** **

**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q/A**

**(Amendment No. 1)**

 

**ý****Quarterly Report Pursuant toSection 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For thequarterly period ended September 30, 2004**

 

**or**

 

**o****Transition Report Pursuant to Section 13 or15(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 itscharter)

 
| **Virginia**                                                    |       | **54-1874630**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **8270 Greensboro Drive, Suite 500  McLean, Virginia**          | ** ** | **22102**                             |
| (Address of principal executive offices)                        |       | (Zip Code)                            |
|                                                            |       |                                  |
| **(703) 584-3400**                                              |
| (Registrant’s telephone number, including  area code)      |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý   No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act)

 

Yes  ý    No  o

 

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

 

18,444,739 shares of common stock, par value $1.00 per share,

outstanding as of October 31, 2004

 

 

----

 

**EXPLANATORY NOTE**

 

This Amendment No. 1 reflects the following:

 

1.               The correction of the fairvalue measurement of mortgage loans held for sale by George Mason Mortgage, LLC(“GMM”) as of July 7, 2004, the date that the Company acquired GMM.  These mortgage loans were sold at a gainprior to September 30, 2004.  Thiscorrection results in a $740,000 decrease in recorded goodwill and acorresponding decrease in gains previously recognized from the sale of held forsale loans from July 7, 2004 to September 30, 2004.

 

2.               The correction of thefair value measurement of the construction to permanent loans held for sale atGMM.  This adjustment results in a$235,000 increase to loans held for sale and a corresponding decrease to goodwill.  In addition, adjustments were recorded,unrelated to purchase accounting, to correctly state unearned fees and costsrecorded post acquisition which resulted in a decrease of $138,000 to loanservice charges, a decrease of $86,000 to salaries and benefits expense and adecrease to loans held for sale of $52,000.

 

3.               The correction of the fairvalue measurement of the pipeline of mortgage loan commitments of GMM that wereunfunded as of the purchase date.  Duringthe period from July 7, 2004 to September 30, 2004, substantially all of theseloan commitments were converted to loans held for sale and subsequently sold ata gain.  This correction results in a $455,000decrease in recorded goodwill, a $421,000 decrease in gains on the sale ofloans held for sale from July 7, 2004 to September 30, 2004, and an increase of$34,000 in loans held for sale.

 

4.               The correction of aliability and associated salary and benefits expense related to the Company’sSupplemental Employee Retirement Plan established as of the acquisition date ofGMM.  This correction results in a$235,000 increase to liabilities and a corresponding increase to salaries andbenefits expense.

 

5.               The reversal of GMMloss reserves that were recorded on loans held for sale and other fair valueadjustments.  This adjustment results ina decrease of $397,000 to goodwill, a decrease of $122,000 to the allowance forloan losses, and a decrease of $275,000 to other liabilities.

 

6.               The correction of anaccrual of management fee income at GMM to reflect actual quarter to dateSeptember 30, 2004 income.  Thisadjustment results in a $128,000 increase in non-interest income, an increase of$258,000 to other assets, and a decrease of $130,000 to goodwill.

 

7.               The correction of theSeptember 30, 2004 measurement of the fair values of derivative instruments andother accounts associated with the Company’s economic hedging of interest raterisk related to loan commitments and loans held for sale.  These adjustments result in a decrease of $17,000to the derivative asset, an increase of $546,000 to the derivative liabilityand an increase of $563,000 to loans held for sale.  The $563,000 adjustment to loans held forsale includes an increase of $586,000 in the basis of the loans as of September30, 2004 for the value of the loan commitments transferred to the loan balanceupon funding of the loan, and a lower of cost or market adjustment of $24,000as of September 30, 2004.  Thesecorrections relate to loan commitments and loans held for sale originated afterthe date of the acquisition.

 

----

 

These corrections affect, among other captions, netincome before income taxes, the provision for income taxes, the resulting netincome after tax to common shareholders and the basic and diluted earnings pershare calculations.  Beginning and endingcash and cash equivalents for all reporting periods are unchanged.

 

This report on Form 10-Q/A for the period endedSeptember 30, 2004 reflects corrections and restatements of the followingunaudited financial statements:  (a) ConsolidatedStatements of Condition at September 30, 2004 (Unaudited); (b) ConsolidatedStatements of Income (Unaudited) for the Three and Nine Months ended September30, 2004; (c) Consolidated Statements of Comprehensive Income (Loss)(Unaudited) for the Three and Nine Months ended September 30, 2004; (d)Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) for theNine Months ended September 30, 2004; and (e) Consolidated Statements of CashFlows (Unaudited) for the Nine Months ended September 30, 2004.  For a more detailed description of the correctionsand restatements, see Note 3 – “Restatement of Consolidated FinancialStatements” to the accompanying Notes to the Consolidated Financial Statementsand “Restatement of Consolidated Financial Statements” in Item 2 – “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthis report on Form 10-Q/A.  This reporton Form 10-Q/A also restates certain financial information for the applicableperiods set forth in Item 2 -  “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” and amendsItem 4 -  “Controls and Procedures.”  Other items in this report of Form 10-Q/A arenot affected by the corrections and restatements and appear unchanged from ouroriginal Form 10-Q for the period ended September 30, 2004.  The issued financial statements contained inthe Company’s original Form 10-Q for the period ended September 30, 2004, asfiled on November 22, 2004, should not be relied upon.

 

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**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q/A**

 
| **PART I – FINANCIAL INFORMATION**                                                                                                  | 2      |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                     |   |
| Item 1. Financial Statements:                                                                                                            | 2      |
|                                                                                                                                     |   |
| Consolidated Statements of Condition  At September 30, 2004 as Restated (Unaudited) and December 31, 2003                                | 2      |
|                                                                                                                                     |   |
| Consolidated Statements of Income (Unaudited)  Three and Nine Months ended September 30, 2004 as Restated and 2003                       | 3      |
|                                                                                                                                     |   |
| Consolidated Statements of Comprehensive  Income (Loss) (Unaudited)  Three and Nine Months ended September 30, 2004 as Restated and 2003 | 4      |
|                                                                                                                                     |   |
| Consolidated Statements of Changes In  Shareholders’ Equity (Unaudited)  Nine Months Ended September 30, 2004 as Restated and 2003  | 5      |
|                                                                                                                                     |   |
| Consolidated Statements of Cash Flows  (Unaudited)  Nine Months ended September 30, 2004 as Restated and 2003                            | 6      |
|                                                                                                                                     |   |
| Notes to Consolidated Financial Statements  (Unaudited) as Restated                                                                      | 7      |
|                                                                                                                                     |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                      | 20     |
|                                                                                                                                     |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                                                      | 40     |
|                                                                                                                                     |   |
| Item 4. Controls and Procedures                                                                                                          | 41     |
|                                                                                                                                     |   |
| **PART II  – OTHER INFORMATION**                                                                                                    | 43     |
|                                                                                                                                     |   |
| Item 1. Legal Proceedings                                                                                                                | 43     |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds                                                                     | 43     |
| Item 3. Defaults Upon Senior Securities                                                                                                  | 43     |
| Item 4. Submission of Matters to a Vote of  Security Holders                                                                             | 43     |
| Item 5. Other Information                                                                                                                | 43     |
| Item  6. Exhibits                                                                                                                        | 43     |
|                                                                                                                                     |   |
| **SIGNATURES**                                                                                                                           | 44     |

 

----

 

** **

**PART I****– FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OF CONDITION

 

At September 30, 2004 and December 31, 2003

 

(In thousands, except share data)

 
| ** **                                                                                                                                                                         | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                         | ** ** | **As Restated**         | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                         |       |                    |       |                   |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Cash and due from banks                                                                                                                                                            |       | $                       | 13,726     |                   | $          | 9,555 |   |
| Federal funds sold                                                                                                                                                                 |       | 25,580                  |       | 3,528                  |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total cash and cash equivalents                                                                                                                                                    |       | 39,306                  |       | 13,083                 |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Investment securities available-for-sale                                                                                                                                           |       | 159,981                 |       | 130,762                |       |
| Investment securities held-to-maturity                                                                                                                                             |       | 148,034                 |       | 142,852                |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total investment securities                                                                                                                                                        |       | 308,015                 |       | 273,614                |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Other investments                                                                                                                                                                  |       | 6,797                   |       | 3,517                  |       |
| Loans held for sale at lower of cost or  market, net                                                                                                                               |       | 347,471                 |       | —                 |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Loans receivable, net of deferred fees and  costs                                                                                                                                  |       | 438,957                 |       | 336,002                |       |
| Allowance for loan losses                                                                                                                                                          |       | (5,168                  | )          | (4,344                 | )          |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Loans receivable, net                                                                                                                                                              |       | 433,789                 |       | 331,658                |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Premises and equipment, net                                                                                                                                                        |       | 14,917                  |       | 6,707                  |       |
| Deferred tax asset                                                                                                                                                                 |       | 4,636                   |       | 4,473                  |       |
| Goodwill                                                                                                                                                                           |       | 14,725                  |       | 22                     |       |
| Accrued interest receivable and other  assets                                                                                                                                      |       | 7,659                   |       | 3,174                  |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total assets                                                                                                                                                                       |       | $                       | 1,177,315  |                   | $          | 636,248 |   |
|                                                                                                                                                                               |       |                    |       |                   |       |
| **Liabilities  and Shareholders’ Equity**                                                                                                                                     |       |                    |       |                   |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Deposits                                                                                                                                                                           |       | $                       | 819,934    |                   | $          | 474,129 |   |
| Other borrowed funds                                                                                                                                                               |       | 159,353                 |       | 74,457                 |       |
| Mortgage funding checks                                                                                                                                                            |       | 76,250                  |       | —                 |       |
| Warehouse financing                                                                                                                                                                |       | 12,596                  |       | —                 |       |
| Escrow liabilities                                                                                                                                                                 |       | 3,519                   |       | —                 |       |
| Accrued interest payable and other  liabilities                                                                                                                                    |       | 12,066                  |       | 2,250                  |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total liabilities                                                                                                                                                                  |       | 1,083,718               |       | 550,836                |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Preferred stock, $1 par value, 10,000,000  shares authorized; Series A preferred stock, cumulative convertible, 0 and 1,364,062  shares outstanding in 2004 and 2003, respectively |       | —                  |       | 1,364                  |       |
| Common stock, $1 par value, 50,000,000  shares authorized; 18,441,155 and 16,377,337 shares outstanding in 2004 and 2003,  respectively                                            |       | 18,441                  |       | 16,377                 |       |
| Additional paid-in capital                                                                                                                                                         |       | 92,792                  |       | 86,790                 |       |
| Accumulated deficit                                                                                                                                                                |       | (16,877                 | )          | (18,614                | )          |
| Accumulated other comprehensive loss                                                                                                                                               |       | (759                    | )          | (505                   | )          |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total shareholders’ equity                                                                                                                                                    |       | 93,597                  |       | 85,412                 |       |
|                                                                                                                                                                               |       |                    |       |                   |       |
| Total liabilities and shareholders’ equity                                                                                                                                    |       | $                       | 1,177,315  |                   | $          | 636,248 |   |

 

See accompanying notes to consolidated financial statements.

 

2

----

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OF INCOME

 

Three and nine months ended September 30, 2004 and 2003

(In thousands, except share and per share data)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                     | ** ** | **As Restated**                      | ** ** | ** **                          | ** ** | **As Restated** | ** ** | ** ** | ** ** |
| Interest income:                                               |       |                                 |       |                                |       |   |   |   |   |
| Loans receivable                                               |       | $                                    | 5,826      |                                | $          | 4,166 |   | $ | 15,425 |   | $ | 12,298 |   |
| Loan held for sale                                             |       | 3,268                                |       | —                              |       | 3,268 |   | — |   |
| Federal funds sold                                             |       | 49                                   |       | 17                                  |       | 96 |   | 98 |   |
| Investment securities available-for-sale                       |       | 1,536                                |       | 754                                 |       | 4,360 |   | 4,047 |   |
| Investment securities held-to-maturity                         |       | 1,432                                |       | 1,207                               |       | 4,260 |   | 1,207 |   |
| Other investments                                              |       | 78                                   |       | 35                                  |       | 162 |   | 90 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Total interest income                                          |       | 12,189                               |       | 6,179                               |       | 27,571 |   | 17,740 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Interest expense:                                              |       |                                 |       |                                |       |   |   |   |   |
| Deposits                                                       |       | 3,668                                |       | 2,062                               |       | 8,448 |   | 6,528 |   |
| Other borrowed funds                                           |       | 1,116                                |       | 279                                 |       | 1,887 |   | 470 |   |
| Warehouse financing                                            |       | 211                                  |       | —                              |       | 211 |   | — |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Total interest expense                                         |       | 4,995                                |       | 2,341                               |       | 10,546 |   | 6,998 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Net interest income                                            |       | 7,194                                |       | 3,838                               |       | 17,025 |   | 10,742 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Provision for loan losses                                      |       | 529                                  |       | 356                                 |       | 918 |   | 602 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Net interest income after provision for  loan losses           |       | 6,665                                |       | 3,482                               |       | 16,107 |   | 10,140 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Non-interest income:                                           |       |                                 |       |                                |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 296                                  |       | 238                                 |       | 798 |   | 684 |   |
| Loan service charges                                           |       | 129                                  |       | 74                                  |       | 414 |   | 342 |   |
| Investment fee income                                          |       | 150                                  |       | 184                                 |       | 498 |   | 473 |   |
| Net gain on sales of loans                                     |       | 1,398                                |       | 175                                 |       | 1,460 |   | 259 |   |
| Net realized gain on investment securities  available-for-sale |       | 3                                    |       | 291                                 |       | 245 |   | 1,201 |   |
| Management fee income                                          |       | 802                                  |       | —                              |       | 802 |   | — |   |
| Other non-interest income                                      |       | 6                                    |       | 9                                   |       | 9 |   | 35 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Total non-interest income                                      |       | 2,784                                |       | 971                                 |       | 4,226 |   | 2,994 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Non-interest expense:                                          |       |                                 |       |                                |       |   |   |   |   |
| Salary and benefits                                            |       | 4,802                                |       | 1,678                               |       | 8,904 |   | 4,869 |   |
| Occupancy                                                      |       | 932                                  |       | 317                                 |       | 1,893 |   | 1,093 |   |
| Professional fees                                              |       | 578                                  |       | 221                                 |       | 922 |   | 872 |   |
| Depreciation                                                   |       | 583                                  |       | 276                                 |       | 1,215 |   | 731 |   |
| Data processing                                                |       | 255                                  |       | 216                                 |       | 647 |   | 671 |   |
| Telecommunications                                             |       | 197                                  |       | 99                                  |       | 405 |   | 294 |   |
| Other operating expenses                                       |       | 1,546                                |       | 877                                 |       | 3,760 |   | 2,676 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Total non-interest expense                                     |       | 8,893                                |       | 3,684                               |       | 17,746 |   | 11,206 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Net income before income taxes                                 |       | 556                                  |       | 769                                 |       | 2,587 |   | 1,928 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Provision for income taxes                                     |       | 172                                  |       | —                              |       | 850 |   | — |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Net income                                                     |       | $                                    | 384        |                                | $          | 769 |   | $ | 1,737 |   | $ | 1,928 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Dividends to preferred shareholders                            |       | —                               |       | 124                                 |       | — |   | 371 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Net income to common shareholders                              |       | $                                    | 384        |                                | $          | 645 |   | $ | 1,737 |   | $ | 1,557 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Earnings per common share - basic                              |       | $                                    | 0.02       |                                | $          | 0.06 |   | $ | 0.10 |   | $ | 0.15 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Earnings per common share - diluted                            |       | $                                    | 0.02       |                                | $          | 0.06 |   | $ | 0.09 |   | $ | 0.15 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Weighted-average common shares outstanding -  basic            |       | 18,439,021                           |       | 10,072,262                          |       | 18,101,639 |   | 10,058,202 |   |
|                                                           |       |                                 |       |                                |       |   |   |   |   |
| Weighted-average common shares outstanding -  diluted          |       | 18,697,179                           |       | 10,344,977                          |       | 18,361,013 |   | 10,249,184 |   |

 

See accompanying notes to consolidated financial statements.

 

3

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and nine months ended September 30, 2004 and 2003

(Dollars in thousands)

(Unaudited)

 
| ** **                                                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                      | ** ** | **As Restated**                      | ** ** | ** **                          | ** ** | **As Restated** | ** ** | ** ** | ** ** |
|                                                                            |       |                                 |       |                                |       |   |   |   |   |
| Net income                                                                      |       | $                                    | 384        |                                | $          | 769 |   | $ | 1,737 |   | $ | 1,928 |   |
| Other comprehensive income (loss):                                              |       |                                 |       |                                |       |   |   |   |   |
| Unrealized gain (loss) on  available-for-sale investment securities:            |       |                                 |       |                                |       |   |   |   |   |
| Unrealized holding gain (loss) arising during  the period, net of tax           |       | 2,537                                |       | (2,169                              | )          | (93 | ) | (2,079 | ) |
| Less: reclassification adjustment for gains  included in net income, net of tax |       | 2                                    |       | 291                                 |       | 161 |   | 1,201 |   |
|                                                                            |       |                                 |       |                                |       |   |   |   |   |
| Comprehensive income (loss)                                                     |       | $                                    | 2,919      |                                | $          | (1,691 | ) | $ | 1,483 |   | $ | (1,352 | ) |

 

See accompanying notes toconsolidated financial statements.

 

4

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine months ended September 30, 2004 and 2003

(In thousands)

(Unaudited)

 
| ** **                                                             | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                             | ** ** | ** **            | ** ** | ** **           | ** ** | ** **         | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Balance, December  31, 2002                                            |       | 1,365                 |       | $                    | 1,365      |               | 10,044     |              | $          | 10,044                           |       | $                        | 51,231     |                                                 | $          | (24,273    | )          | $ | 2,345 |   | $ | 40,712 |   |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Stock options  exercised                                               |       | —                |       | —               |       | 32                 |       | 32                |       | 110                              |       | —                   |       | —                                               |       | 142        |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Dividends on  preferred stock                                          |       | —                |       | —               |       | —             |       | —            |       | —                           |       | (371                     | )          | —                                               |       | (371       | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Preferred stock  converted to common stock                             |       | (1                    | )          | (1                   | )          | 1                  |       | 1                 |       | —                           |       | —                   |       | —                                               |       | —     |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Change in  unrealized loss on investment securities available-for-sale |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (3,280                                               | )          | (3,280     | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Net income                                                             |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,928                    |       | —                                               |       | 1,928      |       |
| Balance,  September 30, 2003                                           |       | 1,364                 |       | $                    | 1,364      |               | 10,077     |              | $          | 10,077                           |       | $                        | 51,341     |                                                 | $          | (22,716    | )          | $ | (935 | ) | $ | 39,131 |   |
| Balance, December  31, 2003                                            |       | 1,364                 |       | $                    | 1,364      |               | 16,377     |              | $          | 16,377                           |       | $                        | 86,790     |                                                 | $          | (18,614    | )          | $ | (505 | ) | $ | 85,412 |   |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Stock options  exercised                                               |       | —                |       | —               |       | 93                 |       | 93                |       | 306                              |       | —                   |       | —                                               |       | 399        |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Public offering  shares issued                                         |       | —                |       | —               |       | 945                |       | 945               |       | 5,358                            |       | —                   |       | —                                               |       | 6,303      |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Preferred stock  converted to common stock                             |       | (1,364                | )          | (1,364               | )          | 1,026              |       | 1,026             |       | 338                              |       | —                   |       | —                                               |       | —     |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Change in  unrealized loss on investment securities available-for-sale |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (254                                                 | )          | (254       | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Net income, as  restated                                               |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,737                    |       | —                                               |       | 1,737      |       |
| Balance,  September 30, 2004, as restated                              |       | —                |       | $                    | —     |               | 18,441     |              | $          | 18,441                           |       | $                        | 92,792     |                                                 | $          | (16,877    | )          | $ | (759 | ) | $ | 93,597 |   |

 

See accompanying notes toconsolidated financial statements.

 

5

----

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

Ninemonths ended September 30, 2004 and 2003

(Inthousands)

(Unaudited)

 
| ** **                                                                                                                                                                                                | ** ** | **2004**        | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                                                                                                                                | ** ** | **As Restated** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                                                                                                                                     |       |            |       |       |       |
| Net income                                                                                                                                                                                                |       | $               | 1,737      |       | $          | 1,928 |   |
| Adjustments to reconcile net income to net  cash used in operating activities:                                                                                                                            |       |            |       |       |       |
| Depreciation                                                                                                                                                                                              |       | 1,215           |       | 731        |       |
| Amortization of premiums and discounts                                                                                                                                                                    |       | 1,557           |       | 1,719      |       |
| Provision for loan losses                                                                                                                                                                                 |       | 918             |       | 602        |       |
| Loans held for sale originated and acquired                                                                                                                                                               |       | (1,247,010      | )          | (30,318    | )          |
| Proceeds from the sale of loans held for  sale                                                                                                                                                            |       | 900,999         |       | 29,792     |       |
| Gain on sale of loans held for sale                                                                                                                                                                       |       | (1,460          | )          | (259       | )          |
| Gain on sale of investment securities  available-for-sale                                                                                                                                                 |       | (245            | )          | (1,201     | )          |
| (Increase) decrease in accrued interest  receivable, other assets, goodwill and deferred tax asset                                                                                                        |       | (19,351         | )          | 3,235      |       |
| Decrease in accrued interest payable,  escrow liabilities and other liabilities                                                                                                                           |       | (13,335         | )          | (17,879    | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Net cash used in operating activities                                                                                                                                                                     |       | (374,975        | )          | (11,650    | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Cash flows from investing activities:                                                                                                                                                                     |       |            |       |       |       |
| Purchase of premises and equipment                                                                                                                                                                        |       | (9,425          | )          | (829       | )          |
| Proceeds from sale, maturity and call of  investment securities available-for-sale                                                                                                                        |       | 23,719          |       | 88,535     |       |
| Proceeds from maturity and call of  investment securities held-to-maturity                                                                                                                                |       | 5,490           |       | —     |       |
| Proceeds from sale of other investments                                                                                                                                                                   |       | 7,442           |       | 350        |       |
| Purchase of investment securities  available-for-sale                                                                                                                                                     |       | (78,959         | )          | (222,938   | )          |
| Purchase of investment securities  held-to-maturity                                                                                                                                                       |       | (30,514         | )          | —     |       |
| Purchase of other investments                                                                                                                                                                             |       | (10,098         | )          | (2,483     | )          |
| Redemptions of investment securities  available-for-sale                                                                                                                                                  |       | 22,817          |       | 51,204     |       |
| Redemptions of investment securities  held-to-maturity                                                                                                                                                    |       | 21,089          |       | —     |       |
| Net cash acquired in acquisition                                                                                                                                                                          |       | 27,599          |       | —     |       |
| Net increase in loans receivable                                                                                                                                                                          |       | (103,592        | )          | (41,736    | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Net cash used in investing activities                                                                                                                                                                     |       | (124,432        | )          | (127,897   | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Cash flows from financing activities:                                                                                                                                                                     |       |            |       |       |       |
| Net increase in deposits                                                                                                                                                                                  |       | 345,805         |       | 35,732     |       |
| Net increase in other borrowed funds                                                                                                                                                                      |       | 27,152          |       | 27,170     |       |
| Net increase in warehouse financing and  mortgage check fundings                                                                                                                                          |       | 88,846          |       | —     |       |
| Proceeds from FHLB advances - long term                                                                                                                                                                   |       | 45,000          |       | 34,000     |       |
| Repayments of FHLB advances - long term                                                                                                                                                                   |       | (7,875          | )          | (417       | )          |
| Proceeds from public offering                                                                                                                                                                             |       | 6,303           |       | —     |       |
| Proceeds from trust preferred issuance                                                                                                                                                                    |       | 20,000          |       | —     |       |
| Stock options exercised                                                                                                                                                                                   |       | 399             |       | 142        |       |
| Dividends on preferred stock                                                                                                                                                                              |       | —          |       | (371       | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Net cash provided by financing activities                                                                                                                                                                 |       | 525,630         |       | 96,256     |       |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Net increase (decrease) in cash and cash  equivalents                                                                                                                                                     |       | 26,223          |       | (43,291    | )          |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Cash and cash equivalents at beginning of  the period                                                                                                                                                     |       | 13,083          |       | 63,371     |       |
|                                                                                                                                                                                                      |       |            |       |       |       |
| Cash and cash equivalents at end of the  period                                                                                                                                                           |       | $               | 39,306     |       | $          | 20,080 |   |
|                                                                                                                                                                                                      |       |            |       |       |       |
| **Supplemental disclosure of cash flow  information:**                                                                                                                                                    |       |            |       |       |       |
| Cash paid during the period for interest                                                                                                                                                                  |       | $               | 9,622      |       | $          | 6,924 |   |
| Cash paid for income taxes                                                                                                                                                                                |       | 80              |       | —     |       |
|                                                                                                                                                                                                      |       |            |       |       |       |
| **Supplemental schedule of noncash investing  and financing activities:**                                                                                                                                 |       |            |       |       |       |
| The Company acquired all of the issued and  outstanding membership interests of George Mason Mortgage, LLC for $17.0  million. In conjunction with the acquisition, liabilities were assumed as  follows: |       |            |       |       |       |
| Fair value of assets acquired                                                                                                                                                                             |       | $               | 356,562    |       |       |   |
| Goodwill                                                                                                                                                                                                  |       | 14,703          |       |       |       |
| Cash paid                                                                                                                                                                                                 |       | (17,000         | )          |       |       |
| Fair value of liabilities assumed                                                                                                                                                                         |       | $               | 354,265    |       |       |   |

 

See accompanying notes toconsolidated financial statements.

 

6

----

 

CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

As Restated

(Unaudited)

 

Note 1

 

*Organization*

 

Cardinal Financial Corporation (the ”Company” or “Cardinal”) wasincorporated on November 24, 1997 under the laws of the Commonwealth ofVirginia as a bank holding company whose activities consist of investment inits wholly owned subsidiaries.  TheCompany opened Cardinal Bank, N.A. (the “Bank”) in 1998 and Cardinal Wealth Services, Inc., an investmentservices subsidiary, in 1999.  In 1999,the Company opened two additional banking subsidiaries and, in late 2000,completed an acquisition of Heritage Bancorp, Inc. and its banking subsidiary,The Heritage Bank (“Heritage”).  Thesebanking subsidiaries were consolidated into the Bank as of March 1, 2002.  On April 15, 2004, the Company receivedapproval from the Federal Reserve Bank of Richmond to be a financial holdingcompany.  In December 2004, CardinalBank, N.A. converted to a state chartered institution and changed its name toCardinal Bank.

 

*Basis of Presentation*

 

In the opinion of management, the accompanyingconsolidated financial statements have been prepared in accordance with therequirements of Regulation S-X, Article 10. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. However, all adjustments that are, in the opinion of management,necessary for a fair presentation have been included.  The results of operations for the three andnine months ended September 30, 2004 are not necessarily indicative of theresults to be expected for the full year ending December 31, 2004.  The unaudited interim financial statementsshould be read in conjunction with the audited financial statements and notesto financial statements that are included in the Company’s Annual Report onForm 10-KSB for the year ended December 31, 2003 (the “2003 Form 10-KSB”).

 

Note 2

 

*Summary of Significant Accounting Policies*

* *

Thefollowing accounting policies have been updated as a result of the acquisitionof George Mason Mortgage, LLC (“GMM”). For a complete list of the Company’s significant accounting polices, seethe Notes to the Consolidated Financial Statements that are presented in the2003 Form 10-KSB.

 

**(a)Loans held for sale**

** **

Loans originated and intended for sale in thesecondary market are carried at the lower of cost or estimated fair value on anaggregate loan basis as determined by outstanding commitments frominvestors.  Net unrealized losses, ifany, are recognized through a valuation allowance by charges tooperations.  Cost basis includes unpaidprincipal

 

7

----

 

balances, origination premiums or discounts, andorigination fees and direct costs that are deferred at the time of origination.

 

**(b) Gain on sale of loans**

** **

Gains or losses on the sale of loans are recognized atthe date of settlement and are based on the difference between the sellingprice and the carrying value of the related loans sold.  Fees and direct costs originally deferredassociated with the origination of the loans held for sale are recognized as anadjustment to the gain on sale when the loans are sold.

 

**(c)Management fee income**

** **

Management fee income representsincome earned for the management and operational support provided by GMM toother mortgage banking companies (the “managed companies”).  The relationship of GMM to these managedcompanies is solely as a mortgage banking advisor.  There are no fiduciary or other specialrelationships with regard to each of the managed companies.  Fees earned by GMM are accrued monthly based onindividual contractual arrangements with each of the managed companies.  

 

**(d)Derivatives and hedging activities**

** **

The Company accounts for its derivatives and hedging activities inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, *Accounting for Derivative Instruments and Hedging Activity,*asamended by SFAS No. 138, *Accounting for CertainDerivative Instruments and Certain Hedging Activities*and SFAS No.149, *Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.* 

 

In the normal course of business, the Company enters into contractualcommitments, including loan commitments and rate lock commitments to extendcredit to finance residential mortgages. These commitments, which contain fixed expiration dates, offer theborrower an interest rate guarantee provided the loan meets underwritingguidelines and closes within the time frame established by the Company.  Interest rate risk arises on thesecommitments and subsequently closed loans if interest rates move between thetime of the interest rate lock and the delivery of the loan to theinvestor.  Loan commitments related tomortgage loans that are intended to be sold are considered derivatives inaccordance with the guidance of SEC Staff Accounting Bulletin No. 105, *Application of Accounting Principles to Loan Commitments.*Accordingly,the fair value of these derivatives at the end of the reporting period has beendetermined through an analysis of changes in market interest rates from theinterest rate lock date and the loan closing date.  

 

Tomitigate the effect of the interest rate risk inherent in providing loancommitments, the Company economically hedges its commitments by entering intobest efforts delivery forward loan sale contracts.  These forward contracts are marked to marketthrough earnings and are not designated as accounting hedges under SFAS No.133.  The change in the fair value ofloan commitments and the change in the fair value of forward sales contractsgenerally move in opposite directions and, accordingly, the impact of changesin these valuations on net income during the loan commitment period isgenerally inconsequential.  

 

Althoughthe forward loan sale contracts also serve as an economic hedge of loans heldfor sale, forward contracts have not been designated as accounting hedges under

 

8

----

 

SFASNo. 133 and, accordingly, loans held for sale are accounted for at the lower ofcost or market in accordance with SFAS No. 65, *Accountingfor Certain Mortgage Banking Activities.*

 

**(e)Business combinations**

** **

Theacquisition of GMM was accounted for as a purchase as required by SFAS No. 141 *Business Combinations.* The purchase accounting method requires thatthe cost of an acquired entity be allocated to the assets acquired andliabilities assumed based on their estimated fair values at the date ofacquisition.  The difference between thefair values and the purchase price is recorded as goodwill.  In addition, SFAS No. 141 requires thatidentified intangible assets acquired in a business combination must beseparately valued and recognized on the balance sheet if they meet certainrequirements.  As of September 30, 2004,the Company had not identified any intangible assets related to its acquisitionof GMM, but began the process of evaluating potential identifiable intangibles.  

 

**(f)Reclassifications**

** **

Certainamounts for the 2003 periods have been reclassified to conform to thepresentation for the 2004 periods.  Inaddition, we have reclassified $244,000 of salaries and benefits expense togain on loan sales from the Form 10-Q as originally filed to the Form 10-Q/A asthese were direct origination costs initially deferred until the loans weresold.

 

**(g)Stock-Based Compensation**

 

### **At September 30, 2004, the Company had twostock-based employee compensation plans, the 1999 Stock Option Plan and the2002 Equity Compensation Plan.  Theseplans are described more fully in Footnote 14 of the 2003 Form 10-KSB.**

### ** **

#### **Aspermitted under SFAS No. 148, *Accounting forStock-Based Compensation – Transition and Disclosure,* which amendedSFAS No. 123, *Accounting for Stock-BasedCompensation,* the Company has elected to continue to follow theintrinsic value method in accounting for its stock-based employee compensationarrangements as defined by Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees,*and related interpretations including Financial Accounting Standards BoardInterpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation,*an interpretationof APB No. 25.  The following tableillustrates the effect on net income and earnings per common share as if theCompany had applied the fair value recognition provisions of SFAS No. 123 tostock-based employee compensation.**

 

9

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| ** **                                                                                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)**                                                                                        | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                        | ** ** | **As Restated**                      | ** ** | ** **                          | ** ** | **As Restated** | ** ** | ** ** | ** ** |
| Net income to common shareholders                                                                                 |       | $                                    | 384        |                                | $          | 645 |   | $ | 1,737 |   | $ | 1,557 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value- based method for all awards |       | (753                                 | )          | (106                                | )          | (1,428 | ) | (434 | ) |
| Pro forma net income (loss)                                                                                       |       | $                                    | (369       | )                                   | $          | 539 |   | $ | 309 |   | $ | 1,123 |   |
|                                                                                                              |       |                                 |       |                                |       |   |   |   |   |
| Earnings (loss) per common share:                                                                                 |       |                                 |       |                                |       |   |   |   |   |
| Basic - as reported                                                                                               |       | $                                    | 0.02       |                                | $          | 0.06 |   | $ | 0.10 |   | $ | 0.15 |   |
| Basic - pro forma                                                                                                 |       | (0.02                                | )          | 0.05                                |       | 0.02 |   | 0.11 |   |
| Diluted - as reported                                                                                             |       | 0.02                                 |       | 0.06                                |       | 0.09 |   | 0.15 |   |
| Diluted - pro forma                                                                                               |       | (0.02                                | )          | 0.05                                |       | 0.02 |   | 0.11 |   |

 

The weightedaverage per share fair values of grants made for the three months endedSeptember 30, 2004 and 2003 were $3.30 and $2.80, respectively.  The weighted average per share values ofgrants made for the nine months ended September 30, 2004 and 2003 were $3.08and $2.12, respectively.  The fair valuesof the options granted were estimated as of grant date using the Black -Scholes option - pricing model based on the following weighted average assumptions:

 
| ** **              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Estimated option life   |       | 10 years                             |       | 10 years                            |       | 10 years |   | 10 years |   |
| Risk free interest rate |       | 4.29                                 | %          | 4.23                                | %          | 4.12 | % | 3.96 | % |
| Expected volatility     |       | 11.80                                | %          | 20.40                               | %          | 11.80 | % | 20.40 | % |
| Expected dividend yield |       | 0.00                                 | %          | 0.00                                | %          | 0.00 | % | 0.00 | % |

 

#### **Therewere options to purchase 219,000 and 508,518 shares of common stock grantedduring the three and nine months ended September 30, 2004, respectively.  Of those grants, 200,000 and 375,204immediately vested on the grant date for the three and nine months endedSeptember 30, 2004, respectively.**

 

Note 3

 

*Restatement of Consolidated FinancialStatements*

* *

Theunaudited Consolidated Statement of Condition at September 30, 2004, theunaudited Consolidated Statements of Income for the three and nine months endedSeptember 30, 2004, the unaudited Consolidated Statements of ComprehensiveIncome (Loss) for the three and nine months ended September 30, 2004, theunaudited Consolidated Statements of Changes in Shareholders’ Equity for thenine months ended September 30, 2004 and the unaudited Consolidated Statementsof Cash Flows for the nine months ended September 30, 2004 have been restatedto correct certain errors.  The effect ofthis restatement on net income to common shareholders for both the three andnine months ended September 30, 2004 was a

 

10

----

 

decreaseof $871,000.  Additionally, basic anddiluted earnings per share for the three months ended September 30, 2004 werecorrected to $0.02 from $0.07.  Basicearnings per share was corrected to $0.10 from $0.14 for the nine months endedSeptember 30, 2004.  Diluted earnings pershare was corrected to $0.09 from $0.14 for the nine months ended September 30,2004.  The following is a summary of theprincipal reasons for the correction and adjustments:

 

1.               The correction of thefair value measurement of mortgage loans held for sale by George MasonMortgage, LLC (“GMM”) as of July 7, 2004, the date that the Company acquiredGMM.  These mortgage loans were sold at again prior to September 30, 2004.  Thiscorrection results in a $740,000 decrease in recorded goodwill and acorresponding decrease in gains previously recognized from the sale of held forsale loans from July 7, 2004 to September 30, 2004.

 

2.               The correction of thefair value measurement of the construction to permanent loans held for sale atGMM.  This adjustment results in a$235,000 increase to loans held for sale and a corresponding decrease togoodwill.  In addition, adjustments wererecorded, unrelated to purchase accounting, to correctly state unearned feesand costs recorded post acquisition which resulted in a decrease of $138,000 toloan service charges, a decrease of $86,000 to salaries and benefits expense anda decrease to loans held for sale of $52,000.

 

3.               The correction of thefair value measurement of the pipeline of mortgage loan commitments of GMM thatwere unfunded as of the purchase date. During the period from July 7, 2004 to September 30, 2004, substantiallyall of these loan commitments were converted to loans held for sale andsubsequently sold at a gain.  Thiscorrection results in a $455,000 decrease in recorded goodwill, a $421,000decrease in gains on the sale of loans held for sale from July 7, 2004 toSeptember 30, 2004, and an increase of $34,000 in loans held for sale.

 

4.               The correction of aliability and associated salary and benefits expense related to the Company’sSupplemental Employee Retirement Plan established as of the acquisition date ofGMM.  This correction results in a$235,000 increase to liabilities and a corresponding increase to salaries andbenefits expense.

 

5.               The reversal of GMMloss reserves that were recorded on loans held for sale and other fair valueadjustments.  This adjustment results ina decrease of $397,000 to goodwill, a decrease of $122,000 to the allowance forloan losses, and a decrease of $275,000 to other liabilities.

 

6.               The correction of anaccrual of management fee income at GMM to reflect actual quarter to dateSeptember 30, 2004 income.  Thisadjustment results in a $128,000 increase in non-interest income, an increase of$258,000 to other assets, and a decrease of $130,000 to goodwill.

 

7.               The correction of theSeptember 30, 2004 measurement of the fair values of derivative instruments andother accounts associated with the Company’s economic hedging of interest raterisk related to loan commitments and loans held for sale.  These adjustments result in a decrease of$17,000 to the derivative asset, an increase of $546,000 to the derivativeliability and an increase of $563,000 to loans held for sale.  The $563,000 adjustment to loans held forsale includes an increase of $586,000 in the basis of the loans as of September30, 2004 for the value of the loan commitments transferred to the loan balanceupon funding of the loan, and a lower of cost or market adjustment of $24,000as of September 30, 2004.  Thesecorrections relate to loan commitments and loans held for sale originated afterthe date of the acquisition.

 

11

----

 

Asummary of the impact of the restatement on net income to common shareholdersfollows:

 
| ** **                                                      | ** ** | **September 30, 2004**          | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------|------------|
| **(Dollars in thousands)**                                      | ** ** | **For the Three  Months Ended** | ** ** | **For the Nine  Months Ended** | ** ** |
| Net income to common shareholders, as  previously reported      |       | $                               | 1,255      |   | $ | 2,608 |   |
| Restatement for fair value adjustment on  loans held for sale   |       | (740                            | )          | (740 | ) |
| Restatement for fair value adjustment on  unfunded commitments  |       | (421                            | )          | (421 | ) |
| Accrual of September 30, 2004 management  fee income receivable |       | 128                             |       | 128 |   |
| Accrual of Supplemental Employee Retirement  Plan expense       |       | (235                            | )          | (235 | ) |
| Restatement for fair value of construction  loans held for sale |       | (52                             | )          | (52 | ) |
| Adjustment to provision for income taxes                        |       | 449                             |       | 449 |   |
| Net income to common shareholders, as  restated                 |       | $                               | 384        |   | $ | 1,737 |   |

 

Thefollowing Notes have been amended in connection with the restatement:  Note 2 - “Summary of Significant AccountingPolicies,” Note 4 – “Acquisition,” Note 6 - “Segment Information,” and Note 7 -“Earnings Per Common Share.” 

 

Thefollowing table presents the captions from the Consolidated Statements ofCondition at September 30, 2004 that were affected by the corrections:

 

**CONSOLIDATED STATEMENTS OF CONDITION**

 

September 30, 2004

(Dollars in thousands)

 
| ** **                                           | ** ** | **September 30,  2004** | ** ** | **September 30,  2004**     | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **As Restated**         | ** ** | **As Previously  Reported** | ** ** |
| Loans held for sale at lower of cost or  market, net |       | $                       | 347,471    |                        | $          | 346,692 |   |
| Allowance for loan losses                            |       | (5,168                  | )          | (5,291                      | )          |
| Loans receivable, net                                |       | 433,789                 |       | 433,666                     |       |
| Goodwill                                             |       | 14,725                  |       | 16,682                      |       |
| Accrued interest receivable and other  assets        |       | 7,659                   |       | 7,418                       |       |
| Total assets                                         |       | 1,177,315               |       | 1,178,129                   |       |
| Accrued interest payable and other  liabilities      |       | 12,066                  |       | 12,009                      |       |
| Total liabilities                                    |       | 1,083,718               |       | 1,083,661                   |       |
| Accumulated deficit                                  |       | (16,877                 | )          | (16,006                     | )          |
| Total shareholders’ equity                      |       | 93,597                  |       | 94,468                      |       |
| Total liabilities and shareholders’ equity      |       | 1,177,315               |       | 1,178,129                   |       |
|                                                      |            |                         |            |                             |            |  |  |

 

Thefollowing table presents the captions from the Consolidated Statements ofIncome for the three and nine months ended September 30, 2004 that wereaffected by the corrections:

 

12

----

 

**CONSOLIDATED STATEMENTS OF INCOME**

Three and nine months ended September 30, 2004

(Dollars in thousands)

 
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2004**                             | ** ** | **2004**                            | ** ** | **2004** | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **As Restated**                      | ** ** | **As Previously  Reported**         | ** ** | **As Restated** | ** ** | **As Previously  Reported** | ** ** |
| Non-interest income:                |       |                                 |       |                                |       |   |   |   |   |
|                                |       |                                 |       |                                |       |   |   |   |   |
| Loan service charges                |       | $                                    | 129        |                                | $          | 267 |   | $ | 414 |   | $ | 552 |   |
| Net gain on sales of loans          |       | 1,398                                |       | 2,802                               |       | 1,460 |   | 2,864 |   |
| Management fee income               |       | 802                                  |       | 674                                 |       | 802 |   | 674 |   |
| Total non-interest income           |       | 2,784                                |       | 4,198                               |       | 4,226 |   | 5,640 |   |
|                                |       |                                 |       |                                |       |   |   |   |   |
| Non-interest expense:               |       |                                 |       |                                |       |   |   |   |   |
| Salary and benefits                 |       | 4,802                                |       | 4,896                               |       | 8,904 |   | 8,998 |   |
| Total non-interest expense          |       | 8,893                                |       | 8,987                               |       | 17,746 |   | 17,840 |   |
| Net income before income taxes      |       | 556                                  |       | 1,876                               |       | 2,587 |   | 3,907 |   |
| Provision for income taxes          |       | 172                                  |       | 621                                 |       | 850 |   | 1,299 |   |
| Net income                          |       | 384                                  |       | 1,255                               |       | 1,737 |   | 2,608 |   |
| Earnings per common share - basic   |       | $                                    | 0.02       |                                | $          | 0.07 |   | $ | 0.10 |   | $ | 0.14 |   |
| Earnings per common share - diluted |       | $                                    | 0.02       |                                | $          | 0.07 |   | $ | 0.09 |   | $ | 0.14 |   |

 

The following table presents the captions from the ConsolidatedStatements of Other Comprehensive Income (Loss) for the three and nine monthsended September 30, 2004 that were affected by the corrections:

 

**CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOME (LOSS)**

Three and nine months ended September 30, 2004 and 2003

(Dollars in thousands)

 
| ** **           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **           | ** ** | **2004**                             | ** ** | **2004**                            | ** ** | **2004** | ** ** | **2004** | ** ** |
| ** **           | ** ** | **As Restated**                      | ** ** | **As Previously  Reported**         | ** ** | **As Restated** | ** ** | **As Previously  Reported** | ** ** |
| Net income           |       | $                                    | 384        |                                | $          | 1,255 |   | $ | 1,737 |   | $ | 2,608 |   |
| Comprehensive income |       | 2,919                                |       | 3,790                               |       | 1,483 |   | 2,354 |   |
|                      |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |

 

13

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The following table presents the captions from the ConsolidatedStatement of Changes in Shareholders’ Equity for the nine months endedSeptember 30, 2004 that were affected by the corrections:

 

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

Nine months ended September 30,2004 and 2003

 

(In thousands)

 
| ** **                      | ** ** | **As Restated** | ** ** | **As Previously  Reported** | ** ** |
|---------------------------------|------------|-----------------|------------|-----------------------------|------------|
|                            |       |            |       |                        |       |
| Accumulated deficit             |       | $               | (16,877    | )                           | $          | (16,006 | ) |
|                            |       |            |       |                        |       |
| Total shareholders’ equity |       | 93,597          |       | 94,468                      |       |
|                                 |            |                 |            |                             |            |  |  |

 

Thefollowing table presents the captions of the Consolidated Statements of CashFlows for the nine months ended September 30, 2004 that were affected by thecorrections:

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

Nine Months Ended September 30,2004

 
| ** **                           | ** ** | **As Restated** | ** ** | **As Previously  Reported** | ** ** |
|--------------------------------------|------------|-----------------|------------|-----------------------------|------------|
|                                 |       |            |       |                        |       |
| Cash flows from operating activities |       | $               | (374,975   | )                           | $          | (374,984 | ) |
|                                 |       |            |       |                        |       |
| Cash flows from investing activities |       | (124,432        | )          | (150,003                    | )          |
|                                      |            |                 |            |                             |            |  |  |

 

**Supplementalschedule of noncash investing and financing activities:**

The Company acquired all ofthe issued and outstanding membership interests of George Mason Mortgage, LLCfor $17.0 million. In conjunction with the acquisition, liabilities wereassumed as follows:

 
| Fair value of assets acquired     |   | $       | 356,562 |    | $      | 372,725 |   |
|-----------------------------------|--------|---------|---------|---------|--------|---------|--------|
| Goodwill                          |   | 14,703  |    | 16,682  |   |
| Cash paid                         |   | (17,000 | )       | (17,000 | )      |
| Downstream of capital to GMM      |   | —  |    | (8,000  | )      |
| Fair value of liabilities assumed |   | $       | 354,265 |    | $      | 364,407 |   |

 

14

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Note 4

 

*Acquisition*

 

Effective July 7, 2004, the Bank completed its acquisition of GMM fromUnited Bank – Virginia, a wholly owned subsidiary of United Bankshares,Inc.  GMM was acquired in a cashtransaction for $17.0 million and is operating as a subsidiary of theBank.  This transaction was accounted foras a purchase and GMM’s assets and liabilities were recorded at fair value asof the purchase date.  GMM’s operatingresults are included in the consolidated results since the date of theacquisition.  This transaction resultedin the recognition of $14.7 million of goodwill, as restated.  GMM’s primary sources of revenue include netinterest income earned on loans held for sale, gain on the sale of loans andmanagement fees earned.  Loans are madepursuant to purchase commitments and are sold servicing released.  The Bank purchased GMM primarily to diversifyits sources of income and increase non-interest income and to provide forincreased residential loans for its portfolio.

 

The following unaudited pro forma condensed combined financialinformation presents the results of operations of the Company as if GMM hadbeen acquired on January 1, 2003.

 
| ** **                                           | ** ** | **Three Months Ended  September 30, 2004** | ** **             | **Nine Months Ended** | ** **             |
|------------------------------------------------------|------------|--------------------------------------------|------------------------|-----------------------|------------------------|
| **(Dollars in thousands)**                           | ** ** | ** **                                 | **September 30, 2004** | ** **            | **September 30, 2003** | ** ** |
| ** **                                           | ** ** | ** **                                 | ** **             | ** **            | ** **             | ** ** | ** ** |
| Net interest income                                  |       | $                                          | 7,308                  |                  | $                      | 21,146 |   | $ | 17,422 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Non-interest income                                  |       | 4,605                                      |                   | 23,157                |                   | 31,277 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Provision for loan losses                            |       | 529                                        |                   | 918                   |                   | 602 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Non-interest expense                                 |       | 9,415                                      |                   | 35,698                |                   | 34,935 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Net income before income taxes                       |       | 1,969                                      |                   | 7,687                 |                   | 13,162 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Provision for income taxes                           |       | 652                                        |                   | 2,365                 |                   | 5,091 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Net income                                           |       | $                                          | 1,317                  |                  | $                      | 5,322 |   | $ | 8,071 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Earnings per common share - basic                    |       | $                                          | 0.07                   |                  | $                      | 0.30 |   | $ | 0.31 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Earnings per common share - diluted                  |       | 0.07                                       |                   | 0.29                  |                   | 0.31 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Weighted-average common shares outstanding  -basic   |       | 18,439,021                                 |                   | 18,101,639            |                   | 10,058,202 |   |
|                                                 |       |                                       |                   |                  |                   |   |   |
| Weighted-average common shares outstanding  -diluted |       | 18,697,179                                 |                   | 18,361,013            |                   | 11,272,231 |   |

 

Thepurchase price is allocated to identifiable tangible and intangible assets attheir fair values. Any portion of the purchase price that cannot be assigned tospecifically identifiable tangible and intangible assets acquired lessliabilities assumed is recorded as goodwill. 

 

Thefollowing table provides a reconciliation of the excess cost of the acquisitionto the Company over the fair value of net assets acquired from GMM (inthousands):

 

15

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| Cash paid by the  Company                                    |   | $      | 17,000 |   |
|--------------------------------------------------------------|--------|--------|--------|--------|
| Fair value of  loans held for sale                           |   | (1,204 | )      |
| Fair value of  construction to permanent loans held for sale |   | (235   | )      |
| Fair value of  unfunded commitments                          |   | (455   | )      |
| Fair value of  reserve for loans losses                      |   | (397   | )      |
| Fair value of  management fee accrual                        |   | (130   | )      |
| Merger costs                                                 |   | 124    |   |
| Goodwill                                                     |   | $      | 14,703 |   |

 

Thetotal fair value adjustments at July 7, 2004 for loans held for sale resultedin an adjustment of $1.9 million. Included in the fair value adjustment was a $1.2 million increase inmortgage loans held for sale, $455,000 of fair value attributable to theacquired pipeline and a $235,000 fair value adjustments to construction topermanent loans held for sale.   Also,fair value adjustments of $122,000 related to the removal of an allowance forloan losses recorded on loans held for sale and a $275,000 reduction of theother loss reserves were recorded in other liabilities.  In addition, a fair value adjustment of$130,000 was recorded for management fee income that was earned by GMM prior tothe acquisition.

 

Noadjustments were recorded for GMM’s other borrowed funds, as they weredetermined to be at fair value as all borrowed funds are short term and havevariable interest rates tied to the Federal Reserve’s discount rate.  All other assets and liabilities of GMM arecurrent assets and liabilities and were determined to be recorded at their fairvalues.

 

### Note 5

###  

*TrustPreferred Securities*

 

In July 2004, the Companyformed a new wholly-owned subsidiary, Cardinal Statutory Trust I (the “Trust”),for the purpose of issuing $20.0 million of floating rate junior subordinateddeferrable interest debentures (“trust preferred securities”).  These trust preferred securities are due in2034 and have an interest rate of LIBOR (London Interbank Offering Rate) plus2.40%, which adjusts quarterly.  Thesesecurities are redeemable at a premium through March 2008 and at parthereafter.  The Company has guaranteedpayment of these securities.  The $20.6million payable by the Company to the Trust is included in other borrowed fundsin the Consolidated Statements of Condition. The Trust is an unconsolidated subsidiary since the Company is not theprimary beneficiary of this entity under FIN 46R.  The additional $619,000 that is payable bythe Company to the Trust relates to the capital of the Trust.  The Company utilized the proceeds from theissuance of the trust preferred securities to make a capital contribution intothe Bank.

 

16

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### Note 6

###  

# *Segment Information*

# * *

In 2003 and forthe first six months of 2004, the Company operated and reported in two businesssegments, commercial banking and investment services.  As of July 7, 2004, the Company beganoperating in a third business segment, mortgage banking, with the completion ofits acquisition of GMM.  The commercialbanking segment includes both commercial and consumer lending and providescustomers such products as commercial loans, real estate loans, and otherbusiness financing and consumer loans. In addition, this segment also provides customers with several choicesof deposit products including demand deposit accounts, savings accounts andcertificates of deposit.  The mortgagebanking segment engages primarily in the origination and acquisitionof residential mortgages for sale into the secondary market on a best effortsbasis.  The investment services segment provides advisoryservices to businesses and individuals, including financial planning andretirement/estate planning.

 

Information aboutthe reportable segments, and reconciliation of this information to theconsolidated financial statements at and for the three and nine months endedSeptember 30, 2004 and 2003, follows:

 

**At and for the Three Months Ended September 30, 2004, asrestated:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 5,716      |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (105 | ) | $ | 7,194 |   |
| Provision for  loan losses  |       | 529                     |       | —                |       | —                   |       | —                        |       | —    |       | 529              |       |
| Non-interest  income        |       | 325                     |       | 2,304                 |       | 150                      |       | —                        |       | 5         |       | 2,784            |       |
| Non-interest  expense       |       | 4,239                   |       | 4,156                 |       | 189                      |       | —                        |       | 309       |       | 8,893            |       |
| Provision for  income taxes |       | 402                     |       | (76                   | )          | (15                      | )          | —                        |       | (155      | )          | 172              |       |
| Net income  (loss)          |       | $                       | 871        |                  | $          | (193                     | )          | $                             | (24        | )         | $          | —           |       | $ | (254 | ) | $ | 384 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 356,438                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,177,315 |   |

 

**At andfor the Three Months Ended September 30, 2003:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 3,815      |                  | $          | —                   |       | $                             | —     |      | $          | —           |       | $ | 23 |   | $ | 3,838 |   |
| Provision for  loan losses  |       | 356                     |       | —                |       | —                   |       | —                        |       | —    |       | 356              |       |
| Non-interest  income        |       | 787                     |       | —                |       | 184                      |       | —                        |       | —    |       | 971              |       |
| Non-interest  expense       |       | 3,196                   |       | —                |       | 217                      |       | —                        |       | 271       |       | 3,684            |       |
| Provision for  income taxes |       | —                  |       | —                |       | —                   |       | —                        |       | —    |       | —           |       |
| Net income  (loss)          |       | $                       | 1,050      |                  | $          | —                   |       | $                             | (33        | )         | $          | —           |       | $ | (248 | ) | $ | 769 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 560,418    |                  | $          | —                   |       | $                             | 229        |      | $          | (36,759          | )          | $ | 39,460 |   | $ | 563,348 |   |

 

17

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**At andfor the Nine Months Ended September 30, 2004:**

 

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 15,493     |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (51 | ) | $ | 17,025 |   |
| Provision for  loan losses  |       | 918                     |       | —                |       | —                   |       | —                        |       | —    |       | 918              |       |
| Non-interest  income        |       | 1,430                   |       | 2,304                 |       | 487                      |       | —                        |       | 5         |       | 4,226            |       |
| Non-interest  expense       |       | 12,017                  |       | 4,156                 |       | 613                      |       | —                        |       | 960       |       | 17,746           |       |
| Provision for  income taxes |       | 1,313                   |       | (76                   | )          | (45                      | )          | —                        |       | (358      | )          | 850              |       |
| Net income  (loss)          |       | $                       | 2,675      |                  | $          | (193                     | )          | $                             | (81        | )         | $          | —           |       | $ | (648 | ) | $ | 1,737 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 356,438                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,177,315 |   |

 

**At andfor the Nine Months Ended September 30, 2003:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 10,666     |                  | $          | —                   |       | $                             | —     |      | $          | —           |       | $ | 76 |   | $ | 10,742 |   |
| Provision for  loan losses  |       | 602                     |       | —                |       | —                   |       | —                        |       | —    |       | 602              |       |
| Non-interest  income        |       | 2,521                   |       | —                |       | 473                      |       | —                        |       | —    |       | 2,994            |       |
| Non-interest  expense       |       | 9,801                   |       | —                |       | 548                      |       | —                        |       | 857       |       | 11,206           |       |
| Provision for  income taxes |       | —                  |       | —                |       | —                   |       | —                        |       |      |       |             |       |
| Net income  (loss)          |       | $                       | 2,784      |                  | $          | —                   |       | $                             | (75        | )         | $          | —           |       | $ | (781 | ) | $ | 1,928 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 560,418    |                  | $          | —                   |       | $                             | 229        |      | $          | (36,759          | )          | $ | 39,460 |   | $ | 563,348 |   |

 

At September 30,2004, the Company did not have any operating segments other than thosereported.  Parent company financialinformation is included in the “Other” category and represents an overheadfunction rather than an operating segment. The parent company’s most significant assets are its net investments inits subsidiaries.  The parent company’snet interest income is comprised of interest income from short-term investmentsand interest expense on trust preferred securities.

 

#### Note 7

####  

##### *EarningsPer Common Share*

##### * *

The following isthe calculation of basic and diluted earnings per common share for the threeand nine months ended September 30, 2004 and 2003. Stock options outstanding atSeptember 30, 2004 and 2003 were 1,245,625 and 861,237, respectively.  Stock options issued that were not includedin the calculation of diluted earnings per share because the exercise priceswere greater than the average market price were 29,000 and 3,545 for the threemonths ended September 30, 2004 and 2003, respectively.  Stock options issued that were not includedin the calculation of diluted earnings per share because the exercise priceswere greater than the average market price were 22,000 and 15,507 for the ninemonths ended September 30, 2004 and 2003, respectively.

 

18

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| **(Dollars in thousands,**                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **except share and per share  data)**     | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **As Restated**                      | ** ** | ** **                          | ** ** | **As Restated** | ** ** | ** ** | ** ** |
| Net income                                |       | $                                    | 384        |                                | $          | 769 |   | $ | 1,737 |   | $ | 1,928 |   |
| Dividends to  preferred shareholders      |       | —                               |       | 124                                 |       | — |   | 371 |   |
| Net income to  common shareholders        |       | $                                    | 384        |                                | $          | 645 |   | $ | 1,737 |   | $ | 1,557 |   |
| Weighted average  common shares - basic   |       | 18,439,021                           |       | 10,072,262                          |       | 18,101,639 |   | 10,058,202 |   |
| Weighted average  common shares - diluted |       | 18,697,179                           |       | 10,344,977                          |       | 18,361,013 |   | 10,249,184 |   |
| Earnings per  common share - basic        |       | $                                    | 0.02       |                                | $          | 0.06 |   | $ | 0.10 |   | $ | 0.15 |   |
| Earnings per  common share - diluted      |       | $                                    | 0.02       |                                | $          | 0.06 |   | $ | 0.09 |   | $ | 0.15 |   |

 

Note 8

 

##### *WarehouseFinancing*

##### * *

In September 2004,GMM and the Bank entered into a one year $150 million floating rate revolvingcredit and security agreement with a third party.  The purpose of this credit facility is tofund residential mortgage loans at GMM pending their sale into the secondarymarket.  The credit facility requires,among other things, that GMM and the Bank have positive quarterly net incomeand maintain specified minimum tangible and regulatory net worth requirements.  The Company has guaranteed repayment of thisdebt and is also required to maintain a minimum tangible net worthrequirement.  The interest rate on thiscredit facility is LIBOR plus between 1.50% and 1.875%.

 

In addition tothis facility, the same lender has also provided a $100 million facility thatis utilized by GMM to warehouse residential mortgage loans pending sale to thislender.  The terms of this facility aresubstantially the same as the above-referenced revolving credit and securityagreement and the cost of this facility is netted against interest earned onthe loans pending settlement with the lender.

 

GMM also has a$60.0 million line of credit with an unaffiliated party, which it uses towarehouse loans pending sale.  This linematures on December 7, 2004 and has an interest rate of LIBOR plus 1.50%.

 

19

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

The following presents management’s discussionand analysis of our consolidated financial condition at September 30, 2004, asrestated,  and December 31, 2003 and theresults of our operations for the three and nine months ended September 30,2004 and 2003.  This discussion should beread in conjunction with our unaudited consolidated financial statements andthe notes thereto appearing elsewhere in this report and the Company’s AnnualReport on Form 10-KSB for the year ended December 31, 2003.

 

**Restatementof Consolidated Financial Statements**

 

Theunaudited Consolidated Statements of Condition at September 30, 2004, theunaudited Consolidated Statements of Income for the three and nine months endedSeptember 30, 2004, the unaudited Consolidated Statements of ComprehensiveIncome (Loss) for the three and nine months ended September 30, 2004, theunaudited Consolidated Statements of Changes in Shareholders’ Equity for thenine months ended September 30, 2004 and the unaudited Consolidated Statementsof Cash Flows for the nine months ended September 30, 2004 have been restatedto correct certain errors.  The effect ofthis restatement on net income to common shareholders for both the three andnine months ended September 30, 2004 was a decrease of $871,000.  Additionally, basic and diluted earnings pershare for the three months ended September 30, 2004 were corrected to $0.02from $0.07.  Basic earnings per share wascorrected to $0.10 from $0.14 for the nine months ended September 30, 2004.  Diluted earnings per share was corrected to$0.09 from $0.14 for the nine months ended September 30, 2004.  The following are the principal reasons forthe correction and adjustments:

 

1.               The correction of thefair value measurement of mortgage loans held for sale by George MasonMortgage, LLC (“GMM”) as of July 7, 2004, the date that the Company acquired GMM.  These mortgage loans were sold at a gainprior to September 30, 2004.  Thiscorrection results in a $740,000 decrease in recorded goodwill and acorresponding decrease in gains previously recognized from the sale of held forsale loans from July 7, 2004 to September 30, 2004.

 

2.               The correction of thefair value measurement of the construction to permanent loans held for sale atGMM.  This adjustment results in a$235,000 increase to loans held for sale and a corresponding decrease togoodwill.  In addition, adjustments wererecorded, unrelated to purchase accounting, to correctly state unearned feesand costs recorded post acquisition which resulted in a decrease of $138,000 toloan service charges, a decrease of $86,000 to salaries and benefits expense anda decrease to loans held for sale of $52,000.

 

3.               The correction of thefair value measurement of the pipeline of mortgage loan commitments of GMM thatwere unfunded as of the purchase date. During the period from July 7, 2004 to September 30, 2004, substantiallyall of these loan commitments were converted to loans held for sale andsubsequently sold at a gain.  Thiscorrection results in a $455,000 decrease in recorded goodwill, a $421,000decrease in gains on the sale of loans held for sale from July 7, 2004 toSeptember 30, 2004, and an increase of $34,000 in

 

20

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loans held for sale.

 

4.               The correction of aliability and associated salary and benefits expense related to the Company’sSupplemental Employee Retirement Plan established as of the acquisition date ofGMM.  This correction results in a$235,000 increase to liabilities and a corresponding increase to salaries andbenefits expense.

 

5.               The reversal of GMMloss reserves that were recorded on loans held for sale and other fair valueadjustments.  This adjustment results ina decrease of $397,000 to goodwill, a decrease of $122,000 to the allowance forloan losses, and a decrease of $275,000 to other liabilities.

 

6.               The correction of anaccrual of management fee income at GMM to reflect actual quarter to dateSeptember 30, 2004 income.  Thisadjustment results in a $128,000 increase in non-interest income, an increase of$258,000 to other assets, and a decrease of $130,000 to goodwill.

 

7.               The correction of theSeptember 30, 2004 measurement of the fair values of derivative instruments andother accounts associated with the Company’s economic hedging of interest raterisk related to loan commitments and loans held for sale.  These adjustments result in a decrease of$17,000 to the derivative asset, an increase of $546,000 to the derivativeliability and an increase of $563,000 to loans held for sale.  The $563,000 adjustment to loans held forsale includes an increase of $586,000 in the basis of the loans as of September30, 2004 for the value of the loan commitments transferred to the loan balanceupon funding of the loan, and a lower of cost or market adjustment of $24,000as of September 30, 2004.  Thesecorrections relate to loan commitments and loans held for sale originated afterthe date of the acquisition.

 

These corrections affect, among other captions, netincome before income taxes, the provision for income taxes, the resulting netincome after tax to common shareholders and the basic and diluted earnings pershare calculations.  Beginning and endingcash and cash equivalents for all reporting periods are unchanged.

 

For more information on the corrections andrestatements, see Note 3 – “Restatement of Consolidated Financial Statements”to the Notes to the Consolidated Financial Statements.

 

**Overview**

 

CardinalFinancial Corporation, a financial services organization headquartered inTysons Corner, Virginia, is committed to providing top quality customerservice, a diversified product mix and convenient venues for banking toconsumers and businesses.  We ownCardinal Bank (the “Bank”), a state chartered community bank, Cardinal WealthServices, Inc., an investment services subsidiary, George Mason Mortgage, LLC,a mortgage banking subsidiary, and Cardinal Statutory Trust I, the issuer of$20.0 million of floating rate junior subordinated deferrable interestdebentures (“trust preferred securities”). Through these subsidiaries, we offer a wide range of banking productsand services to both our commercial and retail customers.  Our commercial relationship managers focus onattracting small and medium-sized businesses as well as commercial real estatedevelopers and builders and professionals, such as physicians, accountants andattorneys.  We have an eighteen locationretail branch banking network and provide competitive retail products andservices.  We complement our core bankingoperations by offering investment products and services to our customers throughour third-party brokerage relationship.

 

21

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OnJuly 7, 2004, the Company acquired GMM, from United Bank – Virginia, a whollyowned subsidiary of United Bankshares, Inc. in a cash transaction for $17.0million.  This transaction resulted inthe recognition of $14.7 million of goodwill. This transaction was accounted for as a purchase, and GMM’s assets andliabilities were recorded at fair value as of the purchase date.  GMM’s operating results are included in theconsolidated results since the date of the acquisition.  GMM, based in Fairfax, Virginia, engagesprimarily in the origination and acquisition of residential mortgages for saleinto the secondary market on a best efforts basis through nine branches locatedthroughout the metropolitan Washington region. GMM has approximately 200 employees and does business in eight states,including Virginia, Maryland and the District of Columbia.  GMM is one of the significant residentialmortgage originators in the greater Washington metropolitan area, reportingoriginations of over $4 billion in 2003 and $2 billion in 2002.  GMM’s primary sources of revenueinclude net interest income earned on loans pending sale, gain on the sale ofloans and management fees earned relating to the management of other entities’portfolios.  Loans are made pursuant topurchase commitments and are sold servicing released.

 

In July 2004, the Companyformed a wholly-owned subsidiary, Cardinal Statutory Trust I, for the purposeof issuing $20.0 million of floating rate junior subordinated deferrableinterest debentures (“trust preferred securities”).  These trust preferred securities are due in2034 and have an interest rate of LIBOR (London Interbank Offering Rate) plus2.40%, which adjusts quarterly.  Thesesecurities are redeemable at a premium through March 2008 and at parthereafter.  The Company has guaranteedpayment of these securities.  The $20.6million payable by the Company to Cardinal Statutory Trust I is included inother borrowed funds in the Consolidated Statements of Condition since CardinalStatutory Trust I is an unconsolidated subsidiary as the Company is not theprimary beneficiary of this entity.  TheCompany utilized the proceeds from the issuance of the trust preferredsecurities to make a capital contribution into the Bank.

 

Net interest income has beenour primary source of income.  With theaddition of GMM, our sources of non-interest income have significantlyincreased and diversified our sources of income.  As discussed further in the interest rate sensitivitysection, we attempt to manage our balance sheet and interest rate risk toenhance and stabilize our net interest income over time.  We do this by monitoring the spread betweenthe interest rates earned on investment securities and loans and the interestrates paid on deposits and other interest-bearing liabilities.  Changes in interest rates may, nevertheless,affect our operating performance and financial condition.  We attempt to minimize our exposure tointerest rate risk, but, because of marketplace uncertainties, inherentlimitations in modeling techniques and the changing nature of the financialservices industry, we are unable to eliminate it.   In addition to management of interest raterisk, we analyze our loan portfolio for exposure to credit risk.  Risk of loan defaults and foreclosures areunavoidable in the banking industry and we try to limit our exposure to thisrisk by monitoring our extensions of credit carefully.  In addition to net interest income,non-interest income is a source of income for us and includes service chargeson deposits and loans, investment fee income, management fees and gains on thesale of loans held for sale and on sales of investment securitiesavailable-for-sale.

 

Ourbusiness strategy, which may change because of changes in the businessenvironment in which we operate, is to grow through geographic expansion whilemaintaining strong asset quality and achieving sustained profitability.  We completed a secondary common stockoffering that raised $41.7 million in equity capital in December 2003 and anadditional $6.3 million in capital following the exercise of the underwriters’over-allotment option in January 2004. This capital is being used to support the expansion of our branch officenetwork and balance sheet growth.  Wewere able to increase our legal lending limit to over $12 million,

 

22

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which has allowed us to expand our commercial andreal estate lending loan portfolios.  Weexpect to increase our loan-to-deposit ratio and shift the mix of our earningassets to higher yielding loans.  We used$17.0 million of the cash that was raised in December 2003 and January 2004 toacquire GMM.  GMM adds to our plans toincrease our selection of banking products and financial services and diversifyour revenue base, increase fee income, and strengthen customer relationships.

 

**Critical Accounting Policies**

 

U.S. generallyaccepted accounting principles are complex and require management to applysignificant judgment to various accounting measurement, reporting, anddisclosure matters.  Management must usejudgment, assumptions and estimates to apply these principles where precisemeasurements are not possible or practical. These policies are critical because they are highly dependent uponsubjective or complex judgments, assumptions and estimates.  Changes in such judgments, assumptions andestimates may have a significant impact on the consolidated financialstatements.  Actual results couldtherefore differ from those reported.

 

The accountingpolicies we view as critical are those relating to our business combination,the determination of the allowance for loan losses, the valuation of deferredtax assets and hedging.

 

#### *Accounting for Business Combinations*

####  

Weaccount for acquisitions of other businesses in accordance with FASB StatementNo. 141, *Business Combinations. *This statement mandates the use ofpurchase accounting and, accordingly, assets and liabilities, includingpreviously unrecorded assets and liabilities, are recorded at fair values as ofthe acquisition date.  We utilize avariety of valuation methods to estimate fair value of acquired assets andliabilities.  These methodologies areoften based upon assumptions and estimates which may change at a future dateand require that the carrying amount of assets and liabilities acquired beadjusted.  The difference between thefair value of assets acquired less the fair value of liabilities acquired isrecorded as goodwill.  Goodwill and anyother intangible assets are accounted for in accordance with FASB Statement No.142, *Goodwill and Other Intangible Assets. *In accordance with this statement,goodwill will not be amortized but will be tested on at least an annual basisfor impairment.

 

#### *Allowance for Loan Losses*

####  

We maintain the allowancefor loan losses at a level that represents management’s best estimate of knownand probable losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loanlosses are impacted by many factors, including general economic conditions,actual and expected credit losses, historical trends and the specificconditions of individual borrowers.  As apart of our analysis, we use comparative peer group data, duration factors andqualitative factors such as levels of and trends in delinquencies andnonaccrual loans, national and local economic trends and conditions andconcentrations of loans exhibiting similar risk profiles to support ourestimates.

 

Credit losses are aninherent part of our business and, although we believe the methodologies fordetermining the allowance for loan losses and the current level of theallowance are adequate, it is possible that there may be unidentified losses inthe portfolio that may become evident at a future date pursuant to additionalanalysis or regulatory comment. Additional provisions for such losses, if necessary, would be recordedin the commercial banking or mortgage banking segment, as appropriate, andwould negatively impact earnings.

 

23

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For purposes of ouranalysis, we categorize our loans into one of five categories:  commercial and industrial, commercial realestate, home equity lines of credit, residential mortgages and consumer.  Peer group annual loss factors (in theabsence of historical results) are applied to all categories and are adjustedby the projected duration of the loans in a particular category and by thequalitative factors mentioned above.  Theindicated loss factors resulting from this analysis are applied to each of theloan categories to determine a reserve level for each of the five categories ofloans.  In addition, we individuallyassign loss factors to all loans that have been identified as having lossattributes, as indicated by deterioration in the financial condition of theborrower or a decline in underlying collateral values.  Since we have limited historical data onwhich to base loss factors for classified loans, we apply, in accordance withregulatory guidelines, a 5% loss factor to all special mention loans, a 15%loss factor to all substandard loans and a 50% loss factor to all loansclassified as doubtful. Loans classified as loss loans are fully reserved orcharged off.

 

#### *Valuation of Deferred Tax Assets*

####  

We record a provision for income tax expense based onthe amounts of current taxes payable (or refundable) and the change in netdeferred tax assets or liabilities during the year.  Deferred tax assets and liabilities arerecognized for the tax effects of differing carrying values of assets andliabilities for tax and financial statement purposes that will reverse infuture periods.  When substantialuncertainty exists concerning the recoverability of a deferred tax asset, thecarrying value of the asset is reduced by a valuation allowance.

 

*Hedging*

 

We account for ourderivatives and hedging activities in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 133, *Accounting for DerivativeInstruments and Hedging Activity*, as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities* and SFAS No. 149, *Amendment of Statement 133on Derivative Instruments and Hedging Activities*.

 

In the normal course ofbusiness, we enter into contractual commitments, including loan commitments andrate lock commitments to extend credit to finance residential mortgages. 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 onthese commitments and subsequently closed loans if interest rates move betweenthe time of the interest rate lock and the delivery of the loan to theinvestor. Loan commitments related to mortgage loans that are intended to besold are considered derivatives in accordance with the guidance of SEC StaffAccounting Bulletin No. 105, *Application of AccountingPrinciples to Loan Commitments*. Accordingly, the fair value of thesederivatives at the end of the reporting period has been determined through ananalysis of changes in market interest rates from the interest rate lock dateand loan closing date.

 

To mitigate the effect ofthe interest rate risk inherent in providing loan commitments, we economicallyhedge our commitments by entering into best efforts delivery forward loan salecontracts. These forward contracts are marked to market through earnings andare not designated as accounting hedges under SFAS No. 133. The change in thefair value of loan commitments and the change in the fair value of forwardsales contracts generally move in opposite directions and, accordingly, theimpact of changes in these valuations on net income during the loan commitmentperiod is generally inconsequential.

 

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

 

24

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###### **New Financial Accounting Standards**

###### ** **

In March 2004, the FASBissued Emerging Issues Task Force Issue No. 03-1 (“EITF 03-1”), *The Meaning ofOther-Than-Temporary Impairment and Its Application to CertainInvestments. *EITF 03-1provided guidance for evaluating whether an investment in debt and equitysecurities is other-than-temporarily impaired and was effective for otherthan-temporary impairment evaluations made in reporting periods beginning afterJune 15, 2004.  According to EITF 03-1, asecurity is impaired when its fair value is less than its carrying value, andan impairment is other-than-temporary if the investor does not have the “abilityand intent” to hold the investment until a forecasted recovery of its carryingamount.  EITF 03-1 requires that once aninvestment is determined to be impaired, the impairment must be assessed usingthe ability-and-intent-to-hold criterion regardless of the severity or amountof the impairment.  If the impairment isdetermined to be other-than-temporary, an impairment loss should be recognizedin earnings.  On September 30, 2004, theFASB Staff issued FSP EITF 03-1-1, which deferred the application ofmeasurement provisions of EITF 03-1.  TheFASB determined that a delay in the effective date of those provisions wasnecessary until it can issue additional guidance on the application of EITF03-1.

 

In December 2004, the FASB issuedFASB Statement No. 123R, *Share-Based Payments: anamendment of FASB Statements 123 and 95.* This statement requires that companiesrecognize to the income statement the grant-date fair value of stock optionsand other equity-based compensation. This statement requires that stock awards be classified as either anequity award or a liability award. Equity awards are valued as of the grant date using either an observablemarket price or a valuation methodology. Liability classified awards are valued at fair value as of eachreporting date.  This statement iseffective for the Company in the third quarter of 2005.  The Company is currently evaluating theimpact this statement will have on its operations.

 

##### ***Statements of Income***

##### * *

Net income to common shareholdersfor the three months ended September 30, 2004 and 2003 was $384,000 and$645,000, respectively, a decrease of $261,000, or 40.5%.  Net income to common shareholders for thenine months ended September 30, 2004 and 2003 was $1.7 million and $1.6 million,respectively, an increase of $180,000, or 11.6%.  The decrease in net income to commonshareholders during the third quarter of 2004 is primarily a result of thecompletion of our business combination with GMM offset by increased netinterest income and non-interest income. In addition, on March 29, 2004, our preferred stock was converted tocommon stock in accordance with the preferred stock terms.  As a result of this stock conversion, netincome to common shareholders for the three and nine months periods of 2004 didnot include preferred stock dividends. Preferred dividends were $124,000 and $371,000 for the three and ninemonths ended September 30, 2003, respectively. Net income for the three and nine months ended September 30, 2004reflect an income tax provision of $172,000 and $850,000, respectively,compared to no tax provision for the same periods of 2003.  The 2003 results were not subject to anincome tax provision because of unrecognized available net operating losscarryforwards.

 

Basic and dilutedearnings per common share were $0.02 and $0.06 for the three months endedSeptember 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, basic earningsper common share were $0.10 and $0.15, respectively.  For the

 

25

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nine months ended September 30, 2004 and 2003, diluted earnings percommon share were $0.09 and $0.15, respectively.  These results are presented after the effectof dividends paid to preferred shareholders in the 2003 periods.  Weighted average fully diluted common sharesoutstanding for the three months ended September 30, 2004 and 2003 were18,697,179 and 10,344,977, respectively. For the nine months ended September 30, 2004 and 2003, weighted averagefully diluted common shares outstanding were 18,361,013 and 10,249,184,respectively.

 

Return on average assetsfor the three months ended September 30, 2004 and 2003 was 0.13% and 0.47%,respectively.  Return on average assetsfor the nine months ended September 30, 2004 and 2003 was 0.27% and 0.41%,respectively.  The decrease in the returnon average assets is a direct result of the increased average total assets dueto the acquisition of GMM and marking loans held for sale and unfunded loancommitments to market value as of the purchase date.  Return on average equity for the three monthsended September 30, 2004 and 2003 was 1.60% and 6.53%, respectively.  Return on average equity for the nine monthsended September 30, 2004 and 2003 was 2.48% and 5.18%, respectively.  The decrease in the return on average equityis a result of the increased equity from our common stock offering.

 

Net interest incomerepresents the difference between interest earned on interest earning assetsand the interest paid on deposits and other interest 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 months ended September 30, 2004 and2003 was $7.2 million and $3.8 million, respectively, a period-to-periodincrease of $3.4 million, or 87.4%.  Netinterest income for the nine months ended September 30, 2004 and 2003 was $17.0million and $10.7 million, respectively, an increase of $6.3 million, or58.5%.  The increase in net interestincome is a result of the increase in the average volume of investmentsecurities and loans receivable, net of the impact of decreased yields, during2004, compared with the same period of 2003, and the addition of GMM and theirloans held for sale portfolio.  Netinterest income recorded by GMM since its acquisition was approximately $1.6million.

 

Our net interest marginfor the three months ended September 30, 2004 and 2003 was 2.55% and 2.88%,respectively.  For the nine months endedSeptember 30, 2004 and 2003, our net interest margin was 2.74% and 2.96%,respectively.  The decrease in the netinterest margin was a result of the change in the mix of earning assets towardslower yielding earning assets and the decreased interest rate environment.  Tables 1 through 4 present an analysis ofaverage earning assets, interest bearing liabilities and demand deposits withrelated components of interest income and interest expense.

 

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

Three Months EndedSeptember 30, 2004, 2003 and 2002

(Dollars in thousands)

 
| ** **                                               | ** ** | **2004**             | ** ** | **2003**                       | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|----------|------------|
| ** **                                               | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                                |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                               |       | $                    | 60,086     |                           | $          | 767      |       | 5.11 | % | $ | 45,983 |   | $ | 708 |   | 6.16 | % | $ | 49,780 |   | $ | 893 |   | 7.18 | % |
| Real estate -  commercial                                |       | 190,371              |       | 2,945                          |       | 6.19     | %          | 121,606 |   | 2,100 |   | 6.91 | % | 94,614 |   | 1,887 |   | 7.98 | % |
| Real estate -  construction                              |       | 58,291               |       | 848                            |       | 5.82     | %          | 23,778 |   | 310 |   | 5.22 | % | 6,675 |   | 100 |   | 5.96 | % |
| Real estate -  residential                               |       | 44,558               |       | 653                            |       | 5.86     | %          | 38,448 |   | 602 |   | 6.27 | % | 19,103 |   | 369 |   | 7.72 | % |
| Home equity lines                                        |       | 55,039               |       | 486                            |       | 3.50     | %          | 34,873 |   | 289 |   | 3.29 | % | 24,268 |   | 263 |   | 4.30 | % |
| Consumer                                                 |       | 7,858                |       | 127                            |       | 6.46     | %          | 8,465 |   | 157 |   | 7.36 | % | 11,884 |   | 225 |   | 7.51 | % |
| Total loans                                              |       | 416,203              |       | 5,826                          |       | 5.60     | %          | 273,153 |   | 4,166 |   | 6.10 | % | 206,324 |   | 3,737 |   | 7.24 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                                |       | 369,623              |       | 3,268                          |       | 3.54     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
| Investment  securities available-for-sale                |       | 165,721              |       | 1,536                          |       | 3.71     | %          | 127,609 |   | 754 |   | 2.36 | % | 127,307 |   | 1,471 |   | 4.62 | % |
| Investment  securities held-to-maturity                  |       | 154,229              |       | 1,432                          |       | 3.71     | %          | 121,343 |   | 1,207 |   | 3.98 | % | — |   | — |   | 0.00 | % |
| Other investments                                        |       | 8,163                |       | 78                             |       | 3.82     | %          | 3,496 |   | 35 |   | 4.00 | % | 1,199 |   | 17 |   | 5.67 | % |
| Federal funds  sold                                      |       | 14,323               |       | 49                             |       | 1.37     | %          | 6,915 |   | 17 |   | 0.98 | % | 62,104 |   | 260 |   | 1.66 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets and interest income       |       | 1,128,262            |       | 12,189                         |       | 4.32     | %          | 532,516 |   | 6,179 |   | 4.64 | % | 396,934 |   | 5,485 |   | 5.53 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  earning assets:                            |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | 14,904               |       |                           |       |     |       | 8,380 |   |   |   |   |   | 19,861 |   |   |   |   |   |
| Premises and  equipment, net                             |       | 14,727               |       |                           |       |     |       | 5,045 |   |   |   |   |   | 4,678 |   |   |   |   |   |
| Goodwill and  intangibles, net                           |       | 15,129               |       |                           |       |     |       | 646 |   |   |   |   |   | 646 |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 11,286               |       |                           |       |     |       | 2,583 |   |   |   |   |   | 3,500 |   |   |   |   |   |
| Allowance for  loan losses                               |       | (4,864               | )          |                           |       |     |       | (3,650 | ) |   |   |   |   | (3,049 | ) |   |   |   |   |
| Total assets                                             |       | $                    | 1,179,444  |                           |       |     |       |   | $ | 545,520 |   |   |   |   |   | $ | 422,570 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**           |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing liabilities:                         |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:                            |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 148,168              |       | 486                            |       | 1.30     | %          | 153,681 |   | 538 |   | 1.39 | % | 130,110 |   | 904 |   | 2.76 | % |
| Money markets                                            |       | 28,065               |       | 42                             |       | 0.60     | %          | 28,765 |   | 43 |   | 0.59 | % | 32,019 |   | 151 |   | 1.87 | % |
| Statement savings                                        |       | 7,827                |       | 16                             |       | 0.83     | %          | 5,741 |   | 8 |   | 0.53 | % | 4,287 |   | 13 |   | 1.24 | % |
| Certificates of  deposit                                 |       | 477,936              |       | 3,124                          |       | 2.61     | %          | 179,540 |   | 1,473 |   | 3.25 | % | 150,658 |   | 1,535 |   | 4.04 | % |
| Total interest -  bearing deposits                       |       | 661,996              |       | 3,668                          |       | 2.22     | %          | 367,727 |   | 2,062 |   | 2.22 | % | 317,074 |   | 2,603 |   | 3.26 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed  funds                                    |       | 206,926              |       | 1,116                          |       | 2.16     | %          | 63,882 |   | 279 |   | 1.74 | % | 4,065 |   | 40 |   | 3.93 | % |
| Warehouse  financing                                     |       | 108,786              |       | 211                            |       | 0.78     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities and interest expense |       | 977,708              |       | 4,995                          |       | 2.04     | %          | 431,609 |   | 2,341 |   | 2.15 | % | 321,139 |   | 2,643 |   | 3.27 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 94,995               |       |                           |       |     |       | 72,819 |   |   |   |   |   | 60,161 |   |   |   |   |   |
| Other liabilities                                        |       | 10,726               |       |                           |       |     |       | 1,596 |   |   |   |   |   | 1,659 |   |   |   |   |   |
| Preferred  shareholders’ equity                     |       | —               |       |                           |       |     |       | 6,824 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 96,015               |       |                           |       |     |       | 32,672 |   |   |   |   |   | 32,786 |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $                    | 1,179,444  |                           |       |     |       |   | $ | 545,520 |   |   |   |   |   | $ | 422,570 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |                 |       | $                              | 7,194      |     | 2.55       | % |   |   | $ | 3,838 |   | 2.88 | % |   |   | $ | 2,842 |   | 2.86 | % |

 

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

(2) We do not haveinvestments that have tax benefit attributes; therefore, there are no taxequivalent adjustments to our net interest income.

 

26

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**Rate andVolume Analysis**

Three Months Ended September 30, 2004, 2003 and 2002

(Dollars in thousands)

 
| ** **                                | ** ** | **Three Months Ended September 30,  2004 Compared to 2003** | ** ** | **Three Months Ended September 30,  2003 Compared to 2002** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                | ** ** | **Average  Volume**                                         | ** ** | **Average  Rate**                                           | ** ** | **Increase  (Decrease)** | ** ** | **Average  Volume** | ** ** | **Average  Rate** | ** ** | **Increase  (Decrease)** | ** ** |
| **Interest  income:**                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                                                           | 217        |                                                        | $          | (158 | ) | $ | 59 |   | $ | (68 | ) | $ | (117 | ) | $ | (185 | ) |
| Real estate -  commercial                 |       | 1,187                                                       |       | (342                                                        | )          | 845 |   | 538 |   | (325 | ) | 213 |   |
| Real estate -  construction               |       | 451                                                         |       | 87                                                          |       | 538 |   | 255 |   | (45 | ) | 210 |   |
| Real estate -  residential                |       | 97                                                          |       | (46                                                         | )          | 51 |   | 373 |   | (140 | ) | 233 |   |
| Home equity  lines                        |       | 167                                                         |       | 30                                                          |       | 197 |   | 115 |   | (89 | ) | 26 |   |
| Consumer                                  |       | (11                                                         | )          | (19                                                         | )          | (30 | ) | (65 | ) | (3 | ) | (68 | ) |
| Total loans                               |       | 2,108                                                       |       | (448                                                        | )          | 1,660 |   | 1,148 |   | (719 | ) | 429 |   |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                 |       | 3,268                                                       |       | —                                                      |       | 3,268 |   | — |   | — |   | — |   |
| Investment  securities available-for-sale |       | 225                                                         |       | 557                                                         |       | 782 |   | 3 |   | (720 | ) | (717 | ) |
| Investment  securities held-to-maturity   |       | 327                                                         |       | (102                                                        | )          | 225 |   | 1,207 |   | — |   | 1,207 |   |
| Other  investments                        |       | 47                                                          |       | (4                                                          | )          | 43 |   | 33 |   | (15 | ) | 18 |   |
| Federal funds  sold                       |       | 18                                                          |       | 14                                                          |       | 32 |   | (231 | ) | (12 | ) | (243 | ) |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Total interest  income                    |       | 5,993                                                       |       | 17                                                          |       | 6,010 |   | 2,160 |   | (1,466 | ) | 694 |   |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:             |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest  checking                        |       | (20                                                         | )          | (32                                                         | )          | (52 | ) | 164 |   | (530 | ) | (366 | ) |
| Money markets                             |       | (1                                                          | )          | 0                                                           |       | (1 | ) | (15 | ) | (93 | ) | (108 | ) |
| Statement  savings                        |       | 3                                                           |       | 5                                                           |       | 8 |   | 5 |   | (10 | ) | (5 | ) |
| Certificates of  deposit                  |       | 2,435                                                       |       | (784                                                        | )          | 1,651 |   | 294 |   | (356 | ) | (62 | ) |
| Total interest -  bearing deposits        |       | 2,417                                                       |       | (811                                                        | )          | 1,606 |   | 448 |   | (989 | ) | (541 | ) |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                      |       | 621                                                         |       | 216                                                         |       | 837 |   | 593 |   | (354 | ) | 239 |   |
| Warehouse  financing                      |       | 211                                                         |       | —                                                      |       | 211 |   | — |   | — |   | — |   |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Total interest  expense                   |       | 3,249                                                       |       | (595                                                        | )          | 2,654 |   | 1,041 |   | (1,343 | ) | (302 | ) |
|                                      |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Net interest  income (2)                  |       | $                                                           | 2,744      |                                                        | $          | 612 |   | $ | 3,356 |   | $ | 1,119 |   | $ | (123 | ) | $ | 996 |   |

 

----

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

(2) We do not have investmentsthat have tax benefit attributes; therefore, there are no tax equivalentadjustments to our net interest income.

 

27

----

 

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

Nine Months EndedSeptember 30, 2004, 2003 and 2002

(Dollars in thousands)

 
| ** **                                               | ** ** | **2004**             | ** ** | **2003**                       | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|----------|------------|
| ** **                                               | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                                |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                               |       | $                    | 58,937     |                           | $          | 2,318    |       | 5.24 | % | $ | 49,883 |   | $ | 2,356 |   | 6.30 | % | $ | 52,156 |   | $ | 2,788 |   | 7.13 | % |
| Real estate -  commercial                                |       | 159,906              |       | 7,508                          |       | 6.26     | %          | 117,416 |   | 6,197 |   | 7.04 | % | 89,634 |   | 5,408 |   | 8.04 | % |
| Real estate -  construction                              |       | 48,651               |       | 2,053                          |       | 5.63     | %          | 15,899 |   | 662 |   | 5.55 | % | 6,185 |   | 282 |   | 6.07 | % |
| Real estate -  residential                               |       | 43,312               |       | 1,856                          |       | 5.71     | %          | 36,663 |   | 1,783 |   | 6.49 | % | 17,448 |   | 1,033 |   | 7.90 | % |
| Home equity lines                                        |       | 50,316               |       | 1,255                          |       | 3.32     | %          | 31,729 |   | 793 |   | 3.34 | % | 23,270 |   | 741 |   | 4.26 | % |
| Consumer                                                 |       | 9,184                |       | 435                            |       | 6.31     | %          | 9,063 |   | 507 |   | 7.48 | % | 12,864 |   | 715 |   | 7.43 | % |
| Total loans                                              |       | 370,306              |       | 15,425                         |       | 5.55     | %          | 260,653 |   | 12,298 |   | 6.29 | % | 201,557 |   | 10,967 |   | 7.26 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                                |       | 124,175              |       | 3,268                          |       | 3.51     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
| Investment  securities available-for-sale                |       | 163,009              |       | 4,360                          |       | 3.57     | %          | 168,735 |   | 4,047 |   | 3.20 | % | 91,846 |   | 3,284 |   | 4.77 | % |
| Investment  securities held-to-maturity                  |       | 154,025              |       | 4,260                          |       | 3.69     | %          | 40,892 |   | 1,207 |   | 3.94 | % | — |   | — |   | 0.00 | % |
| Other investments                                        |       | 5,464                |       | 162                            |       | 3.95     | %          | 2,648 |   | 90 |   | 4.53 | % | 1,197 |   | 53 |   | 5.90 | % |
| Federal funds  sold                                      |       | 11,695               |       | 96                             |       | 1.09     | %          | 11,601 |   | 98 |   | 1.12 | % | 49,428 |   | 613 |   | 1.66 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets and interest income       |       | 828,674              |       | 27,571                         |       | 4.44     | %          | 484,529 |   | 17,740 |   | 4.88 | % | 344,028 |   | 14,917 |   | 5.78 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  earning assets:                            |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | 12,050               |       |                           |       |     |       | 10,376 |   |   |   |   |   | 16,955 |   |   |   |   |   |
| Premises and  equipment, net                             |       | 9,893                |       |                           |       |     |       | 5,091 |   |   |   |   |   | 4,843 |   |   |   |   |   |
| Goodwill and  other intangibles                          |       | 5,100                |       |                           |       |     |       | 646 |   |   |   |   |   | 652 |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 7,887                |       |                           |       |     |       | 3,699 |   |   |   |   |   | 2,003 |   |   |   |   |   |
| Allowance for  loan losses                               |       | (4,564               | )          |                           |       |     |       | (3,511 | ) |   |   |   |   | (3,051 | ) |   |   |   |   |
| Total assets                                             |       | $                    | 859,040    |                           |       |     |       |   | $ | 500,830 |   |   |   |   |   | $ | 365,430 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**           |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing liabilities:                         |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:                            |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 151,448              |       | 1,520                          |       | 1.34     | %          | 146,335 |   | 1,841 |   | 1.68 | % | 104,351 |   | 2,252 |   | 2.89 | % |
| Money markets                                            |       | 26,418               |       | 116                            |       | 0.58     | %          | 26,588 |   | 168 |   | 0.84 | % | 28,229 |   | 424 |   | 2.01 | % |
| Statement savings                                        |       | 7,535                |       | 38                             |       | 0.67     | %          | 5,210 |   | 27 |   | 0.69 | % | 4,275 |   | 40 |   | 1.24 | % |
| Certificates of  deposit                                 |       | 330,802              |       | 6,774                          |       | 2.73     | %          | 175,732 |   | 4,492 |   | 3.42 | % | 131,106 |   | 4,118 |   | 4.20 | % |
| Total interest -  bearing deposits                       |       | 516,203              |       | 8,448                          |       | 2.18     | %          | 353,865 |   | 6,528 |   | 2.47 | % | 267,961 |   | 6,834 |   | 3.41 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed  funds                                    |       | 125,339              |       | 1,887                          |       | 2.01     | %          | 35,980 |   | 470 |   | 1.74 | % | 6,802 |   | 208 |   | 4.09 | % |
| Warehouse  financing                                     |       | 36,527               |       | 211                            |       | 0.77     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities and interest expense |       | 678,069              |       | 10,546                         |       | 2.07     | %          | 389,845 |   | 6,998 |   | 2.40 | % | 274,763 |   | 7,042 |   | 3.43 | % |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 82,839               |       |                           |       |     |       | 69,087 |   |   |   |   |   | 57,915 |   |   |   |   |   |
| Other liabilities                                        |       | 4,857                |       |                           |       |     |       | 1,833 |   |   |   |   |   | 2,505 |   |   |   |   |   |
| Preferred  shareholders’ equity                     |       | 2,123                |       |                           |       |     |       | 6,824 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 91,152               |       |                           |       |     |       | 33,241 |   |   |   |   |   | 23,422 |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $                    | 859,040    |                           |       |     |       |   | $ | 500,830 |   |   |   |   |   | $ | 365,430 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |                 |       | $                              | 17,025     |     | 2.74       | % |   |   | $ | 10,742 |   | 2.96 | % |   |   | $ | 7,875 |   | 3.05 | % |

 

----

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

(2) We do not haveinvestments that have tax benefit attributes; therefore, there are no taxequivalent adjustments to our net interest income.

 

28

----

 

**Rate andVolume Analysis**

Nine Months Ended September 30, 2004, 2003 and 2002

(Dollars in thousands)

 
| ** **                                | ** ** | **Nine Months Ended September 30,  2004 Compared to 2003** | ** ** | **Nine Months Ended September 30,  2003 Compared to 2002** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                | ** ** | **Average  Volume**                                        | ** ** | **Average  Rate**                                          | ** ** | **Increase  (Decrease)** | ** ** | **Average  Volume** | ** ** | **Average  Rate** | ** ** | **Increase  (Decrease)** | ** ** |
| **Interest  income:**                     |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                                                          | 428        |                                                       | $          | (466 | ) | $ | (38 | ) | $ | (122 | ) | $ | (310 | ) | $ | (432 | ) |
| Real estate -  commercial                 |       | 2,243                                                      |       | (932                                                       | )          | 1,311 |   | 1,676 |   | (887 | ) | 789 |   |
| Real estate -  construction               |       | 1,364                                                      |       | 27                                                         |       | 1,391 |   | 442 |   | (62 | ) | 380 |   |
| Real estate -  residential                |       | 327                                                        |       | (254                                                       | )          | 73 |   | 1,138 |   | (388 | ) | 750 |   |
| Home equity  lines                        |       | 469                                                        |       | (7                                                         | )          | 462 |   | 269 |   | (217 | ) | 52 |   |
| Consumer                                  |       | 7                                                          |       | (79                                                        | )          | (72 | ) | (211 | ) | 3 |   | (208 | ) |
| Total loans                               |       | 4,838                                                      |       | (1,711                                                     | )          | 3,127 |   | 3,192 |   | (1,861 | ) | 1,331 |   |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                 |       | 3,268                                                      |       | —                                                     |       | 3,268 |   | — |   | — |   | — |   |
| Investment  securities available-for-sale |       | (137                                                       | )          | 450                                                        |       | 313 |   | 2,749 |   | (1,986 | ) | 763 |   |
| Investment  securities held-to-maturity   |       | 3,339                                                      |       | (286                                                       | )          | 3,053 |   | 1,207 |   | — |   | 1,207 |   |
| Other  investments                        |       | 96                                                         |       | (24                                                        | )          | 72 |   | 64 |   | (27 | ) | 37 |   |
| Federal funds  sold                       |       | 1                                                          |       | (3                                                         | )          | (2 | ) | (469 | ) | (46 | ) | (515 | ) |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Total interest  income                    |       | 11,405                                                     |       | (1,574                                                     | )          | 9,831 |   | 6,743 |   | (3,920 | ) | 2,823 |   |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Interest  checking                        |       | 65                                                         |       | (386                                                       | )          | (321 | ) | 906 |   | (1,317 | ) | (411 | ) |
| Money markets                             |       | (1                                                         | )          | (51                                                        | )          | (52 | ) | (25 | ) | (231 | ) | (256 | ) |
| Statement  savings                        |       | 12                                                         |       | (1                                                         | )          | 11 |   | 9 |   | (22 | ) | (13 | ) |
| Certificates of  deposit                  |       | 3,988                                                      |       | (1,706                                                     | )          | 2,282 |   | 1,402 |   | (1,028 | ) | 374 |   |
| Total interest -  bearing deposits        |       | 4,064                                                      |       | (2,144                                                     | )          | 1,920 |   | 2,292 |   | (2,598 | ) | (306 | ) |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Other borrowed  funds                     |       | 1,165                                                      |       | 252                                                        |       | 1,417 |   | 892 |   | (630 | ) | 262 |   |
| Warehouse  financing                      |       | 211                                                        |       | —                                                     |       | 211 |   | — |   | — |   | — |   |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Total interest  expense                   |       | 5,440                                                      |       | (1,892                                                     | )          | 3,548 |   | 3,184 |   | (3,228 | ) | (44 | ) |
|                                      |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net interest  income (2)                  |       | $                                                          | 5,965      |                                                       | $          | 318 |   | $ | 6,283 |   | $ | 3,559 |   | $ | (692 | ) | $ | 2,867 |   |

 

----

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

(2) We do not haveinvestments that have tax benefit attributes; therefore, there are no taxequivalent adjustments to our net interest income.

 

The provision for loanlosses for the three months ended September 30, 2004 and 2003 was $529,000 and$356,000, respectively.  For the ninemonths ended September 30, 2004 and 2003, the provision for loan losses was$918,000 and $602,000, respectively.  Theincrease in provision expense for the year to date 2004 compared to the year todate 2003 is a result of the loan growth experienced during 2004.  The allowance for loan losses at September30, 2004 and December 31, 2003 was $5.2 million and $4.3 million,respectively.    Our allowance for loanloss to loan ratio at September 30, 2004 was 1.18%, compared to 1.29% atDecember 31, 2003.  We continued toexperience good loan quality with annualized net charged-off loans equal to0.04% to total loans for the nine months ended September 30, 2004, compared to0.02% for the same period of 2003. Non-performing loans were equal to 0.06% of total loans at September 30,2004, compared to 0.12% at December 31, 2003. Additional information on the allowance for loan

 

29

----

 

losses, its allocation to the total loans receivable portfolio andinformation on nonperforming loans can be found in Tables 5, 6 and 7.

 

**Allowance for Loan Losses**

Nine Months Ended September 30, 2004 and 2003

(Dollars in thousands)

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1 |       | $        | 4,344      |     | $          | 3,372 |   |
|                          |       |     |       |     |       |
| Provision for  loan losses    |       | 918      |       | 602      |       |
|                          |       |     |       |     |       |
| Loans charged  off:           |       |     |       |     |       |
| Commercial and  industrial    |       | (101     | )          | (74      | )          |
| Real estate -  commercial     |       | —   |       | —   |       |
| Real estate -  construction   |       | —   |       | —   |       |
| Real estate -  residential    |       | —   |       | —   |       |
| Home equity  lines            |       | —   |       | —   |       |
| Consumer                      |       | (5       | )          | (6       | )          |
| Total loans  charged off      |       | (106     | )          | (80      | )          |
|                          |       |     |       |     |       |
| Recoveries:                   |       |     |       |     |       |
| Commercial and  industrial    |       | 10       |       | 42       |       |
| Real estate -  commercial     |       | —   |       | —   |       |
| Real estate -  construction   |       | —   |       | —   |       |
| Real estate -  residential    |       | —   |       | —   |       |
| Home equity  lines            |       | —   |       | —   |       |
| Consumer                      |       | 2        |       | 7        |       |
| Total recoveries              |       | 12       |       | 49       |       |
|                          |       |     |       |     |       |
| Net (charge  offs) recoveries |       | (94      | )          | (31      | )          |
|                          |       |     |       |     |       |
| Ending balance                |       | $        | 5,168      |     | $          | 3,943 |   |

 
| ** **                                                  | ** ** | **September  30,  2004** | ** ** | **December  31,  2003** | ** ** |
|-------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| Loans:                                                      |       |                     |       |                    |       |
| Balance at  period end                                      |       | $                        | 438,957    |                    | $          | 336,002 |   |
| Allowance for  loan losses to loans receivable, net of fees |       | 1.18                     | %          | 1.29                    | %          |
| Annualized net  charge-offs to average loans receivable     |       | 0.04                     | %          | 0.01                    | %          |
|                                                             |            |                          |            |                         |            |  |  |

 

30

----

 

**Allocation of the Allowance for LoanLosses**

AtSeptember 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **Allocation**          | ** ** | **% of Total***        | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial                       |       | $                       | 771        |                   | 11.89      | % | $ | 1,046 |   | 17.21 | % |
| Real estate -  commercial        |       | 3,030                   |       | 45.04                  | %          | 1,662 |   | 41.56 | % |
| Real estate -  construction      |       | 232                     |       | 14.76                  | %          | 497 |   | 12.57 | % |
| Real estate -  residential       |       | 452                     |       | 13.86                  | %          | 418 |   | 12.64 | % |
| Home equity  lines               |       | 514                     |       | 12.80                  | %          | 486 |   | 12.84 | % |
| Consumer                         |       | 169                     |       | 1.65                   | %          | 235 |   | 3.18 | % |
|                             |       |                    |       |                   |       |   |   |   |   |
| Total allowance  for loan losses |       | $                       | 5,168      |                   | 100.00     | % | $ | 4,344 |   | 100.00 | % |

 

----

* Percentage of loan typeto the total loan portfolio.

 

**Nonperforming Loans Receivable**

At September 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                                    | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Nonaccruing  loans                            |       | $                       | 252        |                   | $          | 390 |   |
|                                          |       |                    |       |                   |       |
| Loans  contractually past-due 90 days or more |       | 6                       |       | 4                      |       |
|                                          |       |                    |       |                   |       |
| Troubled debt  restructurings                 |       | —                  |       | —                 |       |
| Total  nonperforming loans receivable         |       | $                       | 258        |                   | $          | 394 |   |

 

Non-interest income for the three months endedSeptember 30, 2004 and 2003 was $2.8 million and $971,000, respectively, aperiod-to-period increase of $1.8 million, or 186.7%.  Non-interest income for the nine months endedSeptember 30, 2004 and 2003 was $4.2 million compared to $3.0 million, anincrease of $1.2 million, or 41.1%.  Theincrease in non-interest income is primarily attributable to the increase innet gains on sales of loans from GMM since its acquisition and a $802,000increase in management fees attributable to GMM.  The management fees recorded by GMM representincome earned for the management and operational support provided by GMM toother mortgage banking companies. Non-interest income recorded by GMM for the three months ended September30, 2004 was $2.1 million.  Gains onsales of loans include the gross gains on the sale of mortgage loans, net oforigination costs.  Included in the grossgains on sale of mortgage loans are any origination, underwriting, discountpoints and other funding fees received and deferred at origination.  Costs, which are originally capitalized whenthe loan closes and are deferred and subsequently recognized when the loan issold, include direct costs associated with origination, such as commissions anddirect salaries for funded loans.

 

Net realized gains on investment securitiesavailable-for-sale was $3,000 and $291,000 for the three months ended September30, 2004 and 2003, respectively.  For thenine months ended September 30, 2004 and 2003, net realized gains on investmentsecurities available-for-sale were $245,000 and $1.2 million,respectively.  The gains recorded during2003 were recorded on sales of mortgage-backed securities with acceleratedpre-payment speeds as a result of decreasing interest rates.  We are currently using the investmentsecurities portfolio as collateral for additional borrowings we incurred tofund GMM’s loans held for sale.

 

Service charges on deposit accounts increased$58,000 to $296,000 for the three months ended September 30, 2004, compared to$238,000 for the same period of 2003. For the nine months ended September 30, 2004, service charges on depositaccounts increased $114,000 to $798,000, compared to $684,000 for the samenine-month period of 2003.  Increases inservice charges on deposit accounts during 2004 are a direct result of theincrease in depository customer relationships. Loan service charge income increased $55,000 to $129,000 for the threemonths ended September 30, 2004, compared to $74,000 for the same period of2003.  Loan service charge income for thenine months ended September 30, 2004 and 2003 were $414,000 and $342,000,respectively, an increase of $72,000 or 21.1%. The increase in loan service charges during 2004 is a result of theincreased loan account volume experienced during the year.  Investment fee income decreased to $150,000for the three months ended September 30, 2004, compared to $184,000 for thethree months ended September 30, 2003. For the nine months ended September 30, 2004 and 2003, investment feeincome was $498,000 and $473,000, respectively, an increase of $25,000, or5.3%.  The increase in year to dateinvestment fee income is due to the increase in assets under management andtransaction activity in our investments services business segment.

 

Non-interestexpense for the three and nine months ended September 30, 2004 was $8.9 millionand $17.7 million, respectively, compared to $3.7 million and $11.2 million forthe same three and nine months periods of 2003, respectively.  The results reflect period-to-periodincreases of $5.2 million and $6.5 million for the comparable three and ninemonth periods of September 30, 2004 and 2003, respectively.  These increases are primarily a result of theaddition of GMM, which recorded $4.2 million in non-interest expense during thethird quarter of 2004.  In addition, thebranch expansion we have completed throughout the year has also contributed to

 

31

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the increase innon-interest expense.  We have openedfive branches over the first nine months of 2004, with three additionalbranches scheduled to open in the fourth quarter of 2004.  As of September 30, 2003, we had ninebranch locations, compared to fifteen locations at September 30, 2004.  Expenses related to the branch expansion arerepresented in the increases in our salaries and benefits expense, occupancyexpense and depreciation expense.  Otheroperating expenses on our statements of income include business development,data processing and communications expenses and office administration expenses.

 

The effective tax rate for thethree and nine months ended September 30, 2004 was 30.9% and 32.9%,respectively, compared to 0% for each of the comparable periods of 2003.  The increase in the effective tax rate is aresult of having recorded previously unrecognized deferred tax assets relatedto the net operating loss carryforwards during the fourth quarter of 2003.  We recorded a provision for income taxexpense of $172,000 and $850,000 for the three and nine months ended September 30,2004, respectively, compared to $0 for each of the comparable periods of 2003,respectively.    For more information,see “Critical Accounting Policies” above in this discussion.

 

**Statements of Condition**

 

Total assets were $1.2 billion at September 30,2004, compared to $636.2 million at December 31, 2003, an increase of $541.1million or 85.0%.  This growth was primarilythe result of the GMM acquisition and increases in total loans, total depositsand the equity raised in the common stock offering during January 2004.

 

Investment securities were $308.0 million at September 30,2004, compared to $273.6 million at December 31, 2003, an increase of $34.4million or 12.6%.  The investmentportfolio consists of investment securities available-for-sale and investmentsecurities held-to-maturity.  Investmentsecurities held-to-maturity are those securities thatwe have the intent and ability to hold to maturity and are carried at amortizedcost.  Investment securitiesavailable-for-sale are those securities that we intendto hold for an indefinite period of time, but not necessarily untilmaturity.  These securities are carriedat fair value and may be sold as part of an asset/liability strategy, liquiditymanagement, interest rate risk management, regulatory capital management orsimilar factors.  At September 30,2004, investment securities available-for-sale were $160.0 million andinvestment securities held-to-maturity were $148.0 million.  See Table 8 for additional information on ourinvestment securities portfolio.

 

**Investment Securities**

At September 30, 2004and December 31, 2003

(Dollarsin thousands)

 
| **Available-for-sale at September 30,  2004**                 | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations  of U.S. government-sponsored agencies and enterprises |       |                |       |            |       |               |       |
| One to five  years                                                 |       | $                   | 3,000      |            | $          | 2,967              |       | 3.33 | % |
| Five to ten  years                                                 |       | 3,000               |       | 3,027           |       | 4.48               | %          |
| Total U.S.  government-sponsored agencies                          |       | $                   | 6,000      |            | $          | 5,994              |       | 3.91 | % |
|                                                               |       |                |       |            |       |               |       |
| Mortgage-backed  securities*                                       |       |                |       |            |       |               |       |
| Five to ten  years                                                 |       | $                   | 15,840     |            | $          | 15,835             |       | 3.86 | % |
| After ten  years                                                   |       | 137,370             |       | 136,112         |       | 3.96               | %          |
| Total  mortgage-backed securities                                  |       | $                   | 153,210    |            | $          | 151,947            |       | 3.95 | % |
|                                                               |       |                |       |            |       |               |       |
| Treasury  bonds                                                    |       |                |       |            |       |               |       |
| One to five years                                                  |       | $                   | 2,035      |            | $          | 2,040              |       | 2.63 | % |
| Total  treasury bonds                                              |       | $                   | 2,035      |            | $          | 2,040              |       | 2.63 | % |
| Total  investment securities available-for-sale                    |       | $                   | 161,245    |            | $          | 159,981            |       | 3.93 | % |

 
| **Held-to-maturity at September 30, 2004**                    | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations  of U.S. government-sponsored agencies and enterprises |       |                |       |            |       |               |       |
| One to five  years                                                 |       | $                   | 6,000      |            | $          | 5,974              |       | 3.26 | % |
| Five to ten  years                                                 |       | 21,012              |       | 20,997          |       | 4.51               | %          |
| After ten  years                                                   |       | 2,999               |       | 2,988           |       | 4.20               | %          |
| Total U.S.  government-sponsored agencies                          |       | $                   | 30,011     |            | $          | 29,959             |       | 4.23 | % |
|                                                               |       |                |       |            |       |               |       |
| Mortgage-backed  securities*                                       |       |                |       |            |       |               |       |
| Five to ten  years                                                 |       | $                   | 10,896     |            | $          | 10,965             |       | 3.84 | % |
| After ten  years                                                   |       | 99,122              |       | 98,459          |       | 4.02               | %          |
| Total  mortgage-backed securities                                  |       | $                   | 110,018    |            | $          | 109,424            |       | 4.00 | % |
|                                                               |       |                |       |            |       |               |       |
| Corporate  bonds                                                   |       |                |       |            |       |               |       |
| After ten  years                                                   |       | $                   | 8,005      |            | $          | 7,948              |       | 4.21 | % |
| Total  corporate bonds                                             |       | $                   | 8,005      |            | $          | 7,948              |       | 4.21 | % |
| Total  investment securities held-to-maturity                      |       | $                   | 148,034    |            | $          | 147,331            |       | 4.06 | % |
|                                                               |       |                |       |            |       |               |       |
| Total  investment securities                                       |       | $                   | 309,279    |            | $          | 307,312            |       | 3.99 | % |

 

----

* Based on contractual maturities.

 

32

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

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

 

----

* Based on contractual maturities.

 

Loans receivable, net of deferred fees andcosts, increased by $103.0 million, or 30.6%, to $439.0 million atSeptember 30, 2004 from $336.0 million at December 31, 2003 (seeTable 9 for details on the loans receivable portfolio). We experiencedincreases in our commercial real estate, construction, residential real estateand home equity loan portfolios offset by a slight decrease in our commercialand consumer loan portfolios.  Thesedecreases are the result of more paydowns than fundings in those loancategories and a result of portfolio seasonality.  We expect increases within these loancategories over the next several months due to our increased legal lendinglimit of $12.0 million and the volume of loans we have scheduled forfunding.  In addition, the Company has$347.5 million of loans held for sale at September 30, 2004 as a result ofits acquisition of GMM.  Loans that areheld for sale are valued at the lower of cost or market value.

 

33

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**Loans Receivable**

At September 30, 2004and December 31, 2003

(Dollarsin thousands)

 
| ** **                       | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                             |       |                        |       |                       |       |   |   |   |   |
| Commercial                       |       | $                           | 52,222     |                       | 11.89      | % | $ | 57,854 |   | 17.21 | % |
| Real estate -  commercial        |       | 197,792                     |       | 45.04                      | %          | 139,725 |   | 41.56 | % |
| Real estate -  construction      |       | 64,847                      |       | 14.76                      | %          | 42,243 |   | 12.57 | % |
| Real estate -  residential       |       | 60,861                      |       | 13.86                      | %          | 42,495 |   | 12.64 | % |
| Home equity  lines               |       | 56,207                      |       | 12.80                      | %          | 43,176 |   | 12.84 | % |
| Consumer                         |       | 7,259                       |       | 1.65                       | %          | 10,690 |   | 3.18 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Gross loans                      |       | $                           | 439,188    |                       | 100.00     | % | $ | 336,183 |   | 100.00 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Add: net  deferred (fees) costs  |       | (231                        | )          |                       |       | (181 | ) |   |   |
| Less:  allowance for loan losses |       | (5,168                      | )          |                       |       | (4,344 | ) |   |   |
|                             |       |                        |       |                       |       |   |   |   |   |
| Loans  receivable, net           |       | $                           | 433,789    |                       |       |   | $ | 331,658 |   |   |   |

 

34

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Total deposits increased $345.8 million, or 72.9%,to $819.9 million at September 30, 2004, compared to $474.1 million at December 31,2003 (see Table 10 for details on certificates of deposit with balances of$100,000 or more).  We experiencedincreases in non-interest bearing demand deposits, money market and savingsdeposits and certificates of deposit. The increase in deposits is a result of new customers from our branchexpansion, competitive deposit pricing and increased advertising efforts.  In addition, to assist in the funding of theGMM, we added $131.6 million in brokered certificates of deposit during the thirdquarter of 2004 compared to none at December 31, 2003.  These brokered certificates of deposit havescheduled maturities from three to eighteen months.  Additional information on the maturity schedule ofthese deposits can be found in Table 13 “Contractual Obligations,” as discussedbelow.

 

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

At September 30, 2004

(Dollars in thousands)

 
| **Maturities:**                        |   |    |    |
|----------------------------------------|--------|---------|---------|
| Three months  or less                  |   | $       | 60,856  |   |
| Over three  months through six months  |   | 30,803  |    |
| Over six  months through twelve months |   | 67,499  |    |
| Over twelve  months                    |   | 156,311 |    |
|                                   |   | $       | 315,469 |   |

 

Other borrowed funds increased $84.9million to $159.4 million at September 30, 2004, compared to $74.5 millionat December 31, 2003.  We addedFederal Home Loan Bank advances of $43.8 million during the second quarter and$41.1 million during the third quarter of 2004 to leverage against some of ourlarger commercial real estate loan fundings and to assist in the funding of GMM.  In addition, borrowings from the treasury,tax and loan note option of the Federal Reserve System increased to $12.5million at September 30, 2004, compared to none at December 31, 2003.  Table 11 provides information on ourshort-term borrowings.

 

**Short-Term Borrowings**

AtSeptember 30, 2004

(Dollarsin thousands)

 
| **Advance Date**                                           | ** ** | **Original  Term of Advance** | ** ** | **Date Amount  Due** | ** ** | **Interest Rate** | ** ** | **Outstanding** | ** ** |
|------------------------------------------------------------|------------|-------------------------------|------------|----------------------|------------|-------------------|------------|-----------------|------------|
| Dec-03                                                     |       | 12 months                     |       | Dec-04               |       | 1.87              | %          | $               | 5,000      |   |
| Jan-04                                                     |       | 12 months                     |       | Jan-05               |       | 1.56              | %          | 5,000           |       |
| Jan-04                                                     |       | 18 months                     |       | Jul-05               |       | 1.83              | %          | 5,000           |       |
| Mar-03                                                     |       | 24 months                     |       | Mar-05               |       | 1.82              | %          | 1,000           |       |
| Jul-04                                                     |       | 12 months                     |       | Jul-05               |       | 2.15              | %          | 22,000          |       |
| **Total  short-term borrowings and weigthed average rate** |       |                          |       | **1.98**             | **%**      | **$**             | **38,000** |            |
|                                                       |       |                          |       |                 |       |              |       |            |       |
| All other  borrowed funds                                  |       |                          |       |                 |       | 3.75              | %          | 121,353         |       |
| Total other  borrowed funds                                |       |                          |       |                 |       | 3.33              | %          | $               | 159,353    |   |

 

In July 2004, the Company,through a wholly-owned subsidiary, issued $20.0 million of floating rate juniorsubordinated deferrable interest debentures that are due in 2034 and pay acontractual interest rate of LIBOR (London Interbank Offering Rate) plus 2.40%,which adjusts quarterly. We can redeem these debentures at a premium withinfive years of issuance and at par thereafter. We invested the proceeds from theissuance of these debentures in the form of a capital contribution to the Bank.For regulatory purposes, the debentures qualify as Tier I capital of the Bankand the Company. Interest expense on these debentures for the three monthsended September 30, 2004 was $153,000.  Additional information on these debentures can be found in Note 5 to theNotes to Consolidated Financial Statements above.

 

At September 30, 2004, we had a mortgagefunding checks liability of $76.3 million and a warehouse financing liabilityof $12.6 million.  These liabilities arerelated to GMM and are used to fund the loans in process of being sold.  GMM has credit facilities with the Bank, andalso has two third party facilities totaling $310 million.  Additional information on the creditfacilities available to GMM are included in Note 8 tothe Notes to Consolidated Financial Statements above.

 

Shareholders’ equity at September 30,2004 was $93.6 million, an increase of $8.2 million, or 9.6%, compared to $85.4million at December 31, 2003. The increase of $8.2 million from the prioryear is primarily the result of the underwriters’ exercise in January 2004of their over allotment option from the secondary offering in December 2003.  The over-allotment exercise resulted in theissuance of an additional 945,000 shares of the Company’s common stock and thereceipt of $6.3 million in additional cash. Net income of $1.7 million for the year to date through September 30,2004 also added to the increase in shareholders’ equity for the period.  Book value per common share at September 30,2004 was $5.08, compared to $4.80 at December 31, 2003.

 

35

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##### **Business Segment Operations**

##### ** **

**We provide banking and non-banking financialservices and products through our subsidiaries. Prior to July 7, 2004, management operated and reported on theresults of our operations through two business segments, commercial banking andinvestment services.  With the completionof our acquisition of GMM during the third quarter of 2004, we now operate in athird business segment, mortgage banking.**

 

#### ***Commercial Banking***

#### ** **

The commercial banking segmentprovides a wide range of banking services to small businesses and individualsthrough multiple delivery channels. Services offered include commercial and consumer lending, deposit productsand banking via the Internet or telephone.

 

For each of the three monthsended September 30, 2004 and 2003, the commercial banking segment recordednet income of $1.1 million.  For the ninemonths ended September 30, 2004 and 2003, the commercial banking segmentrecorded net income of $2.9 million and $2.8 million, respectively.  Slight increases in earnings for the threeand nine months ended September 30, 2004 compared to the same three andnine month periods of 2003 is a result of decreased gains on sales ofinvestment securities available-for-sale. At September 30, 2004, total assets were $1.1 billion, loansreceivable, net of deferred fees and costs, were $439.0 million and totaldeposits were $819.9 million.  At September 30,2003, total assets were $560.4 million, loans receivable, net of deferred feesand costs, were $290.8 million and total deposits were $459.2 million.

 

*Mortgage Banking*

 

The operations of the mortgage bankingsegment is conducted through George Mason Mortgage, LLC, a wholly ownedsubsidiary of the Bank.  GMM engagesprimarily in the origination and acquisition of residential mortgages for saleinto the secondary market on a best efforts basis.  GMM’s operating results are included in ourthird quarter 2004 financial results from the date of the acquisition on July 7,2004.  Since its acquisition, themortgage banking segment reported a net loss of $422,000.   This loss is the result of loans held forsale and unfunded commitments being recorded at fair value at the time of theacquisition of GMM, thereby resulting in the elimination of embedded gains asof the acquisition date being eliminated from income.  At September 30, 2004, total assets were$356.4 million, loans held for sale, which are recorded at the lower of cost ormarket determined on an aggregate basis, were $347.5 million and mortgagefunding checks and warehouse financing were $76.3 million and $12.6 million,respectively.

 

#### ***Investment Services***

#### ** **

The investment services segment providesinvestment and financial services through an affiliation with a third partybroker-dealer.

 

For the three months ended September 30,2004 and 2003, the investment services segment recorded a net loss of $24,000and $33,000, respectively.  For the ninemonths ended September 30, 2004 and 2003, the investment services segmentrecorded a net loss of $81,000 and $75,000, respectively.  The increase in the net loss for the ninemonths ended September 30, 2004, compared to the same period of 2003, isdue to the management reorganization this segment has experienced over the pasttwelve months.  At of September 30,2004, total assets were $677,000 and total assets under management were $161.6million.  At September 30, 2003,total assets were $229,000 and total assets under management were $121.1 million.  Assets under management from this businesssegment have increased for the nine months ended September 30,

 

36

----

 

2004 compared to the same period of 2003 as a result of increasedtransaction activity and accumulation of assets under management through newcustomers to this segment.

 

Additional information pertaining to our business segments can be foundin Note 5 to the Notes to Consolidated Financial Statements.

 

## **CapitalResources**

## ** **

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

 

Regulatory agencies measure capital adequacyutilizing a formula that takes into account the individual risk profile of afinancial institution.  The guidelinesdefine capital as both tier 1 (primarily common shareholders’ equity, definedto include certain debt obligations) and tier 2 (certain other debt obligationsand a portion of the allowance for loan losses and 45% of unrealized gains inequity securities).

 

At September 30, 2004, our tier 1 andtotal (tier 1 and tier 2) risk-based capital ratios were 13.0% and 13.7%,respectively.  At December 31, 2003,our tier 1 and total risk-based capital ratios were 19.7% and 20.7%,respectively.  Our regulatory capitallevels for the Bank and bank holding company meet those established forwell-capitalized institutions. The decrease in the tier 1 and total risk-basedcapital ratios is a result of the GMM acquisition. Table 12 provides additionalinformation pertaining to our capital ratios.

 

**Capital Components**

At September 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                                           |   | **Actual** |       | **For  Capital  Adequacy Purposes** |       | **To Be  Well   Capitalized Under   Prompt Corrective  Action Provisions** |       |
|------------------------------------------------------|--------|------------|------------|-------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                           |   | **Amount** | ** ** | **Ratio**                           | ** ** | **Amount**                                                                 | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                                           |   |       |       |                                |       |                                                                       |       |   |   |   |   |   |   |
| **At September 30,  2004**                      |   |       |       |                                |       |                                                                       |       |   |   |   |   |   |   |
| Total risk based capital to net risk-weighted assets |   | $          | 104,799    |                                | 13.65      | %                                                                          | $          | 61,419 | > | 8.00 | % | $ | 76,774 | > | 10.00 | % |
| Tier I capital to net risk-weighted assets           |   | 99,631     |       | 12.98                               | %          | 30,709                                                                     | >       | 4.00 | % | 46,064 | > | 6.00 | % |
| Total risk based capital to average total assets     |   | 104,799    |       | 8.55                                | %          | 46,589                                                                     | >       | 4.00 | % | 58,237 | > | 5.00 | % |
|                                                 |   |       |       |                                |       |                                                                       |       |   |   |   |   |   |   |
| **At December 31, 2003**                        |   |       |       |                                |       |                                                                       |       |   |   |   |   |   |   |
| Total risk based capital to net risk-weighted assets |   | $          | 90,239     |                                | 20.66      | %                                                                          | $          | 34,951 | > | 8.00 | % | $ | 43,688 | > | 10.00 | % |
| Tier I capital to net risk-weighted assets           |   | 85,896     |       | 19.66                               | %          | 17,475                                                                     | >       | 4.00 | % | 26,213 | > | 6.00 | % |
| Total risk based capital to average total assets     |   | 90,239     |       | 15.45                               | %          | 23,365                                                                     | >       | 4.00 | % | 29,206 | > | 5.00 | % |

 

**Contractual Obligations**

 

We haveentered into a number of long-term contractual obligations to support ourongoing activities.  These contractualobligations will be funded through operating revenues and liquidity sourcesheld or available to us.  The requiredpayments under such obligations are detailed in Table 13.  In addition, the Company, in the normalcourse of business, is a party to financial instruments with off-balance sheetrisk to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, letters of credit and financial guarantees.  At September 30, 2004, commitments toextend credit were $161.4 million and standby letters of credit were $4.8million.

 

**Contractual Obligations**

AtSeptember 30, 2004

(Dollarsin thousands)

 
| ** **                                           | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|
| ** **                                           | ** ** | **Total**                  | ** ** | **Less than 1  Year** | ** ** | **1 - 2 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
| Certificates  of deposit of $100,000 or more         |       | $                          | 183,833    |   | $ | 54,392 |   | $ | 17,934 |   | $ | 111,053 |   | $ | 454 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Brokered  certificates of deposit                    |       | 131,636                    |       | 104,766 |   | 26,870 |   | — |   | — |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Advances  from the Federal Home Loan Bank of Atlanta |       | 102,083                    |       | 40,500 |   | 11,750 |   | 29,833 |   | 20,000 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Trust  preferred securities                          |       | 20,000                     |       | — |   | — |   | — |   | 20,000 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Operating  lease obligations                         |       | 16,553                     |       | 3,752 |   | 3,815 |   | 7,303 |   | 1,683 |   |
|                                                 |       |                       |       |   |   |   |   |   |   |   |   |
| Total                                                |       | $                          | 454,105    |   | $ | 203,410 |   | $ | 60,369 |   | $ | 148,189 |   | $ | 42,137 |   |

 

## **Liquidity**

## ** **

The objective of liquidity management is toensure the continuous availability of funds to meet the demands of depositors,investors and borrowers and to fund loans, investment securities, and otherassets.  Stable core deposits and astrong capital position are the primary components of a solid foundation forour liquidity position.  In addition, theavailability of regional and national wholesale funding sources includingfederal funds purchased, negotiable certificates of deposit, securities soldunder agreements to repurchase, and borrowings from the Federal Home Loan Bankenhances our liquidity.  Cash flows fromoperations, such as loan payments and payoffs, are also a significant source ofliquidity.  We have a contingency planthat provides for continued monitoring of liquidity needs and available sourcesof liquidity.  We believe we have theability to meet anticipated liquidity needs. Liquid assets, which include cash and due from banks,

 

37

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federal fundssold and investment securities available for sale totaled $199.3 or 16.9% of totalassets as of September 30, 2004.  Wehad investment securities that are classified as held-to-maturity of anadditional $148.0 million.  The Bank usescertain assets in the investment portfolio as collateral against advances fromthe Federal Home Loan Bank of Atlanta, customer repurchase agreements,Treasury, Tax, and Loan Note and the Federal Reserve Discount Window.  At September 30, 2004, advances from theFederal Home Loan Bank of Atlanta totaled $102.1 million, repurchase agreementstotaled $24.2 million, Treasury, Tax and Loan Note totaled $12.5 million andthere were no borrowings from the Federal Reserve Discount Window.  Management is committed to maintainingliquidity at a level sufficient to protect depositors, provide for reasonablegrowth and fully comply with all regulatory requirements.

 

##### **Interest Rate Sensitivity**

##### ** **

Asset/liability management involves themonitoring of our sensitivity to interest rate movements.  In order to measure the effect of interestrates on our net interest income, we take into consideration the expected cashflows from the loan and investment securities portfolios and the expectedmagnitude of the repricing of specific asset and liability categories.  Management evaluates interest sensitivityrisk and then formulates guidelines to manage this risk based upon its outlookregarding the economy, forecasted interest rate movements and other businessfactors.  Management’s goal is tomaximize and stabilize the net interest margin by limiting exposure to interestrate changes.

 

The data in Table 14 reflects the repricingor expected maturities of various assets and liabilities at September 30,2004.  This “gap” analysis represents thedifference between interest sensitive assets and liabilities in a specific timeinterval.  The interest sensitivity gapanalysis presents a position that existed at one particular point in time, andassumes that assets and liabilities with similar repricing characteristics willreprice at the same time and to the same degree.  Additional information on interest rate riskcan be found in Item 3 to this Form 10-Q/A.

 

**Interest Rate Sensitivity Gap Analysis**

AtSeptember 30, 2004

(Dollarsin thousands)

 
| ** **                                                                   | ** ** | **Immediate  Repricing** | ** ** | **2-90  Days** | ** ** | **91-180  Days** | ** ** | **181-365  Days** | ** ** | **1-3  Years** | ** ** | **Over 3  Years** | ** ** | **TOTAL** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------|------------|----------------|------------|------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|-----------|------------|
| **Assets**                                                                   |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Total investment securities and other investments                            |       | $                        | —     |           | $          | 16,895           |       | $                 | 12,115     |           | $          | 28,792            |       | $         | 112,732    |   | $ | 144,278 |   | $ | 314,812 |   |
| Federal funds sold                                                           |       | 25,580                   |       | —         |       | —           |       | —            |       | —         |       | —            |       | 25,580    |       |
| Loans held for sale                                                          |       | 347,471                  |       | —         |       | —           |       | —            |       | —         |       | —            |       | 347,471   |       |
| **Loans receivable**                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Commercial                                                                   |       | 32,342                   |       | 738            |       | 843              |       | 964               |       | 6,896          |       | 10,439            |       | 52,222    |       |
| Real estate - commercial                                                     |       | 41,637                   |       | 265            |       | 665              |       | 506               |       | 7,536          |       | 147,183           |       | 197,792   |       |
| Real estate - construction                                                   |       | 39,157                   |       | 6,718          |       | 7,277            |       | 7,643             |       | 2,028          |       | 2,024             |       | 64,847    |       |
| Real estate - residential                                                    |       | 3,377                    |       | 7,770          |       | 1,482            |       | 812               |       | 5,207          |       | 42,213            |       | 60,861    |       |
| Home equity lines                                                            |       | 50,342                   |       | 2,119          |       | 3,139            |       | 607               |       | —         |       | —            |       | 56,207    |       |
| Consumer                                                                     |       | 2,931                    |       | 7              |       | 19               |       | 132               |       | 370            |       | 3,800             |       | 7,259     |       |
| **Total loans receivable**                                                   |       | 169,786                  |       | 17,617         |       | 13,425           |       | 10,664            |       | 22,037         |       | 205,659           |       | 439,188   |       |
| **Total earning assets**                                                     |       | 542,837                  |       | 34,512         |       | 25,540           |       | 39,456            |       | 134,769        |       | 349,937           |       | 1,127,051 |       |
| **Cumulative rate sensitive assets**                                         |       | $                        | 542,837    |           | $          | 577,349          |       | $                 | 602,889    |           | $          | 642,345           |       | $         | 777,114    |   | $ | 1,127,051 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Liabilities**                                                              |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Deposits**                                                                 |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Noninterest-bearing demand                                                   |       | $                        | 101,934    |           | $          | —           |       | $                 | —     |           | $          | —            |       | $         | —     |   | $ | — |   | $ | 101,934 |   |
| Interest-bearing transaction accounts                                        |       | 194,608                  |       | —         |       | —           |       | —            |       | —         |       | —            |       | 194,608   |       |
| Certificates of deposit - fixed                                              |       | —                   |       | 57,077         |       | 58,232           |       | 57,449            |       | 52,907         |       | 34,578            |       | 260,243   |       |
| Certificates of deposit - no penalty                                         |       | —                   |       | 19,362         |       | 4,008            |       | 52,485            |       | 24,081         |       | 163,213           |       | 263,149   |       |
| **Total deposits**                                                           |       | 296,542                  |       | 76,439         |       | 62,240           |       | 109,934           |       | 76,988         |       | 197,791           |       | 819,934   |       |
| Other borrowed funds & warehouse financing                               |       | 125,497                  |       | 5,625          |       | 6,625            |       | 28,250            |       | 24,500         |       | 57,702            |       | 248,199   |       |
| **Total deposits & other borrowed funds**                                |       | 422,039                  |       | 82,064         |       | 68,865           |       | 138,184           |       | 101,488        |       | 255,493           |       | 1,068,133 |       |
| **Cumulative rate sensitive liabilities**                                    |       | $                        | 422,039    |           | $          | 504,103          |       | $                 | 572,968    |           | $          | 711,152           |       | $         | 812,640    |   | $ | 1,068,133 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Gap**                                                                      |       | $                        | 120,798    |           | $          | (47,552          | )          | $                 | (43,325    | )              | $          | (98,728           | )          | $         | 33,281     |   | $ | 94,444 |   |   |   |
| **Cumulative gap**                                                           |       | 120,798                  |       | 73,246         |       | 29,921           |       | (68,807           | )          | (35,526        | )          | 58,918            |       |      |       |
| **Gap/ total assets**                                                        |       | 10.25                    | %          | -4.04          | %          | -3.68            | %          | -8.38             | %          | 2.82           | %          | 8.02              | %          |      |       |
| **Cumulative gap/ total assets**                                             |       | 10.25                    | %          | 6.22           | %          | 2.54             | %          | -5.84             | %          | -3.02          | %          | 5.00              | %          |      |       |
| **Rate sensitive assets/ rate sensitive  liabilities**                       |       | 1.29                     |       | 0.42           |       | 0.37             |       | 0.29              |       | 1.33           |       | 1.37              |       |      |       |
| **Cumulative rate sensitive assets/ cumulative  rate sensitive liabilities** |       | 1.29                     |       | 1.15           |       | 1.05             |       | 0.90              |       | 0.96           |       | 1.06              |       |      |       |

 

**Caution About Forward-LookingStatements**

 

We make forward-looking statements in this Form 10-Q/A thatare subject to risks and uncertainties. These forward looking statements include statements regarding ourprofitability, liquidity, allowance for loan losses,interest rate sensitivity, market risk, growth strategy, and financial andother goals.  The words “believes,” “expects,”“may,” “will,” “should,” “projects,” “contemplates,” “anticipates,”“forecasts,” “intends,” or other similar words or terms are intended toidentify forward-looking statements.

 

These forward-looking statements are subject tosignificant uncertainties because they are based upon or are affected byfactors including:

 

•                  the ability to successfully manage our growth or implementour growth strategies if we are unable to identify attractive markets,locations or opportunities to expand in the future;

•                  changes in interest rates and interest rate policies;

•                  risks inherent in making loans such as repayment risks andfluctuating collateral values;

•                  the successful management of interest rate risk;

•                  maintaining costcontrols and asset qualities as we open or acquire new branches;

•                  maintainingcapital levels adequate to support our growth;

 

38

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•                  our ability tosuccessfully integrate GMM into the organization and the impact of increasedeconomic activity and interest rates on GMM’s performance in future periods;

•                  the availabilityof warehouse credit facilities to fund GMM’s loan originations and the terms ofsuch credit facilities in fluctuating or rising rate environments may adverselyaffect our earnings or ability to borrow;

•                  reliance on our management team, including our ability toattract and retain key personnel;

•                  competition with other banks and financial institutions, andcompanies outside of the banking industry, including those companies that havesubstantially greater access to capital and other resources;

•                  changes in general economic and business conditions in ourmarket area;

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

•                  problems with technology utilized by us;

•                  changing trendsin customer profiles and behavior; and

•                  changes in banking and other laws and regulations applicableto us.

 

Because of these uncertainties, our actual future results maybe materially different from the results indicated by these forward-lookingstatements.  In addition, our pastresults of operations do not necessarily indicate our future results.

 

39

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**Item 3.****  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Our Asset/Liability Committee is responsiblefor reviewing our liquidity requirements and maximizing our net interestincome, consistent with capital requirements, liquidity, interest rate andeconomic outlooks, competitive factors and customer needs.  One of the tools we use to determine our interest rate risk is gapanalysis.  Gap analysis attempts toexamine the volume of interest rate sensitive assets less interest ratesensitive liabilities in various time intervals.  The difference is the interest sensitivitygap, which indicates how future changes in interest rates may affect netinterest income.  Interest sensitivitygap analysis presents a position that exists at one particular point in timeand assumes that assets and liabilities with similar characteristics willre-price at the same time and to the same degree.  Under our asset/liability policies,regardless of whether interest rates are expected to increase or decrease, theobjective is to maintain a gap position that will minimize negative changes innet interest income.  A negative gap, orliability sensitive position, exists when we have more interest sensitiveliabilities maturing within a certain gap interval than interest sensitiveassets.  Under this scenario, if interestrates were to increase, it would tend to reduce interest income.

 

We can reprice our interest checking, savings, andmoney market accounts at any time.  Wecarefully analyze the impact of any change in interest rates on our deposits,as we may experience a runoff in deposit balances as a result of such changesin interest rates.  We continue toanalyze the activity in our deposit portfolio and make changes in our gapassumptions as the activity dictates. See Table 14 from our management’sdiscussion and analysis, which reflects the repricing or expected maturities ofvarious assets and liabilities at September 30, 2004.  This “gap” analysis represents the differencebetween interest sensitive assets and liabilities in a specific time interval.

 

We also use a simulation process to measure interestrate risk and the impact of rate fluctuations on net interest income.  These simulations incorporate assumptionsregarding balance sheet growth and mix, and the re-pricing and maturitycharacteristics of existing and projected balance sheets.  One of the ways we manage our interest raterisk is through an analysis of the relationship between interest-earning assetsand interest-bearing liabilities to measure the impact that future changes ininterest rates will have on net interest income.  Using this relationship analysis, changes ininterest rates and volumes are used to test the sensitivity of our net interestincome.  While on a simple gap basis weshow liability sensitivity in the short term indicating that an increase ininterest rates may negatively affect short-term net interest income, we wouldlikely take actions to minimize our exposure to negative results and within ashort period of time make adjustments so that net interest income would not be materiallyimpacted.  When we incorporateassumptions regarding pricing of non-maturity deposits, we are asset sensitivein the short term.

 

We expect our net interest income will be greaterover the longer term at higher prevailing interest rate levels.  This is due to the large proportion oflow-cost core deposits such as demand, interest checking, savings, and moneymarket accounts comprising our funding sources, which tend to be less sensitiveto rising rates and can be invested in relatively higher yielding loans andinvestment securities.

 

40

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**Item 4****.**** Controls and Procedures**

 

The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed by it in the reports that it files or submits under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed,summarized and reported within the time periods required by the Securities andExchange Commission, including, without limitation, those controls andprocedures designed to ensure that such information is accumulated andcommunicated to the Company’s management to allow timely decisions regardingrequired disclosures.

 

As of the end of the period covered by this report,an evaluation of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures was carried out under the supervision andwith the participation of the Company’s management, including the chiefexecutive officer and chief financial officer.  Based on and as of thedate of such evaluation, these officers concluded that the Company’s disclosurecontrols and procedures were not effective due to corrections or errors relatedto the Company’s accounting adjustments applied to the acquisition of GMM in acash transaction for $17.0 million on July 7, 2004, as describedbelow.  The existence of the correctionshas been disclosed publicly, and these officers believe that the correctionshave been handled as contemplated by the requirement for disclosure controlsand procedures under the Exchange Act.

 

The Company also maintains a system of internalaccounting controls that is designed to provide assurance that assets aresafeguarded and that transactions are executed in accordance with management’sauthorization and properly recorded.  This system is continually reviewedand is augmented by written policies and procedures, the careful selection andtraining of qualified personnel and an internal audit program to monitor itseffectiveness.  Subsequent to the initialfiling of the Company’s Quarterly Report on Form 10-Q for the period ended September 30,2004 on November 22, 2004, the Company identified the correctionsidentified above.  The acquisition wasaccounted for as a purchase, and GMM’s assets and liabilities were recorded at estimatedfair value as of the purchase date.  Thecorrections were primarily related to the fair value estimates associated with acquiredloans held for sale and the acquired pipeline of unfunded loan commitments andvarious other adjustments primarily related to the GMM acquisition. Thesecorrections will result in a decrease in previously reported gains on the saleof mortgage loans and a corresponding decrease in the goodwill initiallyrecorded.

 

During the evaluation of these corrections, theCompany concluded that the corrections reflect a material weakness in itsinternal control over financial reporting with respect to the accountingadjustments applied to the acquisition of GMM. A material weakness, as defined by the Public Company AccountingOversight Board, is a reportable condition in which the design or operation ofone or more elements of the internal control structure does not sufficientlyreduce the risk of material errors and irregularities occurring and not beingtimely detected.  The Company’smanagement has communicated the material weakness and its background to theCompany’s board of directors and its audit committee and the Company’sindependent registered public accountants. The Company’s independent registeredpublic accountants has informed the Company that it will, because of therestatement of certain financial statements as disclosed below, issue amaterial weakness letter citing (1) insufficient personnel resources andtechnical accounting expertise, (2) absence of appropriate and timely review ofsignificant transactions and appropriate documentation and application of U.S.generally accepted accounting principles and (3) inadequate procedures andoversight for appropriately assessing and applying accounting principles andchanges thereon.

 

41

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As a result of these corrections, the Company isrestating certain financial statements in this amended report, as described inNote 3 to the Consolidated Financial Statements.  Information with respect to the quantitativeimpact of these corrections is included in Note 3.   The corrections occurred as a result of themiscalculations of accounting entries and misapplication of certain financial accountingstandards and did not result from any fraudulent activities. The corrections relatedto purchase accounting were nonrecurring and noncash in nature.  The Company appointed a new Chief FinancialOfficer and hired a new senior accountant in October 2004. The Companybelieves these appointments have strengthened the internal control structure ofthe organization.  The Company continuesto evaluate its financial accounting staff levels and expertise and isimplementing appropriate oversight and review procedures.  The Company believes that it is taking thenecessary corrective actions to eliminate these material weaknesses.

 

Except as described above, there were no changes inthe Company’s internal control over financial reporting identified in connectionwith its evaluation of it that occurred during the Company’s last fiscalquarter that materially affected, or are reasonably likely to materiallyaffect, its internal control over financial reporting.

 

42

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**PART II****–OTHER INFORMATION**

 

**Item 1.**** Legal Proceedings**

 

In the ordinary course of our operations, wemay become party to legal proceedings. Currently, we are not party to any material legal proceedings and nosuch proceedings are, to management’s knowledge, threatened against us.

 

**Item 2.**  Unregistered Sales of Equity Securities and Useof Proceeds

** **

(a) None.

(b) Not applicable.

(c) None.

 

**Item 3.**** Defaults Upon Senior Securities**

 

(a) None.

(b) None.

 

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

 

(a) None.

(b) Not applicable.

(c) Not applicable.

(d) None.

 

**Item 5.****  Other Information**

 

(a) None.

(b) None.

 

**Item 6.****  Exhibits**

 
| 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 |

 

43

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**SIGNATURES**

 

 

**Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this Report tobe signed on its behalf by the undersigned thereunto duly authorized.**

 
| ** **                 | **CARDINAL FINANCIAL CORPORATION**                        |
|----------------------------|-----------------------------------------------------------|
| ** **                 | **(Registrant)**                                          |
| ** **                 | ** **                                                |
| **Date: February 1, 2005** | **/s/ Bernard H. Clineburg**                              | ** ** |
| ** **                 | **Bernard H. Clineburg**                                  |
| ** **                 | **Chairman, President and Chief Executive  Officer**      |
| ** **                 | **(Principal Executive Officer)**                         |
| ** **                 | ** **                                                |
| ** **                 | ** **                                                |
| **Date: February 1, 2005** | **/s/ Robert A. Cern**                                    | ** ** |
| ** **                 | **Robert A. Cern**                                        |
| ** **                 | **Executive Vice President and Chief  Financial Officer** |
| ** **                 | **(Principal Financial Officer)**                         |
| ** **                 | ** **                                                |
| ** **                 | ** **                                                |
| **Date: February 1, 2005** | **/s/ Jennifer L. Deacon**                                | ** ** |
| ** **                 | **Jennifer L. Deacon**                                    |
| ** **                 | **Senior Vice President and Controller**                  |
| ** **                 | **(Principal Accounting Officer)**                        |

 

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