**UNITED        STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM        10-K**

 

**xAnnual Report pursuant to Section 13 or        15(d) of the Securities Exchange Act of 1934**

For the        fiscal year ended December 31, 2007

 

**[   ] Transition Report pursuant to Section 13 or 15(d) of the        Securities Exchange Act of 1934**

For the        transition period from ____________ to _____________

 

Commission file number: 000-33411

 

**NEW        PEOPLES BANKSHARES, INC.**

(Exact        name of registrant as specified in its charter)

 

|                                                                                                                               |                                          |                                                                                           |  |
|-------------------------------------------------------------------------------------------------------------------------------|------------------------------------------|-------------------------------------------------------------------------------------------|--|
| **Virginia**

(State                    or other jurisdiction

of                    incorporation)                           |                                          | **31-1804543**

(IRS                    Employer

                    Identification No.) |
|                                                                                                                          |                                     |                                                                                      |
| **67                    Commerce Drive**

**Honaker, Virginia**

                    (Address of principal executive offices) | **24260**

(Zip                    Code) |

 

Registrant's telephone number,including area        code      **(276)        873-7000**

 

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

 

Securities registered pursuant to Section 12(g) of the        Act**      Common Stock - $2 Par        Value**

 

 

Indicate        by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of        the Securities Act.

|   | Yes [   ]                     No | x |
|--------|-----------------------------------------------------------|---|

 

Indicate by        check mark if the registrant is not required to file reports pursuant to Section 13 of        Section 15(d) of the Act.

|        |
|--------|
|   | Yes [   ]                     No | x |

 

|   |   |
|--------|--------|

 

Indicate        by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation        S-K(Section 229.405 of this chapter) is not contained herein, and will not be contained, to        the best of registrant's knowledge, in definitive proxy or information statements        incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.        [ ]

 

Indicate        by check mark whether the registrant is a large accelerated filer, an accelerated filer, a        non-accelerated filer, or a smaller reporting company. See definition of  "accelerated        filer," "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the        Exchange Act. (Check one):

 

|   | Large accelerated

 filer [  ] |   | Accelerated filer [ X ] | Non-accelerated filer [   ] |  | Smaller reporting

 company [   ] |  |
|--------|------------------------------------------|--------|-------------------------|---------------------------------------|--|--------------------------------------------------|--|

 

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

 

The        aggregate market value of the common stock held by non-affiliates, based on the last        reported sales prices of $15.00 per share on the last business day of the second quarter of        2007 was $103,218,630.00.

 

The        number of shares outstanding of the registrant's common stock, was 9,962,552 as of March        14, 2008.

**DOCUMENTS INCORPORATED BY RFERENCE:**

Portions        of the Corporation's Proxy Statement for the Annual Meeting of Shareholders to be held on        May 22, 2008 are incorporated by reference into Part III hereof.

 

 

 

 

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**TABLE OF CONTENTS**

         

|   | Page |
|--------|------|

**PART I**

|   | Item 1. | Business | 3 |
|--------|---------|----------|---|

         

|   | Item 1A. | Risk Factors | 12 |
|--------|----------|--------------|----|

         

|   | Item 1B. | Unresolved Staff Comments | 16 |
|--------|----------|---------------------------|----|

         

|   | Item 2. | Properties | 16 |
|--------|---------|------------|----|

         

|   | Item 3. | Legal Proceedings | 16 |
|--------|---------|-------------------|----|

         

|   | Item 4. | Submission of Matters to a Vote of Security                        Holders | 16 |
|--------|---------|----------------------------------------------------------------------------|----|

         

**PART II**

|   | Item 5. | Market for Registrant's Common Equity, Related                        Stockholder |
|--------|---------|-----------------------------------------------------------------------------------|

|   | Matters and Issuer Purchases of Equity Securities | 17 |
|--------|---------------------------------------------------|----|

         

|   | Item 6. | Selected Financial Data | 19 |
|--------|---------|-------------------------|----|

         

|   | Item 7. | Management's Discussion and Analysis of Financial                        Condition |
|--------|---------|------------------------------------------------------------------------------------|

|   | and Results of Operations | 20 |
|--------|---------------------------|----|

         

|   | Item 7A. | Quantitative and Qualitative Disclosures About Market                        Risk | 32 |
|--------|----------|-----------------------------------------------------------------------------------|----|

         

|   | Item 8. | Financial Statements and Supplementary Data | 34 |
|--------|---------|---------------------------------------------|----|

         

|   | Item 9. | Changes in and Disagreements with Accountants on |
|--------|---------|--------------------------------------------------|

|   | Accounting and Financial Disclosure | 58 |
|--------|-------------------------------------|----|

         

|   | Item 9A. | Controls and Procedures | 58 |
|--------|----------|-------------------------|----|

         

|   | Item 9B. | Other Information | 58 |
|--------|----------|-------------------|----|

         

**PART III**

|   | Item 10. | Directors, Executive Officers and Corporate                        Governance | 58 |
|--------|----------|-------------------------------------------------------------------------------|----|

         

|   | Item 11. | Executive Compensation | 58 |
|--------|----------|------------------------|----|

         

|   | Item 12. | Security Ownership of Certain Beneficial Owners and                        Management |
|--------|----------|---------------------------------------------------------------------------------------|

|   | and Related Stockholder Matters | 58 |
|--------|---------------------------------|----|

         

|   | Item 13. | Certain Relationships, Related Transactions and Director                        Independence | 59 |
|--------|----------|----------------------------------------------------------------------------------------------|----|

         

|   | Item 14. | Principal Accounting Fees and Services | 59 |
|--------|----------|----------------------------------------|----|

         

**PART IV**

|   | Item 15. | Exhibits, Financial Statement Schedules | 58 |
|--------|----------|-----------------------------------------|----|

         

| **SIGNATURES** | 59 |
|----------------|----|

         

 

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**PART        I**

 

| **Item 1.** | **Business** |
|-------------|--------------|

 

**General**

 

New        Peoples Bankshares, Inc. (New Peoples) is a financial holding company operating under the        laws of Virginia and is headquartered in Honaker, Virginia. New Peoples wholly owns five        subsidiaries: New Peoples Bank, Inc., a Virginia banking corporation (the Bank); NPB        Financial Services, Inc., an insurance and investment services corporation (NPB Financial);        and NPB Web Services, Inc., a web design and hosting company (NPB Web). In July 2004, NPB        Capital Trust I was formed for the issuance of trust preferred securities. In September        2006, NPB Capital Trust 2 was formed for the issuance of trust preferred        securities.

 

The Bank        offers a range of banking and related financial services focused primarily towards serving        individuals, small to medium size businesses, and the professional community. We strive to        serve the banking needs of our customers while developing personal, hometown relationships        with them. Our board of directors believes that marketing customized banking services will        enable us to establish a niche in the financial services marketplace in our        market.

 

The Bank        is headquartered in Honaker, Virginia and operates 30 full service offices in the        southwestern Virginia counties of Russell, Scott, Washington, Tazewell, Buchanan,        Dickenson, Wise, Lee, Smyth, and Bland; Mercer County in southern West Virginia and the        eastern Tennessee counties of Sullivan and Washington. The close proximity and mobile        nature of individuals and businesses in adjoining counties and nearby cities in Virginia,        West Virginia and Tennessee places these markets within our bank's targeted trade area, as        well.

 

We        provide professionals and small and medium size businesses in our market area with        responsive and technologically advanced banking services. These services include loans that        are priced on a deposit relationship basis, easy access to our decision makers, and quick        and innovative action necessary to meet a customer's banking needs. Our capitalization and        lending limit enable us to satisfy the credit needs of a large portion of the targeted        market segment. When a customer needs a loan that exceeds our lending limit, we try to find        other financial institutions to participate in the loan with us.

 

**Our        History**

 

The Bank        was incorporated under the laws of the Commonwealth of Virginia on December 9, 1997 and        began operations on October 28, 1998. On September 27, 2001, the shareholders of the Bank        approved a plan of reorganization under which they exchanged their shares of Bank common        stock for shares of New Peoples common stock. On November 30, 2001, the reorganization was        completed and the Bank became New Peoples' wholly owned subsidiary.

 

In June        2003, New Peoples formed two new wholly-owned subsidiaries, NPB Financial Services, Inc.        and NPB Web Services, Inc.

 

NPB        Financial is a full-service insurance and investment firm, dealing in personal and group        life, health, and disability products, along with mutual funds, fixed rate annuities,        variable annuities, fee based asset management and other investment products through a        broker/dealer relationship with UVEST Financial Services, Inc.

 

 

3

 

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NPB Web        is an internet web site development and hosting company. It produces custom designed web        pages for use on the world wide web and serves as a web site host for customers and        non-profit organizations. It also develops the web sites of other New Peoples' subsidiaries        and supplies advertising and marketing expertise for New Peoples.

 

In July        2004, NPB Capital Trust I was formed to issue $11.3 million in trust preferred        securities.

 

In        September 2006, NPB Capital Trust 2 was formed to issue $5.2 million in trust preferred        securities.

 

**Location and Market Area**

 

We        initially opened with full service branches in Honaker and Weber City, Virginia and in 1999        opened a full service branch in Castlewood, Virginia. During 2000, we opened full service        branches in Haysi and Lebanon, Virginia. During 2001, we opened branches in Pounding Mill,        Virginia and Princeton, West Virginia. In 2002, we opened branch offices in Gate City,        Clintwood, Big Stone Gap, Tazewell and Davenport, Virginia. During 2003, we expanded into        Grundy, Dungannon, and Bristol, Virginia. We expanded into Tennessee and opened an office        in Bloomingdale, Tennessee in 2003, as well. In 2004, we opened offices in Richlands,        Abingdon, and Bristol, Virginia. In 2005 full service branches were opened in Bluefield and        Cleveland, Virginia. During 2006, we opened full service branches in Esserville, Pound, and        Lee County, Virginia and Jonesborough, Tennessee. During 2007, we opened three full service        offices in Bland, and Chilhowie, Virginia; and Bramwell, West Virginia. We purchased two        operating branch banks, including deposits and loans located in Norton and Pennington        Gap, Virginia in June 2007. Management will continue to investigate and consider other        possible sites that would enable us to profitably serve our chosen market area.

 

In order        to open additional banking offices, we must obtain prior regulatory approval which takes        into account a number of factors, including, among others, a determination that we have        adequate capital and a finding that the public interest will be served. While we plan to        seek regulatory approval at the appropriate time to establish additional banking offices,        there can be no assurance when or if we will be able to undertake such expansion        plans.

 

**Internet Site**

 

In March        2001, we opened our internet banking site at www.newpeoplesbank.com. The site includes a        customer service area that contains branch and ATM locations, product descriptions and        current interest rates offered on deposit accounts. Customers with internet access can        access account balances, make transfers between accounts, enter stop payment orders, order        checks, and use an optional bill paying service.

 

**Available Information**

 

We file        annual, quarterly, and current reports, proxy statements and other information with the        Securities and Exchange Commission (the SEC).  Our SEC filings are filed        electronically and are available to the public over the internet at the SEC's web site at        www.sec.gov.  In addition, any document we file with the SEC can be read and copied at        the SEC's public reference facilities at 100 F Street, N.E., Washington, D.C. 20549.         Copies of documents can be obtained at prescribed rates by writing to the Public Reference        Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain        information on the operation of the Public Reference Room by calling the SEC at        1-800-SEC-0330.  We also provide a link to our filings on the SEC website, free of        charge, through our internet website www.npbankshares.com under "Investor        Relations."

         

**Banking Services**

 

*General*. We accept deposits, make consumer and        commercial loans, issue drafts, and provide other services customarily offered by a        commercial bank, such as business and personal checking and savings accounts, walk-up        tellers, drive-in windows, and 24-hour automated teller machines. The Bank is a member of        the Federal Reserve System and its deposits are insured under the Federal Deposit Insurance        Act to the limits provided thereunder.

 

We offer        a full range of short-to-medium term commercial and personal loans. Commercial loans        include both secured and unsecured loans for working capital (including inventory and        receivables), business expansion (including acquisition of real estate and improvements)        and purchase of equipment and machinery. Consumer loans may include secured and unsecured        loans for financing automobiles, home improvements, education, personal investments and        other purposes.

 

Our        lending activities are subject to a variety of lending limits imposed by state law. While        differing limits apply in certain circumstances based on the type of loan or the nature of        the borrower (including the borrower''s relationship

 

4

 

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to the        Bank), in general, the Bank is subject to a loan-to-one borrower limit of an amount equal        to 15% of its capital and surplus in the case of loans which are not fully secured by        readily marketable or other permissible types of collateral. The Bank voluntarily may        choose to impose a policy limit on loans to a single borrower that is less than the legal        lending limit.

 

We        obtain short-to-medium term commercial and personal loans through direct solicitation of        business owners and continued business from existing customers. Completed loan applications        are reviewed by our loan officers. As part of the application process, information is        obtained concerning the income, financial condition, employment and credit history of the        applicant. If commercial real estate is involved, information is also obtained concerning        cash flow after debt service. Loan quality is analyzed based on the Bank's experience and        its credit underwriting guidelines.

         

Loans by        type as a percentage of total loans are as follows:

|                                   | December 31, |    |
|----------------------------------------|--------------|---------|
|                                   | 2007         | 2006    | 2005 | 2004 | 2003 |
| Commercial, financial and agricultural | 17.77%       | 18.34%  | 20.08% | 18.49% | 19.83% |
| Real estate - construction             | 5.63%        | 6.63%   | 5.61% | 2.95% | 2.46% |
| Real estate - mortgage                 | 67.87%       | 65.18%  | 64.47% | 66.72% | 62.68% |
| Installment loans to individuals       | 8.73%        | 9.85%   | 9.84% | 11.83% | 15.03% |
| Total                                  | 100.00%      | 100.00% | 100.00% | 100.00% | 100.00% |
|                                        |              |         |  |  |  |  |  |

        

*Commercial Loans*. We make commercial loans to        qualified businesses in our market area. Our commercial lending consists primarily of        commercial and industrial loans to finance accounts receivable, inventory, property, plant        and equipment. Commercial business loans generally have a higher degree of risk than        residential mortgage loans, but have commensurately higher yields. Residential mortgage        loans generally are made on the basis of the borrower's ability to make repayment from        employment and other income and are secured by real estate whose value tends to be easily        ascertainable. In contrast, commercial business loans typically are made on the basis of        the borrower's ability to make repayment from cash flow from its business and are secured        by business assets, such as commercial real estate, accounts receivable, equipment and        inventory. As a result, the availability of funds for the repayment of commercial business        loans may be substantially dependent on the success of the business itself.

 

Further,        the collateral for commercial business loans may depreciate over time and cannot be        appraised with as much precision as residential real estate. To manage these risks, our        underwriting guidelines require us to secure commercial loans with both the assets of the        borrowing business and other additional collateral and guarantees that may be available. In        addition, we actively monitor certain measures of the borrower, including advance rate,        cash flow, collateral value and other appropriate credit factors.

 

*Residential Mortgage Loans*. Our residential        mortgage loans consist of residential first and second mortgage loans, residential        construction loans, home equity lines of credit and term loans secured by first and second        mortgages on the residences of borrowers for home improvements, education and other        personal expenditures. We make mortgage loans with a variety of terms, including fixed and        floating or variable rates and a variety of maturities.

 

Under        our underwriting guidelines, residential mortgage loans generally are made on the basis of        the borrower's ability to make repayment from employment and other income and are secured        by real estate whose value tends to be easily ascertainable. These loans are made        consistent with the appraisal policies and real estate lending policies, which detail        maximum loan-to-value ratios and maturities.

 

*Construction Loans*. Construction lending        entails significant additional risks, compared to residential mortgage lending.        Construction loans often involve larger loan balances concentrated with single borrowers or        groups of related borrowers. Construction loans also involve additional risks attributable        to the fact that loan funds are advanced upon the security of property under construction,        which is of uncertain value prior to the completion of construction. Thus, it is more        difficult to evaluate accurately the total loan funds required to complete a project and        related loan-to-value ratios. To minimize the risks associated with construction lending,        loan-to-value limitations for residential, multi-family and non-residential properties are        in place. These are in addition to the usual credit analysis of borrowers. Management feels        that the loan-to-value ratios are sufficient to minimize the risk of loss and to compensate        for fluctuations in the real estate market. Maturities for construction loans generally        range from 4 to 12 months for residential property and from 6 to 18 months for        non-residential and multi-family properties.

 

*Consumer Loans*. Our consumer loans consist        primarily of installment loans to individuals for personal, family and household purposes.        The specific types of consumer loans that we make include home improvement loans, debt        consolidation loans and general consumer lending. Consumer loans entail greater risk than        residential mortgage loans do, particularly in the case of consumer loans that are        unsecured, such as lines of credit, or secured by rapidly

 

5

 

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depreciating assets such as automobiles. In such cases, any repossessed        collateral for a defaulted consumer loan may not provide an adequate source of repayment of        the outstanding loan balance as a result of the greater likelihood of damage, loss or        depreciation. The remaining deficiency often does not warrant further substantial        collection efforts against the borrower. In addition, consumer loan collections are        dependent on the borrower's continuing financial stability, and thus are more likely to be        adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the        application of various federal and state laws, including federal and state bankruptcy and        insolvency laws, may limit the amount which can be recovered on such loans. Such loans may        also give rise to claims and defenses by a consumer loan borrower against an assignee of        such loan such as the Bank, and a borrower may be able to assert against such assignee        claims and defenses that it has against the seller of the underlying collateral.

 

Our        underwriting policy for consumer loans is to accept moderate risk while minimizing losses,        primarily through a careful analysis of the borrower. In evaluating consumer loans, we        require our lending officers to review the borrower's level and stability of income, past        credit history and the impact of these factors on the ability of the borrower to repay the        loan in a timely manner. In addition, we maintain an appropriate margin between the loan        amount and collateral value.

 

*Other        Bank Services*. Other bank services include safe deposit boxes,        cashier's checks, certain cash management services, traveler's checks, direct deposit of        payroll and social security checks and automatic drafts for various accounts. We offer ATM        card services that can be used by our customers throughout Virginia and other regions. We        also offer MasterCard and VISA credit card services through an intermediary. Electronic        banking services include debit cards, internet banking, telephone banking and wire        transfers.

 

We do        not anticipate exercising trust powers in the next few years. We may establish a trust        department in the future but cannot do so without the prior approval of the Virginia State        Corporation Commission's Bureau of Financial Institutions. In the interim, we are able to        provide similar services through our affiliation with UVEST Financial Services,        Inc.

 

**Competition**

 

The        banking business is highly competitive. We compete as a financial intermediary with other        commercial banks, savings and loan associations, credit unions, mortgage banking firms,        consumer finance companies, securities brokerage firms, insurance companies, money market        mutual funds and other financial institutions operating in the southwestern Virginia,        southern West Virginia, and eastern Tennessee market area and elsewhere. Our market area is        a highly competitive, highly branched banking market.

 

Competition in the market area for loans to small businesses and        professionals, the Bank's target market, is intense, and pricing is important. Many of our        competitors have substantially greater resources and lending limits than we have. They        offer certain services, such as extensive and established branch networks and trust        services that we do not expect to provide or will not provide in the near future. Moreover,        larger institutions operating in the market area have access to borrowed funds at lower        costs than are available to us. Deposit competition among institutions in the market area        also is strong. As a result, it is possible that we may pay above-market rates to attract        deposits.

 

While        pricing is important, our principal method of competition is service. As a community        banking organization, we strive to serve the banking needs of our customers while        developing personal, hometown relationships with them. As a result, we provide a        significant amount of service and a range of products without the fees that customers can        expect from larger banking institutions.

 

According to a market share report prepared by the Federal Deposit Insurance        Corporation (the FDIC), as of June 30, 2007, the most recent date for which market share        information is available, the Bank's deposits as a percentage of total deposits in its        major market areas were as follows: Russell County, VA - 31.51%, Scott County, VA - 32.75%,        Dickenson County, VA - 26.49%, Tazewell County, VA - 7.52%, Smyth County, VA - 0.71%, Lee        County, VA - 11.29%, Buchanan County, VA - 10.03%, Wise County, VA - 10.26%, city of        Norton, VA - 26.36%, combined Washington County, VA and the City of Bristol, VA - 3.78%,        Mercer County, WV - 5.41%, Sullivan County, TN - 0.62%, and Washington County, TN -        0.91%,.

 

**Employees**

 

As of        December 31, 2007, we had 371 total employees, of which 349 were full-time employees. None        of our employees is covered by a collective bargaining agreement, and we consider relations        with employees to be excellent.

 

6

 

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**Supervision and Regulation**

 

*General*As a bank holding company, we are        subject to regulation under the Bank Holding Company Act of 1956, as amended, and the        examination and reporting requirements of the Board of Governors of the Federal Reserve        System (the Federal Reserve). As a state-chartered commercial bank, the Bank is subject to        regulation, supervision and examination by the Virginia State Corporation Commission's        Bureau of Financial Institutions. It is also subject to regulation, supervision and        examination by the Federal Reserve. Other federal and state laws, including various        consumer protection and compliance laws, govern the activities of the Bank, the investments        that it makes and the aggregate amount of loans that it may grant to one        borrower.

 

The        following description summarizes the significant federal and state laws applicable to New        Peoples and its subsidiaries. To the extent that statutory or regulatory provisions are        described, the description is qualified in its entirety by reference to that particular        statutory or regulatory provision.

 

*The        Bank Holding Company Act*Under the Bank Holding Company Act, New        Peoples is subject to periodic examination by the Federal Reserve, with the cost of any        such examination paid by New Peoples. New Peoples is required to file periodic reports        regarding its operations and any additional information that the Federal Reserve may        require. Activities at the bank holding company level are limited to:

|   | **•** | banking, managing or controlling banks; |
|--------|------------|-----------------------------------------|

|   | ****•**** | furnishing services to or performing services for its                        subsidiaries; and |
|--------|----------------|------------------------------------------------------------------------------------------------|

|   | ****•**** | engaging in other activities that the Federal Reserve has                        determined by regulation or order to be so closely related to banking as to                        be a proper incident to these activities. |
|--------|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Some of        the activities that the Federal Reserve has determined by regulation to be proper incidents        to the business of a bank holding company include making or servicing loans and specific        types of leases, performing specific data processing services and acting in some        circumstances as a fiduciary or investment or financial adviser.

 

With        some limited exceptions, the Bank Holding Company Act requires every bank holding company        to obtain the prior approval of the Federal Reserve before:

|   | ****•**** | acquiring substantially all the assets of any                        bank; |
|--------|----------------|----------------------------------------------------------------------------|

|   | ****•**** | acquiring direct or indirect ownership or control of any                        voting shares of any bank if after such acquisition it would own or control                        more than 5% of the voting shares of 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 Bank Holding Company Act and the Change in        Bank Control Act, together with the regulations promulgated thereunder, require Federal        Reserve approval prior to any person or company acquiring "control" of a bank holding        company. Control is conclusively presumed to exist if an individual or company acquires 25%        or more of any class of voting securities of the bank holding company. Control is        rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any        class of voting securities and either has registered securities under Section 12 of the        Securities Exchange Act of 1934 or no other person owns a greater percentage of that class        of voting securities immediately after the transaction. The regulations provide a procedure        for challenging this rebuttable control presumption.

 

In 1999,        Congress enacted the Gramm-Leach-Bliley Act (GLBA), which made substantial revisions to the        statutory restrictions separating banking activities from other financial activities. Under        the GLBA, bank holding companies that are well-capitalized and well-managed and meet other        conditions can elect to become "financial holding companies." As financial holding        companies, they and their subsidiaries are permitted to acquire or engage in previously        impermissible activities such as insurance underwriting, securities underwriting and        distribution, travel agency activities, insurance agency activities, merchant banking and        other activities that the Federal Reserve determines to be financial in nature or        complementary to these activities. Financial holding companies continue to be subject to        the overall oversight and supervision of the Federal Reserve, but the GLBA applies the        concept of functional regulation to the activities conducted by subsidiaries. For example,        insurance activities would be subject to supervision and regulation by state insurance        authorities. New Peoples has elected to be treated as a financial holding        company.

 

*Payment of Dividends*New Peoples is a legal        entity separate and distinct from its banking and other subsidiaries. New Peoples derives        the majority of its revenues from dividends paid to the company by its subsidiaries. The        Bank is subject to laws and regulations that limit the amount of dividends it can pay. In        addition, both New Peoples and the Bank are subject to various regulatory restrictions        relating to the payment of dividends, including requirements to

 

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maintain        capital at or above regulatory minimums. Banking regulators have indicated that banking        organizations should generally pay dividends only if the organization's net income        available to common shareholders over the past year has been sufficient to fully fund the        dividends and the prospective rate of earnings retention appears consistent with the        organization's capital needs, asset quality and overall financial condition. New Peoples        does not expect that any of these laws, regulations or policies will materially affect the        ability of the Bank to pay dividends. During the year ended December 31, 2007, the Bank,        however, did not declare any dividends to New Peoples in order that it may retain earnings        to fund future loan growth and branch expansion efforts. For additional discussion of        restriction on dividends see Note 17 in the notes to the consolidated financial        statements.

 

The FDIC        has the general authority to limit the dividends paid by FDIC insured banks if the FDIC        deems the payment to be an unsafe and unsound practice. The FDIC has indicated that paying        dividends that deplete a bank's capital base to an inadequate level would be an unsound and        unsafe banking practice.

 

*Insurance of Accounts, Assessments and Regulation by the FDIC*The Bank's deposits are insured by the Deposit Insurance Fund, as        administered by the FDIC, to the maximum amount permitted by law, which is currently        $100,000 for each non-retirement depositor and $250,000 for certain retirement-account        depositors. The Bank pays insurance premiums on deposits in accordance with a deposit        premium assessment system currently under revision by the FDIC in accordance with the        Federal Deposit Insurance Reform Act of 2005 ("FDIRA"), which required that the FDIC revise        its current risk-based deposit premium system by November 2006. On July 11, 2006, the        FDIC issued a notice of proposed rulemaking with respect to the changes required by the        Federal Deposit Insurance Reform Act. This proposed rulemaking imposes deposit insurance        premium assessments based upon perceived risks to the Deposit Insurance Fund, by evaluating        an institution's CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity        to market risk) ratios and other financial ratios and then determining insurance premiums        based upon the likelihood an institution could be downgraded to a CAMELS 3 or worse in the        succeeding year. As a result, institutions deemed to pose less risk would pay lower        premiums than those institutions deemed to pose more risk, which would pay more. On        November 2, 2006, the FDIC adopted final regulations implementing FDIRA. Under the        risk-based assessments, most financial institutions will pay an assessment of between $0.05        and $0.07 for every $100 of domestic deposits annually beginning in 2007. New Peoples is        not aware of any existing circumstances that could result in termination of any of the        Bank's deposit insurance.

 

*Capital Requirements*The Federal Reserve has        issued risk-based and leverage capital guidelines applicable to banking organizations that        it supervises. Under the risk-based capital requirements, New Peoples and the Bank are each        generally required to maintain a minimum ratio of total capital to risk-weighted assets        (including certain off-balance sheet activities, such as standby letters of credit) of 8%.        At least half of the total capital must be composed of "Tier 1 Capital", which is defined        as common equity, retained earnings and qualifying perpetual preferred stock, less certain        intangibles. The remainder may consist of "Tier 2 Capital", which is defined as specific        subordinated debt, some hybrid capital instruments and other qualifying preferred stock and        a limited amount of the loan loss allowance. In addition, each of the federal banking        regulatory agencies has established minimum leverage capital requirements for banking        organizations. Under these requirements, banking organizations must maintain a minimum        ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to        federal bank regulatory evaluation of an organization's overall safety and soundness. In        sum, the capital measures used by the federal banking regulators are:

|   | ****•**** | the Total Capital ratio, which is the total of Tier 1                        Capital and Tier 2 Capital; |
|--------|----------------|----------------------------------------------------------------------------------------------------------|

|   | ****•**** | the Tier 1 Capital ratio; and |
|--------|----------------|-------------------------------|

|   | ****•**** | the leverage ratio. |
|--------|----------------|---------------------|

         

Under        these regulations, a bank holding company or bank will be:

|   | ****•**** | "well capitalized" if it has a Total Capital ratio of 10% or                        greater, a Tier 1 Capital ratio of 6% or greater, a leverage ratio of 5% or                        greater, and is not subject to any written agreement, order, capital                        directive, or prompt corrective action directive by a federal bank                        regulatory agency to meet and maintain a specific capital level for any                        capital measure; |
|--------|----------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ****•**** | "adequately capitalized" if it has a Total Capital ratio of                        8% or greater, a Tier 1 Capital ratio of 4% or greater, and a leverage                        ratio of 4% or greater - or 3% in certain circumstances - and is not well                        capitalized; |
|--------|----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ****•**** | "undercapitalized" if it has a Total Capital ratio of less                        than 8%, a Tier 1 Capital ratio of less than 4% - or 3% in certain                        circumstances; |
|--------|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ****•**** | "significantly undercapitalized" if it has a Total Capital                        ratio of less than 6%, a Tier 1 Capital ratio of less than 3%, or a                        leverage ratio of less than 3%; or |
|--------|----------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ****•**** | "critically undercapitalized" if its tangible equity is                        equal to or less than 2% of average quarterly tangible assets. |
|--------|----------------|-----------------------------------------------------------------------------------------------------------------------------------------------|

         

 

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The        risk-based capital standards of the Federal Reserve explicitly identify concentrations of        credit risk and the risk arising from non-traditional activities, as well as an        institution's ability to manage these risks, as important factors to be taken into account        by the agency in assessing an institution's overall capital adequacy. The capital        guidelines also provide that an institution's exposure to a decline in the economic value        of its capital due to changes in interest rates be considered by the agency as a factor in        evaluating a banking organization's capital adequacy.

 

The FDIC        may take various corrective actions against any undercapitalized bank and any bank that        fails to submit an acceptable capital restoration plan or fails to implement a plan        accepted by the FDIC. These powers include, but are not limited to, requiring the        institution to be recapitalized, prohibiting asset growth, restricting interest rates paid,        requiring prior approval of capital distributions by any bank holding company that controls        the institution, requiring divestiture by the institution of its subsidiaries or by the        holding company of the institution itself, requiring new election of directors, and        requiring the dismissal of directors and officers. As of December 31, 2007, New Peoples and        the Bank were "well capitalized," with Total Capital ratios of 10.29% and 10.11%,        respectively; Tier 1 Capital ratios of 8.73% and 9.04%, respectively; and leverage ratios        of 7.22% and 7.52%, respectively.

 

*Other        Safety and Soundness Regulations*There are a number of        obligations and restrictions imposed on bank holding companies and their depository        institution subsidiaries by federal law and regulatory policy that are designed to reduce        potential loss exposure to the depositors of such depository institutions and to the FDIC        insurance funds in the event that the depository institution is insolvent or is in danger        of becoming insolvent. For example, under the requirements of the Federal Reserve with        respect to bank holding company operations, a bank holding company is required to serve as        a source of financial strength to its subsidiary depository institutions and to commit        resources to support such institutions in circumstances where it might not do so        otherwise.

 

*Interstate Banking and Branching*Current        federal law authorizes interstate acquisitions of banks and bank holding companies without        geographic limitation. A bank headquartered in one state is authorized to merge with a bank        headquartered in another state, as long as neither of the states had opted out of such        interstate merger authority prior to June 1997. After a bank has established branches in a        state through an interstate merger transaction, the bank may establish and acquire        additional branches at any location in the state where a bank headquartered in that state        could have established or acquired branches under applicable federal or state        law.

 

*Monetary Policy*The commercial banking business        is affected not only by general economic conditions but also by the monetary policies of        the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve        include open market operations in United States government securities, changes in the        discount rate on member bank borrowing and changes in reserve requirements against deposits        held by all federally insured banks. The Federal Reserve's monetary policies have had a        significant effect on the operating results of commercial banks in the past and are        expected to continue to do so in the future. In view of changing conditions in the national        and international economy and in the money markets, as well as the effect of actions by        monetary fiscal authorities, including the Federal Reserve, no prediction can be made as to        possible future changes in interest rates, deposit levels, loan demand or the business and        earnings of the Bank.

 

*Federal Reserve System*In 1980, Congress        enacted legislation that imposed reserve requirements on all depository institutions that        maintain transaction accounts or nonpersonal time deposits. NOW accounts, money market        deposit accounts and other types of accounts that permit payments or transfers to third        parties fall within the definition of transaction accounts and are subject to these reserve        requirements, as are any nonpersonal time deposits at an institution. These percentages are        subject to adjustment by the Federal Reserve. Because required reserves must be maintained        in the form of vault cash or in a non-interest-bearing account at, or on behalf of, a        Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the        institution's interest-earning assets.

 

*Transactions with Affiliates*Transactions        between banks and their affiliates are governed by Sections 23A and 23B of the Federal        Reserve Act. An affiliate of a bank is any bank or entity that controls, is controlled by        or is under common control with such bank. Generally, Sections 23A and 23B (i) limit the        extent to which the Bank or its subsidiaries may engage in "covered transactions" with any        one affiliate to an amount equal to 10% of such institution's capital stock and surplus,        and maintain an aggregate limit on all such transactions with affiliates to an amount equal        to 20% of such capital stock and surplus, and (ii) require that all such transactions be on        terms substantially the same, or at least as favorable, to the association or subsidiary as        those provided to a nonaffiliate. The term "covered transaction" includes the making of        loans, purchase of assets, issuance of a guarantee and similar other types of        transactions.

 

*Loans        to Insiders*The Federal Reserve Act and related regulations        impose specific restrictions on loans to directors, executive officers and principal        shareholders of banks. Under Section 22(h) of the Federal Reserve Act,

 

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loans to        a director, an executive officer and to a principal shareholder of a bank, and some        affiliated entities of any of the foregoing, may not exceed, together with all other        outstanding loans to such person and affiliated entities, the bank's loan-to-one borrower        limit. Loans in the aggregate to insiders and their related interests as a class may not        exceed two times the bank's unimpaired capital and unimpaired surplus until the bank's        total assets equal or exceed $100 million, at which time the aggregate is limited to the        bank's unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans, above        amounts prescribed by the appropriate federal banking agency, to directors, executive        officers and principal shareholders of a bank or bank holding company, and their respective        affiliates, unless such loan is approved in advance by a majority of the board of directors        of the bank with any "interested" director not participating in the voting. The FDIC has        prescribed the loan amount, which includes all other outstanding loans to such person, as        to which such prior board of director approval is required, as being the greater of $25,000        or 5% of capital and surplus (up to $500 thousand). Section 22(h) requires that loans to        directors, executive officers and principal shareholders be made on terms and underwriting        standards substantially the same as offered in comparable transactions to other        persons.

 

*Community Reinvestment Act*Under the Community        Reinvestment Act and related regulations, depository institutions have an affirmative        obligation to assist in meeting the credit needs of their market areas, including low and        moderate-income areas, consistent with safe and sound banking practice. The Community        Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act        statement for each of its market areas describing the depository institution's efforts to        assist in its community's credit needs. Depository institutions are periodically examined        for compliance with the Community Reinvestment Act and are periodically assigned ratings in        this regard. Banking regulators consider a depository institution's Community Reinvestment        Act rating when reviewing applications to establish new branches, undertake new lines of        business, and/or acquire part or all of another depository institution. An unsatisfactory        rating can significantly delay or even prohibit regulatory approval of a proposed        transaction by a bank holding company or its depository institution subsidiaries. The Bank        received a rating of "Satisfactory" at its last Community Reinvestment Act performance        evaluation, as of August 13, 2007.

 

The GLBA        and federal bank regulators have made various changes to the Community Reinvestment Act.        Among other changes, Community Reinvestment Act agreements with private parties must be        disclosed and annual reports must be made to a bank's primary federal regulator. A bank        holding company will not be permitted to become a financial holding company and no new        activities authorized under the GLBA may be commenced by a holding company or by a bank        financial subsidiary if any of its bank subsidiaries received less than a "satisfactory"        rating in its latest Community Reinvestment Act examination.

 

*Fair        Lending; Consumer Laws*In addition to the Community Reinvestment        Act, other federal and state laws regulate various lending and consumer aspects of the        banking business. The Federal banking agencies and the Department of Justice, have become        concerned that prospective borrowers experience discrimination in their efforts to obtain        loans from depository and other lending institutions. These agencies have brought        litigation against depository institutions alleging discrimination against borrowers. Many        of these suits have been settled, in some cases on material terms, short of a full        trial.

 

Recently, these governmental agencies have clarified what they consider to        be lending discrimination and have specified various factors that they will use to        determine the existence of lending discrimination under the Equal Credit Opportunity Act        and the Fair Housing Act, including evidence that a lender discriminated on a prohibited        basis, evidence that a lender treated applicants differently based on prohibited factors in        the absence of evidence that the treatment was the result of prejudice or a conscious        intention to discriminate, and evidence that a lender applied an otherwise neutral        non-discriminatory policy uniformly to all applicants, but the practice had a        discriminatory effect, unless the practice could be justified as a business        necessity.

 

Banks        and other depository institutions also are subject to numerous consumer-oriented laws and        regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act,        the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal        Credit Opportunity Act, the Fair and Accurate Credit Transactions Act of 2003 and the Fair        Housing Act, require compliance by depository institutions with various disclosure and        consumer information handling requirements and requirements regulating the availability of        funds after deposit or the making of some loans to customers.

 

*Gramm-Leach-Bliley Act of 1999*The        Gramm-Leach-Bliley Act of 1999 covers a broad range of issues, including a repeal of most        of the restrictions on affiliations among depository institutions, securities firms and        insurance companies. The following description summarizes some of its significant        provisions.

 

The GLBA        permits unrestricted affiliations between banks and securities firms. It also permits bank        holding companies to elect to become financial holding companies, which can engage in a        broad range of financial services.

 

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A        financial holding company may engage in or acquire companies that engage in a broad range        of financial services, including securities activities such as underwriting, dealing,        investment, merchant banking, insurance underwriting, sales and brokerage activities. In        order to become a financial holding company, a bank holding company and all of its        affiliated depository institutions must be well-capitalized, well-managed and have at least        a satisfactory Community Reinvestment Act rating. New Peoples has elected to be treated as        a financial holding company for various reasons.

 

The GLBA        provides that the states continue to have the authority to regulate insurance activities,        but prohibits the states in most instances from preventing or significantly interfering        with the ability of a bank, directly or through an affiliate, to engage in insurance sales,        solicitations or cross-marketing activities. Although the states generally must regulate        bank insurance activities in a nondiscriminatory manner, the states may continue to adopt        and enforce rules that specifically regulate bank insurance activities in specific areas        identified under the law. Under the GLBA, the federal bank regulatory agencies adopted        insurance consumer protection regulations that apply to sales practices, solicitations,        advertising and disclosures.

 

The GLBA        adopted a system of functional regulation under which the Federal Reserve is designated as        the umbrella regulator for financial holding companies, but financial holding company        affiliates are principally regulated by functional regulators such as the FDIC for state        nonmember bank affiliates, the Securities and Exchange Commission for securities        affiliates, and state insurance regulators for insurance affiliates. It repealed the broad        exemption of banks from the definitions of "broker" and "dealer" for purposes of the        Securities Exchange Act of 1934, as amended. It also identified a set of specific        activities, including traditional bank trust and fiduciary activities, in which a bank may        engage without being deemed a "broker," and a set of activities in which a bank may engage        without being deemed a "dealer." Additionally, the GLBA made conforming changes in the        definitions of "broker" and "dealer" for purposes of the Investment Company Act of 1940, as        amended, and the Investment Advisers Act of 1940, as amended.

 

The GLBA        contains extensive customer privacy protection provisions. Under these provisions, a        financial institution must provide to its customers, both at the inception of the customer        relationship and on an annual basis, the institution's policies and procedures regarding        the handling of customers' nonpublic personal financial information. The law provides that,        except for specific limited exceptions, an institution may not provide such personal        information to unaffiliated third parties unless the institution discloses to the customer        that such information may be so provided and the customer is given the opportunity to opt        out of such disclosure. An institution may not disclose to a non-affiliated third party,        other than to a consumer reporting agency, customer account numbers or other similar        account identifiers for marketing purposes. The GLBA also provides that the states may        adopt customer privacy protections that are stricter than those contained in the        act.

 

*USA        Patriot Act*The USA Patriot Act became effective in October 2001        and provides for the facilitation of information sharing among governmental entities and        financial institutions for the purpose of combating terrorism and money laundering. Among        other provisions, the USA Patriot Act permits financial institutions, upon providing notice        to the United States Treasury, to share information with one another in order to better        identify and report to the federal government concerning activities that may involve money        laundering or terrorists' activities. The USA Patriot Act is considered a significant        banking law in terms of information disclosure regarding certain customer transactions.        Although it does create a reporting obligation and cost of compliance for the Bank and NPB        Financial, New Peoples does not expect the USA Patriot Act to materially affect its        products, services or other business activities.

 

The        Federal Bureau of Investigation ("FBI") has sent, and will send, our banking regulatory        agencies lists of the names of persons suspected of terrorist activities. The Bank and NPB        Financial have been requested, and will be requested, to search their records for any        relationships or transactions with persons on those lists. If the Bank or NPB Financial        finds any relationship or transactions, it must file a suspicious activity report and        contact the FBI.

 

The        Office of Foreign Assets Control ("OFAC"), which is a division of the Department of the        Treasury, is responsible for helping to ensure that United States entities do not engage in        transactions with "enemies" of the United States, as defined by various Executive Orders        and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists        of names of persons and organizations suspected of aiding, harboring or engaging in        terrorist acts. If the Bank or NPB Financial finds a name on any account, or wire transfer        that is on an OFAC list, it must freeze such account, file a suspicious activity report and        notify the FBI. The USA Patriot Act also requires financial institutions, such as the Bank        and NPB Financial, to maintain "customer identification programs". These programs must        provide for the collection of certain identifying information at account openings, the        verification of the identity of new account holders within a reasonable time period, the        reasonable belief by a banking organization that it knows each customer's identity, the        recordation of the information used to verify a customer's identity and the comparison of        the names of new customers against government lists of known or suspected terrorists or        terrorist organizations.

 

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*Privacy and Fair Credit Reporting*Financial        institutions, such as the Bank, are required to disclose their privacy policies to        customers and consumers and require that such customers or consumers be given a choice        (through an opt-out notice) to forbid the sharing of nonpublic personal information about        them with nonaffiliated third persons. The Bank has a written privacy policy that is        delivered to each of its customers when customer relationships begin and annually        thereafter. In accordance with the privacy policy, the Bank will protect the security of        information about its customers, educate its employees about the importance of protecting        customer privacy, and allow its customers to remove their names from the solicitation lists        they use and share with others. The Bank requires business partners with whom it shares        such information to have adequate security safeguards and to abide by the redisclosure and        reuse provisions of applicable law. The Bank has programs to fulfill the expressed requests        of customers and consumers to opt out of information sharing subject to applicable law. In        addition to adopting federal requirements regarding privacy, individual states are        authorized to enact more stringent laws relating to the use of customer information. To        date, Virginia has not done so, but is authorized to consider proposals that would impose        additional requirements or restrictions on the Bank. If the federal or state regulators        establish further guidelines for addressing customer privacy issues, the Bank may need to        amend its privacy policies and adapt its internal procedures.

 

*Sarbanes-Oxley Act*On July 30, 2002 President        Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The stated        goals of the Sarbanes-Oxley Act are to increase corporate responsibility, provide enhanced        penalties for accounting and auditing improprieties by publicly traded companies and to        protect investors by improving the accuracy and reliability of corporate disclosures made        pursuant to the securities law. The changes required by the Sarbanes-Oxley Act and its        implementing regulations are intended to allow shareholders to monitor the performance of        companies and their directors more easily and effectively.

 

The        Sarbanes-Oxley Act generally applies to all domestic companies, such as New Peoples, that        file periodic reports with the Securities and Exchange Commission ("SEC") under the        Securities Exchange Act of 1934, as amended. The Sarbanes-Oxley Act includes significant        additional disclosure requirements and new corporate governance rules, which required the        SEC to adopt extensive additional disclosures, corporate governance provisions and other        related rules. New Peoples has expended considerable time and money in complying with the        Sarbanes-Oxley Act and expects to continue to do so in the future.

 

*Future Regulatory Uncertainty*Because federal        and state regulation of financial institutions changes regularly and is the subject of        constant legislative debate, New Peoples cannot forecast how regulation of financial        institutions may change in the future and impact its operations. Although Congress in        recent years has sought to reduce the regulatory burden on financial institutions with        respect to the approval of specific transactions, New Peoples fully expects that the        financial institution industry will remain heavily regulated in the near future and that        additional laws or regulations may be adopted further regulating specific banking        practices.

 

| **Item 1A.** | **Risk Factors** |
|--------------|------------------|

 

***Changes in interest rates could have an adverse effect on our        income.***

 

Our        profitability depends to a large extent upon our net interest income. Net interest income        is the difference between interest income on interest-earning assets, such as loans and        investments, and interest expense on interest-bearing liabilities, such as deposits and        borrowings. Our net interest income will be adversely affected if market interest rates        change so that the interest we pay on deposits and borrowings increases faster than the        interest we earn on loans and investments. Changes in interest rates also affect the value        of our loans. An increase in interest rates could adversely affect borrowers' ability to        pay the principal or interest on existing loans or reduce their desire to borrow more        money. This may lead to an increase in our nonperforming assets or a decrease in loan        originations, either of which could have a material and negative effect on our results of        operations. Interest rates are highly sensitive to many factors that are partly or        completely outside of our control, including governmental monetary policies, domestic and        international economic and political conditions and general economic conditions such as        inflation, recession, unemployment and money supply. Fluctuations in market interest rates        are neither predictable nor controllable and may have a material and negative effect on our        business, financial condition and results of operations.

 

***We        have a high concentration of loans secured by real estate and a downturn in the real estate        market, for any reason, could result in losses and materially and adversely affect        business, financial condition, results of operations and future        prospects.***

 

A        significant portion of our loan portfolio is dependent on real estate. In addition to the        financial strength and cash flow characteristics of the borrower in each case, we often        secure loans with real estate collateral. At December 31, 2007, approximately 73.34% of our        loans have real estate as a primary or secondary component of collateral. The

 

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real        estate collateral in each case provides an alternate source of repayment in the event of        default by the borrower and may deteriorate in value during the time the credit is        extended. An adverse change in the economy affecting values of real estate generally or in        our primary markets specifically could significantly impair the value of our collateral and        result in a significant portion of our portfolio being under-collateralized. In such a        case, it would be likely that we would be required to increase our provision for loan        losses, which would negatively affect our results of operations. If we are required to        liquidate the collateral securing a loan to satisfy the debt during a period of reduced        real estate values, our ability to recover fully on defaulted loans by foreclosing and        selling the real estate collateral would be diminished and we would be more likely to        suffer losses on defaulted loans, which could adversely affect our profitability and        financial condition.

 

***We        will face risks with respect to future expansion.***

 

Our        current strategy is to continue growing in the southwest Virginia, southern West Virginia        and northeastern Tennessee markets. Our expansion strategy will involve a number of risks        such as the time and expense associated with evaluating new markets for expansion, hiring        local management and opening new offices. Any future expansion efforts may entail        substantial costs and may not produce the additional growth or earnings that were        anticipated, which could adversely affect our results of operations. Any expansion plans we        undertake may also divert the attention of our management from the operation of our current        business, which could also have an adverse effect on our results of operations.

 

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

 

Our        business strategy calls for continued growth. We anticipate that we will be able to support        this growth through retained earnings, additional trust preferred security issuances, sale        of additional common stock, or other alternative capital sources. We may need to raise        additional capital in the future to support our continued growth and to maintain our        capital levels. Our ability to raise capital through the sale of additional securities will        depend primarily upon our financial condition and the condition of financial markets at        that time. We may not be able to obtain additional capital in the amounts or on terms        satisfactory to us. Our growth may be constrained if we are unable to raise additional        capital as needed.

 

***The success of our growth strategy depends on our ability to identify        and recruit individuals with experience and relationships in the markets in which we intend        to expand.***

 

We        intend to expand our banking network over the next several years in the southwest Virginia,        southern West Virginia and northeastern Tennessee markets. We believe that to expand into        new markets successfully, we must identify and recruit experienced key management members        with local expertise and relationships in these markets. We expect that competition for        qualified management in the markets in which we expand will be intense and that there will        be a limited number of qualified persons with knowledge of and experience in the community        banking industry in these markets. The process of identifying and recruiting individuals        with the combination of skills and attributes required to carry out our strategy is often        lengthy. Even if we identify individuals that we believe could assist us in establishing a        presence in a new market, we may be unable to recruit these individuals away from more        established banks. Many experienced banking professionals employed by our competitors are        covered by agreements not to compete or solicit their existing customers if they were to        leave their current employment. These agreements make the recruitment of these        professionals more difficult. Our inability to identify, recruit and retain talented        personnel to manage new offices effectively and in a timely manner would limit our growth        and could materially adversely affect our business, financial condition and results of        operations.

 

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

 

We are a        customer-focused and relationship-driven organization. We expect our future growth to be        driven in a large part by the relationships maintained with our customers by our President        and Chief Executive Officer, Kenneth D. Hart, and our other executive and senior lending        officers. We have entered into employment agreements with Mr. Hart and Frank Sexton,        Jr., our Executive Vice President and Chief Operating Officer. The existence of such        agreements, however, does not necessarily assure that we will be able to continue to retain        their services. The unexpected loss of either Mr. Hart or Mr. Sexton or other key employees        could have a material adverse effect on our business and possibly result in reduced        revenues and earnings.

 

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

 

We        maintain an allowance for loan losses that we believe is a reasonable estimate of known and        inherent losses in our loan portfolio. Through a periodic review and consideration of the        loan portfolio, management determines the

 

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amount        of the allowance for loan losses by considering general market conditions, credit quality        of the loan portfolio, the collateral supporting the loans and performance of our customers        relative to their financial obligations with us. The amount of future losses is susceptible        to changes in economic, operating and other conditions, including changes in interest        rates, that may be beyond our control, and these losses may exceed our current estimates.        Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating        loan loss allowances is more difficult, and may be more susceptible to changes in        estimates, and to losses exceeding estimates, than more seasoned portfolios. Although we        believe the allowance for loan losses is a reasonable estimate of known and inherent losses        in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance        will be adequate in the future. Excessive loan losses could have a material impact on our        financial performance. Because of our growth strategy, we expect that our earnings will be        negatively impacted by loan growth, which requires additions to our allowance for loan        losses. Consistent with our loan loss reserve methodology, we expect to make additions to        our loan loss reserve levels as a result of our growth strategy, which may affect our        short-term earnings.

 

Federal        and state regulators periodically review our allowance for loan losses and may require us        to increase our provision for loan losses or recognize further loan charge-offs, based on        judgments different than those of our management. Any increase in the amount of our        provision or loans charged-off as required by these regulatory agencies could have a        negative effect on our operating results.

 

***Lack of seasoning of our loan portfolio may increase the risk of        credit defaults in the future, which would adversely affect our financial condition and        results of operation.***

 

Although        we have experienced lenders who are familiar with their customer base, some of our loans        are too new to have exhibited signs of weakness. In addition, recent expansions into new        markets increase credit risk. In general, new loans do not begin to show signs of credit        deterioration or default until they have been outstanding for some period of time, a        process referred to as "seasoning." As a result, a portfolio of older loans will usually        behave more predictably than a newer portfolio, although there can be no assurance that        more seasoned loans will be of higher quality or perform better. Because a portion of our        loan portfolio is relatively new, the current level of delinquencies and defaults may not        be representative of the level that will prevail when our portfolio becomes more seasoned,        which may be significantly higher than current levels. A higher rate of delinquencies or        defaults on loans could cause us to increase our provision for loan losses and otherwise        negatively affect our financial condition, results of operations and financial        prospects.

 

***Our profitability may suffer because of rapid and unpredictable        changes in the highly regulated environment in which we operate.***

 

We are        subject to extensive supervision by several governmental regulatory agencies at the federal        and state levels. These agencies examine financial and bank holding companies and        commercial banks, establish capital and other financial requirements and approve new        branches, acquisitions or other changes of control. Our ability to establish new banks or        branches or make acquisitions is conditioned on receiving required regulatory approvals        from the applicable regulators. Recently enacted, proposed and future banking legislation        and regulations have had, and will continue to have, or may have a significant impact on        the financial services industry. These regulations, which are intended to protect        depositors and not our shareholders, and the interpretation and application of them by        federal and state regulators, are beyond our control, may change rapidly and unpredictably        and can be expected to influence our earnings and growth. Such changes could subject us to        additional costs, limit the types of financial services and products we may offer, increase        the ability of non-banks to offer competing financial services and products, and/or assist        competitors that are not subject to similar regulation, among other things. Failure to        comply with laws, regulations or policies could result in sanctions by regulatory agencies,        civil money penalties and damage to our reputation, which could have a material adverse        effect on our business, financial condition and results of operation.

***The Bank's ability to pay dividends is subject to regulatory        limitations which, to the extent we require such dividends in the future, may affect our        ability to pay our obligations and pay dividends.***

 

We are a        separate legal entity from the Bank and our other subsidiaries and we do not have        significant operations of our own. We currently depend on the Bank's cash and liquidity as        well as dividends paid by it to us to pay our operating expenses. No assurance can be made        that in the future the Bank will have the capacity to pay the necessary dividends and that        we will not require dividends from the Bank to satisfy our obligations. Various statutes        and regulations limit the availability of dividends from the Bank. It is possible,        depending upon our financial condition and other factors, that federal regulators could        assert that payment of dividends or other payments by the Bank are an unsafe or unsound        practice. In the event the Bank is unable to pay dividends to us, we may not be able to        service our obligations as they become due. Consequently, the inability to receive        dividends from the Bank could adversely affect our financial condition, results of        operations, cash flows and prospects.

 

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***Our business is subject to various lending and other economic risks        that could adversely impact our results of operations and financial        condition.***

 

Changes        in economic conditions, particularly an economic slowdown, could hurt our business. Our        business is directly affected by political and market conditions, broad trends in industry        and finance, legislative and regulatory changes, changes in governmental monetary and        fiscal policies and inflation, all of which are beyond our control. A deterioration in        economic conditions, in particular an economic slowdown within our geographic region, could        result in the following consequences, any of which could hurt our business        materially:

 

|   | ****•**** | loan delinquencies may increase; |
|--------|----------------|----------------------------------|

|   | ****•**** | problem assets and foreclosures may increase; |
|--------|----------------|-----------------------------------------------|

|   | ****•**** | demand for our products and services may decline;                        and |
|--------|----------------|------------------------------------------------------------------------------|

|   | ****•**** | collateral for loans made by us may decline in value, in                        turn reducing a client's borrowing power, and reducing the value of assets                        and collateral associated with our loans held for investment. |
|--------|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Although        our market area is somewhat economically diverse, in certain areas the local economies are        more reliant upon agriculture and coal mining. To the extent an economic downturn        disproportionately affected these two industries, the above-described negative effects        could be exacerbated.

 

A        downturn in the real estate market could hurt our business. Our business activities and        credit exposure are concentrated in Virginia, West Virginia and Tennessee and at December        31, 2007, approximately 73.51% of our loans have real estate as a primary or secondary        component of collateral. As such, a downturn in this regional real estate market could hurt        our business because of the geographic concentration within this regional area.         Deterioration in real estate values in larger metropolitan areas of the country have had        little impact on the markets served by the Bank, although if there is a significant        decline in real estate values in our local markets, the collateral for our loans will        provide less security. As a result, our ability to recover on defaulted loans by selling        the underlying real estate would be diminished, and we would be more likely to suffer        losses on defaulted loans.

 

***We        face strong competition from other financial institutions, financial service companies and        other organizations offering services similar to those offered by us and our subsidiaries,        which could hurt our business.***

 

Our        business operations are centered primarily in Virginia, West Virginia, and Tennessee.        Increased competition within this region may result in reduced loan originations and        deposits. Ultimately, we may not be able to compete successfully against current and future        competitors. Many competitors offer the types of loans and banking services that we offer.        These competitors include other savings associations, national banks, regional banks and        other community banks. We also face competition from many other types of financial        institutions, including finance companies, brokerage firms, insurance companies, credit        unions, mortgage banks and other financial intermediaries. In particular, the Bank's        competitors include other state and national banks and major financial companies whose        greater resources may afford them a marketplace advantage by enabling them to maintain        numerous banking locations and to mount extensive promotional and advertising        campaigns.

 

Additionally, banks and other financial institutions with larger        capitalization and financial intermediaries not subject to bank regulatory restrictions        have larger lending limits and are thereby able to serve the credit needs of larger        clients. These institutions, particularly to the extent they are more diversified than us,        may be able to offer the same loan products and services that we offer at more competitive        rates and prices. If we are unable to attract and retain banking clients, we may be unable        to continue the Bank's loan and deposit growth and our business, financial condition and        prospects may be negatively affected.

 

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

 

Our        banking operations are located primarily in the Virginia counties of Buchanan, Dickenson,        Lee, Russell, Scott, Smyth, Tazewell, Washington, and Wise, the West Virginia county of        Mercer and the Tennessee counties of Sullivan and Washington. Because our lending is        concentrated in this market, we will be affected by the general economic conditions in the        area. Changes in the economy may influence the growth rate of our loans and deposits, the        quality of the loan portfolio and loan and deposit pricing. A significant decline in        general economic conditions caused by inflation, recession, unemployment or other factors        beyond our control would impact the demand for banking products and services generally,        which could negatively affect our financial condition and performance.

 

15

 

----

***Failure to maintain effective systems of internal and disclosure        control could have a material adverse effect on our results of operation and financial        condition.***

 

Effective internal and disclosure controls are necessary for us to provide        reliable financial reports and effectively prevent fraud and to operate successfully as a        public company. If we cannot provide reliable financial reports or prevent fraud, our        reputation and operating results would be harmed. As part of our ongoing monitoring of        internal control we may discover material weaknesses or significant deficiencies in our        internal control as defined under standards adopted by the Public Company Accounting        Oversight Board, or PCAOB, that require remediation. Under the PCAOB standards, a "material        weakness" is a deficiency, or a combination of deficiencies, in internal control over        financial reporting, such that there is a reasonable possibility that a material        misstatement of the company's annual or interim financial statements will not be prevented        or detected on a timely basis. Management has concluded that, as of December 31, 2007,        our internal control over financial reporting was effective. We cannot guarantee, however,        that internal or disclosure control deficiencies might not be identified or come into        existence at a later date. Any failure to maintain effective controls or to timely effect        any necessary improvement of our internal and disclosure controls could, among other        things, result in losses from fraud or error, harm our reputation or cause investors to        lose confidence in our reported financial information, all of which could have a material        adverse effect on our results of operation and financial condition.

 

| **Item 1B.** | **Unresolved Staff Comments** |
|--------------|-------------------------------|

 

As of March        17, 2008, there were no unresolved comments from the staff of the SEC with respect to any        of New Peoples' periodic or current reports.

 

| **Item 2.** | **Properties** |
|-------------|----------------|

 

At        December 31, 2007, the Company's net investment in premises and equipment in service was        $34.9 million. Our main office and operations center is located in Honaker, Virginia. This        location contains a full service branch, and our administration and operations        center.

 

The Bank        owns 27 of its 30 full service branches. The owned properties in Virginia are located in        Abingdon, Big Stone Gap, Bluefield, Bland, Bristol, Castlewood, Chilhowie, Clintwood, Gate        City, Grundy, Haysi, Honaker, Jonesville, Lebanon, Norton, Pennington Gap, Pound, Pounding        Mill, Richlands, Tazewell, and Weber City. Offices in Princeton, West Virginia and        Bloomingdale and Jonesborough, Tennessee are also owned by the Bank.

 

The Bank        has 3 operating lease arrangements of varying lengths. These full service branches are        located in Bramwell, West Virginia; and in Cleveland, and Davenport, Virginia.

 

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

 

We are        in various stages of construction or development for branch locations in Bluewell and        Princeton, West Virginia; and Duffield, Virginia which we anticipate opening subject to        regulatory approval in 2008.

 

We will        continue to investigate and consider other possible sites that will enable us to profitably        serve our chosen market area. Purchases of premises and equipment in the year 2008 will        depend on the decision to open additional branches.

 

| **Item 3.** | **Legal Proceedings** |
|-------------|-----------------------|

 

In the        course of operations, we may become a party to legal proceedings. We are not aware of any        material pending or threatened legal proceedings.

 

| **Item 4.** | **Submission of Matters to a Vote of Security                        Holders** |
|-------------|--------------------------------------------------------------------------------|

 

None

 

 

16

 

----

**PART II**

 

**Item        5.**  **Market for Registrant's        Common Equity, Related Stockholder Matters and Issuer Purchases of Equity        Securities**

 

| (a) | Market Information |
|-----|--------------------|

The Bank        acts as the transfer agent for New Peoples. At present, there is no public trading market        for our common stock. Trades in our common stock occur sporadically on a local        basis.

 

The high        and low trade prices known to us of our common stock for each quarter in the past two years        are set forth in the table below. Other transactions may have occurred at prices about        which we are not aware.

 

|                               | 2007   | 2006   |
|------------------------------------|--------|--------|
|                               | High   | Low    | High | Low |
| 1st                        quarter | $15.00 | $10.00 | $15.00 | $12.00 |
| 2nd                        quarter | 21.00  | 10.00  | 16.00 | 12.00 |
| 3rd                        quarter | 17.00  | 10.00  | 15.50 | 10.23 |
| 4th                        quarter | 15.00  | 4.00   | 15.25 | 12.00 |

 

The most        recent sales price of which management is aware was $13.00 per share during the first        quarter of 2008.

 

| (b) | Holders |
|-----|---------|

On        February 28, 2008, there were approximately 4,389 shareholders of record.

 

| (c) | Dividends |
|-----|-----------|

On        September 12, 2007, we issued a 13 for 10 stock spit effected in the form of a stock        dividend to all shareholders of record on September 4, 2007. We have never declared a cash        dividend. The declaration of dividends in the future will depend on our earnings and        capital requirements. We are subject to certain restrictions imposed by the reserve and        capital requirements of federal and Virginia banking statutes and regulations.        Additionally, we intend to follow a policy of retaining earnings, if any, for the purpose        of increasing net worth and reserves in order to promote growth and the ability to compete        in our market area. As a result, we do not anticipate paying a dividend on our common stock        in 2008. See Note 14 and Note 18 of the Notes to the Consolidated Financial Statements for        further discussion of dividend limitations and capital requirements.

 

 

17

 

----

(d)        Stock Performance Graph

There        currently is not a public trading market for the Company's Common Stock. The Company,        however, is frequently informed of the sales price at which shares of Common Stock are        exchanged in privately negotiated transactions. Because shares of Common Stock are not        listed or traded on an exchange or in the over-the-counter market, the Company cannot be        certain that the prices at which such shares have historically sold are not higher than the        prices that would prevail in an active market where securities professionals participate.        As a result, the comparisons presented in the following graph do not reflect similar market        conditions.

 

The        following graph compares the Company's cumulative shareholder return on its Common Stock,        assuming an initial investment of $100 and reinvestment of all dividends, with the        cumulative return on the S&P 500, the NASDAQ Composite, and SNL Securities Bank and        Thrift Index using the same assumptions, as of December 31st of each year since        December 31, 2002.

 

 

New        Peoples Bankshares, Inc.

 

|                         |         |                |         |         |         |         |
|------------------------------|--------------|---------------------|--------------|--------------|--------------|--------------|
|                         |         | ***Period Ending*** |         |
| ***Index***                  | **12/31/02** | **12/31/03**        | **12/31/04** | **12/31/05** | **12/31/06** | **12/31/07** |
| New Peoples Bankshares, Inc. | 100.00       | 100.00              | 140.00       | 150.00       | 154.00       | 171.60       |
| S&P 500                  | 100.00       | 128.68              | 142.69       | 149.70       | 173.34       | 182.86       |
| NASDAQ Composite             | 100.00       | 150.01              | 162.89       | 165.13       | 180.85       | 198.60       |
| SNL Bank and Thrift Index    | 100.00       | 135.57              | 151.82       | 154.20       | 180.17       | 137.40       |
|                              |              |                     |              |              |              |              |  |  |  |

 

| **Source : SNL Financial LC, Charlottesville, VA                        2008** |
|--------------------------------------------------------------------------------|

 

 

 

 

----

19

 

**Item        6.****     Selected Financial        Data**

 

The        following consolidated summary sets forth selected financial data for us for the periods        and at the dates indicated. The selected financial data has been derived from our audited        financial statements. The following is qualified in its entirety by the detailed        information and the financial statements included elsewhere in this Form 10-K.

 
|                                                                       | For the Years Ended December 31, |   |     |
|----------------------------------------------------------------------------|----------------------------------|--------|----------|
| (Dollars in thousands, except per share data)                              | 2007                             |   | 2006     |   | 2005 |   | 2004 |   | 2003 |   |   |
| **Income Statement Data**                                                  |                             |   |     |   |   |   |   |   |   |   |   |
| Gross interest income                                                      | $ 51,447                         |   | $ 41,280 |   | $ 30,507 |   | $ 24,265 |   | $ 19,956 |   |   |
| Gross interest expense                                                     | 25,738                           |   | 19,393   |   | 11,279 |   | 6,471 |   | 6,332 |   |   |
| Net interest income                                                        | 25,709                           |   | 21,887   |   | 19,228 |   | 17,794 |   | 13,624 |   |   |
| Provision for possible loan losses                                         | 3,840                            |   | 1,277    |   | 1,130 |   | 990 |   | 364 |   |   |
| Net interest income after provision for loan                        losses | 21,869                           |   | 20,610   |   | 18,098 |   | 16,804 |   | 13,260 |   |   |
| Non-interest income                                                        | 4,651                            |   | 3,460    |   | 2,822 |   | 2,605 |   | 1,802 |   |   |
| Non-interest expense                                                       | 23,674                           |   | 19,805   |   | 16,710 |   | 14,469 |   | 10,801 |   |   |
| Income before income taxes                                                 | 2,846                            |   | 4,265    |   | 4,210 |   | 4,940 |   | 4,261 |   |   |
| Income tax expense (benefit)                                               | (24)                             |   | 1,175    |   | 1,487 |   | 1,682 |   | 1,447 |   |   |
| Net income                                                                 | 2,870                            |   | 3,090    |   | 2,723 |   | 3,258 |   | 2,814 |   |   |
| **Per Share Data and Shares Outstanding                        (1)(2)**    |                             |   |     |   |   |   |   |   |   |
| Net income, basic                                                          | 0.29                             |   | 0.31     |   | 0.27 |   | 0.33 |   | 0.29 |   |
| Net income, diluted                                                        | 0.28                             |   | 0.30     |   | 0.26 |   | 0.32 |   | 0.28 |   |
| Cash dividends                                                             | -                                |   | -        |   | - |   | - |   | - |   |
| Book value at end of period                                                | 4.54                             |   | 4.25     |   | 3.93 |   | 4.02 |   | 3.66 |   |
| Tangible book value at period end                                          | 4.06                             |   | 4.25     |   | 3.93 |   | 4.02 |   | 3.66 |   |
| Weighted average shares outstanding, basic                                 | 9,958                            |   | 9,940    |   | 9,886 |   | 9,880 |   | 9,832 |   |
| Weighted average shares outstanding, diluted                               | 10,372                           |   | 10,345   |   | 10,282 |   | 10,056 |   | 9,920 |   |
| Shares outstanding at period end                                           | 9,959                            |   | 9,954    |   | 9,905 |   | 8,983 |   | 8,974 |   |
|                                                                       |                             |   |     |   |   |   |   |   |   |   |
| **Period-End Balance Sheet Data**                                          |                             |   |     |   |   |   |   |   |   |   |
| Total assets                                                               | 765,951                          |   | 635,819  |   | 527,770 |   | 437,751 |   | 342,508 |   |
| Total loans                                                                | 682,260                          |   | 569,198  |   | 468,045 |   | 383,567 |   | 295,438 |   |
| Total allowance for loan losses                                            | (6,620)                          |   | (4,870)  |   | (3,943) |   | (3,090) |   | (2,432) |   |
| Total deposits                                                             | 657,033                          |   | 572,187  |   | 462,692 |   | 388,120 |   | 308,221 |   |
| Shareholders' equity                                                       | 45,249                           |   | 42,346   |   | 38,964 |   | 36,098 |   | 32,805 |   |
| **Performance Ratios**                                                     |                             |   |     |   |   |   |   |   |   |   |
| Return on average assets                                                   | 0.42%                            |   | 0.54%    |   | 0.56% |   | 0.83% |   | 0.86% |   |
| Return on average shareholders' equity                                     | 6.60%                            |   | 7.61%    |   | 7.28% |   | 9.58% |   | 9.46% |   |
| Average shareholders' equity to average assets                             | 6.34%                            |   | 7.06%    |   | 7.72% |   | 8.64% |   | 9.09% |   |
| Net interest margin (2)                                                    | 4.11%                            |   | 4.11%    |   | 4.38% |   | 5.00% |   | 4.58% |   |
| **Asset Quality Ratios**                                                   |                             |   |     |   |   |   |   |   |   |   |
| Net charge-offs to average loans                                           | 0.34%                            |   | 0.07%    |   | 0.07% |   | 0.10% |   | 0.06% |   |
| Allowance to period-end gross loans                                        | 0.97%                            |   | 0.86%    |   | 0.84% |   | 0.81% |   | 0.82% |   |
| Nonperforming loans to gross loans                                         | 0.47%                            |   | 0.21%    |   | 0.12% |   | 0.23% |   | 0.19% |   |
| **Capital and Liquidity Ratios**                                           |                             |   |     |   |   |   |   |   |   |   |
| Risk-based:                                                                |                             |   |     |   |   |   |   |   |   |   |
| Tier 1 capital                                                             | 8.73%                            |   | 10.81%   |   | 11.78% |   | 12.88% |   | 12.20% |   |
| Total capital                                                              | 10.29%                           |   | 12.20%   |   | 12.71% |   | 13.72% |   | 13.10% |   |
| Leverage capital ratio                                                     | 7.22%                            |   | 8.94%    |   | 9.63% |   | 10.64% |   | 9.29% |   |
| Total equity to total assets                                               | 5.91%                            |   | 6.66%    |   | 7.38% |   | 8.25% |   | 9.58% |   |
|                                                                            |                                  |        |          |  |  |  |  |  |  |  |  |  |

| (1) | We have adjusted all share amounts and per share data to                        reflect a two-for-one stock split of our common stock in January 2002, a                        10% stock dividend in June 2005 and a 13 for 10 stock split effected in the                        form of a stock dividend in September 2007. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | Net interest margin is calculated as tax-equivalent net                        interest income divided by average earning assets and represents our net                        yield on our earning assets. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

20

 

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**Item        7.****     Management's Discussion and        Analysis of Financial Condition and Results of Operations**

 

**Caution        About Forward Looking Statements**

 

We make        forward looking statements in this annual report that are subject to risks and        uncertainties. These forward looking statements include statements regarding our        profitability, liquidity, allowance for loan losses, interest rate sensitivity, market        risk, growth strategy, and financial and other goals. The words "believes," "expects,"        "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends,"        or other similar words or terms are intended to identify forward looking        statements.

 

These        forward looking statements are subject to significant uncertainties because they are based        upon or are affected by factors including the following: the ability to successfully manage        our growth or implement our growth strategies if we are unable to identify attractive        markets, locations or opportunities to expand in the future; maintaining capital levels        adequate to support our growth; maintaining cost controls and asset qualities as we open or        acquire new branches; the successful management of interest rate risk; changes in interest        rates and interest rate policies; reliance on our management team, including our ability to        attract and retain key personnel; changes in general economic and business conditions in        our market area; risks inherent in making loans such as repayment risks and fluctuating        collateral values; competition with other banks and financial institutions, and companies        outside of the banking industry, including those companies that have substantially greater        access to capital and other resources; demand, development and acceptance of new products        and services; problems with technology utilized by us; changing trends in customer profiles        and behavior; and changes in banking and other laws and regulations applicable to        us.

 

Because of        these uncertainties, our actual future results may be materially different from the results        indicated by these forward looking statements. In addition, our past results of operations        do not necessarily indicate our future results. We expressly disclaim any obligation to        update or revise any forward-looking statements, whether as a result of new information,        future events or otherwise, except as required by law.

 

For        additional discussion of risk factors that may cause our actual future results to differ        materially from the results indicated within forward looking statements, please see Item 1A        - Risk Factors herein.

 

**General**

 

The        following commentary discusses major components of our business and presents an overview of        our consolidated financial position at December 31, 2007 and 2006 as well as results of        operations for the years ended December 31, 2007, 2006 and 2005. This discussion should be        reviewed in conjunction with the consolidated financial statements and accompanying notes        and other statistical information presented elsewhere in this Form 10-K.

 

We are        not aware of any current recommendations by any regulatory authorities that, if they were        implemented, would have a material effect on our liquidity, capital resources or results of        operations.

 

New        Peoples generates a significant amount of its income from the net interest income earned by        the Bank.  Net interest income is the difference between interest income and interest        expense.  Interest income depends on the amount of interest-earning assets outstanding        during the period and the interest rates earned thereon. The Bank's interest expense is a        function of the average amount of deposits and borrowed money outstanding during the period        and the interest rates paid thereon.  The quality of the assets further influences the        amount of interest income lost on nonaccrual loans and the amount of additions to the        allowance for loan losses. The Bank also generates noninterest income from service charges        on deposit accounts and commissions on insurance and investment products        sold.

 

**Overview**

 

New        Peoples continued expanding in the year 2007 through new branches in Chilhowie and Bland,        Virginia and Bramwell, West Virginia. In addition, the Bank completed its first acquisition        of two branches in Norton and Pennington Gap, Virginia. At the end of 2007, we have 30        offices throughout southwest Virginia, southern West Virginia and northeastern        Tennessee.

 

The        continued growth of branches resulted in another year of growth in assets, loans and        deposits. Total assets grew to $765.9 million at year-end 2007. This represents a $130.1        million, or 20.47% growth from 2006. Total loans also grew at 19.86%, or $113.1 million, to        $682.3 million at December 31, 2007. Total deposits increased 14.83%, or $84.8 million, to        $657.0 million from $572.2 million at the end of 2006.

 

22

 

----

 

In the        year 2007, the economy started to show some downturn on a national level. This has not        greatly affected the markets that we serve, but it may in the future. Nonperforming loans        has increased from $1.2 million at the end of 2006 to $3.2 million at the end of 2007.        Management has taken the erosion of the economy and the increase in nonperforming loans        into consideration and has taken steps to prepare for a recessionary period. During the        year 2007, we made significant provisions to the allowance for loan loss totaling $3.8        million as compared to $1.3 million in 2006. We have enhanced the methodology of        calculating the allowance for loan losses. In addition, we are tightening credit standards        to minimize risk exposure. The allowance for loan loss at the end of 2007 was $6.6 million,        or 0.97% of total assets, as compared to $4.9 million, or 0.84% of total loans at the end        of 2006. We experienced a large loss of $1.5 million that was discovered subsequent to year        end 2007, but was determined to exist at the end of the period. We are aggressively        pursuing recovery on these credits. Net charge-offs to average loans at the end of 2007 was        0.34% as compared to 0.07% in 2006. As deemed necessary, we will continue to make        provisions to the allowance for loan losses.

 

As a        result of the large provisions to the allowance for loan loss, we experienced a decrease in        net income for the year ending 2007 to $2.9 million from $3.1 million in 2006. Net interest        income grew significantly to $25.7 million in 2007 from $19.4 million in 2006. The net        interest margin remained the same at 4.11%. Noninterest income grew to $4.7 million in 2007        from $3.5 million in 2006 primarily from increased volume in deposit related fees.        Noninterest expense also grew from $19.8 million to $23.7 million in 2007. The largest area        of increase was in salary and benefits from new employees at the new branches. We also        recorded a change of accounting estimate related to bank owned life insurance of $638        thousand resulting in a decrease the income tax expense in 2007.

 

We        anticipate growth to slow down in the coming years. However, there are still some markets        we anticipate entering. To accommodate future growth plans, we may need to raise additional        capital.

 

The        return on average assets was 0.42%, 0.54%, and 0.56%, for the periods ending December 31,        2007, 2006, and 2005, respectively. The return on average equity was 6.60%, 7.61%, and        7.28%, for the same periods ending December 31, 2007, 2006, and 2005,        respectively.

 

We        remain focused on being a community bank that strives to meet the financial service needs        of our customers throughout southwest Virginia, southern West Virginia, and eastern        Tennessee.

 

**Critical Accounting Policies**

 

Certain        critical accounting policies affect the more significant judgments and estimates used in        the preparation of our financial statements. Our most critical accounting policy relates to        our provision for loan losses, which reflects the estimated losses resulting from the        inability of our customers to make required payments. If the financial condition of our        borrowers were to deteriorate, resulting in an impairment of their ability to make        payments, our estimates would be updated, and additional provisions could be required. For        further discussion of the estimates used in determining the allowance for loan losses, we        refer you to the section on "Provision for Loan Losses" in this discussion.

 

**Net        Interest Income and Net Interest Margin**

 

Net        interest income for the year ended 2007 increased to $25.7 million from $21.9 million in        2006. This is an increase of $3.8 million, or 17.35%. The majority of the growth is        related to the increased loan volume during the year. Loan income increased to $50.9        million for 2007 from $40.8 million for 2006, which is an increase of $10.1 million, or        24.83%. Total interest expense was $25.7 million for 2007 as compared to $19.4 million for        2006. This $6.3 million, or 32.47%, increase results mainly from an increase in volume of        time deposits with a premium interest rate originating at the newer branch locations.         See the Volume and Rate Analysis table below.

 

Net        interest income for the year ended December 31, 2006 was $21.9 million, an increase of $2.7        million, or 13.83%, compared to the same period in 2005. The increase in net interest        income was primarily the result of increases in interest income from loans, offset by an        increase in interest expense on deposits, short term borrowings, and trust preferred        securities. During 2006, interest income increased $10.8 million, or 35.31%, as a result of        increased loan volume and interest rates. Total interest expense increased $8.1 million, or        71.94%, during 2006. During 2006, short-term time deposits, borrowings and trust preferred        securities repriced at a faster pace than earning assets. As a result, the interest expense        increased significantly. In addition, deposits gathered at the new offices opened in 2006        were obtained at a premium contributing to an increase in interest expense over the        previous year. Pressure to fund loan growth and increased competition were also factors in        the increase in our cost of funds.

 

 

24

 

----

Despite        Federal Reserve Bank interest rate cuts 2007, we were able to maintain a net interest        margin of 4.11% for the year ending December 31, 2007 and 2006. The net interest margin is        defined as net interest income divided by total interest earning assets. The net interest        margin in 2005 was 4.38%. We are closely monitoring our net interest margin and taking        steps to maximize our net interest margin in a declining interest rate        environment.

 

The        following table shows the rates paid on earning assets and deposit liabilities for the        periods indicated.

 

| **Net Interest Margin Analysis**                                                                                                     |
|--------------------------------------------------------------------------------------------------------------------------------------|
| **Average Balances, Income and Expense, and Yields and                        Rates**                                                |
| (Dollars in thousands)                                                                                                               |
|                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                 |   |   |   | For the Year Ended |   | For the Year Ended |   | For the Year Ended |
|                                                                                                                                 |   |   |   | December 31, 2007 |   | December 31, 2006 |   | December 31, 2005 |
|                                                                                                                                 |   |   |   | Average |   | Income/ |   | Yields/ |   | Average |   | Income/ |   | Yields/ |   | Average |   | Income/ |   | Yields/ |
|                                                                                                                                 |   |   |   | Balance |   | Expense |   | Rates |   | Balance |   | Expense |   | Rates |   | Balance |   | Expense |   | Rates |
| ASSETS                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                 | Loans (1), (2), (3) | $ | 611,101 | $ | 50,884 |   | 8.33% | $ | 521,629 | $ | 40,762 |   | 7.81% | $ | 424,419 | $ | 30,006 |   | 7.07% |
|                                                                                                                                 | Federal funds sold |   | 2,779 |   | 129 |   | 4.64% |   | 3,926 |   | 191 |   | 4.87% |   | 7,593 |   | 256 |   | 3.37% |
|                                                                                                                                 | Other investments (3) |   | 7,421 |   | 254 |   | 3.42% |   | 6,524 |   | 327 |   | 5.01% |   | 7,359 |   | 245 |   | 3.33% |
|                                                                                                                                 | Total Earning Assets |   | 621,301 |   | 51,267 |   | 8.25% |   | 532,079 |   | 41,280 |   | 7.76% |   | 439,371 |   | 30,507 |   | 6.94% |
|                                                                                                                                 | Less: Allowance for loans losses |   | (5,280) |   |   |   |   |   | (4,509) |   |   |   |   |   | (3,516) |   |   |   |   |
|                                                                                                                                 | Non-earning assets |   | 69,372 |   |   |   |   |   | 56,988 |   |   |   |   |   | 48,947 |   |   |   |   |
|                                                                                                                                 |   | Total Assets | $ | 685,393 |   |   |   |   | $ | 584,558 |   |   |   |   | $ | 484,802 |   |   |   |   |
|                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                 |
|                                                                                                                                 | Deposits |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                 | Demand - Interest bearing | $ | 20,957 | $ | 164 |   | 0.78% | $ | 18,907 | $ | 142 |   | 0.75% | $ | 23.160 | $ | 164 |   | 0.71% |
|                                                                                                                                 | Savings |   | 45,135 |   | 485 |   | 1.07% |   | 43,637 |   | 489 |   | 1.12% |   | 44,686 |   | 468 |   | 1.05% |
|                                                                                                                                 | Time deposits |   | 458,369 |   | 22,949 |   | 5.01% |   | 380,658 |   | 17,004 |   | 4.47% |   | 310,305 |   | 9,935 |   | 3.20% |
|                                                                                                                                 | Other Borrowings |   | 15,820 |   | 857 |   | 5.42% |   | 14,534 |   | 754 |   | 5.19% |   | 1,281 |   | 43 |   | 3.36% |
|                                                                                                                                 | Trust Preferred Securities |   | 16,496 |   | 1,283 |   | 7.78% |   | 12,683 |   | 1,004 |   | 7.92% |   | 11,341 |   | 669 |   | 5.90% |
|                                                                                                                                 | Total interest bearing liabilities |   | 556,777 |   | 25,738 |   | 4.62% |   | 470,419 |   | 19,393 |   | 4.12% |   | 390.773 |   | 11,279 |   | 2.89% |
|                                                                                                                                 | Non-interest bearing deposits |   | 79,932 |   |   |   |   |   | 69,267 |   |   |   |   |   | 54,218 |   |   |   |   |
|                                                                                                                                 | Other liabilities |   | 5,206 |   |   |   |   |   | 4,264 |   |   |   |   |   | 2,395 |   |   |   |   |
|                                                                                                                                 |   | Total Liabilities |   | 641,915 |   |   |   |   |   | 543,950 |   |   |   |   |   | 447,386 |   |   |   |   |
|                                                                                                                                 | Stockholders' Equity |   | 43,477 |   |   |   |   |   | 40,608 |   |   |   |   |   | 37,416 |   |   |   |   |
|                                                                                                                                 |   | Total Liabilities and Stockholders' Equity | $ | 685,393 |   |   |   |   | $ | 584,558 |   |   |   |   | $ | 484,802 |   |   |   |   |
|                                                                                                                                 | Net Interest Income |   |   | $ | 25,529 |   |   |   |   | $ | 21,887 |   |   |   |   | $ | 19,228 |   |   |
|                                                                                                                                 | Net Interest Margin |   |   |   | 4.11% |   |   |   |   |   | 4.11% |   |   |   |   |   | 4.38% |
|                                                                                                                                 | Net Interest Spread |   |   |   | 3.63% |   |   |   |   |   | 3.64% |   |   |   |   |   | 4.05% |
|                                                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (1) Non-accrual loans are not significant and have been                        included in the average balance of loans outstanding. |
| (2) Loan fees are not material and have been included in                        interest income on loans.                            |
| (3) Tax exempt income is not significant and has been                        treated as fully taxable.                               |
|                                                                                                                                      |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net        interest income is affected by changes in both average interest rates and average volumes        of interest-earning assets and interest-bearing liabilities. The following table sets forth        the amounts of the total changes in interest income and expense which can be attributed to        rate (change in rate multiplied by old volume) and volume (change in

 

25

 

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volume        multiplied by old rate) for the periods indicated. The change in interest due to both        volume and rate has been allocated to the change due to rates.

 

26

 

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| **Volume and Rate Analysis**  |
|-------------------------------|
| (Dollars in thousands)        |
|                          |   |   |   |   |
|                          |   | 2007 Compared to 2006 |   | 2006 Compared to 2005 |
|                          |   | Increase (Decrease) |   | Increase (Decrease) |
|                          |   |   | Volume Effect |   | Rate Effect |   | Change in Interest Income/ Expense |   |   | Volume Effect |   | Rate Effect |   | Change in Interest Income/ Expense |
| Interest Income:              |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          | Loans | $ | 6,992 | $ | 3,130 | $ | 10,122 |   | $ | 6,873 | $ | 3,883 | $ | 10,756 |
|                          | Federal funds sold |   | (56) |   | (6) |   | (62) |   |   | (124) |   | 59 |   | (65) |
|                          | Other investments |   | 45 |   | (118) |   | (73) |   |   | (28) |   | 110 |   | 82 |
|                          | Total Earning Assets |   | 6,981 |   | 3,006 |   | 9,987 |   |   | 6,721 |   | 4,051 |   | 10,773 |
|                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing Liabilities: |   |   |   |   |   |   |   |   |   |   |
|                          | Demand |   | 15 |   | 7 |   | 22 |   |   | (30) |   | 8 |   | (22) |
|                          | Savings |   | 18 |   | (21) |   | (3) |   |   | (10) |   | 31 |   | 21 |
|                          | All other time deposits |   | 3,471 |   | 2,474 |   | 5,945 |   |   | 2,251 |   | 4,823 |   | 7,074 |
|                          | Other borrowings |   | 67 |   | 32 |   | 99 |   |   | 445 |   | 261 |   | 706 |
|                          | Trust Preferred Securities |   | 302 |   | (23) |   | 279 |   |   | 79 |   | 256 |   | 335 |
|                          | Total Interest Bearing Liabilities |   | 3,873 |   | 2,469 |   | 6,342 |   |   | 2,736 |   | 5,378 |   | 8,114 |
|                          | Change in Net Interest Income | $ | 3,108 | $ | 537 | $ | 3,645 |   | $ | 3,986 | $ | (1,327) | $ | 2,659 |

 

**Loans**

 

Our        primary source of income comes from interest earned on loans receivable. We have continued        to have strong loan demand as evidenced by annual increases of $113.1 million, $101.2        million, and $84.5 million for the years 2007, 2006, and 2005, respectively. A schedule of        loans by type is set forth immediately below. Approximately 73.51% of the loan portfolio is        secured by real estate at the end of 2007.

 

Loans        receivable outstanding are summarized as follows:

 

**Loan        Portfolio**

|                                   |   |    |   | December 31, |   |    |
|----------------------------------------|--------|---------|--------|--------------|--------|---------|
| (Dollars in thousands)                 |   | 2007    |   | 2006         |   | 2005    |   | 2004 |   | 2003 |
| Commercial, financial and agricultural | $      | 121,198 | $      | 104,372      | $      | 93,987  | $ | 70,915 | $ | 58,593 |
| Real estate - construction             |   | 38,420  |   | 37,716       |   | 26,267  |   | 11,332 |   | 7,258 |
| Real estate - mortgage                 |   | 463,079 |   | 371,021      |   | 301,740 |   | 255,925 |   | 185,191 |
| Installment loans to individuals       |   | 59,563  |   | 56,089       |   | 46,051  |   | 45,395 |   | 44,396 |
| Total                                  | $      | 682,260 | $      | 569,198      | $      | 468,045 | $ | 383,567 | $ | 295,438 |

 

Our loan        maturities as of December 31, 2007 are shown in the following table:

 

**Maturities of Loans**

| (Dollars in thousands)       | Less than One Year   |   | One to Five Years |   | After Five Years |   | Total   |
|------------------------------|----------------------|--------|-------------------|--------|------------------|--------|---------|
| Commercial and agriculture   | $   68,861 | $      | 35,663            | $      | 13,098           | $      | 117,622 |
| Real estate                  | 195,459              |   | 185,246           |   | 112,655          |   | 493,360 |
| Consumer- installment/ other | 9,741                |   | 47,360            |   | 4,559            |   | 61,660  |
| Total                        | $ 274,061            | $      | 268,269           | $      | 130,311          | $      | 672,642 |
|                         |                 |   |              |   |             |   |    |
| Loans with fixed rates       | $   55,027 | $      | 129,481           | $      | 126,233          | $      | 310,741 |
| Loans with variable rates    | 219,034              |   | 138,788           |   | 4,079            |   | 361,901 |
| Total                        | $ 274,061            | $      | 268,269           | $      | 130,312          | $      | 672,642 |

 

 

26

 

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This        above table reflects the earlier of the maturity or re-pricing dates for loans at December        31, 2007. In preparing this table, no assumptions are made with respect to loan        prepayments. Loan principal payments are included in the earliest period in which the loan        matures or can be re-priced. Principal payments on installment loans scheduled prior to        maturity are included in the period of maturity or re-pricing.

 

**Provision for Loan Losses**

 

The        calculation of the allowance for loan losses is considered a critical accounting policy.        The adequacy of the allowance for loan losses is based upon management's judgment and        analysis. The following factors are included in our evaluation of determining the adequacy        of the allowance: risk characteristics of the loan portfolio, current and historical loss        experience, concentrations and internal and external factors such as general economic        conditions.

 

The        allowance for loan losses increased to $6.6 million at December 31, 2007 as compared to        $4.9 million at December 31, 2006. The allowance for loan losses at the end of 2007 was        approximately 0.97% of total loans as compared to 0.84% at the end of 2006. Net loans        charged off for 2007 were $2.1 million, or 0.34% of average loans, and $350 thousand, or        0.07% of average loans, at the end of 2006. The provision for loan losses was $3.8 million        for 2007 as compared with $1.3 million for 2006 and $1.1 million in 2005.

 

Certain        risks exist in the Bank's loan portfolio. Since the Bank began in 1998, we have experienced        significant loan growth each year. Although we have experienced lenders who are familiar        with their customer base, some of the loans are too new to have exhibited signs of        weakness. Recent expansions into new markets increase potential credit risk. In addition, a        majority of the loans are collateralized by real estate located in our market area. It is        our policy to sufficiently collateralize loans to minimize loss exposures in case of        default. The recent negative trends in the national real estate market and economy pose        potential threats. Local real estate market values have been and remain stable, while        national real estate markets have experienced a downturn. It is uncertain as to when or if        current real estate values will be impacted. We do not believe that there will be a        severely negative effect in our market area, but we deem it prudent to assign more of the        allowance to these types of loans. The market area is somewhat diverse, but certain areas        are more reliant upon agriculture and coal mining. As a result, increased risk of loan        impairments is possible if these industries experience a significant downturn. However, we        do not foresee this happening in the near future. We consider these factors to be the        primary higher risk characteristics of the loan portfolio.

 

Given        the current market environment and the risks in the Bank's loan portfolio, we are        addressing them by making the following improvements to the credit administration process.        In January 2008, we hired a Chief Credit Officer to oversee the credit administration        function of the Bank. We also have further evaluated our loan portfolio by engaging a third        party loan review company who conducted a loan review in January 2008. We are currently        reorganizing the credit administration area to create greater efficiency and to enhance the        credit underwriting process. In addition, a new loan policy is being developed better        addressing the risk factors.

 

All        internal and external factors are considered in determining the adequacy of the allowance        for loan losses. We have enhanced the methodology of the calculation of the allowance for        loan losses during 2007. As the loan portfolio becomes more mature, we have identified        where more of our risks lie from a historical loss perspective. As a result, we have        modified our loss analysis portion of the allowance to be the average of the past three        years' losses. In addition, we are identifying where concentrations in specific industries        exist. We have also enhanced our impairment analysis of watch list credits by more        conservatively estimating liquidation costs. As economic conditions and performance of our        loans change, it is possible that future increases may need to be made to the allowance for        loan losses.

 

An        evaluation of individual loans is performed by the internal loan review department. Loans        are initially risk rated by the originating loan officer. If deteriorations in the        financial condition of the borrower and the capacity to repay the debt occur, along with        other factors, the loan may be downgraded. This is typically determined by either the loan        officer or loan review personnel. Guidance for the evaluation is established by the        regulatory authorities who periodically review the Bank's loan portfolio for compliance.        Classifications used by the Bank are exceptional, very good, standard, acceptable,        transitory risk, other assets especially mentioned, substandard, doubtful and        loss.

 

Due to        the risk factors previously mentioned, all loans classified as other assets especially        mentioned, substandard, doubtful and loss are individually reviewed for impairment. An        evaluation is made to determine if the collateral is sufficient for each of these credits.        If an exposure exists, a specific allowance is directly made for the amount of the        potential loss. The evaluation is inherently subjective as it requires estimates that are        susceptible to significant revision as more information becomes available. Impaired loans        increased to $9.6 million with a valuation allowance of $1.2 million at December 31, 2007        as compared to $1.4 million with a valuation allowance of $82 thousand at

 

27

 

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December        31, 2006. The increase in the valuation allowance is primarily attributed to the following        credits: a hotel credit totaling $3.3 million with an estimated exposure of $315 thousand,        an auto dealer credit relationship of $876 thousand with an estimated $150 thousand        exposure, a small business loan of $411 thousand with an estimated exposure of $332        thousand, a $114 small business loan with a $102 thousand exposure, and a $1.4 million        commercial real estate loan with an estimated exposure of $103 thousand. These impaired        loans totaling $6.0 million comprise 62.73% of the total impaired loans. The respective        valuation allowance for these credits totals $1.0 million, or 78.71% of the total valuation        allowance. Great efforts are being made to minimize future losses on these credits. As        economic conditions and performance of our loans change, it is possible that future        increases may be needed to the allowance for loan losses. The following table provides a        summary of the activity in the allowance for loan losses.

 

**Analysis of the Allowance for Loan Losses**

(Dollars        in thousands)

For the Years Ended December 31,

                  

| Activity                                |   | 2007    |   | 2006   |   | 2005   |   | 2004   |   | 2003   |
|-----------------------------------------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|
| Beginning Balance                       | $      | 4,870   | $      | 3,943  | $      | 3,090  | $      | 2,432  | $      | 2,224  |
| Provision charged to expense            |   | 3,840   |   | 1,277  |   | 1,130  |   | 990    |   | 364    |
| Loan Losses:                            |   |    |   |   |   |   |   |   |   |   |
| Installment loans to individuals        |   | (284)   |   | (223)  |   | (266)  |   | (285)  |   | (180)  |
| Real estate mortgage                    |   | (181)   |   | (148)  |   | (28)   |   | (8)    |   | -      |
| Commercial loans                        |   | (1,701) |   | (52)   |   | (4)    |   | (59)   |   | (7)    |
| Recoveries:                             |   |    |   |   |   |   |   |   |   |   |
| Installment loans to individuals        |   | 50      |   | 29     |   | 19     |   | 20     |   | 31     |
| Real estate mortgage                    |   | 6       |   | 44     |   | 2      |   | -      |   | -      |
| Commercial loans                        |   | 20      |   | -      |   | -      |   | -      |   | -      |
| Net charge offs                         |   | (2,090) |   | (350)  |   | (277)  |   | (332)  |   | (156)  |
| Balance at End of Period                | $      | 6,620   | $      | 4,870  | $      | 3,943  | $      | 3,090  | $      | 2,432  |
| Net charge offs as a % of average loans |   | 0.34%   |   | 0.07%  |   | 0.07%  |   | 0.10%  |   | 0.06%  |

 

Loans        delinquent greater than 90 days still accruing interest and loans in non-accrual status        present a higher risks. As of December 31, 2007, there were 57 loans in non-accrual status        totaling $2.9 million, or 0.43% of total loans. The amount of interest that would have been        recognized on these loans in the year 2007 was $227 thousand. There were 13 loans greater        than 90 days past due and still accruing interest totaling $267 thousand, or 0.04% of total        loans. It is our policy to stop accruing interest on a loan, and to classify that loan as        non-accrual, under the following circumstances: (a) whenever we are advised by the borrower        that scheduled payment or interest payments cannot be met, (b) when our best judgment        indicates that payment in full of principal and interest can no longer be expected, or (c)        when any such loan or obligation becomes delinquent for 90 days unless it is both well        secured and in the process of collection. Non-accrual loans did not have a significant        impact on interest income in any of the periods presented. No loans are classified as        troubled debt restructurings as defined by Financial Accounting Standards Board's (FASB)        Statement of Financial Accounting Standards (SFAS) No. 15, "Accounting by Debtors and        Creditors for Troubled Debt Restructurings." There are also no loans identified as        "potential problem loans." We do not have any commitments to lend additional funds to        non-performing debtors. Following is a summary of non-accrual and past due loans greater        than 90 days still accruing interest:

 

**Non-Accrual and Past Due Loans**

(Dollars        in thousands)

|   | December 31,                                      |   |
|--------|---------------------------------------------------|--------|
|   |                                              |   | 2007 |   | 2006 |   | 2005 |   | 2004 |   | 2003 |
|   | Non-accruing loans                                | $      | 2,946 | $ | 1,206 | $ | 446 | $ | 773 | $ | 539 |
|   | Loans past due 90 days or more and still accruing |   | 267 |   | 9 |   | 116 |   | 115 |   | 26 |
|   | Total                                             | $      | 3,213 | $ | 1,215 | $ | 562 | $ | 888 | $ | 565 |
|   | Percent of total loans                            |   | 0.47% |   | 0.21% |   | 0.12% |   | 0.23% |   | 0.19% |
|        |                                                   |        |  |  |  |  |  |  |  |  |  |  |  |

 

Loss        experience in the loan portfolio increased at the end of 2007. Subsequent to December 31,        2007, we became aware of two credits totaling $1.5 million that were not able to repay and        determined that the impairment existed as of December 31, 2007 and were losses;        consequently, we charged off these credits. This $1.5 million charge off was 71.43% of the        total charge off for 2007. Extensive efforts are underway to recover this loss. Otherwise,        historical losses have been minimal.

 

We have        allocated the allowance according to the amount deemed to be reasonably necessary to        provide for the possibility of losses being incurred within each of the categories of        loans. The allocation of the allowance as shown in the following table should not be        interpreted as an indication that loan losses in future years will occur in the        same

 

29

 

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proportions or that the allocation indicates future loan loss trends.        Furthermore, the portion allocated to each loan category is not the total amount available        for future losses that might occur within such categories since the total allowance is a        general allowance applicable to the entire portfolio.

 

The        allocation of the allowance for loan losses is based on our judgment of the relative risk        associated with each type of loan. We have allocated 21.14% of the allowance to cover real        estate loans, which constituted 73.51% of our loan portfolio at December 31, 2007. The        allocation reflects their lower risk. Residential mortgage loans are secured by real estate        whose value tends to be easily ascertainable. These loans are made consistent with        appraisal policies and real estate lending policies, which detail maximum loan-to-value        ratios and maturities.

 

We have        allocated 49.14% of the allowance to commercial loans, which constituted 17.76% of our loan        portfolio at December 31, 2007. This allocation is due to the fact that commercial loans        have more risk than residential real estate loans. Commercial business loans typically are        made on the basis of the borrower's ability to make repayment from cash flow from its        business and are secured by business assets, such as commercial real estate, accounts        receivable, equipment and inventory. As a result, the availability of funds for the        repayment of commercial business loans may be substantially dependent on the success of the        business itself.

 

We have        allocated 29.72% of the allowance to consumer installment loans, which constituted 8.73% of        our loan portfolio at December 31, 2007. Consumer installment loans entail greater risk        than commercial or real estate loans, because the loans may be unsecured, such as lines of        credit, or secured by rapidly depreciable assets such as automobiles. In addition, consumer        loan collections are dependent on the borrower's continuing financial stability, and thus        are more likely to be adversely affected by job loss, divorce, illness or personal        bankruptcy. Losses related to consumer loans have been influenced by the increase in        personal bankruptcies in recent years. To date, the largest majority of all loans charged        off by the Bank have been consumer loans.

 

In 2007,        we changed the allocations to assign greater risk to real estate loans and commercial        loans. The reason for the changes to these two categories is the increased growth in these        areas over the past years versus the growth in consumer loans. We are not aware of any        significant changes in the composition of the loan portfolio or known risk factors that        would result in a change to the allocation of the allowance for loan losses during the        periods presented other than those mentioned above.

 

The        following table shows the balance and percentage of our allowance for loan losses allocated        to each major category of loans.

 

**Allocation of the Allowance for Loan Losses**

**December 31, 2003 through December 31, 2007**

(Dollars        in thousands)

|                                        |   | December 31,                        2007 |           | December 31,                        2006 |   | December 31,                        2005 |
|---------------------------------------------|--------|------------------------------------------|----------------|------------------------------------------|--------|------------------------------------------|
|                                        |   | Amount                                   |  

  | % of                        ALLL         |   | %of                        Loans         |   | Amount |   | % of                        ALLL |   | %of                        Loans |   | Amount |   | % of                        ALLL |   | % of                        Loans |
| Commercial                                  | $      | 3,254                                    |           | 49%                                      |   | 17.76%                                   | $ | 1,704 |   | 35% |   | 18.34% | $ | 1,380 |   | 35% |   | 20.08% |
| Real estate                        mortgage |   | 1,399                                    |           | 21%                                      |   | 73.51%                                   |   |  

974 |   | 20% |   | 71.81% |   | 789 |   | 20% |   | 70.08% |
| Installment                                 |   | 1,967                                    |           | 30%                                      |   | 8.73%                                    |   | 2,192 |   | 45% |   | 9.85% |   | 1,774 |   | 45% |   | 9.84% |
|                                        |   |                                     |           |                                     |   |                                     |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                       | $      | 6,620                                    |           | 100%                                     |   | 100.00%                                  | $ | 4,870 |   | 100% |   | 100.00% | $ | 3943 |   | 100% |   | 100% |
|                                        |   |                                     |           |                                     |   |                                     |   |   |   |   |   |   |   |   |   |   |   |   |
|                                        |   | December 31,                        2004 |           | December 31.                        2003 |   |                                     |   |   |   |   |
|                                        |   |  

Amount                           |           | % of                        ALLL         |   | % of                        Loans        |   |  

Amount |   | % of                        ALLL |   | % of                        Loans |   |   |   |   |   |   |
| Commercial                                  | $      | 1,081                                    |           | 35%                                      |   | 18.49%                                   | $ | 851 |   | 35% |   | 19.83% |   |   |   |   |   |   |
| Real estate                        mortgage |   |  

618                              |           |  

20%                              |   |  

69.67%                           |   |  

486 |   |  

20% |   |  

65.14% |   |   |   |   |   |   |
| Installment                                 |   | 1,391                                    |           | 45%                                      |   | 11.83%                                   |   | 1095 |   | 45% |   | 15.03% |   |   |   |   |   |   |
| Unallocated                                 |   | -                                        |           | -%                                       |   |                                     |   | - |   | -% |   |   |   |   |   |   |   |   |
| Total                                       | $      | 3,090                                    |           | 100%                                     |   | 100.00%                                  |   | 2,432 |   | 100% |   | 100.00% |   |   |   |   |   |   |

 

**Investment Securities**

 

Total        investment securities increased to $5.0 million at December 31, 2007 from $3.5 million at        December 31, 2006. The portfolio is made up mainly of U. S. Government Agency securities        with fairly short maturities and one mortgage backed security. All securities are        classified as available for sale for liquidity purposes. The carrying amount of certain        securities totaling $3.5 million are pledged by us to secure public deposits at December        31, 2007.

 

 

30

 

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The        Bank, as a member of the Federal Reserve Bank and the Federal Home Loan Bank, is required        to hold stock in each. These equity securities are restricted from trading and are recorded        at a cost of $4.3 million and $2.2 million as of December 31, 2007 and 2006,        respectively.

 

The        carrying values of investment securities are shown in the following table:

 

**Investment Securities Portfolio**

(Dollars        in thousands)

| December 31,               |   | 2007      |   | 2006   |   | 2005      |
|----------------------------|--------|-----------|--------|--------|--------|-----------|
|                       |   | Amortized |   | Fair   |   | Amortized |   | Fair |   | Amortized |   | Fair |
|                       |   | Cost      |   | Value  |   | Cost      |   | Value |   | Cost |   | Value |
| Available for Sale         |   |      |   |   |   |      |   |   |   |   |   |   |
| U.S. Government Agencies   | $      | 4,495     | $      | 4,502  | $      | 3,490     | $ | 3,493 | $ | 6,185 | $ | 6,163 |
| Mortgage backed securities |   | 467       |   | 472    |   | -         |   | - |   | - |   | - |
| Total Securities AFS       | $      | 4,962     | $      | 4,974  | $      | 3,490     | $ | 3,493 | $ | 6,185 | $ | 6,163 |

 

The        amortized cost, fair value and weighted average yield of investment securities at        December 31, 2007, by contractual maturity, are shown in the following schedule.        Expected maturities will differ from contractual maturities because issuers may have the        right to call or prepay obligations with or without call or prepayment        penalties.

 

**Maturities of Securities**

(Dollars        in thousands)

|                                  |   |      |   |   |   | Weighted |
|---------------------------------------|--------|-----------|--------|--------|--------|----------|
|                                  |   | Amortized |   | Fair   |   | Average  |
| Securities Available for Sale         |   | Cost      |   | Value  |   | Yield    |
| Due in one year or less               | $      | 1,994     | $      | 1,997  |   | 4.64%    |
| Due after one year through five years |   | 2,968     |   | 2,977  |   | 5.29%    |
| Total                                 | $      | 4,962     | $      | 4,974  |   | 5.02%    |

 

**Deposits**

 

Total        deposits as of December 31, 2007 were $657.0 million as compared to $572.2 million at        December 31, 2006. This is an increase of $84.8 million, or 14.83%. This growth is        attributed to the branches purchased in Norton and Pennington Gap, Virginia along with the        new branches that were opened in 2007.

 

The        largest areas of growth were in non-interest demand and time deposits. Noninterest bearing        demand deposits increased $12.1 million, or 16.97%, to $83.7 million in 2007 from $71.5        million in 2006. Interest-bearing demand deposits increased by $7.6 million, or 39.23%, to        $26.9 million in 2007 from $19.3 million in 2006. Savings deposits increased $1.8 million,        or 4.26%, to $44.7 million in 2007 from $42.9 million in 2006. Time deposits increased by        $63.3 million, or 14.44%, from $438.5 million in 2006 to $501.8 million in 2007.

 

Time        deposits of $100,000 or more equaled approximately 26.65% of deposits at the end of 2007        and 26.08% of deposits at the end of 2006. We do not have brokered deposits and internet        accounts are limited to customers located in the surrounding geographical area. The average        balance of and the average rate paid on deposits is shown in the net interest margin        analysis above.

 

Maturities of time certificates of deposit of $100,000 or more outstanding        are summarized as follows:

 

| **Maturities of Time Deposits of $100 Thousand and                        More** |
|----------------------------------------------------------------------------------|
| (Dollars in thousands)                                                           |
| December 31, 2007                                                                |
| Three months or less                                                             | **$** | 47,938 |
| Over three months through six months                                             |   | 57,373 |
| Over six months through twelve months                                            |   | 27,912 |
| Over one year                                                                    |   | 41,859 |
| Total                                                                            | **$** | 175,082 |

                               

 

31

 

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**Noninterest Income**

 

Noninterest income increased from $3.5 million in 2006 to $4.7 million in        2007. This is an increase of $1.2 million for the year, or 34.41%. Service charges,        including overdraft fees, increased from $2.0 million for 2006 to $2.4 million for 2007, an        increase of $423 thousand, or 20.81%. This increase is due to increased volume in demand        deposit accounts. Fees increased to $994 thousand in 2007 from $414 thousand in 2006, an        increase of $580 thousand, or 140.05%. This is largely due to reclassifying ATM service        fees from net fees to gross fees. Noninterest expenses are adjusted accordingly. Insurance        and investment fees are fees generated primarily from the sale of life insurance,        annuities, mutual funds, health insurance and other investments. Insurance and investment        commissions continued to increase from $606 thousand in 2006 to $769 thousand in        2007.

 

In 2006,        noninterest income increased $638 thousand, or 22.59%, to $3.5 million from $2.8 million in        2005. The major sources of noninterest income include service charges on deposit accounts        and insurance and investment fees. Service charges increased to $2.0 million in 2006 from        $1.7 million in 2005. This $325 thousand, or 19.04%, increase is primarily attributed to        overdraft fees generated by increased volume of deposit accounts. Insurance and investment        commissions grew by $225 thousand, or 59.03%, from $381 thousand in 2005 to $606 thousand        in 2006.

 

Noninterest income as a percentage of average assets increased to 0.68% in        2007 from 0.59% in 2006 and from 0.57% in 2005. We anticipate this percentage to increase        in 2008 as we increase noninterest income from our nonbank subsidiaries and from increased        service charges.

 

**Noninterest Expense**

 

Noninterest expenses totaled $23.7 million in 2007 as compared to $19.8        million in 2006, an increase of $3.9 million, or 19.53%. The increase in noninterest        expense directly relates to the new branches opened. We are continuing to build our branch        network in the market areas we serve and contiguous markets. As we grow the branch network,        additional staffing is needed. As a result, we expect noninterest expenses to continue to        increase in coming years, but we anticipate it to be at a lower pace.

 

Noninterest expense increased $3.1 million, or 18.52%, from $16.7 million in        2005 to $19.8 million in 2006. The majority of the increase is related to the expenses        associated with the new branches. During 2006, we added four new branch locations. At the        end of 2006, we had 25 full service branch locations.

 

Salaries        and benefits expense are our highest noninterest expenses. In the year 2007, salaries and        benefits were $14.0 million as compared to $11.8 million in 2006. This $2.2 million        increase, or 17.98%, is related to the new branches opened and a full recognition of        salaries and benefits of employees added in 2006. This expense was $10.0 million in 2005,        or an increase of $1.8 million, or 18.11% to 2006.  This increase also is related to        the new branches opened during the period and a full recognition of salaries and benefits        added in 2005.

 

Occupancy and equipment expenses directly correlate with branch expansion.        Occupancy expense increased $347 thousand, or 24.28%, to $1.8 million for 2007 as compared        to $1.4 million for 2006. An increase of $307 thousand, or 27.36% occurred in 2006 from        $1.1 million in 2005. Equipment expense for the year 2007 was $2.3 million as compared to        $2.0 million in 2006. Equipment expense for the period of 2006 increased $248 thousand, or        14.39% from $1.7 million in 2005. Other expenses increased from $3.9 million for 2006 to        $4.9 million in 2007. An increase of FDIC assessment fees of $307 thousand for the period        of 2007 to $367 thousand from $$60 thousand was incurred under the new regulation. We        anticipate this expense to continue to increase.

 

The        ratio of noninterest expense as a percentage of average assets slightly increased in 2007        to 3.45% from 3.39% in 2006. The prior period for the year ending 2006 decreased from 3.44%        in 2005. We expect greater efficiencies to result as we maximize the performance of our        branches. Our efficiency ratio, which is defined as noninterest expense divided by the sum        of net interest income plus noninterest income, was 77.98% for 2007 as compared to 78.14%        for 2006 and 75.74% for 2005.

 

**Goodwill        and Other Intangible Assets**

 

At the end        of the second quarter 2007, we purchased two offices in Norton and Pennington Gap, Virginia        from FNB Southeast. As a result of the branches acquired, the Bank recorded an asset of        goodwill totaling $4.1 million and a core deposit intangible of $810 thousand. The core        deposit intangible will be amortized using the sum-of-the-years-digits method over its        estimated economic life of 6.84 years. During 2007, $103 thousand was amortized, resulting        in a net core deposit intangible of $707 thousand.

 

32

 

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**Life        Insurance and Related Change of Accounting Estimate**

 

We have        life insurance policies with three insurance companies on the lives of four key officers.        The Bank is the beneficiary under each policy. The total cash surrender value of the        policies was $9.7 million and $9.4 million at December 31, 2007 and December 31, 2006,        respectively. Total income for the policies during 2007 was $433 thousand as compared to        $408 thousand and $393 thousand for the years ending 2006 and 2005, respectively. The        minimum guaranteed rate on each of the policies is 4.00%.

 

In the        latter part of 2006 and in January 2007, management began exploring the option to purchase        additional bank owned life insurance to financially protect the Company in case of the        death of other key employees. During the first half of 2007, due diligence was conducted on        products and companies. During this process, the option to purchase separate account bank        owned life insurance became available to the Company in addition to the traditional general        account bank owned life insurance product. The primary difference between the two is that        the separate account product offers the Company greater flexibility in investing the funds        to yield a higher return and also a larger variety of investments to choose. The earnings        stream of the investment is managed through a stable wrap provider. General account        products are sold directly by a particular insurance company which makes the investment        choices and gives substantially less flexibility in investment options. In addition,        separate account products may be classified as a 20% risk weight for capital regulatory        calculations as opposed to 100% risk weights for the general account products. The separate        account product has typically been offered to large financial institutions, but now it is        available to smaller community banks. The Company's past asset size and capital levels did        not qualify us for separate account bank owned life insurance. But now since the Company        has experienced asset and capital growth, the option to purchase and like-kind exchange, or        1035 exchange, the existing policies of $9.7 million became availalble.  As a result,        management decided to purchase the separate account product and 1035 exchange the existing        policies.

 

Up until        this time, the intention of management left the option open to cash in the existing        policies before the death of the insured officers. This created a deferred tax liability on        the earnings of the policies which typically would be tax exempt since they are life        insurance proceeds. Management, the BOLI and Compensation Committees met and decided in        August 2007 to change existing policies and any new purchases of bank owned life insurance        to the separate account product. The Board of Directors ratified this decision in September        2007. As a result, management changed its intention to keep the life insurance policies        until the death of the insured.

 

This        resulted in a change of accounting estimate. As a result, the deferred taxes were adjusted        by $638 thousand and income tax expense was reduced by the same amount during the third        quarter of 2007.

 

**Income Taxes**

 

Due to        timing differences between book and tax treatment of several income and expense items, a        deferred tax asset of $1.1 million existed at December 31, 2007 as compared to a deferred        tax liability of $248 thousand at December 31, 2006. The deferred tax asset represents        decreases to future income tax liabilities from future increased deductions for allowance        for loan losses. The deferred tax liability represents increases to future income tax        liabilities from future decreased deductions for depreciation, increases to income from        unrealized accretion, and increases to deductions related to the allowance for loan losses.        Our income tax expense was computed at the normal corporate income tax rate of 34% of        taxable income included in net income. We do not have significant nontaxable income or        nondeductible expenses.

 

**Capital**

 

Total        capital at the end of 2007 was $45.2 million compared to $42.3 million in 2006. The        increase was $2.9 million, or 6.86%. We remain well-capitalized at the end of 2007, as        defined by the capital guidelines of regulatory agencies. Capital as a percentage of total        assets was 5.91% at December 31, 2007 compared to 6.66% at December 31, 2006.

 

We        anticipate total asset growth to slow down in the near future. With the high amount of        growth we have experienced historically and with the purchase of the two branches in June        2007, we have rapidly utilized the capital of the Company to expand throughout Southwest        Virginia, southern West Virginia, and eastern Tennessee. We still have targeted markets        that we plan to enter and, as a result, may need to raise additional capital to meet these        strategic plans.

 

33

 

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During        the third quarter of 2007, the board of directors approved a 13 for 10 stock split effected        in the form of a stock dividend to shareholders of record on September 4, 2007 and paid on        September 12, 2007.

 

No cash        dividends have been paid historically and none are anticipated in the foreseeable future.        New Peoples' strategic plan is to continue growing but at a slower pace. Earnings will        continue to be retained until the board of directors considers it prudent to pay cash        dividends.

 

**Trust        Preferred Securities**

 

At        December 31, 2007, trust preferred securities totaled $16.5 million with related interest        expense for the year ending 2007 of $1.3 million. Of the total trust preferred securities,        $13.5 million is considered Tier 1 capital. The remaining $3.0 million is considered Tier 2        capital and will be transferred to Tier 1 capital over time as capital levels increase from        retained earnings.

 

**Liquidity**

 

At        December 31, 2007 and 2006, liquid assets in the form of cash, due from banks and federal        funds sold were approximately $22.3 million and $19.9 million, respectively. At December        31, 2007 and 2006 all of our investments are classified as available-for-sale providing an        additional source of liquidity. At the end of 2007, $3.5 million of the $5.0 million        investment portfolio is pledged as collateral for public funds. We believe that our liquid        assets were adequate at both dates.

 

In the        event we need additional funds, we have the ability to purchase federal funds under        established lines of credit totaling $20.4 million. We may also borrow up to $111.7 million        from the Federal Home Loan Bank under a line of credit that is secured by a blanket lien on        residential real estate loans. Additional liquidity is expected to be provided by the        future growth that management expects in deposit accounts and loan repayments. We believe        that this future growth will result from an increase in market share in our targeted trade        areas.  In 2007, we opened three new branches and purchased two offices. We plan to        open additional branches during 2008.

 

In        addition we have a line of credit with Silverton Bank for $1.5 million for operating        expenses.

 

At        December 31, 2007, we had outstanding borrowings from the Federal Home Loan Bank totaling        $42.4 million as compared to no borrowings at the end of 2006. Most of the borrowings are        overnight funds totaling $32.2 million and $10.2 million in term notes maturing during        2012.  During 2007 and 2006, we utilized the lines of credit on short term        arrangements to fund loan growth until deposits grew at the new branch        locations.

 

As of        December 31, 2007, time deposits of $402.8 million mature within one year. Historically, we        have been able to retain a majority of maturing deposits by establishing customer        relationships. We continue to offer premium rates at our new branches to attract new        customers and deposits.

 

Our loan        to deposit ratio at year end 2007 was 103.84% as compared to 99.48% at the end of 2006. We        have continued to experience strong loan demand and deposit growth. As we continue to open        new branches, we anticipate the growth trends to continue but at a much lower pace. We can        lower this ratio as management deems appropriate by managing the rate of growth in our loan        portfolio. This can be done by changing interest rates charged or limiting the amount of        new loans approved.

 

Growth        in loans and deposits does not always occur in the same time period. An excess or deficit        of funds provided affects the amount that we retain in cash or invest in federal funds or        short-term investments. Our practice has been to invest available funds in short-term U.S.        Government Agency securities or federal funds sold in order to provide liquidity and        to provide income until the funds are needed for new loans.

 

We have        primarily used the funds provided by trust preferred securities issued and deposits to fund        the purchase of banking facilities and the loan portfolio.

 

We        believe future deposit growth from our branches, along with available lines of credit, the        ability to sell securities in our available for sale investment portfolio, and the control        we may exercise over loan growth will provide sufficient liquidity to meet future cash        demands.

 

 

35

 

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**Financial Instruments with Off-Balance-Sheet Risk and Credit Risk and        Contractual Obligations**

 

The Bank        is a party to financial instruments with off-balance-sheet risk in the normal course of        business to meet the financing needs of its customers and to reduce its own exposure to        fluctuations in interest rates.  These financial instruments include commitments to        extend credit and standby letters of credit.  Those instruments involve, to varying        degrees, elements of credit and interest rate risk in excess of the amount recognized in        the balance sheet.  The contract or notional amounts of those instruments reflect the        extent of involvement the Bank has in particular classes of financial        instruments.

 

The        Bank's exposure to credit loss in the event of nonperformance by the other party to the        financial instrument for commitments to extend credit and standby letters of credit is        represented by the contractual amount of those instruments.  The Bank uses the same        credit policies in making commitments and conditional obligations as it does for        on-balance-sheet instruments.

 

A        summary of the contract amount of the Bank's exposure to off-balance-sheet risk as of        December 31, 2007 and 2006, is as follows:

         

| (Dollars in                        thousands)                                              |   | 2007   |   | 2006   |
|--------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Financial instruments whose contract amounts represent                        credit risk: |   |   |   |   |
| Commitments to extend                        credit                                        | $      | 57,032 | $      | 51,131 |
| Standby letters of                        credit                                           |   | 3,150  |   | 4,942  |

         

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

 

Unfunded        commitments under lines of credit are commitments for possible future extensions of credit        to existing customers.  Those lines of credit may not actually be drawn upon to the        total extent to which the Bank is committed.

 

Standby        letters of credit are conditional commitments issued by the Bank to guarantee the        performance of a customer to a third party.  Those guarantees are primarily issued to        support public and private borrowing arrangements, including commercial paper, bond        financing, and similar transactions.  The credit risk involved in issuing letters of        credit is essentially the same as that involved in extending loan facilities to        customers.  The Bank holds certificates of deposit, deposit accounts, and real estate        as collateral supporting those commitments for which collateral is deemed        necessary. 

 

New        Peoples and its subsidiaries have Federal Home Loan Bank advances, operating lease        obligations and trust preferred securities indebtedness. The following is a breakdown of        the payment obligations over the life of the agreements:

 

| **Contractual Obligations**             |
|-----------------------------------------|
|                                    | Payments Due by Period |
| (Dollars in thousands)                  |  

Total | Less than 1 year |  

1-3 years |  

3-5 years | More than 5 years |
| Trust preferred securities indebtedness | $ 16,496 | $ - | $ - | $ - | $ 16,496 |
| Federal Home Loan Bank advances         | 42,434 | 32,209 | - | 10,225 | - |
| Operating Lease Obligations             | 245 | 27 | 54 | 54 | 110 |
| Total                                   | $ 59,175 | $ 32,236 | $ 54 | $ 10,279 | $ 16,606 |

                

**Interest Sensitivity**

 

At        December 31, 2007, we had a negative cumulative gap rate sensitivity ratio of 32.86% for        the one year re-pricing period, compared to 32.66% at December 31, 2006. A negative        cumulative gap generally indicates that net interest income would improve in a declining        interest rate environment as liabilities re-price more quickly than assets. Net interest        income would probably decrease in periods during which interest rates are increasing. We        are closely

 

36

 

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monitoring our position and make adjustments periodically to strategically        position ourselves for the interest rate environment that will enhance earnings. On a        quarterly basis, management reviews our interest rate risk and has decided that the current        position is an acceptable risk.

 

| **Interest Sensitivity Analysis**           |
|---------------------------------------------|
| **December 31, 2007**                       |
| (Dollars in thousands)                      |
|                                        |   | 1- 90 Days |   | 91-365 Days |   | 1-3 Years |   | 4-5 Years |   | 6-15 Years |   | Over 15 years |   | Total |
| Uses of funds:                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                       | $ | 191,646 | $ | 83,527 | $ | 106,352 | $ | 166,315 | $ | 91,658 | $ | 42,762 | $ | 682,260 |
| Federal funds sold                          |   | 2,062 |   | - |   | - |   | - |   | - |   | - |   | 2,062 |
| Investments                                 |   | 4,049 |   | 1,000 |   | 2,977 |   | - |   | - |   | 1,206 |   | 9,232 |
| Bank owned life insurance                   |   | 9,745 |   | -, |   | - |   | - |   | - |   | - |   | 9,745 |
| Total earning assets                        | $ | 207,502 | $ | 84,527 | $ | 109,329 | $ | 166,315 | $ | 91,658 | $ | 43,968 | $ | 703,299 |
|                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sources of funds:                           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing DDA                        | $ | 26,857 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 26,857 |
| Savings & MMDA                          |   | 44,721 |   | - |   | - |   | - |   | - |   | - |   | 44,721 |
| Time Deposits                               |   | 154,159 |   | 248,672 |   | 71,647 |   | 27,297 |   | - |   | - |   | 501,775 |
| Trust preferred securities                  |   | 16,496 |   | - |   | - |   | - |   | - |   | - |   | 16,496 |
| Other borrowings                            |   | 32,209 |   | - |   | - |   | 10,225 |   | - |   | - |   | 42,434 |
| Total interest bearing liabilities          | $ | 274,442 | $ | 248,672 | $ | 71,647 | $ | 37,522 | $ | - | $ | - | $ | 632,283 |
| Discrete Gap                                | $ | (66,940) | $ | (164,145) | $ | 37,682 | $ | 128,793 | $ | 91,658 | $ | 43,968 | $ | 71,016 |
| Cumulative Gap                              | $ | (66,940) | $ | (231,085) | $ | (193,403) | $ | (64,610) | $ | 27,048 | $ | 71,016 |   |   |
| Cumulative Gap as % of Total Earning Assets |   | (9.50%) |   | (32.86%) |   | (27.50%) |   | (9.19%) |   | 3.85% |   |   |   |   |

 

| **Item 7A.** | **Quantitative and Qualitative Disclosures About Market                        Risk** |
|--------------|---------------------------------------------------------------------------------------|

 

Market        risk is the risk of loss due to adverse changes in current and future cash flows, fair        values, earnings or capital due to adverse movements in interest rates and other factors,        including foreign exchange rates and commodity prices. Because we have no significant        foreign exchange activities and hold no commodities, interest rate risk represents the        primary risk factor affecting our balance sheet and net interest margin. Significant        changes in interest rates by the Federal Reserve could result in similar changes in other        interest rates that could affect interest earned on our loan and investment portfolios and        interest paid on our deposit accounts. Changes in the interest rates earned and paid also        affect the estimated fair value of our interest bearing assets and liabilities.

 

Our        Asset and Liability Committee has been delegated the responsibility of managing our        interest-sensitive balance sheet accounts to maximize earnings while managing interest rate        risk. The committee, comprised of various members of senior management and five external        board members, is also responsible for establishing policies to monitor and limit our        exposure to interest rate risk and to manage our liquidity and capital positions. The        committee satisfies its responsibilities through quarterly meetings during which product        pricing issues, liquidity measures, capital levels, and interest sensitivity positions are        monitored.

 

We use        an asset/liability management and simulation software model to periodically measure the        potential impact on net interest income of projected or hypothetical changes in interest        rates. Our policy objective is to monitor our position and to manage our short-term and        long-term interest rate risk exposure. Our board of directors has established percentages        for the maximum potential reductions in net interest income that we are willing to accept,        which result from changes in interest rates over the next 12-month period. The percentage        limitations relate to instantaneous and sustained parallel changes in interest rates of        plus and minus certain basis points.

 

 

37

 

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The        following table summarizes our established percentage limitations and the sensitivity of        our net interest income to various interest rate scenarios for the next 12 months, based on        assets and liabilities as of December 31, 2007. At this date, our interest rate risk is        within the established limitations.

                                   

| Immediate Estimated Increase Basis Point                        Change                        In Interest Rates | % Increase

(Decrease) in Net                        Interest Income |  

                         

Established                        Limitation |
|-----------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------|---------------------------------------------------------------------------------------|
| +300                                                                                                            | 16.15%                                                               | (20.00)%                                                                              |
| +200                                                                                                            | 11.17%                                                               | (15.00)%                                                                              |
| +100                                                                                                            | 5.53%                                                                | (7.00)%                                                                               |
| -100                                                                                                            | (5.31)%                                                              | (7.00)%                                                                               |
| -200                                                                                                            | (10.42)%                                                             | (15.00)%                                                                              |
| -300                                                                                                            | (13.25)%                                                             | (20.00)%                                                                              |

                                   

The type        of modeling used to generate the above table does not take into account all strategies that        we might adopt in response to a sudden and sustained change in interest rates. These        strategies may include asset/ liability acquisitions of appropriate maturities in the cash        market and may also include off-balance sheet alternatives to the extent such activity is        authorized by the board of directors.

 

The        committee is also responsible for long-term asset/liability management and completes the        following functions:

| ****•**** | Monitoring available opportunities to undertake major                        corrective actions (in the nature and mix of assets and liabilities) for                        structural mismatches. |
|----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ****•**** | Determining the appropriateness of fixed rate vs. variable                        rate lending and investment strategies and formulation policies to                        influence this activity. |
|----------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ****•**** | Developing parameters for the investment portfolio in the                        context of overall balance sheet management (liquidity, interest rate risk,                        credit risk, risk-based capital, price risk, and earnings). |
|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ****•**** | Establishing financial goals, including minimum standards                        for return on assets and equity. |
|----------------|-------------------------------------------------------------------------------------------------------------------|

| ****•**** | Overseeing the long-term strategic use of capital to                        maximize the return on equity within reasonable levels of risk. |
|----------------|---------------------------------------------------------------------------------------------------------------------------------------------|

 

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**Item        8.****Financial Statements and Supplementary Data**

 

**FINANCIAL STATEMENTS**

 

**CONTENTS**

|   | Page |
|--------|------|

 

| Report of the Independent Registered Public Accounting                        Firm | 35 |
|------------------------------------------------------------------------------------|----|

 

| Management's Annual Report on Internal Control over                        Financial Reporting | 36 |
|------------------------------------------------------------------------------------------------|----|

 

| Consolidated Balance Sheets as of

        December 31, 2007                        and 2006 |  

37 |
|---------------------------------------------------------------------------------------------------------------------------------|------------|

 

Consolidated Statements of Income - Years Ended

|   | December 31, 2007, 2006, and 2005 | 38 |
|--------|-----------------------------------|----|

 

Consolidated Statements of Stockholders' Equity - Years Ended

|   | December 31, 2007, 2006, and 2005 | 39 |
|--------|-----------------------------------|----|

 

Consolidated Statements of Cash Flows - Years Ended

|   | December 31, 2007, 2006 and 2005 | 40 |
|--------|----------------------------------|----|

 

| Notes to Consolidated Financial Statements | 41 |
|--------------------------------------------|----|

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

38

 

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**R        EPORT OF INDEPENDENT REGISTERED PUBLIC        ACCOUNTING FIRM**

        To the Board of Directors and Stockholders        New Peoples Bankshares, Inc.        Honaker, Virginia                      We have audited the accompanying consolidated balance sheets of New        Peoples Bankshares, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the related        consolidated statements of income, stockholders' equity, and cash flows for each of the        years in the three-year period ended December 31, 2007. We also have audited New Peoples        Bankshares, Inc. and Subsidiaries' internal control over financial reporting as of December        31, 2007, based on criteria established in *Internal Control - Integrated Framework*        issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). New        Peoples Bankshares, Inc. and Subsidiaries' management is responsible for these consolidated        financial statements, for maintaining effective internal control over financial reporting,        and for its assessment of the effectiveness of internal control over financial reporting,        included in the accompanying Form 10-K. Our responsibility is to express an opinion on        these consolidated financial statements and an opinion on the company's internal control        over financial reporting based on our audits.*  *   We conducted our audits in accordance with the standards of        the Public Company Accounting Oversight Board (United States). Those standards require that        we plan and perform the audits to obtain reasonable assurance about whether the        consolidated financial statements are free of material misstatement and whether effective        internal control over financial reporting was maintained in all material respects. Our        audits of the consolidated financial statements included examining, on a test basis,        evidence supporting the amounts and disclosures in the financial statements, assessing the        accounting principles used and significant estimates made by management, and evaluating the        overall financial statement presentation. Our audit of internal control over financial        reporting included obtaining an understanding of internal control over financial reporting,        assessing the risk that a material weakness exists, and testing and evaluating the design        and operating effectiveness of internal control based on the assessed risk. Our audits also        included performing such other procedures as we considered necessary in the circumstances.        We believe that our audits provide a reasonable basis for our opinions.*    * A company's internal control over financial reporting is        a process designed to provide reasonable assurance regarding the reliability of financial        reporting and the preparation of financial statements for external purposes in accordance        with generally accepted accounting principles. A company's internal control over financial        reporting includes those policies and procedures that (1) pertain to the maintenance of        records that, in reasonable detail, accurately and fairly reflect the transactions and        dispositions of the assets of the company; (2) provide reasonable assurance that        transactions are recorded as necessary to permit preparation of financial statements in        accordance with generally accepted accounting principles, and that receipts and        expenditures of the company are being made only in accordance with authorizations of        management and directors of the company; and (3) provide reasonable assurance regarding        prevention or timely detection of unauthorized acquisition, use, or disposition of the        company's assets that could have a material effect on the financial statements.*      * Because of its inherent limitations, internal        control over financial reporting may not prevent or detect misstatement. Also, projections        of any evaluation of effectiveness to future periods are subject to the risk that controls        may become inadequate because of changes in conditions, or that the degree of compliance        with the policies or procedures may deteriorate.*     * In our opinion, the consolidated financial        statements referred to above present fairly, in all material respects, the financial        position of New Peoples Bankshares, Inc. and Subsidiaries as of December 31, 2007 and 2006,        and the results of its operations and its cash flows for each of the years in the        three-year period ended December 31, 2007 in conformity with accounting principles        generally accepted in the United States of America. Also in our opinion, New Peoples        Bankshares, Inc. and Subsidiaries maintained, in all material respects, effective internal        control over financial reporting as of December 31, 2007, based on criteria established in        *Internal Control - Integrated Framework* issued by the Committee of Sponsoring        Organizations of the Treadway Commission (COSO).* *                                                                                                            /S/ BROWN, EDWARDS AND COMPANY, L.L.P.                                                                                                     CERTIFIED        PUBLIC ACCOUNTANTS

        Bluefield, West Virginia        March 12, 2008

39

 

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**Management's Annual Report on Internal Control over        Financial Reporting**

Management is responsible for establishing and maintaining        adequate internal control over financial reporting of New Peoples Bankshares, Inc. New        Peoples' internal control system was designed to provide reasonable assurance to management        and the Board of Directors regarding the reliability of financial reporting and the        preparation of financial statements for external purposes in accordance with generally        accepted accounting practices.

All internal control systems, no matter how well designed,        have inherent limitations. Because of these inherent limitations, internal control over        financial reporting can provide only reasonable assurance with respect to financial        statement preparation and presentation, and may not prevent or detect misstatements.        Projections of any evaluation of effectiveness to future periods are subject to the risk        that controls may become inadequate because of changes in conditions, or that the degree of        compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of New Peoples'        internal control over financial reporting as of December 31, 2007. In making this        assessment, management used the criteria set forth by the Committee of Sponsoring        Organizations of the Treadway Commission (COSO) in "Internal Control - Integrated        Framework". Based on our assessment, we believe that, as of December 31, 2007, New Peoples'        internal control over financial reporting was effective based on those        criteria.

The effectiveness of internal control over financial        reporting as of December 31, 2007, has been audited by Brown, Edwards & Company,        L.L.P., the independent registered public accounting firm which also audited the Company's        consolidated financial statements. Brown, Edwards & Company's attestation report of        internal control over financial reporting is included elsewhere in this annual        report.

         

March 12, 2008

         

  /S/ KENNETH D. HART

Kenneth D. Hart

President and Chief Executive Officer

         

         

         

C. Todd Asbury

Senior Vice-President and Chief Financial Officer

         

         

 

41

 

----

**CONSOLIDATED BALANCE SHEETS**

**DECEMBER 31, 2007 AND 2006**

(IN        THOUSANDS EXCEPT SHARE DATA)

| **ASSETS**                                                                                                                    |                                                                                                         |                | 2007    |                                              | 2006                                 |
|-------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|---------------------|---------|---------------------------------------------------|--------------------------------------|
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| Cash and due from banks (Note 3)                                                                                              |                                                                                                         | $                   | 20,195  | $                                                 | 18,451                               |
| Federal funds sold (Note 3)                                                                                                   |                                                                                                         |                | 2,062   |                                              | 1,430                                |
|                                                                                                                               | Total Cash and Cash Equivalents                                                                              |                |    | 22,257                                            |                                 | 19,881 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| Investment Securities                                                                                                         |                                                                                                         |                |    |                                              |                                 |
|                                                                                                                               | Available-for-sale (Note 4)                                                                                  |                |    | 4,974                                             |                                 | 3,493 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| Loans receivable (Note 5)                                                                                                     |                                                                                                         |                | 682,260 |                                              | 569,198                              |
|                                                                                                                          | Allowance for loan losses (Note 6)                                                                           |                |    | (6,620)                                           |                                 | (4,870) |
|                                                                                                                          | Net Loans                                                                                                    |                |    | 675,640                                           |                                 | 564,328 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| Bank premises and equipment, net (Note 7)                                                                                     |                                                                                                         |                | 34,892  |                                              | 29,438                               |
| Equity securities (restricted) (Note 4)                                                                                       |                                                                                                         |                | 4,258   |                                              | 2,152                                |
| Other real estate owned                                                                                                       |                                                                                                         |                | 2,051   |                                              | 1,181                                |
| Accrued interest receivable                                                                                                   |                                                                                                         |                | 4,969   |                                              | 4,140                                |
| Life insurance investments                                                                                                    |                                                                                                         |                | 9,745   |                                              | 9.377                                |
| Goodwill and other intangibles (Note 12)                                                                                      |                                                                                                         |                | 4,829   |                                              | -                                    |
| Other assets                                                                                                                  |                                                                                                         |                | 2,336   |                                              |       1,829 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
|                                                                                                                               | Total Assets                                                                                                 |                | $       | 765,951                                           | $                                    | 635,819 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| **LIABILITIES**                                                                                                               |                                                                                                         |                |    |                                              |                                 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |
| Deposits                                                                                                                      |                                                                                                         |                |    |                                              |                                 |
|                                                                                                                          | Demand deposits                                                                                              |                |    |                                              |                                 |   |
|                                                                                                                          |                                                                                                         | Noninterest bearing | $       | 83,680                                            | $                                    | 71,538 |
|                                                                                                                          |                                                                                                         | Interest-bearing    |    | 26,857                                            |                                 | 19,290 |
|                                                                                                                          | Savings deposits                                                                                             |                |    | 44,721                                            |                                 | 42,894 |
|                                                                                                                          | Time deposits (Note 8)                                                                                       |                |    | 501,775                                           |                                 | 438,465 |
|                                                                                                                          | Total Deposits                                                                                               |                |    | 657,033                                           |                                 | 572,187 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| FHLB advances (Note 18)                                                                                                       |                                                                                                         |                | 42,434  |                                              | -                                    |
| Accrued interest payable                                                                                                      |                                                                                                         |                | 2,822   |                                              | 2,783                                |
| Accrued expenses and other liabilities                                                                                        |                                                                                                         |                | 1,917   |                                              | 2,007                                |
| Trust preferred securities (Note 22)                                                                                          |                                                                                                         |                | 16,496  |                                              | 16,496                               |
|                                                                                                                          | Total Liabilities                                                                                            |                |    | 720,702                                           |                                 | 593,473 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |   |
| **STOCKHOLDERS' EQUITY (Notes 15 & 17)**                                                                                  |                                                                                                         |                |    |                                              |                                 |
| Common stock - $2.00 par value; 12,000,000 shares                        authorized;                                          |                                                                                                         | 19,919              |    | 15,314                                            |
|                                                                                                                          | 9,959,477 and 9,954,178 shares issued and outstanding for                        2007 and 2006, respectively |                |    |                                              |                                 |
| Additional paid-in-capital                                                                                                    |                                                                                                         | 21,484              |    | 21,465                                            |
| Retained earnings                                                                                                             |                                                                                                         | 3,839               |    | 5,565                                             |
| Accumulated other comprehensive income (loss)                                                                                 |                                                                                                         | 7                   |    |         2 |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |
|                                                                                                                          | Total Stockholders' Equity                                                                                   |                | 45,249  |                                              | 42,346                               |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |
|                                                                                                                          | Total Liabilities and Stockholders' Equity                                                                   | $                   | 765,951 | $                                                 | 635,819                              |
|                                                                                                                          |                                                                                                         |                |    |                                              |                                 |
|  

                         

The accompanying notes are an integral part of this                        statement. |
|                                                                                                                               |                                                                                                              |                     |         |                                                   |                                      |  |  |

 

42

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**NEW        PEOPLES BANKSHARES, INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR        THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005**

(IN        THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

 

| **INTEREST AND DIVIDEND INCOME**                      |                                        | 2007   |   | 2006   |   | 2005   |
|-------------------------------------------------------|---------------------------------------------|--------|--------|--------|--------|--------|
|                                                  | Loans including fees                        | $      | 50,884 | $      | 40,762 | $      | 30,006 |
|                                                  | Federal funds sold                          |   | 129    |   | 191    |   | 256 |
|                                                  | Investments                                 |   | 254    |   | 172    |   | 161 |
|                                                  | Dividends on equity securities (restricted) |   | 180    |   | 155    |   | 84 |
|                                                  | Total Interest and Dividend Income          |   | 51,447 |   | 41,280 |   | 30,507 |
|                                                  |                                        |   |   |   |   |   |   |
| **INTEREST EXPENSE**                                  |                                        |   |   |   |   |   |
|                                                  | Deposits                                    |   |   |   |   |   |   |
|                                                  | Demand                                      |   | 164    |   | 142    |   | 164 |
|                                                  | Savings                                     |   | 485    |   | 489    |   | 468 |
|                                                  | Time deposits below $100,000                |   | 14,851 |   | 11,295 |   | 6,917 |
|                                                  | Time deposits above $100,000                |   | 8,098  |   | 5,709  |   | 3,018 |
|                                                  | FHLB advances                               |   | 857    |   | 754    |   | 43 |
|                                                  | Trust Preferred Securities                  |   | 1,283  |   | 1,004  |   | 669 |
|                                                  | Total Interest Expense                      |   | 25,738 |   | 19,393 |   | 11,279 |
|                                                  |                                        |   |   |   |   |   |   |
| **NET INTEREST INCOME**                               |                                        | 25,709 |   | 21,887 |   | 19,228 |
|                                                  |                                        |   |   |   |   |   |   |
| **PROVISION FOR LOAN LOSSES (Note 6)**                |                                        | 3,840  |   | 1,277  |   | 1,130  |
|                                                  |                                        |   |   |   |   |   |   |
| **Net Interest Income after**                         |                                        |   |   |   |   |   |
|                                                  | **Provision for Loan Losses**               |   | 21,869 |   | 20,610 |   | 18,098 |
|                                                  |                                        |   |   |   |   |   |
| **NONINTEREST INCOME**                                |                                        |   |   |   |   |   |
|                                                  | Service charges                             |   | 2,455  |   | 2,032  |   | 1,707 |
|                                                  | Fees, commissions and other income          |   | 994    |   | 414    |   | 341 |
|                                                  | Insurance and investment fees               |   | 769    |   | 606    |   | 381 |
|                                                  | Life insurance investment income            |   | 433    |   | 408    |   | 393 |
|                                                  | Total Noninterest Income                    |   | 4,651  |   | 3,460  |   | 2,822 |
|                                                  |                                        |   |   |   |   |   |   |
| **NONINTEREST EXPENSES**                              |                                        |   |   |   |   |   |
|                                                  | Salaries and employee benefits (Note 14)    |   | 13,978 |   | 11,848 |   | 10,031 |
|                                                  | Occupancy expense                           |   | 1,776  |   | 1,429  |   | 1,122 |
|                                                  | Equipment expense                           |   | 2,254  |   | 1,971  |   | 1,723 |
|                                                  | Advertising and public relations            |   | 437    |   | 381    |   | 352 |
|                                                  | Stationery and supplies                     |   | 316    |   | 293    |   | 245 |
|                                                  | Loss on sale of other real estate owned     |   | -      |   | 30     |   | 38 |
|                                                  | Other operating expenses                    |   | 4,913  |   | 3,853  |   | 3,199 |
|                                                  | Total Noninterest Expenses                  |   | 23,674 |   | 19,805 |   | 16,710 |
|                                                  |                                        |   |   |   |   |   |   |
| **INCOME BEFORE INCOME                        TAXES** |                                        | 2,846  |   | 4,265  |   | 4,210  |
|                                                  |                                        |   |   |   |   |   |   |
| **INCOME TAX EXPENSE (Note 9)**                       |                                        |   |   |   |   |   |

|   | Current income tax expense         |   | 614   |   | 1,175 |   | 1,487 |
|--------|------------------------------------|--------|-------|--------|-------|--------|-------|
|   | Change of accounting estimate      |   | (638) |   | -     |   | -     |
|   | Total Income Tax Expense (benefit) |   | (24)  |   | 1,175 |   | 1,487 |
|        |                                    |        |       |        |       |        |       |  |

|                                                                                  |                   |   |       |   |       |   |       |
|---------------------------------------------------------------------------------------|------------------------|--------|------------|--------|------------|--------|------------|
| **NET INCOME**                                                                        | $                      | 2,870  | $          | 3,090  | $          | 2,723  |
|                                                                                  | **Earnings Per Share** |   |       |   |       |   |       |
|                                                                                  | Basic                  | $      | 0.29       | $      | 0.31       | $      | 0.28       |
|                                                                                  | Fully Diluted          | $      | 0.28       | $      | 0.30       | $      | 0.26       |
|                                                                                  |                   |   |       |   |       |   |       |
| **Average Weighted Shares of Common Stock**                                           |                   |   |       |   |       |   |
|                                                                                  | Basic                  |   | 9,957,949  |   | 9,931,713  |   | 9,885,877  |
|                                                                                  | Fully Diluted          |   | 10,371,577 |   | 10,384,100 |   | 10,281,640 |
|                                                                                       |
| The accompanying notes are an integral part of this                        statement. |

 

 

42

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY**

**FOR        THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005**

(IN        THOUSANDS INCLUDING SHARE DATA )

 

|                                                                                                                  | Shares of Common Stock |   | Common Stock |   | Additional Paid in Capital |   | Retained Earnings |   | Accumu-lated Other Compre-hensive Income (Loss) |   | Total Stockholders'Equity |   | Compre-hensive Income |
|-----------------------------------------------------------------------------------------------------------------------|------------------------|--------|--------------|--------|----------------------------|--------|-------------------|--------|-------------------------------------------------|--------|---------------------------|--------|-----------------------|
| Balance,

December 31, 2004                                                                                           | 6,910                  | $      | 13,820       | $      | 13,118                     | $      | 9,177             | $      | (17)                                            | $      | 36,098                    |   |                  |
|                                                                                                                  |                   |   |         |   |                       |   |              |   |                                            |   |                      |   |                  |
| Net Income                                                                                                            |                   |   |         |   |                       |   | 2,723             |   |                                            |   | 2,723                     |   | 2,723                 |
| Unrealized gain (net of deferred tax of $1) on                        available-for-sale securities                   |                   |   |         |   |                       |   |              |   | 2                                               |   | 2                         |   | 2                     |
| 10% Stock Dividend, June 7, 2005                                                                                      | 691                    |   | 1,382        |   | 8,043                      |   | (9,425)           |   |                                            |   | -                         |   |                  |
| Stock Options Exercised                                                                                               | 18                     |   | 37           |   | 104                        |   |              |   |                                            |   | 141                       |   |                  |
| Balance,

December 31, 2005                                                                                           | 7,619                  | $      | 15,239       | $      | 21,265                     | $      | 2,475             | $      | (15)                                            | $      | 38,964                    | $      | 2,725                 |
|                                                                                                                  |                   |   |         |   |                       |   |              |   |                                            |   |                      |   |                  |
| Net Income                                                                                                            |                   |   |         |   |                       |   | 3,090             |   |                                            |   | 3,090                     |   | 3,090                 |
| Unrealized gain (net of deferred tax of $8) on                        available-for-sale securities                   |                   |   |         |   |                       |   |              |   | 17                                              |   | 17                        |   | 17                    |
| Stock Options Exercised                                                                                               | 38                     |   | 75           |   | 200                        |   |              |   |                                            |   | 275                       |   |                  |
| Balance,

December 31, 2006                                                                                           | 7,657                  | $      | 15,314       | $      | 21,465                     | $      | 5,565             | $      | 2                                               | $      | 42,346                    | $      | 3,107                 |
|                                                                                                                  |                   |   |         |   |                       |   |              |   |                                            |   |                      |   |                  |
| Net Income                                                                                                            |                   |   |         |   |                       |   | 2,870             |   |                                            |   | 2,870                     |   | 2,870                 |
| 13-for-10 stock split, September 12, 2007                                                                             | 2,298                  | $      | 4,596        |   |                       |   | (4,596)           |   |                                            |   |                      |   |                  |
| Unrealized gain(net of deferred tax of $4) on                        available-for-sale securities                    |                   |   |         |   |                       |   |              |   | 5                                               |   | 5                         |   | 5                     |
| Stock Options Exercised                                                                                               | 4                      |   | 9            |   | 19                         |   |              |   |                                            |   | 28                        |   |                  |
| Balance,

December 31, 2007                                                                                           | 9,959                  | $      | 19,919       | $      | 21,484                     | $      | 3,839             | $      | 7                                               | $      | 45,249                    | $      | 2,875                 |
|                                                                                                                  |                   |   |         |   |                       |   |              |   |                                            |   |                      |   |                  |
| The accompanying notes are an integral part of this                        statement.

                          |
|                                                                                                                       |                        |        |              |        |                            |        |                   |        |                                                 |        |                           |        |                       |  |

 

 

 

 

43

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**NEW        PEOPLES BANKSHARES, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR        THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005**

(IN        THOUSANDS)

 

| **CASH FLOWS FROM OPERATING                    ACTIVITIES**                                                                                                                                                          |                                                                   | 2007   |      | 2006    |      | 2005    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------|--------|-----------|---------|-----------|---------|
| Net Income                                                                                                                                                                                                           |                                                                   | $      | 2,870     | $       | 3,090     | $       | 2,723 |
| Adjustments to reconcile net income                    to net cash provided by operating activities:                                                                                                                 |                                                                   |   |      |    |      |    |
|                                                                                                                                                                                                                 | Depreciation                                                           |   |      | 2,598   |      | 2,300   |   | 1,922 |
|                                                                                                                                                                                                                 | Provision for Loan                    Losses                           |   |      | 3,840   |      | 1,277   |   | 1,130 |
|                                                                                                                                                                                                                 | Income (less expenses) on Life                    Insurance            |   |      | (368)   |      | (346)   |   | (337) |
|                                                                                                                                                                                                                 | (Gain) loss on sale of fixed                    assets                 |   |      | -       |      | -       |   | 27 |
|                                                                                                                                                                                                                 | Loss on sale of foreclosed real                    estate              |   |      | -       |      | 30      |   | 38 |
|                                                                                                                                                                                                                 | Amortization (accretion) of bond                    premiums/discounts |   |      | (19)    |      | (29)    |   | (13) |
|                                                                                                                                                                                                                 | Deferred tax expense                    (benefit)                      |   |      | (1,375) |      | (267)   |   | (241) |
|                                                                                                                                                                                                                 | Net change in:                                                         |   |      |    |      |    |   |   |
|                                                                                                                                                                                                                 | Interest receivable                                                    |   |      | (829)   |      | (1,135) |   | (733) |
|                                                                                                                                                                                                                 | Other Assets                                                           |   |      | 867     |      | (725)   |   | (6) |
|                                                                                                                                                                                                                 | Accrued interest payable                                               |   |      | 39      |      | 1,225   |   | 667 |
|                                                                                                                                                                                                                 | Accrued expense and other                    liabilities               |   |      | (90)    |      | 630     |   | 586 |
| Net Cash Provided by Operating                    Activities                                                                                                                                                         |                                                                   |   | 7,533     |    | 6,050     |    | 5,763 |
|                                                                                                                                                                                                                 |                                                                   |   |      |    |      |    |   |
| **CASH FLOWS FROM INVESTING                    ACTIVITIES**                                                                                                                                                          |                                                                   |   |      |    |
| Net increase in loans                                                                                                                                                                                                |                                                                   |   | (101,461) |    | (101,503) |    | (84,755) |
| Purchase of securities available                    for sale                                                                                                                                                         |                                                                   |   | (4,990)   |    | (2,985)   |    | (2,972) |
| Proceeds from sale and maturities                    of securities                    available-for-sale          available-for-sale      |                                                                   |   | 3,533     |    | 5,700     |    | 2,600 |
| Purchase of Federal Reserve Bank                    stock                                                                                                                                                            |                                                                   |   | (128)     |    | (76)      |    | - |
| (Purchase) sale of Federal Home                    Loan Bank stock                                                                                                                                                   |                                                                   |   | (1,978)   |    | 197       |    | (832) |
| Acquisition of branches                                                                                                                                                                                              |                                                                   |   |      |    |      |    |   |
| Loans acquired                                                                                                                                                                                                       |                                                                   |   | (13,691)  |    | -         |    | - |
| Deposits assumed                                                                                                                                                                                                     |                                                                   |   | 60,380    |    | -         |    | - |
| Bank premises                                                                                                                                                                                                        |                                                                   |   | (1,178)   |    | -         |    | - |
| Goodwill and other                    intangibles                                                                                                                                                                    |                                                                   |   | (4,829)   |    | -         |    | - |
| Payments for the purchase of                    property                                                                                                                                                             |                                                                   |   | (6,874)   |    | (9,692)   |    | (4,592) |
| Net change in other real estate                    owned                                                                                                                                                             |                                                                   |   | (870)     |    | 185       |    | (248) |
|                                                                                                                                                                                                                 |                                                                   |   | (72,086)  |    | (108,174) |    | (90,800) |

|                                                                                                                |                                                          |   |   |    |    |
|---------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------|--------|--------|---------|---------|
| **CASH FLOW FROM FINANCING                    ACTIVITIES**                                                          |                                                          |   |   |    |
| Common stock options                    exercised                                                                   |                                                          |   | 28     |    | 275     |   | 141 |
| Trust preferred securities                    borrowing           |                                                          |   | -      |    | 5,155   |   | - |
| Net change in:                                                                                                      |                                                          |   |   |    |    |   |   |
|                                                                                                                | Demand deposits                                               |   |   | 12,582  |    | 11,062 |   | 12,324 |
|                                                                                                                | Savings deposits                                              |   |   | (3,425) |    | (1,884) |   | 1,333 |
|                                                                                                                | Time deposits                                                 |   |   | 15,310  |    | 100,317 |   | 60,915 |
|                                                                                                                | Net increase (decrease) in FHLB                    borrowings |   |   | 42,434  |    | (11,570) |   | 11,570 |
| Net Cash Provided by Financing                    Activities                                                        |                                                          |   | 66,929 |    | 103,355 |   | 86,282 |
| Net increase (decrease) in cash and                    cash equivalents                                             |                                                          |   | 2,376  |    | 1,231   |   | 1,245 |
| Cash and Cash Equivalents,                    Beginning of Year                                                     |                                                          |   | 19,881 |    | 18,650  |   | 17,405 |
| Cash and Cash Equivalents, End of                    Year                                                           |                                                          | $      | 22,257 | $       | 19,881  | $ | 18,650 |
| Supplemental Disclosure of Cash                    Paid During the Year for:                                        |                                                          |   |   |    |    |   |   |
| Interest                                                                                                            |                                                          | $      | 25,777 | $       | 20,619  | $ | 7,247 |
| Taxes                                                                                                               |                                                          | $      | 1,153  | $       | 1,490   | $ | 1,350 |
| Supplemental Disclosure of Non Cash                    Transactions:                                                |                                                          |   |   |    |    |   |   |
| Other real estate acquired in                    settlement of foreclosed loans                                     | $                                                             | 521    | $      | 749     | $       | 210 |
| Loans made to finance sale of                    foreclosed real estate                                             |                                                          | $      | 828    | $       | 455     | $ | 143 |
|                                                                                                                |                                                          |   |   |    |    |   |   |
| The accompanying notes are an                    integral part of this statement.                                   |

 

44

 

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

 

| **NOTE 1** | **NATURE OF OPERATIONS** |
|------------|--------------------------|

**Nature of Operations****-**New Peoples Bankshares, Inc. ("The Company") is a bank holding company whose        principal activity is the ownership and management of a community bank. New Peoples Bank        ("Bank") was organized and incorporated under the laws of the Commonwealth of Virginia on        December 9, 1997. The Bank commenced operations on October 28, 1998, after receiving        regulatory approval. As a state chartered member bank, the Bank is subject to regulation by        the Virginia Bureau of Financial Institutions, the Federal Deposit Insurance Corporation        and the Federal Reserve Bank. The Bank provides general banking services to individuals,        small and medium size businesses and the professional community of southwestern Virginia,        southern West Virginia, and eastern Tennessee. On June 9, 2003, the Company formed two        wholly owned subsidiaries, NPB Financial Services, Inc. and NPB Web Services, Inc. On July        7, 2004 the Company established NPB Capital Trust I for the purpose of issuing additional        trust preferred securities. On September 27, 2006, the Company established NPB Capital        Trust 2 for the purpose of issuing additional trust preferred securities.

 

| **NOTE 2** | **SUMMARY OF SIGNIFICANT ACCOUNTING                        POLICIES:** |
|------------|------------------------------------------------------------------------|

**Consolidation Policy**- The consolidated        financial statements include the Company, the Bank, NPB Financial Services, Inc., and NPB        Web Services, Inc. All significant intercompany balances and transactions have been        eliminated. In accordance with FIN 46R, NPB Capital Trust I and 2 are not included in the        consolidated financial statements.

 

**Use        of Estimates****-**The preparation of        financial statements in conformity with generally accepted accounting principles requires        management to make estimates and assumptions that affect the reported amounts of assets and        liabilities, disclosure of contingent assets and liabilities at the date of the financial        statements and the reported amounts of revenues and expenses during the reporting period.        Actual results could differ from those estimates. The determination of the adequacy of the        allowance for loan losses is based on estimates that are particularly susceptible to        significant changes in the economic environment and market conditions.

 

**Cash        and Cash Equivalents**- Cash and cash equivalents as used in the        cash flow statements include cash and due from banks and federal funds sold.

 

**Investment Securities**- Management determines        the appropriate classification of securities at the time of purchase. If management has the        intent and the Bank has the ability at the time of purchase to hold securities until        maturity, they are classified as held to maturity and carried at amortized historical cost.        Securities not intended to be held to maturity are classified as available for sale and        carried at fair value. Securities available for sale are intended to be used as part of the        Bank's asset and liability management strategy and may be sold in response to changes in        interest rates, prepayment risk or other similar factors.

 

The        amortization of premiums and accretion of discounts are recognized in interest income using        the effective interest method over the period to maturity. Realized gains and losses on        dispositions are based on the net proceeds and the adjusted book value of the securities        sold, using the specific identification method. Realized gains (losses) on securities        available-for-sale are included in noninterest income and, when applicable, are reported as        a reclassification adjustment, net of tax, in other comprehensive income. Unrealized gains        and losses on investment securities available for sale are based on the difference between        book value and fair value of each security. These gains and losses are credited or charged        to stockholders' equity, whereas realized gains and losses flow through the income        statement.

 

**Loans        -**Loans are carried on the balance sheet at unpaid principal        balance, net of any unearned interest and the allowance for loan losses. Interest income on        loans is computed using the effective interest method, except where serious doubt exists as        to the collectibility of the loan, in which accrual of the income is        discontinued.

 

It is        the Bank's policy to stop accruing interest on a loan, and classify that loan as        non-accrual under the following circumstances: (a) whenever we are advised by the borrower        that scheduled payment or interest payments cannot be met, (b) when our best judgment        indicates that payment in full of principal and interest can no longer be expected, or (c)        when any such loan or obligation becomes delinquent for 90 days unless it is both well        secured and in the process of collection. All interest accrued but not collected for loans        that are placed on nonaccrual or charged off are reversed against interest income. The        interest on these loans is accounted for on the cash basis or cost-recovery method, until        qualifying for return to accrual. Loans are returned to accrual status when all the        principal and interest amounts contractually due are brought current and prospects for        future contractual payments are reasonably assured.

 

 

45

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

| **NOTE 2** | **SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES                        (CONTINUED):** |
|------------|------------------------------------------------------------------------------------|

**Loans        (Continued) -**A loan is considered impaired when, based on        current information and events, it is probable that the Company will be unable to collect        the scheduled payments of principal or interest when due according to the contractual terms        of the loan agreement. Factors considered by management in determining impairment include        payment status, collateral value, and the probability of collecting scheduled principal and        interest payments when due. Loans that experience insignificant payment delays and payment        shortfalls generally are not classified as impaired. Management determines the significance        of payment delays and payment shortfalls on a case-by-case basis, taking into consideration        all of the circumstances surrounding the loan and the borrower, including the length of the        delay, the reasons for the delay, the borrower's prior payment record, and the amount of        the shortfall in relation to the principal and interest owed. Impairment is measured on a        loan by loan basis for commercial and construction loans by either the present value of        expected future cash flows discounted at the loan's effective interest rate, the loan's        obtainable market price, or the fair value of the collateral if the loan is collateral        dependent.

 

**Significant Group Concentrations of Credit Risk -**The Company recognizes a concentration as any obligation, direct or        indirect, of the same or affiliated interests which represent 25% or more of the Company's        capital structure, or $11.5 million as of December 31, 2007. Most of the Company's        activities are with customers located within the southwest Virginia, southern West        Virginia, and northeastern Tennessee region. Certain concentrations may pose credit        risk.  The Bank does not have any significant concentrations to any one industry or        customer.

 

**Allowance for Loan Losses -**The allowance for        loan losses is maintained at a level that, in management's judgment, is adequate to absorb        credit losses inherent in the loan portfolio. The loan portfolio is analyzed periodically        and loans are assigned a risk rating. Allowances for impaired loans are generally        determined based on collateral values or the present value of estimated cash flows. A        general allowance is made for all other loans not considered impaired as deemed appropriate        by management. In determining the adequacy of the allowance, management considers the        following factors: the nature of the portfolio, credit concentrations, trends in historical        loss experience, specific impaired loans, the estimated value of any underlying collateral,        prevailing environmental factors and economic conditions, and other inherent risks. While        management uses available information to recognize losses on loans, further reductions in        the carrying amounts of loans may be necessary based on changes in local collateral values        and changes in estimates of cash flows on impaired loans. This evaluation is        inherently subjective as it requires estimates that are susceptible to significant revision        as more information becomes available.

 

The        allowance is increased by a provision for loan losses, which is charged to expense and        reduced by charge-offs, net of recoveries. Loans are charged against the allowance for loan        losses when management believes that collectibility of the principal is unlikely. Past due        status is determined based on contractual terms.

 

**Stock Split** - All share and per share amounts reflected        herein have been adjusted to retroactively reflect those stock splits effected in the form        of stock dividends.

 

**Bank        Premises and Equipment**- Land, buildings and equipment are        recorded at cost less accumulated depreciation. Depreciation is computed using the        straight-line method over the following estimated useful lives:

                       

| Type                            |   | Estimated useful life |
|---------------------------------|--------|-----------------------|
| Buildings                       |   | 39 years              |
| Paving and landscaping          |   | 15 years              |
| Computer equipment and software |   | 3 to 5 years          |
| Vehicles                        |   | 5 years               |
| Furniture and other equipment   |   | 5 to 7 years          |

 

**Advertising Cost**- Advertising costs are        expensed in the period incurred.

 

**Stock        Options**- Effective January 1, 2006, the Company adopted        Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-based Payment, using        the modified prospective transition method. No stock options were granted in 2007 and 2006.        However, if stock options had been granted, the Company would have recognized the expense        of the stock-based employee compensation by using the fair value method directly against        net income.

Prior to        January 1, 2006, employee compensation expense under stock options was reported using the        intrinsic value method; therefore, no stock based compensation cost is reflected in net        income for the year ending December 31, 2005, as all options granted had an exercise price        equal to or greater than the market price of the underlying common stock at date of        grant.

 

47

 

----

 

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 2** | **SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES                        (CONTINUED):** |
|------------|------------------------------------------------------------------------------------|

**Stock        Options (Continued)**- Had compensation cost for the Company's        stock option plan been determined consistent with the fair value model under SFAS 123(R) in        2005, net income would have been reduced to the pro forma amounts reflected        below:

 

|  

(Dollars are in thousands, except                        per share date)                                   |          |   |          |
|--------------------------------------------------------------------------------------------------------------------|---------------|--------|---------------|
| Net Income, as                        reported                                                                     |          | $      | 2,723         |
| Deduct: Compensation expense                        related to stock plans using fair value accounting, net of tax |          |   |  

1,096 |
| Net Income, on pro forma                        basis                                                              |          | $      | 1,627         |
|                                                                                                               |          |   |          |
| Basic earnings per share-                                                                                          | - As reported | $      | 0.31          |
|                                                                                                               | - Pro forma   | $      | 0.16          |
| Diluted earnings per share                                                                                         | - As reported | $      | 0.30          |
|                                                                                                               | - Pro forma   | $      | 0.16          |

 

**Income Taxes**- Deferred income tax assets and        liabilities are determined using the liability (or balance sheet) method. Under this        method, the net deferred tax asset or liability is determined based on the tax effects of        the temporary differences between the book and tax bases of the various balance sheet        assets and liabilities and gives current recognition to changes in tax rates and        laws.

 

**Financial Instruments - Off-balance-sheet instruments**- In the ordinary course of business, the Bank has entered into commitments        to extend credit. Such financial instruments are recorded in the financial statements when        they are funded.

 

**Comprehensive Income**- Generally accepted        accounting principles require that recognized revenue, expenses, gains and losses be        included in net income. Although certain changes in assets and liabilities, such as        unrealized gains and losses on available for sale securities, are reported as a separate        component of the equity section of the balance sheet, such items, along with net income,        are components of comprehensive income.

 

**Earnings Per Share**- Basic earnings per share        computations are based on the weighted average number of shares outstanding during each        year. Dilutive earnings per share reflects the additional common shares that would have        been outstanding if dilutive potential common shares had been issued. Potential common        shares that may be issued relate to outstanding options and are determined by the        Treasury Method.

 

**Other        Real Estate Owned**- Other real estate owned represents properties        acquired through foreclosure or deed taken in lieu of foreclosure. At the time of        acquisition, these properties are recorded at the lower of cost or fair value less        estimated costs to sell. Expenses incurred in connection with operating these properties        and subsequent write-downs, if any, are charged to expense. Subsequent to foreclosure,        management periodically considers the adequacy of the reserve for losses on the property.        Gains and losses on the sales of these properties are credited or charged to income in the        year of the sale.

 

**Business Combinations**- For purchase        acquisitions accounted for as a business combination, the Company is required to record the        assets acquired, including identified intangible assets and liabilities assumed at their        fair value, which in many instances involves estimates based on third party valuations,        such as appraisals, or internal valuations based on discounted cash flow analyses or other        valuation techniques. The determination of the useful lives of intangible assets is        subjective, as is the appropriate amortization method for such intangible assets. In        addition, purchase acquisitions may result in goodwill, which is subject to ongoing        periodic impairment testing based on the fair value of net assets acquired compared to the        carrying value of goodwill. Changes in acquisition multiples, the overall interest rate        environment, or the continuing operations of the assets acquired could have a significant        impact on the periodic impairment testing. For additional discussion concerning our        valuation of intangible assets, see Note 12,  "Intangible Assets."

 

**Reclassification of Financial Statement Presentation**- Certain reclassifications in the Statement of Cash Flows        have been made to the 2006 financial statements regarding trust preferred securities        issued and other assets to conform with the 2007 financial statement presentation. Such        reclassification had no effect on net income as previously reported.

 

48

 

----

 

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 3** | **DEPOSITS IN AND FEDERAL FUNDS SOLD TO                        BANKS:** |
|------------|-------------------------------------------------------------------------|

The Bank        had federal funds sold and cash on deposit with other commercial banks amounting to $11.3        million and $12.0 million at December 31, 2007 and 2006, respectively. Deposit amounts at        other commercial banks may, at times, exceed federally insured limits.

 

| **NOTE 4** | **INVESTMENT SECURITIES:** |
|------------|----------------------------|

The        amortized cost and estimated fair value of securities are as follows:

|                       |   |      |   | Gross      |   | Gross      |   | Approximate |
|----------------------------|--------|-----------|--------|------------|--------|------------|--------|-------------|
|                       |   | Amortized |   | Unrealized |   | Unrealized |   | Fair        |
| (Dollars are in thousands) |   | Cost      |   | Gains      |   | Losses     |   | Value       |
| December 31, 2007          |   |      |   |       |   |       |   |        |
| Available for Sale         |   |      |   |       |   |       |   |        |
| U.S. Government Agencies   | $      | 4,494     | $      | 8          | $      | -          | $      | 4,502       |
| Mortgage backed securities |   | 468       |   | 4          |   | -          |   | 472         |
| Total Securities AFS       | $      | 4,962     | $      | 12         | $      | -          | $      | 4,974       |
|                       |   |      |   |       |   |       |   |        |
| December 31, 2006          |   |      |   |       |   |       |   |        |
| Available for Sale         |   |      |   |       |   |       |   |        |
| U.S. Government Agencies   | $      | 3,490     | $      | 3          | $      | -          | $      | 3,493       |
| Total Securities AFS       | $      | 3,490     | $      | 3          | $      | -          | $      | 3,493       |

 

 

 

At        December 31, 2007 and 2006, the available for sale portfolio included no individual        investments for which the fair market value was less than amortized cost.

 

The        amortized cost and fair value of investment securities at December 31, 2007, by contractual        maturity, are shown in the following schedule. Expected maturities will differ from        contractual maturities because borrowers may have the right to call or prepay obligations        with or without call or prepayment penalties.

 

|                                  |   |      |   |   |   | Weighted |
|---------------------------------------|--------|-----------|--------|--------|--------|----------|
| (Dollars are in thousands)            |   | Amortized |   | Fair   |   | Average  |
| Securities Available for Sale         |   | Cost      |   | Value  |   | Yield    |
| Due in one year or less               | $      | 1,994     | $      | 1,997  |   | 4.64%    |
| Due after one year through five years |   | 2,968     |   | 2,977  |   | 5.29%    |
| Total                                 | $      | 4,962     | $      | 4,974  |   | 5.02%    |

 

Investment securities with a carrying value of $3.5 million and $3.2 million        at December 31, 2007 and 2006, were pledged to secure public deposits and for other        purposes required by law.

 

The        Bank, as a member of the Federal Reserve Bank and the Federal Home Loan Bank, is required        to hold stock in each. These equity securities are restricted from trading and are recorded        at a cost of $4.3 million and $2.2 million as of December 31, 2007 and 2006,        respectively.

 

| **NOTE 5** | **LOANS:** |
|------------|------------|

Loans        receivable outstanding at December 31, are summarized as follows:

|                                                    |   | 2007    |   | 2006    |
|---------------------------------------------------------|--------|---------|--------|---------|
| (Dollars are in thousands)                              |   |    |   |    |
| Commercial, financial and agricultural                  | $      | 121,198 | $      | 104,372 |
| Real estate-construction                                |   | 38,420  |   | 37,716  |
| Real estate-mortgages                                   |   | 463,079 |   | 371,021 |
| Installment loans to                        individuals |   | 59,563  |   | 56,089  |
| Total loans                                             | $      | 682,260 | $      | 569,198 |

 

 

 

 

 

 

50

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

| **NOTE 5** | **LOANS (CONTINUED):** |
|------------|------------------------|

The        following is a summary of information at December 31, pertaining to nonperforming        loans:

 

| (Dollars are in                        thousands)                             |   | 2007   |   | 2006   |
|-------------------------------------------------------------------------------|--------|--------|--------|--------|
| Principal:                                                                    |   |   |   |   |
| Nonaccrual Loans                                                              | $      | 2,946  | $      | 1,206  |
| Loans past due 90 days or more                        still accruing interest |   | 267    |   | 9      |
| Total                        Non-performing Loans                             | $      | 3,213  | $      | 1,215  |

 

At the        end of 2007, impaired loans totaled $9.6 million with a valuation allowance of $1.2        million. At the end of 2006, impaired loans totaled $1.4 million with a valuation allowance        of $82 thousand. Interest income not recognized on these impaired loans was $227 thousand,        $65 thousand and $19 thousand for the years ending 2007, 2006 and 2005, respectively. The        average investment in impaired loans was $6.1 million in 2007, $912 thousand in 2006 and        $1.1 million in 2005.

 

| **NOTE 6** | **ALLOWANCE FOR LOAN LOSSES:** |
|------------|--------------------------------|

 

A        summary of transactions in the allowance for loan losses is as follows:

 

|                            |   | 2007    |   | 2006   |   | 2005   |
|---------------------------------|--------|---------|--------|--------|--------|--------|
| (Dollar are in thousands)       |   |    |   |   |   |   |
| Balance, beginning of year      | $      | 4,870   | $      | 3,943  | $      | 3,090  |
| Provision for loan losses       |   | 3,840   |   | 1,277  |   | 1,130  |
| Recoveries of loans charged off |   | 76      |   | 73     |   | 21     |
| Loans charged off               |   | (2,166) |   | (423)  |   | (298)  |
| Balance, End of Year            | $      | 6,620   | $      | 4,870  | $      | 3,943  |
| Percentage of Loans             |   | 0.97%   |   | 0.86%  |   | 0.84%  |

                       

| **NOTE 7** | **BANK PREMISES AND EQUIPMENT:** |
|------------|----------------------------------|

 

Bank        premises and equipment at December 31, are summarized as follows:

 

|                          |   | 2007     |   | 2006    |
|-------------------------------|--------|----------|--------|---------|
| (Dollars are in thousands)    |   |     |   |    |
| Land                          | $      | 9,394    | $      | 8,936   |
| Buildings and improvements    |   | 20,658   |   | 16,837  |
| Furniture and equipment       |   | 13,780   |   | 11,463  |
| Vehicles                      |   | 665      |   | 434     |
| Construction in progress      |   | 1,776    |   | 566     |
|                          |   | 46,273   |   | 38,236  |
| Less accumulated depreciation |   | (11,381) |   | (8,798) |
| Bank Premises and Equipment   | $      | 34,892   | $      | 29,438  |

 

Depreciation expense for 2007, 2006, and 2005 was $2.6 million, $2.3        million, and $1.9 million, respectively.

 

At        December 31, 2007, construction in progress included the costs of building and land        purchased for new branches in Duffield, Virginia; and Bluewell and Princeton West Virginia.        Each location is anticipated to be complete and operational as full service branches during        2008 at an additional total cost of $680 thousand. At December 31, 2006, construction in        progress included the costs of buildings and land for new branches in Bristol and        Chilhowie, Virginia which have been completed and placed in service.

 

 

 

51

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 8** | **OTHER TIME DEPOSITS:** |
|------------|--------------------------|

The        aggregate amount of time deposits with a minimum denomination of $100,000 was $175.1        million and $149.2 million at December 31, 2007 and 2006, respectively

 

At        December 31, 2007, the scheduled maturities of certificates of deposit are as follows        (dollars are in thousands):

 

| 2008             | $      | 403 |
|------------------|--------|-----|
| 2009             |   | 20  |
| 2010             |   | 52  |
| 2011             |   | 14  |
| 2012             |   | 13  |
| After five years |   | -   |
| Total            | $      | 502 |

 

| **NOTE 9** | **INCOME TAX EXPENSE:** |
|------------|-------------------------|

The        components of income tax expense for the years ended December 31, are as        follows:

 

| (Dollars are in                        thousands)  |   | 2007    |   | 2006  |   | 2005  |
|----------------------------------------------------|--------|---------|--------|-------|--------|-------|
| Current expense                                    | $      | 1,512   | $      | 1,442 | $      | 1,728 |
| Deferred expense                        (benefits) |   | (1,536) |   | (267) |   | (241) |
| Net income Tax                                     | $      | (24)    | $      | 1,175 | $      | 1,487 |

 

The        deferred tax expense (benefit) resulting from temporary differences for the years ended        December 31 is as follows:

 

| (Dollar are in thousands)                                                                                         |   | 2007                  |   | 2006          |   | 2005          |
|-------------------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|---------------|--------|---------------|
| Organization and start-up cost                                                                                    | $      | 2                     | $      | -             | $      | 2             |
| Provision for loan losses                                                                                         |   | (642)                 |   | (299)         |   | (268)         |
| Depreciation                                                                                                      |   | (74)                  |   | (54)          |   | (64)          |
| Deferred compensation expense

Accrued employee benefits

Amortization of core deposits

Amortization of goodwill |   | (34)

(172)

(26)

47 |   | (32)

-

-

- |   | (30)

-

-

- |
| Earnings on bank owned life insurance                                                                             |   | (638)                 |   | 118           |   | 114           |
| Capitalized interest and repair expense                                                                           |   | 1                     |   | -             |   | 5             |
| Deferred Income Tax Expenses (Benefit)                                                                            | $      | (1,536)               | $      | (267)         | $      | (241)         |

 

The net        deferred tax assets and liabilities resulting from temporary differences as of December 31        are summarized

as        follows:

 

| (Dollars are                        in thousands                                                                                  |   | 2007       |   | 2006     |   | 2005            |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|------------|--------|----------|--------|-----------------|
| Deferred Tax Assets:                                                                                                              |   |       |   |     |   |            |
| Organization and start-up cost                                                                                                    | $      | 3          | $      | 5        | $      | 5               |
| Allowance for loan losses                                                                                                         |   | 2,179      |   | 1,537    |   | 1,238           |
| Deferred compensation                                                                                                             |   | 176        |   | 142      |   | 110             |
| Unrealized loss on securities available for                        sale

Accrued employee benefits

Amortization of core deposits |   | -

172

26 |   | -

-

-  |   | 7

-

-

  |
| Capitalized interest and repair                        expense                                                                    |   | 18         |   | 19       |   | 19              |
| Total Assets                                                                                                                      |   | 2,574      |   | 1,703    |   | 1,379           |
|                                                                                                                              |   |       |   |     |   |            |
| Deferred Tax Liabilities                                                                                                          |   |       |   |     |   |            |
| Accelerated depreciation

Amortization of goodwill                                                                                |   | 1,238

47  |   | 1,312

- |   | 1,366

-        |
| Unrealized gain on securities available for                        sale                                                           |   | 4          |   | 1        |   | -               |
| Unrealized income on bank owned                        life insurance                                                             |   | -          |   | 638      |   | 520             |
| Total Liabilities                                                                                                                 |   | 1,289      |   | 1,951    |   | 1,886           |
| Net deferred Tax Asset                        (Liability)                                                                         | $      | 1,285      | $      | (248)    | $      | (507)           |

 

 

52

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

The        following table summarizes the differences between the actual income tax expense and the        amounts computed using the federal statutory tax rates:

 

| (Dollars are in                        thousands)                        |   | 2007   |   | 2006   |   | 2005   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
| Income tax expense at the applicable federal                        rate | $      | 968    | $      | 1,450  | $      | 1,431  |
| Permanent differences resulting from:                                    |   |   |   |   |   |   |
| Nondeductible expenses                                                   |   | 40     |   | 31     |   | 22     |
| Tax exempt interest income                                               |   | (190)  |   | (191)  |   | (90)   |
| State income taxes less federal tax effect                               |   | 40     |   | 24     |   | 42     |
|                                                                     |   |   |   |   |   |   |
| Bank owned life insurance                                                |   | (125)  |   | -      |   | -      |
| Change of accounting estimate                                            |   | (638)  |   | -      |   | -      |
| Other adjustments                                                        |   | 119    |   | (139)  |   | 82     |
| Income Tax Expense                        (benefit)                      | $      | (24)   | $      | 1,175  | $      | 1,487  |

 

| **NOTE 10** | **RELATED PARTY TRANSACTIONS:** |
|-------------|---------------------------------|

During        the year, officers and directors (and companies controlled by them) were customers of and        had loan transactions with the Bank in the normal course of business which amounted to        $11.2 million at December 31, 2007 and $12.0 million at December 31, 2006. During the year        ended December 31, 2007, total principal additions were $11.5 million and principal        payments were $12.3 million. During the year ended December 31, 2006, total principal        additions were $9.9 million and principal payments were $9.6 million. These transactions        were made on substantially the same terms as those prevailing for other customers and did        not involve any abnormal risk. Total related party deposits held at the Bank were $19.8        million and $14.4 million at the end of years 2007 and 2006, respectively.

 

| **NOTE 11** | **SIGNIFICANT ACQUISITION:** |
|-------------|------------------------------|

On June        29, 2007, the Bank finalized the purchase of assets and assumption of liabilities of two        branches of FNB Southeast.  The acquisition of the branches was accounted for as a        business combination and, as the purchase price exceeded the value of the net identified        tangible and intangible assets acquired, resulted in $4.0 million of goodwill being        recorded as an intangible asset on the accompanying balance sheet. The acquisition        provides, in addition to other factors, a strategic opportunity to expand into these        markets without the delay normally experienced in building a branch and future        growth.

 

The        acquisition transaction resulted in an estimated fair value of $13.7 million in loans        acquired and $60.4 million in deposits assumed. The resulting goodwill was $4.0 million.        The estimated core deposit premium is $810 thousand and is being amortized over 6.84        years.

 

The        transaction included the acquisition of two branches. Unaudited pro forma information of        prior periods is not presented as it would not differ materially from the historic        operations.

 

In        October 2007, the Bank agreed to purchase the $6.5 million remaining loan portfolio and        interest receivable from FNB Southeast at a 28.42% discount. In addition, the Bank also        obtained the right to collect on previously charged-off credits of FNB Southeast totaling        $658 thousand in the market area. At the time of settlement, November 2, 2007, the        outstanding balance of the notes purchased was $6.2 million and the discount recorded was        $2.2 million. The loans purchased were originally rejected in the initial due diligence        loan review conducted by the Bank prior to the branches acquisition in June 2007 due to        issues related to documentation deficienciesor history of or current        delinquency status. The total of these loans at December 31, 2007 was $5.5 million with a        recorded $2.2 million discount. The net balance is recorded in the loan portfolio. As of        December 31, 2007, the allocation of the discount to impaired loans was incomplete and will        be finished during 2008. A recourse provision in the agreement requires FNB Southeast to        correct material deficiencies or to purchase back the identified loans at the        discounted amount.  The review of acquire loans was in process at the end of        2007.

 

 

53

 

----

**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 12** | **INTANGIBLE ASSETS:** |
|-------------|------------------------|

On June        29, 2007, the Bank completed the acquisition of two branches in which certain intangible        assets were identified related to the value of core deposits. The estimated fair value of        the core deposits was determined based on the present value of future cash flow related to        those deposits considering the industry standard "financial instrument" type present value        methodology. All-in costs and runoff balances by year are discounted by term specific        Federal Home Loan Bank advance rates, used as a measure of the best available approximate        alternative costs of funds. The estimated economic advantage embedded in the acquired        deposits as compared to alternative values is the core deposit intangible.

 

|                                 | December 31, 2007 |   |
|--------------------------------------|-------------------|--------|
|                                 | Gross Carrying    |   |   | Accumulated |   |
| (Dollars are In thousands)           | Amount            |   |   | Amortization |   |
| Finite-lived intangible assets       |              |   |   |   |   |   |   |
| Core deposit intangibles             | $                 | 810    |   |   | $ | 103 |   |
| Indefinite-lived intangible assets   |              |   |   |   |   |   |   |
| Goodwill                             | $                 | 4,122  |   |   | $ | - |   |
| Aggregate amortization expense       |              |   |   |   |   |   |   |
| For the year ended December 31, 2007 | $                 | 103    |   |   | $ | 103 |   |

 

Amortization expense related to these contract intangibles is based upon the        average economic life of the core deposits. The estimates of expense for the periods are as        indicated below using the sum of the years' digits method of amortization.

 

|   | (Dollars are in thousands) |
|--------|----------------------------|

| Estimated amortization expense        |   |   |
|---------------------------------------|--------|--------|
| For year ended December 31, 2008 | $      | 189    |
| For year ended December 31, 2009 |   | 161    |
| For year ended December 31, 2010 |   | 131    |
| For year ended December 31, 2011 |   | 101    |
| For year ended December 31, 2012 |   | 71     |
| For year ended December 31, 2013 |   | 45     |
| For year ended December 31, 2014 |   | 9      |
| Total                                 | $      | 707    |

 

| **NOTE 13** | **CHANGE OF ACCOUNTING ESTIMATE:** |
|-------------|------------------------------------|

During        the third quarter of 2007, the Company changed its intention related to its ownership of        bank owned life insurance on members of management. When the life insurance was purchased,        the determination was made that the insurance policies may be cashed in before the death of        an insured employee creating a potential taxable event at that time. During September 2007,        the Board of Directors restructered the life insurance program and  decided that the        policies in existence at that time as well as any additional policies to be purchased would        be held to the death of the insured at which time the Company will receive the proceeds in        a tax free transaction. Therefore, as a result, the deferred taxes were adjusted by the        $638 thousand which had been previously provided and income tax expense was reduced by the        same amount during the third quarter of 2007. The adjustment was reflected as a change of        accounting estimate in accordance with Financial Accounting Standards Board Statement No.        154,(As Amended)*Accounting Changes and Error        Corrections*.

 

 

54

 

----

 

| **NOTE 14** | **RETIREMENT PLANS:** |
|-------------|-----------------------|

The        Company has established a qualified defined contribution plan that covers all full time        employees. Under the plan, the Company matches employee contributions up to a maximum of 5%        of their salary. The Company contributed $393 thousand, $356 thousand, and $310 thousand to        the defined contribution plan for 2007, 2006 and 2005, respectively.

 

In        addition, in 2002, the Bank established a salary continuation plan for key executives,        which is funded by single premium life insurance policies. Expenses related to the plan        were $101 thousand, $95 thousand, and $86 thousand, for 2007, 2006 and 2005,        respectively.

 

| **NOTE 15** | **STOCK OPTION PLAN:** |
|-------------|------------------------|

New        Peoples' Stock Option Plan ("the Plan") was adopted on September 27, 2001. The purpose of        the Plan is to reward employees and directors for services rendered and investment risks        undertaken to date and to promote the success of the Company by providing incentives to        employees and directors that will promote the identification of their personal interest        with the long-term financial success of the Company and with growth in shareholder value.        The Plan provides that options for up to 1,287,000 shares of the Company's common stock may        be issued to employees and directors as adjusted for the 13-for-10 stock split effected in        the form of a stock dividend on September 12, 2007 and a 10 percent stock dividend on June        7, 2005. The exercise price may not be less than 100% of the fair market value of the        shares on the award date. Each award becomes exercisable in the event of a change in        control of the Company. All options are subject to exercise or forfeiture if the Company's        capital falls below minimum requirements, as determined by its primary state or federal        regulator. The Plan will expire on May 31, 2011, unless terminated earlier by the board of        directors. At December 31, 2007, there were 168,272 additional shares available for grant        under the Plan. All options granted and outstanding are fully vested.

 

The        Company did not grant any options in 2007 and 2006. The weighted fair value of each option        for the year 2005 was $5.14, and was estimated at the date of grant using the Black-Scholes        option pricing model. The Black-Scholes option pricing model was originally developed for        use in estimating the fair value of traded options, which have different characteristics        from the Company's stock options. The model is also sensitive to changes in assumptions,        which can materially affect the fair value estimate.

 

The        following weighted - average assumptions were used to determine the fair value of options        in the year 2005.

 

|                                           |                           |
|------------------------------------------------|--------------------------------|
| Dividend yield                                 | 0.00%                          |
| Expected life                                  | 7                        years |
| Expected                        volatility     | 20.00%                         |
| Risk free interest                        rate | 4.41%                          |

 

Information about stock options outstanding at December 31, 2007        follows:

 

|   | Exercise                        Price | Number                        Outstanding and Exercisable | Weighted                        Average Remaining Contractual Life |   | Weighted                        Average Exercise |
|--------|---------------------------------------|-----------------------------------------------------------|--------------------------------------------------------------------|--------|--------------------------------------------------|
| $      | 5.25                                  | 260,263                                                   | 4.00                        years                                  | $      | 5.25                                             |
| $      | 6.99                                  | 227,175                                                   | 5.52                        years                                  | $      | 6.99                                             |
| $      | 9.44                                  | 137,865                                                   | 7.00                        years                                  | $      | 9.44                                             |
| $      | 11.54                                 | 411,547                                                   | 8.00                        years                                  | $      | 11.54                                            |
|   | Totals                                | 1,036,850                                                 | 7.11                        years                                  | $      | 8.68                                             |

                       

 

55

 

----

A        summary of the status of the Company's stock option plan is presented below:

 

|                                                                                            |              | 2007                            |    | 2006             |                            | 2005    |
|-------------------------------------------------------------------------------------------------|-------------------|---------------------------------|---------|------------------|---------------------------------|---------|
|                                                                                            | Number of Shares  | Weighted Average Exercise Price |    | Number of Shares | Weighted Average Exercise Price |    | Number of Shares | Weighted Average Exercise Price |
| Outstanding and exercisable,                                                                    |              |                            |    |             |                            |    |   |
|                                                                                            | Beginning of year | 809,062                         | $ 11.28 |             | 851,792                         | $ 11.10 |   | 499,900 | $ 9.56 |
| Granted                                                                                         | -                 | -                               |    | -                | -                               |    | 323,100 | 15.00 |
| Effect of 10% June 7, 2005 Stock Dividend                                                       |              | -                               |    |             |                            |    | 49,715 | (0.87) |
| Effect of 13 for 10 stock split effected in the form of a                        stock dividend | 239,388           | (2.60)                          |    |             |                            |    |   |   |
| Exercised                                                                                       | (4,250)           | 6.93                            |    | (37,705)         | 7.29                            |    | (18,323) | 7.68 |
| Forfeited                                                                                       | (7,350)           | 13.03                           |    | (5,025)          | 11.37                           |    | (2,600) | 10.67 |
| Outstanding and exercisable,                                                                    |              |                            |    |             |                            |    |   |
|                                                                                            | end of year       | 1,036,850                       | $ 8.68  |             | 809,062                         | $ 11.28 |   | 851,792 | $ 11.10 |

 

| **NOTE 16** | **LEASING ACTIVITIES:** |
|-------------|-------------------------|

The        Company's leasing activities consist of the leasing of land and buildings under agreements        in which the Bank is lessee. These leases have been classified as operating        leases.

 

The        following is a schedule by years of future minimum rental payments in thousands, required        under non-cancelable operating leases that have initial or remaining non-cancelable lease        terms in excess of one year as of December 31, 2007:

                         

| Year ending December 31:        |   |   |
|---------------------------------|--------|--------|
| 2008                            | $      | 27     |
| 2009                            |   | 27     |
| 2010                            |   | 27     |
| 2011                            |   | 27     |
| 2012                            |   | 27     |
| Thereafter                      |   | 110    |
| Total minimum payments required | $      | 245    |

 

Rental        commitments of less than one year are not included in the above schedule. Rentals charged        to operations under operating leases were $60 thousand, $60 thousand, and $55 thousand, for        the years ended 2007, 2006, and 2005, respectively.

 

| **NOTE 17** | **DIVIDEND LIMITATIONS ON SUBSIDIARY BANK:** |
|-------------|----------------------------------------------|

The        principal source of funds of the Company is dividends paid by the Bank. The Federal Reserve        Act restricts the amount of dividends the Bank may pay. Approval by the Board of Governors        of the Federal Reserve System is required if the dividends declared by a state member bank,        in any year, exceed the sum of (1) net income of the current year and (2) income net of        dividends for the preceding two years. As of December 31, 2007, approximately $11.1 million        was available for dividend distribution.

 

 

56

 

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| **NOTE 18** | **AVAILABLE LINES OF CREDIT AND FEDERAL HOME LOAN BANK                        ADVANCES:** |
|-------------|-------------------------------------------------------------------------------------------|

The Bank        has federal funds lines of credit with correspondent banks totaling $20.4 million as of        December 31, 2007. In addition, the Bank may borrow up to an additional $69.3 million from        the Federal Home Loan Bank under a line of credit which is secured by a blanket lien on        residential real estate loans.

 

The Bank        had $32.2 million in overnight borrowings subject to daily rate changes from the Federal        Home Loan Bank at December 31, 2007 and none at December 31, 2006.

 

The Bank        had 2 borrowings totaling $10.2 million with a weighted rate of 4.03% from the Federal Home        Loan Bank at December 31, 2007. Both are convertible notes with a quarterly Bermudan call        feature beginning in 2008 and mature in 2012:

 

Borrowings        of $32.2 million were overnight and interest rates change daily as of December 31, 2007.        All other borrowings are at fixed rates.

 

| **NOTE 19** | **FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET                        RISK:** |
|-------------|-------------------------------------------------------------------------------|

In the        normal course of business, the Bank has outstanding commitments and contingent liabilities,        such as commitments to extend credit and standby letters of credit, which are not included        in the accompanying consolidated financial statements. The Bank's exposure to credit loss        in the event of nonperformance by the other party to the financial instruments for        commitments to extend credit and standby letters of credit is represented by the        contractual or notional amount of those instruments. The Bank uses the same credit policies        in making such commitments as it does for instruments that are included in the balance        sheet.

 

Financial instruments whose contract amount represents credit risk were as        follows:

 

| (Dollars are                        in thousands)   |   | 2007   |   | 2006   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Commitments to extend                        credit | $      | 57,032 | $      | 51,131 |
| Standby letters of                        credit    |   | 3,150  |   | 4,942  |

 

Commitments to extend credit are agreements to lend to a customer at either        a fixed or variable interest rate as long as there is no violation of any condition        established in the contract. Commitments generally have fixed expiration dates or other        termination clauses and may require payment of a fee. Since many of the commitments are        expected to expire without being drawn upon, the total commitment amounts do not        necessarily represent future cash requirements. The Bank evaluates each customer's        creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed        necessary by the Bank upon extension of credit, is based on management's credit evaluation.        Collateral held varies but may include accounts receivable, inventory, property and        equipment, and income-producing commercial properties.

 

Standby        letters of credit are conditional commitments issued by the Bank to guarantee the        performance of a customer to a third party. Standby letters of credit generally have fixed        expiration dates or other termination clauses and may require payment of a fee. The credit        risk involved in issuing letters of credit is essentially the same as that involved in        extending loan facilities to customers. The Bank's policy for obtaining collateral, and the        nature of such collateral, is essentially the same as that involved in making commitments        to extend credit.

 

| **NOTE 20** | **LEGAL CONTINGENCIES:** |
|-------------|--------------------------|

Various        legal claims arise from time to time in the normal course of business which, in the opinion        of management, will have no material effect on the Company's consolidated financial        statements.

 

 

57

 

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| **NOTE 21** | **REGULATORY MATTERS:** |
|-------------|-------------------------|

The        Company and the Bank are subject to various capital requirements administered by federal        banking agencies. Failure to meet minimum capital requirements can initiate certain        mandatory and, possibly, additional discretionary actions by regulators that, if        undertaken, could have a direct material effect on the Company's and the Bank's financial        statements. Under capital adequacy guidelines and the regulatory framework for prompt        corrective action, the Company and the Bank must meet specific capital guidelines that        involve quantitative measures of assets, liabilities, and certain off-balance sheet items        as calculated under regulatory accounting practices. The capital amounts and classification        are also subject to qualitative judgments by the regulators about components, risk        weightings, and other factors. Prompt corrective action provisions are not applicable to        bank holding companies.

 

Quantitative measures established by regulation to ensure capital adequacy        require the Company and the Bank to maintain minimum amounts and ratios (set forth in the        following table) of total and Tier 1 capital (as defined) to risk-weighted assets (as        defined) and of Tier 1 capital (as defined) to average assets (as defined). Management        believes that, as of December 31, 2007 and 2006, the Company and the Bank meet all capital        adequacy requirements to which they are subject.

 

As of        September 2007, the most recent date of notification, the Federal Reserve Bank of Richmond        categorized the Bank as well capitalized under the regulatory framework for prompt        corrective action. To be categorized as well capitalized, an institution must maintain        minimum total risk-based, Tier 1 risk-based and Tier1 leverage ratios as set forth in the        following tables. There are no conditions or events since the notification that management        believes have changed the Bank's category.

 

The        Company's and the Bank's actual capital amounts and ratios are presented in the table as of        December 31, 2007 and 2006, respectively.

|                                                           | Actual      | Minimum Capital                        Requirement | Minimum to Be                        Well Capitalized Under Prompt Corrective Action Provisions |
|----------------------------------------------------------------|-------------|----------------------------------------------------|-------------------------------------------------------------------------------------------------|
| (Dollars are in thousands)                                     |        | Amount                                             | Ratio                                                                                           |   | Amount | Ratio |   | Amount | Ratio |
| December 31, 2007:                                             |        |                                               |                                                                                            |   |   |   |   |   |   |
| Total Capital to Risk Weighted Assets                          |        |                                               |                                                                                            |   |   |   |   |   |   |
|                                                           | The Company | $                                                  | 63,542                                                                                          | 10.29% |   | 49,392 | 8% | $ | N/A | N/A |
|                                                           | The Bank    |                                               | 62,681                                                                                          | 10.11% |   | 49,591 | 8% |   | 61,989 | 10% |
| Tier 1 Capital Risk Weighted Assets:                           |        |                                               |                                                                                            |   |   |   |   |   |   |
|                                                           | The Company |                                               | 53,901                                                                                          | 8.73% |   | 24,696 | 4% |   | N/A | N/A |
|                                                           | The Bank    |                                               | 56,061                                                                                          | 9.04% |   | 24,795 | 4% |   | 37,193 | 6% |
| Tier 1 Capital to Average Assets:                              |        |                                               |                                                                                            |   |   |   |   |   |   |
|                                                           | The Company |                                               | 53,901                                                                                          | 7. 22% |   | 29,863 | 4% |   | N/A | N/A |
|                                                           | The Bank    |                                               | 56,061                                                                                          | 7.52% |   | 29,818 | 4% |   | 37,272 | 5% |
|                                                           |        |                                               |                                                                                            |   |   |   |   |   |   |
| December 31,2006:                                              |        |                                               |                                                                                            |   |   |   |   |   |   |
| Total Capital to Risk Weighted Assets                          |        |                                               |                                                                                            |   |   |   |   |   |   |
|                                                           | The Company | $                                                  | 63,710                                                                                          | 12.20% | $ | 41,775 | 8% | $ | N/A | N/A |
|                                                           | The Bank    |                                               | 57,692                                                                                          | 11.06% |   | 41,717 | 8% |   | 52,146 | 10% |
| Tier 1 Capital to Risk                        Weighted Assets: |        |                                               |                                                                                            |   |   |   |   |   |
|                                                           | The Company |                                               | 56,444                                                                                          | 10.81% |   | 20,888 | 4% |   | N/A | N/A |
|                                                           | The Bank    |                                               | 52,822                                                                                          | 10.13% |   | 20,858 | 4% |   | 31,287 | 6% |
| Tier 1 Capital to Average Assets:                              |        |                                               |                                                                                            |   |   |   |   |   |   |
|                                                           | The Company |                                               | 56,444                                                                                          | 8.94% |   | 25,253 | 4% |   | N/A | N/A |
|                                                           | The Bank    |                                               | 52,822                                                                                          | 8.38% |   | 25,222 | 4% |   | 31,527 | 5% |

 

 

58

 

----

 

| **NOTE 22** | **TRUST PREFERRED SECURITIES:** |
|-------------|---------------------------------|

On September 27, 2006, the        Company completed the issuance of $5.2 million in floating rate trust preferred securities        offered by its wholly owned subsidiary, NPB Capital Trust 2. The proceeds of the funds were        used for general corporate purposes, which Include capital management for affiliates and        the acquisition of two branch banks. The securities have a floating rate of 3 month LIBOR        plus 177 basis points, which resets quarterly, with a current rate at December 31, 2007 of        7.01%.                  On July 7, 2004, the Company completed the issuance of $11.3 million in floating rate        trust preferred securities offered by its wholly owned subsidiary, NPB Capital Trust I. The        proceeds of the funds were used for general corporate purposes which included capital        management for affiliates, retirement of indebtedness and other investments. The securities        have a floating rate of 3 month LIBOR plus 260 basis points, which resets quarterly, with a        current rate at December 31, 2007 of 7.84%.

Under the terms of the        subordinated debt transactions, the securities mature in 30 years and are redeemable, in        whole or in part, without penalty, at the option of the Company after five years. Due to        the ability to defer interest and principal payments for 60 months without being considered        in default, the regulatory agencies consider the trust preferred securities as Tier 1        capital up to certain limits.

 

| **NOTE 23** | **DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL                        INSTRUMENTS:** |
|-------------|-----------------------------------------------------------------------------------|

Statement of Financial Accounting Standards No. 107 (SFAS 107) "Disclosures        About the Fair Value of Financial Instruments" defines the fair value of a financial        instrument as the amount at which a financial instrument could be exchanged in a current        transaction between willing parties, other than in a forced liquidation sale. As the        majority of the Bank's financial instruments lack an available trading market, significant        estimates, assumptions and present value calculations are required to determine estimated        fair value. Estimated fair value and the carrying value of financial instruments at        December 31, 2007 and 2006 are as follows:

 

|                                                      |   | December 31,                        2007    |   | December 31,                        2006 |
|-----------------------------------------------------------|--------|---------------------------------------------|--------|------------------------------------------|
|  

(Dollars are in                        thousands) |   | Estimated Fair                        Value |   | Carrying                        Value    |   | Estimated Fair                        Value |   | Carrying                        Value |
| Financial Assets                                          |   |                                        |   |                                     |   |   |   |   |
| Cash and due from bank                                    | $      | 20,195                                      | $      | 20,195                                   | $ | 18,451 | $ | 18,451 |
| Federal funds sold                                        |   | 2,062                                       |   | 2,062                                    |   | 1,430 |   | 1,430 |
| Investment securities                                     |   | 4,974                                       |   | 4,974                                    |   | 3,493 |   | 3,493 |
| Equity securities (restricted)                            |   | 4,258                                       |   | 4,258                                    |   | 2,164 |   | 2,152 |
| Loans                                                     |   | 685,667                                     |   | 682,260                                  |   | 566,023 |   | 569,198 |
| Accrued Interest receivable                               |   | 4,969                                       |   | 4,969                                    |   | 4,140 |   | 4,140 |
| Life insurance investments                                |   | 9,745                                       |   | 9,745                                    |   | 9,377 |   | 9,377 |
|                                                      |   |                                        |   |                                     |   |   |   |   |
| Financial Liabilities                                     |   |                                        |   |                                     |   |   |   |   |
| Demand Deposits                                           |   |                                        |   |                                     |   |   |   |   |
| Non-interest bearing                                      |   | 83,680                                      |   | 83,680                                   |   | 71,538 |   | 71,538 |
| Interest-bearing                                          |   | 26,857                                      |   | 26,857                                   |   | 19,290 |   | 19,290 |
| Savings deposits                                          |   | 44,721                                      |   | 44,721                                   |   | 42,894 |   | 42,894 |
| Time deposits                                             |   | 503,890                                     |   | 501,775                                  |   | 440,982 |   | 438,465 |
| FHLB advances                                             |   | 42,346                                      |   | 42,434                                   |   | - |   | - |
| Accrued interest payable                                  |   | 2,822                                       |   | 2,822                                    |   | 2,783 |   | 2,783 |
| Trust preferred securities                                |   | 16,496                                      |   | 16,496                                   |   | 16,496 |   | 16,496 |

                         

The        carrying value of cash and due from banks, federal funds sold, interest-bearing deposits,        deposits with no stated maturities, trust preferred securities and accrued interest        approximates fair value. The estimated fair value of investment securities was based on        closing market prices. The remaining financial instruments were valued based on the present        value of estimated future cash flows, discounted at various rates in effect for similar        instruments during the months of December 2007 and 2006.

 

 

59

 

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**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 24** | **RECENT ACCOUNTING DEVELOPMENTS:** |
|-------------|-------------------------------------|

In        December 2007, the FASB issued FASB Statement of Financial Accounting Standards No. 14(R),        "Business Combinations" (SFAS 141(R)), which requires all assets acquired and liabilities        assumed in a business combination (with a few exceptions, such as deferred tax assets and        liabilities) be measured at fair value in accordance with SFAS 157. SFAS 141(R) is        effective prospectively for fiscal years beginning on or after December 15, 2008. Earlier        adoption is prohibited. The Company is currently evaluating the impact of adopting SFAS        141(R) on its financial statements.

 

Also in        December 2007, the FASB issued Statement of Financial Accounting Standards No. 160,        "Non-controlling Interests in Consolidated Financial Statements - an amendment of ARB No.        51" SFAS 160), which amends ARB No. 51 to establish accounting and reporting standards for        the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary.        It also amends certain of ARB No.51's consolidation procedures for consistency with the        requirements of SFAS 141(R), "Business Combinations". SFAS 160 is effective for fiscal        years, and interim periods within those fiscal years, beginning on or after December 15,        2008. The Company will not be affected.

 

In        February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159 -        "The Fair Value Option for Financial Assets and Financial Liabilities - Including an        amendment of FASB Statement No. 115". SFAS No. 159 permits entities to choose to measure        eligible items at fair value at specified election dates and report unrealized gains and        losses on items for which the fair value option has been elected in earnings at each        subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after        November 15, 2007. Management is currently evaluating the effect that adoption of this        statement will have on the Company's consolidated financial position and results of        operations when it becomes effective in 2008.

 

In        September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement        provides a single definition of fair value, a framework for measuring fair value, and        expanded disclosures concerning fair value. Previously, different definitions of fair value        were contained in various accounting pronouncements creating inconsistencies in measurement        and disclosures. SFAS No. 157 applies under those previously issued pronouncements that        prescribe fair value as the relevant measure of value, except SFAS No. 123(R) and related        interpretations and pronouncements that require or permit measurement similar to fair value        but are not intended to measure fair value. This pronouncement is effective for fiscal        years beginning after November 15, 2007. The Company is evaluating the impact of this new        standard, but currently believes that adoption will not have a material impact on its        financial position or results of operations.

 

Several        other new accounting standards became effective during the periods presented or will be        effective subsequent to December 31, 2007. None of these new standards had or is expected        to have significant impact on the Company's consolidated financial statements.

 

| **NOTE 25** | **OTHER REAL ESTATE OWNED** |
|-------------|-----------------------------|

 

Other        real estate owned is presented at net realizable value. No material expenses have been        incurred related to the properties.

 

60

 

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**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 26** | **PARENT CORPORATION ONLY FINANCIAL                        STATEMENTS:** |
|-------------|--------------------------------------------------------------------------|

 

**CONDENSED BALANCE SHEETS**

**AS OF        DECEMBER 31, 2007 AND 2006**

(Dollars        in Thousands)

| **ASSETS**                                                                                                                                                                                      |   | 2007   |   | 2006           |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|----------------|
| Due from banks                                                                                                                                                                                  | $      | 107    | $      | 5,041          |
| Investment in subsidiaries                                                                                                                                                                      |   | 61,676 |   | 53,516         |
| Other assets                                                                                                                                                                                    |   | 1,139  |   | 687            |
| Total Assets                                                                                                                                                                                    | $      | 62,922 | $      | 59,244         |
|                                                                                                                                                                                            |   |   |   |           |
| **LIABILITIES**                                                                                                                                                                                 |   |   |   |           |
| Accrued interest payable                                                                                                                                                                        | $      | 289    | $      | 312            |
| Accrued expenses and other liabilities                                                                                                                                                          |   | 888    |   | 90             |
| Trust preferred securities                                                                                                                                                                      |   | 16,496 |   | 16,496         |
| Total Liabilities                                                                                                                                                                               |   | 17,673 |   | 16,898         |
|                                                                                                                                                                                            |   |   |   |           |
| **STOCKHOLDERS' EQUITY**                                                                                                                                                                        |   |   |   |           |
| Common stock-$2.00 par value, 12,000,000 shares authorized;                        9,959,477 and 9,954,178 shares issued and outstanding for 2007 and 2006,                        respectively |   | 19,919 |   |  

15,314 |
| Additional paid capital                                                                                                                                                                         |   | 21,484 |   | 21,465         |
| Retained earnings                                                                                                                                                                               |   | 3,839  |   | 5,565          |
| Accumulated other comprehensive income (loss)                                                                                                                                                   |   | 7      |   | 2              |
| Total Stockholders' Equity                                                                                                                                                                      |   | 45,249 |   | 42,346         |
| Total Liabilities and Stockholders' Equity                                                                                                                                                      | $      | 62,922 | $      | 59,244         |

 

 

**CONDENSED STATEMENTS OF INCOME**

**FOR        THE YEARS ENDED DECEMBER 31, 2007, 2006, AND 2005**

(Dollars        in Thousands)

|                                        |   | 2007   |   | 2006   |   | 2005   |
|---------------------------------------------|--------|--------|--------|--------|--------|--------|
| **Income**                                  |   |   |   |   |   |   |
| Miscellaneous income                        | $      | 38     | $      | 29     | $      | 86     |
| Undistributed income of subsidiaries   |   | 3,853  |   | 3,844  |   | 3,409  |
| Total Income                                |   | 3,891  |   | 3,873  |   | 3,495  |
|                                        |   |   |   |   |   |   |
| **Expenses**                                |   |   |   |   |   |   |
| Trust preferred securities interest expense |   | 1,283  |   | 1,004  |   | 669    |
| Legal fees                                  |   | 47     |   | 47     |   | 34     |
| Accounting fees                             |   | 104    |   | 129    |   | 166    |
| Other operating expenses                    |   | 101    |   | 93     |   | 138    |
| Total Expenses                              |   | 1,535  |   | 1,273  |   | 1,007  |
|                                        |   |   |   |   |   |   |
| **Income before Income Taxes**              |   | 2,356  |   | 2,600  |   | 2,488  |
| Income Tax Benefit                          |   | 514    |   | 490    |   | 235    |
| **Net Income**                              | $      | 2,870  | $      | 3,090  | $      | 2,723  |

 

 

                         

 

 

61

 

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**NEW        PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (CONTINUED)**

 

| **NOTE 27** | **PARENT CORPORATION ONLY FINANCIAL STATEMENTS                        (CONTINUED):** |
|-------------|--------------------------------------------------------------------------------------|

 

**CONDENSED STATEMENTS OF CASH FLOWS**

**FOR        THE YEARS ENDED DECEMBER 31, 2007, 2006, AND 2005**

(Dollars        and Shares in Thousands)

|                                     |                                                                                                               | 2007   |    | 2006   |    | 2005   |
|------------------------------------------|--------------------------------------------------------------------------------------------------------------------|--------|---------|--------|---------|--------|
| **Cash Flows From Operating Activities** |                                                                                                               |   |    |   |    |   |
|                                     | Net Income                                                                                                         | $      | 2,870   | $      | 3,090   | $      | 2,723 |
|                                     | Adjustments to reconcile net income to net cash provided by                        (used) in operating activities: |   |    |   |    |   |   |
|                                     | Income of subsidiaries                                                                                             |   | (3,853) |   | (3,844) |   | (3,049) |
|                                     | Depreciation                                                                                                       |   | -       |   | -       |   | 114 |
|                                     | Net change in:                                                                                                     |   |    |   |    |   |   |
|                                     | Other assets                                                                                                       |   | (453)   |   | (139)   |   | (110) |
|                                     | Other liabilities                                                                                                  |   | 774     |   | 149     |   | (338) |
|                                     | Net Cash Used in Operating Activities                                                                              |   | (662)   |   | (736)   |   | (1,020) |
|                                     |                                                                                                               |   |    |   |    |   |   |
|                                     | **Cash Flows From Investing Activities**                                                                           |   |    |   |    |   |   |
|                                     | Payment for the purchase of property                                                                               |   | -       |   | -       |   | (177) |
|                                     | Proceeds from the sale of property                                                                                 |   | -       |   | -       |   | 2,111 |
|                                     | Investment in subsidiary                                                                                           |   | (4,300) |   | (6,510) |   | (4,550) |
|                                     | Net Cash Used Investing Activities                                                                                 |   | (4.300) |   | (6,510) |   | (2,616) |
|                                     |                                                                                                               |   |    |   |    |   |   |
|                                     | **Cash Flows From Financing Activities**                                                                           |   |    |   |    |   |   |
|                                     | Net proceeds for trust preferred securities                                                                        |   | -       |   | 5,000   |   | - |
|                                     | Exercise of stock options                                                                                     |   | 28      |   | 275     |   | 141 |
|                                     | Net Cash Provided by Financing Activities                                                                          |   | 28      |   | 5,275   |   | 141 |
|                                     |                                                                                                               |   |    |   |    |   |   |
|                                     | **Net Increase in Cash and Cash Equivalents**                                                                      |   | (4,934) |   | (1,971) |   | (3,495) |
|                                     | Cash and Cash Equivalents, Beginning of year                                                                       |   | 5,041   |   | 7,012   |   | 10,507 |
|                                     | **Cash and Cash Equivalents, End of Year**                                                                         | $      | 107     | $      | 5,041   | $      | 7,012 |
|                                          |                                                                                                                    |        |         |        |         |        |  |

 

**NOTE        27    SELECTED QUARTERLY INFORMATION (UNAUDITED)**

 

|                                                                        | **2007 Quarters** |
|-----------------------------------------------------------------------------|-------------------|
| (Dollars in thousands)                                                      | Fourth            |   | Third |   | Second |   | First |
| **Income statement**                                                        |              |   |   |   |   |   |   |
| Interest income                                                             | $ 13,721          | **$** | 13,552 | $ | 12,470 | $ | 11,705 |
| Interest expense                                                            | 6,886             |   | 6,719 |   | 6,210 |   | 5,923 |
| Net interest income                                                         | 6,835             |   | 6,833 |   | 6,260 |   | 5,782 |
| Noninterest income                                                          | 1,344             |   | 1,258 |   | 1,047 |   | 1,001 |
| Total revenue                                                               | 8,179             |   | 8,091 |   | 7,307 |   | 6,783 |
| Provision for credit losses                                                 | 1,300             |   | 1,800 |   | 440 |   | 300 |
| Noninterest expense                                                         | 6,338             |   | 6,372 |   | 5,602 |   | 5,360 |
| Income before income taxes                                                  | 541               |   | (81) |   | 1,265 |   | 1,123 |
| Income tax expense (benefit)                                                | (1)               |   | (706) |   | 364 |   | 321 |
| Net income                                                                  | 542               |   | 625 |   | 901 |   | 802 |
| Average common shares issued and outstanding                                | 9,959,477         |   | 9,958,923 |   | 9,957,529 |   | 9.955,437 |
| Average diluted common shares issued and                        outstanding | 10,282,014        |   | 10,402,413 |   | 10,303,430 |   | 10,384,839 |
| **Period end balance sheet**                                                |              |   |   |   |   |   |   |
| Total loans and leases                                                      | 682,260           |   | 661,377 |   | 635,362 |   | 591,370 |
| Total assets                                                                | 765,951           |   | 745,483 |   | 740,474 |   | 661,125 |
| Total deposits                                                              | 657,033           |   | 663,825 |   | 635,700 |   | 586,621 |
| Total shareholders' equity                                                  | 45,249            |   | 44,709 |   | 44,066 |   | 43,163 |

 

 

62

 

----

 

|  

**NEW PEOPLES BANKSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                        (CONTINUED** |              |
|----------------------------------------------------------------------------------------------------------------------------|-------------------|
|  

**NOTE 27    SELECTED QUARTERLY INFORMATION                        (UNAUDITED)**                    |              |
|  

                                                                                                              | **2006 Quarters** |
| (Dollars in thousands)                                                                                                     | Fourth            |   | Third |   | Second |   | First |
| **Income statement**                                                                                                       |              |   |   |   |   |   |   |
| Interest income                                                                                                            | $ 11,461          | **$** | $ 10,848 | $ | $ 9,965 | $ | $ 9,006 |
| Interest expense                                                                                                           | 5,956             |   | 5,206 |   | 4,406 |   | 3,826 |
| Net interest income                                                                                                        | 5,506             |   | 5,642 |   | 5,559 |   | 5,180 |
| Noninterest income                                                                                                         | 974               |   | 847 |   | 865 |   | 774 |
| Total revenue                                                                                                              | 6,480             |   | 6,489 |   | 6,424 |   | 5,954 |
| Provision for credit losses                                                                                                | 312               |   | 260 |   | 393 |   | 312 |
| Noninterest expense                                                                                                        | 5,379             |   | 5,056 |   | 4,851 |   | 4,518 |
| Income before income taxes                                                                                                 | 789               |   | 1,173 |   | 1,179 |   | 1,124 |
| Income tax expense                                                                                                         | 172               |   | 337 |   | 360 |   | 307 |
| Net income                                                                                                                 | 617               |   | 836 |   | 820 |   | 817 |
| Average common shares issued and outstanding                                                                               | 9,952,945         |   | 9,950,992 |   | 9,943,176 |   | 9,909,206 |
| Average diluted common shares issued and                        outstanding                                                | 10,385,397        |   | 10,387,389 |   | 10,410,740 |   | 10,337,406 |
| **Period end balance sheet**                                                                                               |              |   |   |   |   |   |   |
| Total loans and leases                                                                                                     | $ 569,198         |   | $ 547,483 |   | $ 523,802 |   | $ 490,447 |
| Total assets                                                                                                               | 635,819           |   | 620,506 |   | 583,664 |   | 547,643 |
| Total deposits                                                                                                             | 572,187           |   | 542,985 |   | 511,315 |   | 476,852 |
| Total shareholders' equity                                                                                                 | 42,346            |   | 41,705 |   | 40,857 |   | 39,880 |
|                                                                                                                            |                   |  |  |  |  |  |  |  |

 

 

 

 

63

 

----

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

 

None.

 

**Item        9A. Controls and Procedures**

 

**Management's Report on Internal Control Over Financial        Reporting**

 

Management's Report on Internal Control Over Financial Reporting is included        in Item 8 of this annual report and is incorporated herein by reference.  The        effectiveness of internal control over financial reporting as of December 31, 2007, has        been audited by Brown, Edwards & Company, L.L.P., the independent registered public        accounting firm which also audited the Company's consolidated financial statements, as        stated in its report which is included in Item 8 of this annual report and incorporated        herein by reference.

 

**Changes in Internal Control Over Financial Reporting**

 

There        have been no changes in our internal control over financial reporting during the last        fiscal quarter that materially affected, or are reasonably likely to materially affect,        internal control over financial reporting.

 

 **Disclosure Controls and        Procedures**

 

We        maintain a system of disclosure controls and procedures that is designed to ensure that        material information is accumulated and communicated to management, including our Chief        Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions        regarding required disclosure. As of the end of the period covered by this report, we        carried out an evaluation, under the supervision and with the participation of our        management, including the Chief Executive Officer and Chief Financial Officer, of the        effectiveness of the design and operation of the disclosure controls and procedures        pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based on        that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our        disclosure controls and procedures were operating effectively to ensure that information        required to be disclosed by us in reports that we file or submit under the Securities        Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within        the time periods specified in the SEC's rules and forms.

 

Because        of the inherent limitations in all control systems, no evaluation of controls can provide        absolute assurance that our disclosure controls and procedures will detect or uncover every        situation involving the failure of persons within New Peoples to disclose material        information otherwise required to be set forth in our periodic reports.

 

| **Item 9B.** | **Other Information** |
|--------------|-----------------------|

 

None

 

**PART III**

 

Except        as otherwise indicated, information called for by the following items under Part III is        contained in the Proxy Statement for New Peoples' 2008 Annual Meeting of Shareholders (2008        Proxy Statement) to be held on May 22, 2008.

 

| **Item 10.** | **Directors, Executive Officers and Corporate                        Governance** |
|--------------|-----------------------------------------------------------------------------------|

The        information contained under the captions "Election of Directors," "Executive Officers Who        Are Not Directors," "Corporate Governance and the Board of Directors" and "Section 16(a)        Beneficial Ownership Reporting Compliance" in the 2008 Proxy Statement that is required to        be disclosed in this Item 10 is incorporated herein by reference.

 

| **Item 11.** | **Executive Compensation** |
|--------------|----------------------------|

The        information contained under the captions "Director Compensation" and "Executive        Compensation" and "Related Party Transactions" in the 2008 Proxy Statement that is required        to be disclosed in this Item 11 is incorporated herein by reference.

 

| **Item 12.** | **Security Ownership of Certain Beneficial Owners and                    Management and Related Stockholder Matters** |
|--------------|-----------------------------------------------------------------------------------------------------------------------|

The        information contained under the captions "Security Ownership of Management," "Security        Ownership of Certain Beneficial Owners" and "Equity Compensation Plan Information" in the        2008 Proxy Statement that is required to be disclosed in this Item 12 is incorporated        herein by reference.

 

 

64

 

----

| **Item 13.** | **Certain Relationships, Related Transactions and Director                        Independence** |
|--------------|--------------------------------------------------------------------------------------------------|

The        information contained under the caption "Transactions with Management" and "Corporate        Governance and the Board of Directors" in the 2008 Proxy Statement that is required to be        disclosed in this Item 13 is incorporated herein by reference.

 

| **Item 14.** | **Principal Accounting Fees and Services** |
|--------------|--------------------------------------------|

The        information contained under the caption "Audit Information" in the 2008 Proxy Statement        that is required to be disclosed in this Item 14 is incorporated herein by        reference.

 

| **Item 15.** | **Exhibits and Financial Statement Schedules** |
|--------------|------------------------------------------------|

         

Exhibits

     

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

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

        (a)(3)     The following exhibits are filed as part of this Form        10-K:

         

| 2                                                                                                                                                                                                                                                                                                                                                     | Agreement and Plan of                    Share Exchange dated August 15, 2001 (incorporated by reference to Exhibit 2 to                    Form 8-K filed December 17, 2001)                                                                                                                                 |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                                                                                                                                                                                                                                                                                                                                                   | Articles of Incorporation                    of Registrant (incorporated by reference to Exhibit 3.1 to Quarterly Report on                    Form 10-Q for the quarterly period ended June 30, 2004)                                                                                                        |
| 3.2                                                                                                                                                                                                                                                                                                                                                   | Bylaws of Registrant                    (incorporated by reference to Exhibit 3.1 to Form 8-K filed April 15,                    2004)                                                                                                                                                                        |
| Certain instruments                    relating to capital securities not being registered have been omitted in                    accordance with Item 601(b)(4)(iii) of Regulation S-K. The registrant will                    furnish a copy of any such instrument to the Securities and Exchange Commission                    upon its request. |
| 10.1*                                                                                                                                                                                                                                                                                                                                                 | New Peoples Bank, Inc.                    2001 Stock Option Plan (incorporated by reference to Exhibit 10.1 to Annual                    Report on Form 10-KSB for the fiscal year ended December 31, 2001)                                                                                                   |
| 10.2*                                                                                                                                                                                                                                                                                                                                                 | Form of Non-Employee                    Director Non-Qualified Stock Option Agreement (incorporated by reference to                    Exhibit 10.2 to Form 8-K filed November 30, 2004)                                                                                                                      |
| 10.3*                                                                                                                                                                                                                                                                                                                                                 | Form of Incentive Stock                    Option Agreement (incorporated by reference to Exhibit 10.3 to Form 8-K filed                    November 30, 2004)                                                                                                                                                |
| 10.4*                                                                                                                                                                                                                                                                                                                                                 | Salary Continuation                    Agreement dated December 18, 2002 between New Peoples Bank, Inc. and Kenneth D.                    Hart (incorporated by reference to Exhibit 10.2 to Annual Report on Form 10-K                    for the fiscal year ended December 31, 2002)                       |
| 10.5*                                                                                                                                                                                                                                                                                                                                                 | First Amendment dated June                    30, 2003 to Salary Continuation Agreement between New Peoples Bank, Inc. and                    Kenneth D. Hart (incorporated by reference to Exhibit 10.5 to Annual Report on                    Form 10-K for the fiscal year ended December 31, 2004)   |
| 10.6*                                                                                                                                                                                                                                                                                                                                                 | Salary Continuation                    Agreement dated December 18, 2002 between New Peoples Bank, Inc. and Frank                    Sexton, Jr. (incorporated by reference to Exhibit 10.6 to Annual Report on Form                    10-K for the fiscal year ended December 31, 2004)                |
| 10.7*                                                                                                                                                                                                                                                                                                                                                 | First Amendment dated June                    30, 2003 to Salary Continuation Agreement between New Peoples Bank, Inc. and                    Frank Sexton, Jr. (incorporated by reference to Exhibit 10.7 to Annual Report                    on Form 10-K for the fiscal year ended December 31, 2004) |
| 10.8*                                                                                                                                                                                                                                                                                                                                                 | Base Salaries of Named                    Executive                                                                                                                                                                                                                                                           |
| 10.9*                                                                                                                                                                                                                                                                                                                                                 | Director                    Compensation                                                                                                                                                                                                                                                                      |
| 14                                                                                                                                                                                                                                                                                                                                                    | Code of Ethics                    (incorporated by reference to Exhibit 14 to Annual Report on Form 10-K for the                    fiscal year ended December 31, 2003)                                                                                                                                      |
| 21                                                                                                                                                                                                                                                                                                                                                    | Subsidiaries of the                    Registrant                                                                                                                                                                                                                                                             |
| 23                                                                                                                                                                                                                                                                                                                                                    | Consent of Brown, Edwards                    and Company, L.L.P.                                                                                                                                                                                                                                              |
| 24                                                                                                                                                                                                                                                                                                                                                    | Powers of Attorney                    (contained on signature page)                                                                                                                                                                                                                                           |
| 31.1                                                                                                                                                                                                                                                                                                                                                  | Certification by Chief                    Executive Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                        |
| 31.2                                                                                                                                                                                                                                                                                                                                                  | Certification by Chief                    Financial Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                        |
| 32                                                                                                                                                                                                                                                                                                                                                    | Certification by Chief                    Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section                    1350                                                                                                                                                                 |

____________________________________        Denotes management contract.                     (b)   Exhibits - See Item 15(a)(3) above.           (c)   Financial Statement Schedules - See Item 15(a)(2)        above.

65

 

----

**SIGNATURES**

Pursuant        to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the        registrant has duly caused this report to be signed on its behalf by the undersigned,        thereunto duly authorized.

 

|   | **NEW PEOPLES BANKSHARES, INC.** |
|--------|----------------------------------|

 

|   | By: | /s/ KENNETH D. HART |
|--------|-----|---------------------|

|   | Kenneth D. Hart |
|--------|-----------------|

|   | President and Chief Executive Officer |
|--------|---------------------------------------|

|   | Date: | March 17, 2008 |
|--------|-------|----------------|

         

|   | By: | /s/ C. TODD ASBURY |
|--------|-----|--------------------|

|   | C. Todd Asbury |
|--------|----------------|

|   | Senior Vice President and Chief Financial Officer |
|--------|---------------------------------------------------|

|   | Date: | March 17, 2008 |
|--------|-------|----------------|

 

**POWER        OF ATTORNEY**

Each of        the undersigned hereby appoints Kenneth D. Hart and C. Todd Asbury, and each of them, as        attorneys and agents for the undersigned, with full power of substitution, in his name and        on his behalf as a director of New Peoples Bankshares, Inc. (the "Registrant"), to act and        to execute any and all instruments as such attorneys or attorney deem necessary or        advisable to enable the Registrant to comply with the Securities Exchange Act of 1934, and        any rules, regulations, policies or requirements of the Securities and Exchange Commission        (the "Commission") in respect thereof, in connection with the preparation and filing with        the Commission of the Registrant's Annual Report on Form 10-K for the fiscal year ended        December 31, 2007 (the "Report"), and any and all amendments to such Report, together        with such other supplements, statements, instruments and documents as such attorneys or        attorney deem necessary or appropriate.

 

Pursuant        to the requirements of the Securities Exchange Act of 1934, this report has been signed        below by the following persons on behalf of the registrant in the capacities and on the        dates indicated.

 

                               

 

|   | Signature             | Capacity                      | Date                |
|--------|-----------------------|-------------------------------|---------------------|
|   |                  |                          |                |
|   | /s/ KENNETH D. HART   | President and                 | March 17, 2008 |
|   | Kenneth D. Hart       | Chief Executive Officer       |                |
|   |                  | (Principal Executive Officer) |                |
|   |                  |                          |                |
|   |                  |                          |                |
|   | /s/ C. TODD ASBURY    | Senior Vice President         | March 17, 2008 |
|   | C. Todd Asbury        | and Chief Financial Officer   |                |
|   |                  | (Principal Financial and      |                |
|   |                  | Accounting Officer)           |                |
|   |                  |                          |                |
|   | /s/TIM BALL           | Director                      | March 17, 2008      |
|   | Tim Ball              |                          |                |
|   |                  |                          |                |
|   | /s/JOE CARTER         | Director                      | March 17, 2008      |
|   | Joe Carter            |                          |                |
|   |                  |                          |                |
|   | /s/JOHN D. COX        | Director                      | March 17, 2008      |
|   | John D. Cox           |                          |                |
|   |                  |                          |                |
|   | /s/CHARLES H. GENT    | Director                      | March 17, 2008      |
|   | Charles H. Gent       |                          |                |
|   |                  |                          |                |
|   | /s/HAROLD LYNNE KEENE | Director                      | March 17, 2008      |
|   | Harold Lynne Keene    |                          |                |
|   |                  |                          |                |

 

 

 

66

 

----

|   | Signature                  | Capacity | Date           |
|--------|----------------------------|----------|----------------|
|   |                       |     |           |
|   | /s/FRANK KILGORE           | Director | March 17, 2008 |
|   | Frank Kilgore              |     |           |
|   |                       |     |           |
|   | /s/JOHN MAXFIELD           | Director | March 17, 2008 |
|   | John Maxfield              |     |           |
|   |                       |     |           |
|   | /s/MICHAEL G. MCGLOTHLIN   | Director | March 17, 2008 |
|   | Michael G. McGlothlin      |     |           |
|   |                       |     |           |
|   | /s/FRED MEADE              | Director | March 17, 2008 |
|   | Fred Meade                 |     |           |
|   |                       |     |           |
|   | /s/BILL ED SAMPLE          | Director | March 17, 2008 |
|   | Bill Ed Sample             |     |           |
|   |                       |     |           |
|   | /s/STEPHEN H. STARNES      | Director | March 17, 2008 |
|   | Stephen H. Starnes         |     |           |
|   |                       |     |           |
|   | /s/WILLIAM C. WAMPLER, JR. | Director | March 17, 2008 |
|   | William C. Wampler, Jr.    |     |           |
|   |                       |     |           |
|   | /s/B. SCOTT WHITE          | Director | March 17, 2008 |
|   | B. Scott White             |     |           |

        

 

67

----

         

**EXHIBIT        INDEX**

| 2                                                                                                                                                                                                                                                                                                                                  | Agreement and                    Plan of Share Exchange dated August 15, 2001 (incorporated by reference to                    Exhibit 2 to Form 8-K filed December 17, 2001)                                                                                                                                                    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                                                                                                                                                                                                                                                                                                                                | Articles of                    Incorporation of Registrant (incorporated by reference to Exhibit 3.1 to                    Quarterly Report on Form 10-Q for the quarterly period ended June 30,                    2004)                                                                                                        |
| 3.2                                                                                                                                                                                                                                                                                                                                | Bylaws of                    Registrant (incorporated by reference to Exhibit 3.1 to Form 8-K filed April                    15, 2004)                                                                                                                                                                                           |
| Certain instruments relating to capital securities not being                    registered have been omitted in accordance with Item 601(b)(4)(iii) of                    Regulation S-K. The registrant will furnish a copy of any such instrument to                    the Securities and Exchange Commission upon its request. |
| 10.1*                                                                                                                                                                                                                                                                                                                              | New Peoples                    Bank, Inc. 2001 Stock Option Plan (incorporated by reference to Exhibit 10.1 to                    Annual Report on Form 10-KSB for the fiscal year ended December 31,                    2001)                                                                                                   |
| 10.2*                                                                                                                                                                                                                                                                                                                              | Form of                    Non-Employee Director Non-Qualified Stock Option Agreement (incorporated by                    reference to Exhibit 10.2 to Form 8-K filed November 30, 2004)                                                                                                                                         |
| 10.3*                                                                                                                                                                                                                                                                                                                              | Form of                    Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.3 to                    Form 8-K filed November 30, 2004)                                                                                                                                                                   |
| 10.4*                                                                                                                                                                                                                                                                                                                              | Salary                    Continuation Agreement dated December 18, 2002 between New Peoples Bank, Inc.                    and Kenneth D. Hart (incorporated by reference to Exhibit 10.2 to Annual Report                    on Form 10-K for the fiscal year ended December 31, 2002)                                          |
| 10.5*                                                                                                                                                                                                                                                                                                                              | First Amendment                    dated June 30, 2003 to Salary Continuation Agreement between New Peoples Bank,                    Inc. and Kenneth D. Hart (incorporated by reference to Exhibit 10.5 to Annual                    Report on Form 10-K for the fiscal year ended December 31,                    2004)   |
| 10.6*                                                                                                                                                                                                                                                                                                                              | Salary                    Continuation Agreement dated December 18, 2002 between New Peoples Bank, Inc.                    and Frank Sexton, Jr. (incorporated by reference to Exhibit 10.6 to Annual                    Report on Form 10-K for the fiscal year ended December 31,                    2004)                |
| 10.7*                                                                                                                                                                                                                                                                                                                              | First Amendment                    dated June 30, 2003 to Salary Continuation Agreement between New Peoples Bank,                    Inc. and Frank Sexton, Jr. (incorporated by reference to Exhibit 10.7 to Annual                    Report on Form 10-K for the fiscal year ended December 31,                    2004) |
| 10.8*                                                                                                                                                                                                                                                                                                                              | Base Salaries of                    Named Executive                                                                                                                                                                                                                                                                              |
| 10.9*                                                                                                                                                                                                                                                                                                                              | Director                    Compensation                                                                                                                                                                                                                                                                                         |
| 14                                                                                                                                                                                                                                                                                                                                 | Code of Ethics                    (incorporated by reference to Exhibit 14 to Annual Report on Form 10-K for the                    fiscal year ended December 31, 2003)                                                                                                                                                         |
| 21                                                                                                                                                                                                                                                                                                                                 | Subsidiaries of                    the Registrant                                                                                                                                                                                                                                                                                |
| 23                                                                                                                                                                                                                                                                                                                                 | Consent of                    Brown, Edwards and Company, L.L.P.                                                                                                                                                                                                                                                                 |
| 24                                                                                                                                                                                                                                                                                                                                 | Powers of                    Attorney (contained on signature page)                                                                                                                                                                                                                                                              |
| 31.1                                                                                                                                                                                                                                                                                                                               | Certification by                    Chief Executive Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                           |
| 31.2                                                                                                                                                                                                                                                                                                                               | Certification by                    Chief Financial Officer pursuant to Rule 13a-14(a)                                                                                                                                                                                                                                           |
| 32                                                                                                                                                                                                                                                                                                                                 | Certification by                    Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.                    Section 1350                                                                                                                                                                                    |

____________________________________        Denotes management contract.                    

68