##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q







|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

COMMISSION FILE NUMBER: 0-22955





BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|VIRGINIA                                                       |  | 54-1838100                          
|(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) |  | (I.R.S. EMPLOYER IDENTIFICATION NO.)



|                                         |  |           
|---------------------------------------- |  | ----------
|100 SOUTH MAIN STREET, KILMARNOCK, VA    |  | 22482     
|(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) |  | (ZIP CODE)

(804) 435-1171

(REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE)





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

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 large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  |  ̈
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).     ̈  yes    x  no

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:

2,377,302 shares of common stock on November 10, 2008









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##### Table of Contents

FORM 10-Q

For the interim period ending September 30, 2008.

INDEX



|                               |  |                                                                                                                              |  |   
|------------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------- |  | --
|PART I - FINANCIAL INFORMATION |  |                                                                                                                             
|                               |  |                                                                                                                             
|ITEM 1.                        |  | FINANCIAL STATEMENTS                                                                                                         |  |   
|                               |  |                                                                                                                             
|                               |  | CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2008 (UNAUDITED) AND DECEMBER 31, 2007                                             |  | 3 
|                               |  |                                                                                                                             
|                               |  | CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (UNAUDITED)                |  | 4 
|                               |  |                                                                                                                             
|                               |  | CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 and 2007 (UNAUDITED) |  | 5 
|                               |  |                                                                                                                             
|                               |  | CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (UNAUDITED)                      |  | 6 
|                               |  |                                                                                                                             
|                               |  | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                   |  | 7 
|                               |  |                                                                                                                             
|ITEM 2.                        |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                        |  | 12
|                               |  |                                                                                                                             
|ITEM 3.                        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                   |  | 20
|                               |  |                                                                                                                             
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                                      |  | 20
|                              
|PART II - OTHER INFORMATION   
|                               |  |                                                                                                                             
|ITEM 1.                        |  | LEGAL PROCEEDINGS                                                                                                            |  | 21
|                               |  |                                                                                                                             
|ITEM 1A.                       |  | RISK FACTORS                                                                                                                 |  | 21
|                               |  |                                                                                                                             
|ITEM 2.                        |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                  |  | 21
|                               |  |                                                                                                                             
|ITEM 3.                        |  | DEFAULTS UPON SENIOR SECURITIES                                                                                              |  | 21
|                               |  |                                                                                                                             
|ITEM 4.                        |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                          |  | 21
|                               |  |                                                                                                                             
|ITEM 5.                        |  | OTHER INFORMATION                                                                                                            |  | 21
|                               |  |                                                                                                                             
|ITEM 6.                        |  | EXHIBITS                                                                                                                     |  | 21



2



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##### Table of Contents

PART I  FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

CONSOLIDATED BALANCE
SHEETS



|                                                                                                                       |  |                    |             |   |                   |   |             |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ----------------- | - | ----------- | -
|                                                                                                                       |  | September 30, 2008 |             |   | December 31, 2007 |  
|                                                                                                                       |  | (Unaudited)        |             |   |                   |  
|ASSETS                                                                                                                 |  |                    |             |   |                   |   |             |  
|Cash and due from banks                                                                                                |  | $                  | 4,599,241   |   |                   | $ | 5,015,762   |  
|Interest-bearing deposits                                                                                              |  |                    | 364,014     |   |                   |   | 375,008     |  
|Federal funds sold                                                                                                     |  |                    | 7,155,942   |   |                   |   | 1,392,554   |  
|Securities available for sale, at fair value                                                                           |  |                    | 36,396,181  |   |                   |   | 43,618,174  |  
|Securities held to maturity at amortized cost (fair value, $482,950 and $465,896)                                      |  |                    | 482,373     |   |                   |   | 471,371     |  
|Loans, net of allowance for loan losses of $2,339,163 and $2,347,244                                                   |  |                    | 250,991,246 |   |                   |   | 258,164,836 |  
|Loans available-for-sale                                                                                               |  |                    | 563         |   |                   |   |            |  
|Premises and equipment, net                                                                                            |  |                    | 12,225,489  |   |                   |   | 10,783,844  |  
|Accrued interest receivable                                                                                            |  |                    | 1,326,290   |   |                   |   | 1,478,442   |  
|Other real estate owned                                                                                                |  |                    | 1,005,100   |   |                   |   | 795,054     |  
|Goodwill                                                                                                               |  |                    | 2,807,842   |   |                   |   | 2,807,842   |  
|Other assets                                                                                                           |  |                    | 1,799,921   |   |                   |   | 1,360,963   |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|Total assets                                                                                                           |  | $                  | 319,104,202 |   |                   | $ | 326,263,850 |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|LIABILITIES                                                                                                            |  |                    |             |   |                   |   |             |  
|Noninterest-bearing deposits                                                                                           |  | $                  | 40,760,792  |   |                   | $ | 38,476,633  |  
|Savings and interest-bearing demand deposits                                                                           |  |                    | 99,721,085  |   |                   |   | 106,727,807 |  
|Time deposits                                                                                                          |  |                    | 111,572,284 |   |                   |   | 114,363,000 |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|Total deposits                                                                                                         |  | $                  | 252,054,161 |   |                   | $ | 259,567,440 |  
|                                                                                                                       |  |                   
|Federal Funds purchased and securities sold under repurchase agreements                                                |  |                    | 7,782,680   |   |                   |   | 8,365,313   |  
|Federal Home Loan Bank advances                                                                                        |  |                    | 30,000,000  |   |                   |   | 30,000,000  |  
|Other liabilities                                                                                                      |  |                    | 1,760,404   |   |                   |   | 1,258,234   |  
|Commitments and contingencies                                                                                          |  |                    |            |   |                   |   |            |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|Total liabilities                                                                                                      |  | $                  | 291,597,245 |   |                   | $ | 299,190,987 |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|SHAREHOLDERS EQUITY                                                                                                   |  |                    |             |   |                   |   |             |  
|Common stock ($5 par value; authorized - 5,000,000 shares; outstanding - 2,377,302 and 2,363,917 shares, respectively) |  | $                  | 11,886,508  |   |                   | $ | 11,819,583  |  
|Additional paid-in capital                                                                                             |  |                    | 4,745,040   |   |                   |   | 4,643,827   |  
|Retained Earnings                                                                                                      |  |                    | 11,082,454  |   |                   |   | 10,959,793  |  
|Accumulated other comprehensive (loss), net                                                                            |  |                    | (207,045    | ) |                   |   | (350,340    | )
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|Total shareholders equity                                                                                             |  | $                  | 27,506,957  |   |                   | $ | 27,072,863  |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  
|Total liabilities and shareholders equity                                                                             |  | $                  | 319,104,202 |   |                   | $ | 326,263,850 |  
|                                                                                                                       |  |                    |             |   |                   |   |             |  

See Notes to Consolidated Financial Statements.



3



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##### Table of Contents

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)



|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|--------------------------------------------------- |  | ------------------------------ | --------- | - | ------------------------------ | - | ----------------------------------------- |  | - | ----------------------------------------- | - |  | - | ----------
|                                                    |  | QuarterendedSeptember 30, 2008 |           |   | QuarterendedSeptember 30, 2007 |   | For the ninemonthsendedSeptember 30, 2008 |  |   | For the ninemonthsendedSeptember 30, 2007
|INTEREST INCOME                                     |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Loans, including fees                               |  | $                              | 4,078,488 |   |                                | $ | 4,528,555                                 |  | $ | 12,604,232                                |   |  | $ | 13,261,976
|Securities:                                         |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Taxable                                             |  |                                | 202,597   |   |                                |   | 285,301                                   |  |   | 701,193                                   |   |  |   | 741,408   
|Tax-exempt                                          |  |                                | 191,879   |   |                                |   | 174,349                                   |  |   | 580,472                                   |   |  |   | 546,637   
|Federal funds sold                                  |  |                                | 51,814    |   |                                |   | 116,467                                   |  |   | 189,413                                   |   |  |   | 183,382   
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Total interest income                               |  |                                | 4,524,778 |   |                                |   | 5,104,672                                 |  |   | 14,075,310                                |   |  |   | 14,733,403
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|INTEREST EXPENSE                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Deposits                                            |  |                                | 1,479,468 |   |                                |   | 1,972,760                                 |  |   | 4,922,613                                 |   |  |   | 5,482,513 
|Fed funds purchased                                 |  |                                | 77        |   |                                |   | 295                                       |  |   | 334                                       |   |  |   | 35,746    
|Securities sold under repurchase agreements         |  |                                | 14,813    |   |                                |   | 66,207                                    |  |   | 66,823                                    |   |  |   | 171,118   
|Federal Home Loan Bank advances                     |  |                                | 351,792   |   |                                |   | 349,793                                   |  |   | 1,041,772                                 |   |  |   | 952,631   
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Total interest expense                              |  |                                | 1,846,150 |   |                                |   | 2,389,055                                 |  |   | 6,031,542                                 |   |  |   | 6,642,008 
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Net interest income                                 |  |                                | 2,678,628 |   |                                |   | 2,715,617                                 |  |   | 8,043,768                                 |   |  |   | 8,091,395 
|Provision for loan losses                           |  |                                | 75,000    |   |                                |   | 75,000                                    |  |   | 152,238                                   |   |  |   | 225,000   
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Net interest income after provision for loan losses |  |                                | 2,603,628 |   |                                |   | 2,640,617                                 |  |   | 7,891,530                                 |   |  |   | 7,866,395 
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|NON-INTEREST INCOME                                 |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Income from fiduciary activities                    |  |                                | 166,466   |   |                                |   | 195,404                                   |  |   | 496,356                                   |   |  |   | 528,669   
|Service charges and fees on deposit accounts        |  |                                | 166,092   |   |                                |   | 186,093                                   |  |   | 503,892                                   |   |  |   | 554,179   
|Other service charges and fees                      |  |                                | 446,563   |   |                                |   | 397,284                                   |  |   | 1,258,983                                 |   |  |   | 1,044,460 
|Secondary market lending fees                       |  |                                | 8,376     |   |                                |   | 36,727                                    |  |   | 106,065                                   |   |  |   | 144,271   
|Losses on other real estate owned                   |  |                                | (548      | ) |                                |   |                                          |  |   | (51,556                                   | ) |  |   |          
|Securities gains                                    |  |                                | 541       |   |                                |   |                                          |  |   | 34,261                                    |   |  |   |          
|Net (losses) on other investments                   |  |                                |          |   |                                |   |                                          |  |   | (79,995                                   | ) |  |   |          
|Other income                                        |  |                                | 21,500    |   |                                |   | 21,055                                    |  |   | 35,990                                    |   |  |   | 23,593    
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Total non-interest income                           |  |                                | 808,990   |   |                                |   | 836,563                                   |  |   | 2,303,996                                 |   |  |   | 2,295,172 
|                                                    |  |                                |           |  
|NON-INTEREST EXPENSES                               |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Salaries and employee benefits                      |  |                                | 1,418,431 |   |                                |   | 1,501,635                                 |  |   | 4,417,612                                 |   |  |   | 4,491,906 
|Occupancy expense                                   |  |                                | 450,715   |   |                                |   | 443,529                                   |  |   | 1,283,476                                 |   |  |   | 1,345,664 
|Bank franchise tax                                  |  |                                | 51,792    |   |                                |   | 46,361                                    |  |   | 155,370                                   |   |  |   | 139,083   
|Visa expense                                        |  |                                | 238,372   |   |                                |   | 175,084                                   |  |   | 561,800                                   |   |  |   | 447,307   
|Telephone expense                                   |  |                                | 43,910    |   |                                |   | 48,661                                    |  |   | 140,894                                   |   |  |   | 143,497   
|Other expenses                                      |  |                                | 560,103   |   |                                |   | 515,658                                   |  |   | 1,837,762                                 |   |  |   | 1,761,635 
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Total non-interest expenses                         |  |                                | 2,763,323 |   |                                |   | 2,730,928                                 |  |   | 8,396,914                                 |   |  |   | 8,329,092 
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Net income before income taxes                      |  |                                | 649,295   |   |                                |   | 746,252                                   |  |   | 1,798,612                                 |   |  |   | 1,832,475 
|Income tax expense                                  |  |                                | 154,504   |   |                                |   | 204,863                                   |  |   | 434,095                                   |   |  |   | 470,230   
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Net income                                          |  | $                              | 494,791   |   |                                | $ | 541,389                                   |  | $ | 1,364,517                                 |   |  | $ | 1,362,245 
|                                                    |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Basic Earnings Per Share                            |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Average basic shares outstanding                    |  |                                | 2,373,175 |   |                                |   | 2,367,356                                 |  |   | 2,368,310                                 |   |  |   | 2,369,742 
|Earnings per share, basic                           |  | $                              | 0.21      |   |                                | $ | 0.23                                      |  | $ | 0.58                                      |   |  | $ | 0.57      
|                                                    |  |                                |           |  
|Diluted Earnings Per Share                          |  |                                |           |   |                                |   |                                           |  |   |                                           |   |  |   |           
|Average diluted shares outstanding                  |  |                                | 2,373,175 |   |                                |   | 2,366,938                                 |  |   | 2,368,310                                 |   |  |   | 2,375,060 
|Earnings per share, diluted                         |  | $                              | 0.21      |   |                                | $ | 0.23                                      |  | $ | 0.58                                      |   |  | $ | 0.57      

See Notes to Consolidated Financial Statements.



4



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##### Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

(Unaudited)



|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|--------------------------------------------------------------------------------------------------------- |  | ----------- | ---------- | - | ------------------------ | - | --------- | ---------------- |  | - | ------------------------------------------ | - |  | ------------------------ | -------- | - |  | - | ---------- | -
|                                                                                                          |  | CommonStock |            |   | AdditionalPaid-inCapital |   |           | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome (Loss) |   |  | TotalShareholdersEquity |         
|Balance at January 1, 2007                                                                                |  | $           | 11,873,633 |   |                          | $ | 4,722,592 |                  |  | $ | 10,726,121                                 |   |  | $                        | (954,462 | ) |  | $ | 26,367,884 |  
|Comprehensive Income:                                                                                     |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Net Income                                                                                                |  |             |           |   |                          |   |          |                  |  |   | 1,362,245                                  |   |  |                          |         |   |  |   | 1,362,245  |  
|Changes in unrealized holding gains on securities arising during the period, net of taxes of $15,684      |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          | 30,446   |   |  |   | 30,446     |  
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Total comprehensive income                                                                                |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   | 1,392,691  |  
|Cash dividends paid  $0.495 per share                                                                    |  |             |           |   |                          |   |          |                  |  |   | (1,172,690                                 | ) |  |                          |         |   |  |   | (1,172,690 | )
|Stock repurchases                                                                                         |  |             | (53,000    | ) |                          |   | (100,895  | )                |  |   |                                           |   |  |                          |         |   |  |   | (153,895   | )
|Stock-based compensation                                                                                  |  |             |            |   |                          |   | 35,174    |                  |  |   |                                            |   |  |                          |          |   |  |   | 35,174     |  
|Sale of common stock:                                                                                     |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Stock Options exercised                                                                                   |  |             | 9,450      |   |                          |   | (2,050    | )                |  |   |                                           |   |  |                          |         |   |  |   | 7,400      |  
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Balance at September 30, 2007                                                                             |  | $           | 11,830,083 |   |                          | $ | 4,654,821 |                  |  | $ | 10,915,676                                 |   |  | $                        | (924,016 | ) |  | $ | 26,476,564 |  
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Balance at January 1, 2008                                                                                |  | $           | 11,819,583 |   |                          | $ | 4,643,827 |                  |  | $ | 10,959,793                                 |   |  | $                        | (350,340 | ) |  | $ | 27,072,863 |  
|Comprehensive Income:                                                                                     |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Net Income                                                                                                |  |             |           |   |                          |   |          |                  |  |   | 1,364,517                                  |   |  |                          |         |   |  |   | 1,364,517  |  
|Changes in unrealized holding gains on securities arising during the period, net of taxes of $85,467      |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          | 165,907  |   |  |   | 165,907    |  
|Reclassification adjustment for securities gains included in net income, net of taxes of ($11,649)        |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          | (22,612  | ) |  |   | (22,612    | )
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Total comprehensive income                                                                                |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   | 1,507,812  |  
|Effects of changing the pension plan measurement date pursuant to FAS158, net of tax benefit of ($17,731) |  |             |            |   |                          |   |           |                  |  |   | (34,419                                    | ) |  |                          |          |   |  |   | (34,419    | )
|Cash dividends paid  $0.51 per share                                                                     |  |             |           |   |                          |   |          |                  |  |   | (1,207,437                                 | ) |  |                          |         |   |  |   | (1,207,437 | )
|Stock repurchases                                                                                         |  |             | (37,630    | ) |                          |   | (47,880   | )                |  |   |                                           |   |  |                          |         |   |  |   | (85,510    | )
|Stock-based compensation                                                                                  |  |             |            |   |                          |   | 20,857    |                  |  |   |                                            |   |  |                          |          |   |  |   | 20,857     |  
|Sale of common stock:                                                                                     |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Dividends Reinvested                                                                                      |  |             | 104,555    |   |                          |   | 128,236   |                  |  |   |                                           |   |  |                          |         |   |  |   | 232,791    |  
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  
|Balance at September 30, 2008                                                                             |  | $           | 11,886,508 |   |                          | $ | 4,745,040 |                  |  | $ | 11,082,454                                 |   |  | $                        | (207,045 | ) |  | $ | 27,506,957 |  
|                                                                                                          |  |             |            |   |                          |   |           |                  |  |   |                                            |   |  |                          |          |   |  |   |            |  

See Notes to Consolidated Financial Statements.



5



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##### Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



|                                                                                                     |  |                    |            |   |                    |   |             |  
|---------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ------------------ | - | ----------- | -
|Nine months ended                                                                                    |  | September 30, 2008 |            |   | September 30, 2007 |  
|Cash Flows From Operating Activities                                                                 |  |                    |            |   |                    |   |             |  
|Net Income                                                                                           |  | $                  | 1,364,517  |   |                    | $ | 1,362,245   |  
|Adjustments to reconcile net income to net cash provided by operating activities:                    |  |                    |            |   |                    |   |             |  
|Depreciation                                                                                         |  |                    | 624,965    |   |                    |   | 755,807     |  
|Net amortization and accretion of securities                                                         |  |                    | 9,058      |   |                    |   | 9,284       |  
|Loss on sale of fixed assets                                                                         |  |                    |           |   |                    |   | 8,938       |  
|Provision for loan losses                                                                            |  |                    | 152,238    |   |                    |   | 225,000     |  
|Stock-based compensation                                                                             |  |                    | 20,857     |   |                    |   | 35,174      |  
|Deferred income taxes                                                                                |  |                    |           |   |                    |   | 7,586       |  
|Net securities gains                                                                                 |  |                    | (34,261    | ) |                    |   |            |  
|Loss on sale of other real estate                                                                    |  |                    | 51,556     |   |                    |   | 3,774       |  
|Net loss on other investments                                                                        |  |                    | 79,995     |   |                    |   |            |  
|Increase in accrued income and other assets                                                          |  |                    | (351,221   | ) |                    |   | (293,714    | )
|Increase in other liabilities                                                                        |  |                    | 428,351    |   |                    |   | 104,638     |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Net cash provided by operating activities                                                            |  | $                  | 2,346,055  |   |                    | $ | 2,218,732   |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Cash Flows From Investing Activities                                                                 |  |                    |            |   |                    |   |             |  
|Proceeds from maturities of available-for-sale securities                                            |  |                    | 2,695,495  |   |                    |   | 2,371,370   |  
|Proceeds from sales of available-for-sale securities                                                 |  |                    | 13,645,800 |   |                    |   | 340,400     |  
|Purchases of available-for-sale securities                                                           |  |                    | (8,887,987 | ) |                    |   | (8,020,537  | )
|(Increase) / decrease in interest bearing deposits in other banks                                    |  |                    | 10,994     |   |                    |   | (234,912    | )
|Increase in federal funds sold                                                                       |  |                    | (5,763,388 | ) |                    |   | (2,904,131  | )
|(Loan originations) and principal collections, net                                                   |  |                    | 6,390,622  |   |                    |   | (11,592,911 | )
|Proceeds from sale of other real estate                                                              |  |                    | 368,565    |   |                    |   |            |  
|Purchases of premises and equipment                                                                  |  |                    | (2,066,610 | ) |                    |   | (1,097,308  | )
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Net cash provided by (used in) investing activities                                                  |  | $                  | 6,393,491  |   |                    | $ | (21,138,029 | )
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Cash Flows From Financing Activities                                                                 |  |                    |            |   |                    |   |             |  
|Decrease in demand, savings, and other interest-bearing deposits                                     |  |                    | (4,722,563 | ) |                    |   | (642,592    | )
|Net increase / (decrease) in time deposits                                                           |  |                    | (2,790,716 | ) |                    |   | 13,363,765  |  
|Net increase / (decrease) in securities sold under repurchase agreements and federal funds purchased |  |                    | (582,633   | ) |                    |   | 872,523     |  
|Increase in FHLB advances                                                                            |  |                    |           |   |                    |   | 5,000,000   |  
|Proceeds from issuance of common stock                                                               |  |                    | 232,791    |   |                    |   | 7,400       |  
|Dividends paid                                                                                       |  |                    | (1,207,437 | ) |                    |   | (1,172,690  | )
|Repurchase of common stock                                                                           |  |                    | (85,510    | ) |                    |   | (153,895    | )
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Net cash provided by (used in) financing activities                                                  |  | $                  | (9,156,067 | ) |                    | $ | 17,274,511  |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Net decrease in cash and due from banks                                                              |  |                    | (416,521   | ) |                    |   | (1,644,786  | )
|Cash and due from banks at beginning of period                                                       |  |                    | 5,015,762  |   |                    |   | 6,320,951   |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Cash and due from banks at end of period                                                             |  | $                  | 4,599,241  |   |                    | $ | 4,676,165   |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Supplemental Schedule of Noncash Investing and Financing Activities:                                 |  |                    |            |   |                    |   |             |  
|Interest paid                                                                                        |  | $                  | 6,131,923  |   |                    | $ | 6,587,882   |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Income taxes paid                                                                                    |  |                    | 428,060    |   |                    |   | 309,889     |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Unrealized gain/(loss) on investment securities                                                      |  |                    | 217,113    |   |                    |   | 46,130      |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Change in pension measurement date                                                                   |  |                    | 52,150     |   |                    |   |            |  
|                                                                                                     |  |                    |            |   |                    |   |             |  
|Loans transferred to other real estate owned                                                         |  |                    | 630,167    |   |                    |   | (250,920    | )
|                                                                                                     |  |                    |            |   |                    |   |             |  

See Notes to Consolidated Financial Statements.



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Notes to Consolidated Financial Statements

Note 1: General

Bay Banks of Virginia, Inc. (the
Company) owns 100% of the Bank of Lancaster (the Bank) and 100% of Bay Trust Company, Inc. (the Trust Company). The consolidated financial statements include the accounts of the Bank, the Trust Company, and Bay
Banks of Virginia, Inc.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the
United States of America and to the general practices within the banking industry. However, in managements opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated
financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.

These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the
Companys 2007 Annual Report to Shareholders.

Note 2: Securities

The carrying amounts of debt and other securities and their approximate fair values at September 30, 2008, and December 31, 2007, follow:



|                                                 |  |               |            |                      |   |                         |  |   |           |   |  |   |           
|------------------------------------------------ |  | ------------- | ---------- | -------------------- | - | ----------------------- |  | - | --------- | - |  | - | ----------
|Available-for-sale securities September 30, 2008 |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | FairValue
|(unaudited)                                      |  |               |            |                      |   |                         |  |   |          
|U.S. Government agencies                         |  | $             | 1,627,581  |                      | $ | 1,727                   |  | $ | (11,766   | ) |  | $ | 1,617,542 
|State and municipal obligations                  |  |               | 32,238,566 |                      |   | 405,984                 |  |   | (120,011  | ) |  |   | 32,524,539
|Restricted securities                            |  |               | 2,254,100  |                      |   |                        |  |   |          |   |  |   | 2,254,100 
|                                                 |  |               |            |                      |   |                         |  |   |           |   |  |   |           
|                                                 |  | $             | 36,120,247 |                      | $ | 407,711                 |  | $ | (131,777  | ) |  | $ | 36,396,181
|                                                 |  |               |            |                      |   |                         |  |   |           |   |  |   |           



|                                                |  |               |            |                      |   |                         |  |   |           |   |  |   |           
|----------------------------------------------- |  | ------------- | ---------- | -------------------- | - | ----------------------- |  | - | --------- | - |  | - | ----------
|Available-for-sale securities December 31, 2007 |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | FairValue
|U.S. Government agencies                        |  | $             | 7,771,753  |                      | $ | 30,048                  |  | $ | (13,066   | ) |  | $ | 7,788,735 
|State and municipal obligations                 |  |               | 33,564,201 |                      |   | 201,435                 |  |   | (159,597  | ) |  |   | 33,606,039
|Restricted securities                           |  |               | 2,223,400  |                      |   |                        |  |   |          |   |  |   | 2,223,400 
|                                                |  |               |            |                      |   |                         |  |   |           |   |  |   |           
|                                                |  | $             | 43,559,354 |                      | $ | 231,483                 |  | $ | (172,663  | ) |  | $ | 43,618,174
|                                                |  |               |            |                      |   |                         |  |   |           |   |  |   |           



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|                                               |  |               |         |                      |   |                         |  |           |   |  |   |        
|---------------------------------------------- |  | ------------- | ------- | -------------------- | - | ----------------------- |  | --------- | - |  | - | -------
|Held-to-maturity securities September 30, 2008 |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  | FairValue
|(unaudited)                                    |  |               |         |                      |   |                         |  |          
|State and municipal obligations                |  | $             | 482,373 |                      | $ | 577                     |  | $         |  |  | $ | 482,950
|                                               |  |               |         |                      |   |                         |  |           |   |  |   |        



|                                              |  |               |         |                      |   |                         |  |   |           |   |  |   |        
|--------------------------------------------- |  | ------------- | ------- | -------------------- | - | ----------------------- |  | - | --------- | - |  | - | -------
|Held-to-maturity securities December 31, 2007 |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | FairValue
|State and municipal obligations               |  | $             | 471,371 |                      | $ |                        |  | $ | (5,475    | ) |  | $ | 465,896
|                                              |  |               |         |                      |   |                         |  |   |           |   |  |   |        

Securities with a market value of $9.2 million were pledged as collateral for repurchase
agreements and for other purposes as required by law as of September 30, 2008. The market value of pledged securities at year-end 2007 was $11.8 million.

Securities in an unrealized loss position at September 30, 2008 and December 31, 2007, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest
rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management has the intent and demonstrated ability to hold securities to scheduled
maturity or call dates. Bonds with unrealized loss positions at September 30, 2008 included 3 federal agency and 19 municipal bonds, as shown below.



|                                      |  |                     |           |                   |   |           |  |                |            |           |   |                |  |   |            |  |   |        
|------------------------------------- |  | ------------------- | --------- | ----------------- | - | --------- |  | -------------- | ---------- | --------- | - | -------------- |  | - | ---------- |  | - | -------
|                                      |  | Less than 12 months |           | 12 months or more |   | Total    
|September 30, 2008                    |  | FairValue           |           | UnrealizedLoss    |   | FairValue |  | UnrealizedLoss |            | FairValue |   | UnrealizedLoss
|(unaudited)                           |  |                     |           |                   |   |           |  |                |            |           |   |               
|U.S. Government agencies              |  | $                   | 1,489,095 |                   | $ | 7,280     |  | $              | 57,336     |           | $ | 4,486          |  | $ | 1,546,431  |  | $ | 11,766 
|States and municipal obligations      |  |                     | 5,839,117 |                   |   | 120,011   |  |                |           |           |   |               |  |   | 5,839,117  |  |   | 120,011
|                                      |  |                     |           |                   |   |           |  |                |            |           |   |                |  |   |            |  |   |        
|Total temporarily impaired securities |  | $                   | 7,328,212 |                   | $ | 127,291   |  | $              | 57,336     |           | $ | 4,486          |  | $ | 7,385,548  |  | $ | 131,777
|                                      |  |                     |           |                   |   |           |  |                |            |           |   |                |  |   |            |  |   |        
|                                      |  |                     |          
|                                      |  | Less than 12 months |           | 12 months or more |   | Total    
|December 31, 2007                     |  | FairValue           |           | UnrealizedLoss    |   | FairValue |  | UnrealizedLoss |            | FairValue |   | UnrealizedLoss
|U.S. Government agencies              |  | $                   |          |                   | $ |          |  | $              | 2,557,235  |           | $ | 13,066         |  | $ | 2,557,235  |  | $ | 13,066 
|States and municipal obligations      |  |                     | 3,255,691 |                   |   | 39,393    |  |                | 8,627,762  |           |   | 125,679        |  |   | 11,883,453 |  |   | 165,072
|                                      |  |                     |           |                   |   |           |  |                |            |           |   |                |  |   |            |  |   |        
|Total temporarily impaired securities |  | $                   | 3,255,691 |                   | $ | 39,393    |  | $              | 11,184,997 |           | $ | 138,745        |  | $ | 14,440,688 |  | $ | 178,138
|                                      |  |                     |           |                   |   |           |  |                |            |           |   |                |  |   |            |  |   |        



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Note 3: Loans

The components of loans were as follows:



|                                                             |  |                    |             |   |                   |   |             |  
|------------------------------------------------------------ |  | ------------------ | ----------- | - | ----------------- | - | ----------- | -
|                                                             |  | September 30, 2008 |             |   | December 31, 2007 |  
|                                                             |  | (unaudited)        |             |   |                   |  
|Mortgage loans on real estate:                               |  |                    |             |   |                   |   |             |  
|Construction                                                 |  | $                  | 38,058,901  |   |                   | $ | 45,697,838  |  
|Secured by farmland                                          |  |                    | 82,075      |   |                   |   | 87,206      |  
|Secured by 1-4 family residential                            |  |                    | 141,341,610 |   |                   |   | 144,820,937 |  
|Other real estate loans                                      |  |                    | 45,140,199  |   |                   |   | 40,975,279  |  
|Commercial and industrial loans (not secured by real estate) |  |                    | 14,610,958  |   |                   |   | 18,253,801  |  
|Consumer installment loans                                   |  |                    | 8,292,278   |   |                   |   | 9,423,071   |  
|All other loans                                              |  |                    | 4,973,617   |   |                   |   | 498,617     |  
|Net deferred loan costs and fees                             |  |                    | 831,334     |   |                   |   | 755,331     |  
|                                                             |  |                    |             |   |                   |   |             |  
|Total loans                                                  |  | $                  | 253,330,972 |   |                   | $ | 260,512,080 |  
|Allowance for loan losses                                    |  |                    | (2,339,163  | ) |                   |   | (2,347,244  | )
|                                                             |  |                    |             |   |                   |   |             |  
|Loans, net                                                   |  | $                  | 250,991,809 |   |                   | $ | 258,164,836 |  
|                                                             |  |                    |             |   |                   |   |             |  

Loans upon which the accrual of interest has been discontinued totaled $3.5 million as of
September 30, 2008, and $1.3 million as of December 31, 2007.

Note 4: Allowance for Loan Losses



|                           |  |                    |           |   |                   |   |           |                    |  |   |           |  
|-------------------------- |  | ------------------ | --------- | - | ----------------- | - | --------- | ------------------ |  | - | --------- | -
|                           |  | September 30, 2008 |           |   | December 31, 2007 |   |           | September 30, 2007 | 
|                           |  | (unaudited)        |           |   |                   |   |           | (unaudited)        | 
|Balance, beginning of year |  | $                  | 2,347,244 |   |                   | $ | 2,235,544 |                    |  | $ | 2,235,544 |  
|Provision for loan losses  |  |                    | 152,238   |   |                   |   | 298,299   |                    |  |   | 225,000   |  
|Recoveries                 |  |                    | 8,759     |   |                   |   | 23,993    |                    |  |   | 23,200    |  
|Loans charged off          |  |                    | (169,078  | ) |                   |   | (210,592  | )                  |  |   | (166,256  | )
|                           |  |                    |           |   |                   |   |           |                    |  |   |           |  
|Balance, end of year       |  | $                  | 2,339,163 |   |                   | $ | 2,347,244 |                    |  | $ | 2,317,488 |  
|                           |  |                    |           |   |                   |   |           |                    |  |   |           |  

Information about impaired loans is as follows: for the nine months and twelve months ended:



|                                                                                 |  |                    |           |                   |   |          
|-------------------------------------------------------------------------------- |  | ------------------ | --------- | ----------------- | - | ---------
|                                                                                 |  | September 30, 2008 |           | December 31, 2007
|                                                                                 |  | (unaudited)        |           |                  
|Impaired loans for which an allowance has been provided                          |  | $                  | 2,286,345 |                   | $ | 2,185,721
|Impaired loans for which no allowance has been provided                          |  |                    |          |                   |   |         
|                                                                                 |  |                    |           |                   |   |          
|Total impaired loans                                                             |  | $                  | 2,286,345 |                   | $ | 2,185,721
|                                                                                 |  |                    |           |                   |   |          
|Allowance provided for impaired loans, included in the allowance for loan losses |  | $                  | 873,212   |                   | $ | 1,028,892
|                                                                                 |  |                    |           |                   |   |          
|Average balance impaired loans                                                   |  | $                  | 2,545,487 |                   | $ | 3,115,848
|                                                                                 |  |                    |           |                   |   |          
|Interest income recognized (collected $75,886 and $113,255, respectively)        |  | $                  | 70,956    |                   | $ | 112,912  
|                                                                                 |  |                    |           |                   |   |          



9



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At September 30, 2008 and December 31, 2007, non-accrual loans excluded from impaired loan
disclosure under Statement of Financial Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, totaled $2,481,428 and $1,190,000, respectively. If interest on these loans had been accrued, such
income would have approximated $86,325 during the nine months ended September 30, 2008 and $45,713 during the year ended December 31, 2007.

Note 5: Earnings per share

The following table shows the weighted average number of shares used in computing earnings per
share and the effect on the weighted average number of shares of dilutive potential common stock.



|                               |  |                                |  |                               |      |                    |           |                    |                 |   |               |  |                 |  |               |      |                 |           |  |   |     
|------------------------------ |  | ------------------------------ |  | ----------------------------- | ---- | ------------------ | --------- | ------------------ | --------------- | - | ------------- |  | --------------- |  | ------------- | ---- | --------------- | --------- |  | - | ----
|                               |  | Three Months Ended (unaudited) |  | Nine Months Ended (unaudited)
|                               |  | September 30, 2008             |  | September 30, 2007            |      | September 30, 2008 |           | September 30, 2007
|                               |  | AverageShares                  |  | Per shareAmount               |      | AverageShares      |           |                    | Per shareAmount |   | AverageShares |  | Per shareAmount |  | AverageShares |      | Per shareAmount
|Basic earnings per share       |  | 2,373,175                      |  | $                             | 0.21 |                    | 2,367,356 |                    |                 | $ | 0.23          |  | 2,368,310       |  | $             | 0.58 |                 | 2,369,742 |  | $ | 0.57
|                               |  |                                |  |                               |      |                    |           |                   
|Effect of dilutive securities: |  |                                |  |                               |      |                    |           |                    |                 |   |               |  |                 |  |               |      |                 |           |  |   |     
|                               |  |                                |  |                               |      |                    |           |                   
|Stock options                  |  |                               |  |                               |      |                    | (418      | )                  |                 |   |               |  | .               |  |               |      |                 | 5,318     |  |   |     
|                               |  |                                |  |                               |      |                    |           |                   
|Diluted earnings per share     |  | 2,373,175                      |  | $                             | 0.21 |                    | 2,366,938 |                    |                 | $ | 0.23          |  | 2,368,310       |  | $             | 0.58 |                 | 2,375,060 |  | $ | 0.57

As of September 30, 2008 and 2007, options on 176,414 shares and 134,496 shares,
respectively, were not included in computing diluted earnings per share, because their effects were anti-dilutive.

Note 6: Stock-Based Compensation

Incremental stock-based compensation expense recognized was $20,857during the first nine months of 2008. As of September 30, 2008,
there was $7,809 of unrecognized compensation expense related to stock options.

Stock option compensation expense is the estimated fair
value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There were 40,500 options granted and no options exercised during the nine month period ended September 30, 2008.

Stock option plan activity for the nine months ended September 30, 2008 is summarized below:



|                                  |  |         |   |  |                               |       |                                                      |     |                             |   |  
|--------------------------------- |  | ------- | - |  | ----------------------------- | ----- | ---------------------------------------------------- | --- | --------------------------- | - | -
|                                  |  | Shares  |   |  | WeightedAverage ExercisePrice |       | Weighted AverageRemaining Contractual Life(in years) |     | AggregateIntrinsic Value(1)
|Options outstanding, January 1    |  | 194,161 |   |  | $                             | 15.38 |                                                      | 5.7 |                             |   |  
|Granted                           |  | 40,500  |   |  | $                             | 12.05 |                                                      |     |                             |   |  
|Forfeited                         |  | (47,349 | ) |  | $                             | 15.23 |                                                      |     |                             |   |  
|Exercised                         |  |        |   |  |                               |       |                                                      |     |                             |   |  
|Expired                           |  | (10,898 | ) |  | $                             | 13.89 |                                                      |     |                             |   |  
|                                  |  |         |   |  |                               |       |                                                      |     |                             |   |  
|Options outstanding, September 30 |  | 176,414 |   |  | $                             | 14.75 |                                                      | 6.0 |                             | $ | 
|                                  |  |         |   |  |                               |       |                                                      |     |                             |   |  
|Options exercisable, September 30 |  | 143,414 |   |  | $                             | 15.38 |                                                      | 5.2 |                             | $ | 
|                                  |  |         |   |  |                               |       |                                                      |     |                             |   |  



|(1) | The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock
exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2008. This amount changes based on changes in the market value of the Companys
stock. At September 30, 2008, the exercise price of all options outstanding exceeded the market value of the Companys stock.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Note 7: Goodwill

The Company has goodwill recorded on the consolidated financial statements relating to the purchase of five branches during the years 1994 through 2000. The balance of the goodwill at September 30, 2008 and
December 31, 2007, as reflected on the consolidated balance sheets was $2,807,842. In accordance with SFAS Nos. 141, Business Combinations, and 142, Goodwill and Other Intangible Assets, management determined that these purchases
qualified as acquisitions of businesses and that the related unidentifiable intangibles were goodwill. Therefore, amortization was discontinued effective January 1, 2002. The goodwill balance is tested for impairment at least annually, and
there was no impairment in 2008 or 2007.

Note 8: Employee Benefit Plans

Components of Net Periodic Benefit Cost



|                                                |  |                  |          |   |                         |   |          |      |  |      |        |  |   |       
|----------------------------------------------- |  | ---------------- | -------- | - | ----------------------- | - | -------- | ---- |  | ---- | ------ |  | - | ------
|                                                |  | Pension Benefits |          |   | Post RetirementBenefits
|Nine months ended September 30,                 |  | 2008             |          |   | 2007                    |   |          | 2008 |  | 2007
|Service cost                                    |  | $                | 235,319  |   |                         | $ | 232,687  |      |  | $    | 14,167 |  | $ | 13,862
|Interest cost                                   |  |                  | 186,502  |   |                         |   | 171,122  |      |  |      | 20,498 |  |   | 22,764
|Expected return on plan assets                  |  |                  | (280,537 | ) |                         |   | (194,994 | )    |  |      |       |  |   |      
|Amortization of unrecognized prior service cost |  |                  | 12,279   |   |                         |   | 12,279   |      |  |      |       |  |   |      
|Amortization of unrecognized net loss           |  |                  | 2,887    |   |                         |   | 28,094   |      |  |      | 92     |  |   | 4,159 
|Amortization of transition obligation           |  |                  |         |   |                         |   |         |      |  |      | 2,185  |  |   | 2,185 
|                                                |  |                  |          |   |                         |   |          |      |  |      |        |  |   |       
|Net periodic benefit cost                       |  | $                | 156,450  |   |                         | $ | 249,188  |      |  | $    | 36,942 |  | $ | 42,970
|                                                |  |                  |          |   |                         |   |          |      |  |      |        |  |   |       

Employer Contributions

The Company disclosed in its Annual Report on Form 10-K for the year ended December 31, 2007, that it expected to contribute $314,109 to its pension plan and $17,519 to its post-retirement benefit plan in 2008.
The Company has made the pension plan contribution in full and has contributed $8,665 toward the post-retirement plan during the first nine months of 2008.

Note 9: FHLB Advances

On September 30, 2008, the Bank had Federal Home Loan Bank of Atlanta (FHLB) debt
consisting of three advances, one for $15.0 million, which was acquired on May 18, 2006, one for $10.0 million, which was acquired on September 12, 2006, and one for $5.0 million, which was acquired on May 18, 2007. The interest rate
on the $15 million advance is fixed at 4.81%, payable quarterly and matures on May 18, 2011. The interest rate on the $10 million advance is fixed at 4.23%, payable quarterly and matures on September 12, 2016. The interest rate on the $5
million advance is fixed at 4.485%, payable quarterly and matures on May 18, 2012. The FHLB holds an option to terminate any of the advances on any quarterly payment date.

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans totaling approximately $73 million.
Remaining available credit is $34 million.

Note 10: Fair Value Measurements

SFAS No. 157, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value, establishes a three-level
valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the
measurement date. The three levels are defined as follows:



|         |  |                                                                                                                                                                                                                                                                       
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Level 1: |  | Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.                                                                                                                                             
|         | 
|Level 2: |  | Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the financial instrument.
|         | 
|Level 3: |  | Inputs to the valuation methodology are unobservable and significant to the fair value measurement.                                                                                                                                                                   



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Following is a description of the valuation methodologies used for instruments measured at fair value, as
well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities.Where quoted prices are available in
an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then
fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states
and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation
hierarchy. Currently, all of the Companys securities are considered to be Level 2 securities.

Loans held for sale.Loans held for sale
are required to be measured at the lower of cost or fair value. Under SFAS No. 157, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions.
Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At September 30, 2008, the Company held $563 thousand of loans available for sale.

Impaired loans.SFAS No. 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), or at the fair value of the loans collateral (if the loan is collateral dependent). Fair value of the loans
collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. For more information, refer to Note 4.

Other Real Estate Owned.Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value
component in its valuation follows the provisions of SFAS No. 157.



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion is intended to assist in understanding the results of operations and the financial condition of the Company. This discussion
should be read in conjunction with the above consolidated financial statements and the notes thereto.

EXECUTIVE SUMMARY

Everyone is concerned about the financial crisis that seemed to peak in September. The U.S. economy appears to be in the beginning of a
recession. Stock markets around the world experienced significant declines in October. Banks all over the U.S. are pouring through the details of the U.S. Treasurys Troubled Asset Relief Program Capital Purchase Program to determine if they
want to participate. These are confusing times. Be comforted in the knowledge that the vast majority of banks are well-capitalized, safe, and sound. Community banks have typically not participated in financial fads, and never stopped
lending. This includes your Company, Bay Banks of Virginia, Inc., and your Companys sole bank subsidiary, the Bank of Lancaster. It has always been managements philosophy to plan long term for our customers and investors, rather than
allowing short to intermediate term influences to alter the Companys steady and measured growth policy. This has insulated us from the majority of the turmoil.

The Bank holds no Fannie Mae or Freddie Mac preferred stock, and therefore will not suffer from related earnings write-downs.

Management is continually evaluating risks, including that of a recession. Commercial lending is likely to decline, not necessarily because credit is not available, but because business is slowing. Consumers will cut
back on spending. Mortgage originations are already down. The Banks loan portfolio has declined since December 31, 2007. This did not mean we were not making loans, but simply that normal levels of payoffs exceeded loan originations.
Therefore, we determined that some decline in deposit levels would be acceptable, as the funds were not needed for loan growth.

However,
the loan portfolio has been growing since June. This is a positive sign. In September, management completed a new strategic plan which is generating excitement throughout the Company. Interest margins will be a challenge in these economic times,
especially since the Federal Open Market Committee has cut the Fed Funds target rate by 325 basis points (3.25 percentage points) during 2008, but reduced margins can be offset by increases in volume. This is why your Company will not abandon its
growth plans.

In continuing our tradition of steady and measured growth, the Bank
has opened its 8thbranch office in Burgess, Virginia, in June, and has broken ground for its 9thbranch office in Colonial Beach, Virginia.

Important elements of the
Companys financial position have improved in the midst of the turmoil. Regulatory capital ratios are higher, liquidity is higher, and the allowance for loan losses as a percentage of loans has increased. Credit from correspondent banks remains
available and unchanged.



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Challenges remain. Although interest income is down in 2008, due to both reduced rates and reduced
volume, net interest income has been maintained through reductions in interest expense. However, reductions in the prime rate in October have the potential to reduce interest income further than reductions in interest expense can compensate.

Levels of non-performing loans have increased, but not to the extent experienced by many other financial institutions. We believe these
levels are lower relative to our peers because of our rigorous lending guidelines and controls. We work diligently and conscientiously with every customer who faces repayment challenges. We recognize that foreclosure is a last resort. However, given
the level of economic turmoil our country is currently experiencing, and a banking industry trend to increase loan loss reserves to levels higher than accounting standards might indicate, management is currently considering increasing the
Banks provision for loan losses.

Below the net interest income line, management has made efforts to improve non-interest income and
control non-interest expense. The Score-to-Win program was launched early in 2007 to promote growth in checking accounts and use of the Banks more cost-efficient service channels, like Online Advantage and receipt of account statements
electronically through eVue Advantage. Score-to-Win awards points for credit card and debit card usage which can be redeemed for merchandise. The program also awards bonus points for opening a checking account with a Check-N-Advantage debit card,
and for adding Online Advantage, eVue Advantage, online bill-pay, and a savings account. Increased interchange income has been the result of the related increase in debit card usage.

Another innovative product introduction in 2007 was eDeposit. This product allows commercial customers who deposit large numbers of checks or are not
geographically convenient to a Bank office to make their deposits remotely via a secure internet connection.

In the non-interest expense
area, management continues to control increases in salaries and benefits expense by restructuring responsibilities among existing employees as attrition occurs. To the extent advisable, continuing education remains available to employees. Management
continues to delay capital expenditures, along with their related depreciation expense, as appropriate for non-mission-critical projects.

For more information, visit the Companys website at www.baybanks.com.

CRITICAL ACCOUNTING POLICIES

GENERAL. The Companys financial statements are prepared in accordance with accounting principles generally accepted in the United States
(GAAP). The financial information contained within these statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of
factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. Historical losses are used as one factor in determining the inherent loss that may be present
in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of transactions would be the same,
the timing of events that would impact these transactions could change.

ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an
estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (1) Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for
Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the
differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is evaluated on a regular basis by management and is based upon
managements periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any
underlying collateral and prevailing economic conditions. The use of these values is inherently subjective and actual losses could be greater or less than the estimates.

The allowance for loan losses is increased by charges to income and decreased by loans charged off (net of recoveries). Managements periodic evaluation of the adequacy of the allowance is based on past loan loss
experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, and current economic conditions.

EARNINGS SUMMATION

For the nine months ended
September 30, 2008, net income was $1.4 million, an increase of 0.2% over the similar period in 2007. Diluted earnings per average share for the nine months ended September 30, 2008 were $0.58 as compared to $0.57 for the nine months ended
September 30, 2007. Annualized return on average assets was 0.6% for both nine-month periods ended September 30, 2008 and 2007. Annualized return on average equity was 6.7% for the nine months ended September 30, 2008, down from 6.9%
for the similar period ended September 30, 2007.



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For the quarter ended September 30, 2008, net income was $494,791, or $0.21 per share. Compared to
the prior quarter ended June 30, 2008, this is an improvement from $384,113, and $0.16 per share. Compared to the quarter ended September 30, 2007, net income was higher at $541,389, or $0.23 per share.

The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest
expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, and the volume
of non-performing assets have an effect on net interest income, the net interest margin, and net income. Net interest income before provision for loan losses for the nine months ended September 30, 2008 was $8.0 million, a negligible decrease
of 0.6% compared to the nine months ended September 30, 2007. Net interest income after the provision for loan losses is up 0.3% for the same period comparison as a result of the reduced provision for loan losses.

Although interest income declined by $658 thousand for the year-to-date period ended September 30, 2008 compared to the same period in 2007,
decreases in interest expense of $610 thousand for the same period comparison nearly mitigated the decrease in interest income, leaving net interest income (before the provision for loan losses) down only $48 thousand. The $658 thousand decrease in
interest income was driven mainly by reduced loan yields, a result of reductions in the Wall Street Prime Rate, which affects variable-rate loans. Increases in average loan balances were not sufficient to overcome these reduced rates. The $610
thousand decrease in interest expense was primarily due to reductions in rates on checking and savings accounts.



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Bay Banks of Virginia, Inc.

Net Interest Income Analysis (unaudited)



|                                                          |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|--------------------------------------------------------- |  | ----------------------------------- | ------- | -------------- | ----------------------------------- | -------------------- |  | ---- | -------------- |  | -------------- | ------- | -------------------- | - | ------ |  | ---- | -
|(Fully taxable equivalent basis)                          |  | Nine months endedSeptember 30, 2008 |         |                | Nine months endedSeptember 30, 2007 |                     
|(Dollars in thousands)                                    |  | AverageBalance                      |         | Income/Expense |                                     | AnnualizedYield/Rate |  |      | AverageBalance |  | Income/Expense |         | AnnualizedYield/Rate |  
|INTEREST EARNING ASSETS:                                  |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|Taxable investments                                       |  | $                                   | 18,141  |                | $                                   | 689                  |  | 5.06 | %              |  | $              | 20,022  |                      | $ | 732    |  | 4.87 | %
|Tax-exempt investments (1)                                |  |                                     | 20,838  |                |                                     | 879                  |  | 5.62 | %              |  |                | 19,558  |                      |   | 828    |  | 5.65 | %
|                                                          |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|Total Investments                                         |  |                                     | 38,979  |                |                                     | 1,568                |  | 5.36 | %              |  |                | 39,580  |                      |   | 1,560  |  | 5.26 | %
|                                                          |  |                                     |         |                |                                     |                     
|Gross loans (2)                                           |  |                                     | 253,071 |                |                                     | 12,604               |  | 6.64 | %              |  |                | 251,203 |                      |   | 13,262 |  | 7.04 | %
|Interest-bearing deposits in other banks                  |  |                                     | 368     |                |                                     | 12                   |  | 4.35 | %              |  |                | 198     |                      |   | 9      |  | 5.50 | %
|Federal funds sold                                        |  |                                     | 12,115  |                |                                     | 189                  |  | 2.08 | %              |  |                | 4,617   |                      |   | 183    |  | 5.20 | %
|                                                          |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|TOTAL INTEREST EARNING ASSETS                             |  | $                                   | 304,533 |                | $                                   | 14,373               |  | 6.29 | %              |  | $              | 295,598 |                      | $ | 15,014 |  | 6.77 | %
|                                                          |  |                                     |         |                |                                     |                     
|INTEREST-BEARING LIABILITIES:                             |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|Savings deposits                                          |  | $                                   | 56,350  |                | $                                   | 888                  |  | 2.10 | %              |  | $              | 54,855  |                      | $ | 1,279  |  | 3.11 | %
|NOW deposits                                              |  |                                     | 33,994  |                |                                     | 194                  |  | 0.76 | %              |  |                | 37,605  |                      |   | 296    |  | 1.05 | %
|Time deposits >= $100,000                                 |  |                                     | 45,938  |                |                                     | 1,512                |  | 4.39 | %              |  |                | 39,532  |                      |   | 1,399  |  | 4.72 | %
|Time deposits < $100,000                                  |  |                                     | 63,919  |                |                                     | 1,995                |  | 4.16 | %              |  |                | 64,502  |                      |   | 2,143  |  | 4.43 | %
|Money market deposit accounts                             |  |                                     | 18,524  |                |                                     | 334                  |  | 2.40 | %              |  |                | 16,182  |                      |   | 365    |  | 3.01 | %
|                                                          |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|Total interest bearing deposits                           |  | $                                   | 218,725 |                | $                                   | 4,923                |  | 3.00 | %              |  | $              | 212,676 |                      | $ | 5,482  |  | 3.44 | %
|                                                          |  |                                     |         |                |                                     |                     
|Federal funds purchased                                   |  |                                     | 42      |                |                                     |                     |  | 1.07 | %              |  |                | 855     |                      |   | 36     |  | 5.57 | %
|                                                          |  |                                     |         |                |                                     |                     
|Securities sold to repurchase and federal funds purchased |  |                                     | 7,188   |                |                                     | 67                   |  | 1.24 | %              |  |                | 5,685   |                      |   | 171    |  | 4.01 | %
|FHLB advances                                             |  |                                     | 30,000  |                |                                     | 1,042                |  | 4.63 | %              |  |                | 27,491  |                      |   | 953    |  | 4.62 | %
|                                                          |  |                                     |         |                |                                     |                      |  |      |                |  |                |         |                      |   |        |  |      |  
|TOTAL INTEREST-BEARING LIABILITIES                        |  | $                                   | 255,955 |                | $                                   | 6,032                |  | 3.14 | %              |  | $              | 246,707 |                      | $ | 6,642  |  | 3.59 | %
|                                                          |  |                                     |         |                |                                     |                     
|Net interest income/yield on earning assets               |  |                                     |         |                | $                                   | 8,341                |  | 3.65 | %              |  |                |         |                      | $ | 8,372  |  | 3.78 | %
|Net interest rate spread                                  |  |                                     |         |                |                                     |                      |  | 3.15 | %              |  |                |         |                      |   |        |  | 3.18 | %



Notes:

|(1) | Yield and income assumes a federal tax rate of 34%.
|--- | ---------------------------------------------------

|(2) | Includes Visa Program & nonaccrual loans.
|--- | -----------------------------------------

The
annualized net interest margin was 3.65% for the nine months ended September 30, 2008, compared to 3.78% for the same period in 2007. The main reason for this decline is reductions in the Wall Street Prime rate, as mentioned earlier. Although
reductions in the federal funds target rate have provided some relief by allowing the Bank to reduce the cost of deposits, the cost of funds has not declined as much as the yield on earning assets.

Average interest-earning assets increased 3.0% to $305 million for the nine months ended September 30, 2008 as compared to $296 million for the nine
months ended September 30, 2007. Average interest-earning assets as a percent of total average assets was 94.0% for the nine months ended September 30, 2008 as compared to 93.7% for the comparable period of 2007. As shown above, for the
nine months ended September 30, 2008, the loan portfolio with $253.1 million is the largest category of interest-earning assets.

Average interest-bearing liabilities increased 3.7% to $256.0 million for the nine months ended September 30, 2008, as compared to $246.7 million for the nine months ended September 30, 2007. The largest category of
interest-bearing liabilities is time deposits, with combined average balances of $109.8 million for the nine months ended September 30, 2008.



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The net interest spread, which is the difference between the annualized yield on earning assets and the
annualized cost of interest-bearing liabilities, was 3.15% for the nine months ended September 30, 2008 and 3.18% for the same period in 2007.

LIQUIDITY

The Company maintains adequate short-term assets to meet its liquidity needs as anticipated by management.
Federal funds sold and investments that mature in one year or less provide the major sources of funding for liquidity needs. On September 30, 2008, federal funds sold totaled $7.2 million and securities maturing in one year or less totaled $9.4
million, for a total pool of $37.9 million. The liquidity ratio as of September 30, 2008 was 12.9% as compared to 11.3% as of December 31, 2007. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment
securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. Recently, to provide an additional cushion in these uncertain times, management has chosen to hold funds received from maturing
securities in cash instead of reinvesting those funds in new securities. In addition, as noted earlier, the Company has a line of credit with the FHLB worth $64 million, plus federal funds lines with several correspondent banks.

There have been no material changes to the off balance sheet items disclosed in Managements Discussion and Analysis of Financial Condition
and Results of Operation in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

CONTRACTUAL
OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

CAPITAL RESOURCES

From December 31, 2007 to September 30, 2008, total shareholders equity increased to $27.5 million from $27.1 million or 1.2%. Several
factors impact shareholders equity, including the Companys commitment to returning earnings to its shareholders through dividends while meeting regulatory capital requirements.

The Companys capital resources are also impacted by net unrealized gains or losses on securities. The securities portfolio is marked to market
monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income or loss on the balance sheet and statement of changes in shareholders equity. Another factor effecting Accumulated Other
Comprehensive Income or Loss is changes in the fair value of the Companys pension and post-retirement benefit plans. Shareholders equity before accumulated other comprehensive loss was $27.7 million on September 30, 2008 compared to
$27.4 million on December 31, 2007. Accumulated other comprehensive loss decreased by $143 thousand between December 31, 2007 and September 30, 2008, a result of unrealized gains in the investment portfolio.

Book value per share, basic, on September 30, 2008, compared to September 30, 2007, increased to $11.57 from $11.19, or 3.4%. Book value per
share, basic, before accumulated comprehensive loss on September 30, 2008, compared to December 31, 2007, increased to $11.66 from $11.60. Cash dividends paid for the nine months ended September 30, 2008, were $0.51 per share,
compared to $0.495 per share, for the comparable period ended September 30, 2007, an increase of 3.0%. Of the 5,000,000 common shares authorized, 2,377,302 are outstanding.

The Company began a share repurchase program in August of 1999 and has continued the program into 2008. Repurchases of shares reduced equity by $86
thousand during the first nine months of 2008, compared to $154 thousand during the comparable period in 2007.

The Bank is subject to
minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Council guidelines. These ratios continue to be well in excess of regulatory minimums. As of September 30, 2008, the Bank maintained Tier 1 capital of
$23.7 million, net risk weighted assets of $241.2 million, and Tier 2 capital of $2.3 million. On September 30, 2008, the Tier 1 capital to risk weighted assets ratio was 9.8%, the total capital ratio was 10.8%, and the Tier 1 leverage ratio
was 7.5%.



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FINANCIAL CONDITION

Total assets decreased by 2.2% to $319.1 million during the nine months ended September 30, 2008. Cash and cash equivalents, which produce no income, decreased to $4.6 million on September 30, 2008, from
$5.0 million at year-end 2007.

During the nine months ended September 30, 2008, gross loans decreased by $7.2 million or 2.8%, to
$253.3 million from $260.5 million at year-end 2007. The largest component of this decrease was real estate mortgage loans secured by 1-4 family residential collateral, with a 2.4% decline to $141.3 million.

During the nine months ended September 30, 2008, the Company charged off loans totaling $160 thousand, net of recoveries. For the comparable period
in 2007, total loans charged off were $143 thousand, net of recoveries. The Company maintained $1.0 million of other real estate owned (OREO) as of September 30, 2008, compared to $795 thousand at year-end 2007. All properties
maintained as OREO are actively marketed.

The provision for loan losses amounted to $152 thousand through the nine months ended
September 30, 2008, compared to $225 thousand for the first nine months of 2007. The allowance for loan losses, as a percentage of total loans, was 0.92% at September 30, 2008, compared to 0.90% at December 31, 2007. The allowance for
loan losses is analyzed for adequacy on a quarterly basis to determine the necessary provision. As part of the third quarter 2008 analysis, the factors which reflect changes in the local economy and increases in nonaccrual and impaired loans were
increased. Combined with the reduction in total loan balances and decreases in specific reserves from December 31, 2007, these factor changes contributed to the increased allowance ratio.

As of September 30, 2008, $2.3 million of loans were considered impaired, of which $1.0 million were on non-accrual status. There were $1.3 million
of loans on non-accrual status as of year-end 2007. Impaired loans are identified based on SFAS No. 114. Specific reserves established on impaired loans declined by $156 thousand from December 31, 2007

Loans still accruing interest but delinquent for 90 days or more were $538 thousand on September 30, 2008, as compared to $1.1 million on
December 31, 2007. Management has reviewed these credits and the underlying collateral and expects no additional loss above that which is specifically reserved in the allowance for loan losses.

As of September 30, 2008, securities available for sale at market value totaled $36.4 million as compared to $43.6 million on December 31,
2007. This represents a net decrease of $7.2 million or 16.6% for the nine months. Securities classified as held-to-maturity at book value were $482 thousand as of September 30, 2008, compared to $471 thousand at December 31, 2007. As of
September 30, 2008, the investment portfolio represented 11.6% of total assets and 12.4% of earning assets. The greater portion of the Companys investment portfolio is classified as available-for-sale and marked to market on a monthly
basis. These gains or losses are booked as an adjustment to shareholders equity based upon market conditions, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment
occurs. Management does not consider any of the unrealized losses to be other than temporarily impaired.

As of September 30, 2008,
total deposits were $252.1 million compared to $259.6 million at year-end 2007. This represents a decrease in balances of $7.5 million or 2.9% during the nine months. Components of this decrease include savings and interest-bearing demand deposits
with a 6.6% decrease to $99.7 million. However, noninterest-bearing deposits increased by 5.9% to $40.8 million and time deposits decreased 2.4% increase to $111.6 million.

On June 4, 2008, the Bank opened a new branch office in Burgess, Northumberland County,
Virginia. This is the Banks 8thretail office and a strategic extension of its market into the financially attractive eastern region of that
county.

The Bank has also received approval to establish a retail office in Colonial Beach, Virginia. Purchase of land for this
office was completed in the third quarter, and ground has been broken. Colonial Beach is an incorporated town within Westmoreland County. This will be the Banks 9th banking office and the 2nd in Westmoreland County, another strategic extension
of its market to that countys western end. Management anticipates this branch will open in the first quarter of 2009.

These new
offices will result in increases to depreciation and related expense. Management believes that improvements in customer service, efficiency and an expanded market footprint will reap benefits well in excess of costs over time, and are essential
to the continued growth of the Company. A well-trained and motivated staff will be present in each office to establish the same long-term personal relationships provided to current customers.



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RESULTS OF OPERATIONS

NON-INTEREST INCOME

Non-interest income for the nine months ended September 30, 2008 and 2007 each totaled $2.3
million. This is remarkable given two one-time losses which totaled $169 thousand in the second quarter. First, the sale of one OREO property generated a loss of $51 thousand. Second, due to the sale of Bankers Investment Group to Infinex, the
Banks investment in that entity suffered a loss of $118 thousand. Due to the sale of Bankers Title of Fredericksburg to Bankers Title of Shenandoah, the Banks investment in that entity enjoyed a gain of $38 thousand, which mitigated some
of the above-mentioned losses. Gains of $34 thousand on the sale of securities also helped mitigate those losses. Other noteworthy elements of non-interest income include fee income generated by the Banks Investment Advantage program, which
increased by 30% to $336 thousand for the first nine months of 2008, compared to $259 thousand for the similar period in 2007. Visa® income was $678 thousand for the first nine months of 2008, as compared to $568 thousand for the same period in
2007, an increase of 19%.

Non-interest income of $808,990 for the quarter ended September 30, 2008, is down from $836,563 for the
quarter ended September 30, 2007. Declines in income from fiduciary activities, service charges and fees on deposit accounts, and secondary market lending fees were partially mitigated by increases in other service charges and fees. The
increases in other service charges and fees were due mainly to Visa income, which increased to $287 thousand in the quarter ended September 30, 2008 from $216 thousand in the quarter ended September 30, 2007. Income from Investment
Advantage was down to $79 thousand from $105 thousand for the same quarters.

The Companys fiduciary income is derived from the
operations of its subsidiary, Bay Trust Company, which offers a broad range of trust and related fiduciary services. Among these are estate settlement and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial
accounts, and rollover IRAs, both self-directed and managed. Fiduciary income is largely affected by changes in the performance of the stock and bond market, which directly impacts the market value of the accounts upon which fees are earned,
and explains the quarterly and year-to-date declines shown in the Consolidated Statement of Earnings.

Management continues to explore
methods of increasing non-interest income. Continued expansion of fiduciary services, diversification of business lines, and expansion of fee-based services provided to bank customers are among the areas under regular review.

NON-INTEREST EXPENSE

For the nine months ended
September 30, 2008, non-interest expenses were $8.4 million, an increase of 0.8% compared to the same period in 2007. The largest components of non-interest expense are salaries and benefits, and occupancy expense. For the nine months ended
September 30, 2008, compared to the same period in 2007, management has reduced salary and benefit expense by 1.7%. Similarly, occupancy expense has been reduced by 4.6% to $1.3 million from $1.4 million. This reduction in occupancy expense
positions the Company well for expected increases related to the two new retail offices described earlier.

Other expenses include bank
franchise taxes which totaled $155 thousand through nine months of 2008 and $139 thousand for the same period in 2007; expenses related to the Visa® program which were $562 thousand through nine months of 2008 and $447 thousand through nine
months of 2007; telephone expenses which were $141 thousand for the current period and $143 thousand through nine months of 2007; and other operating expenses which totaled $1.8 million for the current period as well as for the nine months ended
September 30, 2007. Telephone expenses include the cost of the Companys Customer Care Center and data network communications.

For the quarter ended September 30, 2008, non-interest expense increased to $2.8 million from $2.7 million in the quarter ended September 30, 2007, or 1.2%. Although most categories increased when the above-mentioned quarters are
compared, reductions in salaries and benefits expenses nearly mitigated them. Bank franchise tax expense was $51,792 and Visa program expenses were $238,372, for the quarter ended September 30, 2008, both of which were up compared to the same
quarter in 2007. However, the Visa program continues to make a net positive contribution to the Companys net income, which increased to $113,339 for the nine months ended September 30, 2008, an increase of 6.3% over the same period in
2007



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RECENT ACCOUNTING PRONOUNCEMENTS

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board
(FASB) issued SFAS No. 141(R), Business Combinations (SFAS 141(R)). The Standard will significantly change the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes the
criteria for how an acquiring entity in a business combination recognizes the assets acquired and liabilities assumed in the transaction; establishes the acquisition date fair value as the measurement objective for all assets acquired and
liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Acquisition related costs including
finders fees, advisory, legal, accounting valuation and other professional and consulting fees are required to be expensed as incurred. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008 and early implementation
is not permitted. The Company does not expect the implementation to have a material impact on its consolidated financial statements.

In
December 2007, the FASB issued SFAS No.160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties
other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parents ownership interest, and the valuation of retained noncontrolling equity investments when a
subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160
is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company does not expect the implementation of SFAS 160 to have a material impact on its
consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133(SFAS 161). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures
about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and how derivative instruments and related hedged items affect an
entitys financial position, financial performance and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early application permitted. The Company does not expect the
implementation of SFAS 161 to have a material impact on its consolidated financial statements.

In May 2008, the FASB issued SFAS
No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 becomes effective 60 days following the SECs approval of the Public Company Accounting
Oversight Board amendments to AU Section 411. The Company does not expect the implementation of SFAS 162 to have a material impact on its consolidated financial statements.

In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157
(FSP 157-2). FSP FAS 157-2 delays the effective date of SFAS 157, Fair Value Measurements, for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of
Statement 157. FSP 157-2 defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years, for items within the scope of this FSP. Examples of items to which the
deferral would and would not apply are listed in the FSP. The Company does not expect the implementation of FSP 157-2 to have a material impact on its consolidated financial statements.

In April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of Intangible Assets (FSP 142-3). This FSP amends the
factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), Business Combinations, and other U.S. generally
accepted accounting principles. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not
expect the implementation of FSP 142-3 to have a material impact on its consolidated financial statements.



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In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be
Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP APB 14-1). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement)
are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants. The FSP requires that issuers of such instruments should separately account for the liability (debt)
and equity (conversion option) components in a manner that reflects the issuers nonconvertible debt borrowing rate. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and
interim periods within those years. The Bank Company does not expect the implementation of FSP APB 14-1 to have a material impact on its consolidated financial statements.

In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active
(FSP 157-3). FSP 157-3 clarifies the application of SFAS 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when
the market for that financial asset is not active. This FSP was effective upon issuance, including prior periods for which financial statements have not been issued.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Not
required.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

EVALUATION OF DISCLOSURE CONTROLS AND
PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and
with the participation of the Companys management, including the Companys Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Rule 13a-14 of the Exchange Act. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Companys Chief Executive Officer and Principal Financial Officer concluded that the Companys disclosure
controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Companys periodic SEC filings as of September 30, 2008.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Companys internal control over financial reporting during the quarter ended September 30, 2008 that materially affected, or is reasonably likely to materially affect, the Companys internal control
over financial reporting.



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##### Table of Contents

PART II - OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

In the ordinary course of its
operations, the Company is a party to various legal proceedings. Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial
condition, or results of operations of the Company.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

Not required.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

The Company began a share repurchase program in August of 1999 and has continued the program into 2008. There are a total of 280,000 shares authorized for repurchase under the program.

The status of the Companys stock repurchase program is shown in the table below.



|                |  |                                |  |                            |       |                                                                               |       |                                                                              |       
|--------------- |  | ------------------------------ |  | -------------------------- | ----- | ----------------------------------------------------------------------------- | ----- | ---------------------------------------------------------------------------- | ------
|                |  | Total Numberof SharesPurchased |  | AveragePrice Paidper Share |       | Total Number of SharesPurchased as Part ofPublicly Announced Plansor Programs |       | Maximum Number of Sharesthat May Yet Be
PurchasedUnder the Plans or Programs
|July, 2008      |  |                               |  | $                          |      |                                                                               |      |                                                                              | 80,812
|August, 2008    |  | 700                            |  | $                          | 10.79 |                                                                               | 700   |                                                                              | 80,112
|September ,2008 |  | 3,410                          |  | $                          | 10.31 |                                                                               | 3,410 |                                                                              | 76,702
|                |  |                                |  |                            |       |                                                                               |       |                                                                              |       
|Total           |  | 4,110                          |  | $                          | 10.39 |                                                                               | 4,110 |                                                                              |       
|                |  |                                |  |                            |       |                                                                               |       |                                                                              |       



|ITEM 3. | DEFAULT UPON SENIOR SECURITIES
|------- | ------------------------------

None to report.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

There were no
matters submitted to a vote of security holders during the quarter ended September 30, 2008.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

None to report.



|ITEM 6. | EXHIBITS
|------- | --------



|     |  |                                                                                                                       
|---- |  | ----------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|     | 
|31.2 |  | Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 
|     | 
|32.1 |  | Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                  |  |                                          |  |                                                                    
|----------------- |  | ---------------------------------------- |  | -------------------------------------------------------------------
|                  |  | Bay Banks of Virginia, Inc. (Registrant)
|                  |  |                                         
|November 13, 2008 |  | By:                                      |  | /s/ Austin L. Roberts, III                                         
|                  |  |                                          |  | Austin L. Roberts, III                                             
|                  |  |                                          |  | President and Chief Executive Officer (Principal
Executive Officer)
|                  |  |                                         
|                  |  | By:                                      |  | /s/ Deborah M. Evans                                               
|                  |  |                                          |  | Deborah M. Evans                                                   
|                  |  |                                          |  | Treasurer (Principal Financial
Officer)                            



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