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** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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, 2009**                                                                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                      |
| **or**                                                                                                                                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                                                                                                                                |
| **o**                                                                                                                                                                                                                                                                                                                                     | ** ** | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
| ** **                                                                                                                                                                                                                                                                                                                                |
| **For the transition period from                            to                         ** |

 

**Commission File Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Virginia**                    | ** ** | **54-1874630**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of | ** ** | (I.R.S. Employer    |
| incorporation or organization)  | ** ** | Identification No.) |

 

| **8270 Greensboro Drive, Suite 500** |       |       |
|-------------------------------------------|------------|------------|
| **McLean, Virginia**                      | ** ** | **22102**  |
| (Address of principal executive offices)  |       | (Zip Code) |

** **

**(703) 584-3400**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90days.      Yes x   No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post suchfiles).       Yes  o   No  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 
| Large accelerated filer o                |   | Accelerated filer x                    |
|-----------------------------------------------|--------|----------------------------------------|
|                                          |   |                                   |
| Non-accelerated filer o                  |   | Smaller reporting company  o |
| (Do not check if a smaller reporting company) |   |                                   |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act)     Yes o  No x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

28,692,285 shares of common stock, par value $1.00 per share,

outstanding as of November 4, 2009

 

 

 

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**CARDINALFINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I — FINANCIAL INFORMATION**                                                                                           |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                   |   |
| Item 1. Financial Statements:                                                                                                          |   |
|                                                                                                                                   |   |
| Consolidated Statements of ConditionAt September 30, 2009 (unaudited) and December 31, 2008                                  | 3      |
|                                                                                                                                   |   |
| Consolidated Statements of IncomeFor the three and nine months ended September 30, 2009 and 2008  (unaudited)                     | 4      |
|                                                                                                                                   |   |
| Consolidated Statements of Comprehensive IncomeFor the three and nine months ended September 30, 2009 and 2008  (unaudited)       | 5      |
|                                                                                                                                   |   |
| Consolidated Statements of Changes in Shareholders’  EquityFor the nine months ended September 30, 2009 and 2008 (unaudited) | 6      |
|                                                                                                                                   |   |
| Consolidated Statements of Cash FlowsFor the nine months ended September 30, 2009 and 2008 (unaudited)                            | 7      |
|                                                                                                                                   |   |
| Notes to Consolidated Financial Statements (unaudited)                                                                                 | 8      |
|                                                                                                                                   |   |
| Item 2. Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                    | 30     |
|                                                                                                                                   |   |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                                    | 62     |
|                                                                                                                                   |   |
| Item 4. Controls and Procedures                                                                                                        | 63     |
|                                                                                                                                   |   |
| **PART II  — OTHER INFORMATION**                                                                                             | 64     |
|                                                                                                                                   |   |
| Item  1. Legal Proceedings                                                                                                             | 64     |
| Item  1A. Risk Factors                                                                                                                 | 64     |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                                                   | 65     |
| Item 3. Defaults Upon Senior Securities                                                                                                | 65     |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                                           | 65     |
| Item  5. Other Information                                                                                                             | 65     |
| Item 6.  Exhibits                                                                                                                      | 65     |
|                                                                                                                                   |   |
| **SIGNATURES**                                                                                                                         | 66     |

 

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**PART I— FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

CONSOLIDATED STATEMENTS OF CONDITION

 

September 30,2009 and December 31, 2008

 

(Inthousands, except share data)

 
| ** **                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                       | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                       | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                       |       |                   |       |                  |       |
| ** **                                                                                                                                       |       |                   |       |                  |       |
| Cash  and due from banks                                                                                                                         |       | $                      | 12,251     |                  | $          | 14,919 |   |
| Federal  funds sold                                                                                                                              |       | 7,727                  |       | 31,009                |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Total  cash and cash equivalents                                                                                                                 |       | 19,978                 |       | 45,928                |       |
| Investment  securities available-for-sale                                                                                                        |       | 334,670                |       | 265,356               |       |
| Investment  securities held-to-maturity (fair value of $34,932 and $45,759 at  September 30, 2009 and December 31, 2008, respectively) |       | 37,526                 |       | 50,183                |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Total  investment securities                                                                                                                     |       | 372,196                |       | 315,539               |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Other  investments                                                                                                                               |       | 16,467                 |       | 16,370                |       |
| Loans  held for sale                                                                                                                             |       | 151,806                |       | 157,009               |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Loans  receivable, net of deferred fees and costs                                                                                                |       | 1,263,291              |       | 1,139,348             |       |
| Allowance  for loan losses                                                                                                                       |       | (17,473                | )          | (14,518               | )          |
|                                                                                                                                             |       |                   |       |                  |       |
| Loans  receivable, net                                                                                                                           |       | 1,245,818              |       | 1,124,830             |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Premises  and equipment, net                                                                                                                     |       | 15,578                 |       | 16,463                |       |
| Deferred  tax asset, net                                                                                                                         |       | 5,899                  |       | 8,799                 |       |
| Goodwill  and intangibles, net                                                                                                                   |       | 13,995                 |       | 14,173                |       |
| Bank-owned  life insurance                                                                                                                       |       | 33,576                 |       | 33,176                |       |
| Accrued  interest receivable and other assets                                                                                                    |       | 18,090                 |       | 11,470                |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Total  assets                                                                                                                                    |       | $                      | 1,893,403  |                  | $          | 1,743,757 |   |
|                                                                                                                                             |       |                   |       |                  |       |
| **Liabilities and Shareholders’  Equity**                                                                                                   |       |                   |       |                  |       |
| ** **                                                                                                                                       |       |                   |       |                  |       |
| Noninterest  bearing deposits                                                                                                                    |       | $                      | 154,276    |                  | $          | 147,529 |   |
| Interest  bearing deposits                                                                                                                       |       | 1,121,600              |       | 1,032,315             |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Total  deposits                                                                                                                                  |       | 1,275,876              |       | 1,179,844             |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Other  borrowed funds                                                                                                                            |       | 378,645                |       | 367,198               |       |
| Mortgage  funding checks                                                                                                                         |       | 13,167                 |       | 19,178                |       |
| Escrow  liabilities                                                                                                                              |       | 2,329                  |       | 1,832                 |       |
| Accrued  interest payable and other liabilities                                                                                                  |       | 20,036                 |       | 17,699                |       |
|                                                                                                                                             |       |                   |       |                  |       |
| Total  liabilities                                                                                                                               |       | 1,690,053              |       | 1,585,751             |       |
|                                                                                                                                             |       |                   |       |                  |       |
| ** **                                                                                                                                       | ** ** | **2009**               | ** ** | **2008**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Common  stock, $1 par value                                                                                                                      |       |                   |       |                  |       |   |   |   |   |
| Shares  authorized                                                                                                                               |       | 50,000,000             |       | 50,000,000            |       |   |   |   |   |
| Shares  issued and outstanding                                                                                                                   |       | 28,690,285             |       | 24,013,663            |       | 28,690 |   | 24,014 |   |
| Additional  paid-in capital                                                                                                                      |       |                   |       |                  |       | 159,567 |   | 130,709 |   |
| Retained  earnings                                                                                                                               |       |                   |       |                  |       | 9,583 |   | 3,437 |   |
| Accumulated  other comprehensive income (loss), net                                                                                              |       |                   |       |                  |       | 5,510 |   | (154 | ) |
|                                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Total  shareholders’ equity                                                                                                                 |       |                   |       |                  |       | 203,350 |   | 158,006 |   |
|                                                                                                                                             |       |                   |       |                  |       |   |   |   |   |
| Total  liabilities and shareholders’ equity                                                                                                 |       |                   |       |                  |       | $ | 1,893,403 |   | $ | 1,743,757 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

CONSOLIDATEDSTATEMENTS OF INCOME

 

Three and nine months ended September 30,2009 and 2008

(Inthousands, except share data)

(Unaudited)

 
| ** **                                                     | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest  income:                                              |       |                                       |       |                                      |       |   |   |   |   |
| Loans  receivable                                              |       | $                                          | 16,585     |                                      | $          | 16,130 |   | $ | 47,969 |   | $ | 48,497 |   |
| Loans  held for sale                                           |       | 1,630                                      |       | 1,709                                     |       | 5,651 |   | 5,792 |   |
| Federal  funds sold                                            |       | 57                                         |       | 118                                       |       | 102 |   | 433 |   |
| Investment  securities available-for-sale                      |       | 3,264                                      |       | 3,295                                     |       | 8,578 |   | 10,050 |   |
| Investment  securities held-to-maturity                        |       | 354                                        |       | 586                                       |       | 1,258 |   | 1,963 |   |
| Other  investments                                             |       | 33                                         |       | 113                                       |       | 13 |   | 548 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Total  interest income                                         |       | 21,923                                     |       | 21,951                                    |       | 63,571 |   | 67,283 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Interest  expense:                                             |       |                                       |       |                                      |       |   |   |   |   |
| Deposits                                                       |       | 5,710                                      |       | 7,244                                     |       | 18,514 |   | 24,451 |   |
| Other  borrowed funds                                          |       | 3,121                                      |       | 3,427                                     |       | 9,383 |   | 10,172 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Total  interest expense                                        |       | 8,831                                      |       | 10,671                                    |       | 27,897 |   | 34,623 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Net  interest income                                           |       | 13,092                                     |       | 11,280                                    |       | 35,674 |   | 32,660 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Provision  for loan losses                                     |       | 2,050                                      |       | 1,645                                     |       | 4,750 |   | 2,734 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Net  interest income after provision for loan losses           |       | 11,042                                     |       | 9,635                                     |       | 30,924 |   | 29,926 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Noninterest  income:                                           |       |                                       |       |                                      |       |   |   |   |   |
| Service  charges on deposit accounts                           |       | 514                                        |       | 522                                       |       | 1,482 |   | 1,584 |   |
| Loan  fees                                                     |       | 503                                        |       | 365                                       |       | 2,161 |   | 1,029 |   |
| Investment  fee income                                         |       | 975                                        |       | 893                                       |       | 2,665 |   | 2,715 |   |
| Realized  and unrealized gains on mortgage banking activities  |       | 2,833                                      |       | 1,985                                     |       | 9,579 |   | 5,878 |   |
| Net  realized gain on investment securities available-for-sale |       | 73                                         |       | 306                                       |       | 625 |   | 539 |   |
| Net  realized gain (loss) on investment securities trading     |       | 97                                         |       | —                                    |       | (422 | ) | (9 | ) |
| Management  fee income                                         |       | 553                                        |       | 204                                       |       | 1,267 |   | 590 |   |
| Increase  in cash surrender value of bank-owned life insurance |       | 167                                        |       | 165                                       |       | 400 |   | 741 |   |
| Litigation  recovery on previously impaired investment         |       | —                                     |       | —                                    |       | — |   | 190 |   |
| Other  income (loss)                                           |       | (11                                        | )          | (45                                       | )          | (45 | ) | 125 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Total  noninterest income                                      |       | 5,704                                      |       | 4,395                                     |       | 17,712 |   | 13,382 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Noninterest  expense:                                          |       |                                       |       |                                      |       |   |   |   |   |
| Salary  and benefits                                           |       | 5,897                                      |       | 5,754                                     |       | 17,546 |   | 17,250 |   |
| Occupancy                                                      |       | 1,321                                      |       | 1,429                                     |       | 4,055 |   | 4,205 |   |
| Professional  fees                                             |       | 562                                        |       | 489                                       |       | 1,566 |   | 1,687 |   |
| Depreciation                                                   |       | 464                                        |       | 583                                       |       | 1,515 |   | 1,821 |   |
| Data  processing                                               |       | 469                                        |       | 402                                       |       | 1,438 |   | 1,257 |   |
| Telecommunications                                             |       | 328                                        |       | 256                                       |       | 939 |   | 742 |   |
| Amortization  of intangibles                                   |       | 60                                         |       | 59                                        |       | 178 |   | 186 |   |
| Impairment  of Fannie Mae perpetual preferred stock            |       | —                                     |       | 4,408                                     |       | — |   | 4,408 |   |
| Impairment  of goodwill                                        |       | —                                     |       | 2,821                                     |       | — |   | 2,821 |   |
| FDIC  insurance assessment                                     |       | 463                                        |       | 181                                       |       | 2,202 |   | 541 |   |
| Settlement  with mortgage correspondent                        |       | —                                     |       | —                                    |       | — |   | 1,800 |   |
| Other  operating expenses                                      |       | 3,414                                      |       | 2,874                                     |       | 9,282 |   | 8,000 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Total  noninterest expense                                     |       | 12,978                                     |       | 19,256                                    |       | 38,721 |   | 44,718 |   |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Net  income (loss) before income taxes                         |       | 3,768                                      |       | (5,226                                    | )          | 9,915 |   | (1,410 | ) |
|                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Provision  for income taxes                                    |       | 1,164                                      |       | (816                                      | )          | 3,000 |   | 84 |   |
| Net  income (loss)                                             |       | $                                          | 2,604      |                                      | $          | (4,410 | ) | $ | 6,915 |   | $ | (1,494 | ) |
| Earnings  (loss) per common share - basic                      |       | $                                          | 0.09       |                                      | $          | (0.18 | ) | $ | 0.26 |   | $ | (0.06 | ) |
| Earnings  (loss) per common share - diluted                    |       | $                                          | 0.09       |                                      | $          | (0.18 | ) | $ | 0.26 |   | $ | (0.06 | ) |
| Weighted-average  common shares outstanding - basic            |       | 28,999,230                                 |       | 24,327,751                                |       | 26,559,683 |   | 24,393,167 |   |
| Weighted-average  common shares outstanding - diluted          |       | 29,524,878                                 |       | 24,327,751                                |       | 27,047,915 |   | 24,393,167 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Threeand nine months ended September 30, 2009 and 2008

(Inthousands)

(Unaudited)

 
| ** **                                                                                                                                                                                                                                                                                                                   | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                   | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                                                                                                                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Net  income (loss)                                                                                                                                                                                                                                                                                                           |       | $                                          | 2,604      |                                      | $          | (4,410 | ) | $ | 6,915 |   | $ | (1,494 | ) |
| Other  comprehensive income (loss):                                                                                                                                                                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Unrealized  gain (loss) on available-for-sale investment securities:                                                                                                                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Unrealized  holding gain (loss) arising during the period, net of tax expense of $2.1  million and $2.9 million for the three and nine months ended  September 30, 2009, respectively, and net of tax benefit of $447,000 and  $1.2 million for the three and nine months ended September 30, 2008,  respectively. |       | 4,148                                      |       | (643                                      | )          | 5,908 |   | (1,902 | ) |
|                                                                                                                                                                                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Less:  reclassification adjustment for gains included in net income net of tax  expense of $25,000 and $212,000 for the three and nine months ended  September 30, 2009, respectively, and $104,000 and $184,000 for the  three and nine months ended September 30, 2008, respectively.                            |       | (48                                        | )          | (202                                      | )          | (412 | ) | (355 | ) |
|                                                                                                                                                                                                                                                                                                                         |       | 4,100                                      |       | (845                                      | )          | 5,496 |   | (2,257 | ) |
|                                                                                                                                                                                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Unrealized  gain on derivative instruments designated as cash flow hedges, net of tax  expense of $153,000 and $55,000 for the three and nine months ended  September 30, 2009, respectively and tax expense of $250,000 and $135,000  for the three and nine months ended September 30, 2008, respectively.       |       | 467                                        |       | 429                                       |       | 168 |   | 222 |   |
|                                                                                                                                                                                                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Comprehensive  income (loss)                                                                                                                                                                                                                                                                                                 |       | $                                          | 7,171      |                                      | $          | (4,826 | ) | $ | 12,579 |   | $ | (3,529 | ) |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Ninemonths ended September 30, 2009 and 2008

(Inthousands)

(Unaudited)

 
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance,  December 31, 2007                                                             |       | 24,202     |       | $          | 24,202     |           | $          | 131,516      |       | $                 | 4,213      |       | $          | (468 | ) | $ | 159,463 |   |
| Cumulative  effect adjustment at January 1, 2008 for the adoption of SFAS  No. 157 |       | —     |       | —     |       | —         |       | (96          | )          | —            |       | (96        | )          |
| Stock  compensation expense, net of tax benefits                                             |       | —     |       | —     |       | 271            |       | —       |       | —            |       | 271        |       |
| Stock  options exercised                                                                     |       | 11         |       | 11         |       | 44             |       | —       |       | —            |       | 55         |       |
| Purchase  and retirement of common stock                                                     |       | (109       | )          | (109       | )          | (791           | )          | —       |       | —            |       | (900       | )          |
| Dividends  on common stock of $0.03 per share                                                |       | —     |       | —     |       | —         |       | (724         | )          | —            |       | (724       | )          |
| Change  in accumulated other comprehensive loss                                              |       | —     |       | —     |       | —         |       | —       |       | (2,035            | )          | (2,035     | )          |
| Net  loss                                                                                    |       | —     |       | —     |       | —         |       | (1,494       | )          | —            |       | (1,494     | )          |
| Balance,  September 30, 2008                                                            |       | 24,104     |       | $          | 24,104     |           | $          | 131,040      |       | $                 | 1,899      |       | $          | (2,503 | ) | $ | 154,540 |   |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance,  December 31, 2008                                                             |       | 24,014     |       | $          | 24,014     |           | $          | 130,709      |       | $                 | 3,437      |       | $          | (154 | ) | $ | 158,006 |   |
| Public  offering shares issued                                                               |       | 4,378      |       | 4,378      |       | 27,233         |       | —       |       | —            |       | 31,611     |       |
| Stock  compensation expense, net of tax benefits                                             |       | —     |       | —     |       | 300            |       | —       |       | —            |       | 300        |       |
| Stock  options exercised                                                                     |       | 11         |       | 11         |       | 47             |       | —       |       | —            |       | 58         |       |
| Shares  issued to employee benefits plan                                                     |       | 287        |       | 287        |       | 1,278          |       | —       |       | —            |       | 1,565      |       |
| Dividends  on common stock of $0.03 per share                                                |       | —     |       | —     |       | —         |       | (769         | )          | —            |       | (769       | )          |
| Change  in accumulated other comprehensive income                                            |       | —     |       | —     |       | —         |       | —       |       | 5,664             |       | 5,664      |       |
| Net  income                                                                                  |       | —     |       | —     |       | —         |       | 6,915        |       | —            |       | 6,915      |       |
| Balance,  September 30, 2009                                                            |       | 28,690     |       | $          | 28,690     |           | $          | 159,567      |       | $                 | 9,583      |       | $          | 5,510 |   | $ | 203,350 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

CONSOLIDATED STATEMENTS OFCASH FLOWS

 

Nine months ended September 30,2009 and 2008

 

(In thousands)

 

(Unaudited)

 
| ** **                                                                                  | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash  flows from operating activities:                                                      |       |       |       |       |       |
| Net  income (loss)                                                                          |       | $          | 6,915      |       | $          | (1,494 | ) |
| Adjustments  to reconcile net income to net cash provided by operating activities:          |       |       |       |       |       |
| Depreciation                                                                                |       | 1,515      |       | 1,821      |       |
| Amortization  of premiums, discounts and intangibles                                        |       | 304        |       | 255        |       |
| Impairment  of goodwill                                                                     |       | —     |       | 2,821      |       |
| Provision  for loan losses                                                                  |       | 4,750      |       | 2,734      |       |
| Loans  held for sale originated                                                             |       | (2,003,234 | )          | (1,034,323 | )          |
| Proceeds  from the sale of loans held for sale                                              |       | 2,018,016  |       | 1,076,135  |       |
| Realized  and unrealized gains on mortgage banking activities                               |       | (9,579     | )          | (5,878     | )          |
| Proceeds  from sale, maturity and call of investment securities trading                     |       | 1,876      |       | 7,848      |       |
| Purchase  of investment securities trading                                                  |       | (6,523     | )          | (7,856     | )          |
| Loss  on sale of investments securities trading                                             |       | 422        |       | 8          |       |
| Gain  on sale of investment securities available-for-sale                                   |       | (768       | )          | (539       | )          |
| Loss  on sale of investment securities available-for-sale                                   |       | 144        |       | —     |       |
| Gain  on sale of other assets                                                               |       | (16        | )          | —     |       |
| Impairment  of Fannie Mae perpetual preferred stock                                         |       | —     |       | 4,408      |       |
| Increase  in cash surrender value of bank-owned life insurance                              |       | (400       | )          | (740       | )          |
| Stock  compensation expense, net of tax benefits                                            |       | 300        |       | 271        |       |
| (Increase)  decrease in accrued interest receivable, other assets and deferred tax asset    |       | (2,193     | )          | 826        |       |
| Increase  (decrease) in accrued interest payable, escrow liabilities and other  liabilities |       | 2,834      |       | (1,209     | )          |
|                                                                                        |       |       |       |       |       |
| Net  cash provided by operating activities                                                  |       | 14,363     |       | 45,088     |       |
|                                                                                        |       |       |       |       |       |
| Cash  flows from investing activities:                                                      |       |       |       |       |       |
| Purchases  of premises and equipment                                                        |       | (614       | )          | (353       | )          |
| Proceeds  from sale of investment securities available-for-sale                             |       | 5,075      |       | 15,411     |       |
| Proceeds  from sale of mortgage-backed securities available-for-sale                        |       | 43,589     |       | 4,942      |       |
| Proceeds  from maturity and call of investment securities available-for-sale                |       | 25,963     |       | 144,892    |       |
| Proceeds  from maturity and call of investment securities held-to-maturity                  |       | 2,000      |       | 17,492     |       |
| Proceeds  from sale of other investments                                                    |       | —     |       | 913        |       |
| Purchase  of investment securities available-for-sale                                       |       | (71,572    | )          | (110,216   | )          |
| Purchase  of mortgage-backed securities available-for-sale                                  |       | (96,426    | )          | (36,267    | )          |
| Purchase  of other investments                                                              |       | (97        | )          | (3,547     | )          |
| Redemptions  of investment securities available-for-sale                                    |       | 33,010     |       | 22,214     |       |
| Redemptions  of investment securities held-to-maturity                                      |       | 10,564     |       | 9,112      |       |
| Net  increase in loans receivable, net of deferred fees and costs                           |       | (125,738   | )          | (46,847    | )          |
|                                                                                        |       |       |       |       |       |
| Net  cash provided by (used in) investing activities                                        |       | (174,246   | )          | 17,746     |       |
|                                                                                        |       |       |       |       |       |
| Cash  flows from financing activities:                                                      |       |       |       |       |       |
| Net  increase (decrease) in deposits                                                        |       | 96,032     |       | (11,361    | )          |
| Net  increase (decrease) in other borrowed funds - short term                               |       | 11,447     |       | (84,595    | )          |
| Net  decrease in mortgage funding checks                                                    |       | (6,011     | )          | (2,110     | )          |
| Proceeds  from FHLB advances - long term                                                    |       | —     |       | 90,000     |       |
| Repayments  of FHLB advances - long term                                                    |       | —     |       | (31,458    | )          |
| Gain  from early extinguishment of long term FHLB advance                                   |       | —     |       | (253       | )          |
| Proceeds  from issuance of stock                                                            |       | 31,611     |       | —     |       |
| Stock  options exercised                                                                    |       | 58         |       | 55         |       |
| Purchase  and retirement of common stock                                                    |       | —     |       | (900       | )          |
| Shares  issued to employee benefits plan                                                    |       | 1,565      |       | —     |       |
| Dividends  on common stock                                                                  |       | (769       | )          | (724       | )          |
|                                                                                        |       |       |       |       |       |
| Net  cash provided by (used in) financing activities                                        |       | 133,933    |       | (41,346    | )          |
|                                                                                        |       |       |       |       |       |
| Net  (decrease) increase in cash and cash equivalents                                       |       | (25,950    | )          | 21,488     |       |
|                                                                                        |       |       |       |       |       |
| Cash  and cash equivalents at beginning of the period                                       |       | 45,928     |       | 22,421     |       |
|                                                                                        |       |       |       |       |       |
| Cash  and cash equivalents at end of the period                                             |       | $          | 19,978     |       | $          | 43,909 |   |
|                                                                                        |       |       |       |       |       |
| **Supplemental disclosure of cash flow information:**                                       |       |       |       |       |       |
| Cash  paid during the period for interest                                                   |       | $          | 27,926     |       | $          | 34,354 |   |
| Cash  paid for income taxes                                                                 |       | 2,488      |       | 4,106      |       |

 

Seeaccompanying notes to consolidated financial statements.

 

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CARDINAL FINANCIALCORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009(Unaudited)

 

Note 1

 

*Organization*

 

CardinalFinancial Corporation (the “Company”) is incorporated under the laws ofthe Commonwealth of Virginia as a financial holding company whose activitiesconsist of investment in its wholly-owned subsidiaries. The principal operatingsubsidiary of the Company is Cardinal Bank (the “Bank”), a state-charteredinstitution and its subsidiary, George Mason Mortgage, LLC (“George Mason”), amortgage banking company based in Fairfax, Virginia. In January 2009, theBank opened a second mortgage subsidiary, Cardinal First Mortgage, LLC (“CardinalFirst”).  The Bank also has a trustdivision, Cardinal Trust and Investment Services.  The Company also owns Wilson/Bennett CapitalManagement, Inc. (“Wilson/Bennett”), an asset management firm and CardinalWealth Services, Inc. (“CWS”), an investment services subsidiary.

 

*Basis of Presentation*

 

Inthe opinion of management, the accompanying consolidated financial statementshave been prepared in accordance with the requirements of Regulation S-X, Article 10.Accordingly, they do not include all of the information and footnotes requiredby U.S. generally accepted accounting principles for complete financialstatements. However, all adjustments that are, in the opinion of management,necessary for a fair presentation have been included. The results of operationsfor the three and nine months ended September 30, 2009 are not necessarilyindicative of the results to be expected for the full year ending December 31,2009. The unaudited interim financial statements should be read in conjunction withthe audited financial statements and notes to financial statements that areincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2008.

 

TheCompany has not elected the fair value option for any financial instrument.

 

Note 2

 

*Stock-BasedCompensation*

 

AtSeptember 30, 2009, the Company had two stock-based employee compensationplans, the 1999 Stock Option Plan (the “Option Plan”) and the 2002 EquityCompensation Plan (the “Equity Plan”).

 

In1998, the Company adopted the Option Plan pursuant to which the Company maygrant stock options for up to 625,000 shares of the Company’s common stock toemployees and members of the Company’s and its subsidiaries’ boards ofdirectors. As of November 23, 2008, the Option Plan expired, andtherefore, there are no shares of common stock available to grant under thisplan.

 

In2002, the Company adopted the Equity Plan. The Equity Plan authorizes thegranting of options, which may be incentive stock options or non-qualifiedstock options, stock appreciation rights, restricted stock awards, phantomstock awards and performance share awards to directors, eligible officers andkey employees of the Company.  The EquityPlan currently authorizes grants 

 

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andawards with respect to 2,420,000 shares of the Company’s common stock.  There were 385,958 shares of the Company’scommon stock available for future grants and awards in the Equity Plan as of September 30,2009.

 

Stockoptions are granted with an exercise price equal to the common stock’s fairmarket value at the date of grant. Director stock options have ten year termsand vest and become fully exercisable at the grant date. Certain employee stockoptions have ten year terms and vest and become fully exercisable after threeyears.  Other employee stock options haveten year terms and vest and become fully exercisable in 20% incrementsbeginning as of the grant date.  Inaddition, the Company has granted stock options to employees of the Companythat have ten year terms and vest and become fully exercisable in 20%increments beginning after their first year of service.

 

TheCompany has only made awards of stock options under the Option Plan and theEquity Plan.

 

Totalexpense related to the Company’s share-based compensation plans for the threemonths ended September 30, 2009 and 2008 was $72,000 and $73,000,respectively. Total stock compensation expense for the nine months ended September 30,2009 and 2008 was $300,000 and $271,000, respectively.  The total income tax benefit recognized inthe income statement for share-based compensation arrangements was $24,000 and$25,000 for the three months ended September 30, 2009 and 2008,respectively.  For the nine months ended September 30,2009 and 2008, the total income tax benefit recognized in the income statementfor share-based compensation was $102,000 and $92,000, respectively.

 

Therewere no options granted during the three months ended September 30,2009.  For the nine months ended September 30,2009, options granted were 120,650. Options granted for the three and ninemonths ended September 30, 2008 were 1,000 and 17,200, respectively. Theweighted average per share fair value of stock option grants made for the ninemonths ended September 30, 2009 was $2.80. The weighted average per share fair values of stock option grants madeduring the three and nine months ended September 30, 2008 were $3.52 and$3.10, respectively. The fair values of the options granted during all periodsended September 30, 2009 and 2008 were estimated as of the grant dateusing the Black-Scholes option-pricing model based on the following weightedaverage assumptions:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------|------------|------------------------|------------|------------------------|------------|
| ** **              | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **              | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                    |       |                   |       |                   |       |   |   |   |   |
| Estimated option life   |       | —                 |       | 6.5 years              |       | 6.5 years |   | 6.5 years |   |
| Risk free interest rate |       | —                 |       | 3.77%                  |       | 2.10% - 2.56% |   | 3.44 - 3.77% |   |
| Expected volatility     |       | —                 |       | 40.50%                 |       | 44.60% |   | 40.50% |   |
| Expected dividend yield |       | —                 |       | 0.56%                  |       | 0.67% |   | 0.56% |   |

 

Expectedvolatility is based upon the average annual historical volatility of theCompany’s common stock. The estimated option life is derived from the “simplifiedmethod” formula as described in Staff Accounting Bulletin No. 110. Therisk free interest rate is based upon the seven-year U.S. Treasury note rate ineffect at the time of grant.  The expected dividend yield is based uponimplied and historical dividend declarations.

 

Stockoption activity during the nine months ended September 30, 2009 issummarized as follows:

 

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| ** **                                      | ** ** | ** **    | ** ** | ** **   | ** ** | **Weighted**     | ** ** | ** **    | ** ** |
|-------------------------------------------------|------------|---------------|------------|--------------|------------|------------------|------------|---------------|------------|
| ** **                                      | ** ** | ** **    | ** ** | **Weighted** | ** ** | **Average**      | ** ** | **Aggregate** | ** ** |
| ** **                                      | ** ** | ** **    | ** ** | **Average**  | ** ** | **Remaining**    | ** ** | **Intrinsic** | ** ** |
| ** **                                      | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**  | ** ** | **Value**     | ** ** |
| ** **                                      | ** ** | **Shares**    | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **($000)**    | ** ** |
| Outstanding  at December 31, 2008          |       | 2,364,733     |       | $            | 8.70       |             |       |          |       |   |
| Granted                                         |       | 120,650       |       | 6.36         |       |             |       |          |       |
| Exercised                                       |       | (11,223       | )          | 4.60         |       |             |       |          |       |
| Forfeited                                       |       | (221,800      | )          | 9.99         |       |             |       |          |       |
| Expired                                         |       | (8,773        | )          | 6.38         |       |             |       |          |       |
| Outstanding  at September 30, 2009         |       | 2,243,587     |       | $            | 8.48       |             | 5.18       |          | $          | (678,322 | ) |
| Options  exercisable at September 30, 2009 |       | 2,064,587     |       | $            | 8.45       |             | 4.92       |          | $          | (577,320 | ) |

 

For the options exercised during the nine months ended September 30,2009, the intrinsic value was $41,000. No options were exercised during thethree months ended September 30, 2009. Total intrinsic value of options exercised for the three and nine monthsended September 30, 2008 was $37,000 and $38,000, respectively.

 

A summary of the status of the Company’s non-vested stock options andchanges during the nine months ended September 30, 2009 is as follows:

 

| ** **                          | ** ** | ** **    | ** ** | **Weighted**   | ** ** |
|-------------------------------------|------------|---------------|------------|----------------|------------|
| ** **                          | ** ** | ** **    | ** ** | **Average**    | ** ** |
| ** **                          | ** ** | **Number of** | ** ** | **Grant Date** | ** ** |
| ** **                          | ** ** | **Shares**    | ** ** | **Fair Value** | ** ** |
| Balance  at December 31, 2008  |       | 166,600       |       | $              | 5.62       |   |
| Granted                             |       | 120,650       |       | 2.80           |       |
| Vested                              |       | (81,800       | )          | 4.95           |       |
| Forfeited                           |       | (26,450       | )          | 5.72           |       |
| Balance  at September 30, 2009 |       | 179,000       |       | $              | 4.01       |   |

 

AtSeptember 30, 2009, there was approximately $900,000 of total unrecognizedcompensation cost related to non-vested share-based compensation arrangementsgranted under the plans. The cost is expected to be recognized over a weightedaverage period of 2.21 years. The total fair value of shares that vested duringthe three months ended September 30, 2009 and 2008 was $44,500 and$52,000, respectively. For the nine months ended September 30, 2009 and2008, the total fair value of shares that vested was $290,000 and $331,000,respectively.

 

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Note 3

 

# *SegmentInformation*

 

TheCompany operates in three business segments: commercial banking, mortgagebanking, and wealth management and trust services.

 

Thecommercial banking segment includes both commercial and consumer lending andprovides customers with such products as commercial loans, real estate loans,business financing and consumer loans. In addition, this segment providescustomers with several choices of deposit products including demand depositaccounts, savings accounts and certificates of deposit. The mortgage bankingsegment engages primarily in the origination and acquisition of residentialmortgages for sale into the secondary market on a best efforts basis. Thewealth management and trust services segment provides investment and financialadvisory services to businesses and individuals, including financial planning,retirement/estate planning, trust, estates, custody, investment management,escrows, and retirement plans.

 

CardinalFirst Mortgage, LLC is included in the mortgage banking segment for the threeand nine months ended September 30, 2009.

 

Informationabout the reportable segments and reconciliation of this information to theconsolidated financial statements at and for the three and nine months ended September 30,2009 and 2008 is as follows:

 

11

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**At and for the Three Months Ended September 30, 2009 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 12,649     |         | $          | 655                    |       | $          | —     |             | $          | (212             | )          | $ | — |   | $ | 13,092 |   |
| Provision  for loan losses  |       | 2,050          |       | —       |       | —                 |       | —     |       | —           |       | 2,050            |       |
| Non-interest  income        |       | 917            |       | 3,724        |       | 980                    |       | 103        |       | (20              | )          | 5,704            |       |
| Non-interest  expense       |       | 8,334          |       | 3,192        |       | 785                    |       | 687        |       | (20              | )          | 12,978           |       |
| Provision  for income taxes |       | 961            |       | 408          |       | 66                     |       | (271       | )          | —           |       | 1,164            |       |
| Net  income (loss)          |       | $              | 2,221      |         | $          | 779                    |       | $          | 129        |             | $          | (525             | )          | $ | — |   | $ | 2,604 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,861,401  |         | $          | 177,183                |       | $          | 3,477      |             | $          | 228,528          |       | $ | (377,186 | ) | $ | 1,893,403 |   |
| Average  Assets             |       | $              | 1,851,296  |         | $          | 137,303                |       | $          | 3,430      |             | $          | 223,422          |       | $ | (363,556 | ) | $ | 1,851,895 |   |

 

**At and for the Three Months Ended September 30, 2008 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 10,720     |         | $          | 837                    |       | $          | —     |             | $          | (277             | )          | $ | — |   | $ | 11,280 |   |
| Provision  for loan losses  |       | 865            |       | 780          |       | —                 |       | —     |       | —           |       | 1,645            |       |
| Non-interest  income        |       | 1,142          |       | 2,352        |       | 893                    |       | 8          |       | —           |       | 4,395            |       |
| Non-interest  expense       |       | 12,096         |       | 5,728        |       | 859                    |       | 573        |       | —           |       | 19,256           |       |
| Provision  for income taxes |       | 605            |       | (1,148       | )          | 13                     |       | (286       | )          | —           |       | (816             | )          |
| Net  income (loss)          |       | $              | (1,704     | )            | $          | (2,171                 | )          | $          | 21         |             | $          | (556             | )          | $ | — |   | $ | (4,410 | ) |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,615,119  |         | $          | 147,255                |       | $          | 3,579      |             | $          | 167,788          |       | $ | (295,549 | ) | $ | 1,638,192 |   |
| Average  Assets             |       | $              | 1,612,406  |         | $          | 124,567                |       | $          | 3,589      |             | $          | 172,889          |       | $ | (292,558 | ) | $ | 1,620,893 |   |

 

**At and for the Nine Months Ended September 30, 2009 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 34,191     |         | $          | 2,165                  |       | $          | —     |             | $          | (682             | )          | $ | — |   | $ | 35,674 |   |
| Provision  for loan losses  |       | 4,656          |       | 94           |       | —                 |       | —     |       | —           |       | 4,750            |       |
| Non-interest  income        |       | 3,077          |       | 12,419       |       | 2,686                  |       | (406       | )          | (64              | )          | 17,712           |       |
| Non-interest  expense       |       | 25,504         |       | 9,154        |       | 2,376                  |       | 1,751      |       | (64              | )          | 38,721           |       |
| Provision  for income taxes |       | 2,025          |       | 1,835        |       | 105                    |       | (965       | )          | —           |       | 3,000            |       |
| Net  income (loss)          |       | $              | 5,083      |         | $          | 3,501                  |       | $          | 205        |             | $          | (1,874           | )          | $ | — |   | $ | 6,915 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,861,401  |         | $          | 177,183                |       | $          | 3,477      |             | $          | 228,528          |       | $ | (377,186 | ) | $ | 1,893,403 |   |
| Average  Assets             |       | $              | 1,777,923  |         | $          | 170,349                |       | $          | 3,447      |             | $          | 201,099          |       | $ | (369,438 | ) | $ | 1,783,380 |   |

 

**At and for the Nine Months Ended September 30, 2008 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 31,110     |         | $          | 2,470                  |       | $          | —     |             | $          | (920             | )          | $ | — |   | $ | 32,660 |   |
| Provision  for loan losses  |       | 1,790          |       | 944          |       | —                 |       | —     |       | —           |       | 2,734            |       |
| Non-interest  income        |       | 3,565          |       | 7,075        |       | 2,715                  |       | 27         |       | —           |       | 13,382           |       |
| Non-interest  expense       |       | 27,165         |       | 12,979       |       | 2,575                  |       | 1,999      |       | —           |       | 44,718           |       |
| Provision  for income taxes |       | 2,528          |       | (1,512       | )          | 51                     |       | (983       | )          | —           |       | 84               |       |
| Net  income (loss)          |       | $              | 3,192      |         | $          | (2,866                 | )          | $          | 89         |             | $          | (1,909           | )          | $ | — |   | $ | (1,494 | ) |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,615,119  |         | $          | 147,255                |       | $          | 3,579      |             | $          | 167,788          |       | $ | (295,549 | ) | $ | 1,638,192 |   |
| Average  Assets             |       | $              | 1,628,002  |         | $          | 138,243                |       | $          | 3,647      |             | $          | 176,287          |       | $ | (309,726 | ) | $ | 1,636,453 |   |

 

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The Company did not have any operatingsegments other than those reported. Parent company financial information isincluded in the “Other” category and represents an overhead function ratherthan an operating segment. The parent company’s most significant assets are itsnet investments in its subsidiaries. The parent company’s net interest expenseis comprised of interest income from short-term investments and interestexpense on trust preferred securities. The parent company’s non-interestexpense is primarily non-allocable executive salaries and professional servicesrelated to the Company’s regulatory requirements.

 

#### Note 4

####  

##### *Earnings Per Share*

##### * *

The following is the calculation of basic anddiluted earnings per share for the three and nine months ended September 30,2009 and 2008.  Antidilutive outstandingstock options excluded from weighted average shares outstanding for the dilutedearnings per share calculation were 245,990 and 238,880 for three months ended September 30,2009 and 2008, respectively. For the nine months ended September 30, 2009and 2008, antidilutive stock options excluded from weighted average sharesoutstanding for the diluted earnings per share calculation were 392,951 and234,503, respectively.  Theseantidilutive stock options have exercise prices that were greater than theaverage market price of the Company’s common stock for the periodspresented.  In addition, there were noincremental shares related to unvested stock options because the addition ofthese shares to the diluted weighted average share calculations would beantidilutive.

 
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | **Nine  Months Ended** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **(In thousands,**                          | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
| **except per share data)**                  | ** ** | **2009**                | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Net income available to common shareholders |       | $                       | 2,604      |                   | $          | (4,410 | ) | $ | 6,915 |   | $ | (1,494 | ) |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Weighted average common shares - basic      |       | 28,999                  |       | 24,328                 |       | 26,560 |   | 24,393 |   |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Weighted average common shares - diluted    |       | 29,525                  |       | 24,328                 |       | 27,048 |   | 24,393 |   |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Earnings per common share - basic           |       | $                       | 0.09       |                   | $          | (0.18 | ) | $ | 0.26 |   | $ | (0.06 | ) |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Earnings per common share - diluted         |       | $                       | 0.09       |                   | $          | (0.18 | ) | $ | 0.26 |   | $ | (0.06 | ) |

 

Basic earnings per share are impacted by thenumber of shares required to be issued under the Company’s various deferredcompensation plans.  Employees whoparticipate in the Company’s deferred compensation plans can allocate theircontributions to various investment options, including a Company Common Stockinvestment option.  The incrementalweighted average shares attributable to the deferred compensation plansincluded in diluted outstanding shares assumes the participants opt to investall of their contributions into the Company’s Common Stock investment option.

 

The following shows the composition of basicoutstanding shares for the three and nine months ended September 30, 2009and 2008:

 

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| ** **                                                               | ** ** | **Three  Months Ended** | ** ** | **Nine  Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                               | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
| **(in thousands)**                                                       | ** ** | **2009**                | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                     |       |                    |       |                   |       |   |   |   |   |
| Weighted average common  shares outstanding                              |       | 28,690                  |       | 24,105                 |       | 26,269 |   | 24,146 |   |
| Weighted average shares  attributable to the deferred compensation plans |       | 309                     |       | 223                    |       | 291 |   | 247 |   |
| Total weighted average  shares - basic                                   |       | 28,999                  |       | 24,328                 |       | 26,560 |   | 24,393 |   |

 

The following shows the composition ofdiluted outstanding shares for the three and nine months ended September 30,2009 and 2008:

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                      | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(in thousands)**                                                              | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Weighted average shares  outstanding - basic (from above)                       |       | 28,999                 |       | 24,328                 |       | 26,560 |   | 24,393 |   |
| Incremental weighted  average shares attributable to deferredcompensation plans |       | 374                    |       | —                 |       | 361 |   | — |   |
| Weighted average shares  attributable to vested stock options                   |       | 152                    |       | —                 |       | 127 |   | — |   |
| Incremental shares  attributable to unvested stock options                      |       | —                 |       | —                 |       | — |   | — |   |
| Total weighted average  shares - diluted                                        |       | 29,525                 |       | 24,328                 |       | 27,048 |   | 24,393 |   |

 

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Note 5

 

*Investment Securities*

 

The fair value and amortized cost of investment securities at September 30,2009 are shown in the tables below.  SeeNote 12 for a discussion of the Company’s investment securities that have beenclassified as trading.

 
| ** **                                  | ** ** | **September 30,  2009** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **Gross**                    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Amortized**                | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In thousands)**                          | ** ** | **cost**                     | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| * *                                    | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Investment  Securities Available-for-Sale* |       |                         |       |   |   |   |   |   |   |
| U.S. government-sponsored  agencies         |       | $                            | 46,542     |   | $ | 575 |   | $ | (33 | ) | $ | 47,084 |   |
| Mortgage-backed securities                  |       | 226,356                      |       | 7,878 |   | (318 | ) | 233,916 |   |
| Municipal securities                        |       | 48,110                       |       | 891 |   | (272 | ) | 48,729 |   |
| U.S. treasury securities                    |       | 4,895                        |       | 46 |   | — |   | 4,941 |   |
| Total                                       |       | $                            | 325,903    |   | $ | 9,390 |   | $ | (623 | ) | $ | 334,670 |   |
|                                        |       |                         |       |   |   |   |   |   |   |
| *Investment  Securities Held-to-Maturity*   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage-backed securities                  |       | 29,522                       |       | 988 |   | (5 | ) | 30,505 |   |
| Corporate bonds                             |       | 8,004                        |       | — |   | (3,577 | ) | 4,427 |   |
| Total                                       |       | $                            | 37,526     |   | $ | 988 |   | $ | (3,582 | ) | $ | 34,932 |   |

 

The fair value and amortized cost of investment securities bycontractual maturity at September 30, 2009 are shown below.  Expected maturities may differ fromcontractual maturities because many issuers have the right to call or prepayobligations with or without call or prepayment penalties.

 
| ** **                         | ** ** | **Available-for-Sale** | ** ** | **Held-to-Maturity** | ** ** |
|------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                         | ** ** | **Amortized**          | ** ** | **Fair**             | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In thousands)**                 | ** ** | **cost**               | ** ** | **Value**            | ** ** | **cost** | ** ** | **Value** | ** ** |
| After 1 year but within 5  years   |       | $                      | 10,226     |                 | $          | 10,352 |   | $ | — |   | $ | — |   |
| After 5 years but within  10 years |       | 36,592                 |       | 37,131               |       | — |   | — |   |
| After 10 years                     |       | 52,729                 |       | 53,271               |       | 8,004 |   | 4,427 |   |
| Mortgage-backed securities         |       | 226,356                |       | 233,916              |       | 29,522 |   | 30,505 |   |
|                               |       |                   |       |                 |       |   |   |   |   |
| Total                              |       | $                      | 325,903    |                 | $          | 334,670 |   | $ | 37,526 |   | $ | 34,932 |   |

 

The following table shows the Company’s investment securities’ grossunrealized losses and their fair value, aggregated by investment category andthe length of time that individual securities have been in a continuousunrealized loss position at September 30, 2009.

 

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| **Investment Securities Available-for-Sale** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| **(In thousands)**                           | ** ** | **Fair Value**          | ** ** | **Unrealized loss**   | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| U.S. government - sponsored agencies         |       | $                       | 5,067      |                  | $          | (33            | )          | $ | — |   | $ | — |   | $ | 5,067 |   | $ | (33 | ) |
| Mortgage-backed securities                   |       | 607                     |       | (9                    | )          | 9,263          |       | (309 | ) | 9,870 |   | (318 | ) |
| Municipal securities                         |       | 5,862                   |       | (111                  | )          | 8,237          |       | (161 | ) | 14,099 |   | (272 | ) |
| Total temporarily impaired securities        |       | $                       | 11,536     |                  | $          | (153           | )          | $ | 17,500 |   | $ | (470 | ) | $ | 29,036 |   | $ | (623 | ) |

 
| **Investment Securities  Held-to-Maturity** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| **(In thousands)**                          | ** ** | **Fair Value**          | ** ** | **Unrealized loss**   | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| Mortgage-backed securities                  |       | $                       | 96         |                  | $          | (2             | )          | $ | 27 |   | $ | (3 | ) | $ | 123 |   | $ | (5 | ) |
| Corporate bonds                             |       | —                  |       | —                |       | 4,427          |       | (3,577 | ) | 4,427 |   | (3,577 | ) |
| Total temporarily impaired securities       |       | $                       | 96         |                  | $          | (2             | )          | $ | 4,454 |   | $ | (3,580 | ) | $ | 4,550 |   | $ | (3,582 | ) |

 

The Company completesreviews for other-than-temporary impairment at least quarterly.  At September 30, 2009 certain of theCompany’s investment grade securities were in an unrealized loss position.  Investment securities with unrealized losseshave interest rates that are less than current market interest rates and,therefore, the indicated decrease in values are not a result of permanent creditimpairment. Municipal securities, with an amortized cost totaling $48.1 millionat September 30, 2009, are the primary component of the unrealized lossesin the available-for-sale investment securities portfolio at September 30,2009.  The majority of the municipalsecurities have been downgraded to AA or single A from AAA due to thedowngrades of the monoline insurance companies that insured those bonds.  The downgraded bonds remain generalobligations of the municipalities and while prices for these municipalsecurities are generally below book value, the Company expects to receivepayment of all principal and interest amounts due.

 

In addition, theheld-to-maturity portfolio includes investments in four pooled trust preferredsecurities, totaling $8.0 million of par value at September 30, 2009 (eachsecurity has a par value of $2.0 million). The collateral underlying these structured securities are instrumentsissued by financial institutions or insurers. The Company owns the A-3 tranches in each issuance.  Each of the bonds are rated by more than onerating agency.  Two of the securitieshave a composite rating of AA and two of the securities have a composite ratingof BBB.  These ratings are consistentwith the grades from the other rating agencies. There is minimal observable trading activity for these types ofsecurities.  The Company has estimatedthe fair value of the securities through the use of internal calculations andcompared the results to information provided by external pricing services.  Given the level of subordination below theA-3 tranches, and the actual and expected performance of the underlyingcollateral, the Company expects to receive all contractual interest andprincipal payments recovering the amortized cost basis of each of the foursecurities, and concluded that these securities are not other-than-temporarilyimpaired.

 

No other-than-temporaryimpairment has been recognized on the securities in our investment portfoliofor the 2009 periods presented.  See Note12 for disclosure of the impairment recognized during 2008.

 

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#### Note 6

####  

##### *DerivativeInstruments and Hedging Activities*

##### * *

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

 

These forward loan sales contract derivativehedges are recorded at fair value in the statement of condition as an otherasset or other liability with a corresponding offset to accumulated othercomprehensive income in shareholders’ equity. Amounts are reclassified fromaccumulated other comprehensive income to the income statement in the period orperiods that the loan sale is reflected in income.

 

At September 30, 2009, accumulated othercomprehensive income included an after-tax unrealized gain of $103,000 relatedto forward loan sales contracts. Loans held for sale are generally sold withinsixty days of closing and, therefore, substantially all of the amount recordedin accumulated other comprehensive income at September 30, 2009 that isrelated to the Company’s cash flow hedges will be recognized in earnings duringthe fourth quarter of 2009. For the three and nine months ended September 30,2009, the hedge ineffectiveness recorded through earnings was immaterial.

 

At September 30, 2009, the Company had$96.0 million in loan commitments and associated forward sales and had $127.0****million in forward sales associated with $151.8 million ofloans held for sale. Loans held for sale that are classified asconstruction-to-permanent total $23.2 million at September 30, 2009 andare not sold forward until the construction phase has been completed.  At September 30, 2009, the fair value ofthe derivative asset was $2.6 million and the fair value of the derivativeliability was $2.7 million.

 

The Company has interest rate swaps tomitigate its exposure to interest rate risk. These interest rate swaps have an aggregate notional amount of $10.0million to hedge against changes in cash flows caused by movement in interestrates related to the Company’s issuance of $20.0 million in trust preferredsecurities.  In addition, the Company hasan interest rate swap to mitigate the variability in the fair value for oneloan receivable.  At September 30,2009, accumulated other comprehensive income included an after-tax unrealizedgain of $64,000 related to these interest rate swaps.  For the three and nine months ended September 30,2009, the hedge ineffectiveness recorded through earnings was immaterial.

 

#### Note 7

####  

*Goodwilland Other Intangibles*

 

Information concerning total amortizableother intangible assets at September 30, 2009 is as follows:

 

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| ** **                          | ** ** | ** **                  | ** ** | ** **                    | ** ** | **Wealth Management**       | ** ** | ** **                    | ** ** | ** **                  | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **Mortgage Banking**        | ** ** | **and Trust Services**        | ** ** | **Total**                   | ** ** |
| **(In thousands)**                  | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Balance at  December 31, 2008  |       | $                           | 1,781      |                          | $          | 841                         |       | $                             | 795        |                        | $          | 536 |   | $ | 2,576 |   | $ | 1,377 |   |
| 2009 amortization  related to:      |       |                        |       |                          |       |                        |       |                          |       |                        |       |   |   |
| Customer relationship  intangibles  |       | —                      |       | 148                           |       | —                      |       | 30                            |       | —                      |       | 178 |   |
| Balance at  September 30, 2009 |       | $                           | 1,781      |                          | $          | 989                         |       | $                             | 795        |                        | $          | 566 |   | $ | 2,576 |   | $ | 1,555 |   |

 

Theaggregate amortization expense was $60,000 and $59,000 for the three monthsended September 30, 2009 and 2008, respectively. For the nine months endedSeptember 30, 2009 and 2008, the aggregate amortization expense was$178,000 and $186,000 respectively.

 

Theestimated amortization expense for the next five years is as follows:

 

| **(In thousands)**             | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| 2009 (October – December) |       | $          | 60         |   |
| 2010                           |       | 238        |       |
| 2011                           |       | 238        |       |
| 2012                           |       | 238        |       |
| 2013                           |       | 189        |       |
| 2014 and thereafter            |       | 58         |       |
|                                |            |            |            |  |

 

Thecarrying amount of goodwill is as follows:

 
| **(In thousands)**                                        | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Wealth  Management  and Trust  Services** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|---------------------------------------------|------------|-----------|------------|
| Balance at December 31,  2008 and September 30, 2009 |       | $                       | 22         |                  | $          | 10,120                                      |       | $         | 2,832      |   | $ | 12,974 |   |
|                                                           |            |                         |            |                       |            |                                             |            |           |            |  |  |  |  |

 

Goodwillof each of the Company’s business segments is tested for impairment on anannual basis or more frequently if events or circumstances warrant. During theperiod ended September 30, 2009, the Company performed an evaluation of thegoodwill associated with its acquisition of George Mason, which is included inthe mortgage banking segment.  TheCompany employed the services of a valuation consultant to assist with thegoodwill evaluation.  The analysisincluded certain valuation techniques, including a discounted cash flowapproach.  Based on the results of theanalysis, the fair value of George Mason exceeded its carrying value.  As a result, no impairment wasindicated.  For the quarter ended September 30,2008, upon completion of its impairment testing of the goodwill associated withits acquisition of George Mason, the Company recorded an impairment charge of$2.8 million.

 

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Note8

 

*Commitmentsand Contingencies*

 

TheCompany is a party to financial instruments with off-balance sheet risk in thenormal course of business to meet the financing needs of its customers. Thesefinancial instruments include commitments to extend credit and standby lettersof credit and financial guarantees. Commitments to extend credit are agreementsto lend to a customer so long as there is no violation of any conditionestablished in the contract. Commitments generally have fixed expiration datesup to one year or other termination clauses and may require payment of afee.  Since many of the commitments areexpected to expire without being drawn upon, the total commitment amounts donot necessarily represent future cash requirements. These instruments representobligations of the Company to extend credit or guarantee borrowings and are notrecorded on the consolidated statements of condition. The rates and terms ofthese instruments are competitive with others in the market in which theCompany operates.

 

TheCompany uses the same credit policies in making commitments and conditionalobligations as it does for on-balance-sheet instruments. The Company evaluateseach customer’s creditworthiness on a case-by-case basis and requirescollateral to support financial instruments when deemed necessary. The amountof collateral obtained upon extension of credit is based upon management’sevaluation of the counterparty. Collateral held varies but may include depositsheld by the Company, marketable securities, accounts receivable, inventory,property, plant and equipment, and income-producing commercial properties.

 

Standbyletters of credit are conditional commitments issued by the Company toguarantee the performance of the contractual obligations by a customer to athird party. The majority of these guarantees extend until satisfactorycompletion of the customer’s contractual obligations. All standby letters ofcredit outstanding at September 30, 2009 are collateralized.

 

AtSeptember 30, 2009, commitments to extend credit were $440.2 million andstandby letters of credit were $14.1 million. The fair value of the liabilityassociated with standby letters of credit at September 30, 2009 was notsignificant. Commitments to extend credit of $96.4 million as of September 30,2009 are related to the mortgage banking segment’s pipeline and are of a shortterm nature.

 

Thoseinstruments may involve, to varying degrees, elements of credit and interestrate risk in excess of the amount recognized in the consolidated statements offinancial condition.  Credit risk isdefined as the possibility of sustaining a loss because the other parties to afinancial instrument fail to perform in accordance with the terms of thecontract.  The Company’s maximum exposureto credit loss under standby letters of credit and commitments to extend creditis represented by the contractual amounts of those instruments.

 

GeorgeMason estimates a reserve (early pay-off reserve) for mortgage loans sold that arerepaid by the borrower within a certain number of days following the loan sale,thereby requiring that George Mason refund part of the service release premiumand/or premium pricing received from the investor.  The reserve as of September 30, 2009 wasinconsequential.

 

GeorgeMason has a reserve for its estimated exposure to repurchase loans previouslysold to investors for which borrowers failed to provide full and accurateinformation on their loan application or for which appraisals have not been acceptableor where the loan was not underwritten in accordance with the loan programspecified by the loan investor. At September 30, 2009, the balance in thisreserve was immaterial. The Company evaluates the merits of each 

 

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claimand estimates its reserve based on actual and expected claims received andconsiders the historical amounts paid to settle such claims.  The Company has worked over the past twelvemonths to reduce and limit its exposure to loan repurchases and claims frominvestors.

 

Inaddition, George Mason, as part of the service it provides to its managedcompanies, purchases the loans originated by the managed companies at the timeof origination. These loans are then sold by George Mason to investors.  George Mason has agreements with its managedcompanies requiring that, for any loans that were originated by a managedcompany and for which investors have requested George Mason to repurchase dueto the borrowers’ failure to provide full and accurate information on orrelated to their loan application or for which appraisals have not beenacceptable or when the loan was not underwritten in accordance with the loanprogram specified by the loan investor, the managed company be responsible forbuying back the loan.  In the event thatthe managed company’s financial condition deteriorates and it is unable to fundthe repurchase of such loans, George Mason may have to provide the funds torepurchase these loans from investors. In this instance, George Mason would establish an allowance on thereceivable from the managed company. There is no such allowance recorded at September 30,2009 as management expects to fully recover amounts owed by managed companiesas of September 30, 2009.

 

Duringthe second quarter of 2008, George Mason entered into an agreement with amortgage correspondent related to the loan purchase agreement between the twoparties.  This agreement provided for therelease of known and unknown claims by the mortgage correspondent in exchangefor a $1.8 million payment made by George Mason to the correspondent.  The terms of this agreement require that theCompany may be obligated to make additional payments to the correspondent infuture periods based on certain conditions. The Company believes the additionalexposure under this agreement is not material. The amount of this relatedexposure declines with the passage of time.

 

TheCompany has counter-party risk that may arise from the possible inability ofGeorge Mason’s third party investors to meet the terms of their forward salescontracts.  George Mason works withthird-party investors that are generally well-capitalized, are investment gradeand exhibit strong financial performance to mitigate this risk.  The Company does not expect any third-partyinvestor to fail to meet its obligation. In addition, the Company has derivative counterparty risk relating tocertain interest rate swaps it has with third parties.  This risk may arise from the inability of thethird party to meet the terms of the contracts. The Company monitors the financial condition of these third parties onan annual basis.  The Company does notexpect any of these third parties to fail to meet its obligations.

 

Note9

 

*FairValue Measurements*

 

Thefair value framework under U.S. generally accepted accounting principlesdefines fair value as the exchange price that would be received for an asset orpaid to transfer a liability (an exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date.  It also establishes a fair value hierarchywhich requires an entity to maximize the use of observable inputs and minimizethe use of unobservable inputs when measuring the fair value.  There are three levels of inputs that may beused to measure fair value:

 

Level1 — Quoted prices in active markets for identical assets or liabilities as ofthe measurement date.

 

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Level2 — Quoted prices for similar instruments in active markets; quoted prices foridentical or similar instruments in markets that are not active; andmodel-derived valuations in which all significant inputs and significant valuedrivers are observable in active markets.

 

Level3 — Valuations derived from valuation techniques in which one or moresignificant inputs or significant value drivers are unobservable.

 

RecurringFair Value Measurements

 

TheCompany’s investment securities available-for-sale are recorded at fair valueusing reliable and unbiased evaluations by an industry-wide valuation serviceand therefore fall into the Level 2 category. This service uses evaluated pricing models that vary based on assetclass and include available trade, bid, and other market information.  Generally, the methodology includes brokerquotes, proprietary models, vast descriptive terms and conditions databases, aswell as extensive quality control programs.

 

TheCompany has an interest rate swap to hedge against the change in fair value ofone fixed rate loan.  This loan isrecorded at fair value using observable rates from a national valuationservice.  These rates are applied to athird party industry-wide valuation model, and therefore, the valuations fallinto a Level 2 category.  In addition,loans are evaluated for impairment and the carrying value of such loans isrecorded at fair value based on appraisals of the underlying collateralcompleted by third parties using Level 2 valuation inputs.

 

TheCompany’s interest rate swap derivatives are recorded at fair value usingobservable rates from a national valuation service.  These rates are applied to a third partyindustry-wide valuation model, and therefore, the valuations fall into a Level2 category.

 

Assetsand liabilities measured at fair value on a recurring basis as of September 30,2009 are shown below:

 

**At September 30, 2009 (in thousands)**

 
| ** **                                             | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                           | ** ** |
|--------------------------------------------------------|------------|-------------|------------|-----------------------------------------------------------------------------|------------|
| **Description**                                        | ** ** | **Balance** | ** ** | **Quoted Prices in  Active markets for  Identical Assets********(Level 1)** | ** ** | **Significant  Other  Observable  Inputs********(Level 2)** | ** ** | **Significant  Unobservable  Inputs********(Level 3)** | ** ** |
| Investment securities available-for-sale               |       | $           | 334,670    |                                                                        |       |   | $ | 334,670 |   |   |   |
| Loans receivable                                       |       | 20,573      |       |                                                                        |       | 20,573 |   |   |   |
| Derivative liability - interest rate swaps             |       | 1,624       |       |                                                                        |       | 1,624 |   |   |   |
| Derivative asset - forward loan sales commitments      |       | 2,618       |       |                                                                        |       | 2,618 |   |   |   |
| Derivative liability - forward loan sales  commitments |       | 1,113       |       |                                                                        |       | 1,113 |   |   |   |
|                                                        |            |             |            |                                                                             |            |  |  |  |  |  |  |

 

Thefair value of the Company’s interest rate lock commitments and forward loansale commitments are included in the above table.  In the normal course of business, GeorgeMason and Cardinal First (collectively, the “mortgage companies”) enter intocontractual interest rate 

 

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lockcommitments to extend credit to borrowers with fixed expiration dates.  The commitments become effective when theborrowers “lock-in” a specified interest rate within the time framesestablished by the mortgage companies. All borrowers are evaluated for credit worthiness prior to the extensionof the commitment.  Market risk arises ifinterest rates move adversely between the time of the interest rate lock by theborrower and the sale date of the loan to an investor.  To mitigate the effect of the interest raterisk inherent in providing rate lock commitments to borrowers, the mortgagecompanies enter into best efforts forward sales contracts to sell loans toinvestors.  The forward sales contractslock in an interest rate and price for the sale of loans similar to the specificrate lock commitments.  Both the ratelock commitments to the borrowers and the forward sales contracts to investorsthrough to the date the loan closes are undesignated derivatives andaccordingly, are marked to fair value through earnings.

 

Theeffects of fair value measurements for the interest rate lock commitmentderivatives and forward sales contract derivatives on earnings for the ninemonths ended September 30, 2009 were as follows:

 
| **(in thousands)**      | ** ** | **Notional  or  Principal  Amount** | ** ** | **Expected  Premium  (Discount)********to Par** | ** ** | **Movement********of Interest  Rates** | ** ** | **Security********Price********Change** | ** ** | **Total Fair  Value  Adjustment** | ** ** |
|-------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|
| Rate lock commitments   |       | $                                   | 85,664     |                                            | $          | 741                                    |       | $                                       | 185        |                              | $          | — |   | $ | 926 |   |
| Forward sales contracts |       | 182,033                             |       | —                                          |       | —                                 |       | (628                                    | )          | (628                              | )          |
|                         |            |                                     |            |                                                 |            |                                        |            |                                         |            |                                   |            |  |  |  |  |  |

 

Theexpected premium (discount) to par considers two elements (a) the interestrate differential and (b) the servicing rights value.  The interest rate differential is thedifference, if any, between the mortgage loan rates to be paid by the borrowerin the retail market and mortgage loan pricing demanded by investors in thesecondary or wholesale market.  TheCompany sells all of its loans on a servicing released basis, and receives aservicing release premium upon sale.  Theservicing rights value is based on contractual terms with investors and rangedfrom 0.17% to 2.75% of the loan amount, depending on the loan type.  The Company assumes an approximate 40%fallout rate based on recent historical experience when measuring the fairvalue of the rate lock commitments. Fallout is defined as interest rate lock commitments for which theCompany does not close a mortgage loan.

 

Thefair value of the forward sales contracts to investors considers the marketprice movement of the same type of security between the trade date and thebalance sheet date.  The market pricechanges are multiplied by the notional amount of the forward sales contracts tomeasure the fair value.

 

Tocalculate the effects of the changes in interest rates from the date of thecommitment through loan origination, and then period end, the Company utilizesapplicable published mortgage-backed investment security prices, and multipliesthe price movement between the rate lock date and the balance sheet date by thenotional loan commitment amount.

 

Atloan closing, the fair value of the interest rate lock commitment is includedin the cost basis of loans held for sale. Loans held for sale are carried at the lower of cost or fair value.

 

Forthe three months ended September 30, 2009, the change in fair value of theinterest rate lock commitments, loans held for sale, and forward loan salescontracts based only on changes in 

 

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marketinterest rates was $628,000.   Interestrate movements have an offsetting impact on the security prices that serve tomeasure the fair value of these instruments.

 

George Mason serves as apass through conduit for the managed companies to sell loans to investors onthe secondary market.  Concurrent withentering into a rate lock agreement with a borrower, the managed company loanis sold forward to an investor in the secondary market.  After the managed company closes the loan, itis assigned to George Mason.  GeorgeMason then facilitates the transfer of the loan to the investor.  George Mason does not earn any spread orother fees from the loan assignment nor from the transfer to the investor.  All gains in the loan sale are earned by themanaged company.  At September 30,2009, loans held for sale includes $55.4 million of loans originated by themanaged companies that will be delivered to the investors by George Mason.  Any change in the fair value of the loansheld for sale originated by the managed company will result in an equal andoffsetting change in liability to the managed company.

 

Nonrecurring Fair ValueMeasurements

 

Certainassets and liabilities are measured at fair value on a nonrecurring basis andare not included in the tables above. These assets include the Company’s valuation of the goodwill related toits acquisition of George Mason and the valuation of the Company’s corporatebonds held in its held-to-maturity investment securities portfolio.

 

**At September 30, 2009 (in thousands)**

 
| ** **                 | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                            | ** ** |
|----------------------------|------------|-------------|------------|------------------------------------------------------------------------------|------------|
| **Description**            | ** ** | **Balance** | ** ** | **Quoted Prices  in Active  markets for  Identical Assets********(Level 1)** | ** ** | **Significant  Other  Observable  Inputs********(Level 2)** | ** ** | **Significant  Unobservable  Inputs********(Level 3)** | ** ** |
| Goodwill–George Mason |       | $           | 10,120     |                                                                         |       |   |   |   | $ | 10,120 |   |
| Corporate bonds            |       | 4,427       |       |                                                                         |       | $ | 4,427 |   |   |   |
|                            |            |             |            |                                                                              |            |  |  |  |  |  |  |  |

 

During the third quarter of2009, the Company performed its annual assessment of the goodwill related toits George Mason mortgage banking subsidiary. The Company employed the services of a valuation consultant to assist withthis analysis.  The consultant employedboth the market approach and income approach of evaluation.  The market approach involves a comparison toother companies that have readily available market values or other transactionsinvolving similar companies.  The incomeapproach recognizes that most businesses derive their value from their abilityto generate future returns, and the cash flow generating power of an operatingbusiness is the single most important determinant of value. The income approachutilizes the discounted cash flow method and arrives at a value by discountingestimated future free cash flows and its estimated terminal value at the end ofthe holding period by a discount rate. In this analysis, cash flows wereprojected for five years and the terminal value is an estimate of the fairvalue of the company at the end of the five year holding period. The discountrate represents the George Mason’s equity cost of capital, which is generallydefined as the rate of return required by investors for alternate investmentsof equal risk.

 

Due to the distressed anddisorderly current market for mortgage banking companies and the very limitednumber of transactions that have occurred over the past year and the even morelimited amount of data on these transactions, in determining the fair value ofGeorge Mason, considerably more weight was given to the income approach  (80%) versus the market approach 

 

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(20%).  Although only a 20% weight was applied to thevalue generated by the market approach, the income approach includes numerousinputs that are based on the current market, including the revenue and expenseassumptions and the underlying discount rates applied to the free cash flowsand terminal cash flow.  Based upon thisanalysis, the fair value of George Mason exceeded its carrying value.

 

TheCompany’s corporate bond portfolio consists of four pooled trust preferredsecurities, with a total par value of $8.0 million at September 30, 2009(each security has a par value of $2.0 million).  The Company owns senior A-3 tranches of eachof these pools and uses the services of a consultant to estimate the projectedcash flow of each investment based upon several scenarios regarding likelypossible default rates of the underlying issuers of each pool.  The analysis yielded a result that fellwithin the range of values provided by external pricing sources.

 

FairValue of Financial Instruments

 

Thefollowing discloses the estimated fair value of financial instruments.  The assumptions used and the estimatesdisclosed represent management’s best judgment of appropriate valuationmethods.  These estimates are based on pertinentinformation available to management at the valuation date.  In certain cases, fair values are not subjectto precise quantification or verification and may change as economic and marketfactors and management’s evaluation of those factors change.

 

Althoughmanagement uses its best judgment in estimating the fair value of financialinstruments, there are inherent limitations in any estimation technique.  Because of the wide range of valuationtechniques and the numerous estimates and assumptions which must be made, itmay be difficult to make reasonable comparisons between the Company’s fairvalue information and that of other banking institutions.  It is important that the many uncertaintiesbe considered when using the estimated fair value disclosures and that, becauseof these uncertainties, the aggregate fair value amount should not be construedas representative of the underlying value of the Company.

 

Thefollowing summarizes the significant methodologies and assumptions used inestimating the fair values presented in the following table.

 

*Cashand Cash Equivalents*

 

Thecarrying amount of cash and cash equivalents is used as a reasonable estimateof fair value.

 

*InvestmentSecurities Held-to-Maturity and Other Investments*

 

Fairvalues for certain investment securities held-to-maturity are based on quotedmarket prices or prices quoted for similar financial instruments.  For the Company’s corporate bonds, fair valueis estimated through the use of internal calculations and the results arecompared to information provided by external pricing sources.  Fair value for other investments is estimatedat their cost since no active trading markets exist.

 

*LoansReceivable, Net*

 

Inorder to determine the fair market value for loans receivable, the loan portfoliowas segmented based on loan type, credit quality and maturities.  For certain variable rate loans with nosignificant credit concerns and frequent repricings, estimated fair values arebased on current carrying amounts.  Thefair values of other loans are estimated using discounted cash flow analyses,at interest rates currently being offered for loans with similar terms toborrowers of similar credit quality.

 

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*Deposits*

 

Thefair values for demand deposits are equal to the carrying amount since they arepayable on demand at the reporting date. The carrying amounts of variable rate, fixed-term money market accountsand certificates of deposit (CDs) approximate their fair value at the reportingdate.  Fair values for fixed-rate CDs areestimated using a discounted cash flow calculation that applies interest ratescurrently being offered on CDs to a schedule of aggregated expected monthlymaturities on time deposits.

 

*OtherBorrowed Funds*

 

Thefair value of other borrowed funds is estimated using a discounted cash flowcalculation that applies interest rates currently available for loans withsimilar terms.

 

*Other Commitmentsto Extend Credit*

 

Thefair value of these financial instruments is based on the credit quality andrelationship, fees, interest rates, probability of funding, compensatingbalance and other covenants or requirements. These commitments have expiration dates and generally expire within oneyear.  Many commitments are expected to,and typically do, expire without being drawn upon.  The rates and terms of these instruments arecompetitive with others in the market in which the Company operates.  The carrying amounts are reasonable estimatesof the fair value of these financial instruments and are zero at September 30,2009.

 

*AccruedInterest Receivable*

 

Thecarrying amount of accrued interest receivable approximates its fair value.

 

Thefollowing summarizes the carrying amount of these financial assets andliabilities that the Company has not recorded at fair value on a recurringbasis:

* *
| ** **                                                    | ** ** | **September 30, 2009** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                    | ** ** | **Carrying**                | ** ** | **Estimated** | ** ** |
| **(In  thousands)**                                           | ** ** | **Amount**                  | ** ** | **Fair Value** | ** ** |
|                                                          |       |                        |       |   |   |
| Financial  assets:                                            |       |                        |       |   |   |
| Cash  and cash equivalents                                    |       | $                           | 19,978     |   | $ | 19,978 |   |
| Investment  securities held-to-maturity and other investments |       | 53,993                      |       | 51,399 |   |
| Loans  receivable, net                                        |       | 1,263,291                   |       | 1,267,930 |   |
| Accrued  interest receivable                                  |       | 5,760                       |       | 5,760 |   |
|                                                          |       |                        |       |   |   |
| Financial  liabilities:                                       |       |                        |       |   |   |
| Demand  deposits                                              |       | $                           | 154,276    |   | $ | 154,276 |   |
| Interest  checking                                            |       | 122,853                     |       | 122,853 |   |
| Money  market and statement savings                           |       | 370,205                     |       | 370,205 |   |
| Certificates  of deposit                                      |       | 628,542                     |       | 638,616 |   |
| Other  borrowed funds                                         |       | 378,645                     |       | 382,181 |   |
| Mortgage  funding checks                                      |       | 13,167                      |       | 13,167 |   |
| Accrued  interest payable                                     |       | 1,633                       |       | 1,633 |   |

 

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| ** **                                                    | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **Carrying**               | ** ** | **Estimated** | ** ** |
| **(In  thousands)**                                           | ** ** | **Amount**                 | ** ** | **Fair Value** | ** ** |
|                                                          |       |                       |       |   |   |
| Financial  assets:                                            |       |                       |       |   |   |
| Cash  and cash equivalents                                    |       | $                          | 45,928     |   | $ | 45,928 |   |
| Investment  securities held-to-maturity and other investments |       | 66,553                     |       | 62,129 |   |
| Loans  receivable, net                                        |       | 1,125,509                  |       | 1,118,012 |   |
| Accrued  interest receivable                                  |       | 5,204                      |       | 5,204 |   |
|                                                          |       |                       |       |   |   |
| Financial  liabilities:                                       |       |                       |       |   |   |
| Demand  deposits                                              |       | $                          | 147,529    |   | $ | 147,529 |   |
| Interest  checking                                            |       | 118,868                    |       | 118,868 |   |
| Money  market and statement savings                           |       | 306,892                    |       | 306,892 |   |
| Certificates  of deposit                                      |       | 606,555                    |       | 616,985 |   |
| Other  borrowed funds                                         |       | 367,198                    |       | 331,856 |   |
| Mortgage  funding checks                                      |       | 19,178                     |       | 19,178 |   |
| Accrued  interest payable                                     |       | 1,660                      |       | 1,660 |   |

 

Note10

 

*FairValue of Derivative Instruments and Hedging Activities*

 

Thefollowing table discloses the derivative instruments’ location on the Company’sstatement of condition and the fair value of those instruments at September 30,2009.  In addition, the gains and lossesrelated to these derivative instruments is provided for the three months ended September 30,2009.

 

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**DerivativeInstruments and Hedging Activities**

**At of September 30, 2009**

**(in thousands)**

 
| ** **                                                  | ** ** | **Asset  Derivatives**                        | ** ** | **Liability  Derivatives** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                                  | ** ** | **Balance Sheet  Location**              | ** ** | **Fair Value**        | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| **Derivatives Designated as Hedging Instruments**           |       |                                          |       |                       |       |   |   |   |   |
| Interest  Rate Swaps                                        |       | Accrued Interest Receivable  and Other Assets |       | $                          | —     |   | Accrued Interest Payable  and Other Liabilities |   | $ | 1,624 |   |
| Forward  Loan Sales Commitments                             |       | Accrued Interest Receivable  and Other Assets |       | 1,685                      |       | Accrued Interest Payable  and Other Liabilities |   | 920 |   |
| **Total Derivatives Designated as Hedging Instruments**     |       |                                          |       | 1,685                      |       |   |   | 2,544 |   |
|                                                        |       |                                          |       |                       |       |   |   |   |   |
| **Derivatives Not Designated as Hedging Instruments**       |       |                                          |       |                       |       |   |   |   |   |
| Forward  Rate Lock Commitments                              |       | Accrued Interest Receivable  and Other Assets |       | 934                        |       | Accrued Interest Payable  and Other Liabilities |   | 193 |   |
| **Total Derivatives Not Designated as Hedging Instruments** |       |                                          |       | 934                        |       |   |   | 193 |   |
|                                                        |       |                                          |       |                       |       |   |   |   |   |
| **Total Derivatives**                                       |       |                                          |       | $                          | 2,619      |   |   |   | $ | 2,737 |   |

 

**Impact ofDerivative Instruments on the Statement of Income**

**For theThree Months Ended September 30, 2009**

**(in thousands)**

 
| **Derivatives in Fair Value Hedging  Relationships** | ** ** | **Locations of Gain  (Loss) Recognized in  Income on Derivative** | ** ** | **Amount of Gain  (Loss) Recognized in  Income on Derivative** | ** ** | **Location of Gain  (Loss) Recognized  in Income on  Hedged Item** | ** **   | **Amount of Gain  (Loss) Recognized  in Income on  Hedged Item** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------|------------|
|                                                                     |       |                                                                                            |       |                                                                                         |       |                                                                                             |         |                                                                                           |       |
| Interest  Rate Swaps                                                     |       | Other Income                                                                                    |       | $                                                                                            | (31        | )                                                                                                | Other Income |                                                                                           | $          | 31 |   |
| **Total**                                                                | ** ** | ** **                                                                                      | ** ** | **$**                                                                                        | **(31**    | **)**                                                                                            |         |                                                                                           | **$**      | **31** |   |

 
| **Derivatives in Cash Flow Hedging  Relationships** | ** ** | **Amount of Gain  (Loss) Recognized in  Other  Comprehensive  Income on Derivative  (Effective Portion)** | ** ** | **Location of Gain  (Loss) Reclassified  from Accumulated  Other Comprehensive  Income into Income  (Effective Portion)** | ** **   | **Amount of Gain  (Loss) Reclassified  from Accumulated  Other  Comprehensive  Income into Income  (Effective Portion)** | ** ** | **Location of Gain  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** | **Amount of Gain  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                    |       |                                                                                                                                         |       |                                                                                                                                                              |         |                                                                                                                                                        |       |                                                                                                                                                                                |       |                                                                                                                                                                              |       |
| Interest Rate Swaps                                                     |       | $                                                                                                                                            | (135       | )                                                                                                                                                                 | Other Income |                                                                                                                                                        | $          | —                                                                                                                                                                              |       | Other Income                                                                                                                                                                      |       | $ | — |   |
|                                                                    |       |                                                                                                                                         |       |                                                                                                                                                              |         |                                                                                                                                                        |       |                                                                                                                                                                                |       |                                                                                                                                                                              |       |
| Forward Loan Sales  Commitments                                         |       | (120                                                                                                                                         | )          | Other Income                                                                                                                                                      |         | 679                                                                                                                                                         |       | Other Income                                                                                                                                                                        |       | (679                                                                                                                                                                              | )          |
| **Total**                                                               | ** ** | **$**                                                                                                                                        | **(255**   | **)**                                                                                                                                                             | ** **   | ** **                                                                                                                                                  | **$**      | **315**                                                                                                                                                                             |       |                                                                                                                                                                              |       | **$** | **(315** | **)** |

 

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Note 11

 

*Allowance for Loan Losses*

 

Activity in the Company’sallowance for loan losses for the nine months ended September 30, 2009 and2008 is shown below.

 
| **(In  thousands)**                | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1 |       | $        | 14,518     |     | $          | 11,641 |   |
| Provision  for loan losses         |       | 4,750    |       | 2,734    |       |
| Loans  charged-off                 |       | (1,800   | )          | (1,141   | )          |
| Recoveries                         |       | 5        |       | 23       |       |
| Ending  balance, September 30 |       | $        | 17,473     |     | $          | 13,257 |   |

 

Note 12

 

*Net Gains on InvestmentSecurities Available-for-Sale and Held- for-Trading*

 

During the three monthsended March 31, 2009, the Company sold all shares of its Fannie Maeperpetual preferred stock for a loss of $217,000.  The Company elected to sell these shares as aresult of these shares being traded well below their par value following theplacement of Fannie Mae into conservatorship by federal regulators during2008.  The Company recognized another-than-temporary impairment of $4.4 million on this investment in2008.  The full amount of this impairmentwas deemed to be related to credit deterioration of the issuer, and not relatedto equity market conditions.  Because ofthe minimal likelihood that these shares would recover, the Company made thedecision to exit this type of investment security and no longer owns anysimilar equity investment in its investment securities portfolio.

 

At September 30, 2009,certain of the Company’s mortgage-backed and municipal investment gradesecurities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricingchanges due to recent and negative conditions in the current market environmentand not as a result of permanent credit impairment.  Contractual cash flows for the agencymortgage-backed securities are guaranteed and/or funded by the U.S.government.  Other mortgage-backedsecurities and municipal securities have third party protective elements andthere are no negative indications that the contractual cash flows will not bereceived when due.  The Company has theability and intent to hold these investments for a period of time sufficient toallow for an anticipated recovery in value.

 

Additionally,for the three months ended September 30, 2009, the Company had tradinggains of  $97,000 and for the nine monthsended September 30, 2009, trading losses of $422,000 as a result of thepurchase of investments to economically hedge against fair value changes of theCompany’s nonqualified deferred compensation plan liability.  Those investments were designated as tradingsecurities, and as such, the changes in fair value are reflected inearnings.  The trading losses for thenine months ended September 30, 2009 were primarily the result of lowerstock prices and were partially offset by a reduction in the period’scompensation expense associated with this benefit plan.  These investment securities economicallyhedge changes in fair value of the Company’s deferred compensation planobligation and are not listed in the tables included in the investmentsecurities disclosure in Note 5 above. The fair value of these trading 

 

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securitiesis $4.2 million at September 30, 2009 and are included in Other Assets onthe statement of condition.

 

Note 13

 

*Common Stock Issued to EmployeeBenefit Plans*

 

The Company issued 287,000shares of common stock during the nine month period ended September 30,2009.  These shares were issued to fundthe Company’s obligation to its participants that had elected the CardinalCommon Stock investment option in its various nonqualified deferredcompensation plans.  These shares wereissued at $5.45 per share for a total addition to shareholders’ equity of $1.6million.

 

Note 14

 

*Subsequent Events*

 

The Company has evaluatedthe need for disclosures and/or adjustments resulting from subsequent eventsthrough November 6, 2009, the date the financial statements were availableto be issued.  This evaluation did notresult in any subsequent events that necessitated disclosure and/oradjustments.

 

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**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

Thefollowing presents management’s discussion and analysis of our consolidatedfinancial condition at September 30, 2009 and December 31, 2008 andthe unaudited results of our operations for the three and nine months ended September 30,2009 and 2008. This discussion should be read in conjunction with our unauditedconsolidated financial statements and the notes thereto appearing elsewhere inthis report and the audited consolidated financial statements and the notes toconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

**CautionAbout Forward-Looking Statements**

 

We makecertain forward-looking statements in this Form 10-Q that are subject torisks and uncertainties.  Theseforward-looking statements include statements regarding our profitability,liquidity, allowance for loan losses, interest rate sensitivity, market risk,growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,”“anticipates,” “forecasts,” “intends,” or other similar words or terms areintended to identify forward-looking statements.

 

These forward-looking statements are subject to significantuncertainties because they are based upon or are affected by factors including:

 

·                  the effects of future economic, business and marketconditions;

·                  governmental monetary and fiscal policies;

·                  legislative and regulatory changes, including changesin banking, securities, and tax laws and regulations and their application byour regulators, and changes in the scope and cost of FDIC insurance and othercoverages;

·                  changes in accounting policies, rules andpractices;

·                  the risks of changes in interest rates on levels,composition and costs of deposits, loan demand, and the values and liquidity ofloan collateral, securities, and interest sensitive assets and liabilities;

·                  changes in assumptions underlying the establishment ofreserves for possible loan losses, reserves for repurchases of mortgage loanssold and other estimates;

·                  the risks of mergers, acquisitions and divestitures,including, without limitation, the related time and costs of implementing suchtransactions, integrating operations as part of these transactions and possiblefailures to achieve expected gains, revenue growth and/or expense savings fromsuch transactions;

·                  the ability to successfully manage our growth orimplement our growth strategies if we are unable to identify attractivemarkets, locations or opportunities to expand in the future;

·                  risks inherent in making loans such as repayment risksand fluctuating collateral values;

·                  changes in market conditions, specifically declines inthe residential and commercial real estate market, volatility and disruption ofthe capital and credit markets, soundness of other financial institutions we dobusiness with;

·                  there is no assurance that recently enactedlegislation, in particular the Emergency 

 

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Economic Stabilization Act of 2008 and the AmericanRecovery and Reinvestment Act of 2009, will stabilize the U.S. financial systemand there is uncertainty in the implementation of this legislation by federalregulators;

·                  sudden declines and significant volatility in marketprices and market illiquidity may cause us to record an other-than-temporaryimpairment, specifically our pooled trust preferred securities portfolio;

·                  exposure to repurchase loans sold to investors forwhich borrowers failed to provide full and accurate information on or relatedto their loan application or for which appraisals have not been acceptable orwhen the loan was not underwritten in accordance with the loan programspecified by the loan investor;

·                  maintaining cost controls and asset quality as we openor acquire new branches;

·                  maintaining capital levels adequate to support ourgrowth;

·                  reliance on our management team, including our abilityto attract and retain key personnel;

·                  competition with other banks and financialinstitutions, and companies outside of the banking industry, including thosecompanies that have substantially greater access to capital and otherresources;

·                  changes in operations of George Mason Mortgage, LLC asa result of the activity in the residential real estate market and anyassociated impact on the fair value of goodwill in the future;

·                  risks anduncertainties related to future trust operations;

·                  changes in the operations of Wilson/BennettCapital Management, Inc., its customer base and assets under managementand any associated impact on the fair value of goodwill in the future;

·                  demand, development and acceptance of new products andservices;

·                  problems with technology utilized by us;

·                  changing trends in customer profiles and behavior; and

·                  other factors described from time to time in ourreports filed with the SEC.

 

Because ofthese uncertainties, our actual future results may be materially different fromthe results indicated by these forward-looking statements.  In addition, our past results of operationsdo not necessarily indicate our future results.

 

Inaddition, this section should be read in conjunction with the description ofour “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Qand our Annual Report on Form 10-K for the year ended December 31,2008.

 

**Overview**

 

Weare a financial holding company formed in 1997 and headquartered in FairfaxCounty, Virginia.  We were formedprincipally in response to opportunities resulting from the consolidation ofseveral Virginia-based banks.  These bankconsolidations were typically accompanied by the dissolution of local boards ofdirectors and relocation or termination of management and customer serviceprofessionals and a general deterioration of personalized customer service.

 

Weown Cardinal Bank (the “Bank”), a Virginia state-chartered community bank with25 banking offices located in Northern Virginia and the greater Washington D.C.metropolitan area.  The Bank offers awide range of traditional bank loan and deposit products and services to bothour commercial and retail customers.  Ourcommercial relationship managers focus on attracting small and medium sizedbusinesses as well as government contractors, commercial real estate developersand builders and professionals, such as physicians, accountants and attorneys.

 

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Additionally,we complement our core banking operations by offering a wide range of servicesthrough our various subsidiaries, including mortgage banking through GeorgeMason Mortgage, LLC (“George Mason”) and Cardinal First Mortgage, LLC, (“CardinalFirst”), collectively the “mortgage banking segment,” retail securitiesbrokerage through Cardinal Wealth Services, Inc. (“CWS”), asset managementthrough Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), andtrust, estate, custody, investment management and retirement planning through thetrust division of Cardinal Bank.

 

Netinterest income is our primary source of revenue. We define revenue as netinterest income plus noninterest income. As discussed further in the interestrate sensitivity section, we manage our balance sheet and interest rate riskexposure to maximize, and concurrently stabilize, net interest income. We dothis by monitoring our liquidity position and the spread between the interestrates earned on interest-earning assets and the interest rates paid oninterest-bearing liabilities. We attempt to minimize our exposure to interestrate risk, but are unable to eliminate it entirely.  In addition tomanagement of interest rate risk, we analyze our loan portfolio for exposure tocredit risk. Loan defaults and foreclosures are inherent risks in the bankingindustry, and we attempt to limit our exposure to these risks by carefullyunderwriting and then monitoring our extensions of credit. In addition to netinterest income, noninterest income is an important source of revenue for usand includes, among other things, service charges on deposits and loans,investment fee income, which includes trust revenues, gains and losses on salesof investment securities available-for-sale, gains on sales of mortgage loans,and management fee income.

 

**CriticalAccounting Policies**

 

*General*

 

U. S. generally acceptedaccounting principles are complex and require management to apply significantjudgment to various accounting, reporting, and disclosure matters.  Management must use assumptions, judgmentsand estimates when applying these principles where precise measurements are notpossible or practical.  These policiesare critical because they are highly dependent upon subjective or complexjudgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have asignificant impact on the consolidated financial statements.  Actual results, in fact, could differ frominitial estimates.

 

The accounting policieswe view as critical are those relating to judgments, assumptions and estimatesregarding the determination of the allowance for loan losses, the fair valuemeasurements of certain assets and liabilities, accounting for economic hedgingactivities, accounting for impairment testing of goodwill, accounting for the impairmentof amortizing intangible assets and other long-lived assets, and the valuationof deferred tax assets.

 

#### ***Allowance for Loan Losses***

#### ** **

**We maintain the allowance for loan losses at a level thatrepresents management’s best estimate of known and inherent losses in our loanportfolio.  Both the amount of theprovision expense and the level of the allowance for loan losses are impactedby many factors, including general and industry-specific economic conditions,actual and expected credit losses, historical trends and specific conditions ofindividual borrowers.  Unusual andinfrequently occurring events, such as weather-related disasters, may impactour assessment of possible credit losses. As a part of our analysis, we use comparative peer group data andqualitative factors such as levels of**

 

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**andtrends in delinquencies and nonaccrual loans, national and local economictrends and conditions and concentrations of loans exhibiting similar riskprofiles to support our estimates.**

** **

Forpurposes of our analysis, we categorize our loans into one of fivecategories:  commercial and industrial, commercial real estate (includingconstruction), home equity lines of credit, residential mortgages, and consumerloans. In the absence of meaningful historical loss factors, peer group lossfactors are applied and are adjusted by the qualitative factors mentionedabove. The indicated loss factors resulting from this analysis are applied foreach of the five categories of loans. In addition, we individually assign lossfactors to all loans that have been identified as having loss attributes, asindicated by deterioration in the financial condition of the borrower or adecline in underlying collateral value if the loan is collateral dependent.Since we have limited historical data on which to base loss factors forclassified loans, we typically apply, in accordance with regulatory guidelines,a 5% loss factor to loans classified as special mention, a 15% loss factor toloans classified as substandard and a 50% loss factor to loans classified asdoubtful. Loans classified as loss loans are fully reserved or charged off.   In certain instances, we evaluate theimpairment of certain loans on a loan by loan basis.  For these loans, we analyze the fair value ofthe collateral underlying the loan and consider estimated costs to sell thecollateral.  If the net collateral valueis less than the loan balance (including accrued interest and any unamortizedpremium or discount associated with the loan) we recognize an impairment andestablish a specific reserve for the impaired loan.

 

Creditlosses are an inherent part of our business and, although we believe themethodologies for determining the allowance for loan losses and the currentlevel of the allowance are adequate, it is possible that there may beunidentified losses in the portfolio at any particular time that may becomeevident at a future date pursuant to additional internal analysis or regulatorycomment. Additional provisions for such losses, if necessary, would be recordedin the commercial banking or mortgage banking segments, as appropriate, andwould negatively impact earnings.

 

*FairValue Measurements*

 

Wedetermine the fair values of financial instruments based on the fair valuehierarchy, which requires an entity to maximize the use of observable inputsand minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputsthat may be used to measure fair value. We carry our investment securities available-for-sale portfolio, certainloans receivable, derivative assets and derivative liabilities at fairvalue.  Our investment securitiesavailable-for-sale are recorded at fair value using reliable and unbiasedevaluations by an industry-wide valuation service.  This service uses evaluated pricing modelsthat vary based on asset class and include available trade, bid, and othermarket information.  Generally, themethodology includes broker quotes, proprietary models, vast descriptive termsand conditions databases, as well as extensive quality control programs.  For certain of our held-to-maturityinvestment securities where there is minimal observable trading activity, weuse a discounted cash flow approach to estimate fair value based on internalcalculations and compare our results to information provided by externalpricing sources.  Our interest rate swapderivatives are recorded at fair value using observable inputs from a nationalvaluation service.  These inputs areapplied to a third party industry-wide valuation model.

 

Wealso fair value our interest rate lock commitments, forwards loan sales andmortgage loans held for sale.  The fairvalue of our interest rate lock commitments considers the expected premium(discount) to par and we apply certain fallout rates for those rate lockcommitments for which we do not close a mortgage loan.  In addition, we calculate the effects of thechanges in 

 

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interestrates from the date of the commitment through loan origination, and then periodend, using applicable published mortgage-backed investment securityprices.  The fair value of the forwardsales contracts to investors considers the market price movement of the sametype of security between the trade date and the balance sheet date.  At loan closing, the fair value of theinterest rate lock commitment is included in the cost basis of loans held forsale, which are carried at the lower of cost or fair value.

 

Wehave not elected the fair value option for any financial asset or liability.

 

*Accountingfor Economic Hedging Activities*

 

Werecord all derivative instruments on the statement of condition at their fairvalues*.*We do not enter into derivative transactions for speculative purposes.For derivatives designated as hedges, we contemporaneously document the hedgingrelationship, including the risk management objective and strategy forundertaking the hedge, how effectiveness will be assessed at inception and ateach reporting period and the method for measuring ineffectiveness.  We evaluate the effectiveness of thesetransactions at inception and on an ongoing basis.  Ineffectiveness is recorded throughearnings.  For derivatives designated ascash flow hedges, the fair value adjustment is recorded as a component of othercomprehensive income, except for the ineffective portion which is recorded inearnings.  For derivatives designated asfair value hedges, the fair value adjustments for both the hedged item and thehedging instrument are recorded through the income statement with anydifference considered the ineffective portion of the hedge.

 

Wediscontinue hedge accounting prospectively when it is determined that thederivative is no longer highly effective. In situations in which cash flowhedge accounting is discontinued, we continue to carry the derivative at itsfair value on the statement of condition and recognize any subsequent changesin fair value in earnings over the term of the forecasted transaction. Whenhedge accounting is discontinued because it is probable that a forecastedtransaction will not occur, we recognize immediately in earnings any gains andlosses that were accumulated in other comprehensive income.

 

Inthe normal course of business, we enter into contractual commitments, includingrate lock commitments, to finance residential mortgage loans. Thesecommitments, which contain fixed expiration dates, offer the borrower aninterest rate guarantee provided the loan meets underwriting guidelines andcloses within the time frame established by us. Interest rate risk arises on thesecommitments and subsequently closed loans if interest rates change between thetime of the interest rate lock and the delivery of the loan to the investor.Loan commitments related to residential mortgage loans intended to be sold areconsidered derivatives and are marked to market through earnings.

 

Tomitigate the effect of the interest rate risk inherent in providing rate lockcommitments, we economically hedge our commitments by entering into bestefforts delivery forward loan sales contracts. During the rate lock commitmentperiod, these forward loan sales contracts are marked to market throughearnings and are not designated as accounting hedges. The fair values of loancommitments and the fair values of forward loan sales contracts generally movein opposite directions, and the net impact of changes of these valuations onnet income during the loan commitment period is generally inconsequential. Atthe closing of the loan, the loan commitment derivative expires and we record aloan held for sale and continue to be obligated under the same forward loansales contract.   The forward salescontract is then designated as a hedge against the variability in cash to bereceived from the loan sale.  Loans heldfor sale are accounted for at the lower of cost or fair value*.*

 

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*Accounting for Impairment Testingof Goodwill*

 

Goodwillis not amortized but is tested on at least an annual basis for impairment.

 

Totest goodwill for impairment, we perform an analysis to compare the fair valueof the reporting unit to which the goodwill is assigned to the carrying valueof the reporting unit. We make estimates of the discounted cash flows from theexpected future operations of the reporting unit. This discounted cash flowanalysis involves the use of unobservable inputs including:  estimated future cash flows from operations;an estimate of a terminal value; a discount rate; and other inputs.  If the analysis indicates that the fair valueof the reporting unit is less than its carrying value, we do an analysis tocompare the implied fair value of the reporting unit’s goodwill with thecarrying amount of that goodwill. The implied fair value of the goodwill isdetermined by allocating the fair value of the reporting unit to all its assetsand liabilities. If the implied fair value of the goodwill is less than thecarrying value, an impairment loss is recognized.

 

*Accounting for the Impairment of Amortizing IntangibleAssets and Other Long-Lived Assets*

 

Wecontinually review our long-lived assets for impairment whenever events orchanges in circumstances indicate that the remaining estimated useful life ofsuch assets might warrant revision or that the balances may not be recoverable.We evaluate possible impairment by comparing estimated future cash flows,before interest expense and on an undiscounted basis, with the net book valueof long-term assets, including amortizable intangible assets. If undiscountedcash flows are insufficient to recover assets, further analysis is performed inorder to determine the amount of the impairment.

 

Animpairment loss is then recorded for the excess of the carrying amount of theassets over their fair values. Fair value is usually determined based on thepresent value of estimated expected future cash flows using a discount ratecommensurate with the risks involved.

 

#### ***Valuation of Deferred Tax Assets***

#### ** **

Werecord a provision for income tax expense based on the amounts of current taxespayable or refundable and the change in net deferred tax assets or liabilitiesduring the year. Deferred tax assets and liabilities are recognized for the taxeffects of differing carrying values of assets and liabilities for tax andfinancial statement purposes that will reverse in future periods. Whensubstantial uncertainty exists concerning the recoverability of a deferred taxasset, the carrying value of the asset is reduced by a valuation allowance. Theamount of any valuation allowance established is based upon an estimate of thedeferred tax asset that is more likely than not to be recovered. Increases ordecreases in the valuation allowance result in increases or decreases to theprovision for income taxes.

 

###### **NewFinancial Accounting Standards**

 

Effective January 1,2009, we adopted new accounting guidance for disclosures about derivative instrumentsand hedging activities*. *This guidance requires companieswith derivative instruments to disclose information about how and why a companyuses derivative instruments, how derivative instruments and related hedgeditems are accounted for, and how derivative instruments and related hedgeditems affect a company’s financial position, financial performance, and cashflows.  The required disclosures includethe 

 

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fair value of derivativeinstruments and their gains and losses in tabular format, information aboutcredit-risk-related contingent features in derivative agreements, counterpartycredit risk, and the Company’s strategies and objectives for using derivativeinstruments.  This guidance is effectiveprospectively for periods beginning on or after November 15, 2008.  The adoption provided for enhanced disclosurebut otherwise did not have a material impact on our consolidated financialcondition or results of operations.  See Note10 to our notes to the consolidated financial statements.

 

##### **In April 2009, we adopted newaccounting guidance for recognition and presentation of other-than-temporary impairments.  This standard modified the indicator ofother-than-temporary impairment for debt securities.  In addition, it amended the amount of another-than-temporary impairment that is recognized in earnings when there arecredit losses on a debt security for which management does not intend to selland for which it is more likely than not that the entity will not have to sellprior to recovery of the amortized cost basis of the debt security.  In those situations, the portion of the totalimpairment that is attributable to the credit loss would be recognized inearnings, and the remaining difference between the debt security’s amortizedcost basis and its fair value would be included in other comprehensiveincome.  This guidance is effective forinterim and annual periods ending after June 15, 2009. **Theadoption of this standard did not have a material impact on our consolidatedfinancial condition or results of operations.

##### ** **

InApril 2009, we adopted new accounting guidance for determining whena market for an asset or a liability is active or inactive and determining whena transaction is distressed.  Thisstandard reaffirmed the exit price objective of fair value measurements andprovides guidance on inactive markets and distressed transactions.  This standard is to be applied prospectivelyand is effective for interim and annual periods ending June 15, 2009.  The adoption of this standard did not have amaterial impact on our consolidated financial condition or results ofoperations.

 

In April 2009, weadopted new accounting guidance for interim disclosures about fairvalue of financial instruments.  This guidancerequires disclosures about fair value of financial instruments for interimreporting periods of publicly traded companies as well as in annual financialstatements.  This guidance requires thosedisclosures in summarized financial information at interim reportingperiods.  This standard is effective forinterim reporting periods ending after June 15, 2009.  The adoption provided for enhanced disclosurebut otherwise did not have a material impact on our consolidated financialcondition or results of operations.

 

##### **On July 1,2009, we adopted**new accounting guidance for the FASB accountingstandards codification and the hierarchy of generally accepted accounting principles,the “Codification.”  The Codification isthe exclusive authoritative reference for nongovernmental U.S. GAAP for use infinancial statements issued for interim and annual periods ending after September 15,2009, except for SEC rules and interpretive releases, which are alsoauthoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting andreporting standards.

 

##### **2009 EconomicEnvironment**

 

Ourcredit quality remains strong despite the challenges we face during the currenteconomic environment.  At September 30,2009, we have non-accrual loans totaling $9.5 million and $25,000 in loans contractuallypast due 90 days or more as to principal or interest.  Net charge-offs were 0.20% of our averageloans receivable for the nine months ended September 30, 2009. Ourmortgage banking segment has profited from the recent actions taken by the FederalReserve to reduce interest rates which has spurred an increase in mortgageactivity as 

 

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homeowners have reactedby applying to refinance their current mortgages and other consumers have seenan opportunity to purchase housing as it has become more affordable. Net incomefrom our mortgage banking segment increased to $779,000 and $3.5 million forthe three and nine months ended September 30, 2009, respectively, comparedto losses of $2.2 million and $2.9 million for the three and nine month periodsof 2008.  In addition, during the secondquarter of 2009, we successfully raised $31.6 million in common equity capitalto further capitalize the Company, to further penetrate our existing footprintand take advantage of bank consolidation opportunities.

 

Themarket disturbances that have been experienced in the financial markets overthe past year continue to impact our results. Market illiquidity continues toimpact certain portions of our investment securities portfolio, specificallythe ratings of certain monoline insurance providers, which has affected thepricing of certain municipal securities in our portfolio. In addition, we holdan investment of $8.0 million in par value of pooled trust preferredsecurities, which are significantly below book value as of September 30,2009 due to the lack of liquidity in the market and investor apprehension forinvesting in these types of investments.

 

Therecessionary conditions together with deterioration in the overall economy maycontinue to affect these and other markets in which we do business and couldadversely impact our results for the remainder of 2009 and into 2010. Thedegree of the impact is dependent upon the duration and severity of theaforementioned conditions.

 

Whileour loan growth has continued to be strong during 2009, continued negativeeconomic conditions are likely to adversely affect our loan portfolio,including causing increases in delinquencies and default rates, which we expectcould impact our charge-offs and provision for loan losses.  Continued deterioration in real estate valuesand household incomes could result in higher credit losses for us.  Also, in the ordinary course of business, wemay also be subject to a concentration of credit risk to a particular industry,counterparty, borrower or issuer.  Adeterioration in the financial condition or prospects of a particular industryor a failure or downgrade of, or default by, any particular entity or group ofentities could negatively impact our businesses, perhaps materially.  The systems by which we set limits andmonitor the level of our credit exposure to individual entities and industriesalso may not function as we have anticipated.

 

Liquidityis essential to our business.  Theprimary sources of funding for our Bank include customer deposits and wholesalefunding.  Our liquidity could be impairedby an inability to access the capital markets or by unforeseen outflows ofcash, including deposits.  This situationmay arise due to circumstances that we may be unable to control, such asgeneral market disruption, negative views about the financial services industrygenerally, or an operational problem that affects a third party or us.  Our ability to borrow from other financialinstitutions on favorable terms or at all could be adversely affected byfurther disruptions in the capital markets or other events.  While we believe we have a healthy liquidityposition, any of the above factors could materially impact our liquidityposition in the future.

 

Inaddition to Emergency Economic Stabilization Act of 2008 (“ESSA”), the U.S.government has continued to respond to the ongoing financial crisis and economicslowdown by enacting new legislation and expanding or establishing a number ofprograms and initiatives.  The AmericanRecovery and Reinvestment Act (“ARRA”) is intended to expand and establishgovernment spending programs and provide tax cuts to stimulate theeconomy.  Congress and the U.S.government continue to evaluate and develop various programs and initiativesdesigned to stabilize the financial and housing markets and stimulate theeconomy, including the U.S. Treasury’s announced Financial Stability Plan andthe U.S. government’s announced foreclosure prevention program.  There can be no assurance as to the impactthese programs will have on the financial markets, including the extreme levelsof volatility and limited credit availability 

 

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currently beingexperienced.  The failure of theseefforts to stabilize the financial markets and a continuation or worsening ofcurrent financial market conditions could materially and adversely affect ourbusiness, financial condition, results of operations, access to credit, ourregulatory capital position or the trading price of our common stock.

 

InMay 2009, the FDIC adopted a final rule imposing a 5 basis pointspecial assessment on each insured financial institution’s total assets minusits tier 1 capital.  This specialassessment is to assist in the replenishment of the Deposit Insurance Fund as aresult of the increase in financial institution failures over the pastyear.  The FDIC may impose an additionalspecial assessment during 2009 if the FDIC believes that the reserve ratio ofthe Deposit Insurance Fund is estimated to fall to a level that would adverselyaffect public confidence or to a level which shall be close to or belowzero.  The latest possible date forimposing an additional special assessment would be December 31, 2009.  An additional special assessment is probablefor 2009.  In addition, the FDICannounced a Notice of Proposed Rulemaking that would require insuredinstitutions to prepay their estimated quarterly risk-based assessments for thefourth quarter of 2009 and for all of 2010, 2011, and 2012.  The FDIC also voted to adopt a uniform three-basispoint increase in assessment rates effective January 1, 2011, and extend therestoration period from seven to eight years.

 

##### **Statements ofIncome**

##### ** **

*General*

 

Forthe three months ended September 30, 2009 and 2008, we reported net incomeof $2.6 million and a net loss of $4.4 million, respectively.  Net interest income after the provision forloan losses increased $1.4 million to $11.0 million for the three months ended September 30,2009 compared to $9.6 million for the three months ended September 30,2008.  The increase in net interestincome after provision for loan losses is a direct result of an increase in ournet interest income of $1.8 million to $13.1 million for the three months endedSeptember 30, 2009, despite an increase in our provision for loanlosses.  Provision for loan losses forthe three months ended September 30, 2009 was $2.1 million, an increase of$405,000 compared to $1.6 million for the same period of 2008.  Noninterest income for the three months endedSeptember 30, 2009 was $5.7 million, an increase of $1.3 million, or 30%,compared to $4.4 million for the three months ended September 30,2008.  The increase in noninterest incomeis primarily due to an increase in realized and unrealized gains on mortgagebanking activities, which increased $848,000 to $2.8 million for the threemonths ended September 30, 2009 compared to $2.0 million for the quarterended September 30, 2008.  For thethree months ended September 30, 2009, noninterest expense decreased to$13.0 million, compared to $19.3 million for the same period of 2008.  The decrease in noninterest expense isattributable to the impairments recorded during the third quarter of 2008 forour investment in Fannie Mae perpetual preferred stock ($4.4 million) and animpairment in the goodwill associated with our acquisition of George Mason($2.8 million).  No such impairments wererecorded during 2009.

 

Forthe three months ended September 30, 2009, basic and diluted income percommon share were each $0.09.  Basic anddiluted loss per common share for the three months ended September 30,2008 were each $0.18.  Weighted averagefully diluted shares outstanding for the three months ended September 30,2009 and 2008 were 29,524,878 and 24,327,751, respectively.

 

Returnon average assets for the three months ended September 30, 2009 and 2008was 0.56% and (1.09%), respectively. Return on average equity for the threemonths ended September 30, 2009 and 2008 was 5.20% and (11.03%),respectively.

 

Netincome for the nine months ended September 30, 2009 was $6.9 million.  For the year-to-date September 30, 2008,we recorded a net loss of $1.5 million. Net interest income after the provision for loan losses for the ninemonths ended September 30, 2009 increased $1.0 million to $30.9 million comparedto $30.0 million for the nine months ended September 30, 

 

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2008.  The increase in net interest income afterprovision for loan losses is directly related to our increase in net interestincome during 2009.  Net interest incomeincreased $3.0 million to $35.7 million for the nine months ended September 30,2009 compared to $32.7 million for the same period of 2008.  Provision for loan losses for the nine monthsended September 30, 2009 and 2008 was $4.8 million and $2.7 million,respectively, an increase of $2.0 million, or 74%.  Noninterest income was $17.7 million for thenine months ended September 30, 2009, an increase of $4.3 million, or 32%,from $13.4 million for the nine months ended September 30, 2008.  The increase in noninterest income isprimarily a result of the increase in realized and unrealized gains on mortgagebanking activities, which increased $3.7 million to $9.6 million for the ninemonths ended September 30, 2009. Noninterest expense for the nine months ended September 30, 2009was $38.7 million compared to $44.7 million for the same period of 2008.  The decrease in noninterest expense wasprimarily related to the aforementioned impairments recorded during the thirdquarter of 2008.

 

Forthe nine months ended September 30, 2009, basic and diluted income percommon share were each $0.26.  Basic anddiluted loss per common share for the nine months ended September 30, 2008were each $0.06.  Weighted average fullydiluted shares outstanding for the nine months ended September 30, 2009and 2008 were 27,047,915 and 24,393,167, respectively.

 

Returnon average assets for the nine months ended September 30, 2009 and 2008was 0.52% and (0.12%), respectively. Return on average equity for the ninemonths ended September 30, 2009 and 2008 was 5.12% and (1.23%),respectively.

 

*General—Business Segments*

 

We operate in three businesssegments, commercial banking, mortgage banking and wealth management and trustservices.  Net income attributable to thecommercial banking segment for the three months ended September 30, 2009was $2.2 million compared to a net loss of $1.7 million for the three monthsended September 30, 2008.  Netinterest income increased $1.9 million to $12.6 million for the three monthsended September 30, 2009, compared to $10.7 million for the same period of2008.  Provision for loan lossesincreased $1.2 million to $2.1 million for the three months ended September 30,2009 compared to $865,000 for the same period of 2008.  The increase in provision expense is relatedto current economic and market conditions and an increase in loan charge-offsduring 2009.  Noninterest income decreasedto $917,000 for the three months ended September 30, 2009 compared to $1.1million for the three months ended September 30, 2008.  During the third quarter of 2009, gains of$73,000 were recorded on sales of investment securities available-for-sale, comparedto $306,000 for the three months ended September 30, 2008.  Noninterest expense was $8.3 million for thethree months ended September 30, 2009, compared to $12.1 million for thesame period of 2008.  The decrease isprimarily due to an other-than-temporary impairment charge recorded during thethird quarter of 2008 for our investment in Fannie Mae perpetual preferredstock.  No such impairment was recordedduring 2009.  For the nine months ended September 30,2009, net income for the commercial banking segment was $5.1 million comparedto $3.2 million for the nine months ended September 30, 2008.  Net interest income increased $3.1 million to$34.2 million for the nine months ended September 30, 2009 as compared to$31.1 million for the same period of 2008. Provision for loan losses increased $2.9 million to $4.7 million for theyear-to-date period of 2009, compared to $1.8 million for 2008.  Noninterest expense was $25.5 million for thenine months ended September 30, 2009 compared to $27.2 million for thesame period of 2008.

 

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Themortgage banking segment reported net income of $779,000 for the three months endedSeptember 30, 2009 compared to a net loss of $2.2 million for the threemonths ended September 30, 2008. The increase in net income for the three months ended September 30,2009 was primarily attributable to an increase in loan origination volume dueto the decrease in mortgage interest rates and more affordable housingprices.  In addition, during the thirdquarter of 2008, the mortgage banking segment recorded a goodwill impairmentcharge of $2.8 million which contributed to the loss reported in 2008.  For the nine months ended September 30,2009, this segment reported net income of $3.5 million compared to a loss of$2.9 million for the same nine month period of 2008.  Again, the increase in net income isprimarily related to the increase in loan origination volume during 2009 ascompared to 2008, and the aforementioned goodwill impairment charge which wasrecorded during 2008.  In addition, thissegment recorded a $1.8 settlement with a mortgage correspondent during 2008.

 

Thewealth management and trust services segment, which includes CWS,Wilson/Bennett and the trust division of the Bank, recorded net income of$129,000 and $21,000 for the three month periods ended September 30, 2009and 2008, respectively.  For the ninemonths ended September 30, 2009 and 2008, net income from this reportingsegment was $205,000 and $89,000, respectively. The increase in noninterest income during 2009 as compared to 2008 isprimarily a result of an increase in customer relationships in this businesssegment.

 

*NetInterest Income*

 

Netinterest income represents the difference between interest and fees earned oninterest -earning assets and the interest paid on deposits and otherinterest-bearing liabilities. The level of net interest income is impactedprimarily by variations in the volume and mix of these assets and liabilities,as well as changes in interest rates. Net interest income for the three monthsended September 30, 2009 and 2008 was $13.1 million and $11.3 million,respectively, a period-to-period increase of $1.8 million, or 16%. For the ninemonths ended September 30, 2009 and 2008, net interest income was $35.7million and $32.7 million, respectively, an increase of $3.0 million, or9%.  The yields on both our assets andliabilities fell during the quarter and year-to-date periods as interest ratesdecreased.  The increase in net interestincome is primarily the result of a greater decrease in our cost ofinterest-bearing liabilities than our decrease in the yields earned for averageearning assets.

 

Specifically,interest income on loans receivable increased $448,000 for the three monthsended September 30, 2009 compared to the same three month period of2008.  Interest income on loans held forsale decreased $79,000 to $1.6 million for the three months ended September 30,2009.  The increase in average volume forboth loans receivable and loans held for sale negated the impact of thedecreases in rates.  Interest income oninvestment securities decreased $269,000 for the three months ended September 30,2009 as compared to the three months ended September 30, 2008.  The decrease in interest income on investmentsecurities is directly related to lower weighted average interest rates of theinvestment securities we hold due to the current interest rateenvironment.  Total interest expense hasdecreased $1.8 million for the three months ended September 30, 2009 ascompared to the same period of 2008.  Thedecrease in total interest expense is mostly related to the decreases we havetaken in the interest rates we pay on our interest checking and savings depositaccounts.  In addition, our certificatesof deposit are repricing at lower interest rates.

 

Forthe year-to-date September 30, 2009, interest income on loans receivabledecreased $530,000 to $48.0 million compared to $48.5 million for the same 2008period.  Interest income on investmentsecurities decreased $2.2 million for the nine months ended September 30,2009 as compared to the nine month period ended September 30, 2008.  These decreases when comparing theyear-to-date September 30, 2009 and 2008 periods are directly related tothe decreased interest rate environment.

 

Wehave certain loans and investment securities for which a portion of the incomerealized is tax-exempt.  Net interestincome on a tax equivalent basis for the three months ended September 30,2009 and 2008 was $13.2 million and $11.4 million, respectively.  For the nine months ended September 30,2009 and 2008, net interest income on a tax equivalent basis was $36.0 millionand $33.1 million, respectively.

 

Ournet interest margin, which equals net interest income divided by averageinterest earning assets, was 2.97% and 2.96% for the three months ended September 30,2009 and 2008, respectively.  For thenine months ended September 30, 2009 and 2008, our net interest margin was2.81% and 2.84%, respectively.  Theslight changes in the net interest margin for the three and nine months ended September 30,2009 compared to the same periods of 2008 are again attributable to the currentinterest rate environment.  The followingtables present an analysis of average earning assets and interest-bearingliabilities with related components of interest income and interest expense ona tax equivalent basis.

 

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**AverageBalance Sheets and Interest Rates on Interest-Earning Assets andInterest-Bearing Liabilities**

Three Months Ended September 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                               | ** ** | ** **  | ** ** | **2009**     | ** ** | ** **  | ** ** | ** **  | ** ** | **2008**     | ** ** | ** **  | ** ** | ** **  | ** ** | **2007**     | ** ** | ** **  | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** |
| **Assets**                                               |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest-earning assets:                                 |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Loans (1):                                               |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Commercial and  industrial                               |       | $           | 148,446    |         | $          | 1,781       |       | 4.80        | %          | $            | 119,891    |        | $          | 1,843       |       | 6.15         | %          | $           | 108,266    |   | $ | 2,132 |   | 7.88 | % |
| Real estate - commercial                                 |       | 567,150     |       | 8,893        |       | 6.27        | %          | 454,513     |       | 7,447        |       | 6.55        | %          | 385,432     |       | 6,556        |       | 6.80        | %          |
| Real estate -  construction                              |       | 178,585     |       | 2,251        |       | 5.04        | %          | 189,041     |       | 2,703        |       | 5.72        | %          | 171,846     |       | 3,639        |       | 8.47        | %          |
| Real estate -  residential                               |       | 201,500     |       | 2,596        |       | 5.15        | %          | 213,360     |       | 2,984        |       | 5.60        | %          | 200,792     |       | 2,749        |       | 5.48        | %          |
| Home equity lines                                        |       | 114,414     |       | 1,033        |       | 3.58        | %          | 96,196      |       | 1,131        |       | 4.66        | %          | 72,365      |       | 1,323        |       | 7.25        | %          |
| Consumer                                                 |       | 2,815       |       | 42           |       | 5.92        | %          | 2,608       |       | 40           |       | 6.08        | %          | 8,222       |       | 165          |       | 7.96        | %          |
| Total loans                                              |       | 1,212,910   |       | 16,596       |       | 5.47        | %          | 1,075,609   |       | 16,148       |       | 6.01        | %          | 946,923     |       | 16,564       |       | 7.00        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Loans held for sale                                      |       | 131,417     |       | 1,630        |       | 4.96        | %          | 118,009     |       | 1,709        |       | 5.79        | %          | 233,646     |       | 4,256        |       | 7.29        | %          |
| Investment securities  available-for-sale                |       | 286,835     |       | 3,384        |       | 4.72        | %          | 258,807     |       | 3,421        |       | 5.29        | %          | 293,554     |       | 3,696        |       | 5.04        | %          |
| Investment securities  held-to-maturity                  |       | 39,347      |       | 354          |       | 3.60        | %          | 54,373      |       | 586          |       | 4.30        | %          | 85,850      |       | 896          |       | 4.17        | %          |
| Other investments                                        |       | 15,728      |       | 33           |       | 0.84        | %          | 15,726      |       | 113          |       | 2.91        | %          | 10,944      |       | 166          |       | 6.05        | %          |
| Federal funds sold                                       |       | 91,776      |       | 57           |       | 0.25        | %          | 19,068      |       | 118          |       | 2.45        | %          | 5,003       |       | 71           |       | 5.69        | %          |
| Total interest-earning  assets and interest income (2)   |       | 1,778,013   |       | 22,054       |       | 4.96        | %          | 1,541,592   |       | 22,095       |       | 5.73        | %          | 1,575,920   |       | 25,649       |       | 6.51        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Noninterest earning  assets:                             |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Cash and due from banks                                  |       | 1,213       |       |         |       |        |       | 7,241       |       |         |       |        |       | $           | 5,659      |         |       |        |       |   |
| Premises and equipment,  net                             |       | 15,723      |       |         |       |        |       | 17,276      |       |         |       |        |       | 19,347      |       |         |       |        |       |
| Goodwill and other  intangibles, net                     |       | 14,025      |       |         |       |        |       | 17,060      |       |         |       |        |       | 17,341      |       |         |       |        |       |
| Accrued interest and  other assets                       |       | 59,613      |       |         |       |        |       | 50,487      |       |         |       |        |       | 51,685      |       |         |       |        |       |
| Allowance for loan  losses                               |       | (16,692     | )          |         |       |        |       | (12,763     | )          |         |       |        |       | (10,512     | )          |         |       |        |       |
| Total assets                                             |       | $           | 1,851,895  |         |       |        |       |        | $          | 1,620,893    |       |        |       |        |       | $            | 1,659,440  |        |       |   |   |   |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| **Liabilities  and Shareholders’ Equity**           |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest - bearing  liabilities:                         |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest - bearing  deposits:                            |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest checking                                        |       | 120,990     |       | 282          |       | 0.92        | %          | 114,362     |       | 605          |       | 2.10        | %          | 117,665     |       | 904          |       | 3.05        | %          |
| Money markets                                            |       | 54,539      |       | 113          |       | 0.82        | %          | 40,434      |       | 230          |       | 2.26        | %          | 53,155      |       | 345          |       | 2.58        | %          |
| Statement savings                                        |       | 314,226     |       | 967          |       | 1.22        | %          | 345,687     |       | 2,379        |       | 2.73        | %          | 359,379     |       | 4,226        |       | 4.66        | %          |
| Certificates of deposit                                  |       | 631,746     |       | 4,348        |       | 2.73        | %          | 446,411     |       | 4,030        |       | 3.58        | %          | 498,113     |       | 5,903        |       | 4.70        | %          |
| Total interest - bearing  deposits                       |       | 1,121,501   |       | 5,710        |       | 2.02        | %          | 946,894     |       | 7,244        |       | 3.04        | %          | 1,028,312   |       | 11,378       |       | 4.39        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Other borrowed funds                                     |       | 362,391     |       | 3,121        |       | 3.42        | %          | 359,976     |       | 3,427        |       | 3.78        | %          | 319,767     |       | 3,834        |       | 4.76        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Total interest-bearing  liabilities and interest expense |       | 1,483,892   |       | 8,831        |       | 2.36        | %          | 1,306,870   |       | 10,671       |       | 3.24        | %          | 1,348,079   |       | 15,212       |       | 4.48        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Noninterest-bearing  liabilities:                        |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Demand deposits                                          |       | 150,336     |       |         |       |        |       | 136,575     |       |         |       |        |       | 123,178     |       |         |       |        |       |
| Other liabilities                                        |       | 17,280      |       |         |       |        |       | 17,477      |       |         |       |        |       | 31,216      |       |         |       |        |       |
| Common shareholders’  equity                        |       | 200,387     |       |         |       |        |       | 159,971     |       |         |       |        |       | 156,967     |       |         |       |        |       |
| Total liabilities and  shareholders’ equity         |       | $           | 1,851,895  |         |       |        |       |        | $          | 1,620,893    |       |        |       |        |       | $            | 1,659,440  |        |       |   |   |   |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Net interest income and  net interest margin (2)         |       |        |       | $            | 13,223     |        | 2.97       | %           |       |         | $          | 11,424      |       | 2.96        | %          |         |       | $           | 10,437     |   | 2.65 | % |

 

----

(1)   Non-accrual loans are included in averagebalances and do not have a material effect on the average yield.  Interest income on non-accruing loans was notmaterial for the periods presented.

(2)   Interest income for loans receivable,investment securities available-for-sale and fed funds sold (which includesinvestments in money market preferred stock) is reported on a fullytaxable-equivalent basis at a rate of 34%.

 

41

----

Table ofContents

 

**Rate andVolume Analysis**Three MonthsEnded September 30, 2009, 2008 and 2007

(In thousands)

 
| ** **                                | ** ** | **2009  Compared to 2008** | ** ** | **2008  Compared to 2007** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **Change  Due to**         | ** ** | ** **                 | ** ** | **Change  Due to** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Average**                | ** ** | **Average**                | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume  (3)**            | ** ** | **Rate**                   | ** ** | **(Decrease)** | ** ** | **Volume  (3)** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                          | 439        |                       | $          | (501 | ) | $ | (62 | ) | $ | 229 |   | $ | (518 | ) | $ | (289 | ) |
| Real estate -  commercial                 |       | 1,846                      |       | (400                       | )          | 1,446 |   | 1,175 |   | (284 | ) | 891 |   |
| Real estate -  construction               |       | (150                       | )          | (302                       | )          | (452 | ) | 364 |   | (1,300 | ) | (936 | ) |
| Real estate -  residential                |       | (164                       | )          | (224                       | )          | (388 | ) | 168 |   | 67 |   | 235 |   |
| Home equity lines                         |       | 210                        |       | (308                       | )          | (98 | ) | 428 |   | (620 | ) | (192 | ) |
| Consumer                                  |       | 3                          |       | (1                         | )          | 2 |   | (113 | ) | (12 | ) | (125 | ) |
| Total loans                               |       | 2,184                      |       | (1,736                     | )          | 448 |   | 2,251 |   | (2,667 | ) | (416 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans held for sale                       |       | 194                        |       | (273                       | )          | (79 | ) | (2,106 | ) | (441 | ) | (2,547 | ) |
| Investment securities  available-for-sale |       | 370                        |       | (407                       | )          | (37 | ) | (437 | ) | 162 |   | (275 | ) |
| Investment securities  held-to-maturity   |       | (163                       | )          | (69                        | )          | (232 | ) | (327 | ) | 17 |   | (310 | ) |
| Other investments                         |       | 2                          |       | (82                        | )          | (80 | ) | 70 |   | (123 | ) | (53 | ) |
| Federal funds sold                        |       | 442                        |       | (503                       | )          | (61 | ) | 201 |   | (154 | ) | 47 |   |
| Total interest income  (2)                |       | 3,029                      |       | (3,070                     | )          | (41 | ) | (348 | ) | (3,206 | ) | (3,554 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest - bearing  deposits              |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | 35                         |       | (358                       | )          | (323 | ) | (25 | ) | (274 | ) | (299 | ) |
| Money markets                             |       | 80                         |       | (197                       | )          | (117 | ) | (83 | ) | (32 | ) | (115 | ) |
| Statement savings                         |       | (217                       | )          | (1,195                     | )          | (1,412 | ) | (166 | ) | (1,681 | ) | (1,847 | ) |
| Certificates of deposit                   |       | 1,673                      |       | (1,355                     | )          | 318 |   | (613 | ) | (1,260 | ) | (1,873 | ) |
| Total interest -  bearing deposits        |       | 1,571                      |       | (3,105                     | )          | (1,534 | ) | (887 | ) | (3,247 | ) | (4,134 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                      |       | 23                         |       | (329                       | )          | (306 | ) | 482 |   | (889 | ) | (407 | ) |
| Total interest expense                    |       | 1,594                      |       | (3,434                     | )          | (1,840 | ) | (405 | ) | (4,136 | ) | (4,541 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                   |       | $                          | 1,435      |                       | $          | 364 |   | $ | 1,799 |   | $ | 57 |   | $ | 930 |   | $ | 987 |   |

 

----

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

(2)          Interest income for loans receivable, investmentsecurities available-for-sale and fed funds sold (which includes investments inmoney market preferred stock) is reported on a fully taxable-equivalent basisat a rate of 34%.

(3)          Changes attributable to rate/volume have beenallocated to volume.

 

42

----

Table ofContents

 

**Average Balance Sheets and InterestRates on Interest-Earning Assets and Interest-Bearing Liabilities**

Nine Months Ended September 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                               | ** ** | ** **  | ** ** | **2009**     | ** ** | ** **  | ** ** | ** **  | ** ** | **2008**     | ** ** | ** **  | ** ** | ** **  | ** ** | **2007**     | ** ** | ** **  | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** |
| **Assets**                                               |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest-earning assets:                                 |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Loans (1):                                               |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Commercial and  industrial                               |       | $           | 158,966    |         | $          | 5,721       |       | 4.80        | %          | $            | 127,572    |        | $          | 6,080       |       | 6.35         | %          | $           | 106,764    |   | $ | 6,143 |   | 7.67 | % |
| Real estate - commercial                                 |       | 531,923     |       | 24,984       |       | 6.26        | %          | 432,948     |       | 21,304       |       | 6.56        | %          | 354,731     |       | 17,815       |       | 6.70        | %          |
| Real estate -  construction                              |       | 177,728     |       | 6,095        |       | 4.57        | %          | 190,428     |       | 8,723        |       | 6.11        | %          | 164,295     |       | 10,393       |       | 8.43        | %          |
| Real estate -  residential                               |       | 202,133     |       | 8,094        |       | 5.34        | %          | 213,018     |       | 8,970        |       | 5.61        | %          | 199,342     |       | 8,156        |       | 5.46        | %          |
| Home equity lines                                        |       | 109,935     |       | 3,003        |       | 3.65        | %          | 90,593      |       | 3,338        |       | 4.92        | %          | 66,832      |       | 3,674        |       | 7.35        | %          |
| Consumer                                                 |       | 2,586       |       | 118          |       | 6.05        | %          | 2,680       |       | 130          |       | 6.48        | %          | 7,020       |       | 424          |       | 8.08        | %          |
| Total loans                                              |       | 1,183,271   |       | 48,015       |       | 5.41        | %          | 1,057,239   |       | 48,545       |       | 6.12        | %          | 898,984     |       | 46,605       |       | 6.91        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Loans held for sale                                      |       | 168,428     |       | 5,651        |       | 4.47        | %          | 132,921     |       | 5,792        |       | 5.81        | %          | 261,505     |       | 13,954       |       | 7.11        | %          |
|  Investment  securities - trading                   |       | —      |       | —       |       | 0.00        | %          | —      |       | —       |       | 0.00        | %          | 15          |       | 1            |       | 4.61        | %          |
|  Investment  securities available-for-sale          |       | 239,301     |       | 8,905        |       | 4.96        | %          | 264,376     |       | 10,400       |       | 5.25        | %          | 264,249     |       | 9,748        |       | 4.92        | %          |
| Investment securities  held-to-maturity                  |       | 44,351      |       | 1,258        |       | 3.78        | %          | 61,475      |       | 1,963        |       | 4.25        | %          | 91,343      |       | 2,858        |       | 4.17        | %          |
| Other investments                                        |       | 15,697      |       | 13           |       | 0.11        | %          | 15,138      |       | 548          |       | 4.82        | %          | 9,893       |       | 442          |       | 5.96        | %          |
| Federal funds sold                                       |       | 57,563      |       | 102          |       | 0.24        | %          | 23,023      |       | 433          |       | 2.52        | %          | 31,244      |       | 1,235        |       | 5.28        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Total interest-earning  assets and interest income (2)   |       | 1,708,611   |       | 63,944       |       | 4.99        | %          | 1,554,172   |       | 67,681       |       | 5.81        | %          | 1,557,233   |       | 74,843       |       | 6.41        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Noninterest earning  assets:                             |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Cash and due from banks                                  |       | 1,026       |       |         |       |        |       | 7,526       |       |         |       |        |       | $           | 7,297      |         |       |        |       |   |
| Premises and equipment,  net                             |       | 15,977      |       |         |       |        |       | 17,765      |       |         |       |        |       | 19,835      |       |         |       |        |       |
| Goodwill and other  intangibles, net                     |       | 14,090      |       |         |       |        |       | 17,140      |       |         |       |        |       | 17,403      |       |         |       |        |       |
| Accrued interest and  other assets                       |       | 59,401      |       |         |       |        |       | 52,042      |       |         |       |        |       | 48,513      |       |         |       |        |       |
| Allowance for loan  losses                               |       | (15,725     | )          |         |       |        |       | (12,192     | )          |         |       |        |       | (10,096     | )          |         |       |        |       |
| Total assets                                             |       | $           | 1,783,380  |         |       |        |       |        | $          | 1,636,453    |       |        |       |        |       | $            | 1,640,185  |        |       |   |   |   |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| **Liabilities  and Shareholders’ Equity**           |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest - bearing  liabilities:                         |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest - bearing  deposits:                            |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Interest checking                                        |       | 121,062     |       | 960          |       | 1.06        | %          | 121,338     |       | 2,101        |       | 2.31        | %          | 124,155     |       | 2,738        |       | 2.95        | %          |
| Money markets                                            |       | 49,504      |       | 397          |       | 1.07        | %          | 40,860      |       | 764          |       | 2.50        | %          | 57,531      |       | 1,076        |       | 2.50        | %          |
| Statement savings                                        |       | 286,180     |       | 3,255        |       | 1.52        | %          | 366,209     |       | 8,312        |       | 3.03        | %          | 357,343     |       | 12,641       |       | 4.73        | %          |
| Certificates of deposit                                  |       | 619,158     |       | 13,902       |       | 3.00        | %          | 450,650     |       | 13,274       |       | 3.93        | %          | 531,418     |       | 18,733       |       | 4.71        | %          |
| Total interest - bearing  deposits                       |       | 1,075,904   |       | 18,514       |       | 2.30        | %          | 979,057     |       | 24,451       |       | 3.34        | %          | 1,070,447   |       | 35,188       |       | 4.39        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Other borrowed funds                                     |       | 363,422     |       | 9,383        |       | 3.45        | %          | 349,178     |       | 10,172       |       | 3.89        | %          | 264,551     |       | 8,949        |       | 4.52        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Total interest-bearing  liabilities and interest expense |       | 1,439,326   |       | 27,897       |       | 2.59        | %          | 1,328,235   |       | 34,623       |       | 3.48        | %          | 1,334,998   |       | 44,137       |       | 4.42        | %          |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Noninterest-bearing  liabilities:                        |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Demand deposits                                          |       | 144,233     |       |         |       |        |       | 127,945     |       |         |       |        |       | 123,621     |       |         |       |        |       |
| Other liabilities                                        |       | 19,780      |       |         |       |        |       | 18,706      |       |         |       |        |       | 24,196      |       |         |       |        |       |
| Common shareholders’  equity                        |       | 180,041     |       |         |       |        |       | 161,567     |       |         |       |        |       | 157,370     |       |         |       |        |       |
| Total liabilities and  shareholders’ equity         |       | $           | 1,783,380  |         |       |        |       |        | $          | 1,636,453    |       |        |       |        |       | $            | 1,640,185  |        |       |   |   |   |
|                                                     |       |        |       |         |       |        |       |        |       |         |       |        |       |        |       |         |       |        |       |
| Net interest income and  net interest margin (2)         |       |        |       | $            | 36,047     |        | 2.81       | %           |       |         | $          | 33,058      |       | 2.84        | %          |         |       | $           | 30,706     |   | 2.63 | % |

 

----

(1)          Non-accrual loans are included in averagebalances and do not have a material effect on the average yield.  Interest income on non-accruing loans was notmaterial for the periods presented.

(2)          Interest income for loans receivable,investment securities available-for-sale and fed funds sold (which includesinvestments in money market preferred stock) is reported on a fully taxable-equivalentbasis at a rate of 34%.

 

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**Rate andVolume Analysis**

Nine Months Ended September 30, 2009, 2008 and2007

(In thousands)

 
| ** **                                | ** ** | **2009  Compared to 2008** | ** ** | **2008  Compared to 2007** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **Change  Due to**         | ** ** | ** **                 | ** ** | **Change  Due to** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Average**                | ** ** | **Average**                | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume  (3)**            | ** ** | **Rate**                   | ** ** | **(Decrease)** | ** ** | **Volume  (3)** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                          | 1,496      |                       | $          | (1,855 | ) | $ | (359 | ) | $ | 1,197 |   | $ | (1,260 | ) | $ | (63 | ) |
| Real estate -  commercial                 |       | 4,870                      |       | (1,190                     | )          | 3,680 |   | 3,928 |   | (439 | ) | 3,489 |   |
| Real estate -  construction               |       | (582                       | )          | (2,046                     | )          | (2,628 | ) | 1,653 |   | (3,323 | ) | (1,670 | ) |
| Real estate -  residential                |       | (458                       | )          | (418                       | )          | (876 | ) | 560 |   | 254 |   | 814 |   |
| Home equity lines                         |       | 713                        |       | (1,048                     | )          | (335 | ) | 1,313 |   | (1,649 | ) | (336 | ) |
| Consumer                                  |       | (4                         | )          | (8                         | )          | (12 | ) | (262 | ) | (32 | ) | (294 | ) |
| Total loans                               |       | 6,035                      |       | (6,565                     | )          | (530 | ) | 8,389 |   | (6,449 | ) | 1,940 |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans held for sale                       |       | 1,547                      |       | (1,688                     | )          | (141 | ) | (6,861 | ) | (1,301 | ) | (8,162 | ) |
| Investment securities -  trading          |       | —                     |       | —                     |       | — |   | (1 | ) | — |   | (1 | ) |
| Investment securities  available-for-sale |       | (986                       | )          | (509                       | )          | (1,495 | ) | 5 |   | 647 |   | 652 |   |
| Investment securities  held-to-maturity   |       | (550                       | )          | (155                       | )          | (705 | ) | (930 | ) | 35 |   | (895 | ) |
| Other investments                         |       | 19                         |       | (554                       | )          | (535 | ) | 235 |   | (129 | ) | 106 |   |
| Federal funds sold                        |       | 656                        |       | (987                       | )          | (331 | ) | (326 | ) | (476 | ) | (802 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Total interest income  (2)                |       | 6,721                      |       | (10,458                    | )          | (3,737 | ) | 511 |   | (7,673 | ) | (7,162 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest - bearing  deposits:             |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | (7                         | )          | (1,134                     | )          | (1,141 | ) | (58 | ) | (579 | ) | (637 | ) |
| Money markets                             |       | 161                        |       | (528                       | )          | (367 | ) | (311 | ) | (1 | ) | (312 | ) |
| Statement savings                         |       | (1,822                     | )          | (3,235                     | )          | (5,057 | ) | 327 |   | (4,656 | ) | (4,329 | ) |
| Certificates of deposit                   |       | 4,946                      |       | (4,318                     | )          | 628 |   | (2,843 | ) | (2,616 | ) | (5,459 | ) |
| Total interest -  bearing deposits        |       | 3,278                      |       | (9,215                     | )          | (5,937 | ) | (2,885 | ) | (7,852 | ) | (10,737 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                      |       | 405                        |       | (1,194                     | )          | (789 | ) | 2,867 |   | (1,644 | ) | 1,223 |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Total interest expense                    |       | 3,683                      |       | (10,409                    | )          | (6,726 | ) | (18 | ) | (9,496 | ) | (9,514 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                   |       | $                          | 3,038      |                       | $          | (49 | ) | $ | 2,989 |   | $ | 529 |   | $ | 1,823 |   | $ | 2,352 |   |

 

----

(1)   Non-accrual loans are included in averagebalances and do not have a material effect on the average yield.  Interest income on non-accruing loans was notmaterial for the periods presented.

(2)   Interest income for loans receivable,investment securities available-for-sale and fed funds sold (which includesinvestments in money market preferred stock) is reported on a fullytaxable-equivalent basis at a rate of 34%.

(3)   Changes attributable to rate/volume have beenallocated to volume.

 

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*Provisionfor Loan Losses*

 

Theprovision for loan losses for the three months ended September 30, 2009and 2008 was $2.1 million and $1.6 million, respectively. For the nine monthsended September 30, 2009 and 2008, provision for loan losses was $4.8million and $2.7 million, respectively. The increase in our provision expense for the 2009 periods compared tothe same periods of 2008 is a direct result of increases in non-performingloans and the adverse migration of certain loans through our allowance for loanlosses calculation model because of current and ongoing adverse economicconditions.  While we continue to reportstrong credit quality in our loan portfolio, we have experienced increases inour watch list credits and net charge-offs. Our provision expense was also impacted by net new loan growth inaddition to our evaluation of the credit quality in our loan portfolio and thequalitative factors we use to determine the adequacy of our loan loss reservesas described above in “Critical Accounting Policies—Allowance for Loan Losses.”

 

During2009, we charged off three residential loans held at George Mason totaling$454,000 and eleven residential loans at the Bank totaling $1.3 million.  In addition, installment loans at the Banktotaling $4,000 have been charged-off during the 2009.  The Bank recorded partial charge-offs of twocommercial loans totaling $40,000 during 2009. All of these charge-offs were taken against our allowance for loanlosses.

 

Theallowance for loan losses at September 30, 2009 and December 31, 2008was $17.5 million and $14.5 million, respectively. Our allowance for loanlosses ratio to loans receivable, net was 1.38% and 1.27% at September 30,2009 and December 31, 2008, respectively. Nonperforming loans at September 30, 2009 and December 31,2008, were $9.5 million and $5.1 million, respectively.

 

Whileour loan growth has been strong during 2009, continued recessionary economicconditions are likely to adversely affect our loan portfolio, including causingincreases in delinquencies and default rates, which we expect could impact ourcharge-offs and provision for loan losses. Continued deterioration in real estate values and household incomescould result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to aconcentration of credit risk to a particular industry, counterparty, borroweror issuer.  A deterioration in thefinancial condition or prospects of a particular industry or a failure ordowngrade of, or default by, any particular entity or group of entities couldnegatively impact our businesses, perhaps materially, and the systems by whichwe set limits and monitor the level of our credit exposure to individualentities and industries, may not function as we have anticipated.

 

Additionalinformation on the allowance for loan losses, its allocation to the loansreceivable portfolio and information on nonperforming loans can be found in thefollowing tables.

 

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**Allowance for Loan Losses**

Nine Months Ended September 30, 2009 and 2008

(In thousands)

 
| ** **                          | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance,  January 1, |       | $        | 14,518     |     | $          | 11,641 |   |
|                                |       |     |       |     |       |
| Provision for loan  losses          |       | 4,750    |       | 2,734    |       |
|                                |       |     |       |     |       |
| Loans charged off:                  |       |     |       |     |       |
| Commercial and  industrial          |       | (40      | )          | (88      | )          |
| Residential                         |       | (1,756   | )          | (1,012   | )          |
| Consumer                            |       | (4       | )          | (41      | )          |
| Total loans charged off             |       | (1,800   | )          | (1,141   | )          |
|                                |       |     |       |     |       |
| Recoveries:                         |       |     |       |     |       |
| Commercial and  industrial          |       | 5        |       | 3        |       |
| Consumer                            |       | —   |       | 20       |       |
| Total recoveries                    |       | 5        |       | 23       |       |
|                                |       |     |       |     |       |
| Net (charge offs)  recoveries       |       | (1,795   | )          | (1,118   | )          |
|                                |       |     |       |     |       |
| Ending balance,  September 30, |       | $        | 17,473     |     | $          | 13,257 |   |

 
| ** **                                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **2009**               | ** ** | **2008**               | ** ** |
| Loans:                                                      |       |                   |       |                   |       |
| Balance at period end                                       |       | $                      | 1,263,291  |                   | $          | 1,086,531 |   |
| Allowance for loan  losses to loans receivable, net of fees |       | 1.38                   | %          | 1.22                   | %          |
| Annualized net  charge-offs to average loans receivable     |       | 0.20                   | %          | 0.14                   | %          |
|                                                             |            |                        |            |                        |            |  |  |

 

**Allocation of the Allowance for LoanLosses**

At September 30,2009 and December 31, 2008

(In thousands)

 
| ** **                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                       | ** ** | **Allocation**         | ** ** | **% of Total***       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       | $                      | 1,997      |                  | 11.75      | % | $ | 2,129 |   | 14.12 | % |
| Real estate -  commercial        |       | 9,732                  |       | 46.90                 | %          | 6,110 |   | 41.41 | % |
| Real estate -  construction      |       | 2,713                  |       | 15.18                 | %          | 3,118 |   | 16.53 | % |
| Real estate -  residential       |       | 1,798                  |       | 16.72                 | %          | 2,138 |   | 18.57 | % |
| Home equity lines                |       | 1,164                  |       | 9.21                  | %          | 965 |   | 9.16 | % |
| Consumer                         |       | 69                     |       | 0.24                  | %          | 58 |   | 0.21 | % |
|                             |       |                   |       |                  |       |   |   |   |   |
| Total allowance for  loan losses |       | $                      | 17,473     |                  | 100.00     | % | $ | 14,518 |   | 100.00 | % |

 

----

* Percentage of loan typeto the total loan portfolio.

 

**Nonperforming Loans Receivable**

At September 30,2009 and December 31, 2008

(Inthousands)

 
| ** **                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Nonaccruing loans                                                |       | $                      | 9,454      |                  | $          | 4,671 |   |
|                                                             |       |                   |       |                  |       |
| Loans contractually  past-due 90 days or more and still accruing |       | 25                     |       | 379                   |       |
|                                                             |       |                   |       |                  |       |
| Total nonperforming  loans receivable                            |       | $                      | 9,479      |                  | $          | 5,050 |   |

 

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* *

*NoninterestIncome*

 

Noninterestincome includes service charges on deposits and loans, realized and unrealizedgains on mortgage banking activities, investment fee income, and management feeincome, and continues to be an important factor in our operating results.Noninterest income for the three months ended September 30, 2009 and 2008was $5.7 million and $4.4 million, respectively, an increase of $1.3 million, or30%.   Realized and unrealized gains onmortgage banking activities by our mortgage banking segment for the threemonths ended September 30, 2009 and 2008 were $2.8 million and $2.0million, respectively, an increase of $848,000, or 43%.  Included in realized and unrealized gains onmortgage banking activities are any origination, underwriting, and discountpoints and other funding fees received and deferred at loan origination. Costsinclude direct costs associated with the loan origination, such as commissionsand salaries that are deferred at the time of origination.  Income from loan fees increased $138,000 to$503,000 for the three months ended September 30, 2009, compared to$365,000 for the same period of 2008. Management fee income for the three months ended September 30, 2009and 2008 was $553,000 and $204,000, respectively, an increase of $349,000.Management fee income represents the income earned for services George Masonprovides to other mortgage companies owned by local home builders and generallyfluctuates based on the volume of loan sales. The increases in realized andunrealized gains on mortgage banking activities, loan fees and management feeincome is directly related to the increase in loan origination activity andsales volume occurring in the mortgage banking segment as a result of thedecreases in mortgage rates and more affordable home prices during the 2009.

 

Servicecharges on deposit accounts decreased marginally to $514,000 for the threemonths ended September 30, 2009 compared to $522,000 for the same periodof 2008.

 

Investmentfee income increased $82,000 to $975,000 for the three months ended September 30,2009 compared to $893,000 for the same period of 2008. The increase ininvestment fee income is attributable to an increase in customer relationshipsin our trust division.

 

Forthe nine months ended September 30, 2009 and 2008, noninterest income was$17.7 million and $13.4 million, respectively, an increase of $4.3 million, or32%.  Realized and unrealized gains onmortgage banking activities by our mortgage banking segment for the nine monthsended September 30, 2009 and 2008 were $9.6 million and $5.9 million,respectively, an increase of $3.7 million, or 63%.  Income from loan fees increased $1.1 millionto $2.2 million 

 

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forthe nine months ended September 30, 2009, compared to $1.0 million for thesame period of 2008.  Management feeincome for the nine months ended September 30, 2009 and 2008 was $1.3million and $590,000, respectively, an increase of $677,000. The increases inrealized and unrealized gains on mortgage banking activities, loan fees andmanagement fee income is again directly related to the increase in loanorigination activity and sales volume occurring in the mortgage bankingsegment.

 

Servicecharges on deposit accounts decreased $102,000 to $1.5 million for theyear-to-date period ended September 30, 2009 compared to $1.6 million forthe same period of 2008.   Investment feeincome decreased $50,000 to $2.7 million for the nine months ended September 30,2009.

 

Theincrease in the cash surrender value of our bank-owned life insurance for thethree months ended September 30, 2009 and 2008 was $167,000 and $165,000,respectively.  For the year-to-date September 30,2009 and 2008, the increase in the cash surrender value was $400,000and $741,000,respectively, a decrease of $341,000. The year-to-date decrease is directly related to the decreases in theunderlying value of the investments due to the current economic environment.

 

Forthe three month period ended September 30, 2009, we recorded net gains onsales of investment securities available-for-sale of $73,000 compared to$306,000 for the three months ended September 30, 2008.  For the nine month period ended September 30,2009 and 2008, we recorded net gains on sales of investment securitiesavailable-for-sale of $625,000 and $539,000, respectively.  Included in the net gains for theyear-to-date period of 2009, were losses on sales of investment securitiesavailable-for-sale of $217,000 which resulted from the sale of all of ourshares of Fannie Mae perpetual preferred stock. Additionally, we had trading losses of $422,000 for the nine monthsended September 30, 2009 as a result of our purchase of investments toeconomically hedge against fair value changes of the Company’s nonqualifieddeferred compensation plan liability. These investments total $4.2 million at September 30, 2009 and areincluded in Other Assets on the statement of condition at that date.  The trading losses were primarily the resultof lower stock prices and were partially offset by a reduction in the period’scompensation expense associated with this benefit plan.

 

Noninterestincome represented 30% and 28% of our total revenues for the three months endedSeptember 30, 2009 and 2008, respectively. For the nine months ended September 30, 2009 and 2008, noninterestincome represented 33% and 29%, respectively, of our total revenues.

 

*NoninterestExpense*

 

Noninterestexpense includes salaries and benefits, occupancy costs, professional fees,depreciation, data processing, telecommunications and miscellaneous expenses.Noninterest expense for the three months ended September 30, 2009 was$13.0 million, compared to $19.3 million for the same period of 2008, a decreaseof $6.3 million.  For the nine monthsended September 30, 2009 and 2008, noninterest expense was $38.7 millionand $44.7 million, respectively.  Duringthe third quarter of 2008, we recorded two impairment charges.  We recognized an other-than-temporary impairmentcharge of $4.4 million on our investment in Fannie Mae perpetual preferredstock and an impairment to the goodwill associated with George Mason of $2.8million.

 

Forthe quarter ended September 30, 2009, salaries and benefits expenseincreased to $5.9 million up from $5.8 million for the quarter ended September 30,2008.  The increase in salaries 

 

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andbenefits expense is mostly related to an increase in incentive pay due tobetter than expected results during 2009 for the quarter and year-to-date.  For the nine months ended September 30,2009 and 2008, salaries and benefits expense was $17.5 million and $17.3million, respectively.

 

During2009, our FDIC insurance assessment has increased significantly due to changesin the assessment calculation and a special assessment imposed during thesecond quarter of 2009.  The increase inassessment is a result of the FDIC’s efforts in replenishing the levels of theDeposit Institution Fund as a result of recent bank failures.  FDIC insurance assessments for the threemonths ended September 30, 2009 and 2008 were $463,000 and $181,000,respectively.  For the year-to-dateperiods ended September 30, 2009 and 2008, the expense related to FDICinsurance assessments was $2.2 million and $541,000, respectively.  Included in the nine month period ended September 30,2009, is the FDIC imposed special assessment which totaled $850,000.

 

Chargesrelated to George Mason’s repurchases of mortgage loans previously sold toinvestors increased to $517,000 for the three months ended September 30,2009 compared to $367,000 for the same period of 2008.  For the nine months ended September 30,2009, repurchase charges were $1.7 million, an increase of $685,000 from $1.0million for the nine months ended September 30, 2008.  These charges are included in Other OperatingExpenses on the consolidated statements of income, and account for the majorityof the increase in this category for the nine month periods presented.  We have worked over the past twelve months toreduce and limit our exposure to loan repurchases and claims from investors andbelieve that any additional expense recorded will be minimal in futureperiods.  During the second quarter of2008, George Mason made a cash settlement with one of its mortgagecorrespondents related to the loan purchase agreement between the twoparties.  This settlement provided forthe release of known and unknown claims by the mortgage correspondent inexchange for the cash settlement.  Theexpense associated with this settlement was $1.8 million, and is presentedseparately on our consolidated statement of income.

 

*IncomeTaxes*

 

Forthe three months ended September 30, 2009, we recorded a provision forincome taxes of $1.2 million, compared to a benefit of $816,000 for the sameperiod of 2008.  Our effective tax ratefor the three months ended September 30, 2009 was 30.9%.  For the nine months ended September 30,2009 and 2008, we recorded a provision for income taxes of $3.0 million and$84,000, respectively.  Our effective taxrate for the nine months ended September 30, 2009 was 30.3%.  For the 2008 periods presented, the incometax provision was impacted by the other-than-temporary impairment recorded forour investment in Fannie Mae perpetual preferred stock.  See also “Critical Accounting Policies —Valuation of Deferred Tax Assets.”

 

**Statementsof Condition**

 

Totalassets were $1.89 billion and $1.74 billion at September 30, 2009 and December 31,2008, respectively.  The increase in ourtotal assets was primarily driven by the increase in total deposits.  Total deposits increased $96.0 million to$1.28 billion at September 30, 2009 compared to $1.18 billion at December 31,2008.  In addition, during the secondquarter of 2009, we raised $31.6 million in additional common equity capital,also contributing to our increase in total assets at September 30, 2009.

 

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*InvestmentSecurities*

 

Investmentsecurities were $372.2 million at September 30, 2009, compared to $315.5million at December 31, 2008, an increase of $56.7 million. The increasein investment securities is primarily due to investment of our excess cash as aresult of increased deposits and capital. The investment securities portfolio consists of investment securitiesavailable-for-sale and investment securities held-to-maturity. Investmentsecurities available-for-sale are those securities that we intend to hold foran indefinite period of time, but not necessarily until maturity. Thesesecurities are carried at fair value and may be sold as part of anasset/liability strategy, liquidity management or regulatory capitalmanagement.  Investment securitiesheld-to-maturity are those securities that we have the intent and ability tohold to maturity and are carried at amortized cost. At September 30, 2009,investment securities available-for-sale were $334.7 million and investmentsecurities held-to-maturity were $37.5 million. At December 31, 2008,investment securities available-for-sale were $265.4 million and investmentsecurities held-to-maturity were $50.2 million. See the following table for additional information on our investmentsecurities portfolio.

 

Wecomplete reviews for other-than-temporary impairment at least quarterly.  As of September 30, 2009, 86% of the parvalue of our investment securities portfolio consisted of securities rated AAAby a leading rating agency.  Investmentsecurities which carry a AAA rating are judged to be of the best quality andcarry the smallest degree of investment risk. At September 30, 2009, 95% of our mortgage-backed investmentsecurities portfolio were guaranteed by the Federal National MortgageAssociation (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and theGovernment National Mortgage Association (GNMA).  During the third quarter of 2008, FNMA andFHLMC were placed into conservatorship by federal regulators.  We expect to receive full payment of interestand principal on the securities in the investment portfolio.

 

Wehave $11.5 million in non-government non-agency mortgage-backedsecurities.  These securities are ratedAAA.  The various protective elements onthe non-agency securities may change in the future if market conditions or thefinancial stability of credit insurers changes, which could impact the ratingsof these securities.

 

AtSeptember 30, 2009 certain of our investment grade securities were in anunrealized loss position.  Investmentsecurities with unrealized losses have interest rates that are less thancurrent market interest rates and, therefore, the indicated decrease in valuesare not a result of permanent credit impairment. Municipal securities, with anamortized cost totaling $48.1 million at September 30, 2009, are theprimary component of the unrealized losses in the available-for-sale investmentsecurities portfolio at September 30, 2009.  The majority of our municipal securities havebeen downgraded to AA or single A from AAA due to the downgrades of themonoline insurance companies that insured those bonds.  The downgraded bonds remain generalobligations of the municipalities and while prices for these municipalsecurities are generally below book value, we expect to receive payment of allprincipal and interest amounts due to us.

 

Inaddition, our held-to-maturity portfolio includes investments in four pooledtrust preferred securities, totaling $8.0 million of par value at September 30,2009 (each security has a par value of $2.0 million).  The collateral underlying these structuredsecurities are instruments issued by financial institutions or insurers.  We own the A-3 tranches in each issuance.  Each of the bonds are rated by more than onerating agency.  Two of the securitieshave a composite rating of AA and two of the securities have a composite ratingof BBB.  These ratings are consistentwith the grades from the other rating agencies. There is minimal observable trading activity for these types ofsecurities.  We have estimated the fairvalue of these securities through the use of internal calculations and comparedour results to information provided by external 

 

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pricingservices.  Given the level ofsubordination below our A-3 tranches, and the actual and expected performanceof the underlying collateral, we expect to receive all contractual interest andprincipal payments recovering the amortized cost basis of each of the foursecurities and have concluded that these securities are notother-than-temporarily impaired.

 

Noother-than-temporary impairment has been recognized on the securities in ourinvestment portfolio during 2009.

 

AtSeptember 30, 2008, we recorded an other-than-temporary impairment of $4.4million related to our investment in Fannie Mae perpetual preferred stock.  This impairment was due to the shares beingtraded well below their par value following the placement of Fannie Mae intoconservatorship by federal regulators in September 2008.  During the first quarter of 2009, we sold allof our Fannie Mae perpetual preferred stock for a loss of $217,000.

 

Wehold $15.7 million in FHLB stock at September 30, 2009.  In September 2008, the FHLB announced achange in their dividend declaration and payment schedule beginning during thefourth quarter of 2008.  The change wasinitiated so that the dividend can be declared and paid to member banks afterthe FHLB has calculated their net income for the preceding quarter.  During the third quarter of 2009, we receiveda dividend totaling $33,000 for our investment in FHLB stock.

 

**Investment Securities**

At September 30,2009 and December 31, 2008

(In thousands)

 
| ** **                                        | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|---------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at September 30, 2009** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies               |       |          |       |      |       |        |       |
| One to five years                                 |       | $             | 5,331      |      | $          | 5,411       |       | 2.92 | % |
| Five to ten years                                 |       | 31,236        |       | 31,633    |       | 4.25        | %          |
| After ten years                                   |       | 9,975         |       | 10,040    |       | 5.02        | %          |
| Total U.S. government-sponsored  agencies         |       | 46,542        |       | 47,084    |       | 4.26        | %          |
|                                              |       |          |       |      |       |        |       |
| Mortgage-backed  securities (1)                   |       |          |       |      |       |        |       |
| One to five years                                 |       | 9             |       | 9         |       | 8.96        | %          |
| Five to ten years                                 |       | 35,626        |       | 37,021    |       | 4.23        | %          |
| After ten years                                   |       | 190,721       |       | 196,886   |       | 4.88        | %          |
| Total mortgage-backed  securities                 |       | 226,356       |       | 233,916   |       | 4.77        | %          |
|                                              |       |          |       |      |       |        |       |
| Tax exempt municipal  securities (2)              |       |          |       |      |       |        |       |
| Five to ten years                                 |       | 5,356         |       | 5,498     |       | 3.25        | %          |
| After ten years                                   |       | 40,426        |       | 40,941    |       | 4.02        | %          |
| Taxable municipal  securities                     |       |          |       |      |       |        |       |
| After ten years                                   |       | 2,328         |       | 2,290     |       | 5.15        | %          |
| Total municipal  securities                       |       | 48,110        |       | 48,729    |       | 3.98        | %          |
|                                              |       |          |       |      |       |        |       |
| U. S. treasury  securities                        |       |          |       |      |       |        |       |
| One to five years                                 |       | 4,895         |       | 4,941     |       | 2.36        | %          |
| Total U.S. treasury  securities                   |       | 4,895         |       | 4,941     |       | 2.36        | %          |
| Total investment  securities available-for-sale   |       | $             | 325,903    |      | $          | 334,670     |       | 4.55 | % |

 
| ** **                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at September 30, 2009** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| Mortgage-backed  securities (1)                 |       |          |       |      |       |        |       |
| One to five years                               |       | $             | 2,096      |      | $          | 2,159       |       | 4.34 | % |
| Five to ten years                               |       | 6,693         |       | 6,996     |       | 4.58        | %          |
| After ten years                                 |       | 20,733        |       | 21,350    |       | 4.35        | %          |
| Total mortgage-backed  securities               |       | 29,522        |       | 30,505    |       | 4.40        | %          |
|                                            |       |          |       |      |       |        |       |
| Corporate bonds                                 |       |          |       |      |       |        |       |
| After ten years                                 |       | 8,004         |       | 4,427     |       | 1.55        | %          |
| Total corporate bonds                           |       | 8,004         |       | 4,427     |       | 1.55        | %          |
| Total investment  securities held-to-maturity   |       | 37,526        |       | 34,932    |       | 3.80        | %          |
|                                            |       |          |       |      |       |        |       |
| Total investment securities                     |       | $             | 363,429    |      | $          | 369,602     |       | 4.47 | % |

 

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| ** **                                       | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|--------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2008** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies              |       |          |       |      |       |        |       |
| Five to ten years                                |       | $             | 24,917     |      | $          | 24,962      |       | 5.28 | % |
| After ten years                                  |       | 436           |       | 166       |       | 8.25        | %          |
| Total U.S.  government-sponsored agencies        |       | 25,353        |       | 25,128    |       | 5.33        | %          |
|                                             |       |          |       |      |       |        |       |
| Mortgage-backed  securities (1)                  |       |          |       |      |       |        |       |
| One to five years                                |       | 4,263         |       | 4,277     |       | 4.19        | %          |
| Five to ten years                                |       | 42,503        |       | 43,626    |       | 4.45        | %          |
| After ten years                                  |       | 158,969       |       | 160,301   |       | 5.27        | %          |
| Total mortgage-backed  securities                |       | 205,735       |       | 208,204   |       | 5.08        | %          |
|                                             |       |          |       |      |       |        |       |
| Municipal securities  (2)                        |       |          |       |      |       |        |       |
| After ten years                                  |       | 33,265        |       | 31,424    |       | 4.09        | %          |
| Total municipal  securities                      |       | 33,265        |       | 31,424    |       | 4.09        | %          |
|                                             |       |          |       |      |       |        |       |
| U. S. treasury  securities                       |       |          |       |      |       |        |       |
| One to five years                                |       | 598           |       | 600       |       | 1.02        | %          |
| Total U.S. treasury  securities                  |       | 598           |       | 600       |       | 1.02        | %          |
| Total investment  securities available-for-sale  |       | $             | 264,951    |      | $          | 265,356     |       | 4.97 | % |

 
| ** **                                     | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2008** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies            |       |          |       |      |       |        |       |
| One to five years                              |       | $             | 2,001      |      | $          | 2,025       |       | 4.30 | % |
| Total U.S.  government-sponsored agencies      |       | 2,001         |       | 2,025     |       | 4.30        | %          |
|                                           |       |          |       |      |       |        |       |
| Mortgage-backed  securities (1)                |       |          |       |      |       |        |       |
| One to five years                              |       | 1,836         |       | 1,867     |       | 4.26        | %          |
| Five to ten years                              |       | 9,267         |       | 9,463     |       | 4.45        | %          |
| After ten years                                |       | 29,075        |       | 29,142    |       | 4.39        | %          |
| Total mortgage-backed  securities              |       | 40,178        |       | 40,472    |       | 4.40        | %          |
|                                           |       |          |       |      |       |        |       |
| Corporate bonds                                |       |          |       |      |       |        |       |
| After ten years                                |       | 8,004         |       | 3,262     |       | 4.09        | %          |
| Total corporate bonds                          |       | 8,004         |       | 3,262     |       | 4.09        | %          |
| Total investment  securities held-to-maturity  |       | 50,183        |       | 45,759    |       | 4.34        | %          |
|                                           |       |          |       |      |       |        |       |
| Total investment  securities                   |       | $             | 315,134    |      | $          | 311,115     |       | 4.87 | % |

 

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(1)  Based on contractualmaturities.

(2) Yields fortax-exempt municipal securities are not reported on a tax-equivalent basis.

 

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*LoansReceivable*

 

Loansreceivable, net of deferred fees and costs, were $1.26 billion at September 30,2009 and $1.14 billion at December 31, 2008, an increase of $123.9million.  See the following table fordetails on the loans receivable portfolio. During 2009, the mix of our loanportfolio changed slightly, with decreases in commercial and industrial loans,increases in commercial real estate loans, real estate construction loans andhome equity lines, and decreases in real estate residential loans.  Loans held for sale at September 30,2009 were $151.8 million compared to $157.0 million at December 31,2008.  Loans held for sale are valued atthe lower of cost or fair value.

 

**Loans Receivable**

At September 30, 2009 and December 31, 2008

(In thousands)

 
| ** **                       | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                             |       |                         |       |                        |       |   |   |   |   |
| Commercial and  industrial       |       | $                            | 148,591    |                        | 11.75      | % | $ | 160,989 |   | 14.12 | % |
| Real estate -  commercial        |       | 592,925                      |       | 46.90                       | %          | 472,131 |   | 41.41 | % |
| Real estate -  construction      |       | 191,932                      |       | 15.18                       | %          | 188,484 |   | 16.53 | % |
| Real estate -  residential       |       | 211,334                      |       | 16.72                       | %          | 211,651 |   | 18.57 | % |
| Home equity lines                |       | 116,441                      |       | 9.21                        | %          | 104,370 |   | 9.16 | % |
| Consumer                         |       | 2,988                        |       | 0.24                        | %          | 2,393 |   | 0.21 | % |
|                             |       |                         |       |                        |       |   |   |   |   |
| Gross loans                      |       | $                            | 1,264,211  |                        | 100.00     | % | 1,140,018 |   | 100.00 | % |
|                             |       |                         |       |                        |       |   |   |   |   |
| Net deferred (fees)  costs       |       | (920                         | )          |                        |       | (670 | ) |   |   |
| Less: allowance for  loan losses |       | (17,473                      | )          |                        |       | (14,518 | ) |   |   |
|                             |       |                         |       |                        |       |   |   |   |   |
| Loans receivable, net            |       | $                            | 1,245,818  |                        |       |   | $ | 1,124,830 |   |   |   |

 

*Deposits*

 

Totaldeposits were $1.28 billion at September 30, 2009 compared to $1.18billion at December 31, 2008. We had increases in our noninterest bearingchecking products, interest bearing and money market checking accounts, savingsaccounts and certificates of deposit. Overall, deposit balances increased ascustomers are seeking smaller financial institutions to deposit their moneywith as a result of the current economic turmoil and are increasing thebalances held with financial institutions as a result of the increased protectionof their money by the FDIC.  See thefollowing table for details on certificates of deposit with balances of$100,000 or more. During 2008, we joined the Certificates of Deposit AccountRegistry Service (“CDARS”).   CDARSallows our customers to access FDIC insurance protection on multi-milliondollar certificates of deposit through our Bank.  When a customer places a large depositthrough CDARS, we place their funds into certificates of deposit with otherbanks in the CDARS network in increments of less than $250,000 so thatprincipal and interest are eligible for FDIC insurance protection.  At September 30, 2009 and December 31,2008, we had $50.4 million and

 

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$53.5million, respectively, in CDARS deposits, which are considered to be brokereddeposits.  Brokered certificates ofdeposit not in the CDARS network were $33.2 million and $35.7 million at September 30,2009 and December 31, 2008, respectively.

 

**Certificates of Deposit of $100,000or More**

At September 30, 2009

(In thousands)

 
| ** **                             | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------|------------|-----------------|------------|-----------|------------|
| **Maturities:**                        |       |           |       |            |       |      |       |
| Three months or less                   |       | $              | 86,751     |            | $          | 44,403    |       | $ | 131,154 |   |
| Over three months  through six months  |       | 55,370         |       | 9,504           |       | 64,874    |       |
| Over six months through  twelve months |       | 58,803         |       | 5,004           |       | 63,807    |       |
| Over twelve months                     |       | 80,823         |       | 9,841           |       | 90,664    |       |
|                                   |       | $              | 281,747    |            | $          | 68,752    |       | $ | 350,499 |   |

 

----

* No-Penalty certificates of deposit can be redeemedat anytime at the request of the depositor.

 

*Borrowings*

 

Otherborrowed funds increased $11.4 million to $378.6 million at September 30,2009, compared to $367.2 million at December 31, 2008.  Treasury, Tax & Loan Note optionborrowings increased $542,000 to $1.2 million at September 30, 2009compared to $692,000 at December 31, 2008. FHLB advances remained at $280.0 million at September 30, 2009compared to December 31, 2008. Customer repurchase agreements increased$10.9 million to $76.8 million at September 30, 2009 compared to $65.9million at December 31, 2008.  Wehad no federal funds purchased at each of September 30, 2009 and December 31,2008.  The following table providesinformation on our borrowings.

 

**Short-Term Borrowings and OtherBorrowed Funds**

At September 30, 2009

(In thousands)

 
| ** **                                                     | ** ** | ** ** | ** ** | **Amount** | ** **  |
|----------------------------------------------------------------|------------|------------|------------|------------|-------------|
| **Short-term  borrowed funds:**                                |       |       |       |       |        |
| TT&L note option                                           |       | 0.10       | %          | $          | 1,234       |   |
| Customer repurchase  agreements                                |       | 0.49       | %          | 76,792     |        |
| **Total  short-term borrowed funds and weighted average rate** | ** ** | **0.48**   | **%**      | **$**      | **78,026**  | ** ** |
| ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** **  |
| **Other  borrowed funds:**                                     |       |       |       |       |        |
| Trust preferred                                                |       | 4.43       | %          | $          | 20,619      |   |
| FHLB advances - long  term                                     |       | 3.98       | %          | 280,000    |        |
| **Other  borrowed funds and weighted average rate**            | ** ** | **4.01**   | **%**      | **$**      | **300,619** | ** ** |
|                                                           |       |       |       |       |        |
| **Total  other borrowed funds and weighted average rate**      | ** ** | **3.28**   | **%**      | **$**      | **378,645** | ** ** |

 

*Shareholders’Equity*

 

Shareholders’equity at September 30, 2009 was $203.4 million compared to $158.0 millionat December 31, 2008, an increase of $45.3 million, or 29%. During thesecond quarter of 2009, we issued 4.4 million shares of our common stock fortotal common equity capital raised of $31.6 million.  This additional capital will allow us tocontinue to penetrate our existing footprint and take full advantage of bankconsolidation opportunities.  During thethree months ended March 31, 2009, we issued 287,000 shares of our commonstock to employee benefit plans for a total addition of $1.6 million toshareholder’s equity.  In addition, ouraccumulated other comprehensive income increased $5.7 million for the year todate September 30, 2009, which was primarily related to the change in themarket value of our available-for-sale investment securities.  Net income of $6.9 million for the ninemonths ended September 30, 2009 also contributed to our increase inshareholders’ equity.  Book value pershare at September 30, 2009 was $7.09 compared to $6.58 at December 31,2008. Tangible book value per share (which is book value per share adjusted forchanges in other comprehensive income, less goodwill and other intangibleassets) at September 30, 2009 was $6.41 compared to $6.00 at December 31,2008.

 

##### **Business SegmentOperations**

 

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

 

*Commercial Banking*

 

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

 

Forthe three months ended September 30, 2009, the commercial banking segmentrecorded net income of $2.2 million compared to a net loss of $1.7 million forthe same period of

 

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2008.For the nine months ended September 30, 2009 and 2008, net income for thisbusiness segment was $5.1 million and $3.2 million, respectively.  See “**Statements of Income**– *General–Business**Segments*”above for additional information regarding the operating results for thecommercial banking segment for the periods presented.  At September 30, 2009, total assets forthis segment were $1.86 billion, loans receivable, net of deferred fees andcosts, were $1.26 billion and total deposits were $1.28 billion. At September 30,2008, total assets were $1.62 billion, loans receivable, net of deferred feesand costs, were $1.09 billion and total deposits were $1.09 billion.

 

*MortgageBanking*

 

Theoperations of the mortgage banking segment are conducted through George Mason,and, as of the first quarter of 2009, Cardinal First. The Bank opened CardinalFirst to originate mortgage loans for new homes and refinancing in Virginia,Maryland and Washington, D.C., principally for existing Cardinal Bankcustomers. Both George Mason and Cardinal First engage primarily in theorigination and acquisition of residential mortgages for sale into thesecondary market on a best efforts basis.

 

Forthe three months ended September 30, 2009 and 2008, the mortgage bankingsegment recorded net income of $779,000 and a loss of $2.2 million,respectively. For the nine months ended September 30, 2009 net income was$3.5 million and for the same year-to-date period of 2008 a net loss of $2.9million was recorded.  The increase innet income is primarily attributable to the decrease in mortgage interest ratesand the availability of affordable housing for consumers in our market.  See “**Statements of Income**– *General–Business**Segments*”above for additional information regarding the operating results for themortgage banking segment for the periods presented.  At September 30, 2009, total assets forthis segment were $177.2 million; loans held for sale were $151.8 million andmortgage funding checks were $13.2 million. At September 30, 2008, totalassets were $147.3 million; loans held for sale were $134.6 million andmortgage funding checks were $7.3 million.

 

*Wealth Management and Trust Services*

 

Thewealth management and trust services segment provides investment and financialservices to businesses and individuals, including financial planning,retirement/estate planning, trusts, estates, custody, investment management,escrows, and retirement plans. Operations of the Bank’s trust division, CWS andWilson/Bennett are included in this operating segment.

 

Forthe three months ended September 30, 2009 and 2008, the wealth managementand trust services segment recorded net income of $129,000 and $21,000,respectively. For the nine months ended September 30, 2009 and 2008, netincome for this business segment was $205,000 and $89,000, respectively.  For the three months ended September 30,2009 and 2008, noninterest income was $980,000 and $893,000, respectively.  Noninterest expense for the three monthsended September 30, 2009 and 2008 was $785,000 and $859,000,respectively.  For each of the ninemonths ended September 30, 2009 and 2008 noninterest income was $2.7million.  Noninterest expense for thenine months ended September 30, 2009 and 2008 was $2.4 million and $2.6million, respectively.  At September 30,2009, total assets were $3.5 million and managed and custodial assets were $3.1billion. At September 30, 2008, total assets for this segment were $3.6million and managed and custodial assets were $3.2 billion.

 

Additionalinformation pertaining to our business segments can be found in Note 3 to thenotes to consolidated financial statements.

 

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## **Capital Resources**

## ** **

Capitaladequacy is an important measure of financial stability and performance. Ourobjectives are to maintain a level of capitalization that is sufficient tosustain asset growth and promote depositor and investor confidence.

 

Regulatoryagencies measure capital adequacy utilizing a formula that takes into accountthe individual risk profile of the financial institution. The guidelines definecapital as both Tier 1 (which includes common shareholders’ equity, defined toinclude certain debt obligations) and Tier 2 (which includes certain other debtobligations, a portion of the allowance for loan losses, and 45% of anyunrealized gains in equity securities).

 

AtSeptember 30, 2009, our Tier 1 and total (Tier 1 and Tier 2) risk-basedcapital ratios were 13.16% and 14.31%, respectively. At December 31, 2008,our Tier 1 and total risk-based capital ratios were 11.67% and 12.72%,respectively.  Our regulatory capitallevels for the Bank and bank holding company meet those established forwell-capitalized institutions.  Theincrease in our risk-based capital ratios was primarily a result of our raising$31.6 million in common equity capital during the second quarter of 2009.  This additional capital will help us tofurther penetrate our existing footprint and take advantage of bankconsolidation opportunities.

 

Thefollowing table provides additional information pertaining to our capitalratios.

 

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**Capital Components**

AtSeptember 30, 2009 and December 31, 2008

(Inthousands)

 
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **To Be Well**        | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **Capitalized Under** | ** ** |
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                       | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                       | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | ** **            | ** ** | **Ratio**  | ** ** | **Amount**            | ** ** | ** ** | ** ** | **Ratio** | ** ** |
|                                                             |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **Cardinal  Financial Corporation (Consolidated):**              |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **At  September 30, 2009**                                  |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| Total risk-based capital/  Total capital to risk-weighted assets |       | $          | 221,533    |                  | 14.31      | %                     | $          | 123,890               |       | >  |       | 8.00                  | %          | $ | 154,863 |   | >  |   | 10.00 | % |
| Tier I capital/ Tier I  capital to risk-weighted assets          |       | 203,845    |       | 13.16                 | %          | 61,945                |       | >             |       | 4.00       | %          | 92,818                |       | >  |   | 6.00 | % |
| Tier I capital/ Total  capital to average assets                 |       | 203,845    |       | 11.09                 | %          | 73,515                |       | >             |       | 4.00       | %          | 91,894                |       | >  |   | 5.00 | % |
|                                                             |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **At  December 31, 2008**                                   |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 178,420    |                  | 12.72      | %                     | $          | 112,207               |       | >  |       | 8.00                  | %          | $ | 140,259 |   | >  |   | 10.00 | % |
| Tier I capital/ Tier I  capital to risk-weighted assets          |       | 163,716    |       | 11.67                 | %          | 56,104                |       | >             |       | 4.00       | %          | 84,156                |       | >  |   | 6.00 | % |
| Tier I capital/ Total  capital to average assets                 |       | 163,716    |       | 9.90                  | %          | 66,168                |       | >             |       | 4.00       | %          | 82,711                |       | >  |   | 5.00 | % |

 
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **To Be Well**        | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | **Capitalized Under** | ** ** |
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                       | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                       | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | ** **            | ** ** | **Ratio**  | ** ** | **Amount**            | ** ** | ** ** | ** ** | **Ratio** | ** ** |
|                                                             |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **Cardinal  Bank:**                                              |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **At  September 30, 2009**                                  |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 186,180    |                  | 12.08      | %                     | $          | 123,285               |       | >  |       | 8.00                  | %          | $ | 154,107 |   | >  |   | 10.00 | % |
| Tier I capital/ Tier I  capital to risk-weighted assets          |       |       | 168,492    |                  | 10.93      | %                     | 61,643     |                  | >  |       | 4.00       | %                     | 92,464     |   | >  |   | 6.00 | % |
| Tier I capital/ Total  capital to average assets                 |       | 168,492    |       | 9.21                  | %          | 73,207                |       | >             |       | 4.00       | %          | 91,509                |       | >  |   | 5.00 | % |
|                                                             |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| **At  December 31, 2008**                                   |       |       |       |                  |       |                  |       |                  |       |       |       |                  |       |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 168,513    |                  | 12.04      | %                     | $          | 111,957               |       | >  |       | 8.00                  | %          | $ | 139,946 |   | >  |   | 10.00 | % |
| Tier I capital/ Tier I  capital to risk-weighted assets          |       | 153,810    |       | 10.99                 | %          | 55,978                |       | >             |       | 4.00       | %          | 83,968                |       | >  |   | 6.00 | % |
| Tier I capital/ Total  capital to average assets                 |       | 153,810    |       | 9.32                  | %          | 66,018                |       | >             |       | 4.00       | %          | 82,523                |       | >  |   | 5.00 | % |

 

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**ContractualObligations**

 

Wehave entered into a number of long-term contractual obligations to support ourongoing business activities. These contractual obligations will be fundedthrough operating revenues and liquidity sources held or available to us andexclude contractual interest costs, where applicable. The required paymentsunder such obligations are detailed in the following table.

 

**Contractual Obligations**

At September 30, 2009

(In thousands)

 
| ** **                                           | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|
| ** **                                           | ** ** | **Total**                  | ** ** | **Less than 1  Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
| Long-Term Debt  Obligations:                         | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit                              |       | $                          | 544,988    |   | $ | 385,517 |   | $ | 72,800 |   | $ | 85,200 |   | $ | 1,471 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Brokered certificates  of deposit                    |       | 83,553                     |       | 80,843 |   | 2,710 |   | — |   | — |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Advances from the  Federal Home Loan Bank of Atlanta |       | 280,000                    |       | 10,000 |   | 65,000 |   | 50,000 |   | 155,000 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Trust preferred  securities                          |       | 20,619                     |       | — |   | — |   | — |   | 20,619 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Operating lease  obligations                         |       | 13,982                     |       | 3,846 |   | 4,227 |   | 3,169 |   | 2,740 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Total                                                |       | $                          | 943,142    |   | $ | 480,206 |   | $ | 144,737 |   | $ | 138,369 |   | $ | 179,830 |   |

 

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

 

Weare a party to financial instruments with off-balance sheet risk to meet thefinancing needs of our customers. These financial instruments includecommitments to extend credit and standby letters of credit. Those instrumentsinvolve, to varying degrees, elements of credit risk in excess of the amountrecognized on the balance sheet.

 

TheBank’s maximum exposure to credit loss in the event of nonperformance by theother party to the financial instrument for commitments to extend credit andstandby letters of credit is represented by the contractual amount of thoseinstruments. The Bank uses the same credit policies in making commitments andconditional obligations as it does for on-balance sheet instruments.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the agreement. Commitments generallyhave expiration dates or other termination clauses and may require payment of afee. Since many of the commitments are expected to expire without being drawnupon, the total commitment amounts do

 

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notnecessarily represent future funding requirements. We evaluate each customer’scredit worthiness on a case-by-case basis. The amount of collateral obtained is based on management’s creditevaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory,property and equipment, and income-producing commercial properties.

 

Unfundedcommitments under lines of credit are commitments for possible futureextensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to whichwe have committed.

 

Standbyletters of credit are conditional commitments we issued to guarantee theperformance of the contractual obligations by a customer to a third party.Those guarantees are primarily issued to support public and private borrowingarrangements, including commercial paper, bond financing, and similartransactions. The credit risk involved in issuing standby letters of credit isessentially the same as that involved in extending loan facilities tocustomers. We hold certificates of deposit, deposit accounts, real estate orother appropriate forms of collateral supporting those commitments for whichcollateral is deemed necessary.

 

AtSeptember 30, 2009, commitments to extend credit were $440.2 million andstandby letters of credit were $14.1 million. The fair value of the liabilityassociated with standby letters of credit at September 30, 2009 was notsignificant.  Commitments to extendcredit of $96.4 million as of September 30, 2009 are related to themortgage banking segment’s pipeline and are of a short term nature.

 

Wehave counter-party risk which may arise from the possible inability of GeorgeMason’s third-party investors to meet the terms of their forward salescontracts. George Mason works with third-party investors that are generallywell-capitalized, are investment grade and exhibit strong financial performanceto mitigate this risk.  We do not expectany third-party investor to fail to meet its obligation.  In addition, we have derivative counterpartyrisk relating to certain interest rate swaps we have with third parties.  This risk may arise from the inability of thethird party to meet the terms of the contract. We continuously monitor the financial condition of these third parties.  We do not expect these third parties to failto meet their obligations.

 

GeorgeMason estimates a reserve (early pay-off reserve) for mortgage loans sold thatare repaid by the borrower within a certain number of days following the loansale, thereby requiring that George Mason refund part of the service releasepremium and/or premium pricing received from the investor pursuant to the loansale agreement.  The reserve at September 30,2009 was inconsequential.

 

GeorgeMason has a reserve for its estimated exposure to repurchase loans previouslysold to investors for which borrowers failed to provide full and accurateinformation on their loan application or for which appraisals have not beenacceptable or when the loan was not underwritten in accordance with the loanprogram specified by the loan investor. At September 30, 2009, thisreserve was immaterial.  We evaluate themerits of each claim and estimate the reserve based on actual and expectedclaims received and consider the historical amounts paid to settle such claims.

 

Inaddition, George Mason, as part of the service it provides to its managedcompanies, purchases the loans originated by managed companies at the time oforigination.  These loans are then soldby George Mason to investors.  GeorgeMason has agreements with its managed companies requiring that, for any loansthat were originated by a managed company and for which investors haverequested George Mason to repurchase due to the borrowers failure to 

 

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provide full and accurateinformation on or related to their loan application or for which appraisalshave not been acceptable, the managed company be responsible for buying backthe loan.  In the event that the managedcompany’s financial condition deteriorates and it is unable to fund therepurchase of such loans, George Mason may have to provide the funds torepurchase these loans from investors. In this instance, George Mason would establish an allowance on thereceivable from the managed company. There is no such allowance recorded at September 30, 2009 asmanagement expects to fully recover amounts owed by managed companies as ofthat date.

 

During the second quarter of2008, George Mason entered into an agreement with a mortgage correspondentrelated to the loan purchase agreement between the two parties.  The agreement provided for the release ofknown and unknown claims by the mortgage correspondent in exchange for a $1.8million payment made by George Mason to the correspondent.  The terms of this agreement require that wemay be obligated to make additional payments to the correspondent in futureperiods based on certain conditions.  Webelieve the additional exposure under this agreement is not material.  The amount of the exposure declines with thepassage of time.

 

## **Liquidity**

 

Liquidityin the banking industry is defined as the ability to meet the demand for fundsof both depositors and borrowers. We must be able to meet these needs byobtaining funding from depositors or other lenders or by converting noncashitems into cash.  The objective of ourliquidity management program is to ensure that we always have sufficientresources to meet the demands of our depositors and borrowers. Stable coredeposits and a strong capital position provide the base for our liquidityposition. We believe we have demonstrated our ability to attract depositsbecause of our convenient branch locations, personal service and pricing.

 

Inaddition to deposits, we have access to various wholesale funding markets.These markets include the brokered CD market, the repurchase agreement marketand the federal funds market. During 2008, we joined the Certificates ofDeposit Account Registry Service (“CDARS”). CDARS allows our customers to access FDIC insurance protection onmulti-million dollar certificates of deposit through our Bank.  When a customer places a large depositthrough CDARS, we place their funds into certificates of deposit with otherbanks in the CDARS network in increments of less than $250,000 so thatprincipal and interest are eligible for FDIC insurance protection.  We also maintain secured lines of credit withthe Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta.Having diverse funding alternatives reduces our reliance on any one source forfunding.

 

Cashflow from amortizing assets or maturing assets can also provide funding to meetthe needs of depositors and borrowers.

 

Wehave established a formal liquidity contingency plan which establishes a liquiditymanagement team and provides guidelines for liquidity management. For ourliquidity management program, we first determine our current liquidity positionand then forecast liquidity based on anticipated changes in the balance sheet.In this forecast, we expect to maintain a liquidity cushion. We also stresstest our liquidity position under several different stress scenarios.Guidelines for the forecasted liquidity cushion and for liquidity cushions foreach stress scenario have been established. In addition, one stress testcombines all other stress tests to see how liquidity would react to severalnegative scenarios occurring at the same time. We believe that we havesufficient resources to meet our liquidity needs.

 

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Liquidassets, which include cash and due from banks, federal funds sold andinvestment securities available for sale, totaled $354.6 million at September 30,2009 or 19% of total assets. We held investments that are classified asheld-to-maturity in the amount of $37.5 million at September 30, 2009. Tomaintain ready access to the Bank’s secured lines of credit, the Bank haspledged roughly half of its investment securities and a portion of itsresidential real estate loan portfolio to the Federal Home Loan Bank of Atlantawith additional investment securities and certain loans in its commercial realestate and commercial & industrial portfolios pledged to the FederalReserve Bank of Richmond. Additional borrowing capacity at the Federal HomeLoan Bank of Atlanta at September 30, 2009 was $2 million. Borrowingcapacity with the Federal Reserve Bank of Richmond was $383 million at September 30,2009. We anticipate maintaining liquidity at a level sufficient to protectdepositors, provide for reasonable growth and fully comply with all regulatoryrequirements.

 

##### **Interest RateSensitivity**

 

Weare exposed to various business risks including interest rate risk. Our goal isto maximize net interest income without incurring excessive interest rate risk.Management of net interest income and interest rate risk must be consistentwith the level of capital and liquidity that we maintain. We manage interest raterisk through an asset and liability committee (“ALCO”). ALCO is responsible formanaging the interest rate risk in conjunction with liquidity and capitalmanagement.

 

Weemploy an independent consulting firm to model our interest ratesensitivity.  We use a net interestincome simulation model as our primary tool to measure interest ratesensitivity. Many assumptions are developed based on expected activity in thebalance sheet. For maturing assets, assumptions are created for theredeployment of these assets. For maturing liabilities, assumptions aredeveloped for the replacement of these funding sources. Assumptions are alsodeveloped for assets and liabilities that could reprice during the modeled timeperiod. These assumptions also cover how we expect rates to change onnon-maturity deposits such as interest checking, money market checking, savingsaccounts as well as certificates of deposit. With the funding markets stilllacking liquidity, forecasts for deposit rate movements carry greater uncertaintythan when this market is functioning normally. Based on inputs that include the current balance sheet, the currentlevel of interest rates and the developed assumptions, the model then producesan expected level of net interest income assuming that market rates remainunchanged. This is considered the base case. Next, the model determines whatnet interest income would be based on specific changes in interest rates. Therate simulations are performed for a two year period and include ramped ratechanges of down 100 basis points and up 200 basis points. The down 200 basispoint scenario was discontinued given the current level of interest rates.  In the ramped down rate change, the modelmoves rates gradually down 100 basis points over the first year and then ratesremain flat in the second year.

 

Forthe up 200 basis point scenario, rates are gradually moved up 200 basis pointsin the first year and then rates remain flat in the second year. In both the upand down scenarios, the model assumes a parallel shift in the yield curve. Theresults of these simulations are then compared to the base case.

 

AtSeptember 30, 2009, we were asset sensitive for the entire two yearsimulation period.   Asset sensitivemeans that yields on the Bank’s interest-earning assets will rise faster thaninterest-bearing liability costs in a rising rate environment.  For a declining rate environment, assetyields will fall faster than interest-bearing liability costs.  Being asset sensitive our net interest incomeshould increase in a rising rate scenario. In the up 200 basis point scenario, our net interest income wouldimprove by not more than 0.5% for the one year period and by not more than 4.5%over the two year time horizon.  In thedown 100 basis point scenario the interest rate risk model indicates that ournet interest income will be nearly unchanged from the base case over the oneyear period and the two year time horizon.

 

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**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

OurAsset/Liability Committee is responsible for reviewing our liquidityrequirements and maximizing our net interest income consistent with capitalrequirements, liquidity, interest rate and economic outlooks, competitivefactors and customer needs. Interest rate risk arises because the assets of theBank and the liabilities of the Bank have different maturities andcharacteristics. In order to measure this interest rate risk, we use asimulation process that measures the impact of changing interest rates on netinterest income. This model is run for the Bank by an independent consultingfirm. The simulations incorporate assumptions related to expected activity inthe balance sheet. For maturing assets, assumptions are developed for theredeployment of these assets. For maturing liabilities, assumptions aredeveloped for the replacement of these funding sources. Assumptions are alsodeveloped for assets and liabilities that reprice during the modeled timeperiod. These assumptions also cover how we expect rates to change onnon-maturity deposits such as interest checking, money market checking, savingsaccounts as well as certificates of deposit. With the funding markets stilllacking liquidity, forecasts for deposit rate movements carry greateruncertainty than when this market is functioning normally.  Based on inputs that include the most recentperiod end balance sheet, the current level of interest rates and the developedassumptions, the model then produces an expected level of net interest incomeassuming that interest rates remain unchanged. This becomes the base case.Next, the model determines the impact on net interest income given specifiedchanges in interest rates. The rate simulations are performed for a two yearperiod and include ramped rate changes of down 100 basis points and up 200basis points. The down 200 basis point scenario was discontinued given thecurrent level of interest rates.  In theramped down rate change, the model moves rates gradually down 100 basis pointsover the first year and then rates remain flat in the second year.

 

Forthe up 200 basis point scenario, rates are gradually increased by 200 basispoints in the first year and remain flat in the second year. In both the up anddown scenarios, the model assumes a parallel shift in the yield curve. Theresults of these simulations are then compared to the base case.

 

AtSeptember 30, 2009, we were asset sensitive for the entire two yearsimulation period.   Asset sensitivemeans that yields on the Bank’s interest-earning assets will rise faster thaninterest-bearing liability costs in a rising rate environment.  For a declining rate environment, assetyields will fall faster than interest-bearing liability costs.  Being asset sensitive our net interest incomeshould increase in a rising rate environment. In the up 200 basis point scenario, our net interest income wouldimprove by not more than 0.5% for the one year period and by not more than 4.5%over the two year time horizon.  In thedown 100 basis point scenario the interest rate risk model indicates that ournet interest income will be nearly unchanged from the base case over the oneyear period and the two year time horizon.

 

Seealso “Interest Rate Sensitivity” in Item 2 above for a discussion of ourinterest rate risk.

 

Wehave counter-party risk that may arise from the possible inability of GeorgeMason’s third party investors to meet the terms of their forward salescontracts.  George Mason works withthird-party investors that are generally well-capitalized, are investment gradeand exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor tofail to meet its obligation.  Inaddition, we have derivative counterparty risk relating to certain interestrate swaps we have with a third party. This risk may arise from the inability of the third party to meet theterms of the contracts.  We monitor thefinancial condition of this third party on an annual basis.  We do not expect this third party to fail tomeet its obligation.

 

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**Item 4.  Controls and Procedures**

 

TheCompany maintains disclosure controls and procedures that are designed toensure that the information required to be disclosed by it in the reports thatit files or submits under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods requiredby the Securities and Exchange Commission, including, without limitation, thosecontrols and procedures designed to ensure that such information is accumulatedand communicated to the Company’s management to allow timely decisionsregarding required disclosures.

 

Asof the end of the period covered by this report, an evaluation of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures was carried out under the supervision and with the participationof the Company’s management, including its chief executive officer and chieffinancial officer. Based on and as of the date of such evaluation, theseofficers concluded that the Company’s disclosure controls and procedures wereeffective.

 

TheCompany also maintains a system of internal accounting controls that isdesigned to provide assurance that assets are safeguarded and that transactionsare executed in accordance with management’s authorization and are properlyrecorded. This system is continually reviewed and is augmented by writtenpolicies and procedures, the careful selection and training of qualifiedpersonnel and an internal audit program to monitor its effectiveness. Therewere no changes in our internal control over financial reporting identified inconnection with our evaluation of it that occurred during our last fiscalquarter that materially affected, or are likely to materially affect, ourinternal control over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Inthe ordinary course of our operations, we become party to various legalproceedings.  Currently, we are not partyto any material legal proceedings, and no such proceedings are, to management’sknowledge, threatened against us.

 

**Item 1A.  Risk Factors**

 

Our operations are subjectto many risks that could adversely affect our future financial condition and performanceand, therefore, the market value of our securities.  The risk factors that are applicable to usare outlined in our Annual Report on Form 10-K for the year ended December 31,2008 and our Quarterly Reports on Form 10Q for the periods ended in 2009.  There have been no materialchanges in our risk factors from those disclosed.

 

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**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

** **

(a)  None.

(b)  Not applicable.

(c)          Forthe three months ended September 30, 2009, we did not purchase shares ofour common stock.

 

**Item 3.  Defaults Upon Senior Securities**

 

(a)  None.

(b)  None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

(a)  None.

(b)  Not applicable.

(c)  None.

(d)  None.

 

**Item 5.  Other Information**

 

(a) None.

(b)  None.

 

**Item 6.  Exhibits**

 
| 10.1 |   | Amendment  to Executive Employment Agreement of Bernard H. Clineburg (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K filed July 23,  2009). |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                        |
| 31.2 |   | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                        |
| 32.1 |   | Statement  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |
| 32.2 |   | Statement of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |

 

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**SIGNATURES**

** **

**Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Report to be signed on its behalf by the undersigned thereuntoduly authorized.**

 
|                         | CARDINAL  FINANCIAL CORPORATION                                                      |
|------------------------------|--------------------------------------------------------------------------------------|
|                         | (Registrant)                                                                         |
|                         |                                                                                 |
| Date:  November 6, 2009 | /s/  Bernard H. Clineburg                                                            |
|                         | Bernard  H. Clineburg                                                                |
|                         | Chairman  and Chief Executive Officer                                                |
|                         | (Principal  Executive Officer)                                                       |
|                         |                                                                                 |
|                         |                                                                                 |
| Date:  November 6, 2009 | /s/  Mark A. Wendel                                                                  |
|                         | Mark  A. Wendel                                                                      |
|                         | Executive  Vice President and Chief Financial Officer  (Principal Financial Officer) |
|                         |                                                                                 |
|                         |                                                                                 |
| Date:  November 6, 2009 | /s/  Jennifer L. Deacon                                                              |
|                         | Jennifer  L. Deacon                                                                  |
|                         | Senior  Vice President and Controller                                                |
| ** **                   | **(Principal  Accounting Officer)**                                                  |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                           |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                 |       | Amendment  to Executive Employment Agreement of Bernard H. Clineburg (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K filed July 23,  2009). |
| 31.1                 |       | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                        |
| 31.2                 |       | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                        |
| 32.1                 |       | Statement  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |
| 32.2                 |       | Statement  of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350                                                                                             |

 

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