |       |
| Fourth Quarter         |       | 11.79      |       | 8.94     |       |    | 0.01       |          |       |

 

*DividendPolicy.*   The board of directors intends to followa policy of retaining any earnings necessary to operate our business inaccordance with all regulatory policies while maximizing the long-term returnfor the Company’s investors. Our future dividend policy is subject to thediscretion of the board of directors and future dividend payments will dependupon a number of factors, including future earnings, alternative investmentopportunities, financial condition, cash requirements, and general businessconditions.

Our ability to distribute cash dividends will dependprimarily on the ability of our subsidiaries to pay dividends to us. CardinalBank is subject to legal limitations on the amount of dividends it is permittedto pay. Furthermore, neither Cardinal Bank nor we may declare or pay a cashdividend on any of our capital stock if we are insolvent or if the payment ofthe dividend would render us insolvent or unable to pay our obligations as theybecome due in the ordinary course of business. For additional information onthese limitations, see “Government Regulation and Supervision—Payment ofDividends” in Item 1 above.

*Repurchases.*   Wedid not repurchase any of our securities during 2006.

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*StockPerformance Graph.*   The graph set forth belowshows the cumulative shareholder return on the Company’s Common Stock duringthe five-year period ended December 31, 2006, as compared with: (i) anoverall stock market index, the NASDAQ Composite; and (ii) a publishedindustry index, the SNL Bank Index. The stock performance graph assumes that$100 was invested on December 31, 2001 in our common stock and each of thecomparable indices and that dividends were reinvested.

****

| ** **                      | ** ** | **Period Ending** | ** ** |
|---------------------------------|------------|------------------------|------------|
| **Index**                       | ** ** | ** **             | ** ** | **12/31/01** | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
| Cardinal  Financial Corporation |       | $                      | 100.00     |   |   | $ | 68.18 |   |   | $ | 129.62 |   | $ | 174.61 |   | $ | 172.59 |   | $ | 161.39 |   |
| NASDAQ Composite                |       | 100.00                 |       |   | 68.76 |   |   | 103.67 |   | 113.16 |   | 115.57 |   | 127.58 |   |
| SNL Bank Index                  |       | 100.00                 |       |   | 91.69 |   |   | 123.69 |   | 138.61 |   | 140.50 |   | 164.35 |   |
|                                 |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 6.**                        SelectedFinancial Data

**Selected Financial Data**(Inthousands, except per share data)

| ** **                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **Income Statement Data:**                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Interest income                                                  |       | $                                           | 87,401     |   | $ | 67,374 |   | $ | 40,522 |   | $ | 24,602 |   | $ | 20,242 |   |
| Interest expense                                                 |       | 46,047                                      |       | 29,891 |   | 15,969 |   | 9,429 |   | 9,586 |   |
| Net interest  income                                             |       | 41,354                                      |       | 37,483 |   | 24,553 |   | 15,173 |   | 10,656 |   |
| Provision for loan  losses                                       |       | 1,232                                       |       | 2,456 |   | 1,626 |   | 1,001 |   | 444 |   |
| Net interest  income after provision for loan losses             |       | 40,122                                      |       | 35,027 |   | 22,927 |   | 14,172 |   | 10,212 |   |
| Non-interest  income                                             |       | 21,684                                      |       | 24,669 |   | 9,409 |   | 3,829 |   | 2,864 |   |
| Non-interest  expense                                            |       | 51,245                                      |       | 44,653 |   | 27,154 |   | 15,355 |   | 13,605 |   |
| Net income (loss)  before income taxes                           |       | 10,561                                      |       | 15,043 |   | 5,182 |   | 2,646 |   | (529 | ) |
| Provision  (benefit) for income taxes                            |       | 3,173                                       |       | 5,167 |   | 1,713 |   | (3,508 | ) | — |   |
| Net income (loss)                                                |       | 7,388                                       |       | 9,876 |   | 3,469 |   | 6,154 |   | (529 | ) |
| Dividends to  preferred shareholders                             |       | —                                      |       | — |   | — |   | 495 |   | 495 |   |
| Net income (loss)  to common shareholders                        |       | $                                           | 7,388      |   | $ | 9,876 |   | $ | 3,469 |   | $ | 5,659 |   | $ | (1,024 | ) |
| **Balance Sheet Data:**                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Total assets                                                     |       | $                                           | 1,638,429  |   | $ | 1,452,287 |   | $ | 1,211,576 |   | $ | 636,248 |   | $ | 486,323 |   |
| Loans receivable,  net of fees                                   |       | 845,449                                     |       | 705,644 |   | 489,896 |   | 336,002 |   | 249,106 |   |
| Allowance for loan  losses                                       |       | 9,638                                       |       | 8,301 |   | 5,878 |   | 4,344 |   | 3,372 |   |
| Loans held for  sale                                             |       | 338,731                                     |       | 361,668 |   | 365,454 |   | — |   | — |   |
| Total investment  securities                                     |       | 329,296                                     |       | 294,224 |   | 289,507 |   | 273,614 |   | 163,665 |   |
| Total deposits                                                   |       | 1,218,882                                   |       | 1,069,872 |   | 824,210 |   | 474,129 |   | 423,479 |   |
| Other borrowed  funds                                            |       | 194,631                                     |       | 155,421 |   | 201,085 |   | 74,457 |   | 2,000 |   |
| Total shareholders’  equity                                 |       | 155,873                                     |       | 147,879 |   | 95,105 |   | 85,412 |   | 40,712 |   |
| Preferred shares  outstanding                                    |       | —                                      |       | — |   | — |   | 1,364 |   | 1,365 |   |
| Common shares  outstanding                                       |       | 24,459                                      |       | 24,363 |   | 18,463 |   | 16,377 |   | 10,044 |   |
| **Per Common Share Data:**                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic net income  (loss)                                         |       | $                                           | 0.30       |   | $ | 0.45 |   | $ | 0.19 |   | $ | 0.55 |   | $ | (0.13 | ) |
| Fully diluted net  income (loss)                                 |       | 0.30                                        |       | 0.44 |   | 0.19 |   | 0.54 |   | (0.13 | ) |
| Book value                                                       |       | 6.37                                        |       | 6.07 |   | 5.15 |   | 4.80 |   | 3.37 |   |
| Tangible book  value (1)                                         |       | 5.75                                        |       | 5.37 |   | 4.41 |   | 5.24 |   | 3.76 |   |
| **Performance Ratios:**                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Return on average  assets                                        |       | 0.51                                        | %          | 0.74 | % | 0.37 | % | 1.18 | % | (0.14 | ) |
| Return on average  equity                                        |       | 4.87                                        |       | 7.67 |   | 3.69 |   | 13.84 |   | (1.61 | ) |
| Net interest  margin (2)                                         |       | 2.98                                        |       | 2.92 |   | 2.72 |   | 3.00 |   | 2.92 |   |
| Efficiency ratio  (3) (4)                                   |       | 77.70                                       |       | 71.84 |   | 79.95 |   | 80.81 |   | 100.63 |   |
| Non-interest  income to average assets                           |       | 1.49                                        |       | 1.85 |   | 1.00 |   | 0.73 |   | 0.74 |   |
| Non-interest  expense to average assets                          |       | 3.52                                        |       | 3.35 |   | 2.90 |   | 2.94 |   | 3.50 |   |
| Loans receivable,  net of fees to total deposits                 |       | 69.36                                       |       | 65.96 |   | 59.44 |   | 70.87 |   | 58.82 |   |
| **Asset Quality Ratios:**                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Net charge-offs to  average loans receivable, net of fees        |       | 0.00                                        | %          | 0.01 | % | 0.02 | % | 0.01 | % | 0.05 | % |
| Nonperforming  loans to loans receivable, net of fees            |       | 0.01                                        |       | 0.03 |   | 0.11 |   | 0.12 |   | 0.39 |   |
| Nonperforming  loans to total assets                             |       | 0.01                                        |       | 0.01 |   | 0.05 |   | 0.06 |   | 0.20 |   |
| Allowance for loan  losses to nonperforming loans                |       | 11,822.87                                   |       | 3,879.00 |   | 1,074.60 |   | 1,102.54 |   | 345.49 |   |
| Allowance for loan  losses to loans receivable, net of fees      |       | 1.14                                        |       | 1.18 |   | 1.20 |   | 1.29 |   | 1.35 |   |
| **Capital Ratios:**                                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Tier 1 risk-based  capital                                       |       | 13.25                                       | %          | 14.83 | % | 12.65 | % | 19.66 | % | 12.25 | % |
| Total risk-based  capital                                        |       | 14.06                                       |       | 15.65 |   | 13.40 |   | 20.66 |   | 13.35 |   |
| Leverage capital  ratio                                          |       | 10.68                                       |       | 10.71 |   | 8.83 |   | 15.45 |   | 8.97 |   |
| **Other:**                                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Average  shareholders’ equity to average total assets       |       | 10.43                                       | %          | 9.66 | % | 10.05 | % | 7.84 | % | 8.45 | % |
| Average loans  receivable, net of fees to average total deposits |       | 68.42                                       |       | 60.34 |   | 59.97 |   | 63.02 |   | 59.36 |   |
| Average common shares  outstanding:                              |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                            |       | 24,424                                      |       | 22,113 |   | 18,448 |   | 10,218 |   | 7,949 |   |
| Diluted                                                          |       | 24,987                                      |       | 22,454 |   | 18,705 |   | 11,468 |   | 7,949 |   |

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(1)             Tangible book value is calculated as totalshareholders’ equity, excluding accumulated other comprehensive income, lessgoodwill and other intangible assets, divided by common shares outstanding.

(2)             Net interest margin is calculated as netinterest income divided by total average earning assets and reported on a taxequivalent basis at a rate of 35%.

(3)             Efficiency ratio is calculated as totalnon-interest expense (excluding impairment losses) divided by the total of netinterest income and non-interest income (excluding recovery of impairedinvestment).

(4)             The calculation of the efficiency ratio,which is a financial measure not prepared in accordance with generally acceptedaccounting principles (“GAAP”), and a reconciliation of the efficiency ratio toour GAAP financial information are included in our Table 1 to Item 7 to thisAnnual Report on Form 10-K.

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

The following presentsmanagement’s discussion and analysis of our consolidated financial condition atDecember 31, 2006 and 2005 and the results of our operations for the yearsended December 31, 2006, 2005 and 2004. The discussion should be read inconjunction with the consolidated financial statements and related notesincluded in this report.

**Caution AboutForward-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 forward-lookingstatements are subject to significant uncertainties because they are based uponor 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 the successful management of interest rate risk;

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

·       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;

·       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;

·       risksand uncertainties related to future trust operations, including our ability tosuccessfully integrate trust operations into the organization;

·       changesin operations of Wilson/Bennett Capital Management, Inc., its customerbase and assets under management and any associated impact on the fair value ofgoodwill in the future;

·       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” in Item 1A 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.

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**Overview**

We are a locally managed financial holding companyheadquartered in Tysons Corner, Virginia, committed to providing superiorcustomer service, a diversified mix of financial products and services, andconvenient banking to our retail and business consumers. We own Cardinal Bank(the “Bank”), a Virginia state-chartered community bank, Cardinal WealthServices, Inc. (“CWS”), an investment services subsidiary, andWilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), an assetmanagement firm acquired in June 2005. Through these three subsidiariesand George Mason Mortgage, LLC (“George Mason”), a mortgage banking subsidiaryof the Bank, we offer a wide range of traditional banking products and servicesto both our commercial and retail customers. Our commercial relationshipmanagers focus on attracting small and medium sized businesses as well asgovernment contractors, commercial real estate developers and builders and professionals,such as physicians, accountants and attorneys. We have 25 branch officelocations and seven mortgage banking office locations and provide competitiveproducts and services. We complement our core banking operations by offering afull range of investment products and services to our customers through ourthird-party brokerage relationship with Raymond James Financial Services, Inc.and asset management services through Wilson/Bennett.

On June 9, 2005, we acquired Wilson/Bennett for atotal consideration of $6.5 million, which consisted of a payment of $1.5million in cash and the issuance of 611,111 shares of our common stock, whichwe valued at $4.9 million. Wilson/Bennett’s assets and liabilities wererecorded at fair value as of the purchase date. This transaction resulted inthe recognition of $3.6 million of goodwill and $2.6 million of otherintangible assets. Wilson/Bennett uses a value-oriented approach that focuseson large capitalization stocks. Wilson/Bennett’s primary source of revenue ismanagement fees earned on the assets it manages for its customers. Thesemanagement fees are generally based upon the market value of managed andcustodial assets and, accordingly, revenues from Wilson/Bennett will be,assuming a consistent customer base, more when appropriate indices, such as theS&P 500, are higher and lower when such indices are depressed.

On February 9, 2006, we acquired certainfiduciary and other assets and assumed certain liabilities of FBR NationalTrust Company, formerly a subsidiary of Friedman, Billings, Ramsey Group, Inc.Our new trust division acts as trustee or custodian for assets in excess of $6billion as of February 28, 2007. Services provided by this divisioninclude trust, estates, custody, investment management, escrows, and retirementplans. This acquisition did not have a significant impact on operating resultsfor the year ended December 31, 2006. The trust division is included,along with CWS and Wilson/Bennett, in the Wealth Management and Trust Servicessegment. In prior periods, this segment was called Investment Services or Trustand Investment Services.

In July 2006, we announced the retirement of JohnW. Fisher, Wilson/Bennett’s founder, Chief Executive Officer and President,from Wilson/Bennett and as a member of our board of directors as of September 30,2006. As Mr. Fisher transitioned out of his involvement withWilson/Bennett, several significant clients unexpectedly either terminated oradvised us that they intended to terminate their asset management contractsduring the third quarter. This triggered an evaluation of our goodwill andintangible assets. Accordingly, we updated our analysis of the fair value ofthe goodwill and intangible assets associated with our acquisition ofWilson/Bennett. The updated analysis indicated an impairment to the goodwilland certain customer relationships and Mr. Fisher’s employment agreement. Werecorded a non-cash impairment loss totaling $2.9 million pretax, and $1.9million after tax, during the quarter ended September 30, 2006.

Since Mr. Fisher’s retirement announcement,Wilson/Bennett has added experienced portfolio managers and professional salesstaff to assist with cross-sell opportunities with our other divisions. We willcontinue to monitor the operations of Wilson/Bennett, its customer base andmanaged and custodial assets and any associated impact on goodwill and theremaining intangible assets in the future.

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On July 7, 2004, we acquired George Mason in acash transaction for $17.0 million. This transaction resulted in therecognition of $12.9 million of goodwill and $1.7 million of amortizableintangible assets. This transaction was accounted for as a purchase, and GeorgeMason’s assets and liabilities were recorded at fair value as of the purchasedate and its operating results are included in our consolidated results sincethe date of the acquisition. George Mason, based in Fairfax, Virginia, engagesprimarily in the origination and acquisition of residential mortgages for saleinto the secondary market on a best efforts basis through seven brancheslocated throughout the metropolitan Washington, D.C. region. George Mason doesbusiness in eight states, primarily Virginia and Maryland, and the District ofColumbia. George Mason is one of the largest residential mortgage originatorsin the greater Washington metropolitan area, generating originations ofapproximately $3.0 billion and $4.3 billion of loans in 2006 and 2005,respectively, excluding advances on construction loans and including loanspurchased from other mortgage banking companies which are owned by local homebuilders but managed by George Mason. George Mason’s primary sources of revenueinclude net interest income earned on loans held for sale, gains on sales ofloans and contractual management fees earned relating to services provided toother mortgage companies owned by local home builders. Loans are made pursuantto purchase commitments and are sold servicing released.

George Mason also offers a construction-to-permanentloan program. This program provides variable rate financing for customers toconstruct their residences. Once the home has been completed, the loan convertsto fixed rate financing and is sold into the secondary market. Theseconstruction-to-permanent loans generate fee income as well as net interestincome for George Mason and are classified as loans held for sale.

George Mason’s business is both cyclical and seasonal.The cyclical nature of its business is influenced by, among other factors, thelevels of and trends in mortgage interest rates, national and local economicconditions and consumer confidence in the economy. Historically, George Masonhas its lowest levels of quarterly loan closings during the first quarter ofthe year.

In July 2004, we formed a wholly-owned subsidiary,Cardinal Statutory Trust I, for the purpose of issuing $20.0 million offloating rate junior subordinated deferrable interest debentures (“trustpreferred securities”). These trust preferred securities are due in 2034 andpay interest at a rate equal to LIBOR (London Interbank Offered Rate) plus2.40%, which adjusts quarterly. These securities are redeemable at par beginning September 2009. Undercertain qualifying events, these securities are redeemable at a premium throughMarch 2008 and at par thereafter. The interest rate on this debtwas 7.76% at December 31, 2006. We have guaranteed payment of thesesecurities. The $20.6 million payable by us to Cardinal Statutory Trust I isincluded in other borrowed funds in the consolidated statements of conditionsince Cardinal Statutory Trust I is an unconsolidated subsidiary as we are notthe primary beneficiary of this entity. We utilized the proceeds from theissuance of the trust preferred securities to make a capital contribution intothe 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 exposure to maximize, and concurrently stabilize, netinterest income. We do this by monitoring our liquidity position and the spreadbetween the interest rates earned on interest-earning assets and the interestrates paid on interest-bearing liabilities. We attempt to minimize our exposureto interest rate risk, but are unable to eliminate it entirely.  In addition to management of interest raterisk, we also analyze our loan portfolio for exposure to credit risk. Loandefaults and foreclosures are inherent risks in the banking industry and weattempt to limit our exposure to these risks by carefully underwriting and thenmonitoring our extensions of credit. In addition to net interest income,non-interest income is an increasingly important source of revenue for us andincludes, among other things, service charges on deposits and loans, investmentfee income and gains and losses on sales of investment securitiesavailable-for-sale, gains on sales of loans and management fee income.

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Netinterest income and non-interest income represented the following percentagesof total revenue for the three years ended December 31, 2006:

| ** ** | ** ** | **Net Interest  Income** | ** ** | **Non-Interest  Income** | ** ** |
|------------|------------|-------------------------------|------------|--------------------------|------------|
| 2006       |       |                          | 65.6       | %                        |       |   | 34.4 | % |   |
| 2005       |       |                          | 60.3       | %                        |       |   | 39.7 | % |   |
| 2004       |       |                          | 72.3       | %                        |       |   | 27.7 | % |   |

 

Non-interest income is a larger percentage of ourtotal revenue in 2005 than 2004 primarily because we owned George Mason for afull year in 2005 compared to approximately a half year in 2004. Non-interestincome is a lower percentage of our total revenue in 2006 than 2005 becausemortgage originations were lower due to the cyclical nature of the business.

Our business strategy isto grow through regional expansion, while maintaining strong asset quality andachieving increased profitability. We completed a secondary common stockoffering that raised $39.8 million in capital during the second quarter of 2005.This capital is being used to support our continuing expansion and balancesheet growth. As a result of this increased capital and retained earnings, weincreased our legal lending limit to $21.3 million as of December 31,2006, which allows us to expand our commercial and real estate loan portfolios.

**FinancialDevelopments**

The year ended December 31, 2006 was our fourthconsecutive year of profitability. For the year, we reported net income of $7.4million. George Mason contributed $1.9 million to consolidated net incomeduring 2006. Wilson/Bennett was included in our operating results for the fullyear and, as a result of the previously mentioned impairment charge recordedduring the third quarter of 2006, recorded a net loss of $2.1 million. Thetrust division was included in our operating results since February 9,2006, the date of its acquisition, and contributed $178,000 of pretax income. Totalassets increased by $186.1 million in 2006, from $1.45 billion at December 31,2005, to $1.64 billion at December 31, 2006. Total loans receivable, netof deferred fees and costs, increased to $845.4 million at December 31,2006, compared to $705.6 million at December 31, 2005, an increase of$139.8 million. Total deposits increased by $149.0 million in 2006, from $1.07billion at December 31, 2005, to $1.22 billion at December 31, 2006.

For the year ended December 31, 2005, we reportednet income of $9.9 million. George Mason was included in our operating resultsfor the full year and contributed $6.7 million to consolidated net incomeduring 2005. Wilson/Bennett was included in our operating results since June 9,2005, the date of its acquisition, and contributed $107,000 of pretax income. Totalassets increased by $240.7 million in 2005, from $1.21 billion at December 31,2004, to $1.45 billion at December 31, 2005. Total loans receivable, netof deferred fees and costs, increased to $705.6 million at December 31,2005, compared to $489.9 million at December 31, 2004, an increase of$215.7 million. Total deposits increased by $245.7 million in 2005, from $824.2million at December 31, 2004, to $1.07 billion at December 31, 2005.

For the year ended December 31,2004, we had net income of $3.5 million, or $0.19 per diluted common share. GeorgeMason was included in our operating results since July 7, 2004 andcontributed approximately $1.4 million to consolidated net income during 2004.

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**Critical AccountingPolicies**

*General*

U.S. generally acceptedaccounting principles are complex and require management to apply significantjudgment to various accounting, reporting, and disclosure matters. Managementmust use assumptions, judgments, and estimates when applying these principleswhere precise measurements are not possible or practical. These policies arecritical because they are highly dependent upon subjective or complexjudgments, assumptions and estimates. Changes in such judgments, assumptionsand estimates may have a significant impact on the consolidated financialstatements. Actual results, in fact, could differ from initial estimates.

The accounting policies weview as critical are those relating to judgments, assumptions and estimatesregarding the determination of the allowance for loan losses, accounting foreconomic hedging activities, accounting for business combinations andimpairment testing of goodwill, accounting for the impairment of intangibleassets, and the valuation of deferred tax assets.

*Allowance for Loan Losses*

We maintain the allowancefor loan losses at a level that represents management’s best estimate of knownand inherent losses in our loan portfolio. Both the amount of the provisionexpense and the level of the allowance for loan losses are impacted by manyfactors, including general and industry-specific economic conditions, actualand expected credit losses, historical trends and specific conditions of theindividual borrowers. Unusual and infrequently occurring events, such ashurricanes and other weather-related disasters, may impact our assessment ofpossible credit losses. As a part of our analysis, we use comparative peergroup data and qualitative factors, such as levels of and trends indelinquencies and non-accrual loans, national and local economic trends andconditions and concentrations of loans exhibiting similar risk profiles tosupport our estimates.

For purposes of ouranalysis, we categorize our loans into one of five categories:  commercial and industrial, commercial realestate (including construction), home equity lines of credit, residentialmortgages, and consumer loans. In the absence of meaningful historical lossfactors, peer group loss factors are applied and are adjusted by thequalitative factors mentioned above. The indicated loss factors resulting fromthis analysis are applied for each of the five categories of loans. Inaddition, we individually assign loss factors to all loans that have beenidentified as having loss attributes, as indicated by deterioration in thefinancial condition of the borrower or a decline in underlying collateral valueif the loan is collateral dependent. Since we have limited historical data onwhich to base loss factors for classified loans, we apply, in accordance withregulatory guidelines, a 5% loss factor to all loans classified as specialmention, a 15% loss factor to all loans classified as substandard and a 50%loss factor to all loans classified as doubtful. Loans classified as loss loansare fully reserved or charged off.

Credit losses are aninherent part of our business and, although we believe the methodologies fordetermining the allowance for loan losses and the current level of theallowance are adequate, it is possible that there may be unidentified losses inthe portfolio at any particular time that may become evident at a future datepursuant to additional internal analysis or regulatory comment. Additionalprovisions for such losses, if necessary, would be recorded in the CommercialBanking or Mortgage Banking segments, as appropriate, and would negativelyimpact earnings.

*Accounting for Economic Hedging Activities*

We account for ourderivatives and hedging activities in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 133, *Accounting for DerivativeInstruments and Certain Hedging Activities*, as amended, whichrequires that all derivative instruments be recorded on the statement of 

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conditionat their fair values. We do not enter into derivative transactions forspeculative purposes. For derivatives designated as hedges, wecontemporaneously document the hedging relationship, including the riskmanagement objective and strategy for undertaking the hedge, how effectivenesswill be assessed at inception and at each reporting period and the method formeasuring ineffectiveness. We evaluate the effectiveness of these transactionsat inception and on an ongoing basis. Ineffectiveness is recorded throughearnings. For derivatives designated as cash flow hedges, the fair valueadjustment is recorded as a component of other comprehensive income, except forthe ineffective portion. For derivatives designated as fair value hedges, thefair value adjustments for both the hedged item and the hedging instrument arerecorded through the income statement with any difference considered theineffective portion of the hedge.

In the normal course ofbusiness, we enter into contractual commitments, including rate lockcommitments, to finance residential mortgage loans. These commitments, whichcontain fixed expiration dates, offer the borrower an interest rate guaranteeprovided the loan meets underwriting guidelines and closes within the timeframeestablished by us. Interest rate risk arises on these commitments andsubsequently closed loans if interest rates change between the time of theinterest rate lock and the delivery of the loan to the investor. Loancommitments related to residential mortgage loans intended to be sold areconsidered derivatives and are marked to market through earnings.

To mitigate the effect ofinterest rate risk inherent in providing rate lock commitments, we economicallyhedge our commitments by entering into best efforts delivery forward loan salescontracts. During the rate lock commitment period, these forward loan salescontracts are marked to market through earnings and are not designated asaccounting hedges under SFAS No. 133, as amended. The fair values of loancommitments and the fair values of forward loan sales contracts generally movein opposite directions, and the net impact of changes in these valuations onnet income during the loan commitment period is generally inconsequential. Atthe closing of the loan, the loan commitment derivative expires and we record aloan held for sale and continue to be obligated under the same forward loansales contract. Loans held for sale are accounted for at the lower of cost ormarket in accordance with SFAS No. 65, *Accounting for CertainMortgage Banking Activities*. Prior to October 1, 2005, thechanges in value of the forward loan sales contracts from the date the loanclosed to the date it was sold to an investor were marked to market throughearnings. On October 1, 2005, we began designating our forward salescontracts as hedges to mitigate the variability in cash flow to be receivedfrom the sale of mortgage loans.

We discontinue hedgeaccounting prospectively, when it is determined that the derivative is no longerhighly effective in offsetting changes in anticipated cash flows of the loansheld for sale. In situations in which hedge accounting is discontinued, wecontinue to carry the derivative at its fair value on the statement ofcondition and recognize any subsequent changes in its fair value in earnings. Whenhedge accounting is discontinued because it is probable an anticipated loansale will not occur, we recognize immediately in earnings any gains and lossesthat were accumulated in other comprehensive income.

*Accounting for Business Combinations and ImpairmentTesting of Goodwill*

We account foracquisitions of other businesses in accordance with SFAS No. 141, *Business Combinations*. This statement mandates the use ofpurchase accounting and, accordingly, assets and liabilities, includingpreviously unrecorded assets and liabilities, are recorded at fair values as ofthe acquisition date. We utilize a variety of valuation methods to estimatefair value of acquired assets and liabilities. These methodologies are oftenbased upon assumptions and estimates which may change at a future date andrequire that the carrying amount of assets and liabilities acquired beadjusted. To support our purchase allocations, we have utilized independentconsultants to identify and value identifiable purchased intangibles. Thedifference between the fair value of assets acquired and the liabilitiesassumed is recorded as goodwill. Goodwill and any other intangible assets areaccounted for in accordance with SFAS 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.

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To test goodwill forimpairment, we perform an analysis to compare the fair value of the reportingunit to which the goodwill is assigned to the carrying value of the reportingunit. We make estimates of the discounted cash flows from the expected future operationsof the reporting unit. If the analysis indicates that the fair value of thereporting unit is less than its carrying value, we do an analysis to comparethe implied fair value of the reporting unit’s goodwill with the carryingamount of that goodwill. The implied fair value of the goodwill is determinedby allocating the fair value of the reporting unit to all its assets andliabilities. If the implied fair value of the goodwill is less than thecarrying value, an impairment loss is recognized.

*Accounting for theImpairment of Intangible Assets*

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, we continually review our long-lived assets forimpairment whenever events or changes in circumstances indicate that theremaining estimated useful life of such assets might warrant revision or thatthe balances may not be recoverable. We evaluate possible impairment bycomparing estimated future cash flows, before interest expense and on anundiscounted basis, with the net book value of long-term assets, includingamortizable intangible assets. If undiscounted cash flows are insufficient torecover assets, further analysis is performed in order to determine the amountof the impairment.

An impairment loss isrecognized for the excess of the carrying amount of the assets over their fairvalues. Fair value is usually determined based on the present value ofestimated expected future cash flows using a discount rate commensurate withthe risks involved.

*Valuation of DeferredTax Assets*

We record a provision forincome tax expense based on the amounts of current taxes payable or refundableand the change in net deferred tax assets or liabilities during the year. Deferredtax assets and liabilities are recognized for the tax effects of differingcarrying values of assets and liabilities for tax and financial statementpurposes that will reverse in future periods. When substantial uncertaintyexists concerning the recoverability of a deferred tax asset, the carryingvalue of the asset is reduced by a valuation allowance. The amount of anyvaluation allowance established is based upon an estimate of the deferred taxasset that is more likely than not to be recovered.  Increases or decreases in the valuationallowance result in increases or decreases to the provision for income taxes.

**New FinancialAccounting Standards**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, *Share-BasedPayment.*This statement requires that companies recognize in theincome statement the grant-date fair value of stock options and otherequity-based compensation. We applied this standard beginning January 1,2006. This statement requires that stock awards be classified as either anequity award or a liability award. Equity classified awards are valued as ofthe grant date using either an observable market price or a valuationmethodology. Liability classified awards are valued at fair value as of eachreporting date. We adopted SFAS No. 123R using the modified prospectiveapplication method which requires, among other things, that we recognizecompensation cost for all awards outstanding at January 1, 2006 for whichthe requisite service had not been rendered. All of our unvested stock optionsare classified as equity awards.

On July 13, 2006, the FASB issued Interpretation No. 48(“FIN No. 48”), *Accounting for Uncertaintyin Income Taxes: an interpretation of FASB Statement No. 109.*This interpretation clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements in accordance with SFAS No. 109,*Accounting for Income Taxes.* FIN No. 48 prescribes arecognition threshold and measurement principles for financial statementdisclosure of tax positions taken or expected to be taken on a tax return. 

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This interpretation iseffective for fiscal years beginning after December 15, 2006. We do not expect the adoption of this standardto have a material impact on our consolidated financial position or results ofoperations.

In September 2006, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB No. 108”).SAB No. 108 discusses the process of quantifying financial statementmisstatements to determine if any restatement of prior financial statements isrequired. The statement addresses the two techniques commonly used in practicein accumulating and quantifying misstatements, and requires that the techniquewith the most severe result be used in determining whether a misstatement ismaterial. SAB No. 108 was effective for fiscal years ending after November 15,2006. We adopted this standard during 2006. See Note 25 in the Notes toConsolidated Financial Statements in Item 8 below for information related tothe adoption of this standard and the impact on our consolidated financialposition and results of operations at and for the year ended December 31,2006.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements.*SFAS No. 157defines fair value, establishes a framework for measuring fair value inaccordance with U.S. generally accepted accounting principles, and expandsdisclosures about fair value measurements. The statement clarifies that theexchange price is the price in an orderly transaction between marketparticipants to sell an asset or transfer a liability at the measurement date. Thestatement emphasizes that fair value is a market-based measurement and not anentity-specific measurement. It also establishes a fair value hierarchy used infair value measurements and expands the required disclosures of assets andliabilities measured at fair value. This standard is effective for fiscal yearsbeginning after December 15, 2007. The adoption of this standard is notexpected to have a material impact on our consolidated financial position orresults of operations.

In September 2006, the FASB issued SFAS No. 158,*Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans.*SFAS No. 158 amends SFAS Nos.87, 88, 106 and 132R. SFAS No. 158 requires an employer to recognize inits statement of financial position an asset for a plan’s overfunded status ora liability for a plan’s underfunded status. Secondly, it requires employers tomeasure the plan assets and obligations that determine its funded status as ofthe end of the fiscal year. Lastly, employers are required to recognize changesin the funded status of a defined benefit postretirement plan in the year thatthe changes occur with the changes reported in comprehensive income. Thestandard was effective for fiscal years ending after December 15, 2006.Adoption of this standard did not have a material impact on our consolidatedfinancial position or results of operations.

In February 2007, theFASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities—including anamendment of FAS 115*.SFAS No. 159 allows entities to choose, at specified election dates, tomeasure eligible financial assets and liabilities at fair value that are nototherwise required to be measured at fair value. If a company elects the fairvalue option for an eligible item, changes in that item’s fair value insubsequent reporting periods must be recognized in current earnings. SFAS No. 159also establishes presentation and disclosure requirements designed to drawcomparison between entities that elect different measurement attributes forsimilar assets and liabilities. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. Early adoption is permitted subject tospecific requirements outlined in the new standard. We will evaluate this standard to determine the impact, ifany, on our consolidated financial position or results of operations.

**Financial Overview**

***2006 Compared to 2005***

At December 31, 2006, total assets were $1.64billion, an increase of 12.8%, or $186.1 million, from $1.45 billion at December 31,2005. Total loans receivable, net of deferred fees and costs, increased 19.8%,or $139.8 million, to $845.4 million at December 31, 2006, from $705.6million at December 31, 2005. Total investment securities increased by$35.1 million, or 11.9%, to $329.3 million at December 31, 2006, from 

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$294.2 million at December 31,2005. Total deposits increased 13.9%, or $149.0 million, to $1.22 billionat December 31, 2006, from $1.07 billion at December 31, 2005. Otherborrowed funds, which primarily include repurchase agreements, FHLB advancesand our payable to Cardinal Statutory Trust I, increased $39.2 million to$194.6 million at December 31, 2006, from $155.4 million at December 31,2005. Our balance sheet growth is a result of our continued increase in marketshare in our designated market area, additional branch locations and theaddition of experienced banking professionals during 2006.

Shareholders’ equity at December 31, 2006 was$155.9 million, an increase of $8.0 million from $147.9 million at December 31,2005. The increase in shareholders’ equity was primarily attributable to netincome of $7.4 million for the year ended December 31, 2006. Totalshareholders’ equity to total assets at December 31, 2006 and 2005 was9.5% and 10.2%, respectively. Book value per share at December 31, 2006and 2005 was $6.37 and $6.07, respectively. Total risk-based capital torisk-weighted assets was 14.06% at December 31, 2006 compared to 15.65% atDecember 31, 2005. Accordingly, the Company was considered “wellcapitalized” for regulatory purposes at December 31, 2006.

We recorded net income of$7.4 million, or $0.30 per diluted common share, for the year ended December 31,2006, compared to net income of $9.9 million, or $0.44 per diluted commonshare, in 2005. The decrease in net income for the year ended December 31,2006 compared to the same period of 2005 is primarily a result of theimpairment charges to the goodwill and certain other intangible assets relatedto our acquisition of Wilson/Bennett. In July 2006, we announced the retirementof John W. Fisher, Wilson/Bennett’s founder, Chief Executive Officer andPresident, from Wilson/Bennett and as a member of our Board of Directors as ofSeptember 30, 2006. As Mr. Fisher transitioned out of his involvementwith Wilson/Bennett, several significant clients unexpectedly either terminatedor advised us that they intended to terminate their asset management contractsduring the third quarter. This triggered an evaluation of our goodwill andintangible assets. Accordingly, we updated our analysis of the fair value ofthe goodwill and intangible assets associated with our acquisition ofWilson/Bennett. The updated analysis indicated an impairment to the goodwill andcertain customer relationships and Mr. Fisher’s employment agreement. Werecorded a non-cash impairment loss totaling $2.9 million pretax, and $1.9million after tax, during the quarter ended September 30, 2006. Excludingthese impairment charges, we would have recorded net income of $9.3 million forthe year ended December 31, 2006, a decrease of $585,000 compared to thesame period of 2005. A reconciliation of this non-GAAP financial measure to ourGAAP financial information is presented in Table 1 below.

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**Table 1.**

**Reconciliation of GAAP to Non-GAAP Financial Measures**YearsEnded December 31, 2006, 2005 and 2004(In thousands, except per share data)

| ** **                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| GAAP reported  non-interest expense                                      |       | $        | 51,245     |     | $          | 44,653   |       | $ | 27,154 |   |
| Less nonrecurring  expenses, pretax                                      |       |     |       |     |       |     |       |
| Impairment of goodwill                                                   |       | 960      |       | —   |       | —   |       |
| Impairment of customer relationships intangible                          |       | 1,454    |       | —   |       | —   |       |
| Impairment of employment/non-compete agreement                           |       | 513      |       | —   |       | —   |       |
| Non-interest  expense without nonrecurring expenses                      |       | $        | 48,318     |     | $          | 44,653   |       | $ | 27,154 |   |
| GAAP reported net income                                                 |       | $        | 7,388      |     | $          | 9,876    |       | $ | 3,469 |   |
| Less nonrecurring  expenses, after tax                                   |       |     |       |     |       |     |       |
| Impairment of goodwill                                                   |       | 624      |       | —   |       | —   |       |
| Impairment of customer relationships intangible                          |       | 946      |       | —   |       | —   |       |
| Impairment of employment/non-compete agreement                           |       | 333      |       | —   |       | —   |       |
| Net income  without nonrecurring expenses                                |       | $        | 9,291      |     | $          | 9,876    |       | $ | 3,469 |   |
| GAAP reported earnings per common share, basic                           |       | $        | 0.30       |     | $          | 0.45     |       | $ | 0.19 |   |
| Less nonrecurring  expenses, after tax:                                  |       |     |       |     |       |     |       |
| Impairment of goodwill                                                   |       | 0.03     |       | —   |       | —   |       |
| Impairment of customer relationships intangible                          |       | 0.04     |       | —   |       | —   |       |
| Impairment of employment/non-compete agreement                           |       | 0.01     |       | —   |       | —   |       |
| Earnings per  common share without nonrecurring expenses - basic         |       | $        | 0.38       |     | $          | 0.45     |       | $ | 0.19 |   |
| GAAP reported earnings per common share, fully  diluted                  |       | $        | 0.30       |     | $          | 0.44     |       | $ | 0.19 |   |
| Less nonrecurring  expenses, after tax:                                  |       |     |       |     |       |     |       |
| Impairment of goodwill                                                   |       | 0.02     |       | —   |       | —   |       |
| Impairment of customer relationships intangible                          |       | 0.04     |       | —   |       | —   |       |
| Impairment of employment/non-compete agreement                           |       | 0.01     |       | —   |       | —   |       |
| Earnings per  common share without nonrecurring expenses - fully diluted |       | $        | 0.37       |     | $          | 0.44     |       | $ | 0.19 |   |
| Calculation of efficiency ratio(1):                                      |       |     |       |     |       |     |       |
| Non-interest  expense without nonrecurring expenses (from above)         |       | $        | 48,318     |     | $          | 44,653   |       | $ | 27,154 |   |
| GAAP reported net interest income                                        |       | 41,354   |       | 37,483   |       | 24,553   |       |
| GAAP reported non-interest income                                        |       | 21,684   |       | 24,669   |       | 9,409    |       |
| Less: litigation  recovery on previously impaired investment             |       | 855      |       | —   |       | —   |       |
| Non-interest  income without litigation recovery                         |       | 20,829   |       | 24,669   |       | 9,409    |       |
| Total net interest income and non-interest income  for efficiency ratio  |       | $        | 62,183     |     | $          | 62,152   |       | $ | 33,962 |   |
| Efficiency ratio  without nonrecurring income and expenses               |       | 77.70    | %          | 71.84    | %          | 79.95    | %          |

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(1)          Efficiency ratio iscalculated as total non-interest expense (excluding impairment losses) dividedby the total of net interest income and non-interest income (excluding recoveryof impaired investment).

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The return on averageassets for the years ended December 31, 2006 and 2005 was 0.51% and 0.74%,respectively. The return on average equity for the years ended December 31,2006 and 2005 was 4.87% and 7.67%, respectively.

***2005 Compared to 2004***

At December 31, 2005, total assets were $1.45billion, an increase of 19.9%, or $240.7 million, from $1.21 billion at December 31,2004. Total loans receivable, net of deferred fees and costs, increased 44.0%,or $215.7 million, to $705.6 million at December 31, 2005, from $489.9million at December 31, 2004. Total investment securities increased by$4.7 million, or 1.6%, to $294.2 million at December 31, 2005, from $289.5million at December 31, 2004. Total deposits increased 29.8%, or$245.8 million, to $1.07 billion at December 31, 2005, from $824.2million at December 31, 2004. Other borrowed funds, which primarily includerepurchase agreements, FHLB advances and our payable to Cardinal StatutoryTrust I, decreased $45.7 million to $155.4 million at December 31, 2005,from $201.1 million at December 31, 2004.

Shareholders’ equity at December 31, 2005 was$147.9 million, an increase of $52.8 million from $95.1 million at December 31,2004. The increase in shareholders’ equity was primarily attributable to $39.8million of additional equity raised during our 2005 common stock offering andnet income of $9.9 million. Total shareholders’ equity to total assets at December 31,2005 and 2004 was 10.2% and 7.9%, respectively. Book value per share at December 31,2005 and 2004 was $6.07 and $5.15, respectively. Total risk-based capital torisk-weighted assets was 15.65% at December 31, 2005 compared to 13.40% atDecember 31, 2004. Accordingly, the Company was considered “wellcapitalized” for regulatory purposes at December 31, 2005. Risk-basedcapital to risk-weighted assets increased from 2004 to 2005 primarily as aresult of the additional capital raised during our 2005 common stock offering.

We recorded net income of $9.9 million, or $0.44 perdiluted common share, for the year ended December 31, 2005, compared tonet income of $3.5 million, or $0.19 per diluted common share, in 2004. Aspreviously mentioned, George Mason is included in our operating results for thefull year ended December 31, 2005 compared to approximately the last sixmonths of 2004.

The return on averageassets for the years ended December 31, 2005 and 2004 was 0.74% and 0.37%,respectively. The return on average equity for the years ended December 31,2005 and 2004 was 7.67% and 3.69%, respectively.

**Statements ofOperations**

***Net Interest Income/Margin***

Net interest income is ourprimary source of revenue, representing the difference between interest andfees earned on interest-bearing assets and the interest paid on deposits andother interest-bearing liabilities. The level of net interest income isaffected primarily by variations in the volume and mix of these assets andliabilities, as well as changes in interest rates. At the end of 2003, thefederal funds rate was at 1.00%, its lowest level in over forty years. During2004, as economic activity increased, the Federal Reserve raised the keyfederal funds rate five times to 2.25% by year end. The Federal Reservecontinued this policy in 2005, increasing the federal funds rate eight times to4.25% by year end, and in 2006 increased the federal funds rate four times to5.25% by year end. See “Interest Rate Sensitivity” for further information.

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***2006 Compared to 2005***

Net interest income on a tax equivalent basis for theyear ended December 31, 2006 was $41.6 million, compared to $37.5 millionfor the year ended December 31, 2005, an increase of $4.1 million, or10.9%. The increase in net interest income was primarily a result of increasesin the interest rates and average volume of loans receivable and investmentsecurities, net of the impact of increased funding costs during 2006, comparedwith 2005. The increase in funding costs was primarily attributable to anincrease in rates paid on average interest-bearing liabilities. Net increasesin loans receivable and investment securities were funded through the increasein total deposits and a decrease in loans held for sale.

Our net interest margin, on a tax equivalent basis,for the years ended December 31, 2006 and 2005 was 2.98% and 2.92%,respectively, primarily as a result of a 105 basis point increase in the ratesearned on average interest-earning assets offset by an increased cost ofaverage interest-bearing liabilities of 113 basis points. The average yield oninterest-earning assets increased to 6.29% in 2006 from 5.24% in 2005, and ourcost of interest-bearing liabilities increased to 3.93% in 2006 from 2.80% in2005. The cost of other borrowed funds, which generally are shorter termfundings and which we continue to utilize in 2006 to help fund our balancesheet growth, increased 115 basis points to 4.16% in 2006 from 3.01% in 2005. Thecost of deposit liabilities increased 98 basis points to 3.88% in 2006 from2.90% for 2005.

Total earning assets increased by 10.5% to $1.53billion at December 31, 2006, compared to $1.39 billion at December 31,2005. This resulted primarily from a $139.8 million increase in loansreceivable, net of deferred fees and costs. Total investment securitiesincreased $35.1 million or 11.9% during 2006 to $329.3 million at December 31,2006, from $294.2 million at December 31, 2005. These increases werefunded by deposit growth of $149.0 million, or 13.9%, and an increase in otherborrowed funds of $39.2 million during 2006 to $194.6 million at December 31,2006, from $155.4 million at December 31, 2005.

Average loans receivable increased $180.7 million to$768.2 million during 2006 from $587.5 million in 2005. Average balances ofnonperforming assets, which consist of non-accrual loans, are included in thenet interest margin calculation and did not have a material impact on our netinterest margin in 2006 and 2005. Additional interest income of approximately $15,000for 2006 and $18,000 for 2005 would have been realized had all nonperformingassets performed as originally expected. Nonperforming assets exclude loansthat are both past due 90 days or more and still accruing interest due to anassessment of collectibility.

Average total depositsincreased $149.1 million to $1.12 billion in 2006 from $973.7 million in 2005. Thelargest increase in average deposit balances was experienced in statementsavings, which increased $145.3 million compared to 2005, a result of ouradvertised Simply Savings product which was introduced during 2006. Thissavings product allows new customers to earn a yield of 5.01% on fundsdeposited with us.

***2005 Compared to 2004***

Net interest income for the year ended December 31,2005 was $37.5 million, compared to $24.6 million for the year ended December 31,2004, an increase of $12.9 million, or 52.7%. The increase in net interestincome was primarily a result of increases in the average volume of loans heldfor sale and loans receivable, net of the impact of increased funding costsduring 2005, compared with 2004. The increase in funding costs was primarilyattributable to an increase in rates paid on average interest-bearingliabilities. Net increases in loans held for sale and loans receivable werefunded through the increases in total deposits and other borrowed funds.

Our net interest margin for the years ended December 31,2005 and 2004 was 2.92% and 2.72%, respectively, primarily as a result of a 75basis point increase in the rate earned on average interest-earning assetspartially offset by an increased cost of average interest-bearing liabilitiesof 63 basis points. The 

40

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average yield oninterest-earning assets increased to 5.24% in 2005 from 4.49% in 2004, and ourcost of interest-bearing liabilities increased to 2.80% in 2005 from 2.17% in2004. The cost of other borrowed funds, which generally are shorter termfundings and which we utilized in 2005 to help fund our balance sheet growth,increased 83 basis points to 3.01% in 2005 from 2.18% in 2004. The cost ofdeposit liabilities increased 65 basis points to 2.90% in 2005 from 2.25% for2004.

Total earning assets increased by 19.6% to $1.39billion at December 31, 2005, compared to $1.16 billion at December 31,2004. This resulted primarily from a $215.7 million increase in loansreceivable, net of deferred fees and costs. This increase was funded by depositgrowth of $245.7 million, or 29.8%. Other borrowed funds decreased by $45.7million during 2005 to $155.4 million at December 31, 2005, from $201.1million at December 31, 2004.

Average loans receivable increased $196.1 million to$587.5 million during 2005 from $391.4 million in 2004. Average balances ofnonperforming assets, which consist of non-accrual loans, are included in thenet interest margin calculation and did not have a material impact on our netinterest margin in 2005 and 2004. Additional interest income of approximately$18,000 for 2005 and $25,000 for 2004 would have been realized had allnonperforming assets performed as originally expected. Nonperforming assetsexclude loans that are both past due 90 days or more and still accruinginterest due to an assessment of collectibility.

Average total deposits increased $321.0 million to$973.7 million in 2005 from $652.7 million in 2004. The largest increase inaverage deposit balances was experienced in certificates of deposit, whichincreased $192.9 million compared to 2004, a result of our branch expansion andincreased advertising of our rates. During 2004, to assist in the funding ofGeorge Mason’s loans held for sale, we began using the brokered certificates ofdeposit market. At December 31, 2004, we had $86.7 million of brokeredcertificates of deposit. At December 31, 2005, our brokered certificatesof deposit decreased $76.9 million to $9.8 million. As maturities in ourbrokered certificates of deposit portfolio occurred, we were able to replacethat funding with increases in our core deposit products. Our utilization ofthe brokered certificates of deposit market averaged $38.9 million in 2005, adecrease of $13.4 million from an average of $52.3 million in 2004.

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 31,2006 and the resulting yields and cost of funding for those years.

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**Table 2.**

**AverageBalance Sheets and Interest Rates on Interest-Earning Assets andInterest-Bearing Liabilities**YearsEnded December 31, 2006, 2005 and 2004(In thousands)

| ** **                                               | ** ** | **2006**    | ** ** | **2005**     | ** ** | **2004**   | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $           | 85,269     |         |       | $          | 6,314      |   |   | 7.40 | % | $ | 66,414 |   |   | $ | 4,030 |   |   |   | 6.07 | % |   | $ | 58,293 |   |   | $ | 3,046 |   |   |   | 5.23 | % |   |
| Real estate—commercial                              |       | 288,567     |       |         | 19,082     |       |       | 6.61 |   | 255,505 |   |   | 16,199 |   |   |   | 6.34 |   |   | 170,730 |   |   | 10,617 |   |   |   | 6.22 |   |   |
| Real estate—construction                            |       | 143,476     |       |         | 12,040     |       |       | 8.39 |   | 77,634 |   |   | 5,468 |   |   |   | 7.04 |   |   | 52,459 |   |   | 3,024 |   |   |   | 5.76 |   |   |
| Real estate—residential                             |       | 172,809     |       |         | 9,012      |       |       | 5.22 |   | 115,829 |   |   | 5,936 |   |   |   | 5.12 |   |   | 49,057 |   |   | 2,780 |   |   |   | 5.67 |   |   |
| Home equity lines                                        |       | 73,194      |       |         | 5,089      |       |       | 6.95 |   | 67,086 |   |   | 3,458 |   |   |   | 5.15 |   |   | 52,221 |   |   | 1,856 |   |   |   | 3.55 |   |   |
| Consumer                                                 |       | 4,865       |       |         | 367        |       |       | 7.54 |   | 5,046 |   |   | 359 |   |   |   | 7.11 |   |   | 8,665 |   |   | 552 |   |   |   | 6.37 |   |   |
| Total loans                                              |       | 768,180     |       |         | 51,904     |       |       | 6.76 |   | 587,514 |   |   | 35,450 |   |   |   | 6.03 |   |   | 391,425 |   |   | 21,875 |   |   |   | 5.59 |   |   |
| Loans held for sale, net                                 |       | 259,743     |       |         | 19,288     |       |       | 7.43 |   | 372,866 |   |   | 19,379 |   |   |   | 5.20 |   |   | 181,700 |   |   | 6,814 |   |   |   | 3.75 |   |   |
| Investment  securities available-for-sale                |       | 226,011     |       |         | 10,483     |       |       | 4.64 |   | 159,720 |   |   | 6,195 |   |   |   | 3.88 |   |   | 161,741 |   |   | 5,830 |   |   |   | 3.60 |   |   |
| Investment  securities held-to-maturity                  |       | 106,938     |       |         | 4,351      |       |       | 4.07 |   | 127,407 |   |   | 4,914 |   |   |   | 3.86 |   |   | 151,286 |   |   | 5,622 |   |   |   | 3.72 |   |   |
| Other investments                                        |       | 6,409       |       |         | 378        |       |       | 5.90 |   | 6,269 |   |   | 261 |   |   |   | 4.16 |   |   | 6,139 |   |   | 251 |   |   |   | 4.09 |   |   |
| Federal funds sold                                       |       | 25,675      |       |         | 1,206      |       |       | 4.70 |   | 31,981 |   |   | 1,175 |   |   |   | 3.67 |   |   | 10,473 |   |   | 130 |   |   |   | 1.24 |   |   |
| Total  interest-earning assets and interest income       |       | 1,392,956   |       |         | 87,610     |       |       | 6.29 |   | 1,285,757 |   |   | 67,374 |   |   |   | 5.24 |   |   | 902,764 |   |   | 40,522 |   |   |   | 4.49 |   |   |
| Noninterest-earning  assets:                             |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | 6,813       |       |         |       |       |       |   |   | 6,657 |   |   |   |   |   |   |   |   |   | 11,015 |   |   |   |   |   |   |   |   |   |
| Premises and  equipment, net                             |       | 19,758      |       |         |       |       |       |   |   | 17,446 |   |   |   |   |   |   |   |   |   | 11,229 |   |   |   |   |   |   |   |   |   |
| Goodwill and other  intangibles, net                     |       | 19,763      |       |         |       |       |       |   |   | 18,363 |   |   |   |   |   |   |   |   |   | 7,515 |   |   |   |   |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 24,532      |       |         |       |       |       |   |   | 10,919 |   |   |   |   |   |   |   |   |   | 8,533 |   |   |   |   |   |   |   |   |   |
| Allowance for loan  losses                               |       | (8,853      | )          |         |       |       |       |   |   | (6,974 | ) |   |   |   |   |   |   |   |   | (4,759 | ) |   |   |   |   |   |   |   |   |
| Total assets                                             |       | $           | 1,454,969  |         |       |       |       |   |   |   | $ | 1,332,168 |   |   |   |   |   |   |   |   |   | $ | 936,297 |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity**           |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest—bearing  liabilities:                      |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest—bearing  deposits:                         |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | $           | 136,368    |         |       | $          | 3,796      |   |   | 2.78 | % | $ | 113,628 |   |   | $ | 1,366 |   |   |   | 1.20 | % |   | $ | 151,727 |   |   | $ | 2,016 |   |   |   | 1.33 | % |   |
| Money markets                                            |       | 117,527     |       |         | 2,881      |       |       | 2.45 |   | 166,301 |   |   | 4,397 |   |   |   | 2.64 |   |   | 26,304 |   |   | 155 |   |   |   | 0.59 |   |   |
| Statement savings                                        |       | 154,643     |       |         | 7,272      |       |       | 4.70 |   | 9,302 |   |   | 106 |   |   |   | 1.13 |   |   | 7,806 |   |   | 58 |   |   |   | 0.74 |   |   |
| Certificates of  deposit                                 |       | 598,187     |       |         | 25,142     |       |       | 4.20 |   | 570,669 |   |   | 19,030 |   |   |   | 3.33 |   |   | 377,770 |   |   | 10,465 |   |   |   | 2.77 |   |   |
| Total  interest—bearing deposits                    |       | 1,006,725   |       |         | 39,091     |       |       | 3.88 |   | 859,900 |   |   | 24,899 |   |   |   | 2.90 |   |   | 563,607 |   |   | 12,694 |   |   |   | 2.25 |   |   |
| Other borrowed  funds                                    |       | 163,078     |       |         | 6,792      |       |       | 4.16 |   | 162,176 |   |   | 4,883 |   |   |   | 3.01 |   |   | 139,637 |   |   | 3,047 |   |   |   | 2.18 |   |   |
| Warehouse financing                                      |       | 2,423       |       |         | 164        |       |       | 6.77 |   | 45,571 |   |   | 109 |   |   |   | 0.24 |   |   | 31,981 |   |   | 228 |   |   |   | 0.71 |   |   |
| Total  interest-bearing liabilities and interest expense |       | 1,172,226   |       |         | 46,047     |       |       | 3.93 |   | 1,067,647 |   |   | 29,891 |   |   |   | 2.80 |   |   | 735,225 |   |   | 15,969 |   |   |   | 2.17 |   |   |
| Noninterest-bearing  liabilities:                        |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 116,041     |       |         |       |       |       |   |   | 113,813 |   |   |   |   |   |   |   |   |   | 89,114 |   |   |   |   |   |   |   |   |   |
| Other liabilities                                        |       | 15,018      |       |         |       |       |       |   |   | 21,980 |   |   |   |   |   |   |   |   |   | 17,847 |   |   |   |   |   |   |   |   |   |
| Preferred  shareholders’ equity                     |       | —      |       |         |       |       |       |   |   | — |   |   |   |   |   |   |   |   |   | 1,589 |   |   |   |   |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 151,684     |       |         |       |       |       |   |   | 128,728 |   |   |   |   |   |   |   |   |   | 92,522 |   |   |   |   |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $           | 1,454,969  |         |       |       |       |   |   |   | $ | 1,332,168 |   |   |   |   |   |   |   |   |   | $ | 936,297 |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |        |       |         | $          | 41,563     |       |   | 2.98 | % |   |   |   | $ | 37,483 |   |   |   | 2.92 | % |   |   |   |   | $ | 24,553 |   |   |   | 2.72 | % |   |

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

(2)             Interest income for loans receivable and investmentsecurities available-for-sale is reported on a fully taxable-equivalent basisat a rate of 35%.

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**Table 3.**

**Rate and Volume Analysis**YearsEnded December 31, 2006, 2005 and 2004(In thousands)

| ** **                               | ** ** | **2006 Compared to 2005** | ** ** | **2005 Compared to 2004** | ** ** |
|------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **Average**                              | ** ** | **Average**                              | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                               | ** ** | **Volume**                               | ** ** | **Rate**                                 | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                |       | $                                        | 1,144      |                                     | $          | 1,140 |   |   | $ | 2,284 |   |   | $ | 424 |   |   | $ | 560 |   |   |   | $ | 984 |   |   |
| Real estate—commercial              |       | 2,096                                    |       | 787                                      |       |   | 2,883 |   |   | 5,272 |   |   | 310 |   |   |   | 5,582 |   |   |
| Real estate—construction            |       | 4,637                                    |       | 1,935                                    |       |   | 6,572 |   |   | 1,451 |   |   | 993 |   |   |   | 2,444 |   |   |
| Real estate—residential             |       | 2,920                                    |       | 156                                      |       |   | 3,076 |   |   | 3,784 |   |   | (628 | ) |   |   | 3,156 |   |   |
| Home equity lines                        |       | 315                                      |       | 1,316                                    |       |   | 1,631 |   |   | 528 |   |   | 1,074 |   |   |   | 1,602 |   |   |
| Consumer                                 |       | (13                                      | )          | 21                                       |       |   | 8 |   |   | (231 | ) |   | 38 |   |   |   | (193 | ) |   |
| Total loans                              |       | 11,099                                   |       | 5,355                                    |       |   | 16,454 |   |   | 11,228 |   |   | 2,347 |   |   |   | 13,575 |   |   |
| Loans held for sale, net                 |       | (5,879                                   | )          | 5,788                                    |       |   | (91 | ) |   | 7,169 |   |   | 5,396 |   |   |   | 12,565 |   |   |
| Investment securities available-for-sale |       | 2,571                                    |       | 1,717                                    |       |   | 4,288 |   |   | (73 | ) |   | 438 |   |   |   | 365 |   |   |
| Investment securities held-to-maturity   |       | (789                                     | )          | 226                                      |       |   | (563 | ) |   | (887 | ) |   | 179 |   |   |   | (708 | ) |   |
| Other investments                        |       | 6                                        |       | 111                                      |       |   | 117 |   |   | 5 |   |   | 5 |   |   |   | 10 |   |   |
| Federal funds sold                       |       | (232                                     | )          | 263                                      |       |   | 31 |   |   | 267 |   |   | 778 |   |   |   | 1,045 |   |   |
| Total interest income                    |       | 6,776                                    |       | 13,460                                   |       |   | 20,236 |   |   | 17,709 |   |   | 9,143 |   |   |   | 26,852 |   |   |
| **Interest expense:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest—bearing  deposits:         |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                        |       | 273                                      |       | 2,157                                    |       |   | 2,430 |   |   | (506 | ) |   | (144 | ) |   |   | (650 | ) |   |
| Money markets                            |       | (1,290                                   | )          | (226                                     | )          |   | (1,516 | ) |   | 825 |   |   | 3,417 |   |   |   | 4,242 |   |   |
| Statement savings                        |       | 1,641                                    |       | 5,525                                    |       |   | 7,166 |   |   | 12 |   |   | 36 |   |   |   | 48 |   |   |
| Certificates of deposit                  |       | 918                                      |       | 5,194                                    |       |   | 6,112 |   |   | 5,344 |   |   | 3,221 |   |   |   | 8,565 |   |   |
| Total interest—bearing deposits     |       | 1,542                                    |       | 12,650                                   |       |   | 14,192 |   |   | 5,675 |   |   | 6,530 |   |   |   | 12,205 |   |   |
| Other borrowed  funds                    |       | 27                                       |       | 1,882                                    |       |   | 1,909 |   |   | 492 |   |   | 1,344 |   |   |   | 1,836 |   |   |
| Warehouse  financing                     |       | (103                                     | )          | 158                                      |       |   | 55 |   |   | 97 |   |   | (216 | ) |   |   | (119 | ) |   |
| Total interest expense                   |       | 1,466                                    |       | 14,690                                   |       |   | 16,156 |   |   | 6,264 |   |   | 7,658 |   |   |   | 13,922 |   |   |
| Net interest income (2)                  |       | $                                        | 5,310      |                                     | $          | (1,230 | ) |   | $ | 4,080 |   |   | $ | 11,445 |   |   | $ | 1,485 |   |   |   | $ | 12,930 |   |   |

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

(2)          Interest income forloans receivable and investment securities available-for-sale is reported on afully taxable-equivalent basis at a rate of 35%.

(3)          Changes attributable torate/volume have been allocated to volume.

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**Interest Rate Sensitivity**

We are exposed to variousbusiness risks including interest rate risk. Our goal is to maximize netinterest income without incurring excessive interest rate risk. Management ofnet interest income and interest rate risk must be consistent with the level ofcapital and liquidity that we maintain. We manage interest rate risk through anasset and liability committee (“ALCO”). ALCO is responsible for managing ourinterest rate risk in conjunction with liquidity and capital management.

We employ an independentconsulting firm to model our interest rate sensitivity. We use a net interestincome simulation model as our primary tool to measure interest ratesensitivity. Many assumptions are developed based on expected activity in thebalance sheet. For maturing assets, assumptions are created for theredeployment 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, savings accounts as well as certificatesof deposit. Based on inputs that include the current balance sheet, the currentlevel of interest rates and the developed assumptions, the model then producesan expected level of net interest income assuming that market rates remainunchanged. This is considered the base case. Next, the model determines what netinterest income would be based on specific changes in interest rates. The ratesimulations are performed for a two year period and include ramped rate changesof down 200 basis points and up 200 basis points. In the ramped down ratechange, the model moves rates gradually down 200 basis points over the firstyear and then rates remain flat in the second year. For the up 200 basis pointscenario, rates are gradually moved up 200 basis points in the first year andthen rates remain flat in the second year. In both the up and down scenarios,the model assumes a parallel shift in the yield curve. The results of thesesimulations are then compared to the base case.

At December 31, 2006,we were liability sensitive for the entire two year simulation period. Liabilitysensitive means that we have more liabilities repricing than assets. We havemore of our liabilities in non-maturity or short-term deposit products than wehave in floating rate assets. In a decreasing interest rate environment, netinterest income would grow for a liability sensitive bank. In the down 200basis point scenario, net interest income improves by not more than 3.8% forthe one year period and by not more than 6.0% over the two year time horizon. Inthe up 200 basis point scenario, the bank shows asset sensitivity for the firstyear with net interest income improving by not more than 2.3% but by the secondyear net interest income falls compared to the base case so that over the twoyear period, net interest income improves by 1.3%.

**Provision Expense and Allowance for Loan Losses**

Our policy is to maintainthe allowance for loan losses at a level that represents our best estimate ofknown and inherent losses in the loan portfolio. Both the amount of theprovision and the level of the allowance for loan losses are impacted by manyfactors, including general and industry-specific economic conditions, actualand expected credit losses, historical trends and specific conditions ofindividual borrowers.

The provision for loanlosses was $1.2 million and $2.5 million for the years ended December 31,2006 and 2005, respectively. The allowance for loan losses at December 31,2006 was $9.6 million compared to $8.3 million at December 31, 2005. Ourallowance for loan loss ratio at December 31, 2006 was 1.14% compared to1.18% at December 31, 2005. The decrease in the allowance for loan lossratio is primarily reflective of a shift in the loan mix in our portfolio witha greater percentage of the overall loan portfolio comprised of lower riskresidential real estate loans, an improvement in overall credit quality and ourevaluation of our loan portfolio and the qualitative factors we use todetermine the adequacy of our loan loss reserve. We continued to experiencestrong loan quality with annualized net charged-off loans equal to 

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lessthan 0.01% to average loans receivable for the year ended December 31,2006, and non-performing loans equal to 0.01% of total loans as of December 31,2006.

The provision for loanlosses was $1.6 million for 2004. The growth in loans during 2004 was comprisedprimarily of increases in our residential and commercial real estate loanportfolios and our home equity loan portfolio, which require lower allowancesthan the remainder of the loan portfolio.

See “Critical AccountingPolicies” above for more information on our allowance for loan lossesmethodology.

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

**Table 4.**

**Allowance for LoanLosses**YearsEnded December 31, 2006, 2005, 2004, 2003, and 2002(In thousands)

| ** **                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Beginning balance,  January 1             |       | $        | 8,301      |     | $          | 5,878    |       | $        | 4,344      |     | $          | 3,372 |   | $ | 3,104 |   |
| Provision for loan  losses                     |       | 1,232    |       | 2,456    |       | 1,626    |       | 1,001    |       | 444      |       |
| Transfer to liability on  unfunded commitments |       | —   |       | —   |       | —   |       | —   |       | (74      | )          |
| Loans charged off:                             |       |     |       |     |       |     |       |     |       |     |       |
| Commercial and  industrial                     |       | (42      | )          | (120     | )          | (100     | )          | (74      | )          | (63      | )          |
| Consumer                                       |       | (1       | )          | (9       | )          | (8       | )          | (6       | )          | (54      | )          |
| Total loans charged off                        |       | (43      | )          | (129     | )          | (108     | )          | (80      | )          | (117     | )          |
| Recoveries:                                    |       |     |       |     |       |     |       |     |       |     |       |
| Commercial and  industrial                     |       | 148      |       | 82       |       | 14       |       | 43       |       | 12       |       |
| Consumer                                       |       | —   |       | 14       |       | 2        |       | 8        |       | 3        |       |
| Total recoveries                               |       | 148      |       | 96       |       | 16       |       | 51       |       | 15       |       |
| Net (charge offs)  recoveries                  |       | 105      |       | (33      | )          | (92      | )          | (29      | )          | (102     | )          |
| Ending balance, December 31,              |       | $        | 9,638      |     | $          | 8,301    |       | $        | 5,878      |     | $          | 4,344 |   | $ | 3,372 |   |

                                                                                                                                    

| **Loans:**                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Balance at year end                                         |       | $        | 845,449    |     | $          | 705,644  |       | $        | 489,896    |     | $          | 336,002 |   | $ | 249,106 |   |
| Allowance for loan  losses to loans receivable, net of fees |       | 1.14%    |       | 1.18%    |       | 1.20%    |       | 1.29%    |       | 1.35%    |       |
| Net charge-offs to average loans receivable                 |       | 0.00%    |       | 0.01%    |       | 0.02%    |       | 0.01%    |       | 0.05%    |       |
|                                                             |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

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**Table 5.**

**Allocation of theAllowance for Loan Losses**AtDecember 31, 2006, 2005, 2004, 2003, and 2002(In thousands)

| ** **                       | ** ** | **2006**       | ** ** | **2005**                  | ** ** | **2004**       | ** ** |
|----------------------------------|------------|----------------|------------|---------------------------|------------|----------------|------------|
| ** **                       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       |           | $          | 1,670                     |       |           |       | 12.09 | % |   |   | $ | 1,153 |   |   |   | 9.83 | % |   |   | $ | 963 |   |   |   | 11.53 | % |   |
| Real estate—commercial      |       |           | 3,687      |                      |       |           | 37.50      |   |   |   | 3,338 |   |   |   | 39.01 |   |   |   | 2,732 |   |   |   | 44.88 |   |   |
| Real estate—construction    |       |           | 1,764      |                      |       |           | 18.27      |   |   |   | 1,432 |   |   |   | 18.13 |   |   |   | 768 |   |   |   | 14.18 |   |   |
| Real estate—residential     |       |           | 2,025      |                      |       |           | 23.80      |   |   |   | 1,490 |   |   |   | 21.65 |   |   |   | 692 |   |   |   | 15.69 |   |   |
| Home equity lines                |       |           | 384        |                      |       |           | 7.75       |   |   |   | 721 |   |   |   | 10.63 |   |   |   | 612 |   |   |   | 12.32 |   |   |
| Consumer                         |       |           | 108        |                      |       |           | 0.59       |   |   |   | 167 |   |   |   | 0.75 |   |   |   | 111 |   |   |   | 1.40 |   |   |
| Total allowance for loan  losses |       |           | $          | 9,638                     |       |           |       | 100.00 | % |   |   | $ | 8,301 |   |   |   | 100.00 | % |   |   | $ | 5,878 |   |   |   | 100.00 | % |   |

 

| ** **                      | ** ** | **2003**       | ** ** | **2002**                  | ** ** |
|---------------------------------|------------|----------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial                      |       |           | $          | 1,046                     |       |   |   | 17.21 | % |   |   | $ | 1,301 |   |   |   | 23.40 | % |   |
| Real estate—commercial     |       |           | 1,662      |                      |       |   | 41.56 |   |   |   | 1,386 |   |   |   | 46.63 |   |   |
| Real estate—construction   |       |           | 497        |                      |       |   | 12.57 |   |   |   | 19 |   |   |   | 2.32 |   |   |
| Real estate—residential    |       |           | 418        |                      |       |   | 12.64 |   |   |   | 241 |   |   |   | 12.77 |   |   |
| Home equity lines               |       |           | 486        |                      |       |   | 12.84 |   |   |   | 201 |   |   |   | 10.77 |   |   |
| Consumer                        |       |           | 235        |                      |       |   | 3.18 |   |   |   | 224 |   |   |   | 4.11 |   |   |
| Total allowance for loan losses |       |           | $          | 4,344                     |       |   |   | 100.00 | % |   |   | $ | 3,372 |   |   |   | 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 sales 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, 2006 and2005 was $21.7 million and $24.7 million, respectively. The decrease innon-interest income for the year ended December 31, 2006, compared to thesame period of 2005, is primarily the result of decreased gains on sales ofloans held for sale of $5.9 million. The decrease in gains on sales of loansheld for sale is due to the slowdown in the regional housing market. Includedin the net gains on sales of loans held for sale are any origination,underwriting, and discount points and other funding fees received and deferredat loan origination. Costs include direct costs associated with the loanorigination, such as commissions and salaries that are deferred at the time oforigination. Also contributing to the decrease in non-interest income,management fee income decreased by $811,000 in 2006 compared to 2005. Managementfees represent the income earned for services George Mason provides to othermortgage companies owned by local home builders and generally fluctuates basedon the volume of loan sales.

Service charges on deposit accounts increased $259,000to $1.6 million for the year ended December 31, 2006, compared to $1.3million for the year ended December 31, 2005. Deposit service chargesincreased primarily as a result of an increased number of transaction accountsin 2006 compared to 2005. Loan service charges decreased $524,000 to $2.2million for the year ended December 31, 2006, compared to $2.7 million in2005. Loan service charges decreased due to decreases in loan originations atGeorge Mason during 2006, compared to originations during 2005 because of theaforementioned slowdown in the regional housing market. Investment fee incomeincreased $1.9 million to $3.3 million for the year ended December 31,2006, compared to $1.4 million for the year ended December 31, 2005. Theincrease in investment fee income is primarily attributable to the addition ofthe trust division in February 2006 and a full year of operations ofWilson/Bennett in 2006. Included in other income are gains related to theextinguishment of two borrowings totaling $769,000 for the year ended December 31,2006 compared to a gain of $140,000 for the year ended December 31, 2005. 

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During the fourth quarterof 2006, we received a litigation settlement from a previously charged offinvestment of $855,000. In addition, we invested $30.0 million in bank-ownedlife insurance during the third quarter of 2006. The increase in the cashsurrender value of the insurance policy for the year ended December 31,2006 was $646,000 and is included in other income. There were no similartransactions for the year ended December 31, 2005.

Non-interest income forthe years ended December 31, 2005 and 2004 was $24.7 million and $9.4million, respectively. The increase in non-interest income for the year ended December 31,2005, compared to the same period of 2004, is primarily the result of increasedgains on sales of loans held for sale of $11.3 million. This increase is aresult of including the operations of George Mason in our operating results forthe full year of 2005 compared to slightly less than six months in 2004. Alsocontributing to the increase in non-interest income, and also as a directresult of the George Mason acquisition, management fee income rose by $1.3million in 2005 compared to 2004.

Service charges on depositaccounts increased $245,000 to $1.3 million for the year ended December 31,2005, compared to $1.1 million for the year ended December 31, 2004. Depositservice charges increased primarily as a result of an increased number oftransaction accounts in 2005 compared to 2004. Loan service charges increased$1.7 million to $2.7 million for the year ended December 31, 2005,compared to $958,000 in 2004. Loan service charges increased due to increasedloan volume at the Bank and including the operations of George Mason for thefull year of 2005. Investment fee income increased $760,000 to $1.4 million forthe year ended December 31, 2005, compared to $657,000 for the year ended December 31,2004. Investment fee income increased due to increases in assets undermanagement at CWS and the addition of $582,000 in fee income fromWilson/Bennett since its acquisition in June 2005.

The following tableprovides additional detail on non-interest income for the years ended December 31,2006, 2005, and 2004.

**Table 6.**

**Non-Interest Income**YearsEnded December 31, 2006, 2005, and 2004(In thousands)

| ** **                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Insufficient  funds fee income                                 |       | $        | 729        |     | $          | 637      |       | $ | 540 |   |
| Service charges  on deposit accounts                           |       | 207      |       | 167      |       | 202      |       |
| Other fee income  on deposit accounts                          |       | 131      |       | 123      |       | 101      |       |
| ATM transaction  fees                                          |       | 463      |       | 356      |       | 205      |       |
| Loan service charges                                           |       | 2,177    |       | 2,701    |       | 958      |       |
| Investment fee  income                                         |       | 1,341    |       | 1,417    |       | 657      |       |
| Trust adminstration  fee income                                |       | 1,989    |       | —   |       | —   |       |
| Bank-owned life  insurance income                              |       | 646      |       | —   |       | —   |       |
| Net gain on sales  of loans                                    |       | 10,059   |       | 15,975   |       | 4,696    |       |
| Management fee  income                                         |       | 2,221    |       | 3,032    |       | 1,749    |       |
| Net realized gain  on investment securities available-for-sale |       | 61       |       | 33       |       | 245      |       |
| Net gain (loss)  on sales of assets                            |       | 15       |       | (13      | )          | (1       | )          |
| Credit card fees                                               |       | 63       |       | 51       |       | 41       |       |
| Litigation  recovery on previously impaired investment         |       | 855      |       | —   |       | —   |       |
| Gain on debt  extinguishments                                  |       | 769      |       | 140      |       | —   |       |
| Other income                                                   |       | (42      | )          | 50       |       | 16       |       |
| **Total non-interest income**                                  |       | $        | 21,684     |     | $          | 24,669   |       | $ | 9,409 |   |

 

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***Non-Interest Expense***

Non-interest expense includes, among other things,salaries and benefits, occupancy costs, professional fees, depreciation, dataprocessing, telecommunications and miscellaneous expenses. Non-interest expensewas $51.2 million and $44.7 million for the years ended December 31, 2006and 2005, respectively, an increase of $6.6 million, or 14.8%. The increase innon-interest expense for the year ended December 31, 2006, compared to2005, was primarily the result of the branch expansion that has occurred overthe past two years and our acquisition of the trust division in February 2006.In addition, we recorded an impairment charge of $2.9 million related toWilson/Bennett (see “Overview” and “Financial Overview” above for moreinformation). Expenses related to the branch expansion are represented in theincreases in our salaries and benefits expense, occupancy expense anddepreciation. Advertising and marketing and telecommunications have alsoincreased to support our branch openings and strong asset growth over the pastyear. We expect non-interest expense to continue to increase going forward aswe open new branches in 2007.

Non-interest expense was $44.7 million and $27.2million for the years ended December 31, 2005 and 2004, respectively, anincrease in 2005 of $17.5 million, or 64.4%. The increase in non-interestexpense for the year ended December 31, 2005, compared to 2004, wasprimarily the result of a full year of operations of George Mason and ourbranch expansion. The acquisition of Wilson/Bennett in June 2005 alsoresulted in increased non-interest expense.

The following tablereflects the components of non-interest expense for the years ended December 31,2006, 2005 and 2004.

**Table 7.**

**Non-Interest Expense**YearsEnded December 31, 2006, 2005, and 2004(In thousands)

| ** **                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Salary and benefits                           |       | $        | 24,616     |     | $          | 22,480   |       | $ | 13,354 |   |
| Occupancy                                     |       | 5,242    |       | 4,293    |       | 2,897    |       |
| Professional fees                             |       | 2,149    |       | 2,212    |       | 1,610    |       |
| Depreciation                                  |       | 3,172    |       | 2,822    |       | 1,838    |       |
| Amortization of  intangibles                  |       | 420      |       | 409      |       | 49       |       |
| Impairment of  goodwill and intangible assets |       | 2,927    |       | —   |       | —   |       |
| Data processing                               |       | 1,358    |       | 1,559    |       | 969      |       |
| Stationary and  supplies                      |       | 1,374    |       | 1,551    |       | 965      |       |
| Advertising and  marketing                    |       | 2,026    |       | 1,993    |       | 1,613    |       |
| Telecommunications                            |       | 1,247    |       | 1,189    |       | 611      |       |
| Other taxes                                   |       | 1,572    |       | 1,422    |       | 548      |       |
| Travel and  entertainment                     |       | 776      |       | 763      |       | 427      |       |
| Bank operations                               |       | 719      |       | 860      |       | 676      |       |
| Premises and  equipment                       |       | 1,675    |       | 1,400    |       | 800      |       |
| Miscellaneous                                 |       | 1,972    |       | 1,700    |       | 797      |       |
| Total non-interest  expense                   |       | $        | 51,245     |     | $          | 44,653   |       | $ | 27,154 |   |

 

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**Income Taxes**

Werecorded a provision for income tax expense of $3.2 million for the year ended December 31,2006, a decrease of $2.0 million compared to 2005. Our effective tax rate forthe years ended December 31, 2006 and 2005 was 30.0 % and 34.3%, respectively.The decrease in effective tax rates from 2005 to 2006 is primarily the resultof our adding tax-exempt investments during 2006.

Werecorded a provision for income tax expense of $1.7 million for the year ended December 31,2004. Our effective tax rate for the year ended December 31, 2004 was33.0%. The increase in effective tax rates from 2004 to 2005 is primarily theresult of our marginal tax rate increasing from 34% in 2004 to 35% in 2005.

For more information, see “Critical Accounting Policies”above. In addition, Note 11 to the Notes to Consolidated Financial Statementsprovides additional information with respect to the deferred tax accounts andthe net operating loss carryforward.

**Statements of Condition**

**Loans Receivable, Net**

Totalloans receivable, net of deferred fees and costs, were $845.4 million at December 31,2006, an increase of $139.8 million, or 19.8%, compared to $705.6 million at December 31,2005. We achieved growth in all our loan categories with the exception of ourhome equity lines and consumer loans. Home equity lines decreased $9.5 million,or 12.7%, to $65.6 million at December 31, 2006 from $75.0 million at December 31,2005, primarily as a result of repayments during 2006 and decreasedoriginations as a result of the slowdown in the regional housing market. Loansheld for sale, net decreased $22.9 million to $338.7 million at December 31,2006 compared to $361.7 million at December 31, 2005, again as a result ofthe slowdown in the regional housing market during 2006.

Loansreceivable accounted for on a non-accrual basis at December 31, 2006 and December 31,2005 were $82,000 and $214,000, respectively. Accruing loans, which arecontractually past due 90 days or more as to principal or interest payments, atDecember 31, 2006 and December 31, 2005 were none and $33,000,respectively. There were no loans at December 31, 2006 and December 31,2005 that were “troubled debt restructurings” as defined in SFAS No. 15, *Accounting by Debtors and Creditors for Troubled DebtRestructurings.*

Interestincome on non-accrual loans, if recognized, is recorded using the cash basismethod of accounting. When a loan is placed on non-accrual, unpaid interest isreversed against interest income if it was accrued in the current year and ischarged to the allowance for loan losses if it was accrued in prior years. Whileon non-accrual, the collection of interest is recorded as interest income onlyafter all past-due principal has been collected. When all past contractualobligations are collected and, in our opinion, the borrower has demonstratedthe ability to remain current, the loan is returned to an accruing status. 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 the years ended December 31,2006 and 2005 was $15,000 and $18,000, respectively. The interest incomerealized prior to the loans being placed on non-accrual status for the yearended December 31, 2006 was $9,000. No interest income was realized priorto loans being placed on nonaccrual status for the year ended December 31,2005.

Totalloans receivable, net of deferred fees and costs, increased $215.7 million to$705.6 million at December 31, 2005, as compared to December 31, 2004.The strongest growth was in commercial real estate loans, residential realestate loans, and real estate construction loans.

Loansreceivable accounted for on a non-accrual basis at December 31, 2004 were$547,000. There were no accruing loans, which were contractually past due 90days or more as to principal or interest payments at December 31, 2004. Therewere no loans at December 31, 2004 that were “troubled debt 

49

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restructurings”as defined in SFAS No. 15. Gross interest income that would have beenrecorded if the non-accrual loans had been current with their original termsand had been outstanding throughout the period, or since origination if heldfor part of the period for 2004 was $25,000. The interest income realized priorto these loans being placed on non-accrual status for the year ended December 31,2004 was $21,000.

The ratioof non-performing loans to total loans was 0.01%, 0.03% and 0.11% at December 31,2006, 2005 and 2004, respectively.

The following tables present the composition of our loansreceivable portfolio at the end of each of the five years ended December 31,2006 and additional information on non-performing loans receivable.

**Table 8.**

**LoansReceivable**AtDecember 31, 2006, 2005, 2004, 2003, and 2002(In thousands)

| ** **                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Commercial and  industrial       |       | $        | 102,284    |     | 12.09      | %        | $          | 69,392 |   | 9.83 | % | $ | 56,512 |   | 11.53 | % |
| Real estate—commercial      |       | 317,201  |       | 37.50    |       | 275,381  |       | 39.01 |   | 220,012 |   | 44.88 |   |
| Real estate—construction    |       | 154,525  |       | 18.27    |       | 128,009  |       | 18.13 |   | 69,535 |   | 14.18 |   |
| Real estate—residential     |       | 201,320  |       | 23.80    |       | 152,818  |       | 21.65 |   | 76,932 |   | 15.69 |   |
| Home equity lines                |       | 65,557   |       | 7.75     |       | 75,048   |       | 10.63 |   | 60,408 |   | 12.32 |   |
| Consumer                         |       | 4,904    |       | 0.59     |       | 5,255    |       | 0.75 |   | 6,816 |   | 1.40 |   |
| Gross loans                      |       | 845,791  |       | 100.00   | %          | 705,903  |       | 100.00 | % | 490,215 |   | 100.00 | % |
| Net deferred  (fees) costs       |       | (342     | )          |     |       | (259     | )          |   |   | (319 | ) |   |   |
| Less: allowance  for loan losses |       | (9,638   | )          |     |       | (8,301   | )          |   |   | (5,878 | ) |   |   |
| Loans receivable, net            |       | $        | 835,811    |     |       |     | $          | 697,343 |   |   |   | $ | 484,018 |   |   |   |

 

| ** **                       | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Commercial and  industrial       |       | $        | 57,854     |     | 17.21      | % | $ | 58,292 |   | 23.40 | % |
| Real estate—commercial      |       | 139,725  |       | 41.56    |       | 116,135 |   | 46.63 |   |
| Real estate—construction    |       | 42,243   |       | 12.57    |       | 5,781 |   | 2.32 |   |
| Real estate—residential     |       | 42,495   |       | 12.64    |       | 31,808 |   | 12.77 |   |
| Home equity lines                |       | 43,176   |       | 12.84    |       | 26,831 |   | 10.77 |   |
| Consumer                         |       | 10,690   |       | 3.18     |       | 10,235 |   | 4.11 |   |
| Gross loans                      |       | 336,183  |       | 100.00   | %          | 249,082 |   | 100.00 | % |
| Net deferred  (fees) costs       |       | (181     | )          |     |       | 24 |   |   |   |
| Less: allowance  for loan losses |       | (4,344   | )          |     |       | (3,372 | ) |   |   |
| Loans receivable, net            |       | $        | 331,658    |     |       |   | $ | 245,734 |   |   |   |

 

**Table 9.**

**Nonperforming Loans Receivable**AtDecember 31, 2006, 2005, 2004, 2003, and 2002(In thousands)

| ** **                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Nonaccruing loans                             |       |     | $          | 82       |       |     | $          | 214      |       | $        | 547        |   | $ | 390 |   | $ | 917 |   |
| Loans contractually  past-due 90 days or more |       |     | —     |     |       | 33       |       | —   |       | 4        |       | 59 |   |
| Total nonperforming  loans receivable         |       |     | $          | 82       |       |     | $          | 247      |       | $        | 547        |   | $ | 394 |   | $ | 976 |   |

 

50

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The following tablepresents information on loan maturities and interest rate sensitivity.

**Table 10.**

**Loan Maturities and Interest Rate Sensitivity**AtDecember 31, 2006(In thousands)

| ** **                    | ** ** | ** **        | ** ** | **Between**         | ** ** | ** **          | ** ** | ** ** | ** ** |
|-------------------------------|------------|-------------------|------------|---------------------|------------|---------------------|------------|------------|------------|
| ** **                    | ** ** | **One Year** | ** ** | **One and**    | ** ** | **After**           | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **or Less**  | ** ** | **Five Years** | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| Commercial and  industrial    |       | $                 | 75,165     |                | $          | 23,055              |       |       | $          | 4,064 |   |   | $ | 102,284 |   |
| Real estate—commercial   |       | 66,303            |       | 184,122             |       |                | 66,776     |       |       | 317,201 |   |
| Real estate—construction |       | 135,647           |       | 18,467              |       |                | 411        |       |       | 154,525 |   |
| Real estate—residential  |       | 111,497           |       | 84,648              |       |                | 5,175      |       |       | 201,320 |   |
| Home equity lines             |       | 64,450            |       | 1,107               |       |                | —     |       |       | 65,557 |   |
| Consumer                      |       | 2,274             |       | 2,041               |       |                | 589        |       |       | 4,904 |   |
| **Total  loans receivable**   |       | $                 | 455,336    |                | $          | 313,440             |       |       | $          | 77,015 |   |   | $ | 845,791 |   |
| Fixed—rate loans         |       |              |       | $                   | 122,944    |                |       | $          | 62,655     |   |   | $ | 185,599 |   |
| Floating—rate  loans     |       |              |       | 190,496             |       |                | 14,360     |       |       | 204,856 |   |
| **Total loans receivable**    |       |              |       | $                   | 313,440    |                |       | $          | 77,015     |   |   | $ | 390,455 |   |

----

*                    Maturities byperiod are based on the repricing characteristics and not contractual maturities.

**InvestmentSecurities**

Our investment securities portfolio is used as asource of income and liquidity. The investment portfolio consists of investmentsecurities available-for-sale and investment securities held-to-maturity. Investmentsecurities available-for-sale are those securities that we intend to hold foran indefinite period of time, but not necessarily until maturity. Thesesecurities are carried at fair value and may be sold as part of anasset/liability strategy, liquidity management or regulatory capital management.Investment securities held-to-maturity are those securities that we have theintent and ability to hold to maturity and are carried at amortized cost. Investmentsecurities were $329.3 million at December 31, 2006, an increase of $35.1million or 11.9%, from $294.2 million in investment securities at December 31,2005.

Of the $329.3 million in the investment portfolio at December 31,2006, $97.7 million were classified as held-to-maturity, and $231.6 millionwere classified as available-for-sale. At December 31, 2006, the yield onthe available-for-sale investment portfolio was 4.73% and the yield on theheld-to-maturity portfolio was 4.28%. During 2006, we began purchasingbank-qualified tax-exempt municipal investment securities. At December 31,2006, tax-exempt municipal securities were $25.0 million.

At December 31, 2006 and 2005, investmentsecurities with unrealized losses are investment grade securities. Investmentsecurities with unrealized losses have interest rates that are less thancurrent market interest rates and, therefore, the indicated temporary lossesare not a result of permanent credit impairment. Mortgage-backed investmentsecurities, which are the primary component of the unrealized losses in theinvestment securities portfolio at those dates, are primarily comprised of securitiesissued by the Federal National Mortgage Association (FNMA), Federal Home LoanMortgage Corporation (FHLMC) and Government National Mortgage Association(GNMA).

Investment securities increased to $294.2 million atDecember 31, 2005, from $289.5 million at December 31, 2004. AtDecember 31, 2005, $115.3 million were classified as held-to-maturity, and$179.0 million were classified as available-for-sale. The yield on theavailable-for-sale investment portfolio was 4.38%, and the yield on theheld-to-maturity portfolio was 4.19% at December 31, 2005.

51

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The following tablereflects the composition of the investment portfolio at December 31, 2006,2005, and 2004.

**Table 11.**

**InvestmentSecurities**AtDecember 31, 2006, 2005, and 2004(In thousands)

| ** **                                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2006** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                             |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | $             | 51,973     |      | $          | 51,517      |       |   | 4.90 |   | % |
| Five to ten years                                               |       | 15,520        |       | 15,480    |       |        | 5.72       |   |   |
| Total U.S. government-sponsored agencies                        |       | 67,493        |       | 66,997    |       |        | 5.09       |   |   |
| Mortgage-backed  securities*                                    |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | 4,406         |       | 4,312     |       |        | 4.18       |   |   |
| Five to ten years                                               |       | 10,599        |       | 10,291    |       |        | 3.76       |   |   |
| After ten years                                                 |       | 127,197       |       | 124,511   |       |        | 4.76       |   |   |
| Total mortgage-backed securities                                |       | 142,202       |       | 139,114   |       |        | 4.67       |   |   |
| Municipal securities                                            |       |          |       |      |       |        |       |   |   |
| After ten years                                                 |       | 25,047        |       | 25,031    |       |        | 4.10       |   |   |
| Total U.S. treasury securities                                  |       | 25,047        |       | 25,031    |       |        | 4.10       |   |   |
| U. S. treasury  securities                                      |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | 489           |       | 489       |       |        | 5.14       |   |   |
| Total U.S. treasury securities                                  |       | 489           |       | 489       |       |        | 5.14       |   |   |
| Total investment  securities available-for-sale                 |       | $             | 235,231    |      | $          | 231,631     |       |   | 4.73 |   | % |

 

| ** **                                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|---------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2006** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                           |       |          |       |      |       |        |       |   |   |
| One to five years                                             |       | $             | 8,967      |      | $          | 8,734       |       |   | 3.50 |   | % |
| Five to ten years                                             |       | 13,018        |       | 12,777    |       |        | 4.44       |   |   |
| After ten years                                               |       | 2,000         |       | 1,971     |       |        | 5.30       |   |   |
| Total U.S. government-sponsored agencies                      |       | 23,985        |       | 23,482    |       |        | 4.16       |   |   |
| Mortgage-backed  securities*                                  |       |          |       |      |       |        |       |   |   |
| Five to ten years                                             |       | 6,702         |       | 6,544     |       |        | 4.21       |   |   |
| After ten years                                               |       | 58,974        |       | 57,560    |       |        | 4.35       |   |   |
| Total mortgage-backed securities                              |       | 65,676        |       | 64,104    |       |        | 4.34       |   |   |
| Corporate bonds                                               |       |          |       |      |       |        |       |   |   |
| After ten years                                               |       | 8,004         |       | 7,864     |       |        | 4.21       |   |   |
| Total corporate bonds                                         |       | 8,004         |       | 7,864     |       |        | 4.21       |   |   |
| Total investment securities held-to-maturity                  |       | 97,665        |       | 95,450    |       |        | 4.28       |   |   |
| Total investment  securities                                  |       | $             | 332,896    |      | $          | 327,081     |       |   | 4.60 |   | % |

 

52

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| ** **                                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2005** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                             |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | $             | 43,784     |      | $          | 43,264      |       |   | 4.79 |   | % |
| Five to ten years                                               |       | 15,175        |       | 15,147    |       |        | 5.42       |   |   |
| Total U.S. government-sponsored agencies                        |       | 58,959        |       | 58,411    |       |        | 4.88       |   |   |
| Mortgage-backed  securities*                                    |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | 5,441         |       | 5,269     |       |        | 4.02       |   |   |
| Five to ten years                                               |       | 8,980         |       | 8,678     |       |        | 3.88       |   |   |
| After ten years                                                 |       | 108,309       |       | 104,613   |       |        | 4.21       |   |   |
| Total mortgage-backed securities                                |       | 122,730       |       | 118,560   |       |        | 4.17       |   |   |
| U. S. treasury  securities                                      |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | 2,015         |       | 1,984     |       |        | 2.63       |   |   |
| Total U.S. treasury securities                                  |       | 2,015         |       | 1,984     |       |        | 2.63       |   |   |
| Total investment  securities available-for-sale                 |       | $             | 183,704    |      | $          | 178,955     |       |   | 4.38 |   | % |

 

| ** **                                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|---------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2005** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                           |       |          |       |      |       |        |       |   |   |
| One to five years                                             |       | $             | 9,500      |      | $          | 9,172       |       |   | 3.52 |   | % |
| Five to ten years                                             |       | 13,020        |       | 12,698    |       |        | 4.37       |   |   |
| After ten years                                               |       | 3,000         |       | 2,936     |       |        | 4.22       |   |   |
| Total U.S. government-sponsored agencies                      |       | 25,520        |       | 24,806    |       |        | 4.03       |   |   |
| Mortgage-backed  securities*                                  |       |          |       |      |       |        |       |   |   |
| Five to ten years                                             |       | 7,662         |       | 7,470     |       |        | 4.21       |   |   |
| After ten years                                               |       | 74,082        |       | 71,937    |       |        | 4.24       |   |   |
| Total mortgage-backed securities                              |       | 81,744        |       | 79,407    |       |        | 4.23       |   |   |
| Corporate bonds                                               |       |          |       |      |       |        |       |   |   |
| After ten years                                               |       | 8,005         |       | 7,812     |       |        | 4.21       |   |   |
| Total corporate bonds                                         |       | 8,005         |       | 7,812     |       |        | 4.21       |   |   |
| Total investment securities held-to-maturity                  |       | 115,269       |       | 112,025   |       |        | 4.19       |   |   |
| Total investment  securities                                  |       | $             | 298,973    |      | $          | 290,980     |       |   | 4.31 |   | % |

 

| ** **                                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2004** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                             |       |          |       |      |       |        |       |   |   |
| 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       |   |   |
| U.S. treasury  securities                                       |       |          |       |      |       |        |       |   |   |
| One to five years                                               |       | 2,031         |       | 2,018     |       |        | 2.63       |   |   |
| Total U.S. treasury securities                                  |       | 2,031         |       | 2,018     |       |        | 2.63       |   |   |
| Total investment  securities available-for-sale                 |       | $             | 153,331    |      | $          | 151,554     |       |   | 3.94 |   | % |

 

53

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| ** **                                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|---------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2004** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                           |       |          |       |      |       |        |       |   |   |
| 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                                               |       | 8,005         |       | 7,923     |       |        | 4.21       |   |   |
| Total corporate bonds                                         |       | 8,005         |       | 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 |   | % |

----

*                    Basedon contractual maturities.

**Deposits and OtherBorrowed Funds**

Total deposits were $1.22 billion at December 31,2006, an increase of $149.0 million, or 13.9%, from $1.07 billion at December 31,2005. This growth is primarily attributable to the opening of two branchoffices during 2006 and our promotional efforts.  At December 31, 2006, we had $5.0 millionof brokered certificates of deposit, compared to $9.8 million at December 31,2005.

Other borrowed funds, which primarily includerepurchase agreements, FHLB advances and our payable to Cardinal StatutoryTrust I, were $194.6 million at December 31, 2006, an increase of $39.2million, from $155.4 million at December 31, 2005. The primary reason forthe increase in other borrowed funds at December 31, 2006 was an increasein funding from advances from the Federal Home Loan Bank of Atlanta. Advancesfrom the Federal Home Loan Bank of Atlanta were $122.7 million at December 31,2006, compared to $88.5 million at December 31, 2005.  Advances taken during 2006 were utilizedprimarily to leverage some of our larger commercial real estate fundings and toassist in financing the George Mason inventory of loans held for sale.

Other borrowed funds at each of December 31, 2006and 2005, included $20.6 million payable to Cardinal Statutory Trust I, theissuer of our trust preferred securities. This debt had an interest rate of7.76% and 6.89% at December 31, 2006 and 2005, respectively. In accordancewith FIN No. 46, *Consolidation of VariableInterest Entities,*Cardinal Statutory Trust I is an unconsolidatedentity as we are not the primary beneficiary of the trust.

At December 31, 2006, other borrowed funds alsoincluded $46.3 million in customer repurchase agreements and $5.0 millionborrowed under the Federal Reserve Treasury, Tax & Loan note option.

54

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Thefollowing table reflects the short-term borrowings and other borrowed fundsoutstanding at December 31, 2006.

**Table 12.**

**Short-TermBorrowings and Other Borrowed Funds**AtDecember 31, 2006(In thousands)

**Short-term FHLB advances:**

| **Advance Date**                                                | ** ** | **Term of Advance** | ** ** | **Date Due** | ** ** | **Interest Rate** | ** **  | **Outstanding** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------|------------|-------------------|------------|------------------------|-------------|-----------------|------------|
| Mar-03                                                               |       |                          | 4  years   |              |       |                   | Mar-07      |            |       |   | 2.81 | % |   |   | $ | 1,000 |   |   |
| Apr-04                                                               |       |                          | 3  years   |              |       |                   | Apr-07      |            |       |   | 3.15 |   |   |   | 3,000 |   |   |
| Jun-05                                                               |       |                          | 2  years   |              |       |                   | Jun-07      |            |       |   | 4.12 |   |   |   | 10,000 |   |   |
| Jun-06                                                               |       |                          | 1  year    |              |       |                   | Jun-07      |            |       |   | 5.50 |   |   |   | 6,000 |   |   |
| Jul-03                                                               |       |                          | 4  years   |              |       |                   | Jul-07      |            |       |   | 2.63 |   |   |   | 6,250 |   |   |
| Dec-04                                                               |       |                          | 3 years    |              |       |                   | Dec-07      |            |       |   | 3.59 |   |   |   | 7,500 |   |   |
| **Total  short-term FHLB advances and weighted average rate**        |       | **3.85**                      | **%**      |              |       | **$**                  | **33,750**  |            |       |
| **Other  short-term borrowed funds:**                                |       |                          |       |              |       |                   |        |            |
| TT&L Note option                                                 |       | 4.69                          | %          |              |       | $                      | 4,981       |            |       |
| Customer repurchase  agreements                                      |       | 2.14                          |       |              |       | 46,323                 |        |            |
| **Total  other short-term borrowed funds and weighted average rate** |       | **2.39**                      | **%**      |              |       | **$**                  | **51,304**  |            |       |
| **Other  borrowed funds:**                                           |       |                          |       |              |       |                   |        |            |
| Trust preferred                                                      |       | 7.76                          | %          |              |       | $                      | 20,619      |            |       |
| FHLB advances—long term                                         |       | 4.17                          |       |              |       | 88,958                 |        |            |
| **Other  borrowed funds and weighted average rate**                  |       | **4.85**                      | **%**      |              |       | **$**                  | **109,577** |            |       |
| **Total  other borrowed funds and weighted average rate**            |       | **4.02**                      | **%**      |              |       | **$**                  | **194,631** |            |       |

 

Total deposits at December 31, 2005 were $1.07billion compared to $824.2 million at December 31, 2004, an increase of$245.7 million, or 29.8%. This growth is primarily attributable to the openingof three branch offices during 2005 and our promotional efforts. AtDecember 31, 2005, we had $9.8 million of brokered certificates ofdeposit, compared to $86.7 million at December 31, 2004. We began usingthe brokered certificates of deposit market during 2004 to assist us in thefunding of George Mason’s loans held for sale portfolio. We have since replacedmost of this funding with core deposit growth. Other borrowed funds decreased$45.7 million to $155.4 million at December 31, 2005, from $201.1 millionat December 31, 2004. This decrease was a result of payoffs of advancesfrom the Federal Home Loan Bank of Atlanta.

 

55

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The following tablereflects the maturities of the certificates of deposit of $100,000 or more asof December 31, 2006, 2005 and 2004.

**Table 13.**

**Certificatesof Deposit of $100,000 or More**AtDecember 31, 2006, 2005, and 2004(In thousands)

| ** **                             | ** ** | **2006**            | ** ** |
|----------------------------------------|------------|---------------------|------------|
| **Maturities:**                        | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
| Three months or less                   |       |                | $          | 116,204 |   |   |   | $ | 23,220 |   |   | $ | 139,424 |   |
| Over three months  through six months  |       |                | 24,608     |   |   |   | 10,974 |   |   | 35,582 |   |
| Over six months through  twelve months |       |                | 22,601     |   |   |   | 20,869 |   |   | 43,470 |   |
| Over twelve months                     |       |                | 43,530     |   |   |   | 774 |   |   | 44,304 |   |
|                                   |       |                | $          | 206,943 |   |   |   | $ | 55,837 |   |   | $ | 262,780 |   |

 

| ** **                             | ** ** | **2005**            | ** ** |
|----------------------------------------|------------|---------------------|------------|
| **Maturities:**                        | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
| Three months or less                   |       |                | $          | 15,025 |   |   |   | $ | 3,530 |   |   | $ | 18,555 |   |
| Over three months  through six months  |       |                | 21,637     |   |   |   | 34,937 |   |   | 56,574 |   |
| Over six months through  twelve months |       |                | 56,231     |   |   |   | 59,536 |   |   | 115,767 |   |
| Over twelve months                     |       |                | 58,390     |   |   |   | 34,341 |   |   | 92,731 |   |
|                                   |       |                | $          | 151,283 |   |   |   | $ | 132,344 |   |   | $ | 283,627 |   |

 

| ** **                             | ** ** | **2004**            | ** ** |
|----------------------------------------|------------|---------------------|------------|
| **Maturities:**                        | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
| Three months or less                   |       |                | $          | 3,821 |   |   |   | $ | 3,462 |   |   | $ | 7,283 |   |
| Over three months  through six months  |       |                | 7,801      |   |   |   | 572 |   |   | 8,373 |   |
| Over six months through  twelve months |       |                | 6,979      |   |   |   | 27,171 |   |   | 34,150 |   |
| Over twelve months                     |       |                | 40,847     |   |   |   | 134,649 |   |   | 175,496 |   |
|                                   |       |                | $          | 59,448 |   |   |   | $ | 165,854 |   |   | $ | 225,302 |   |

----

*                    No-Penaltycertificates of deposit can be redeemed at anytime at the request of thedepositor.

**Business SegmentOperations**

Weprovide banking and non-banking financial services and products through oursubsidiaries. We operate in three business segments, commercial banking, mortgagebanking and wealth management and trust services.

Thecommercial banking segment includes both commercial and consumer lending andprovides customers such products as commercial loans, real estate loans, andother business financing and consumer loans. In addition, this segment alsoprovides customers with various deposit products including demand depositaccounts, savings accounts and certificates of deposit.

Themortgage banking segment engages primarily in the origination and acquisitionof residential mortgages for sale into the secondary market on a best effortsbasis.

Thewealth management and trust services segment provides investment and financialservices to businesses and individuals, including financial planning,retirement/estate planning, trusts, estates, custody, investment management,escrows, and retirement plans. Wilson/Bennett has been included in thisoperating segment since the date of its acquisition on June 9, 2005. On February 9,2006, we acquired certain fiduciary and other assets and assumed certainliabilities of FBR National Trust Company, formerly a subsidiary of Friedman,Billings, Ramsey Group, Inc.

56

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Information about the reportable segments, andreconciliation of this information to the consolidated financial statements at December 31,2006, 2005 and 2004 follows.

**Table 14.**

**Segment Reporting**December 31,2006, 2005 and 2004(In thousands)

**At and for the Year Ended December 31, 2006:**

| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|-------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Management**          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       | $              | 38,091     |         | $          | 4,344                   |       |       | $          | —           |       |             | $          | (1,081 | ) |   | $ | — |   |   |   | $ | 41,354 |   |   |
| Provision for  loan losses  |       | 1,232          |       | —       |       |                    | —     |       |       | —           |       |             | —     |   |   |   | 1,232 |   |   |
| Non-interest  income        |       | 4,415          |       | 13,892       |       |                    | 3,330      |       |       | 47               |       |             | —     |   |   |   | 21,684 |   |   |
| Non-interest  expense       |       | 27,127         |       | 15,241       |       |                    | 6,591      |       |       | 2,286            |       |             | —     |   |   |   | 51,245 |   |   |
| Provision for  income taxes |       | 4,571          |       | 1,060        |       |                    | (1,307     | )          |       | (1,151           | )          |             | —     |   |   |   | 3,173 |   |   |
| Net income (loss)           |       | $              | 9,576      |         | $          | 1,935                   |       |       | $          | (1,954           | )          |             | $          | (2,169 | ) |   | $ | — |   |   |   | $ | 7,388 |   |   |
| Total Assets                |       | $              | 1,572,051  |         | $          | 360,470                 |       |       | $          | 5,500            |       |             | $          | 163,879 |   |   | $ | (463,471 | ) |   |   | $ | 1,638,429 |   |   |

 

**At and for the Year Ended December 31, 2005:**

| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|-------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Management**          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       | $              | 32,171     |         | $          | 6,203                   |       |       | $          | —           |       |             | $          | (891 | ) |   | $ | — |   |   |   | $ | 37,483 |   |   |
| Provision for  loan losses  |       | 2,456          |       | —       |       |                    | —     |       |       | —           |       |             | —     |   |   |   | 2,456 |   |   |
| Non-interest  income        |       | 1,964          |       | 21,255       |       |                    | 1,367      |       |       | 83               |       |             | —     |   |   |   | 24,669 |   |   |
| Non-interest  expense       |       | 23,802         |       | 17,332       |       |                    | 1,422      |       |       | 2,097            |       |             | —     |   |   |   | 44,653 |   |   |
| Provision for  income taxes |       | 2,764          |       | 3,413        |       |                    | (56        | )          |       | (954             | )          |             | —     |   |   |   | 5,167 |   |   |
| Net income (loss)           |       | $              | 5,113      |         | $          | 6,713                   |       |       | $          | 1                |       |             | $          | (1,951 | ) |   | $ | — |   |   |   | $ | 9,876 |   |   |
| Total Assets                |       | $              | 1,387,504  |         | $          | 376,618                 |       |       | $          | 6,882            |       |             | $          | 160,856 |   |   | $ | (479,573 | ) |   |   | $ | 1,452,287 |   |   |

 

**At and for the Year Ended December 31, 2004:**

| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|-------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Management**          | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **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              |       |             | $          | 115,985 |   |   | $ | (421,203 | ) |   |   | $ | 1,211,576 |   |   |

 

During the third quarter of 2006, we recorded a non-cashimpairment loss totaling $2.9 million pretax, and $1.9 million aftertax ($0.03 per share basic and diluted) in our Wealth Management and Trust Servicessegment.

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**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 (which includescommon shareholders’ equity, defined to include certain debt obligations) andTier 2 (to include certain other debt obligations and a portion of theallowance for loan losses and 45% of unrealized gains in equity securities).

Shareholders’ equity at December 31, 2006 was$155.9 million, an increase of $8.0 million, compared to $147.9 million at December 31,2005. The increase in shareholders’ equity was primarily attributable torecorded net income of $7.4 million for the year ended December 31, 2006. Totalshareholders’ equity to total assets at December 31, 2006 and 2005 was9.5% and 10.2%, respectively. Book value per share at December 31, 2006and 2005 was $6.37 and $6.07, respectively. Total risk-based capital torisk-weighted assets was 14.06% at December 31, 2006 compared to 15.65% atDecember 31, 2005. Accordingly, we were considered “well capitalized” forregulatory purposes at December 31, 2006, as we were at December 31,2005.

Shareholders’ equity at December 31, 2005 was$147.9 million, an increase of $52.8 million, compared to $95.1 million at December 31,2004. The increase in shareholders’ equity was primarily attributable to $39.8million of additional equity raised during our 2005 common stock offering andnet income of $9.9 million. Total shareholders’ equity to total assets at December 31,2005 and 2004 was 10.2% and 7.9%, respectively. Book value per share at December 31,2005 and 2004 was $6.07 and $5.15, respectively. Total risk-based capital torisk-weighted assets was 15.65% at December 31, 2005 compared to 13.40% atDecember 31, 2004. Accordingly, we were considered “well capitalized” forregulatory purposes at December 31, 2005, as we were at December 31,2004.

As noted above, regulatory capital levels for the bankand bank holding company meet those established for well-capitalizedinstitutions. While we are currently considered well-capitalized, we may fromtime-to-time find it necessary to access the capital markets to meet our growthobjectives or capitalize on specific business opportunities.

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The following table shows the minimum capitalrequirement and our capital position at December 31, 2006, 2005, and 2004for the Company and for the Bank.

**Table 15.**

**Capital Components**AtDecember 31, 2006, 2005, and 2004(In thousands)

| ** **                                                       | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| **Cardinal Financial Corporation (Consolidated):**               | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                       | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **At December 31, 2006**                                    | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total risk-based capital/  Total capital to risk-weighted assets |       | $          | 170,457    |                                         | 14.06%     |                                                                                             | $          | 97,010 | 3 | 8.00% |   | $ | 121,263 | 3 | 10.00% |   |
| Tier I capital/ Tier I  capital to risk-weighted assets          |       | 160,656    |       | 13.25%                                       |       | 48,505                                                                                           | 3     | 4.00% |   | 72,758 | 3 | 6.00% |   |
| Tier I capital/ Total  capital to average assets                 |       | 160,656    |       | 10.68%                                       |       | 60,180                                                                                           | 3     | 4.00% |   | 75,225 | 3 | 5.00% |   |
| **At December 31, 2005**                                    | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 159,155    |                                         | 15.65%     |                                                                                             | $          | 81,334 | 3 | 8.00% |   | $ | 101,668 | 3 | 10.00% |   |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 150,742    |       | 14.83%                                       |       | 40,667                                                                                           | 3     | 4.00% |   | 61,001 | 3 | 6.00% |   |
| Tier I capital/  Total capital to average assets                 |       | 150,742    |       | 10.71%                                       |       | 56,308                                                                                           | 3     | 4.00% |   | 70,386 | 3 | 5.00% |   |
| **At December 31, 2004**                                    | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 107,660    |                                         | 13.40%     |                                                                                             | $          | 64,294 | 3 | 8.00% |   | $ | 80,368 | 3 | 10.00% |   |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 101,670    |       | 12.65%                                       |       | 32,147                                                                                           | 3     | 4.00% |   | 48,221 | 3 | 6.00% |   |
| Tier I capital/  Total capital to average assets                 |       | 101,670    |       | 8.83%                                        |       | 46,075                                                                                           | 3     | 4.00% |   | 57,594 | 3 | 5.00% |   |

 

| ** **                                                      | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| **Cardinal Bank:**                                              | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                       | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **At December 31, 2006**                                        |       |       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total risk-based capital/ Total capital to risk-weighted assets |       | $          | 141,885    |                                         | 11.73%     |                                                                                             | $     | 96,742 | >  | 8.00% |   | $ | 120,927 | >  | 10.00% |   |
| Tier I capital/ Tier I capital to risk-weighted assets          |       | 132,084    |       | 10.92%                                       |       | 48,371                                                                                           | >  | 4.00% |   | 72,556 | >  | 6.00% |   |
| Tier I capital/ Total capital to average assets                 |       | 132,084    |       | 8.80%                                        |       | 60,038                                                                                           | >  | 4.00% |   | 75,048 | >  | 5.00% |   |
| **At December 31, 2005**                                        |       |       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total risk-based capital/ Total capital to risk-weighted assets |       | $     | 129,042    |                                         | 12.73%     |                                                                                             | $          | 81,097 | >  | 8.00% |   | $ | 101,372 | >  | 10.00% |   |
| Tier I capital/ Tier I capital to risk-weighted assets          |       | 120,628    |       | 11.90%                                       |       | 40,549                                                                                           | >  | 4.00% |   | 60,823 | >  | 6.00% |   |
| Tier I capital/ Total capital to average assets                 |       | 120,628    |       | 8.61%                                        |       | 56,014                                                                                           | >  | 4.00% |   | 70,018 | >  | 5.00% |   |
| **At  December 31, 2004**                                       |       |       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Total risk-based capital/ Total capital to risk-weighted assets |       | $     | 92,774     |                                         | 11.64%     |                                                                                             | $          | 63,770 | >  | 8.00% |   | $ | 79,712 | >  | 10.00% |   |
| Tier I capital/ Tier I capital to risk-weighted assets          |       | 86,783     |       | 10.89%                                       |       | 31,885                                                                                           | >  | 4.00% |   | 47,827 | >  | 6.00% |   |
| Tier  I capital/ Total capital to average assets                |       | 86,783     |       | 7.58%                                        |       | 45,815                                                                                           | >  | 4.00% |   | 57,269 | >  | 5.00% |   |

 

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**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 by obtaining funding from depositors or otherlenders or by converting non-cash items into cash. The objective of ourliquidity management program is to ensure that we always have sufficientresources to meet the demands of our depositors and borrowers. Stable coredeposits and a strong capital position provide the base for our liquidity position.We believe we have demonstrated our ability to attract deposits because of ourconvenient branch locations, personal service and pricing.

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

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

We have established aformal liquidity contingency plan which establishes a liquidity management teamand provides guidelines for liquidity management. For our liquidity managementprogram, we first determine our current liquidity position and then forecastliquidity based on anticipated changes in the balance sheet. In this forecast,we expect to maintain a liquidity cushion. We also stress test our liquidityposition under several different stress scenarios. Guidelines for theforecasted liquidity cushion and for liquidity cushions for each stressscenario have been established. In addition, one stress test combines all otherstress tests to see how liquidity would react to several negative scenariosoccurring at the same time. We believe that we have sufficient resources tomeet our liquidity needs.

George Mason and the Bankhave a $150 million floating rate revolving credit and security agreement witha third party. The purpose of this credit facility is to fund residentialmortgage loans made by George Mason prior to their sale into the secondarymarket. The credit facility requires, among other things, that George Mason andthe Bank have positive quarterly net income and maintain specified minimumtangible and regulatory net worth levels. The Company has guaranteed repaymentof this debt. The interest rate on this credit facility is LIBOR plus between1.50% and 1.875%. At December 31, 2006, none of this line was utilized.

In addition to thisfacility, this same lender also has provided a $100 million facility that isutilized by George Mason to warehouse residential mortgage loans held for saleto this lender. The terms of this facility are substantially the same as theabove-referenced revolving credit and security agreement and the cost of thisfacility is netted against interest earned on the loans pending settlement withthe lender. Loans under this credit facility are considered sold when financed.

Liquid assets, whichinclude cash and due from banks, federal funds sold and investment securitiesavailable for sale, totaled $267.7 million at December 31, 2006, or 16.3%of total assets. We held investments that are classified as held-to-maturity inthe amount of $97.7 million at December 31, 2006. To maintain ready accessto the Bank’s secured lines of credit, the Bank has pledged the majority of itssecurities to the Federal Home Loan Bank of Atlanta with additional securitiespledged to the Federal Reserve Bank of Richmond. Additional borrowing capacityat the Federal Home Loan Bank of Atlanta at December 31, 2006 wasapproximately $215.4 million. Borrowing capacity with the Federal Reserve Bankof Richmond was approximately $15.5 million at December 31, 2006. GeorgeMason has $250 million of lines of credit available from outside sources. Weanticipate maintaining liquidity at a level sufficient to protect depositors,provide for reasonable growth and fully comply with all regulatoryrequirements.

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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:

**Table 16.**

**Contractual Obligations**AtDecember 31, 2006(In thousands)

| ** **                                          | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **Total**  | ** ** | **Less than  1 Year**           | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More than  5 Years** | ** ** |
| Long-Term Debt  Obligations:                        |       |       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Certificates of deposit                             |       | $          | 557,873    |                                      | $          | 447,774 |   | $ | 98,145 |   |   | $ | 11,864 |   |   |   | $ | 90 |   |   |
| Brokered certificates of deposit                    |       | 4,966      |       | —                                    |       | — |   |   | 4,966 |   |   |   | — |   |   |
| Advances from the Federal Home Loan Bank of Atlanta |       | 122,708    |       | 33,750                                    |       | 13,958 |   |   | 25,000 |   |   |   | 50,000 |   |   |
| Trust preferred securities                          |       | 20,619     |       | —                                    |       | — |   |   | — |   |   |   | 20,619 |   |   |
| Operating lease  obligations                        |       | 15,060     |       | 3,760                                     |       | 2,815 |   |   | 4,414 |   |   |   | 4,071 |   |   |
| Total                                               |       | $          | 721,226    |                                      | $          | 485,284 |   | $ | 114,918 |   |   | $ | 46,244 |   |   |   | $ | 74,780 |   |   |

 

**FinancialInstruments with Off-Balance-Sheet Risk and Credit 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 balancesheet.

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.

We have derivativecounter-party risk which may arise from the possible inability of GeorgeMason’s third-party investors to meet the terms of their forward salescontracts. George Mason works with third-party investors that are generallywell-capitalized, are investment grade and exhibit strong financial performanceto mitigate this risk.  We do not expectany third-party investor to fail to meet its obligation.

Asummary of the contract amount of the Bank’s exposure to off-balance-sheetrisk as of December 31, 2006 and 2005, is as follows:

| ** **                                                                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                     | ** ** | **(In thousands)** | ** ** |
| Financial  instruments whose contract amounts represent potential credit risk: |       |                    |       |     |       |
| Commitments to extend credit                                                   |       | $                       | 372,154    |     | $          | 325,571 |   |
| Standby letters  of credit                                                     |       | 8,097                   |       | 7,012    |       |
|                                                                                |            |                         |            |          |            |  |  |

 

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 

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expire without being drawnupon, the total commitment amounts do not necessarily represent future cashrequirements. We evaluate each customer’s credit worthiness on a case-by-casebasis. The amount of collateral obtained is based on management’s creditevaluation of the counterparty. Collateral held varies but may include accountsreceivable, inventory, property and equipment, and income-producingcommercial properties.

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, 2006 and 2005. Quarterlyper share results may not calculate to the year-end per share results due torounding.

During the third quarterof 2006, we recorded a non-cash impairment loss totaling $2.9 millionpretax, and $1.9 million after tax ($0.03 per share basic and diluted) inour Wealth Management and Trust Services segment.

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**Table 17.**

**QuarterlyData**Yearsended December 31, 2006 and 2005(In thousands, except per share data)

| ** **                                                | ** ** | **2006**    | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|
| ** **                                                | ** ** | **Fourth**  | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** |
| ** **                                                | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Interest income                                           |       | $           | 23,125     |   | $ | 22,866 |   | $ | 21,700 |   | $ | 19,710 |   |
| Interest expense                                          |       | 13,297      |       | 12,446 |   | 10,989 |   | 9,315 |   |
| Net interest  income                                      |       | 9,828       |       | 10,420 |   | 10,711 |   | 10,395 |   |
| Provision for  loan losses                                |       | (362        | )          | (230 | ) | (390 | ) | (250 | ) |
| Net interest  income after provision for loan losses      |       | 9,466       |       | 10,190 |   | 10,321 |   | 10,145 |   |
| Non-interest  income                                      |       | 6,020       |       | 4,961 |   | 5,539 |   | 5,164 |   |
| Non-interest  expense                                     |       | 12,320      |       | 15,045 |   | 12,448 |   | 11,432 |   |
| Net income before  income taxes                           |       | 3,166       |       | 106 |   | 3,412 |   | 3,877 |   |
| Provision for  income taxes                               |       | 965         |       | (149 | ) | 1,048 |   | 1,309 |   |
| Net income                                                |       | $           | 2,201      |   | $ | 255 |   | $ | 2,364 |   | $ | 2,568 |   |
| Less nonrecurring  items, after tax                       |       |        |       |   |   |   |   |   |   |
| Impairment of goodwill                                    |       | —      |       | 624 |   | — |   | — |   |
| Impairment of customer relationships intangible           |       | —      |       | 946 |   | — |   | — |   |
| Impairment of employment/non-compete agreement            |       | —      |       | 333 |   | — |   | — |   |
| Net income  without recurring items                       |       | $           | 2,201      |   | $ | 2,158 |   | $ | 2,364 |   | $ | 2,568 |   |
| Earnings per share—basic                             |       | $           | 0.09       |   | $ | 0.01 |   | $ | 0.10 |   | $ | 0.11 |   |
| Earnings per  share—diluted                          |       | $           | 0.09       |   | $ | 0.01 |   | $ | 0.09 |   | $ | 0.10 |   |
| Less nonrecurring items,  after tax                       |       |        |       |   |   |   |   |   |   |
| Impairment of goodwill                                    |       | —      |       | 0.03 |   | — |   | — |   |
| Impairment of customer relationships intangible           |       | —      |       | 0.04 |   | — |   | — |   |
| Impairment of employment/non-compete agreement            |       | —      |       | 0.01 |   | — |   | — |   |
| Earnings per share—basic, without recurring items    |       | $           | 0.09       |   | $ | 0.09 |   | $ | 0.10 |   | $ | 0.11 |   |
| Earnings per  share—diluted, without recurring items |       | $           | 0.09       |   | $ | 0.09 |   | $ | 0.09 |   | $ | 0.10 |   |

 

| ** **                                           | ** ** | **2005**    | ** ** |
|------------------------------------------------------|------------|-------------|------------|
| ** **                                           | ** ** | **Fourth**  | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** |
| ** **                                           | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Interest income                                      |       | $           | 19,616     |   | $ | 18,341 |   | $ | 15,926 |   | $ | 13,491 |   |
| Interest expense                                     |       | 9,191       |       | 8,230 |   | 6,802 |   | 5,669 |   |
| Net interest  income                                 |       | 10,425      |       | 10,111 |   | 9,124 |   | 7,822 |   |
| Provision for  loan losses                           |       | (587        | )          | (500 | ) | (820 | ) | (549 | ) |
| Net interest  income after provision for loan losses |       | 9,838       |       | 9,611 |   | 8,304 |   | 7,273 |   |
| Non-interest  income                                 |       | 5,863       |       | 7,349 |   | 6,275 |   | 5,183 |   |
| Non-interest  expense                                |       | 11,032      |       | 12,405 |   | 11,121 |   | 10,095 |   |
| Net income before  income taxes                      |       | 4,669       |       | 4,555 |   | 3,458 |   | 2,361 |   |
| Provision for  income taxes                          |       | 1,682       |       | 1,570 |   | 1,166 |   | 749 |   |
| Net income                                           |       | $           | 2,987      |   | $ | 2,985 |   | $ | 2,292 |   | $ | 1,612 |   |
| Earnings per share—basic                        |       | $           | 0.12       |   | $ | 0.12 |   | $ | 0.11 |   | $ | 0.09 |   |
| Earnings per  share—diluted                     |       | $           | 0.12       |   | $ | 0.12 |   | $ | 0.11 |   | $ | 0.09 |   |

 

 

63

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

Our Asset/Liability Committee is responsible forreviewing our liquidity requirements and maximizing our net interest incomeconsistent with capital requirements, liquidity, interest rate and economicoutlooks, competitive factors and customer needs. Interest rate risk arisesbecause the assets of the Bank and the liabilities of the Bank have differentmaturities and characteristics. In order to measure this interest rate risk, weuse a simulation process that measures the impact of changing interest rates onnet interest income. This model is run for the Bank by an independentconsulting firm that was hired by the Bank in the fourth quarter of 2004. Thesimulations incorporate assumptions related to expected activity in the balancesheet. For maturing assets, assumptions are developed for the redeployment ofthese assets. For maturing liabilities, assumptions are developed for thereplacement of these funding sources. Assumptions are also developed for assetsand liabilities that reprice during the modeled time period. These assumptionsalso cover how we expect rates to change on non-maturity deposits such as NOW,Money Market, savings accounts as well as certificates of deposit. Based oninputs that include the most recent period end balance sheet, the current levelof interest rates and the developed assumptions, the model then produces anexpected level of net interest income assuming that interest rates remainunchanged. This becomes the base case. Next, the model determines the impact onnet interest income given specified changes in interest rates. The ratesimulations are performed for a two year period and include ramped rate changesof down 200 basis points and up 200 basis points. In the ramped down ratechange, the model moves rates gradually down 200 basis points over the firstyear and then rates remain flat in the second year. For the up 200 basis pointscenario, rates are gradually increased by 200 basis points in the first yearand remain flat in the second year. In both the up and down scenarios, themodel assumes a parallel shift in the yield curve. The results of thesesimulations are then compared to the base case.

At December 31, 2006, we were liability sensitivefor the entire two year simulation period. Liability sensitive means that wehave more liabilities repricing than assets. We have more of our liabilities innon-maturity or short-term deposit products than we have in floating rateassets. In a decreasing interest rate environment, net interest income wouldgrow for a liability sensitive bank. In the down 200 basis point scenario, netinterest income improves by not more than 3.8% for the one year period and bynot more than 6.0% over the two year time horizon. In the up 200 basis pointscenario, the bank shows asset sensitivity for the first year with net interestincome improving by not more than 2.3% but by the second year net interest incomefalls compared to the base case so that over the two year period, net interestincome improves by 1.3%.

See also “Interest RateSensitivity” in Item 7 above for a discussion of our interest rate risk.

**Item8.**                        FinancialStatements and Supplementary Data
|                                                                  | ** ** | **Page** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|
| Reports of Independent Registered Public Accounting  Firm.       |       |     | 65         |   |   |
| Consolidated Statements of Condition                             |       |     | 67         |   |   |
| Consolidated Statements of Income                                |       |     | 68         |   |   |
| Consolidated Statements of Comprehensive Income                  |       |     | 69         |   |   |
| Consolidated Statements of Changes in Shareholders’  Equity |       |     | 70         |   |   |
| Consolidated Statements of Cash Flows                            |       |     | 71         |   |   |
| Notes to  Consolidated Financial Statements                      |       |     | 72         |   |   |

 

 

64

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and ShareholdersCardinal Financial Corporation:

We have audited the accompanying consolidatedstatements of condition of Cardinal Financial Corporation and subsidiaries (theCompany) as of December 31, 2006 and 2005, and the related consolidatedstatements of income, comprehensive income, changes in shareholders’ equity andcash flows for each of the years in the three-year period ended December 31,2006. 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 (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation.  We believe thatour 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, 2006 and 2005, and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended December 31, 2006, in conformity with U.S. generally acceptedaccounting principles.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as ofDecember 31, 2006, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 15,2007, expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.

As discussed in Note 25 tothe consolidated financial statements, the Company changed its method ofquantifying errors in 2006.

/s/ KPMG LLP

McLean,Virginia

March 15, 2007

65

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**Report ofIndependent Registered Public Accounting Firm**

The Board ofDirectors and Shareholders

Cardinal Financial Corporation:

We have auditedmanagement's assessment, included in the accompanying *Management’sReport on Internal Control Over Financial Reporting*, that CardinalFinancial Corporation and subsidiaries (the Company) maintained effective internalcontrol over financial reporting as of December 31, 2006, based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). The Company's management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management's assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management's assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

Acompany's internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company's internal control over financial reporting includes thosepolicies and procedures 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 reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements. 

Becauseof its inherent limitations, internal control over financial reporting may notprevent 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.

Inour opinion, management's assessment that the Company maintained effectiveinternal control over financial reporting as of December 31, 2006, is fairlystated, in all material respects, based on criteria established in *Internal**Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). Also, in our opinion, the Company maintained, inall material respects, effective internal control over financial reporting asof December 31, 2006, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

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, 2006 and2005, and the related consolidated statements of income, comprehensive income,changes in shareholders’ equity and cash flows for each of the years in thethree-year period ended December 31, 2006, and our report dated March 15, 2007,expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMGLLP

McLean, Virginia

March15, 2007

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CONDITIONDecember 31, 2006 and 2005(In thousands, except share data)

| **Assets**                                                                                                                                              | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash and due from  banks                                                                                                                                |       | $          | 24,585     |       | $          | 16,514 |   |
| Federal funds  sold                                                                                                                                     |       | 11,491     |       | 20,075     |       |
| Total cash and cash equivalents                                                                                                                         |       | 36,076     |       | 36,589     |       |
| Investment  securities available-for-sale                                                                                                               |       | 231,631    |       | 178,955    |       |
| Investment  securities held-to-maturity (market value of $95,450 and $112,025 at  December 31, 2006 and December 31, 2005, respectively) |       | 97,665     |       | 115,269    |       |
| Total investment securities                                                                                                                             |       | 329,296    |       | 294,224    |       |
| Other investments                                                                                                                                       |       | 9,158      |       | 7,092      |       |
| Loans held for  sale, net                                                                                                                               |       | 338,731    |       | 361,668    |       |
| Loans receivable,  net of deferred fees and costs                                                                                                       |       | 845,449    |       | 705,644    |       |
| Allowance for  loan losses                                                                                                                              |       | (9,638     | )          | (8,301     | )          |
| Loans receivable, net                                                                                                                                   |       | 835,811    |       | 697,343    |       |
| Premises and  equipment, net                                                                                                                            |       | 20,039     |       | 18,201     |       |
| Deferred tax  asset                                                                                                                                     |       | 6,415      |       | 4,399      |       |
| Goodwill and  intangibles, net                                                                                                                          |       | 17,493     |       | 20,502     |       |
| Bank-owned life insurance                                                                                                                               |       | 30,646     |       | —     |       |
| Accrued interest  receivable and other assets                                                                                                           |       | 14,764     |       | 12,269     |       |
| Total assets                                                                                                                                            |       | $          | 1,638,429  |       | $          | 1,452,287 |   |
| **Liabilities and Shareholders’ Equity**                                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-interest  bearing deposits                                                                                                                          |       | $          | 123,301    |       | $          | 114,915 |   |
| Interest bearing  deposits                                                                                                                              |       | 1,095,581  |       | 954,957    |       |
| Other borrowed  funds                                                                                                                                   |       | 194,631    |       | 155,421    |       |
| Mortgage funding  checks                                                                                                                                |       | 46,159     |       | 41,635     |       |
| Escrow  liabilities                                                                                                                                     |       | 3,229      |       | 11,013     |       |
| Accrued interest  payable and other liabilities                                                                                                         |       | 19,655     |       | 26,467     |       |
| Total liabilities                                                                                                                                       |       | 1,482,556  |       | 1,304,408  |       |
| Common stock, $1 par value                                                                                                                              | **2006**   | **2005**   |       |       |       |   |   |
| Shares authorized                                                                                                                                       | 50,000,000 | 50,000,000 |       |       |       |   |   |
| Shares issued and outstanding                                                                                                                           | 24,459,155 | 24,362,685 |       | 24,459     |       | 24,363 |   |
| Additional  paid-in capital                                                                                                                             |       | 132,985    |       | 132,150    |       |
| Retained earnings  (deficit)                                                                                                                            |       | 705        |       | (5,269     | )          |
| Accumulated other  comprehensive loss                                                                                                                   |       | (2,276     | )          | (3,365     | )          |
| Total shareholders’ equity                                                                                                                         |       | 155,873    |       | 147,879    |       |
| Total liabilities  and shareholders’ equity                                                                                                        |       | $          | 1,638,429  |       | $          | 1,452,287 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF INCOMEYears Ended December 31, 2006, 2005, and 2004(In thousands, except per share data)

| ** **                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income:                                               |       |     |       |     |       |     |       |
| Loans receivable                                               |       | $        | 51,872     |     | $          | 35,450   |       | $ | 21,875 |   |
| Loans held for sale                                            |       | 19,288   |       | 19,379   |       | 6,814    |       |
| Federal funds sold                                             |       | 1,206    |       | 1,175    |       | 130      |       |
| Investment securities  available-for-sale                      |       | 10,306   |       | 6,195    |       | 5,830    |       |
| Investment securities  held-to-maturity                        |       | 4,351    |       | 4,914    |       | 5,622    |       |
| Other investments                                              |       | 378      |       | 261      |       | 251      |       |
| Total interest income                                          |       | 87,401   |       | 67,374   |       | 40,522   |       |
| Interest expense:                                              |       |     |       |     |       |     |       |
| Deposits                                                       |       | 39,091   |       | 24,899   |       | 12,694   |       |
| Other borrowed funds                                           |       | 6,792    |       | 4,883    |       | 3,047    |       |
| Warehouse financing                                            |       | 164      |       | 109      |       | 228      |       |
| Total interest expense                                         |       | 46,047   |       | 29,891   |       | 15,969   |       |
| Net interest income                                            |       | 41,354   |       | 37,483   |       | 24,553   |       |
| Provision for loan  losses                                     |       | 1,232    |       | 2,456    |       | 1,626    |       |
| Net interest income  after provision for loan losses           |       | 40,122   |       | 35,027   |       | 22,927   |       |
| Non-interest income:                                           |       |     |       |     |       |     |       |
| Service charges on  deposit accounts                           |       | 1,593    |       | 1,334    |       | 1,089    |       |
| Loan service charges                                           |       | 2,177    |       | 2,701    |       | 958      |       |
| Investment fee income                                          |       | 3,330    |       | 1,417    |       | 657      |       |
| Net gain on sales of  loans                                    |       | 10,059   |       | 15,975   |       | 4,696    |       |
| Net realized gain on  investment securities available-for-sale |       | 61       |       | 33       |       | 245      |       |
| Management fee income                                          |       | 2,221    |       | 3,032    |       | 1,749    |       |
| Litigation recovery on  previously impaired investment         |       | 855      |       | —   |       | —   |       |
| Other income                                                   |       | 1,388    |       | 177      |       | 15       |       |
| Total non-interest  income                                     |       | 21,684   |       | 24,669   |       | 9,409    |       |
| Non-interest expense:                                          |       |     |       |     |       |     |       |
| Salary and benefits                                            |       | 24,616   |       | 22,480   |       | 13,354   |       |
| Occupancy                                                      |       | 5,242    |       | 4,293    |       | 2,897    |       |
| Professional fees                                              |       | 2,149    |       | 2,212    |       | 1,610    |       |
| Depreciation                                                   |       | 3,172    |       | 2,822    |       | 1,838    |       |
| Data processing                                                |       | 1,358    |       | 1,559    |       | 969      |       |
| Telecommunications                                             |       | 1,247    |       | 1,189    |       | 611      |       |
| Amortization of  intangibles                                   |       | 420      |       | 409      |       | 49       |       |
| Impairment of goowill  and intangible assets                   |       | 2,927    |       | —   |       | —   |       |
| Other operating expenses                                       |       | 10,114   |       | 9,689    |       | 5,826    |       |
| Total non-interest  expense                                    |       | 51,245   |       | 44,653   |       | 27,154   |       |
| Net income before income  taxes                                |       | 10,561   |       | 15,043   |       | 5,182    |       |
| Provision for income  taxes                                    |       | 3,173    |       | 5,167    |       | 1,713    |       |
| Net income                                                     |       | $        | 7,388      |     | $          | 9,876    |       | $ | 3,469 |   |
| Earnings per common  share—basic                          |       | $        | 0.30       |     | $          | 0.45     |       | $ | 0.19 |   |
| Earnings per common  share—diluted                        |       | $        | 0.30       |     | $          | 0.44     |       | $ | 0.19 |   |
| Weighted-average common  shares outstanding—basic         |       | 24,424   |       | 22,113   |       | 18,448   |       |
| Weighted-average common shares outstanding—diluted        |       | 24,987   |       | 22,454   |       | 18,705   |       |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOMEYears Ended December 31, 2006, 2005 and 2004(In thousands)

| ** **                                                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income                                                                                                                                                 |       | $        | 7,388      |     | $          | 9,876    |       | $ | 3,469 |   |
| Other comprehensive  income:                                                                                                                               |       |     |       |     |       |     |       |
| Unrealized loss  on available-for-sale investment securities:                                                                                              |       |     |       |     |       |     |       |
| Unrealized holding gain (loss) arising during the  year, net of tax expense of $390 in 2006 and tax benefit of $1,023 in 2005  and $344 in 2004       |       | 741      |       | (1,974   | )          | (412     | )          |
| Less: reclassification adjustment for gains included  in net income net of tax expense of $21 in 2006, $11 in 2005, and $85 in 2004                        |       | (40      | )          | (22      | )          | (164     | )          |
|                                                                                                                                                       |       | 701      |       | (1,996   | )          | (576     | )          |
| Unrealized gain (loss) on derivative instruments  designated as cash flow hedges, net of tax expense of $105 in 2006 and tax  benefit of $149 in 2005 |       | 348      |       | (288     | )          | —   |       |
| Comprehensive  income                                                                                                                                      |       | $        | 8,437      |     | $          | 7,592    |       | $ | 2,893 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITYYears Ended December 31, 2006, 2005 and 2004(In thousands)

| ** **                                                                            | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------|------------|---------------|------------|------------|------------|------------|------------|----------------|------------|---------------|------------|------------------------|------------|------------|------------|
| ** **                                                                            | ** ** | ** **    | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Preferred** | ** ** | **Preferred** | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Earnings**  | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **Shares**    | ** ** | **Stock**     | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **(Deficit)** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
| 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 accumulated other comprehensive loss                                        |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | — |   |   | (576 | ) |   | (576 | ) |
| Net income                                                                            |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | 3,469 |   |   | — |   |   | 3,469 |   |
| Balance, December 31, 2004                                                       |       |          | —     |          |       |       | —     |       |       |           | 18,463     |          |       |                   | 18,463     |       |       |   | 92,868 |   |   | (15,145 | ) |   | (1,081 | ) |   | 95,105 |   |
| Stock options exercised                                                               |       |          | —     |          |       |       | —     |       |       |           | 114        |          |       |                   | 114        |       |       |   | 683 |   |   | — |   |   | — |   |   | 797 |   |
| Public offering shares issued                                                         |       |          | —     |          |       |       | —     |       |       |           | 5,175      |          |       |                   | 5,175      |       |       |   | 34,592 |   |   | — |   |   | — |   |   | 39,767 |   |
| Shares issued in acquisition                                                          |       |          | —     |          |       |       | —     |       |       |           | 611        |          |       |                   | 611        |       |       |   | 4,251 |   |   | — |   |   | — |   |   | 4,862 |   |
| Dividends on common stock of $0.01 per share                                     |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | (244 | ) |   | — |   |   | — |   |   | (244 | ) |
| Change in accumulated other comprehensive loss                                        |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | — |   |   | (2,284 | ) |   | (2,284 | ) |
| Net income                                                                            |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | 9,876 |   |   | — |   |   | 9,876 |   |
| Balance, December 31, 2005                                                       |       |          | —     |          |       |       | —     |       |       |           | 24,363     |          |       |                   | 24,363     |       |       |   | 132,150 |   |   | (5,269 | ) |   | (3,365 | ) |   | 147,879 |   |
| Cumulative effect at January 1, 2006, of change  in method of quantifying errors |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | 25 |   |   | (438 | ) |   | — |   |   | (413 | ) |
| Stock options exercised                                                               |       |          | —     |          |       |       | —     |       |       |           | 96         |          |       |                   | 96         |       |       |   | 813 |   |   | — |   |   | — |   |   | 909 |   |
| Payment of deferred compensation shares                                               |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | (3 | ) |   | — |   |   | — |   |   | (3 | ) |
| Dividends on common stock of $0.04 per share                                          |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | (976 | ) |   | — |   |   | (976 | ) |
| Change in accumulated other comprehensive loss                                        |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | — |   |   | 1,089 |   |   | 1,089 |   |
| Net income                                                                            |       |          | —     |          |       |       | —     |       |       |           | —     |          |       |                   | —     |       |       |   | — |   |   | 7,388 |   |   | — |   |   | 7,388 |   |
| Balance,  December 31, 2006                                                      |       |          | —     |          |       |       | $          | —     |       |           |       | 24,459        |       |                   |       | $          | 24,459     |   |   |   | $ | 132,985 |   |   | $ | 705 |   |   | $ | (2,276 | ) |   | $ | 155,873 |   |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31, 2006, 2005, and 2004(In thousands)

| ** **                                                                                                                                                                                                                                                        | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Cash flows from operating activities:                                                                                                                                                                                                                             |       |       |       |       |       |       |       |
| Net income                                                                                                                                                                                                                                                        |       | $          | 7,388      |       | $          | 9,876      |       | $ | 3,469 |   |
| Adjustments to reconcile  net income to net cash provided by (used in) operating activities:                                                                                                                                                                      |       |       |       |       |       |       |       |
| Depreciation                                                                                                                                                                                                                                                      |       | 3,172      |       | 2,822      |       | 1,838      |       |
| Amortization of  premiums, discounts and intangibles                                                                                                                                                                                                              |       | 1,073      |       | 1,757      |       | 2,075      |       |
| Impairment of  goodwill and intangible assets                                                                                                                                                                                                                     |       | 2,927      |       | —     |       | —     |       |
| Provision for loan  losses                                                                                                                                                                                                                                        |       | 1,232      |       | 2,456      |       | 1,626      |       |
| Loans held for  sale originated                                                                                                                                                                                                                                   |       | (2,982,830 | )          | (4,520,954 | )          | (1,839,721 | )          |
| Proceeds from the  sale of loans held for sale                                                                                                                                                                                                                    |       | 3,015,826  |       | 4,540,715  |       | 1,820,897  |       |
| Gain on sales of  loans held for sale                                                                                                                                                                                                                             |       | (10,059    | )          | (15,975    | )          | (4,696     | )          |
| Gain on sale of  investment securities available-for-sale                                                                                                                                                                                                         |       | (61        | )          | (33        | )          | (245       | )          |
| (Gain) loss on  sale of other assets                                                                                                                                                                                                                              |       | (15        | )          | 13         |       | (1         | )          |
| Increase in cash  surrender value of bank-owned life insurance                                                                                                                                                                                                    |       | (646       | )          | —     |       | —     |       |
| (Increase)  decrease in accrued interest receivable, other assets and deferred tax asset                                                                                                                                                                          |       | (4,474     | )          | (3,653     | )          | 6,485      |       |
| Increase  (decrease) in accrued interest payable, escrow liabilities and other  liabilities                                                                                                                                                                       |       | (7,366     | )          | 12,743     |       | (4,050     | )          |
| Net cash provided  by (used in) operating activities                                                                                                                                                                                                              |       | 26,167     |       | 29,767     |       | (12,323    | )          |
| Cash flows from investing activities:                                                                                                                                                                                                                             |       |       |       |       |       |       |       |
| Net purchases of  premises and equipment                                                                                                                                                                                                                          |       | (4,957     | )          | (5,514     | )          | (8,377     | )          |
| Proceeds from  sale, maturity and call of investment securities available-for-sale                                                                                                                                                                                |       | 12,000     |       | 6,000      |       | 14,000     |       |
| Proceeds from  sale, maturity and call of mortgage-backed securities available-for-sale                                                                                                                                                                           |       | 9,701      |       | 4,896      |       | 9,719      |       |
| Proceeds from  maturity and call of investment securities held-to-maturity                                                                                                                                                                                        |       | 1,533      |       | —     |       | 9,985      |       |
| Proceeds from sale  of other investments                                                                                                                                                                                                                          |       | 4,005      |       | 8,626      |       | 9,558      |       |
| Purchase of  investment securities available-for-sale                                                                                                                                                                                                             |       | (51,772    | )          | (50,776    | )          | (6,000     | )          |
| Purchase of  mortgage-backed securities available-for-sale                                                                                                                                                                                                        |       | (54,250    | )          | (12,715    | )          | (72,959    | )          |
| Purchase of  investment securities held-to-maturity                                                                                                                                                                                                               |       | —     |       | —     |       | (16,472    | )          |
| Purchase of  mortgage-backed securities held-to-maturity                                                                                                                                                                                                          |       | —     |       | —     |       | (14,042    | )          |
| Purchase of other  investments                                                                                                                                                                                                                                    |       | (6,071     | )          | (7,608     | )          | (13,528    | )          |
| Purchase of bank-owned life insurance                                                                                                                                                                                                                             |       | (30,000    | )          | —     |       | —     |       |
| Redemptions of investment  securities available-for-sale                                                                                                                                                                                                          |       | 24,787     |       | 29,721     |       | 30,525     |       |
| Redemptions of  investment securities held-to-maturity                                                                                                                                                                                                            |       | 15,709     |       | 21,975     |       | 26,452     |       |
| Net cash paid in  acquisition                                                                                                                                                                                                                                     |       | (339       | )          | (1,379     | )          | (15,365    | )          |
| Net increase in  loans receivable, net of deferred fees and costs                                                                                                                                                                                                 |       | (139,700   | )          | (215,128   | )          | (154,790   | )          |
| Net cash used in  investing activities                                                                                                                                                                                                                            |       | (219,354   | )          | (221,902   | )          | (201,294   | )          |
| Cash flows from financing activities:                                                                                                                                                                                                                             |       |       |       |       |       |       |       |
| Net increase in  deposits                                                                                                                                                                                                                                         |       | 149,010    |       | 245,662    |       | 350,081    |       |
| Repayments of  warehouse financing assumed in acquisition                                                                                                                                                                                                         |       | —     |       | —     |       | (335,584   | )          |
| Net increase  (decrease) in other borrowed funds—short term                                                                                                                                                                                                  |       | 15,960     |       | (57,164    | )          | 62,008     |       |
| Net increase  (decrease) in warehouse financing                                                                                                                                                                                                                   |       | —     |       | (30,245    | )          | 30,245     |       |
| Net increase  (decrease) in mortgage funding checks                                                                                                                                                                                                               |       | 4,524      |       | (4,757     | )          | 46,392     |       |
| Proceeds from FHLB  advances—long term                                                                                                                                                                                                                       |       | 65,000     |       | 25,000     |       | 52,500     |       |
| Repayments of FHLB  advances—long term                                                                                                                                                                                                                       |       | (41,750    | )          | (13,500    | )          | (8,500     | )          |
| Proceeds from  public offering                                                                                                                                                                                                                                    |       | —     |       | 39,767     |       | 6,302      |       |
| Proceeds from  trust preferred issuance                                                                                                                                                                                                                           |       | —     |       | —     |       | 20,000     |       |
| Stock options  exercised                                                                                                                                                                                                                                          |       | 909        |       | 797        |       | 498        |       |
| Deferred  compensation payments                                                                                                                                                                                                                                   |       | (3         | )          | —     |       | —     |       |
| Dividends on  common stock                                                                                                                                                                                                                                        |       | (976       | )          | (244       | )          | —     |       |
| Net cash provided  by financing activities                                                                                                                                                                                                                        |       | 192,674    |       | 205,316    |       | 223,942    |       |
| Net (decrease)  increase in cash and cash equivalents                                                                                                                                                                                                             |       | (513       | )          | 13,181     |       | 10,325     |       |
| Cash and cash  equivalents at beginning of year                                                                                                                                                                                                                   |       | 36,589     |       | 23,408     |       | 13,083     |       |
| Cash and cash  equivalents at end of year                                                                                                                                                                                                                         |       | $          | 36,076     |       | $          | 36,589     |       | $ | 23,408 |   |
| **Supplemental disclosure of cash flow  information:**                                                                                                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the year for interest                                                                                                                                                                                                                           |       | $          | 45,973     |       | $          | 30,096     |       | $ | 15,124 |   |
| Cash paid for  income taxes                                                                                                                                                                                                                                       |       | 4,976      |       | 3,456      |       | 135        |       |
| **Supplemental  schedule of noncash investing and financing activities:**                                                                                                                                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unsettled  purchases of investment securities available-for-sale                                                                                                                                                                                                  |       | $          | 460        |       | 8,175      |       | $          | — |   |
| On February 9, 2006,  the Company acquired certain fiduciary and other assets and assumed the  liabilities of FBR National Trust Company. In conjunction with the acquisition,  the following noncash changes to our financial condition occurred: |       |       |       |       |       |       |       |
| Fair value of  non-cash assets acquired                                                                                                                                                                                                                           |       | $          | 507        |       |       |       |       |   |
| Fair value of  liabilities assumed                                                                                                                                                                                                                                |       | 127        |       |       |       |       |       |
| On June 9, 2005, the  Company acquired all of the issued and outstanding common stock of  Wilson/Bennett Capital Management, Inc. In conjunction with the  acquisition, the following noncash changes to our financial condition  occurred:        |       |       |       |       |       |       |       |
| Fair value of  non-cash assets acquired, primarily goodwill and intangibles                                                                                                                                                                                       |       |       |       | $          | 6,296      |       |       |   |
| Fair value of  liabilities assumed                                                                                                                                                                                                                                |       |       |       | 33         |       |       |       |
| Common shares  issued in acquisition                                                                                                                                                                                                                              |       |       |       | 4,862      |       |       |       |
| On July 7, 2004, the  Company acquired all of the issued and outstanding membership interests of  George Mason Mortgage, LLC. In conjunction with the acquisition, the  following noncash changes to our financial condition occurred:   |       |       |       |       |       |       |       |
| Fair value of  non-cash assets acquired                                                                                                                                                                                                                           |       |       |       |       |       | $          | 367,288    |   |
| Fair value of  liabilities assumed                                                                                                                                                                                                                                |       |       |       |       |       | 351,923    |       |

 

See accompanying notes to consolidated financial statements.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements

**(1) Organization**

Cardinal FinancialCorporation (the ”Company”) is incorporated under the laws of theCommonwealth of Virginia as a financial holding company whose activitiesconsist of investment in its wholly-owned subsidiaries. The principal operatingsubsidiary of the Company is Cardinal Bank (the “Bank”), a state-charteredinstitution. On July 7, 2004, the Bank acquired George Mason Mortgage, LLC(“George Mason”), a mortgage banking company based in Fairfax, Virginia. On June 9,2005, the Company acquired Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”),an asset management firm. The Company also owns Cardinal Wealth Services, Inc.(“CWS”), an investment services subsidiary. On February 9, 2006, the Bankacquired certain fiduciary and other assets and assumed certain liabilities ofFBR National Trust Company (“Trust Services”), formerly a subsidiary ofFriedman, Billings, Ramsey Group, Inc. Additional information on theCompany’s acquisitions can be found in Note 3, Business Combinations*.*

**(2) Summary ofSignificant Accounting Policies**

*(a) Use ofEstimates*

U.S. generally acceptedaccounting principles are complex and require management to make estimates,judgments and assumptions that affect the reported amounts of assets andliabilities, and disclosures of contingent assets and contingent liabilities,at the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period. Significant estimatesaffecting the Company’s financial statements relate to accounting for businesscombinations and impairment testing of goodwill, the allowance for loan losses,derivative instruments and hedging activities, accounting for impairment ofintangible assets and the valuation of the deferred tax assets. Actual resultscould differ from those estimates.

*(b) Principles ofConsolidation*

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

*(c) Accounting forBusiness Combinations*

The acquisitions of GeorgeMason, Wilson/Bennett and Trust Services were accounted for as purchases asrequired by Statement of Financial Accounting Standards (“SFAS”) No. 141, *Business Combinations*. The purchase method requires that thecost of an acquired entity be allocated to the assets acquired and liabilitiesassumed, based on their estimated fair values at the date of acquisition. Theexcess of the cost of an acquired entity over the net of the amounts assignedto assets acquired and liabilities assumed is recorded as goodwill.

*(d) Cash and CashEquivalents*

For the consolidatedstatements of cash flows, the Company has defined cash and cash equivalents ascash and due from banks and federal funds sold.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

*(e) InvestmentSecurities*

The Company classifies its investment securities inone of two categories:  available-for-saleor held-to-maturity. Held-to-maturity securities arethose securities for which the Company has the ability and intent to hold untilmaturity. All other securities are classified as available-for-sale.

Held-to-maturity securities are carried at amortizedcost. Available-for-sale securities are carried at estimated fairvalue. Unrealized gains and losses, net of applicable tax, 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 securities below their cost that are deemed other than temporaryare treated as realized losses, resulting in the establishment of a new costbasis for the security.

Premiums and discounts arerecognized in interest income using the effective interest method. Prepaymentsof the mortgages securing mortgage-backed securities may affect the anticipatedmaturity date and, therefore, the yield to maturity. The Company uses actualprincipal prepayment experience and estimates of future principal prepaymentsin calculating the yield necessary to apply the effective interest method.

*(f) Loans Held forSale*

Loans originated and intended for sale into thesecondary market are carried at the lower of cost or estimated fair value,determined on an aggregate loan basis. Estimated fair value is determined byoutstanding commitments from investors. Net unrealized losses, if any, arerecognized through a valuation allowance by charges to operations. The carryingamount of loans held for sale includes principal balances, valuationallowances, origination premiums or discounts and fees and direct costs thatare deferred at the time of origination.

The Company accounts forthe sale of mortgage loans to third-party investors pursuant to SFAS No. 140,*Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities, a replacement of FASB Statement 125*because the loan assets have been legally isolated from the Company; theCompany has no ability to restrict or constrain the ability of third-partyinvestors to pledge or exchange the mortgage loans; and, because the Companydoes not have the entitlement or ability to repurchase the mortgage loans orunilaterally cause third-party investors to put the mortgage loans back to theCompany. 

*(g) LoansReceivable and Allowance for Loan Losses*

Loans receivable that management has the intent andability to hold for the foreseeable future or until maturity or pay-off arereported at their outstanding principal balance adjusted for any charge-offs,and net of the allowance for loan losses and deferred fees and costs. Loanorigination fees and certain direct origination costs are deferred andamortized as an adjustment of the yield using the payment terms required by theloan contract.

Loans are generally placed into non-accrual statuswhen they are past-due 90 days as to either principal or interest or when,in the opinion of management, the collection of principal and/or interest is indoubt. A loan remains in non-accrual status until the loan is current as topayment of both principal and interest or past-due less than 90 days andthe borrower demonstrates the ability to pay and remain current. Loans arecharged-off when a loan or a portion thereof is considered uncollectible. Whencash payments 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

are received, they areapplied to principal first, then to accrued interest. It is the Company’spolicy not to record interest income on non-accrual loans until principal hasbecome current.

The Company determines and recognizes impairment ofcertain loans when, based on current information and events, it is probablethat the Company will be unable to collect all amounts due according to theloan agreement. A loan is not considered impaired during a period of delay inpayment if the Company expects to collect all amounts due, including past-dueinterest. An impaired loan is measured at the present value of its expectedfuture cash flows discounted at the loan’s coupon rate, or at the loan’sobservable market price or fair value of the collateral if the loan iscollateral dependent.

The allowance for loan losses is increased byprovisions for loan losses and recoveries of previously charged-off loans, anddecreased by loan charge-offs.

The Company maintains the allowance for loan losses ata level that represents management’s best estimate of known and inherent lossesin our loan portfolio. Both the amount of the provision expense and the levelof the allowance for loan losses are impacted by many factors, includinggeneral and industry-specific economic conditions, actual and expected creditlosses, historical trends and specific conditions of the individual borrowers. Unusualand infrequently occurring events, such as weather-related disasters, mayimpact the assessment of possible credit losses. As a part of its analysis, theCompany uses comparative peer group data and qualitative factors, such aslevels of and trends in delinquencies and non-accrual loans, national and localeconomic trends and conditions and concentrations of loans exhibiting similarrisk profiles to support estimates.

For purposes of this analysis, the Company categorizesloans into one of five categories: commercial and industrial, commercial real estate (includingconstruction), home equity lines of credit, residential mortgages, and consumerloans. In the absence of meaningful historical loss factors, peer group lossfactors are applied and are adjusted by the qualitative factors mentioned above.The indicated loss factors resulting from this analysis are applied to each ofthe five categories of loans. In addition, the Company individually assignsloss factors to all loans that have been identified as having loss attributes,as indicated by deterioration in the financial condition of the borrower or adecline in underlying collateral value if the loan is collateral dependent. Sincethe Company has limited historical data on which to base loss factors forclassified loans, the Company applies, in accordance with regulatoryguidelines, a 5% loss factor to all loans classified as special mention, a 15%loss factor to all loans classified as substandard and a 50% loss factor to allloans classified as doubtful. Loans classified as loss loans are fully reservedor charged off.

In addition, variousregulatory agencies, as part of their examination process, periodically reviewthe Company’s allowance for loan losses. These agencies may require the Companyto recognize additions to the allowance based on their risk evaluation andcredit judgment. Management believes that the allowance for loan losses at December 31,2006 and 2005 is a reasonable estimate of known and inherent losses in the loanportfolio at those dates.

*(h) Premises andEquipment*

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 three to 25 years. Amortization of leasehold improvements iscomputed using the straight-line method over the useful lives of theimprovements or the lease term, whichever is shorter. Purchased computersoftware which is capitalized is amortized over estimated useful lives of oneto three years. Internally developed software is expensed.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

*(i) Goodwill andOther Intangibles*

Goodwill, which represents the excess of purchaseprice over fair value of net assets acquired, is not amortized but is evaluatedat least annually for impairment by comparing its fair value with its recordedamount. An impairment loss is recognized to the extent that the carrying amountexceeds fair value.

The Company performs an annual impairment evaluationof the goodwill associated with the George Mason, Wilson/Bennett, and TrustServices reporting units in the quarter the purchase occurred, or morefrequently as circumstances warrant.  Note 23 discusses the impairment charges takenduring the year ended December 31, 2006. No impairment was indicated in2005. The Company also has amortizable intangible assets. These intangibleassets are being amortized on a straight-line basis over their estimated usefullives from three to ten years. These assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountmay not be recoverable.

*(j) Bank-Owned LifeInsurance*

Bank-owned life insuranceis a bank-eligible asset designed to recover the costs of providing pre- andpost-retirement benefits and to finance general employee benefit expenses. Underthe insurance policy, executives or other key individuals are the insureds andthe Company is the owner and beneficiary of the policy. As such, the insuredhas no claim to the insurance policy, the policy’s cash value, or a portion ofthe policy’s death proceeds. The Company accounts for its bank-owned lifeinsurance under Financial Accounting Standards Board (“FASB”) TechnicalBulletin 85-4, *Accounting for FinancialPurchases of Life Insurance.*The cash surrender value of the policyis recorded in other assets. The increase in the cash surrender value over timeis recorded as other non-interest income.

*(k) Gain on Sale ofLoans*

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 amounts of the loanssold, which include deferred fees and direct origination costs.

*(l) Management FeeIncome*

Management fee incomerepresents income earned for the management and operational support provided byGeorge Mason to other mortgage banking companies (the “managed companies”)owned by local homebuilders. The relationship of George Mason to these managedcompanies is solely as service provider and there is no fiduciary relationship.Fees earned by George Mason are accrued based on contractual arrangements witheach of the managed companies and are generally determined as a percentage ofthe managed company’s net income before income taxes.

*(m) Investment FeeIncome*

Investmentfee income represents commissions paid by customers of CWS and asset managementfees paid by the customers of Wilson/Bennett for investment services. Revenuefrom Trust Services is also a component of investment fee income and isrecognized in the period earned in accordance with contractual percentage ofassets under management or custody. Trust Services revenue is generallydetermined based upon the fair value of assets under management or custody atthe end of the period. Fees are recognized in income as they are earned.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

*(n) Income Taxes*

Deferredtax assets and liabilities are recognized for the tax effects of differingcarrying values of assets and liabilities for tax and financial statementpurposes that will reverse in future periods. 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.

When uncertainty exists concerning the recoverabilityof a deferred tax asset, the carrying value of the asset may be reduced by avaluation allowance. The amount of any valuation allowance established is basedupon an estimate of the deferred tax asset that is more likely than not to berecovered.  Increases or decreases in thevaluation allowance result in increases or decreases to the provision forincome taxes.

*(o) Earnings Per CommonShare*

Basic earnings per common share is computed bydividing net income available to common shareholders by the weighted-average numberof shares of common stock outstanding during the periods, including shareswhich will be issued to settle liabilities of the deferred compensation plans. 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 primarily tooutstanding stock options, and the dilutive potential common shares resultingfrom outstanding stock options are determined using the treasury stock method. Commonstock equivalents for diluted earnings per share purposes also includes commonshares which may be issued, but are not required to be issued, to settle theCompany’s obligations under its deferred compensation plans.

*(p) Derivative Instrumentsand Hedging Activities*

TheCompany accounts for derivatives and hedging activities in accordance with SFASNo. 133, *Accounting for DerivativeInstruments and Certain Hedging Activities*,**as amended, which requires that allderivative instruments be recorded on the statement of condition at their fairvalues. The Company does not enter into derivative transactions for speculativepurposes. For derivatives designated as hedges, the Company contemporaneouslydocuments the hedging relationship, including the risk management objective andstrategy for undertaking the hedge, how effectiveness will be assessed atinception and at each reporting period and the method for measuringineffectiveness. The Company evaluates the effectiveness of these transactionsat inception and on an ongoing basis. Ineffectiveness is recorded throughearnings. For derivatives designated as cash flow hedges, the fair valueadjustment is recorded as a component of other comprehensive income, except forthe ineffective portion. For derivatives designated at fair value hedges, thefair value adjustments for both the hedged item and the hedging instrument arerecorded through the income statement with any difference considered theineffective portion of the hedge.

Inthe normal course of business, the Company enters into contractual commitments,including rate lock commitments, to finance residential mortgage loans. Thesecommitments, which contain fixed expiration dates, offer the borrower aninterest rate guarantee provided the loan meets underwriting guidelines andcloses within the timeframe established by the Company. Interest rate riskarises on these commitments and subsequently closed loans if interest rateschange between the time of the interest rate lock and the delivery of the loanto the investor. Loan commitments related to residential mortgage loansintended to be sold are considered derivatives and are marked to market throughearnings.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

To mitigate the effect of interest rate risk inherentin providing rate lock commitments, the Company economically hedges itscommitments by entering into best efforts forward delivery loan salescontracts. During the rate lock commitment period, these forward loan salescontracts are marked to market through earnings and are not designated asaccounting hedges under SFAS No. 133, as amended. The fair values of loancommitments and the fair values of forward sales contracts generally move inopposite directions, and the net impact of the changes in these valuations onnet income during the loan commitment period is generally inconsequential. Atthe closing of the loan, the loan commitment derivative expires and the Companyrecords a loan held for sale and continues to be obligated under the sameforward loan sales contract. Loans held for sale are accounted for at the lowerof cost or market in accordance with SFAS No. 65, *Accountingfor Certain Mortgage Banking Activities*. Prior to October 1,2005, the changes in value of the forward loan sales contracts from the datethe loan closed to the date it was sold to an investor were marked to marketthrough earnings. On October 1, 2005, the Company began designating itsforward sales contracts as hedges to mitigate the variability in cash flow tobe received from the sale of mortgage loans.

The Company discontinueshedge accounting prospectively when it is determined that the derivative is nolonger highly effective in offsetting changes in anticipated cash flows of theloans held for sale. In situations in which hedge accounting is discontinued,we continue to carry the derivative at its fair value on the statement ofcondition and recognize any subsequent changes in its fair value in earnings. Whenhedge accounting is discontinued because it is probable an anticipated loansale will not occur, the Company recognizes immediately in earnings any gainsand losses that were accumulated in other comprehensive income.

*(q) Stock-BasedCompensation*

On January 1, 2006, the Company adopted SFAS No. 123R,*Share-Based Payment*. * *Thisstatement requires that companies recognize in the income statement thegrant-date fair value of stock options and other equity-based compensation. Thestatement also requires stock awards to be classified as either an equity awardor a liability award. Equity classified awards are valued as of the grant dateusing either an observable market price or a valuation methodology. Liabilityclassified awards are valued at fair value at each reporting date. All of theCompany’s stock options are classified as equity awards.

The Company has adopted SFAS No. 123R using themodified prospective application method, which requires, among other things,recognition of compensation costs for all awards outstanding at January 1,2006 for which the requisite service had not been rendered. Total compensationcost charged against income as a result of the adoption of SFAS No. 123Rfor the year ended December 31, 2006 was $395,000. The total income taxbenefit recognized in the income statement for share-based compensationarrangements was $138,000 for the year ended December 31, 2006. There wasno compensation expense related to stock-based compensation during the yearsended December 31, 2005 and 2004.

Prior to the adoption of SFAS No. 123R, the Companyapplied the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, inaccounting for its fixed plan stock options. Under this method, compensationexpense was recorded only if the current market price of the underlying stockexceeded the exercise price on the date of grant.

At December 31, 2006, the Company had twostock-based employee compensation plans, which are described more fully in Note18.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Stock options are granted with an exercise price equalto the common stock’s fair market value at the date of grant. Director stockoptions have ten year terms and vest and become fully exercisable at the grantdate. Certain employee stock options have ten year terms and vest and becomefully exercisable after three years. Other employee stock options have ten yearterms and vest and become fully exercisable in 20% increments beginning as ofthe grant date. In addition, the Company has granted stock options to employeesof the Company that have ten year terms and vest and become fully exercisablein 20% increments beginning after their first year of service. During 2005,certain stock options granted to employees had ten year terms and vested andbecame fully exercisable immediately.

Thefollowing table illustrates the effect on net income and earnings per share ofcommon stock as if the Company had applied the fair value recognitionprovisions of SFAS No. 123R to stock-based employee compensation for theperiods indicated:

| ** **                                                                                                             | ** ** | **Years ended December 31,**                    | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2005**                                                       | ** ** | ** ** | ** ** | **2004** | ** ** |
| ** **                                                                                                             | ** ** | **(In thousands, except  per share data)** | ** ** |
| Net income  available to common shareholders as reported                                                               |       | $                                                              | 9,876      |   |   |   | $ | 3,469 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value-based  method, net of related tax |       | (4,066                                                         | )          |   |   | (1,427 | ) |
| Pro forma net income                                                                                                   |       | $                                                              | 5,810      |   |   |   | $ | 2,042 |   |
| Earnings per  common share:                                                                                            |       |                                                           |       |   |   |   |   |
| Basic—as reported                                                                                                 |       | $                                                              | 0.45       |   |   |   | $ | 0.19 |   |
| Basic—pro forma                                                                                                   |       | 0.26                                                           |       |   |   | 0.11 |   |
| Diluted—as reported                                                                                               |       | 0.44                                                           |       |   |   | 0.19 |   |
| Diluted—pro forma                                                                                                 |       | 0.26                                                           |       |   |   | 0.11 |   |

 

Total pro forma stock-based employee compensationexpense for 2005 reflects the immediate vesting attributes of the stock optionsthat were granted during 2005.

Theweighted average per share fair values of stock option grants made in 2006,2005, and 2004 were $5.76, $4.73, and $3.11, respectively. The fair values ofthe options granted were estimated on the grant date using the Black-Scholesoption-pricing model based on the following weighted average assumptions:

| ** **               | ** ** | **2006**           | ** ** | **2005**    | ** ** | **2004**  | ** ** |
|--------------------------|------------|--------------------|------------|-------------|------------|-----------|------------|
| Estimated option  life   |       | 6.5  years         |       | 5.75  years |       | 10  years |       |
| Risk free  interest rate |       | 5.03  – 4.44% |       | 4.30%       |       | 4.07%     |       |
| Expected  volatility     |       | 43.20%             |       | 43.1%       |       | 11.8%     |       |
| Expected dividend yield  |       | 0.40%              |       | 0.00%       |       | 0.00%     |       |

 

Expected volatility is based upon the average annualhistorical volatility of the Company’s common stock. The estimated option lifeis derived from the “simplified method” formula as described in StaffAccounting Bulletin No. 107. The risk free interest rate is based upon thefive-year U.S. Treasury note rate in effect at the time of grant. The expecteddividend yield is based upon implied and historical dividend declarations.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

On October 19, 2005,the Company’s board of directors authorized that any outstanding, unvestedoptions with no intrinsic value (i.e., their per share exercise price isgreater than the market price) on or before December 31, 2005 be amendedto become fully vested. This modification resulted in the immediate vesting of54,000 stock options that were held by employees of the Company. The optionsthat vested had exercise prices ranging from $9.58 to $11.15. On October 19,2005, the market value of the Company’s common stock was $9.81. Thismodification did not result in the recognition of expense in 2005 because theoptions had no intrinsic value at the grant date or on the date ofmodification. Vesting of these options was accelerated to eliminate the need torecognize the remaining fair value compensation expense associated with theseoptions following the adoption of SFAS No. 123R. The amount ofcompensation expense related to these options that would have been recognizedin the financial statements after the Company’s implementation of SFAS No. 123R,assuming no forfeitures, was $127,000.

*(r) Reclassifications*

Certain amounts for 2005and 2004 have been reclassified to conform to the presentation for 2006.

**(3) BusinessCombinations**

**Trust Services**

On February 9, 2006, the Bank acquired certainfiduciary and other assets and assumed certain liabilities of FBR NationalTrust Company, formerly a subsidiary of Friedman, Billings, Ramsey Group, Inc.The Bank acts as trustee or custodian for assets under management in excess of$5 billion as a result of this transaction. This transaction diversifies theBank’s sources of non-interest income and allows it to provide additionalservices to its customers.

This transaction was accounted for as a purchase andthe acquired assets and assumed liabilities were recorded at their fair valuesas of the purchase date. This acquisition did not have a significant impact onoperating results for the year ended December 31, 2006.

The operating results of the trust division areincluded in the Company’s consolidated operating results and its WealthManagement and Trust Services segment information since the date ofacquisition.

The fair value of the net assets acquired was $380,000.The acquisition resulted in the recognition of an intangible asset forpurchased customer relationships of $161,000, which is being amortized on astraight-line basis over nine years, and in the recognition of goodwill of$178,000. The Company used the assistance of an independent valuationconsultant to determine the value assigned to identifiable intangible assets.Goodwill will not be amortized but will be reviewed for impairment whenevidence of impairment exists or, at a minimum, on an annual basis.

For federal income taxpurposes, the Trust Services intangibles are deductible over a 15 year period.

**Wilson/BennettCapital Management, Inc.**

On June 9, 2005, the Company acquiredWilson/Bennett Capital Management, Inc. for $1.5 million in cash and611,111 shares of its common stock. The primary shareholder of Wilson/Bennettat the time of its acquisition by the Company was a member of the Company’sboard of directors.

The common stock utilized to complete this transactionwas newly issued by the Company, was not registered with the Securities andExchange Commission (the “SEC”), and therefore cannot be sold until 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

so registered unless it issold pursuant to an exemption from such registration. The owners of the sharesare permitted to resell them under Rule 144 of the Securities Act becausethey have held the shares for more than one year. The trading restriction willcompletely lapse June 9, 2007. Because of this trading restriction, theCompany valued for purchase accounting purposes the 611,111 restricted sharesat 89% of the fair market value of its unrestricted shares, or $4.9 million.

The operating results of Wilson/Bennett are includedin the Company’s consolidated operating results and the Wealth Management andTrust Services segment information since the date of acquisition and are notmaterial to consolidated operating results and, therefore, no proformainformation relating to this acquisition is presented. The acquisition resultedin the recognition of the following intangible assets which are being amortizedon a straight-line basis over the periods indicated:

Employment/non-compete agreement – $698,000 (4 years)Trade name intangible – $46,000 (3 years)Purchased customer relationships – $1,858,000 (10 years)

The transaction also resulted in the recognition ofgoodwill of $3.5 million. The Company used the assistance of an independentvaluation consultant to determine the value assigned to identifiableamortizable intangibles. See Note 23 for additional information on theintangible assets related to this acquisition and the impairment chargerecorded during the year ended December 31, 2006.

Due to the trading restriction described above, theCompany has agreed to provide certain demand registration rights with respectto the 611,111 common shares issued. The owners of these shares have the rightto make one written request to the Company for the registration of one-third ofthe shares under the Securities Act of 1933, as amended, to permit the resaleof the shares. In the event that a change of control of the Company occurs, orthe Company’s employment of its current chief executive officer terminates,both as described in the registration rights agreement, then the registrationrights would cover all the shares. The Company has the option to repurchase anysuch shares following the receipt of a written request for registration fromthe shareholders. The purchase price has been decreased by the estimated costto register these shares with the SEC.

On June 29, 2006, the Company entered into anAmendment to the Employment Agreement (the “Amendment”) with John W. Fisher,president and chief executive officer of Wilson/Bennett. The Amendment amendedthe Employment Agreement dated as of June 8, 2005 between the Company and Mr. Fisher.As provided in the Amendment, Mr. Fisher retired from the business on September 30,2006, and has agreed to assist the Company in a consulting and business developmentfunction, as requested by the Company through April 30, 2007, and to honorhis non-compete agreement with the Company, which will end on September 30,2007.

For federal income taxpurposes, the Wilson/Bennett goodwill and intangibles are deductible over a 15year period.

**George MasonMortgage, LLC**

On July 7, 2004, the Bank acquired George Mason,in a cash transaction for $17.0 million. George Mason engages primarily in theorigination and acquisition of residential mortgages for sale into the secondarymarket on a best efforts basis through seven branches throughout themetropolitan Washington, D.C. region. This transaction was also accounted foras a purchase and George Mason’s assets and liabilities were recorded at fairvalue as of the purchase date. George Mason’s operating results are 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

included in theconsolidated operating results and Mortgage Banking segment information sincethe date of acquisition. This transaction resulted in the recognition of $12.9million of goodwill and $1.7 million of other intangible assets. George Mason’sprimary sources of revenue include net interest income earned on loans held forsale, gain on sales of loans and management fees earned. Loans are madepursuant to purchase commitments and are sold servicing released. The Bankpurchased George Mason primarily to diversify its sources of income andincrease non-interest income and be a source of residential loans for its loansreceivable portfolio.

Thefollowing unaudited pro forma condensed financial information presents theresults of operations of the Company as if George Mason had been acquired on January 1,2004.

| ** **                                               | ** ** | **For the Year Ended** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **December 31,**                 | ** ** |
| ** **                                               | ** ** | **2004**                              | ** ** |
| ** **                                               | ** ** | **(In thousands)**               | ** ** |
| Net interest  income                                     |       |                                  | $          | 28,674 |   |   |
| Non-interest  income                                     |       |                                  | 28,254     |   |   |
| Provision for loan  losses                               |       |                                  | 1,627      |   |   |
| Non-interest  expense                                    |       |                                  | 45,019     |   |   |
| Net income before  income taxes                          |       |                                  | 10,282     |   |   |
| Provision for  income taxes                              |       |                                  | 3,228      |   |   |
| Net income                                               |       |                                  | $          | 7,054 |   |   |
| Earnings per common share—basic                     |       |                                  | $          | 0.38 |   |   |
| Earnings per  common share—diluted                  |       |                                  | $          | 0.38 |   |   |
| Weighted-average  common shares outstanding—basic   |       |                                  | 18,448     |   |   |
| Weighted-average common  shares outstanding—diluted |       |                                  | 18,705     |   |   |

 

The unaudited pro forma results of operationssummarized above are not necessarily indicative of the results that would haveoccurred if the acquisition had been consummated on January 1, 2004.

For federal income taxpurposes, the George Mason goodwill and intangibles are deductible over a 15year period.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

**(4) InvestmentSecurities and Other Investments**

Thefair value and amortized cost of investment securities at December 31,2006 and 2005 are shown below.

| ** **                                  | ** ** | **2006**                | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **Gross**               | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                  | ** ** | **cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| *Investment  Securities Available-for-Sale* | * *   | * *                | * *   |   | * * | * * |   |   | * * | * * |   | * * | * * |
| U.S. government-sponsored agencies          |       | $                       | 67,493     |   |   | $ | — | * * |   |   | $ | (496 | *)* |   | $ | 66,997 |   |
| Mortgage-backed  securities                 |       | 142,202                 |       |   | 152 | * * |   |   | (3,240 | *)* |   | 139,114 |   |
| Municipal  securities                       |       | 25,047                  |       |   | 122 | * * |   |   | (138 | *)* |   | 25,031 |   |
| U.S. treasury  securities                   |       | 489                     |       |   | — | * * |   |   | — | * * |   | 489 |   |
| Total                                       |       | $                       | 235,231    |   |   | $ | 274 | * * |   |   | $ | (3,874 | *)* |   | $ | 231,631 |   |
| *Investment Securities Held-to-Maturity*    |       |                    |       |   |   | * * |   |   |   | * * |   |   |   |
| U.S. government-sponsored agencies          |       | $                       | 23,985     |   |   | $ | — | * * |   |   | $ | (503 | *)* |   | $ | 23,482 |   |
| Mortgage-backed  securities                 |       | 65,676                  |       |   | 17 | * * |   |   | (1,589 | *)* |   | 64,104 |   |
| Corporate bonds                             |       | 8,004                   |       |   | 10 | * * |   |   | (150 | *)* |   | 7,864 |   |
| Total                                       |       | $                       | 97,665     |   |   | $ | 27 | * * |   |   | $ | (2,242 | *)* |   | $ | 95,450 |   |

 

| ** **                                  | ** ** | **2005**                | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **Gross**               | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                  | ** ** | **cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| *Investment  Securities Available-for-Sale* | * *   | * *                | * *   |   | * * | * * |   |   | * * | * * |   | * * | * * |
| U.S. government-sponsored agencies          |       | $                       | 58,959     |   |   | $ | 2 | * * |   |   | $ | (550 | *)* |   | $ | 58,411 |   |
| Mortgage-backed  securities                 |       | 122,730                 |       |   | 28 | * * |   |   | (4,198 | *)* |   | 118,560 |   |
| U.S. treasury  securities                   |       | 2,015                   |       |   | — | * * |   |   | (31 | *)* |   | 1,984 |   |
| Total                                       |       | $                       | 183,704    |   |   | $ | 30 | * * |   |   | $ | (4,779 | *)* |   | $ | 178,955 |   |
| *Investment Securities Held-to-Maturity*    |       |                    |       |   |   | * * |   |   |   | * * |   |   |   |
| U.S. government-sponsored agencies          |       | $                       | 25,520     |   |   | $ | — | * * |   |   | $ | (714 | *)* |   | $ | 24,806 |   |
| Mortgage-backed  securities                 |       | 81,744                  |       |   | 12 | * * |   |   | (2,349 | *)* |   | 79,407 |   |
| Corporate bonds                             |       | 8,005                   |       |   | — | * * |   |   | (193 | *)* |   | 7,812 |   |
| Total                                       |       | $                       | 115,269    |   |   | $ | 12 | * * |   |   | $ | (3,256 | *)* |   | $ | 112,025 |   |

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Thefair value and amortized cost of investment securities by contractual maturityat December 31, 2006 are shown below. Expected maturities may differ fromcontractual maturities because many issuers have the right to call or prepayobligations with or without call or prepayment penalties.

| ** **                         | ** ** | **Available-for-Sale**  | ** ** | **Held-to-Maturity** | ** ** |
|------------------------------------|------------|-------------------------|------------|----------------------|------------|
| ** **                         | ** ** | **Amortized**           | ** ** | **Fair**             | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                         | ** ** | **cost**                | ** ** | **Value**            | ** ** | **cost** | ** ** | **Value** | ** ** |
| ** **                         | ** ** | **(In thousands)** | ** ** |
| After 1 year but  within 5 years   |       | $                       | 52,462     |                 | $          | 52,006 |   |   | $ | 8,967 |   |   | $ | 8,734 |   |
| After 5 years but  within 10 years |       | 15,520                  |       | 15,480               |       |   | 13,018 |   |   | 12,777 |   |
| After 10 years                     |       | 25,047                  |       | 25,031               |       |   | 10,004 |   |   | 9,835 |   |
| Mortgage-backed  securities        |       | 142,202                 |       | 139,114              |       |   | 65,676 |   |   | 64,104 |   |
| Total                              |       | $                       | 235,231    |                 | $          | 231,631 |   |   | $ | 97,665 |   |   | $ | 95,450 |   |

 

For the years ended December 31, 2006, 2005, and2004, proceeds from sales of investment securities available-for-sale amounted$9.8 million, $4.9 million, and $23.7 million, respectively. Gross realizedgains in 2006, 2005, and 2004, amounted to $61,000, $33,000, and $250,000,respectively. Gross realized losses in 2004 were $5,000. There were no realizedlosses in 2006 and 2005.

Thetable below shows the Company’s investment securities’ gross unrealized lossesand their fair value, aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position, at December 31,2006.

| ** **                                    | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|----------------|------------|
| ** **                                    | ** ** | **Fair Value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| ** **                                    | ** ** | **(In thousands)**                | ** ** |
| **Investment Securities  Available-for-Sale** |       |                                   |       | ** **                           |       |           | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| U.S. government—sponsored  agencies      |       |                                   | $          | 20,548                               | ** ** |           |       | $ | (37 | ) |   |   | $ | 45,339 | ** ** |   |   | $ | (459 | ) |   |   | $ | 65,887 | ** ** |   |   | $ | (496 | ) |   |
| Mortgage-backed  securities                   |       |                                   | 11,858     | ** **                           |       |           | (47        | ) |   |   | 95,863 | ** ** |   |   | (3,192 | ) |   |   | 107,721 | ** ** |   |   | (3,239 | ) |   |
| Municipal  securities                         |       |                                   | 14,444     | ** **                           |       |           | (138       | ) |   |   | — | ** ** |   |   | — |   |   |   | 14,444 | ** ** |   |   | (138 | ) |   |
| U.S. treasury  securities                     |       |                                   | 488        | ** **                           |       |           | (1         | ) |   |   | — | ** ** |   |   | — |   |   |   | 488 | ** ** |   |   | (1 | ) |   |
| Total temporarily  impaired securities        |       |                                   | $          | 47,338                               | ** ** |           |       | $ | (223 | ) |   |   | $ | 141,202 | ** ** |   |   | $ | (3,651 | ) |   |   | $ | 188,540 | ** ** |   |   | $ | (3,874 | ) |   |

 

| ** **                                  | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**           | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------|------------|
| ** **                                  | ** ** | **Fair Value**                    | ** ** | **Unrealized loss**             | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                | ** ** |
| **Investment Securities  Held-to-Maturity** |       |                                   |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. government—sponsored agencies     |       |                                   | $          | —                               |       |                |       | $ | — |   |   |   | $ | 23,453 |   |   |   | $ | (503 | ) |   |   | $ | 23,453 |   |   |   | $ | (503 | ) |   |
| Mortgage-backed securities                  |       |                                   | —     |                                 |       |                | —     |   |   |   | 61,163 |   |   |   | (1,589 | ) |   |   | 61,163 |   |   |   | (1,589 | ) |   |
| Corporate bonds                             |       |                                   | —     |                                 |       |                | —     |   |   |   | 5,850 |   |   |   | (150 | ) |   |   | 5,850 |   |   |   | (150 | ) |   |
| Total temporarily impaired securities       |       |                                   | $          | —                               |       |                |       | $ | — |   |   |   | $ | 90,466 |   |   |   | $ | (2,242 | ) |   |   | $ | 90,466 |   |   |   | $ | (2,242 | ) |   |

 

Investment securities with unrealized losses areinvestment grade securities. Investment securities with unrealized losses haveinterest rates that are less than current market interest rates and, therefore,the indicated temporary losses are not a result of permanent credit impairment.Mortgage-backed investment securities, which are the primary component of theunrealized losses in the investment securities portfolio, are primarily comprisedof bonds issued by the Federal National Mortgage Association (FNMA), FederalHome Loan Mortgage Corporation (FHLMC) and Government National MortgageAssociation (GNMA). The Company has the ability and intent to hold theseinvestment securities until their values recover or until maturity.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Investmentsecurities that were pledged to secure borrowed funds and other balances asrequired at December 31, 2006 and 2005 had carrying values of $191.7million and $224.9 million, respectively.

| ** **                                                                    | ** ** | **2006**                | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                    | ** ** | **(In thousands)** | ** ** |
| FHLB advances                                                                 |       | $102,731                |       | $        | 121,274    |   |
| Repurchase  agreements                                                        |       | 55,645                  |       | 66,991   |       |
| Debtor in  possession, public deposits, and trust division deposits |       | 3,491                   |       | 17,258   |       |
| FRB discount  window and TT&L note option                                 |       | 29,853                  |       | 19,410   |       |
|                                                                          |       | $                       | 191,720    |     | $          | 224,933 |   |
|                                                                               |            |                         |            |          |            |  |  |

 

Other investments at December 31,2006 include $8.4 million of Federal Home Loan Bank stock and $63,000 ofCommunity Bankers’ Bank stock. At December 31, 2005, other investments included$6.4 million of Federal Home Loan Bank stock, and $63,000 of Community Bankers’Bank stock.  As a member of the FederalHome Loan Bank of Atlanta (“FHLB”), the Company’s banking subsidiary isrequired to hold stock in this entity. Stock membership in Community Bankers’Bank allows the Company to participate in loan purchases and sales. Inaddition, included in other investments at December 31, 2006 and 2005 isthe Company’s $619,000 investment in Cardinal Statutory Trust I. AtDecember 31, 2006, the Company had an equity investment in a local bankholding company of $50,000. These investments are carried at cost since noactive trading markets exist.

**(5) LoansReceivable**

Theloan portfolio at December 31, 2006 and 2005 consists of the following:

| ** **                    | ** ** | **2006**                | ** ** | **2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                    | ** ** | **(In thousands)** | ** ** |
| Commercial and  industrial    |       | $                       | 102,284    |     | $          | 69,392 |   |
| Real estate—commercial   |       | 317,201                 |       | 275,381  |       |
| Real estate—construction |       | 154,525                 |       | 128,009  |       |
| Real estate—residential  |       | 201,320                 |       | 152,818  |       |
| Home equity lines             |       | 65,557                  |       | 75,048   |       |
| Consumer                      |       | 4,904                   |       | 5,255    |       |
|                          |       | 845,791                 |       | 705,903  |       |
| Net deferred fees             |       | (342                    | )          | (259     | )          |
| Loans receivable, net of fees |       | 845,449                 |       | 705,644  |       |
| Allowance for  loan losses    |       | (9,638                  | )          | (8,301   | )          |
| Loans receivable,  net        |       | $                       | 835,811    |     | $          | 697,343 |   |

 

Substantially all of the Company’s loans, commitmentsand standby letters of credit have been granted to customers located in theWashington, D.C. metropolitan area. As a matter of regulatory restriction, theCompany’s banking subsidiary limits the amount of credit extended to any singleborrower or group of related borrowers. Loans in process at December 31,2006 and 2005 were $210,000 and $440,000, respectively.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Ananalysis of the change in the allowance for loan losses follows:

| ** **                  | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Balance, beginning  of year |       | $                       | 8,301      |     | $          | 5,878    |       | $ | 4,344 |   |
| Provision for  loan losses  |       | 1,232                   |       | 2,456    |       | 1,626    |       |
| Loans charged-off           |       | (43                     | )          | (129     | )          | (108     | )          |
| Recoveries                  |       | 148                     |       | 96       |       | 16       |       |
| Balance, end of year        |       | $                       | 9,638      |     | $          | 8,301    |       | $ | 5,878 |   |

 

At December 31, 2006 and 2005, the Company hadimpaired loans of $82,000 and $214,000, respectively, which were on non-accrualstatus. These impairments had valuation allowances of $11,000 and $48,000, asof December 31, 2006 and 2005, respectively. The average balance ofimpaired loans was $293,000, $329,000, and $298,000 for 2006, 2005 and 2004,respectively. Interest income that would have been recorded had these loansbeen performing would have been $15,000 for 2006, $18,000 for 2005, and $25,000for 2004. The interest income realized prior to these loans being placed onnon-accrual status for the years ended December 31, 2006 and 2004 was$9,000 and $21,000, respectively. No interest income was realized prior tothese loans being placed on non-accrual status in 2005.

Loans totaling $391.1million serve as collateral for Federal Home Loan Bank advances at December 31,2006.

**(6) Loans Held forSale, Net**

Theloans held for sale portfolio at December 31, 2006 and 2005, consisted ofthe following:

| ** **                | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------|------------|-------------------------|------------|----------|------------|
| ** **                | ** ** | **(In thousands)** | ** ** |
| Residential               |       | $                       | 294,115    |     | $          | 295,813 |   |
| Construction-to-permanent |       | 44,145                  |       | 64,202   |       |
|                      |       | 338,260                 |       | 360,015  |       |
| Net deferred  costs       |       | 471                     |       | 1,653    |       |
| Loans held for  sale, net |       | $                       | 338,731    |     | $          | 361,668 |   |

 

Loans that are classified as construction-to-permanentare those loans that provide variable rate financing for customers to constructtheir residences. Once the home has been completed, the loan converts to fixedrate financing and is sold into the secondary market.

At December 31, 2006and 2005, George Mason maintained a reserve of $57,000  and $116,000, respectively, for loans soldthat paid off within a contractually agreed upon period, thereby requiring thatGeorge Mason refund part of the service release premium and/or premium pricingreceived from the investor.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

**(7) Premises andEquipment**

Componentsof premises and equipment at December 31, 2006 and 2005 were as follows:

| ** **                                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                      | ** ** | **(In thousands)** | ** ** |
| Land                                            |       | $                       | 4,350      |     | $          | 3,450 |   |
| Buildings                                       |       | 6,667                   |       | 5,706    |       |
| Furniture and  equipment                        |       | 14,484                  |       | 12,622   |       |
| Leasehold  improvements                         |       | 5,784                   |       | 4,649    |       |
| Total cost                                      |       | 31,285                  |       | 26,427   |       |
| Less accumulated  depreciation and amortization |       | 11,246                  |       | 8,226    |       |
| Premises and  equipment, net                    |       | $                       | 20,039     |     | $          | 18,201 |   |

 

Depreciation expense for the years ended December 31,2006, 2005, and 2004 was $3.2 million, $2.8 million, and $1.8 million,respectively.

The Company has entered into operating leases foroffice space over various terms. The leases generally have options to renew andare subject to annual increases as well as allocations of real estate taxes andcertain operating expenses.

Minimumfuture rental payments under the noncancelable operating leases, as of December 31,2006 were as follows:

| **Year ending December 31,** | ** ** | **Amount**              | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| 2007                                        |       |                    | $          | 3,760 |   |   |
| 2008                                        |       |                    | 2,815      |   |   |
| 2009                                        |       |                    | 2,286      |   |   |
| 2010                                        |       |                    | 1,116      |   |   |
| 2011                                        |       |                    | 1,012      |   |   |
| Thereafter                                  |       |                    | 4,071      |   |   |
|                                        |       |                    | $          | 15,060 |   |   |

 

The total rent expense was $5.2 million, $4.5 million,and $3.2 million in 2006, 2005 and 2004, respectively and is recorded inoccupancy expense in the consolidated statements of income.

TheCompany subleased excess office space. Future minimum lease payments undernoncancellable subleasing arrangements as of December 31, 2006 were asfollows:

| **Year ending December 31,** | ** ** | **Amount**              | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| 2007                                        |       |                    | $          | 313 |   |   |
| 2008                                        |       |                    | 222        |   |   |
| 2009                                        |       |                    | 176        |   |   |
| 2010                                        |       |                    | 182        |   |   |
| 2011                                        |       |                    | 187        |   |   |
| Thereafter                                  |       |                    | 278        |   |   |
|                                        |       |                    | $          | 1,358 |   |   |

 

86

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

The total rent income was$412,000, $602,000, and $573,000 in 2006, 2005, and 2004, respectively and isrecorded as a reduction of occupancy expense in the consolidated statements ofincome.

**(8) Deposits**

Depositsconsist of the following at December 31, 2006 and 2005:

| ** **                            | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Non-interest-bearing  demand deposits |       | $                       | 123,301    |     | $          | 114,915 |   |
| Interest-bearing deposits:            |       |                    |       |     |       |
| Interest checking                     |       | 137,092                 |       | 84,481   |       |
| Money market and statement savings    |       | 395,652                 |       | 231,882  |       |
| Certificates of deposit               |       | 562,837                 |       | 638,594  |       |
| Total  interest-bearing deposits      |       | 1,095,581               |       | 954,957  |       |
| Total deposits                        |       | $                       | 1,218,882  |     | $          | 1,069,872 |   |

 

Interestexpense by deposit categories is as follows:

| ** **                          | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                          | ** ** | **(In thousands)** | ** ** |
| Interest checking                   |       | $                       | 3,796      |     | $          | 1,366    |       | $ | 2,016 |   |
| Money market and  statement savings |       | 10,153                  |       | 4,503    |       | 213      |       |
| Certificates of  deposit            |       | 25,142                  |       | 19,030   |       | 10,465   |       |
| Total interest  expense             |       | $                       | 39,091     |     | $          | 24,899   |       | $ | 12,694 |   |

 

The aggregate amount of time deposits, each with aminimum denomination of $100,000 was $262.8 million and $283.6 million at December 31,2006 and 2005, respectively.

Brokeredcertificates of deposits at December 31, 2006 and 2005 were $5.0 millionand $9.8 million, respectively.At December 31, 2006, the scheduledmaturities of certificates of deposit were as follows:

| ** **           | ** ** | **(In thousands)** | ** ** |
|----------------------|------------|-------------------------|------------|
| 2007                 |       |                    | $          | 447,772 |   |   |
| 2008                 |       |                    | 83,942     |   |   |
| 2009                 |       |                    | 19,168     |   |   |
| 2010                 |       |                    | 4,153      |   |   |
| 2011 and  thereafter |       |                    | 7,802      |   |   |
|                 |       |                    | $          | 562,837 |   |   |

 

87

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

**(9) Other BorrowedFunds**

At December 31,2006 and 2005, other borrowed funds consisted of the following:

| ** **                                 | ** ** | **2006**                | ** ** | **2005** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Fixed rate FHLB  advances                  |       | $                       | 106,708    |     | $          | 88,458 |   |
| Variable rate  FHLB advances               |       | 16,000                  |       | —   |       |
| Repurchase  agreements                     |       | 46,323                  |       | 41,170   |       |
| Payable to  Statutory Trust I              |       | 20,619                  |       | 20,619   |       |
| Treasury,  Tax & Loan note option |       | 4,981                   |       | 5,174    |       |
|                                       |       | $                       | 194,631    |     | $          | 155,421 |   |

 

The Company had fixed rate advances from the FHLB of$106.7 million at December 31, 2006. These advances mature through 2016and have interest rates ranging from 2.29% to 4.55%. Certain fixed rate FHLBadvances have call options through 2009. The Company also has two variable rateFHLB advances totaling $16.0 million at December 31, 2006. The firstvariable rate advance is $6.0 million and matures in 2007, but can be paid offat any time by the Company. The interest rate the Company pays on this advanceis tied to the federal funds purchased rate and reprices daily. The interestrate for this advance at December 31, 2006 was 5.50%. The second variablerate advance is $10.0 million and matures in 2016 and has call options beginningin 2008. The variable rate is based on the three month LIBOR (London Interbank OfferedRate) less 50 basis points for the first two years of the advance and then theinterest rate is fixed at 4.00% if the advance is not called. The interest rateon this advance was 4.86% at December 31, 2006.

At December 31, 2005, the Company had $88.5million in fixed rate advances from the FHLB with maturities through 2014 andinterest rates ranging from 2.07% to 4.31%. The Company had no variable rateFHLB advances at December 31, 2005.

The contractualmaturities of the fixed and variable rate advances at December 31, 2006and 2005 were as follows:

| ** **                                 | ** ** | **At December 31, 2006** | ** ** |
|--------------------------------------------|------------|-----------------------------------------|------------|
| **Type of Advance**              | ** ** | **Interest Rate**                  | ** ** | **Advance Term** | ** ** | **Maturity Date** | ** ** | **Balance** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                 | ** ** |
| Daily Rate Credit  (variable rate advance) |       | 5.50%                                   |       | 12  months |   |   | 2007 |   |   | 6,000 |   |
| Expandable                                 |       | 4.12%                                   |       | 24  months |   |   | 2007 |   |   | 10,000 |   |
| Fixed Rate Credit                          |       | 2.63%  – 3.59%                     |       | 36 –  48 months |   |   | 2007 |   |   | 17,750 |   |
| Fixed Rate Credit                          |       | 4.08%  – 4.31%                     |       | 36  months |   |   | 2008 |   |   | 10,000 |   |
| Principal  Reducing Credit                 |       | 2.29%                                   |       | 60  months |   |   | 2008 |   |   | 3,958 |   |
| Convertible                                |       | 3.50%                                   |       | 60  months |   |   | 2009 |   |   | 10,000 |   |
| Convertible                                |       | 4.24%  – 4.52%                     |       | 60  months |   |   | 2011 |   |   | 15,000 |   |
| Flipper Advance  (variable rate advance)   |       | 4.86%                                   |       | 120  months |   |   | 2016 |   |   | 10,000 |   |
| Convertible                                |       | 3.93%  – 4.55%                     |       | 120  months |   |   | 2016 |   |   | 40,000 |   |
| **Total FHLB Advances**                    | ** ** | **4.08%**                               | ** ** | ** ** | ** ** |   |   |   | ** ** | **$** | **122,708** | ** ** |
|                                            |            |                                         |            |  |  |  |  |  |  |  |  |  |

 

88

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

 

| ** **                    | ** ** | **At December 31, 2005** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|
| **Type of Advance** | ** ** | **Interest Rate**                  | ** ** | **Advance Term** | ** ** | **Maturity Date** | ** ** | **Balance** | ** ** |
| ** **                    | ** ** | **(In thousands)**                      | ** ** |
| Fixed Rate Credit             |       | 2.07%  – 2.58%                     |       | 24 –  36 months |   |   | 2006 |   |   | $ | 9,250 |   |
| Expandable                    |       | 4.12%                                   |       | 24  months |   |   | 2007 |   |   | 5,000 |   |
| Fixed Rate Credit             |       | 2.63%  – 3.59%                     |       | 36 –  48 months |   |   | 2007 |   |   | 17,750 |   |
| Fixed Rate Credit             |       | 4.08%  – 4.31%                     |       | 36  months |   |   | 2008 |   |   | 10,000 |   |
| Principal  Reducing Credit    |       | 2.29%                                   |       | 60  months |   |   | 2008 |   |   | 6,458 |   |
| Convertible                   |       | 2.91%  – 3.50%                     |       | 60  months |   |   | 2009 |   |   | 15,000 |   |
| Convertible                   |       | 3.72%                                   |       | 60  months |   |   | 2010 |   |   | 5,000 |   |
| Convertible                   |       | 3.33%  – 3.47%                     |       | 120  months |   |   | 2014 |   |   | 20,000 |   |
| **Total FHLB Advances**       | ** ** | **3.27%**                               | ** ** | ** ** | ** ** |   |   |   | ** ** | **$** | **88,458** | ** ** |

 

The average balances of FHLB advances for the yearsended December 31, 2006 and 2005 were $80.5 million and $91.4 million,respectively. The maximum amount outstanding at any month-end during the yearsended December 31, 2006 and 2005 was $122.7 million and $100.3 million,respectively. Total interest expense on FHLB advances for the years ended December 31,2006, 2005, and 2004 was $2.8 million, $2.9 million, and $2.3 million,respectively.

During 2006, the Company extinguished two FHLBadvances totaling $20.0 million. The gain on the extinguishment of theseadvances for the year ended December 31, 2006 was $769,000 and wasrecorded in other non-interest income in the consolidated statements of income.During 2005, the Company extinguished one FHLB advance totaling$5.0 million. The gain on the 2005 extinguishment was $140,000. No suchextinguishments occurred during 2004.

Securities sold under agreements to repurchasegenerally mature within one to four days and are reflected in the consolidatedstatements of financial condition at the amount of cash received. At December 31,2006 and 2005 the Company had repurchase agreements of $46.3 million and $41.2million, respectively. The weighted-average interest rate of these repurchaseagreements was 2.14% and 1.41% at December 31, 2006 and 2005, respectively.The average balances of the repurchase agreements during 2006 and 2005 were$40.7 million and $34.7 million, respectively, and the maximum amountoutstanding at any month-end during 2006 and 2005 was $52.7 million and $41.2million, respectively.  Interest expenseon repurchase agreements for 2006, 2005, and 2004 was $870,000, $429,000, and$180,000, respectively.

The Company had no outstanding federal funds purchasedat December 31, 2006 and at December 31, 2005. However, the Companydid have federal funds purchased outstanding at other times during those years.Interest expense on federal funds purchased in 2006, 2005, and 2004 was$229,000, $216,000, and $114,000, respectively. The Company had no outstandingshort-term dealer repurchase agreements at December 31, 2006 and at December 31,2005. However, the Company did have short-term dealer repurchase agreementsoutstanding at other times during those years. Interest expense on short-termdealer repurchase agreements in 2006 and 2005 was $711,000 and $184,000,respectively. There was no interest expense for short-term dealer repurchaseagreements for the year ended December 31, 2004.

The Company has a Treasury, Tax, & Loan (“TT&L”)note option with the Federal Reserve. At December 31, 2006 and 2005, theoutstanding balance in the TT&L note option was $5.0 million and $5.2million, respectively. Interest expense related to the TT&L note option in2006, 2005, and 2004 was $142,000, $91,000, and $23,000, respectively. TheCompany has a line of credit at the Federal Reserve discount window in theamount of $15.5 million at December 31, 2006, which was not utilizedas of that 

89

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

date. Interest expenserelated to the discount window for 2004 was $28,000. There was no interestexpense related to the discount window in 2006 or 2005.

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 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. At December 31,2006, the interest rate on trust preferred securities was 7.76%. Thesesecurities are redeemable at par beginning September 2009. Under certainqualifying events, 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 the Trust is included in other borrowedfunds. The Trust is an unconsolidated subsidiary since the Company is not theprimary beneficiary of this entity under FASB Interpretation No. 46R*Consolidation of Variable Interest Entities*.The additional $619,000 that is payable by the Company to the Trust representsthe Company’s capital investment in the Trust. The Company utilized theproceeds from the issuance of the trust preferred securities to make a capitalcontribution into the Bank. Interest expense on the trust preferred securitiesin 2006, 2005, and 2004 was $1.6 million, $1.2 million and $382,000,respectively.

Thescheduled maturities of other borrowed funds at December 31, 2006 were asfollows:

| ** **                    | ** ** | **2007**                | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011 and  thereafter** | ** ** |
|-------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|
| ** **                    | ** ** | **(In thousands)** | ** ** |
| FHLB advances                 |       | $                       | 33,750     |     | $          | 13,958   |       | $        | 10,000     |                          |       | $ | — |   |   |   | $ | 65,000 |   |   |
| Repurchase  agreements        |       | 46,323                  |       | —   |       | —   |       |     | —     |                          |       |   | — |   |   |
| Payable to  Statutory Trust I |       | —                  |       | —   |       | —   |       |     | —     |                          |       |   | 20,619 |   |   |
| TT&L note  option         |       | 4,981                   |       | —   |       | —   |       |     | —     |                          |       |   | — |   |   |
|                          |       | $                       | 85,054     |     | $          | 13,958   |       | $        | 10,000     |                          |       | $ | — |   |   |   | $ | 85,619 |   |   |

 

**(10) Loans Held forSale Financing**

George Mason and the Bank have a $150 million floatingrate revolving credit and security agreement with a third party. The purpose ofthis credit facility is to fund residential mortgage loans at George Masonprior to their sale into the secondary market. The credit facility requires,among other things, that George Mason and the Bank have positive quarterly netincome and maintain specified minimum tangible and regulatory net worthrequirements. The Company has guaranteed repayment of this debt. The interestrate on this credit facility is LIBOR plus between 1.50% and 1.875%. At December 31,2006 and 2005, none of this line was utilized.

The same lender has also provided a $100 millionfacility that is utilized by George Mason to fund residential mortgage loansheld for sale to this lender. The terms of this facility are substantially thesame as the above-referenced revolving credit and security agreement and thecost of this facility is netted against interest earned on the loans pendingsettlement with the lender. Loans under this credit facility are consideredsold when financed.

Interest expense relatedto George Mason’s warehouse financing was $164,000, $109,000 and $228,000 forthe years ended December 31, 2006, 2005 and 2004, respectively.

90

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

**(11) Income Taxes**

The Company and its subsidiaries file consolidatedfederal tax returns on a calendar-year basis. The Company recorded incometax expense of $3.2 million, $5.2 million and $1.7 million for the years ended December 31,2006, 2005 and 2004, respectively.

Theprovision for income tax expense is reconciled to the amount computed byapplying the federal corporate tax rate to income before taxes as follows:

| ** **                                                          | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                          | ** ** | **(In thousands)** | ** ** |
| Income tax at  federal corporate rate                               |       | $                       | 3,591      |     | $          | 5,115    |       | $ | 1,762 |   |
| Change in  valuation allowance                                      |       | 195                     |       | 100      |       | 97       |       |
| Change in the  carrying rate of deferred tax assets and liabilities |       | (67                     | )          | —   |       | —   |       |
| Expected state  tax benefit of losses of nonbank entities           |       | (195                    | )          | (100     | )          | (97      | )          |
| State tax  expense, net of federal tax benefit                      |       | 73                      |       | —   |       | —   |       |
| Nontaxable income                                                   |       | (402                    | )          | —   |       | —   |       |
| Nondeductible  expenses                                             |       | 26                      |       | 15       |       | 17       |       |
| Other                                                               |       | (48                     | )          | 37       |       | (66      | )          |
|                                                                |       | $                       | 3,173      |     | $          | 5,167    |       | $ | 1,713 |   |

 

Thecomponents of income tax expense are as follows:

| ** **                                                                                                                                        | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                                        | ** ** | **(In thousands)** | ** ** |
| Included in net income                                                                                                                            |       |                    |       |     |       |     |       |
| Current                                                                                                                                           |       |                    |       |     |       |     |       |
| Federal                                                                                                                                           |       | $                       | 5,550      |     | $          | 5,178    |       | $ | 134 |   |
| State                                                                                                                                             |       | 116                     |       | —   |       | —   |       |
| Total current                                                                                                                                     |       | 5,666                   |       | 5,178    |       | 134      |       |
| Deferred                                                                                                                                          |       |                    |       |     |       |     |       |
| Federal                                                                                                                                           |       | (2,487                  | )          | (11      | )          | 1,579    |       |
| State                                                                                                                                             |       | (6                      | )          | —   |       | —   |       |
| Total deferred                                                                                                                                    |       | (2,493                  | )          | (11      | )          | 1,579    |       |
| Total included in net income                                                                                                                      |       | $                       | 3,173      |     | $          | 5,167    |       | $ | 1,713 |   |
| Included in  shareholders’ equity:                                                                                                           |       |                    |       |     |       |     |       |
| Deferred tax expense (benefit) related to the change  in the net unrealized gain (loss) on investment securities available for sale               |       | $                       | 390        |     | $          | (1,023   | )          | $ | (344 | ) |
| Deferred tax expense (benefit) related to the change  in the net unrealized gain (loss) on derivative instruments designated as  cash flow hedges |       | 105                     |       | (149     | )          | —   |       |
| Total included in  shareholders’ equity                                                                                                      |       | $                       | 495        |     | $          | (1,172   | )          | $ | (344 | ) |

 

91

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Thetax effects of temporary differences between the financial reporting basis andincome tax basis of assets and liabilities relate to the following:

| ** **                                                                  | ** ** | **2006**                | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                  | ** ** | **(In thousands)** | ** ** |
| Deferred tax assets:                                                        |       |                    |       |     |       |
| Allowance for loan losses                                                   |       | $                       | 3,364      |     | $          | 2,800 |   |
| Net operating loss carryforwards                                            |       | 1,030                   |       | 835      |       |
| Unrealized losses on investment securities available-for-sale               |       | 1,257                   |       | 1,627    |       |
| Unrealized losses on derivative instruments  designated as cash flow hedges |       | 42                      |       | 149      |       |
| Deferred compensation                                                       |       | 1,553                   |       | 943      |       |
| Goodwill and intangibles, net                                               |       | 311                     |       | (576     | )          |
| Other                                                                       |       | 396                     |       | 84       |       |
| Total gross deferred tax assets                                             |       | 7,953                   |       | 5,862    |       |
| Less valuation  allowance                                                   |       | (1,030                  | )          | (835     | )          |
| Net deferred tax assets                                                     |       | 6,923                   |       | 5,027    |       |
| Deferred tax  liabilities:                                                  |       |                    |       |     |       |
| Prepaid expenses                                                            |       | —                  |       | (90      | )          |
| Depreciation                                                                |       | (45                     | )          | (207     | )          |
| Loan origination costs                                                      |       | (463                    | )          | (331     | )          |
| Total gross deferred tax liabilities                                        |       | (508                    | )          | (628     | )          |
| Net deferred tax asset                                                      |       | $                       | 6,415      |     | $          | 4,399 |   |

 

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. Whenuncertainty exists concerning the recoverability of a deferred tax asset, thecarrying value of the asset may be reduced by a valuation allowance. Valuation allowances of $1.0 million and $835,000at December 31, 2006 and 2005, respectively, have been established fordeferred tax assets. This valuation allowance relates primarily to the stateportion of the net operating losses of the parent company and CWS asrealization is dependent upon generating future taxable income within thoseentities. Management believes that future operations of the Company willgenerate sufficient taxable income to realize the net deferred tax assets at December 31,2006 and 2005.

The Company used all ofits federal net operating loss carryforwards as of December 31, 2005.

**(12) DerivativeInstruments and Hedging Activities**

The Company is a party to forward loan salescontracts, which are utilized to mitigate exposure to fluctuations in interestrates related to closed loans which are held for sale.

Beginning on October 1, 2005, the Companydesignated these derivatives as cash flow hedges in accordance with SFASNo. 133, as amended. These hedges are recorded at fair value in thestatement of condition as an other asset or other liability with acorresponding offset to accumulated other comprehensive income in shareholders’equity. Amounts are reclassified from accumulated other comprehensive income tothe income statement in the period or periods that the loan sale is reflectedin income.

92

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

At December 31, 2006 and 2005, accumulated othercomprehensive income included an after tax unrealized gain (loss) of $348,000and ($288,000), respectively, related to forward loan sale contracts. Loansheld for sale are generally sold within sixty days of closing and, therefore,substantially all of the amount recorded in accumulated other comprehensiveincome at December 31, 2006 which is related to the Company’s cash flowhedges will be recognized in earnings during the first quarter of 2007. In  each of the years ended December 31,2006 and 2005, the Company recorded a charge to earnings of $1,000 due to hedgeineffectiveness.

At December 31, 2006, the Company had $81.6million in loan commitments and associated forward sales and had $301.9 millionin forward loan sales associated with $301.9 million of loans held for salecontracts. At December 31, 2006, the derivative asset was $2.8 million andthe derivative liability was $1.6 million.

At December 31, 2005,the Company had $109.9 million in loan commitments and associated forward salesand had $279.0 million in forward loan sales associated with $279.0 million ofloans held for sale contracts. At December 31, 2005, the derivative assetwas $1.4 million and the derivative liability was $1.8 million.

**(13) RegulatoryMatters**

The Bank, as a state-chartered bank, is subject to thedividend restrictions established by the State Corporation Commission of theCommonwealth of Virginia. Under such restrictions, the Bank may not, withoutthe prior approval of the Bank’s primary regulator, declare dividends in excessof the sum of the current year’s earnings (as defined) plus the retainedearnings (as defined) from the prior two years. At December 31, 2006,there were approximately $21.8 million of accumulated earnings at the Bankwhich could be paid as dividends to the Company.

The Bank is required to maintain a minimumnon-interest earning average reserve balance with the Federal Reserve Bank. Theaverage amount of the required reserve was $100,000 for 2006.

The Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”) requires banking regulators to stratify banks into fivequality tiers based upon their relative capital strengths and increase theregulation of the weaker institutions. The key measures of capital are: (1) totalcapital (Tier I capital plus the allowance for loan losses up to certainlimitations) as a percent of total risk-weighted assets, (2) Tier Icapital (as defined) as a percent of total risk-weighted assets (as defined),and (3) Tier I capital (as defined) as a percent of total average assets(as defined).

93

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Theregulatory capital of the Company at December 31, 2006 and 2005 is asfollows:

| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| **At December 31, 2006** | ** ** | **Actual**              | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                              | ** ** | **Amount**              | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                       | 170,457    |                       | 14.06%     |                       | $          | 97,010                     | 3     | 8.00%                      |       | $ | 121,263 | 3 | 10.00% |   |
| Tier I capital to  risk weighted assets |       | 160,656                 |       | 13.25%                     |       | 48,505                     | 3     | 4.00%                      |       | 72,758                     | 3     | 6.00% |   |
| Tier I capital to  average assets       |       | 160,656                 |       | 10.68%                     |       | 60,180                     | 3     | 4.00%                      |       | 75,225                     | 3     | 5.00% |   |
|                                         |            |                         |            |                            |            |                            |            |                            |            |                            |            |  |  |  |  |  |

 

| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                              | ** ** | ** **              | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| **At December 31, 2005** | ** ** | **Actual**              | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                              | ** ** | **Amount**              | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                       | 159,155    |                       | 15.65%     |                       | $          | 81,334                     | 3     | 8.00%                      |       | $ | 101,668 | 3 | 10.00% |   |
| Tier I capital to  risk weighted assets |       | 150,742                 |       | 14.83%                     |       | 40,667                     | 3     | 4.00%                      |       | 61,001                     | 3     | 6.00% |   |
| Tier I capital to  average assets       |       | 150,742                 |       | 10.71%                     |       | 56,308                     | 3     | 4.00%                      |       | 70,386                     | 3     | 5.00% |   |
|                                         |            |                         |            |                            |            |                            |            |                            |            |                            |            |  |  |  |  |  |

 

Theregulatory capital of the Bank at December 31, 2006 and 2005 is as follows:

| ** **                              | ** ** | ** **              | ** ** | **For Capital**       | ** ** | **To Be Well  Capitalized Under  Prompt Corrective** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|--------------------------------------------------------------------------|------------|
| **At December 31, 2006**                | ** ** | **Actual**              | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions**                                               | ** ** |
| ** **                              | ** ** | **Amount**              | ** ** | **Ratio**                  | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                       | 141,885    |                       | 11.73%     |                                                                     | $          | 96,742 | 3 | 8.00% |   | $ | 120,927 | 3 | 10.00% |   |
| Tier I capital to  risk weighted assets |       | 132,084                 |       | 10.92%                     |       | 48,371                                                                   | 3     | 4.00% |   | 72,556 | 3 | 6.00% |   |
| Tier I capital to  average assets       |       | 132,084                 |       | 8.80%                      |       | 60,038                                                                   | 3     | 4.00% |   | 75,048 | 3 | 5.00% |   |
|                                         |            |                         |            |                            |            |                                                                          |            |  |  |  |  |  |  |  |  |  |

 

| ** **                              | ** ** | ** **              | ** ** | **For Capital**       | ** ** | **To Be Well  Capitalized Under  Prompt Corrective** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|--------------------------------------------------------------------------|------------|
| **At December 31, 2005**                | ** ** | **Actual**              | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions**                                               | ** ** |
| ** **                              | ** ** | **Amount**              | ** ** | **Ratio**                  | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Total capital to  risk weighted assets  |       | $                       | 129,042    |                       | 12.73%     |                                                                     | $          | 81,097 | 3 | 8.00% |   | $ | 101,372 | 3 | 10.00% |   |
| Tier I capital to  risk weighted assets |       | 120,628                 |       | 11.90%                     |       | 40,549                                                                   | 3     | 4.00% |   | 60,823 | 3 | 6.00% |   |
| Tier I capital to  average assets       |       | 120,628                 |       | 8.61%                      |       | 56,014                                                                   | 3     | 4.00% |   | 70,018 | 3 | 5.00% |   |
|                                         |            |                         |            |                            |            |                                                                          |            |  |  |  |  |  |  |  |  |  |

 

At December 31, 2006 and 2005, the Company andthe Bank met all regulatory capital requirements and are considered “well-capitalized”from a regulatory perspective.

George Mason is alsorequired to maintain defined capital levels under Department of Housing andUrban Development guidelines. At December 31, 2006 and 2005, George Masonmaintained capital in excess of these required guidelines.

94

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

**(14) Related-PartyTransactions**

Certain directors, officers and employees and/or theirrelated business interests are at present, as in the past, banking customers inthe ordinary course of business of the Company. As such, the Company has had,and expects to have in the future, banking transactions in the ordinary courseof its business with directors, officers, principal shareholders and theirassociates, on substantially the same terms, including interest rates andcollateral on loans, as those prevailing at the same time for comparabletransactions with non-related parties and do not involve more than normal riskof collectibility or present other unfavorable features.

Analysisof activity for loans to related parties follows:

| ** **                   | ** ** | **2006**                | ** ** | **2005** | ** ** |
|------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                   | ** ** | **(In thousands)** | ** ** |
| Balance,  beginning of year  |       | $                       | 34,998     |     | $          | 22,076 |   |
| New loans                    |       | 11,844                  |       | 17,587   |       |
| Loans paid off or  paid down |       | (6,360                  | )          | (4,665   | )          |
| Balance, end of year         |       | $                       | 40,482     |     | $          | 34,998 |   |

 

George Mason leases itsheadquarters office space from a director of the Company who is the manager anda 3.1% owner of the limited liability company that owns the building in whichthe space is leased. The lease commenced on July 1, 2002 and willterminate on June 30, 2007 without any option to extend. The rent thatGeorge Mason pays for the use of this space ranges from $1.2 million to $1.5million per year during the term of the lease. Rent payments totaled $1.2million in 2006 and in 2005.

**(15) Earnings PerCommon Share**

Thefollowing is the calculation of basic and diluted earnings per common share.

| ** **                           | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                           | ** ** | **(In thousands, except per share data)** | ** ** |
| Net income                           |       | $                                                                  | 7,388      |     | $          | 9,876    |       | $ | 3,469 |   |
| Weighted average  shares for basic   |       | 24,424                                                             |       | 22,113   |       | 18,448   |       |
| Weighted average  shares for diluted |       | 24,987                                                             |       | 22,454   |       | 18,705   |       |
| Basic earnings  per common share     |       | $                                                                  | 0.30       |     | $          | 0.45     |       | $ | 0.19 |   |
| Diluted earnings per  common share   |       | $                                                                  | 0.30       |     | $          | 0.44     |       | $ | 0.19 |   |

 

Basic earnings per share is impacted by the number ofshares required to be issued under the Company’s various deferred compensationplans and diluted earnings per share is impacted by those common shares whichmay be, but are not required to be, issued under these plans.

95

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Thefollowing shows the composition of basic outstanding shares for the years endedDecember 31, 2006, 2005, and 2004:

| ** **                                                                    | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                                    | ** ** | **(in thousands)** | ** ** |
| Weighted average  shares outstanding—basic                               |       | 24,391                  |       | 22,104   |       | 18,448   |       |
| Weighted average  shares attributable to the deferred compensation plan match |       | 33                      |       | 9        |       | —   |       |
| Total weighted average  shares - basic                                        |       | 24,424                  |       | 22,113   |       | 18,448   |       |

 

Thefollowing shows the composition of diluted outstanding shares for the yearsended December 31, 2006, 2005, and 2004:

| ** **                                                                                  | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                  | ** ** | **(in thousands)** | ** ** |
| Weighted average  shares outstanding—basic                                             |       | 24,391                  |       | 22,104   |       | 18,448   |       |
| Weighted average  shares attributable to deferred compensation plan contributions and match |       | 216                     |       | 77       |       | —   |       |
| Weighted average  shares attributable to vested stock options                               |       | 380                     |       | 273      |       | 257      |       |
| Total weighted average  shares - diluted                                                    |       | 24,987                  |       | 22,454   |       | 18,705   |       |

 

Outstanding stock optionsexcluded from the weighted average shares outstanding for the diluted earningsper share calculation were 22,998 at December 31, 2005. These stockoptions have exercise prices that were greater than the average market price ofthe Company’s common stock for the year. There were no outstanding stock optionsexcluded from the weighted average shares outstanding for the diluted earningsper share calculation at December 31, 2006 and 2004, respectively. Inaddition, there are no incremental shares related to stock options ascalculated under SFAS No. 123R because the addition of these shares to thediluted weighted average share calculation would be antidilutive.

**(16) 401(k) Plan**

Employees who work twenty(20) hours or more a week and have been employed by the Company for a month canelect to participate in and make contributions into a 401(k) Plan. TheCompany contributes $0.50 for $1.00 of employee contributions up to a maximumof 3% of the employee’s compensation. Expense related to the Company’s match in2006, 2005, and 2004 was $546,000, $521,000, and $286,000, respectively. Employeesare immediately vested in the Company’s matching contribution.

**(17) DeferredCompensation Plans**

In January 2005, theCompany began deferred compensation plans for its directors and certainemployees. Under the directors’ plan, a director may elect to defer all or aportion of any director-related fees including fees for serving on boardcommittees. Under the employees’ plan, certain employees may defer all or aportion of their compensation including any bonus or commission compensation. Directorand employee deferrals, other than employees of George Mason, are matched 50%by the Company. Deferrals made by employees of George Mason are not eligiblefor the Company match. The amount of the Company match is deemed invested inCompany common stock which vests immediately for the directors and after fouryears for employees. The maximum Company match per employee is $50,000 per 

96

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

year and$10,000 per year per director. Expense relating to the plans was $136,000 in2006 and $52,000 in 2005 and is included in salary and benefits expense in theconsolidated statements of income.

**(18) Director andEmployee Stock-Based Compensation Plans**

At December 31, 2006, the Company had twostock-based employee compensation plans, the 1999 Stock Option Plan (the “OptionPlan”) and the 2002 Equity Compensation Plan (the “Equity Plan”).

In 1998, the Company adopted the Option Plan pursuantto which the Company may grant stock options for up to 625,000 shares of theCompany’s common stock to employees and members of the Company’s and itssubsidiaries’ boards of directors. There are 17,044 shares of the Company’scommon stock available for future grants in the Option Plan as of December 31,2006.

In 2002, the Company adopted the Equity Plan. TheEquity Plan authorizes the granting of options, which may be incentive stockoptions or non-qualified stock options, stock appreciation rights, restrictedstock awards, phantom stock awards or performance share awards to directors,eligible officers and key employees of the Company. In 2006, the shareholdersapproved an amendment to the Equity Plan to increase the number of shares ofcommon stock reserved for issuance under it from 1,970,000 to 2,420,000. Thereare 248,383 shares of the Company’s common stock available for future grantsand awards in the Equity Plan as of December 31, 2006.

Thefollowing table presents a summary of the Company’s stock option activity forthe years ended December 31, 2005 and 2004:

| ** **                         | ** ** | ** **         | ** ** | **Weighted** | ** ** |
|------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                         | ** ** | ** **         | ** ** | **Average**  | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| ** **                         | ** ** | **Shares**         | ** ** | **Price**    | ** ** |
| Balance at  December 31, 2003 |       | 847,437            |       |         | $          | 4.57 |   |   |
| Granted                            |       | 537,018            |       |         | 8.71       |   |   |
| Exercised                          |       | (114,063           | )          |         | 4.36       |   |   |
| Forfeited                          |       | (39,904            | )          |         | 6.29       |   |   |
| Balance at  December 31, 2004 |       | 1,230,488          |       |         | $          | 6.34 |   |   |
| Granted                            |       | 1,210,245          |       |         | 10.06      |   |   |
| Exercised                          |       | (113,977           | )          |         | 6.08       |   |   |
| Forfeited                          |       | (57,535            | )          |         | 8.24       |   |   |
| Balance at  December 31, 2005 |       | 2,269,221          |       |         | $          | 8.29 |   |   |

 

97

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Stockoption activity during the year ended December 31, 2006 is summarized asfollows:

| ** **                                     | ** ** | ** **         | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|------------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                     | ** ** | ** **         | ** ** | **Weighted** | ** ** | **Average**           | ** ** | ** **    | ** ** |
| ** **                                     | ** ** | ** **         | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Aggregate** | ** ** |
| ** **                                     | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Intrinsic** | ** ** |
| ** **                                     | ** ** | **Shares**         | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **Value**     | ** ** |
| Outstanding at  December 31, 2005         |       | 2,269,221          |       |         | $          | 8.29                  |       |          |       |   |   |   |   |   |
| Granted                                        |       | 286,000            |       |         | 11.83      |                  |       |          |       |   |   |   |   |
| Exercised                                      |       | (96,230            | )          |         | 8.49       |                  |       |          |       |   |   |   |   |
| Forfeited                                      |       | (42,090            | )          |         | 10.24      |                  |       |          |       |   |   |   |   |
| Outstanding at  December 31, 2006         |       | 2,416,901          |       |         | $          | 8.70                  |       |          |       | 7.62 |   |   | $ | 3,754,056 |   |
| Options exercisable at  December 31, 2006 |       | 2,006,295          |       |         | $          | 8.44                  |       |          |       | 7.46 |   |   | $ | 3,632,572 |   |

 

Informationpertaining to stock options outstanding at December 31, 2006 is asfollows:

| ** **                                  | ** ** | ** ** | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Weighed Average**     | ** ** | ** **                   | ** ** | **Weighted Average** | ** ** |
| ** **                                  | ** ** | **Number** | ** ** | **Remaining**                | ** ** | **Exercise**                 | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | ** ** | ** ** | **Outstanding**              | ** ** | **Contractual Life**    | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $2.41 – $3.56                          |       |       | 128,466    |                         |       |                         | 5.0 years  |   |   |   | $ | 3.26 |   |   | 128,466 |   |   | $ | 3.26 |   |   |
| $3.95 – $5.50                          |       |       | 409,378    |                         |       |                         | 5.8 years  |   |   |   | 4.75 |   |   | 322,528 |   |   | 4.77 |   |   |
| $6.38 – $8.28                          |       |       | 262,472    |                         |       |                         | 6.7 years  |   |   |   | 8.08 |   |   | 225,116 |   |   | 8.08 |   |   |
| $8.50 – $9.59                          |       |       | 636,176    |                         |       |                         | 8.1 years  |   |   |   | 8.96 |   |   | 632,776 |   |   | 8.97 |   |   |
| $9.78 – $12.65                         |       |       | 980,409    |                         |       |                         | 8.7 years  |   |   |   | 11.05 |   |   | 697,409 |   |   | 10.73 |   |   |
| Outstanding at year end                     |       |       | 2,416,901  |                         |       |                         | 7.6 years  |   |   |   | 8.70 |   |   | 2,006,295 |   |   | 8.44 |   |   |
|                                             |            |            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Total intrinsic value of options exercised during theyears ended December 31, 2006, 2005, and 2004 was $169,000, $560,000, and$773,000 respectively.

Asummary of the status of the Company’s non-vested stock options and changesduring the year ended December 31, 2006 is as follows:

| ** **                         | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                         | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Grant Date** | ** ** |
| ** **                         | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
| Balance at  December 31, 2005 |       |               | 240,981    |                |       |   | $ | 2.10 |   |   |
| Granted                            |       |               | 286,000    |                |       |   | 5.76 |   |   |
| Vested                             |       |               | (108,685   | )                   |       |   | 2.08 |   |   |
| Forfeited                          |       |               | (7,690     | )                   |       |   | 3.65 |   |   |
| Balance at  December 31, 2006 |       |               | 410,606    |                |       |   | $ | 4.63 |   |   |

 

At December 31, 2006, there was $1.7 million oftotal unrecognized compensation cost related to non-vested share-basedcompensation arrangements granted under the plans. The cost is expected to berecognized over a weighted average period of 3.7 years. The total fair value ofshares that vested during the years ended December 31, 2006, 2005, and2004 was $387,000, $5.2 million, and $970,000, respectively.

98

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

At the Board of Directorsmeeting held on December 13, 2006, the Board approved the re-pricing of92,300 options with an exercise price of $3.25 per share to a new exerciseprice of $4.12 per share to equal the fair market value price per share of theCompany’s common stock on the original grant date in 2002. SFAS No. 123Rrequires the re-pricing of equity awards to be treated as a modification of theoriginal award and provides that such a modification is an exchange of theoriginal award for a new award. SFAS No. 123R considers the modificationto be the repurchase of the old award for a new award of equal or greatervalue, incurring additional compensation cost for any incremental value. Thisincremental difference in value is measured as the excess, if any, of the fairvalue of the modified award determined in accordance with the provisions ofSFAS No. 123R over the fair value of the original award immediately beforeits terms are modified, measured based on the share price and other pertinentfactors at that date. SFAS No. 123R provides that this incremental fairvalue, plus the remaining unrecognized compensation cost from the originalmeasurement of the fair value of the old option, must be recognized over theremaining vesting period. The modifications resulted in an incrementalcompensation cost of $58,000. Of the 92,300 options affected by the re-pricing,61,500 options were vested at December 13, 2006. Therefore, additionalcompensation cost of $39,000 for the 61,500 stock options that were vested wasrecognized immediately and is included in the stock-based compensation expensefor the year ended December 31, 2006.

**(19) SegmentReporting**

The Company operates in three business segments:Commercial Banking, Mortgage Banking, and Wealth Management and Trust Services.

The Commercial Banking segment includes bothcommercial and consumer lending and provides customers with such products ascommercial loans, real estate loans, business financing and consumer loans. Inaddition, this segment provides customers with various deposit productsincluding demand deposit accounts, savings accounts and certificates ofdeposit. The Mortgage Banking segment engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis. The Wealth Management and Trust Services segment providesinvestment and financial advisory services to businesses and individuals, includingfinancial planning, retirement/estate planning, trust, estates, custody,investment management, escrows, and retirement plans.

99

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

Informationabout the reportable segments and reconciliation of this information to theconsolidated financial statements as of and for the years ended December 31,2006, 2005 and 2004 follows:

**At and for the Year Ended December 31, 2006:**

| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------|------------|-------------------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Management**          | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial**          | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | **Intersegment** | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**             | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**        | ** ** | **Elimination** | ** ** | **Consolidated** | ** ** |
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Net interest  income        |       | $                       | 38,091     |         | $          | 4,344                   |       |             | $          | —          |       |             |       | $ | (1,081 | ) |   | $ | — |   |   | $ | 41,354 |   |   |
| Provision for  loan losses  |       | 1,232                   |       | —       |       |                    | —     |             |       |            | —     |             |       | — |   |   | 1,232 |   |   |
| Non-interest  income        |       | 4,415                   |       | 13,892       |       |                    | 3,330      |             |       |            | 47         |             |       | — |   |   | 21,684 |   |   |
| Non-interest  expense       |       | 27,127                  |       | 15,241       |       |                    | 6,591      |             |       |            | 2,286      |             |       | — |   |   | 51,245 |   |   |
| Provision for  income taxes |       | 4,571                   |       | 1,060        |       |                    | (1,307     | )                |       |            | (1,151     | )                |       | — |   |   | 3,173 |   |   |
| Net income (loss)           |       | $                       | 9,576      |         | $          | 1,935                   |       |             | $          | (1,954          | )          |             |       | $ | (2,169 | ) |   | $ | — |   |   | $ | 7,388 |   |   |
| Total Assets                |       | $                       | 1,572,051  |         | $          | 360,470                 |       |             | $          | 5,500           |       |             |       | $ | 163,879 |   |   | $ | (463,471 | ) |   | $ | 1,638,429 |   |   |

 

**At and for the Year Ended December 31, 2005:**

| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------|------------|-------------------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Management**          | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial**          | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | **Intersegment** | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**             | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**        | ** ** | **Elimination** | ** ** | **Consolidated** | ** ** |
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Net interest  income        |       | $                       | 32,171     |         | $          | 6,203                   |       |             | $          | —          |       |             |       | $ | (891 | ) |   | $ | — |   |   | $ | 37,483 |   |   |
| Provision for  loan losses  |       | 2,456                   |       | —       |       |                    | —     |             |       |            | —     |             |       | — |   |   | 2,456 |   |   |
| Non-interest  income        |       | 1,964                   |       | 21,255       |       |                    | 1,367      |             |       |            | 83         |             |       | — |   |   | 24,669 |   |   |
| Non-interest  expense       |       | 23,802                  |       | 17,332       |       |                    | 1,422      |             |       |            | 2,097      |             |       | — |   |   | 44,653 |   |   |
| Provision for  income taxes |       | 2,764                   |       | 3,413        |       |                    | (56        | )                |       |            | (954       | )                |       | — |   |   | 5,167 |   |   |
| Net income (loss)           |       | $                       | 5,113      |         | $          | 6,713                   |       |             | $          | 1               |       |             |       | $ | (1,951 | ) |   | $ | — |   |   | $ | 9,876 |   |   |
| Total Assets                |       | $                       | 1,387,504  |         | $          | 376,618                 |       |             | $          | 6,882           |       |             |       | $ | 160,856 |   |   | $ | (479,573 | ) |   | $ | 1,452,287 |   |   |

 

**At and for the Year Ended December 31, 2004:**

| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Wealth**              | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------|------------|-------------------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                  | ** ** | ** **              | ** ** | ** **   | ** ** | **Management**          | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Commercial**          | ** ** | **Mortgage** | ** ** | **and**                 | ** ** | **Intersegment** | ** ** | ** **      | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**             | ** ** | **Banking**  | ** ** | **Trust Services** | ** ** | **Other**        | ** ** | **Elimination** | ** ** | **Consolidated** | ** ** |
| ** **                  | ** ** | **(In thousands)** | ** ** |
| 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             |       |             |       | $ | 115,985 |   |   | $ | (421,203 | ) |   | $ | 1,211,576 |   |   |

 

100

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

During the year ended December 31, 2006, theCompany recorded a non-cash impairment loss totaling $2.9 million pretax, and$1.9 million after tax ($0.03 per share basic and diluted) through the WealthManagement and Trust Services segment.

The Company did not haveany operating segments other than those reported. Parent company financialinformation is included in the “Other” category and represents an overheadfunction rather than an operating segment. The parent company’s mostsignificant assets are its net investments in its subsidiaries. The parentcompany’s net interest expense is comprised of interest income from short-terminvestments and interest expense on trust preferred securities.

**(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 and 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, 2006 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 $81.6 million as of December 31,2006 are related to George Mason’s pipeline and are of a short term nature. Commitmentsto extend credit of $290.6 million primarily have floating rates as of December 31,2006.

Those instruments may involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized inthe consolidated statements of financial condition. Credit risk is defined asthe possibility of sustaining a loss because the other parties to a financialinstrument fail to perform in accordance with the terms of the contract. TheCompany’s maximum exposure to credit loss under standby letters of credit andcommitments to extend credit is represented by the contractual amounts of thoseinstruments.

Asummary of the contract amount of the Bank’s exposure to off-balance-sheet riskas of December 31, 2006 and 2005 is as follows:

| ** **                                                                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                     | ** ** | **(In thousands)** | ** ** |
| Financial instruments  whose contract amounts represent potential credit risk: |       |                    |       |     |       |
| Commitments to extend credit                                                   |       | $                       | 372,154    |     | $          | 325,571 |   |
| Standby letters  of credit                                                     |       | 8,097                   |       | 7,012    |       |
|                                                                                |            |                         |            |          |            |  |  |

 

101

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

The Company has not recorded a liability associatedwith standby letters of credit at December 31, 2006 and 2005 as suchamounts were immaterial.

George Mason maintains a reserve for loans sold thatpay off earlier than the contractual agreed upon period, thereby requiring thatGeorge Mason refund part of the service release premium and/or premium pricingreceived from the investor. The reserves as of December 31, 2006 and 2005were $57,000 and $116,000, respectively.

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.

The Company has derivative counter-party risk whichmay arise from the possible inability of George Mason’s third-party investorsto meet the terms of their forward sales contracts. George Mason works withthird-party investors that are generally well-capitalized, are investment gradeand exhibit strong financial performance to mitigate this risk. The Companydoes not expect any third-party investor to fail to meet its obligation.

The Company has guaranteedpayment of the $20.0 million debt of Statutory Trust I and has also guaranteedrepayment of any borrowing under George Mason’s $150 million line of credit.

**(21) Disclosures ofFair Value of 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 financial instruments, thereare inherent limitations in any estimation technique. Therefore, these fairvalue estimates are not necessarily indicative of the amounts the Company wouldrealize in a market transaction. Because of the wide range of valuationtechniques and the numerous estimates and assumptions which must be made, itmay be difficult to make reasonable comparisons between the Company’s fairvalue information and that of other banking institutions. It is important thatthe many uncertainties be considered when using the estimated fair valuedisclosures and that, because of these uncertainties, the aggregate fair valueamount should 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 following table.

*Cash and CashEquivalents*

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

102

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

*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 commitments 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, at interest rates currentlybeing offered for loans with similar terms to borrowers of similar creditquality.

*Deposits*

The fair values for demanddeposits are equal to the carrying amount since they are payable on demand atthe reporting date. The carrying amounts of variable rate, fixed-term moneymarket accounts and certificates of deposit (CDs) approximate their fair valueat the reporting date. Fair values for fixed-rate CDs are estimated usinga discounted cash flow calculation that applies interest rates currently beingoffered on CDs to a schedule of aggregated expected monthly maturities on timedeposits.

*Other BorrowedFunds*

The fair value of otherborrowed funds is estimated using a discounted cash flow calculation thatapplies interest rates currently available for loans with similar terms.

*DerivativeInstruments Related to Loans Held for Sale*

Derivative instrumentsrelated to loans held for sale are carried at fair value. Fair value isdetermined through quotes obtained from actively traded mortgage markets and,for rate lock commitments, is based upon the change in market interest ratesbetween making the rate lock commitment and the loan closing and, for forwardloan sale commitments, is based upon the change in market interest rates fromentering into the forward loan sales contract and the sale of the loan to theinvestor.

*Other Commitmentsto Extend 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 have expiration dates andgenerally expire within one year. Many commitments are expected to, andtypically do, expire without being drawn upon. The rates and terms of theseinstruments are competitive with others in the market in which the Companyoperates. The carrying amounts are reasonable estimates of the fair value ofthese financial instruments and are zero at December 31, 2006 and 2005.

103

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

*Accrued InterestReceivable*

The carrying amount of accrued interest receivableapproximates its fair value.

Thefair values of financial instruments as of December 31, 2006 and 2005 aresummarized as follows:

| ** **                                  | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **Carrying**                    | ** ** | **Estimated** | ** ** |
| ** **                                  | ** ** | **Amount**                      | ** ** | **Fair Value** | ** ** |
| ** **                                  | ** ** | **(In thousands)**         | ** ** |
| Financial assets:                           |       |                            |       |   |   |
| Cash and cash equivalents                   |       | $                               | 36,076     |   | $ | 36,076 |   |
| Investment securities and other investments |       | 338,454                         |       | 336,239 |   |
| Loans held for sale, net                    |       | 338,731                         |       | 338,739 |   |
| Loans receivable, net                       |       | 845,449                         |       | 832,567 |   |
| Accrued interest receivable                 |       | 5,667                           |       | 5,667 |   |
| Derivative asset                            |       | 2,807                           |       | 2,807 |   |
| Financial liabilities:                      |       |                            |       |   |   |
| Demand deposits                             |       | $                               | 123,301    |   | $ | 123,301 |   |
| Interest checking                           |       | 137,092                         |       | 137,092 |   |
| Money market and statement savings          |       | 395,652                         |       | 395,652 |   |
| Certificates of deposit                     |       | 562,837                         |       | 561,264 |   |
| Other borrowed funds                        |       | 194,631                         |       | 193,846 |   |
| Mortgage funding checks                     |       | 46,159                          |       | 46,159 |   |
| Accrued interest payable                    |       | 878                             |       | 878 |   |
| Derivative liability                        |       | 1,592                           |       | 1,592 |   |
| Other:                                      |       |                            |       |   |   |
| Commitments to  extend credit               |       | $                               | —     |   | $ | — |   |

 

104

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements (Continued)

 

| ** **                                  | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **Carrying**                    | ** ** | **Estimated** | ** ** |
| ** **                                  | ** ** | **Amount**                      | ** ** | **Fair Value** | ** ** |
| ** **                                  | ** ** | **(In thousands)**         | ** ** |
| Financial assets:                           |       |                            |       |   |   |
| Cash and cash equivalents                   |       | $                               | 36,589     |   | $ | 36,589 |   |
| Investment securities and other investments |       | 301,316                         |       | 298,072 |   |
| Loans held for sale, net                    |       | 361,668                         |       | 362,750 |   |
| Loans receivable, net                       |       | 705,644                         |       | 698,149 |   |
| Accrued interest receivable                 |       | 4,185                           |       | 4,185 |   |
| Derivative asset                            |       | 1,395                           |       | 1,395 |   |
| Financial liabilities:                      |       |                            |       |   |   |
| Demand deposits                             |       | $                               | 114,915    |   | $ | 114,915 |   |
| Interest checking                           |       | 84,481                          |       | 84,481 |   |
| Money market and statement savings          |       | 231,883                         |       | 231,883 |   |
| Certificates of deposit                     |       | 638,594                         |       | 633,834 |   |
| Other borrowed funds                        |       | 155,421                         |       | 152,915 |   |
| Mortgage funding checks                     |       | 41,635                          |       | 41,635 |   |
| Accrued interest payable                    |       | 803                             |       | 803 |   |
| Derivative liability                        |       | 1,789                           |       | 1,789 |   |
| Other:                                      |       |                            |       |   |   |
| Commitments to  extend credit               |       | $                               | —     |   | $ | — |   |

 

 

105

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

**(22) Parent CompanyOnly Financial Statements**

The Cardinal FinancialCorporation (Parent Company only) condensed financial statements are asfollows:

**PARENT COMPANY ONLYCONDENSED STATEMENTS OF CONDITIONDecember 31, 2006 and 2005(In thousands)**

| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                       |       |     |       |     |       |
| Cash and cash  equivalents                       |       | $        | 13,609     |     | $          | 20,864 |   |
| Other investments                                |       | 113      |       | 63       |       |
| Investment in  subsidiaries                      |       | 148,463  |       | 137,973  |       |
| Premises and  equipment, net                     |       | 1,069    |       | 1,185    |       |
| Goodwill                                         |       | 134      |       | 134      |       |
| Other assets                                     |       | 491      |       | 637      |       |
| Total assets                                     |       | $        | 163,879    |     | $          | 160,856 |   |
| **Liabilities and Shareholders’ Equity**    |       |     |       |     |       |
| Debt to Cardinal  Statutory Trust I              |       | $        | 20,619     |     | $          | 20,619 |   |
| Other liabilities                                |       | (12,613  | )          | (7,642   | )          |
| Total liabilities                                |       | 8,006    |       | 12,977   |       |
| Total  shareholders’ equity                 |       | $        | 155,873    |     | $          | 147,879 |   |
| Total liabilities  and shareholders’ equity |       | $        | 163,879    |     | $          | 160,856 |   |

 

106

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

**PARENTCOMPANY ONLY CONDENSED STATEMENTS OF OPERATIONSYears Ended December 31, 2006, 2005, and 2004(In thousands)**

| ** **                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income:                                                                            |       |     |       |     |       |     |       |
| Net interest  expense                                                              |       | $(1,081  | )          | $(891    | )          | $(257    | )          |
| Other income                                                                       |       | 47       |       | 83       |       | 7        |       |
| Total income                                                                       |       | (1,034   | )          | (808     | )          | (250     | )          |
| Expense - general  and administrative                                              |       | 2,286    |       | 2,097    |       | 1,400    |       |
| Net loss before income taxes and equity in  undistributed earnings of subsidiaries |       | (3,320   | )          | (2,905   | )          | (1,650   | )          |
| Income tax  benefit                                                                |       | (1,151   | )          | (954     | )          | (561     | )          |
| Equity in  undistributed earnings of subsidiaries                                  |       | 9,557    |       | 11,827   |       | 4,558    |       |
| Net income                                                                         |       | $7,388   |       | $9,876   |       | $3,469   |       |

 

107

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

**PARENT COMPANY ONLYCONDENSED STATEMENTS OF CASH FLOWSYears ended December 31, 2006, 2005, and 2004(In thousands)**

| ** **                                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                         |       |     |       |     |       |     |       |
| Net income                                                                     |       | $        | 7,388      |     | $          | 9,876    |       | $ | 3,469 |   |
| Adjustments to reconcile net income to net cash used  in operating activities: |       |     |       |     |       |     |       |
| Equity in undistributed earnings of subsidiaries                               |       | (9,557   | )          | (11,827  | )          | (4,558   | )          |
| Depreciation                                                                   |       | 116      |       | 123      |       | 240      |       |
| Increase in other assets and liabilities                                       |       | (5,082   | )          | (4,806   | )          | (914     | )          |
| Net cash used in operating activities                                          |       | (7,135   | )          | (6,634   | )          | (1,763   | )          |
| Cash flows from  investing activities:                                         |       |     |       |     |       |     |       |
| Capital investments in subsidiaries                                            |       | —   |       | (22,000  | )          | (60,000  | )          |
| Purchase of other investments                                                  |       | (50      | )          | —   |       | —   |       |
| Net change in premises and equipment                                           |       | —   |       | —   |       | 4        |       |
| Net cash paid in acquisition                                                   |       | —   |       | (1,379   | )          | —   |       |
| Net cash used in investing activities                                          |       | (50      | )          | (23,379  | )          | (59,996  | )          |
| Cash flows from  financing activities:                                         |       |     |       |     |       |     |       |
| Proceeds from public stock offerings                                           |       | —   |       | 39,767   |       | 6,302    |       |
| Proceeds from issuance of debt to Cardinal Statutory  Trust I                  |       | —   |       | —   |       | 20,000   |       |
| Distribution of deferred compensation balance                                  |       | (3       | )          | —   |       | —   |       |
| Dividends on common stock                                                      |       | (976     | )          | (244     | )          | —   |       |
| Stock options exercised                                                        |       | 909      |       | 797      |       | 498      |       |
| Net cash (used in) provided by financing activities                            |       | (70      | )          | 40,320   |       | 26,800   |       |
| Net increase  (decrease) in cash and cash equivalents                          |       | (7,255   | )          | 10,307   |       | (34,959  | )          |
| Cash and cash  equivalents at beginning of year                                |       | 20,864   |       | 10,557   |       | 45,516   |       |
| Cash and cash  equivalents at end of year                                      |       | $        | 13,609     |     | $          | 20,864   |       | $ | 10,557 |   |
| Supplemental  schedule of noncash investing and financing activities:          |       |     |       |     |       |     |       |
| Common shares  issued in acqusition of Wilson/Bennett                          |       | $        | —     |     | $          | 4,862    |       | $ | — |   |

 

108

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

**(23) Goodwill andOther Intangible Assets**

On June 29, 2006, the Company entered into anAmendment to the Employment Agreement (the “Amendment”) with John W. Fisher,president and chief executive officer of Wilson/Bennett. The Amendment amendedthe Employment Agreement dated as of June 8, 2005 between the Company and Mr. Fisher.As provided in the Amendment, Mr. Fisher retired from the business on September 30,2006, and has agreed to assist the Company in a consulting and business developmentfunction, as requested by the Company through April 30, 2007, and to honorhis non-compete agreement with the Company, which will end on September 30,2007.

During the third quarter and as Mr. Fishertransitioned out of his involvement with Wilson/Bennett, Mr. Fisher’sannounced retirement had a negative impact on the operations, customer base andassets under management with Wilson/Bennett. In particular, several significantclients unexpectedly either terminated or advised the Company that theyintended to terminate their asset management contracts with Wilson/Bennettduring the third quarter of 2006. In addition and as a result of this customerloss, the value of purchased customer relationships and Mr. Fisher’semployment and noncompete agreement decreased. Accordingly, the Company updatedthe analysis of the fair value of the goodwill and intangible assets associatedwith the acquisition of Wilson/Bennett. The analysis was prepared usingvaluation techniques, including the discounted cash flow approach. The updatedanalysis indicated that goodwill and intangibles related to Wilson/Bennett, adivision of Wealth Management and Trust Services segment, were impaired. As aresult, the Company recorded non-cash impairment charges of $2.0 million associatedwith Mr. Fisher’s employment agreement and the customer relationshipintangible assets recognized as part of the Wilson/Bennett acquisition. TheCompany also recorded an additional $960,000 of impairment charges associatedwith the goodwill of Wilson/Bennett.

Informationconcerning amortizable intangibles at December 31, 2006 is as follows:

| ** **                          | ** ** | **Mortgage Banking**   | ** ** | **Wealth Management   and Trust Services** | ** ** | **Total**                   | ** ** |
|-------------------------------------|------------|-----------------------------|------------|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**                                  | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                          | ** ** | **(In thousands)**     | ** ** |
| Balances at  December 31, 2004 |       |                        | $          | 1,781                                                          |       |                        |       | $ | 49 |   |   | $ | — |   |   | $ | — |   |   | $ | 1,781 |   |   | $ | 49 |   |   |
| 2005 activity:                      |       |                        |       |                                                           |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Customer relationship intangibles   |       |                        | —     |                                                           |       |                        | 198        |   |   | 1,858 |   |   | 104 |   |   | 1,858 |   |   | 302 |   |   |
| Employment/non-compete   agreement  |       |                        | —     |                                                           |       |                        | —     |   |   | 698 |   |   | 98 |   |   | 698 |   |   | 98 |   |   |
| Trade name                          |       |                        | —     |                                                           |       |                        | —     |   |   | 46 |   |   | 9 |   |   | 46 |   |   | 9 |   |   |
| Balances at  December 31, 2005 |       |                        | 1,781      |                                                           |       |                        | 247        |   |   | 2,602 |   |   | 211 |   |   | 4,383 |   |   | 458 |   |   |
| 2006 activity:                      |       |                        |       |                                                           |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Customer relationship intangibles   |       |                        | —     |                                                           |       |                        | 198        |   |   | (1,294 | ) |   | 120 |   |   | (1,294 | ) |   | 318 |   |   |
| Employment/non-compete   agreement  |       |                        | —     |                                                           |       |                        | —     |   |   | (513 | ) |   | 87 |   |   | (513 | ) |   | 87 |   |   |
| Trade name                          |       |                        | —     |                                                           |       |                        | —     |   |   | — |   |   | 15 |   |   | — |   |   | 15 |   |   |
| Balances at  December 31, 2006 |       |                        | $          | 1,781                                                          |       |                        |       | $ | 445 |   |   | $ | 795 |   |   | $ | 433 |   |   | $ | 2,576 |   |   | $ | 878 |   |   |

 

The decrease in the gross carrying amounts of thecustomer relationship intangibles in 2006 of $1.3 million includes theimpairment charge of $1.5 million related to Wilson/Bennett and acquiredcustomer 

109

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

relationships related toTrust Services acquisition of $161,000. The decrease in the gross carryingamount of the employment/non-compete agreement in 2006 of $513,000 is theimpairment charge related to Wilson/Bennett.

Theaggregate amortization expense for 2006, 2005 and 2004 was $420,000, $409,000and $49,000, respectively. The estimated amortization expense which has beenupdated as a result of the impairment charges recorded in the Wealth Managementand Trust Services segment, for the next five years is as follows:

| ** ** | ** ** | **(In thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2007       |       |                    | $          | 254 |   |   |
| 2008       |       |                    | 245        |   |   |
| 2009       |       |                    | 238        |   |   |
| 2010       |       |                    | 238        |   |   |
| 2011       |       |                    | 238        |   |   |

 

Thechanges in the carrying amount of goodwill for the years ended December 31,2006 and 2005 were as follows:

| ** **                                          | ** ** | **Commercial  Banking** | ** ** | **Mortgage   Banking** | ** ** | **Wealth  Management and  Trust Services** | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|------------------------------------------------------|------------|-----------|------------|
| ** **                                          | ** ** | **(In thousands)** | ** ** |
| Balance at  December 31, 2004                  |       |                    | $          | 22                          |       |                                                 |       | $         | 12,941     |   |   |   | $ | — |   |   | $ | 12,963 |   |
| 2005 activity:                                      |       |                    |       |                        |       |                                                 |       |      |       |   |   |   |   |   |   |
| Goodwill attributable to Wilson/Bennett acquisition |       |                    | —     |                        |       |                                                 | —     |      |       |   | 3,614 |   |   | 3,614 |   |
| Balance at  December 31, 2005                  |       |                    | 22         |                        |       |                                                 | 12,941     |      |       |   | 3,614 |   |   | 16,577 |   |
| 2006 activity:                                      |       |                    |       |                        |       |                                                 |       |      |       |   |   |   |   |   |   |
| Trust division  acquisition                         |       |                    |       |                        |       |                                                 |       |      |       |   | 178 |   |   | 178 |   |
| Goodwill impairment charge                          |       |                    | —     |                        |       |                                                 | —     |      |       |   | (960 | ) |   | (960 | ) |
| Balance at  December 31, 2006                  |       |                    | $          | 22                          |       |                                                 |       | $         | 12,941     |   |   |   | $ | 2,832 |   |   | $ | 15,795 |   |

 

TheCompany evaluates impairment of goodwill annually. The evaluation of goodwillfor the Commercial and Mortgage Banking segments did not result in impairmentlosses in 2006 and 2005.

**(24) OtherOperating Expenses**

The following shows thecomposition of other operating expenses for the years ended December 31,2006, 2005, and 2004:

110

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

**Non-InterestExpenseYears Ended December 31, 2004, 2003 and 2002(In thousands)**

| ** **                  | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Stationary and  supplies    |       | 1,374                   |       | 1,551    |       | 965      |       |
| Advertising and  marketing  |       | 2,026                   |       | 1,993    |       | 1,613    |       |
| Other taxes                 |       | 1,572                   |       | 1,422    |       | 548      |       |
| Travel and  entertainment   |       | 776                     |       | 763      |       | 427      |       |
| Bank operations             |       | 719                     |       | 860      |       | 676      |       |
| Premises and  equipment     |       | 1,675                   |       | 1,400    |       | 800      |       |
| Miscellaneous               |       | 1,972                   |       | 1,700    |       | 797      |       |
| Total  non-interest expense |       | $                       | 10,114     |     | $          | 9,689    |       | $ | 5,826 |   |
|                             |            |                         |            |          |            |          |            |  |  |  |

 

**(25) SAB 108Cumulative Effect Adjustment**

In September 2006, the Securities and ExchangeCommission (SEC) issued Staff Accounting Bulletin No. 108 (“SAB 108”), *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*. SAB 108 wasissued in order to eliminate the diversity in practice surrounding how publiccompanies quantify financial statement misstatements.

Traditionally, there have been two widely-recognizedmethods for quantifying the effects of financial statement misstatements: the “roll-over”method and the “iron curtain” method. The roll-over method focuses primarily onthe impact of a misstatement on the income statement—including the reversingeffect of prior year misstatements—but its use can lead to the accumulation ofmisstatements in the balance sheet. The iron-curtain method, on the other hand,focuses primarily on the effect of correcting the period-end balance sheet withless emphasis on the reversing effects of prior year errors on the incomestatement. Prior to our application of the guidance in SAB 108, the Companyused the roll-over method for quantifying financial statement misstatements.

In SAB 108, the SEC staff established an approach thatrequires quantification of financial statement misstatements based on theeffects of the misstatements on each of the company’s financial statements andthe related financial statement disclosures. This model is commonly referred toas a “dual approach” because it requires quantification of errors under boththe iron curtain and the roll-over methods.

SAB 108 permits existing public companies to initiallyapply its provisions either by (i) restating prior financial statements asif the “dual approach” had always been applied or (ii) recording thecumulative effect of initially applying the “dual approach” as adjustments tothe carrying values of assets and liabilities as of January 1, 2006 withan offsetting adjustment recorded to the opening balance of retained earnings.

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

TheCompany identified the following errors through the application of its internalcontrols over financial reporting and had concluded that the individual errorswere immaterial under the roll-over method for the periods indicated. However,when applying the dual approach, and after considering all relevantquantitative and qualitative factors, the Company concluded that thesemisstatements are material to the 2006 financial statements when consideringthe aggregate impact. For this reason, the Company corrected the errors throughthe recording of cumulative effect adjustments to retained earnings as of January 1,2006:

| ** **                        | ** ** | **Period in which misstatement  originated (1)** | ** ** | **Adjustment  Recorded as of  January 1,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                        | ** ** | **2002**                                                             | ** ** | **2003**                                                  | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                        | ** ** | **(In thousands)**                                              | ** ** |
| Accounts  receivable (2)          |       | $                                                                    | —     |                                                      | $          | — |   | $ | — |   | $ | (72 | ) |   | $ | (72 | ) |   |
| Compensation  expense (3)         |       | (41                                                                  | )          | (38                                                       | )          | (38 | ) | (38 | ) |   | (155 | ) |   |
| Deferred loan  fees and costs (4) |       | —                                                               |       | —                                                    |       | (31 | ) | (135 | ) |   | (166 | ) |   |
| Deferred tax  asset (5)           |       | 14                                                                   |       | 13                                                        |       | 24 |   | 86 |   |   | 137 |   |   |
| Federal income  taxes payable (6) |       | —                                                               |       | (69                                                       | )          | (113 | ) | — |   |   | (182 | ) |   |
| Impact on net  income (7)         |       | $                                                                    | (27        | )                                                         | $          | (94 | ) | $ | (158 | ) | $ | (159 | ) |   | $ | (438 | ) |   |
| Non-net income  impact:           |       |                                                                 |       |                                                      |       |   |   |   |   |   |   |   |   |
| Additional  paid-in capital (8)   |       | $                                                                    | 5          |                                                      | $          | 7 |   | $ | 6 |   | $ | 7 |   |   | $ | 25 |   |   |
| Net effect of adjustments  (9)    |       |                                                                 |       |                                                      |       |   |   |   |   |   | $ | (413 | ) |   |

----

 

(1)   The Companyquantified these errors under the roll-over method and concluded that they wereimmaterial individually and in the aggregate.

(2)   Accountsreceivable related to the Company’s Wilson/Bennett subsidiary was overstated by$72,000 during 2005, resulting in an overstatement of investment fee income bythe same amount. The Company recorded a $72,000 reduction to accountsreceivable as of January 1, 2006 with a corresponding reduction inretained earnings to correct these misstatements.

(3)   The Companydid not recognize stock compensation expense related to stock options grantedwith an exercise price that was less than the fair market value of the Company’sstock on the grant date in 2002. As a result of this error, compensationexpense was understated by $155,000 (cumulative) in the years prior to 2006.The Company recorded a $155,000 increase in accrued compensation as of January 1,2006 with a corresponding reduction in retained earnings to correct thesemisstatements.

(4)   The Companyincorrectly recognized mortgage origination fees associated with loans held forinvestment into income rather than amortizing the fees over the lives of theloans, in accordance with SFAS No. 91 *Accounting forNonrefundable Fees and Costs Associated with Originating or Acquiring Loans andInitial Direct Costs of Leases.* As a result, the Company overstated gainon sales of loans by $166,000 (cumulative) in 2005 and 2004. The Companyrecorded an increase to deferred loan fees in the amount of $166,000 as of January 1,2006 with a corresponding reduction in retained earnings to correct thesemisstatements.

(5)   As a resultof the misstatements described above, the provision for income taxes wasoverstated by $137,000 (cumulative) in the years prior to 2006. The Companyrecorded an increase in our deferred tax 

112

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**Notes to Consolidated Financial Statements  (Continued)

assets in the amount of$137,000 as of January 1, 2006 with a corresponding increase in retainedearnings to correct these misstatements.

(6)   The Companyincorrectly recorded alternative minimum tax credits that were not properlyestablished. As a result, the Company understated the tax provision by $69,000in 2003 and $113,000 in 2004. The Company recorded an increase in federalincome tax payable of $182,000 as of January 1, 2006, with a correspondingreduction in retained earnings to correct these misstatements.

(7)   Representsthe net over-statement of net income for the indicated periods resulting fromthese misstatements.

(8)   Representsthe reclassification from accrued compensation cost to additional paid-incapital for the options that were exercised with a fair market value greaterthan the assigned exercise price. Refer to (3) above for a summary relatedto the accrued stock compensation errors that were corrected.

(9)   Representsthe net reduction in shareholders’ equity recorded as of January 1, 2006 forthe initial application of SAB 108.

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**Item9.**                        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.

**Item9A.**                Controls andProcedures

**Disclosure Controls and Procedures**

The Company maintainsdisclosure controls and procedures that are designed to provide assurance thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods required by theSecurities and Exchange Commission. An evaluation of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures as ofthe end of the period covered by this report was carried out under thesupervision and with the participation of management, including the Company’sChief Executive Officer and Chief Financial Officer. Based on the evaluation,the aforementioned officers concluded that the Company’s disclosure controlsand procedures were effective as of the end of such period.

**Management’s Report on Internal Control over FinancialReporting**

Management of the Companyis responsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rule 13a-15(f) under theSecurities Exchange Act of 1934. The Company’s internal control over financialreporting is designed to provide reasonable assurance regarding the reliabilityof the Company’s financial reporting and the preparation of published financialstatements in accordance with generally accepted accounting principles.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Therefore, even those systems determined to be effectivecan provide only reasonable assurance with respect to financial statementpreparation and presentation. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Management assessed theeffectiveness of the Company’s internal control over financial reporting as of December 31,2006. In making this assessment, management used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) in *Internal Control-Integrated Framework*.  Based on management’s assessment, managementbelieves that as of December 31, 2006, the Company’s internal control overfinancial reporting was effective based on criteria set forth by COSO in *Internal Control-Integrated Framework*.

Management’s assessment ofthe effectiveness of internal control over financial reporting as of December 31,2006, has been audited by KPMG LLP, the independent registered publicaccounting firm that also audited the Company’s consolidated financialstatements. KPMG LLP’s attestation report on management’s assessment of theCompany’s internal control over financial reporting appears on page 66hereof.

**Changes in Internal Control Over Financial Reporting**

There was no change in theCompany’s internal control over financial reporting identified in connectionwith the evaluation of internal controls that occurred during the fourthquarter of 2006 that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**Item9B.**               Other Information

None.

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**PART III**

**Item10.**                 Directors,Executive Officers and Corporate Governance

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained in the“Election of Directors” section and under the headings “Executive Officers,” “Independenceof the Directors,”  “The Committees ofthe Board of Directors,” “Code of Ethics” and “Section 16(a) BeneficialOwnership Reporting Compliance” in the Company’s Proxy Statement for the 2007Annual Meeting of Shareholders is incorporated herein by reference.

**Item11.**                 ExecutiveCompensation

Pursuant to GeneralInstruction G(3) of Form 10-K, the information contained in the“Executive Compensation” section (except for the “Compensation Committee Reporton Executive Compensation”)  and  under the heading “Director Compensation” inthe Company’s Proxy Statement for the 2007 Annual Meeting of Shareholders isincorporated herein by reference.

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

*Security Ownership ofCertain Beneficial Owners and Management.**  *Pursuant to General Instruction G(3) ofForm 10-K, the information contained under the headings “SecurityOwnership of Directors and Executive Officers” and “Security Ownership ofCertain Beneficial Owners” in the Company’s Proxy Statement for the 2007 AnnualMeeting of Shareholders is incorporated herein by reference.

*EquityCompensation Plan Information.**  *The following table sets forthinformation as of December 31, 2006, with respect to compensation plansunder which shares of our Common Stock are authorized 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                                             |       |       | 339,767    |                                                                                                                                                 |       |                                                                                                             | $          | 4.65                                                                                                                                             |       |   |   | 17,044 |   |   |
| 2002 Equity  Compensation Plan                              |       |       | 2,077,134  |                                                                                                                                                 |       |                                                                                                             | $          | 9.36                                                                                                                                             |       |   |   | 248,383 |   |   |
| Equity  Compensation Plans Not Approved by Shareholders (2) |       |       | —     |                                                                                                                                                 |       |                                                                                                             | —     |                                                                                                                                             |       |   | — |   |   |
| **Total**                                                   |       |       | 2,416,901  |                                                                                                                                                 |       |                                                                                                             | $          | 8.70                                                                                                                                             |       |   |   | 265,427 |   |   |

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(1)          Amountsexclude any securities to be issued upon exercise of outstanding options,warrants and rights.

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

**Item13.**                 CertainRelationships and Related Transactions, and Director Independence

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 2007 Annual Meeting of Shareholders is incorporatedherein by reference.

**Item14.**                 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 the2007 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 above. |
|--------|--------|---------------------------------------------------------------------------------------------|
|   |   | (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 as of June 14,  2006) (incorporated by reference to Exhibit 3.1 to the Current Report on  Form 8-K filed October 5, 2006). |
|   |   |                                                                                        |   | 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 Christopher W. Bergstrom (incorporated by reference to  Exhibit 10.5 to the Form SB-2).* |
|   |   |                                                                                        |   | 10.3 |   | Cardinal Financial  Corporation 1999 Stock Option Plan, as amended (incorporated by reference to  Exhibit 10.7 to the Form SB-2).* |
|   |   |                                                                                        |   | 10.4 |   | Cardinal Financial  Corporation 2002 Equity Compensation Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.4 to the  Registration Statement on Form S-8, Registration No. 333-134923).* |
|   |   |                                                                                        |   | 10.5 |   | Cardinal Financial  Corporation Executive Deferred Income Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.4 to the  Registration Statement on Form S-8, Registration No. 333-134934).* |
|   |   |                                                                                        |   | 10.6 |   | Cardinal Financial  Corporation Directors Deferred Income Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.5 to the  Registration Statement on Form S-8, Registration No. 333-134934).* |
|   |   |                                                                                        |   | 10.7 |   | George Mason Mortgage,  LLC Executive Deferred Income Plan, as amended and restated April 21,  2006 (incorporated by reference to Exhibit 4.6 to the Registration  Statement on Form S-8, Registration No. 333-134934).* |
|   |   |                                                                                        |   | 10.8 |   | Executive Employment  Agreement, dated March 1, 2004, between Cardinal Financial Corporation  and Kim C. Liddell (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q for the period ended March 31,  2006).* |
|   |   |                                                                                        |   | 21 |   | Subsidiaries of Cardinal  Financial Corporation. |
|   |   |                                                                                        |   | 23 |   | Consent of KPMG LLP. |

116

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|   |   |   |   | 31.1 |   | Rule 13a-14(a) Certification  of Chief Executive Officer.      |
|--------|--------|--------|--------|------|--------|--------------------------------------------------------------------------|
|   |   |   |   | 31.2 |   | Rule 13a-14(a) Certification  of Chief Financial Officer.      |
|   |   |   |   | 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. |

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*                    Managementcontracts and compensatory plans and arrangements.

(b)          Exhibits

See Item 15(a)(3) above.

(c)           FinancialStatement Schedules

See Item 15(a)(2) above.

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**SIGNATURES**

Pursuant to therequirements of Section 13 and 15 (d) of the Securities Exchange Actof 1934, as amended, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized.
|                     | ** ** | CARDINAL FINANCIAL CORPORATION |
|---------------------|------------|--------------------------------|
| ** **          | ** ** | ** **                     | ** ** | ** ** | ** ** | * * |
| ** **          | ** ** | ** **                     | ** ** | ** ** | ** ** | * * |
| March 15, 2007 |       | By:                            |   | /s/ BERNARD H.  CLINEBURG |
| ** **          |       |                           | * * | Name: |   | Bernard H. Clineburg |
| ** **          |       |                           |   | Title: |   | Chairman and Chief Executive Officer |

 

Pursuant to therequirements 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 12, 2007.

|                            | **Signatures** | ** **                                             | ** ** | ** ** | **Titles** | ** ** |
|----------------------------|----------------|--------------------------------------------------------|------------|------------|------------|------------|
| /s/ BERNARD H. CLINEBURG   | * *       | Chairman and Chief  Executive Officer                  |
| Name: Bernard H. Clineburg | ** **     | (Principal Executive Officer)                          |
| /s/ MARK A. WENDEL         |           | Executive Vice President  and                          |
| Name: Mark A. Wendel       | ** **     | Chief Financial Officer (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/ WILLIAM G. BUCK        |           | Director                                               |
| Name: William G. Buck      | ** **     | ** **                                             |
| /s/ SIDNEY O. DEWBERRY     |           | Director                                               |
| Name: Sidney O. Dewberry   | ** **     | ** **                                             |
| /s/ MICHAEL A. GARCIA      |           | Director                                               |
| Name: Michael A. Garcia    | ** **     | ** **                                             |
| /s/ J. HAMILTON LAMBERT    |           | Director                                               |
| Name: J. Hamilton Lambert  | ** **     | ** **                                             |
| /s/ ALAN G. MERTEN         |           | Director                                               |
| Name: Alan G. Merten       | ** **     | ** **                                             |
| /s/ WILLIAM E. PETERSON    |           | Director                                               |
| Name: William E. Peterson  | ** **     | ** **                                             |

118

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| /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      | ** ** | ** ** |
| /s/ ALICE M.  STARR          | * *   | Director   |
| Name: Alice M. Starr         | ** ** | ** ** |

 

119

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**EXHIBITINDEX**
| **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 as of  June 14, 2006) (incorporated by reference to Exhibit 3.1 to the  Current Report on Form 8-K filed October 5, 2006).                                       |
|       | 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 Christopher W. Bergstrom (incorporated by reference to  Exhibit 10.5 to the Form SB-2).*                                           |
|       | 10.3       |            |       | Cardinal  Financial Corporation 1999 Stock Option Plan, as amended (incorporated by  reference to Exhibit 10.7 to the Form SB-2).*                                                                                                                  |
|       | 10.4       |            |       | Cardinal  Financial Corporation 2002 Equity Compensation Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.4 to the  Registration Statement on Form S-8, Registration No. 333-134923).*               |
|       | 10.5       |            |       | Cardinal  Financial Corporation Executive Deferred Income Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.4 to the  Registration Statement on Form S-8, Registration No. 333-134934).*              |
|       | 10.6       |            |       | Cardinal  Financial Corporation Directors Deferred Income Plan, as amended and restated  April 21, 2006 (incorporated by reference to Exhibit 4.5 to the  Registration Statement on Form S-8, Registration No. 333-134934).*              |
|       | 10.7       |            |       | George Mason Mortgage,  LLC Executive Deferred Income Plan, as amended and restated April 21,  2006 (incorporated by reference to Exhibit 4.6 to the Registration  Statement on Form S-8, Registration No. 333-134934).*                  |
|       | 10.8       |            |       | Executive  Employment Agreement, dated March 1, 2004, between Cardinal Financial  Corporation and Kim C. Liddell (incorporated by reference to  Exhibit 10.1 to the Quarterly Report on Form 10-Q for the  period ended March 31, 2006).* |
|       | 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.                                                                                                                                                                                           |
|       | 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.                                                                                                                                                                                      |

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*                    Management contractsand compensatory plans and arrangements.

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