Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 
| ** ** | **x** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|------------|-------|----------------------------------------------------------------------------------------------------|

** **

**For the quarterly period ended June 30,2009**

 

**or**

 
| ** ** | **o** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|------------|-------|-----------------------------------------------------------------------------------------------------|

 

**For the transition period from              to              **

 

**Commission File Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Virginia**                              | ** ** | **54-1874630**      |
|-------------------------------------------|------------|---------------------|
| (State or other jurisdiction of           |       | (I.R.S. Employer    |
| incorporation or organization)            |       | Identification No.) |
| ** **                                |       |                |
| **8270 Greensboro Drive, Suite 500** |       |                |
| **McLean, Virginia**                      | ** ** | **22102**           |
| (Address of principal executive offices)  |       | (Zip Code)          |

 

**(703) 584-3400**

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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

 

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

 

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

 

28,690,285 shares of common stock, par value $1.00 per share,

outstanding as of July 29, 2009

 

 

 

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**CARDINALFINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I –  FINANCIAL INFORMATION**                                                                                      | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                         | ** ** |
| Item 1.  Financial Statements:                                                                                                     |       |
|                                                                                                                               |       |
| Consolidated  Statements of Condition  At June 30, 2009 (unaudited) and December 31, 2008                                | 3          |
|                                                                                                                               |       |
| Consolidated  Statements of Income  For the three and six months ended June 30, 2009 and 2008 (unaudited)                     | 4          |
|                                                                                                                               |       |
| Consolidated  Statements of Comprehensive Income  For the three and six months ended June 30, 2009 and 2008 (unaudited)       | 5          |
|                                                                                                                               |       |
| Consolidated  Statements of Changes in Shareholders’ Equity  For the six months ended June 30, 2009 and 2008 (unaudited) | 6          |
|                                                                                                                               |       |
| Consolidated  Statements of Cash Flows  For the six months ended June 30, 2009 and 2008 (unaudited)                           | 7          |
|                                                                                                                               |       |
| Notes to  Consolidated Financial Statements (unaudited)                                                                            | 8          |
|                                                                                                                               |       |
| Item 2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations                                 | 27         |
|                                                                                                                               |       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                                | 61         |
|                                                                                                                               |       |
| Item 4. Controls  and Procedures                                                                                                   | 63         |
|                                                                                                                               |       |
| **PART II – OTHER  INFORMATION**                                                                                         | 64         |
| ** **                                                                                                                         |       |
| Item 1. Legal  Proceedings                                                                                                         | 64         |
| Item 1A. Risk Factors                                                                                                              | 64         |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                               | 67         |
| Item 3.  Defaults Upon Senior Securities                                                                                           | 67         |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                                       | 67         |
| Item 5. Other  Information                                                                                                         | 67         |
| Item 6. Exhibits                                                                                                                   | 68         |
|                                                                                                                               |       |
| **SIGNATURES**                                                                                                                     | 69         |

 

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Table ofContents

 

**PART I – FINANCIALINFORMATION**

 

**Item 1.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OF CONDITION

 

June 30,2009 and December 31, 2008

 

(Inthousands, except share data)

 
| ** **                                                                                                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                  | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                  | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                  |       |              |       |                  |       |
|                                                                                                                                        |       |              |       |                  |       |
| Cash  and due from banks                                                                                                                    |       | $                 | 12,371     |                  | $          | 14,919 |   |
| Federal  funds sold                                                                                                                         |       | 48,442            |       | 31,009                |       |
|                                                                                                                                        |       |              |       |                  |       |
| Total  cash and cash equivalents                                                                                                            |       | 60,813            |       | 45,928                |       |
| Investment  securities available-for-sale                                                                                                   |       | 240,158           |       | 265,356               |       |
| Investment  securities held-to-maturity (fair value of $37,917 and $45,759 at  June 30, 2009 and December 31, 2008, respectively) |       | 40,910            |       | 50,183                |       |
|                                                                                                                                        |       |              |       |                  |       |
| Total  investment securities                                                                                                                |       | 281,068           |       | 315,539               |       |
|                                                                                                                                        |       |              |       |                  |       |
| Other  investments                                                                                                                          |       | 16,467            |       | 16,370                |       |
| Loans  held for sale                                                                                                                        |       | 232,197           |       | 157,009               |       |
|                                                                                                                                        |       |              |       |                  |       |
| Loans  receivable, net of deferred fees and costs                                                                                           |       | 1,198,671         |       | 1,139,348             |       |
| Allowance  for loan losses                                                                                                                  |       | (16,150           | )          | (14,518               | )          |
|                                                                                                                                        |       |              |       |                  |       |
| Loans  receivable, net                                                                                                                      |       | 1,182,521         |       | 1,124,830             |       |
|                                                                                                                                        |       |              |       |                  |       |
| Premises  and equipment, net                                                                                                                |       | 15,773            |       | 16,463                |       |
| Deferred  tax asset, net                                                                                                                    |       | 8,188             |       | 8,799                 |       |
| Goodwill  and intangibles, net                                                                                                              |       | 14,054            |       | 14,173                |       |
| Bank-owned  life insurance                                                                                                                  |       | 33,409            |       | 33,176                |       |
| Accrued  interest receivable and other assets                                                                                               |       | 19,924            |       | 11,470                |       |
|                                                                                                                                        |       |              |       |                  |       |
| Total  assets                                                                                                                               |       | $                 | 1,864,414  |                  | $          | 1,743,757 |   |
|                                                                                                                                        |       |              |       |                  |       |
| **Liabilities and Shareholders’  Equity**                                                                                              |       |              |       |                  |       |
| ** **                                                                                                                                  |       |              |       |                  |       |
| Non-interest  bearing deposits                                                                                                              |       | $                 | 158,540    |                  | $          | 147,529 |   |
| Interest  bearing deposits                                                                                                                  |       | 1,083,040         |       | 1,032,315             |       |
|                                                                                                                                        |       |              |       |                  |       |
| Total  deposits                                                                                                                             |       | 1,241,580         |       | 1,179,844             |       |
|                                                                                                                                        |       |              |       |                  |       |
| Other  borrowed funds                                                                                                                       |       | 380,906           |       | 367,198               |       |
| Mortgage  funding checks                                                                                                                    |       | 19,042            |       | 19,178                |       |
| Escrow  liabilities                                                                                                                         |       | 3,880             |       | 1,832                 |       |
| Accrued  interest payable and other liabilities                                                                                             |       | 22,407            |       | 17,699                |       |
|                                                                                                                                        |       |              |       |                  |       |
| Total  liabilities                                                                                                                          |       | 1,667,815         |       | 1,585,751             |       |
|                                                                                                                                        |       |              |       |                  |       |
| ** **                                                                                                                                  | ** ** | **2009**          | ** ** | **2008**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Common  stock, $1 par value                                                                                                                 |       |              |       |                  |       |   |   |   |   |
| Shares  authorized                                                                                                                          |       | 50,000,000        |       | 50,000,000            |       |   |   |   |   |
| Shares  issued and outstanding                                                                                                              |       | 28,690,285        |       | 24,013,663            |       | 28,690 |   | 24,014 |   |
| Additional  paid-in capital                                                                                                                 |       |              |       |                  |       | 159,506 |   | 130,709 |   |
| Retained  earnings                                                                                                                          |       |              |       |                  |       | 7,265 |   | 3,437 |   |
| Accumulated  other comprehensive loss, net                                                                                                  |       |              |       |                  |       | 1,138 |   | (154 | ) |
|                                                                                                                                        |       |              |       |                  |       |   |   |   |   |
| Total  shareholders’ equity                                                                                                            |       |              |       |                  |       | 196,599 |   | 158,006 |   |
|                                                                                                                                        |       |              |       |                  |       |   |   |   |   |
| Total  liabilities and shareholders’ equity                                                                                            |       |              |       |                  |       | $ | 1,864,414 |   | $ | 1,743,757 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATEDSTATEMENTS OF INCOME

 

Threeand six months ended June 30, 2009 and 2008

(Inthousands, except share data)

(Unaudited)

 
| ** **                                                      | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest  income:                                               |       |                                  |       |                                |       |   |   |   |   |
| Loans  receivable                                               |       | $                                     | 16,055     |                                | $          | 15,754 |   | $ | 31,384 |   | $ | 32,366 |   |
| Loans  held for sale                                            |       | 2,196                                 |       | 1,955                               |       | 4,021 |   | 4,084 |   |
| Federal  funds sold                                             |       | 31                                    |       | 178                                 |       | 44 |   | 316 |   |
| Investment  securities available-for-sale                       |       | 2,429                                 |       | 3,447                               |       | 5,314 |   | 6,755 |   |
| Investment  securities held-to-maturity                         |       | 419                                   |       | 628                                 |       | 904 |   | 1,377 |   |
| Other  investments                                              |       | —                                |       | 215                                 |       | (19 | ) | 433 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  interest income                                          |       | 21,130                                |       | 22,177                              |       | 41,648 |   | 45,331 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Interest  expense:                                              |       |                                  |       |                                |       |   |   |   |   |
| Deposits                                                        |       | 6,047                                 |       | 7,859                               |       | 12,804 |   | 17,207 |   |
| Other  borrowed funds                                           |       | 3,120                                 |       | 3,273                               |       | 6,262 |   | 6,745 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  interest expense                                         |       | 9,167                                 |       | 11,132                              |       | 19,066 |   | 23,952 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net  interest income                                            |       | 11,963                                |       | 11,045                              |       | 22,582 |   | 21,379 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Provision  for loan losses                                      |       | 1,484                                 |       | 769                                 |       | 2,700 |   | 1,089 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net  interest income after provision for loan losses            |       | 10,479                                |       | 10,276                              |       | 19,882 |   | 20,290 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Noninterest  income:                                            |       |                                  |       |                                |       |   |   |   |   |
| Service  charges on deposit accounts                            |       | 496                                   |       | 535                                 |       | 968 |   | 1,062 |   |
| Loan  service charges                                           |       | 825                                   |       | 354                                 |       | 1,658 |   | 664 |   |
| Investment  fee income                                          |       | 880                                   |       | 922                                 |       | 1,691 |   | 1,823 |   |
| Realized  and unrealized gains on mortgage banking activities   |       | 3,403                                 |       | 1,576                               |       | 6,746 |   | 3,893 |   |
| Net  realized gains on investment securities available-for-sale |       | —                                |       | 214                                 |       | 552 |   | 214 |   |
| Net  realized gain (loss) on investment securities trading      |       | 111                                   |       | (5                                  | )          | (520 | ) | (9 | ) |
| Management  fee income                                          |       | 383                                   |       | 302                                 |       | 714 |   | 386 |   |
| Increase  in cash surrender value of bank-owned life insurance  |       | 157                                   |       | 252                                 |       | 233 |   | 575 |   |
| Litigation  recovery on previously impaired investment          |       | —                                |       | —                              |       | — |   | 190 |   |
| Other  income (loss)                                            |       | (4                                    | )          | 225                                 |       | (34 | ) | 189 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  noninterest income                                       |       | 6,251                                 |       | 4,375                               |       | 12,008 |   | 8,987 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Noninterest  expense:                                           |       |                                  |       |                                |       |   |   |   |   |
| Salary  and benefits                                            |       | 6,164                                 |       | 5,493                               |       | 11,650 |   | 11,495 |   |
| Occupancy                                                       |       | 1,357                                 |       | 1,377                               |       | 2,734 |   | 2,776 |   |
| Professional  fees                                              |       | 521                                   |       | 615                                 |       | 1,004 |   | 1,198 |   |
| Depreciation                                                    |       | 510                                   |       | 593                                 |       | 1,051 |   | 1,239 |   |
| Data  processing                                                |       | 515                                   |       | 413                                 |       | 969 |   | 855 |   |
| Telecommunications                                              |       | 322                                   |       | 252                                 |       | 611 |   | 486 |   |
| Amortization  of intangibles                                    |       | 60                                    |       | 63                                  |       | 119 |   | 127 |   |
| FDIC  insurance assessment                                      |       | 1,324                                 |       | 180                                 |       | 1,739 |   | 360 |   |
| Settlement  with mortgage correspondent                         |       | —                                |       | 1,800                               |       | — |   | 1,800 |   |
| Other  operating expenses                                       |       | 2,932                                 |       | 2,853                               |       | 5,866 |   | 5,125 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total  noninterest expense                                      |       | 13,705                                |       | 13,639                              |       | 25,743 |   | 25,461 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net  income before income taxes                                 |       | 3,025                                 |       | 1,012                               |       | 6,147 |   | 3,816 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Provision  for income taxes                                     |       | 883                                   |       | 138                                 |       | 1,836 |   | 900 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net  income                                                     |       | $                                     | 2,142      |                                | $          | 874 |   | $ | 4,311 |   | $ | 2,916 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Earnings  per common share - basic                              |       | $                                     | 0.08       |                                | $          | 0.04 |   | $ | 0.17 |   | $ | 0.12 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Earnings  per common share - diluted                            |       | $                                     | 0.08       |                                | $          | 0.04 |   | $ | 0.17 |   | $ | 0.12 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average  common shares outstanding - basic             |       | 25,965,314                            |       | 24,370,905                          |       | 25,319,694 |   | 24,426,234 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average  common shares outstanding - diluted           |       | 26,462,234                            |       | 24,858,450                          |       | 25,787,621 |   | 24,867,818 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME (LOSS)

Three and six monthsended June 30, 2009 and 2008

(In thousands)

(Unaudited)

 
| ** **                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                                                                                                                                                                                                                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                                                                                                                                                                                                                                                                                                                  |       | $                                     | 2,142      |                                | $          | 874 |   | $ | 4,311 |   | $ | 2,916 |   |
| Other comprehensive  income (loss):                                                                                                                                                                                                                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Unrealized gain (loss)  on available-for-sale investment securities:                                                                                                                                                                                                                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Unrealized holding gain  (loss) arising during the period, net of tax benefit of $27 thousand for the  three months ended June 30, 2009 and net of tax expense of $751 thousand  for the six months ended June 30, 2009; net of tax benefit of $1.9  million and $750 thousand for the three and six months ended June 30,  2008, respectively.              |       | (54                                   | )          | (3,341                              | )          | 1,760 |   | (1,270 | ) |
|                                                                                                                                                                                                                                                                                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Less: reclassification  adjustment for net gains included in net income net of tax expense of $188  thousand for the six months ended June 30, 2009; and net of tax expense  of $73 thousand for each of the three and six months ended June 30,  2008.                                                                                                           |       | —                                |       | (141                                | )          | (364 | ) | (141 | ) |
|                                                                                                                                                                                                                                                                                                                                                                        |       | (54                                   | )          | (3,482                              | )          | 1,396 |   | (1,411 | ) |
|                                                                                                                                                                                                                                                                                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Unrealized gain (loss)  on derivative instruments designated as cash flow hedges, net of tax expense  of $31 thousand and tax benefit of $140 thousand for the three and six months  ended June 30, 2009, respectively, and net of tax expense of $29  thousand and tax benefit of $114 thousand for the three and six months ended  June 30, 2008, respectively. |       | 106                                   |       | 32                                  |       | (104 | ) | (208 | ) |
|                                                                                                                                                                                                                                                                                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Comprehensive income  (loss)                                                                                                                                                                                                                                                                                                                                                |       | $                                     | 2,194      |                                | $          | (2,576 | ) | $ | 5,603 |   | $ | 1,297 |   |

 

See accompanying notes toconsolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Sixmonths ended June 30, 2009 and 2008

(Inthousands)

(Unaudited)

 
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance,  December 31, 2007                                                             |       | 24,202     |       | $          | 24,202     |           | $          | 131,516      |       | $                 | 4,213      |       | $          | (468 | ) | $ | 159,463 |   |
| Cumulative  effect adjustment at January 1, 2008 for the adoption of SFAS  No. 157 |       | —     |       | —     |       | —         |       | (96          | )          | —            |       | (96        | )          |
| Stock  compensation expense, net of tax benefits                                             |       | —     |       | —     |       | 197            |       | —       |       | —            |       | 197        |       |
| Stock  options exercised                                                                     |       | —     |       | —     |       | 1              |       | —       |       | —            |       | 1          |       |
| Purchase  and retirement of common stock                                                     |       | (95        | )          | (95        | )          | (681           | )          | —       |       | —            |       | (776       | )          |
| Dividends  on common stock of $0.02 per share                                                |       | —     |       | —     |       | —         |       | (484         | )          | —            |       | (484       | )          |
| Change  in accumulated other comprehensive loss                                              |       | —     |       | —     |       | —         |       | —       |       | (1,619            | )          | (1,619     | )          |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Net  income                                                                                  |       | —     |       | —     |       | —         |       | 2,916        |       | —            |       | 2,916      |       |
| Balance,  June 30, 2008                                                                 |       | 24,107     |       | $          | 24,107     |           | $          | 131,033      |       | $                 | 6,549      |       | $          | (2,087 | ) | $ | 159,602 |   |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance,  December 31, 2008                                                             |       | 24,014     |       | $          | 24,014     |           | $          | 130,709      |       | $                 | 3,437      |       | $          | (154 | ) | $ | 158,006 |   |
| Public  offering shares issued                                                               |       | 4,378      |       | 4,378      |       | 27,244         |       | —       |       | —            |       | 31,622     |       |
| Stock  compensation expense, net of tax benefits                                             |       | —     |       | —     |       | 228            |       | —       |       | —            |       | 228        |       |
| Stock  options exercised                                                                     |       | 11         |       | 11         |       | 47             |       | —       |       | —            |       | 58         |       |
| Shares  issued to employee benefits plan                                                     |       | 287        |       | 287        |       | 1,278          |       | —       |       | —            |       | 1,565      |       |
| Dividends  on common stock of $0.02 per share                                                |       | —     |       | —     |       | —         |       | (483         | )          | —            |       | (483       | )          |
| Change  in accumulated other comprehensive income                                            |       | —     |       | —     |       | —         |       | —       |       | 1,292             |       | 1,292      |       |
|                                                                                         |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Net  income                                                                                  |       | —     |       | —     |       | —         |       | 4,311        |       | —            |       | 4,311      |       |
| Balance,  June 30, 2009                                                                 |       | 28,690     |       | $          | 28,690     |           | $          | 159,506      |       | $                 | 7,265      |       | $          | 1,138 |   | $ | 196,599 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCASH FLOWS

 

Six Months Ended June 30,2009 and 2008

 

(In thousands)

 

(Unaudited)

 
| ** **                                                                              | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash  flows from operating activities:                                                  |       |       |       |       |       |
| Net  income                                                                             |       | $          | 4,311      |       | $          | 2,916 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:      |       |       |       |       |       |
| Depreciation                                                                            |       | 1,051      |       | 1,239      |       |
| Amortization  of premiums, discounts and intangibles                                    |       | 160        |       | 203        |       |
| Provision  for loan losses                                                              |       | 2,700      |       | 1,089      |       |
| Loans  held for sale originated                                                         |       | (1,458,487 | )          | (687,458   | )          |
| Proceeds  from the sale of loans held for sale                                          |       | 1,390,045  |       | 705,761    |       |
| Realized  and unrealized gains on mortgage banking activities                           |       | (6,746     | )          | (3,893     | )          |
| Proceeds  from sale, maturity and call of investment securities trading                 |       | 1,851      |       | 7,848      |       |
| Purchase  of investment securities trading                                              |       | (6,329     | )          | (7,856     | )          |
| Loss  on sale of investments securities trading                                         |       | 520        |       | 8          |       |
| Gain  on sale of investment securities available-for-sale                               |       | (769       | )          | (214       | )          |
| Loss  on sale of investment securities available-for-sale                               |       | 217        |       | —     |       |
| Loss  on sale of other assets                                                           |       | 4          |       | —     |       |
| Increase  in cash surrender value of bank-owned life insurance                          |       | (233       | )          | (575       | )          |
| Stock  compensation expense, net of tax benefits                                        |       | 228        |       | 197        |       |
| Decrease  in accrued interest receivable and other assets                               |       | (4,742     | )          | (1,662     | )          |
| Increase  in accrued interest payable, escrow liabilities and other liabilities         |       | 6,756      |       | 1,734      |       |
|                                                                                    |       |       |       |       |       |
| Net  cash provided by (used in) operating activities                                    |       | (69,463    | )          | 19,337     |       |
|                                                                                    |       |       |       |       |       |
| Cash  flows from investing activities:                                                  |       |       |       |       |       |
| Net  purchases of premises and equipment                                                |       | (365       | )          | (194       | )          |
| Proceeds  from sale, maturity and call of investment securities available-for-sale      |       | 25,737     |       | 89,070     |       |
| Proceeds  from sale, maturity and call of mortgage-backed securities available-for-sale |       | 43,589     |       | —     |       |
| Proceeds  from maturity and call of investment securities held-to-maturity              |       | 2,000      |       | 16,492     |       |
| Proceeds  from sale of other investments                                                |       | —     |       | 911        |       |
| Purchase  of investment securities available-for-sale                                   |       | (31,688    | )          | (110,216   | )          |
| Purchase  of mortgage-backed securities available-for-sale                              |       | (31,308    | )          | (34,758    | )          |
| Purchase  of other investments                                                          |       | (97        | )          | (3,106     | )          |
| Redemptions  of investment securities available-for-sale                                |       | 21,597     |       | 15,563     |       |
| Redemptions  of investment securities held-to-maturity                                  |       | 7,204      |       | 6,820      |       |
| Net  increase in loans receivable, net of deferred fees and costs                       |       | (60,391    | )          | (31,410    | )          |
|                                                                                    |       |       |       |       |       |
| Net  cash used in investing activities                                                  |       | (23,722    | )          | (50,828    | )          |
|                                                                                    |       |       |       |       |       |
| Cash  flows from financing activities:                                                  |       |       |       |       |       |
| Net  increase in deposits                                                               |       | 61,736     |       | 16,668     |       |
| Net  increase (decrease) in other borrowed funds - short term                           |       | 13,708     |       | (23,315    | )          |
| Net  decrease in mortgage funding checks                                                |       | (136       | )          | (1,491     | )          |
| Proceeds  from FHLB advances - long term                                                |       | —     |       | 80,000     |       |
| Repayments  of FHLB advances - long term                                                |       | —     |       | (31,250    | )          |
| Gain  from early extinguishment of long term FHLB advance                               |       | —     |       | (253       | )          |
| Proceeds  from issuance of stock                                                        |       | 31,622     |       | —     |       |
| Stock  options exercised                                                                |       | 58         |       | 1          |       |
| Purchase  and retirement of common stock                                                |       | —     |       | (776       | )          |
| Shares  issued to employee benefits plan                                                |       | 1,565      |       | —     |       |
| Dividends  on common stock                                                              |       | (483       | )          | (484       | )          |
|                                                                                    |       |       |       |       |       |
| Net  cash provided by financing activities                                              |       | 108,070    |       | 39,100     |       |
|                                                                                    |       |       |       |       |       |
| Net  increase in cash and cash equivalents                                              |       | 14,885     |       | 7,609      |       |
|                                                                                    |       |       |       |       |       |
| Cash  and cash equivalents at beginning of the year                                     |       | 45,928     |       | 22,421     |       |
|                                                                                    |       |       |       |       |       |
| Cash  and cash equivalents at end of the period                                         |       | $          | 60,813     |       | $          | 30,030 |   |
|                                                                                    |       |       |       |       |       |
| **Supplemental disclosure of cash flow information:**                                   |       |       |       |       |       |
| Cash  paid during the period for interest                                               |       | $          | 19,010     |       | $          | 23,952 |   |
| Cash  paid for income taxes                                                             |       | 1,308      |       | 3,336      |       |

 

Seeaccompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATIONAND SUBSIDIARIES**

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

 

Note1

 

*Organization*

 

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

 

*Basisof Presentation*

 

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

 

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

 

**Note 2**

** **

***Stock-Based Compensation***

** **

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

 

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

 

In2002, the Company adopted the Equity Plan. The Equity Plan authorizes thegranting of options, which may be incentive stock options or non-qualifiedstock options, stock appreciation rights, restricted stock awards, phantomstock awards and performance share awards to directors, eligible officers andkey employees of the Company.  The EquityPlan currently authorizes grants and awards with respect to 2,420,000 shares ofthe Company’s common stock.  There were

 

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219,658shares of the Company’s common stock available for future grants and awards inthe Equity Plan as of June 30, 2009.

 

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

 

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

 

Totalexpense related to the Company’s share-based compensation plans for the threemonths ended June 30, 2009 and 2008 was $162,000 and $122,000,respectively. Total stock compensation expense for the six months ended June 30,2009 and 2008 was $228,000 and $197,000, respectively. The total income taxbenefit recognized in the income statement for share-based compensationarrangements was $55,000 and $41,000 for the three months ended June 30,2009 and 2008, respectively.  For the sixmonths ended June 30, 2009 and 2008, the total income tax benefitrecognized in the income statement for share-based compensation was $78,000 and$67,000, respectively.

 

Optionsgranted during the three and six months ended June 30, 2009 were 52,500and 120,650, respectively. Options granted for each of the three and six monthsended June 30, 2008 were 16,200. The weighted average per share fair value of stock option grants duringthe three and six months ended June 30, 2009 was $3.38 and $2.80respectively.  For the three and sixmonths ended June 30, 2008, the weighted average per share fair value ofstock option grants were each $3.08.  Thefair values of the options granted during all periods ended June 30, 2009and 2008 were estimated as of the grant date using the Black-Scholesoption-pricing model based on the following weighted average assumptions:

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

 

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

 

Stockoption activity during the six months ended June 30, 2009 is summarized asfollows:

 

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| ** **                                 | ** ** | ** **    | ** ** | ** **   | ** ** | **Weighted**     | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|---------------|------------|--------------|------------|------------------|------------|---------------|------------|
| ** **                                 | ** ** | ** **    | ** ** | **Weighted** | ** ** | **Average**      | ** ** | **Aggregate** | ** ** |
| ** **                                 | ** ** | ** **    | ** ** | **Average**  | ** ** | **Remaining**    | ** ** | **Intrinsic** | ** ** |
| ** **                                 | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**  | ** ** | **Value**     | ** ** |
| ** **                                 | ** ** | **Shares**    | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **($000)**    | ** ** |
| Outstanding  at December 31, 2008     |       | 2,364,733     |       | $            | 8.70       |             |       |          |       |   |
| Granted                                    |       | 120,650       |       | 6.36         |       |             |       |          |       |
| Exercised                                  |       | (11,223       | )          | 4.60         |       |             |       |          |       |
| Forfeited                                  |       | (55,500       | )          | 10.47        |       |             |       |          |       |
| Expired                                    |       | (8,773        | )          | 6.38         |       |             |       |          |       |
| Outstanding  at June 30, 2009         |       | 2,409,887     |       | $            | 8.57       |             | 5.06       |          | $          | (1,783,232 | ) |
| Options  exercisable at June 30, 2009 |       | 2,209,437     |       | $            | 8.52       |             | 4.78       |          | $          | (1,534,359 | ) |

 

For the options exercised during the three and six months ended June 30,2009, the intrinsic values were $26,000 and $36,000, respectively. Totalintrinsic value of options exercised for each of the three and six months endedJune 30, 2008 were less than $1,000.

 

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

 
| ** **                         | ** ** | ** **    | ** ** | **Weighted**   | ** ** |
|------------------------------------|------------|---------------|------------|----------------|------------|
| ** **                         | ** ** | ** **    | ** ** | **Average**    | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Grant Date** | ** ** |
| ** **                         | ** ** | **Shares**    | ** ** | **Fair Value** | ** ** |
| Balance  at December 31, 2008 |       | 166,600       |       | $              | 5.62       |   |
| Granted                            |       | 120,650       |       | 2.80           |       |
| Vested                             |       | (69,300       | )          | 4.86           |       |
| Forfeited                          |       | (17,500       | )          | 5.71           |       |
| Balance  at June 30, 2009     |       | 200,450       |       | $              | 4.18       |   |

 

AtJune 30, 2009, there was $1.0 million of total unrecognized compensationcost related to non-vested share-based compensation arrangements granted underthe plans. The cost is expected to be recognized over a weighted average periodof 2.75 years. The total fair value of shares that vested during the threemonths ended June 30, 2009 and 2008 was $143,000 and $110,000,respectively. For the six months ended June 30, 2009 and 2008, the totalfair value of shares that vested was $247,000 and $278,000, respectively.

 

Note3

 

# *SegmentInformation*

#  

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

 

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

 

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individuals,including financial planning, retirement/estate planning, trust, estates,custody, investment management, escrows, and retirement plans.

 

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

 

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

 

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

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 11,412     |         | $          | 779                    |       | $          | —     |             | $          | (228             | )          | $ | — |   | $ | 11,963 |   |
| Provision  for loan losses  |       | 1,416          |       | 68           |       | —                 |       | —     |       | —           |       | 1,484            |       |
| Non-interest  income        |       | 820            |       | 4,458        |       | 885                    |       | 116        |       | (28              | )          | 6,251            |       |
| Non-interest  expense       |       | 9,223          |       | 3,005        |       | 784                    |       | 721        |       | (28              | )          | 13,705           |       |
| Provision  for income taxes |       | 387            |       | 744          |       | 35                     |       | (283       | )          | —           |       | 883              |       |
| Net  income (loss)          |       | $              | 1,206      |         | $          | 1,420                  |       | $          | 66         |             | $          | (550             | )          | $ | — |   | $ | 2,142 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,824,990  |         | $          | 259,708                |       | $          | 3,407      |             | $          | 217,798          |       | $ | (441,489 | ) | $ | 1,864,414 |   |
| Average  Assets             |       | $              | 1,769,354  |         | $          | 204,305                |       | $          | 3,434      |             | $          | 198,632          |       | $ | (399,303 | ) | $ | 1,776,422 |   |

 

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

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 10,437     |         | $          | 884                    |       | $          | —     |             | $          | (276             | )          | $ | — |   | $ | 11,045 |   |
| Provision  for loan losses  |       | 605            |       | 164          |       | —                 |       | —     |       | —           |       | 769              |       |
| Non-interest  income        |       | 1,358          |       | 2,088        |       | 922                    |       | 7          |       | —           |       | 4,375            |       |
| Non-interest  expense       |       | 7,355          |       | 4,694        |       | 844                    |       | 746        |       | —           |       | 13,639           |       |
| Provision  for income taxes |       | 1,105          |       | (649         | )          | 27                     |       | (345       | )          | —           |       | 138              |       |
| Net  income (loss)          |       | $              | 2,730      |         | $          | (1,237                 | )          | $          | 51         |             | $          | (670             | )          | $ | — |   | $ | 874 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,698,916  |         | $          | 172,952                |       | $          | 3,625      |             | $          | 173,959          |       | $ | (323,119 | ) | $ | 1,726,333 |   |
| Average  Assets             |       | $              | 1,645,803  |         | $          | 147,394                |       | $          | 3,630      |             | $          | 178,222          |       | $ | (322,179 | ) | $ | 1,652,870 |   |

 

**At and for the Six Months Ended June 30, 2009 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 21,542     |         | $          | 1,510                  |       | $          | —     |             | $          | (470             | )          | $ | — |   | $ | 22,582 |   |
| Provision  for loan losses  |       | 2,606          |       | 94           |       | —                 |       | —     |       | —           |       | 2,700            |       |
| Non-interest  income        |       | 2,159          |       | 8,695        |       | 1,706                  |       | (508       | )          | (44              | )          | 12,008           |       |
| Non-interest  expense       |       | 17,170         |       | 5,962        |       | 1,591                  |       | 1,064      |       | (44              | )          | 25,743           |       |
| Provision  for income taxes |       | 1,064          |       | 1,427        |       | 39                     |       | (694       | )          | —           |       | 1,836            |       |
| Net  income (loss)          |       | $              | 2,861      |         | $          | 2,722                  |       | $          | 76         |             | $          | (1,348           | )          | $ | — |   | $ | 4,311 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,824,990  |         | $          | 259,708                |       | $          | 3,407      |             | $          | 217,798          |       | $ | (441,489 | ) | $ | 1,864,414 |   |
| Average  Assets             |       | $              | 1,740,628  |         | $          | 187,146                |       | $          | 3,455      |             | $          | 189,752          |       | $ | (372,426 | ) | $ | 1,748,555 |   |

 

**At and for the Six Months Ended June 30, 2008 (inthousands):**

 
| ** **                  | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth  Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                  | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust  Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net  interest income        |       | $              | 20,390     |         | $          | 1,632                  |       | $          | —     |             | $          | (643             | )          | $ | — |   | $ | 21,379 |   |
| Provision  for loan losses  |       | 925            |       | 164          |       | —                 |       | —     |       | —           |       | 1,089            |       |
| Non-interest  income        |       | 2,423          |       | 4,723        |       | 1,822                  |       | 19         |       | —           |       | 8,987            |       |
| Non-interest  expense       |       | 15,069         |       | 7,250        |       | 1,716                  |       | 1,426      |       | —           |       | 25,461           |       |
| Provision  for income taxes |       | 1,923          |       | (364         | )          | 38                     |       | (697       | )          | —           |       | 900              |       |
| Net  income (loss)          |       | $              | 4,896      |         | $          | (695                   | )          | $          | 68         |             | $          | (1,353           | )          | $ | — |   | $ | 2,916 |   |
|                        |       |           |       |         |       |                   |       |       |       |             |       |             |       |
| Total  Assets               |       | $              | 1,698,916  |         | $          | 172,952                |       | $          | 3,625      |             | $          | 173,959          |       | $ | (323,119 | ) | $ | 1,726,333 |   |
| Average  Assets             |       | $              | 1,635,886  |         | $          | 145,197                |       | $          | 3,677      |             | $          | 177,964          |       | $ | (318,406 | ) | $ | 1,644,318 |   |

 

TheCompany did not have any operating segments other than those reported. Parentcompany financial information is included in the “Other” category andrepresents an overhead function rather than an operating segment. The parentcompany’s most significant assets are its net investments in its subsidiaries.The parent company’s net interest expense is comprised of interest 

 

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incomefrom short-term investments and interest expense on trust preferred securities.The parent company’s non-interest expense is primarily non-allocable executivesalaries and professional services related to the Company’s regulatoryrequirements.

 

#### **Note 4**

#### ** **

##### ***Earnings Per Share***

##### ** **

Thefollowing is the calculation of basic and diluted earnings per share for thethree and six months ended June 30, 2009 and 2008.  Antidilutive outstanding stock optionsexcluded from weighted average shares outstanding for the diluted earnings pershare calculation were 320,513 and 242,715 for three months ended June 30,2009 and 2008, respectively. For the six months ended June 30, 2009 and2008, antidilutive stock options excluded from weighted average sharesoutstanding for the diluted earnings per share calculation were 514,319 and232,881, respectively.  Theseantidilutive stock options have exercise prices that were greater than theaverage market price of the Company’s common stock for the periodspresented.  In addition, there were noincremental shares related to unvested stock options because the addition ofthese shares to the diluted weighted average share calculations would beantidilutive.

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands,**                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **except  per share data)**                  | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                         |       |                   |       |                 |       |   |   |   |   |
| Net  income available to common shareholders |       | $                      | 2,142      |                 | $          | 874 |   | $ | 4,311 |   | $ | 2,916 |   |
|                                         |       |                   |       |                 |       |   |   |   |   |
| Weighted  average common shares - basic      |       | 25,965                 |       | 24,371               |       | 25,320 |   | 24,426 |   |
|                                         |       |                   |       |                 |       |   |   |   |   |
| Weighted  average common shares - diluted    |       | 26,462                 |       | 24,858               |       | 25,788 |   | 24,868 |   |
|                                         |       |                   |       |                 |       |   |   |   |   |
| Earnings  per common share - basic           |       | $                      | 0.08       |                 | $          | 0.04 |   | $ | 0.17 |   | $ | 0.12 |   |
|                                         |       |                   |       |                 |       |   |   |   |   |
| Earnings  per common share - diluted         |       | $                      | 0.08       |                 | $          | 0.04 |   | $ | 0.17 |   | $ | 0.12 |   |

 

Basicearnings per share is impacted by the number of shares required to be issuedunder the Company’s various deferred compensation plans.  Employees who participate in the Company’sdeferred compensation plans can allocate their contributions to variousinvestment options, including a Company Common Stock investment option.  The incremental weighted average sharesattributable to the deferred compensation plans included in diluted outstandingshares assumes the participants opt to invest all of their contributions intothe Company’s Common Stock investment option.

 

Thefollowing shows the composition of basic outstanding shares for the three andsix months ended June 30, 2009 and 2008:

 

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| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(in  thousands)**                                                      | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| Weighted  average common shares outstanding                              |       | 25,671                 |       | 24,144               |       | 25,037 |   | 24,166 |   |
| Weighted  average shares attributable to the deferred compensation plans |       | 294                    |       | 227                  |       | 282 |   | 260 |   |
| Total  weighted average shares - basic                                   |       | 25,965                 |       | 24,371               |       | 25,319 |   | 24,426 |   |

 

Thefollowing shows the composition of diluted outstanding shares for the three andsix months ended June 30, 2009 and 2008:

 
| ** **                                                                           | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                           | ** ** | **June 30,**       | ** ** | **June 30,**     | ** ** |
| **(in  thousands)**                                                                  | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                           | ** ** | ** **              | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average shares outstanding - basic (from  above)                            |       | 25,965                  |       | 24,371                |       | 25,320 |   | 24,426 |   |
| Incremental weighted average shares attributable  to deferred****compensation  plans | ** ** | 355                     | ** ** | 330                   | ** ** | 354 | ** ** | 283 | ** ** |
| Weighted average shares attributable to vested  stock options                        |       | 142                     |       | 157                   |       | 114 |   | 159 |   |
| Incremental shares attributable to unvested stock  options                           |       | —                  |       | —                |       | — |   | — |   |
| Total weighted average shares - diluted                                              |       | 26,462                  |       | 24,858                |       | 25,788 |   | 24,868 |   |

 

Note5

 

*InvestmentSecurities*

 

Thefair value and amortized cost of investment securities at June 30, 2009are shown in the tables below.  See Note11 for a discussion of the Company’s investment securities that have beenclassified as trading.

 
| ** **                                 | ** ** | **June 30, 2009** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **Gross**              | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Amortized**          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  thousands)**                        | ** ** | **cost**               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **value** | ** ** |
| *Investment Securities Available-for-Sale* | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S.  government-sponsored agencies        |       | $                      | 21,523     |   | $ | 199 |   | $ | (63 | ) | $ | 21,659 |   |
| Mortgage-backed  securities                |       | 172,664                |       | 5,140 |   | (817 | ) | 176,987 |   |
| Municipal  securities                      |       | 33,746                 |       | — |   | (1,922 | ) | 31,824 |   |
| U.S.  treasury securities                  |       | 9,671                  |       | 55 |   | (38 | ) | 9,688 |   |
| Total                                      |       | $                      | 237,604    |   | $ | 5,394 |   | $ | (2,840 | ) | $ | 240,158 |   |
|                                       |       |                   |       |   |   |   |   |   |   |
| *Investment Securities Held-to-Maturity*   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage-backed  securities                |       | 32,906                 |       | 717 |   | (14 | ) | 33,609 |   |
| Corporate  bonds                           |       | 8,004                  |       | — |   | (3,696 | ) | 4,308 |   |
| Total                                      |       | $                      | 40,910     |   | $ | 717 |   | $ | (3,710 | ) | $ | 37,917 |   |

 

Thefair value and amortized cost of investment securities by contractual maturityat June 30, 2009 are shown below. Expected maturities may differ from contractual maturities because manyissuers have the right to call or prepay obligations with or without call orprepayment penalties.

 
| ** **                         | ** ** | **Available-for-Sale** | ** ** | **Held-to-Maturity** | ** ** |
|------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                         | ** ** | **Amortized**          | ** ** | **Fair**             | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In  thousands)**                | ** ** | **cost**               | ** ** | **Value**            | ** ** | **cost** | ** ** | **Value** | ** ** |
| After  1 year but within 5 years   |       | $                      | 10,238     |                 | $          | 10,194 |   | $ | — |   | $ | — |   |
| After  5 years but within 10 years |       | 21,434                 |       | 21,631               |       | — |   | — |   |
| After  10 years                    |       | 33,268                 |       | 31,346               |       | 8,004 |   | 4,308 |   |
| Mortgage-backed  securities        |       | 172,664                |       | 176,987              |       | 32,906 |   | 33,609 |   |
| Total                              |       | $                      | 237,604    |                 | $          | 240,158 |   | $ | 40,910 |   | $ | 37,917 |   |

 

Thefollowing table shows the Company’s investment securities’ gross unrealizedlosses and their fair value, aggregated by investment category and the lengthof time that individual securities have been in a continuous unrealized lossposition at June 30, 2009.

 
| **Investment Securities Available-for-Sale** | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| **(In  thousands)**                          | ** ** | **Fair Value**          | ** ** | **Unrealized loss**   | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| U.S.  treasury securities                    |       | $                       | 4,852      |                  | $          | (38            | )          | $ | — |   | $ | — |   | 4,852 |   | (38 | ) |
| U.S.  government - sponsored agencies        |       | 10,753                  |       | (63                   | )          | —         |       | — |   | 10,753 |   | (63 | ) |
| Mortgage-backed  securities                  |       | 11,343                  |       | (48                   | )          | 9,638          |       | (769 | ) | 20,981 |   | (817 | ) |
| Municipal  securities                        |       | 21,761                  |       | (1,041                | )          | 9,139          |       | (881 | ) | 30,900 |   | (1,922 | ) |
| Total  temporarily impaired securities       |       | $                       | 48,709     |                  | $          | (1,190         | )          | $ | 18,777 |   | $ | (1,650 | ) | $ | 67,486 |   | $ | (2,840 | ) |
| ** **                                   | ** ** | ** **              | ** ** | ** **            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Investment Securities Held-to-Maturity**   | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
| **(In  thousands)**                          | ** ** | **Fair Value**          | ** ** | **Unrealized loss**   | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** | **Fair Value** | ** ** | **Unrealized loss** | ** ** |
| Mortgage-backed  securities                  |       | $                       | 1,306      |                  | $          | (4             | )          | $ | 766 |   | $ | (9 | ) | $ | 2,072 |   | $ | (13 | ) |
| Corporate  bonds                             |       | —                  |       | —                |       | 4,308          |       | (3,696 | ) | 4,308 |   | (3,696 | ) |
| Total  temporarily impaired securities       |       | $                       | 1,306      |                  | $          | (4             | )          | $ | 5,074 |   | $ | (3,705 | ) | $ | 6,380 |   | $ | (3,709 | ) |

 

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TheCompany completes reviews for other-than-temporary impairment at leastquarterly.  At June 30, 2009 certainof the Company’s investment grade securities were in an unrealized lossposition.  Investment securities withunrealized losses have interest rates that are less than current marketinterest rates and, therefore, the indicated decrease in values are not aresult of permanent credit impairment. Municipal securities, with an amortizedcost totaling $33.7 million at June 30, 2009, are the primary component ofthe unrealized losses in the available-for-sale investment securities portfolioat June 30, 2009.  The majority ofthe municipal securities have been downgraded to AA or single A from AAA due tothe downgrades of the monoline insurance companies that insured thosebonds.  The downgraded bonds remaingeneral obligations of the municipalities and while prices for these municipalsecurities are generally below book value, the Company expects to receivepayment of all principal amounts due.

 

Inaddition, the held-to-maturity portfolio includes investments in four pooledtrust preferred securities, totaling $8.0 million of par value at June 30,2009 (each security has a par value of $2.0 million).  The collateral underlying these structuredsecurities are instruments issued by financial institutions or insurers.  The Company owns the A-3 tranches in eachissuance.  Each of the bonds are rated bymore than one rating agency.  Two of thesecurities have a composite rating of AA and two of the securities have acomposite rating of BBB.  These ratingsare consistent with the grades from the other rating agencies.  There is minimal observable trading activityfor these types of securities.  TheCompany has estimated the fair value of the securities through the use ofinternal calculations and compared the results to information provided byexternal pricing services.  Given thelevel of subordination below the A-3 tranches, and the actual and expectedperformance of the underlying collateral, the Company expects to receive allcontractual interest and principal payments recovering the amortized cost basisof each of the four securities, and concluded that these securities are notother-than-temporarily impaired.

 

Noother-than-temporary impairment has been recognized on the securities in ourinvestment portfolio for the periods presented.

 

#### **Note 6**

#### ** **

##### ***Derivative Instruments andHedging Activities***

##### ** **

TheCompany is a party to forward loan sales contracts, which are utilized tomitigate exposure to fluctuations in interest rates related to closed loanswhich are held for sale and designated in a cash flow hedge relationship.

 

TheCompany designates these derivatives as cash flow hedges. These hedges arerecorded at fair value in the statement of condition as an other asset or otherliability with a corresponding offset to accumulated other comprehensive incomein shareholders’ equity. Amounts are reclassified from accumulated othercomprehensive income to the income statement in the period or periods that theloan sale is reflected in income.

 

AtJune 30, 2009, accumulated other comprehensive income included anafter-tax unrealized loss of $266,000 related to forward loan sales contracts.Loans held for sale are generally sold within sixty days of closing and,therefore, substantially all of the amount recorded in accumulated othercomprehensive income at June 30, 2009 that is related to the Company’scash flow hedges will be recognized in earnings during the third quarter of2009. For the six months ended June 30, 2009, the hedge ineffectivenessrecorded through earnings was immaterial.

 

AtJune 30, 2009, the Company had $93.0 million in loan commitments andassociated forward sales and had $199.5****million inforward sales associated with $200.4 million of loans held for sale. Loans heldfor sale that are classified as construction-to-permanent total $31.8 millionat June 30, 2009 and are not sold forward until the construction phase hasbeen completed.  At June 30, 2009,the fair value of the derivative asset was $3.1 million and the fair value ofthe derivative liability was $3.6 million.

 

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TheCompany has interest rate swaps to mitigate its exposure to interest rate riskfor certain loans receivable.  Inaddition, the Company has two interest rate swaps with an aggregate notionalamount of $10.0 million to hedge against changes in cash flows caused bymovement in interest rates related to the Company’s issuance of $20.0 millionin trust preferred securities.  At June 30,2009, accumulated other comprehensive income included an after-tax unrealizedgain of $162,000 related to these interest rate swaps.  For the six months ended June 30, 2009,the hedge ineffectiveness recorded through earnings was immaterial.

 

#### **Note 7**

#### ** **

*Goodwill and Other Intangibles*

 

Informationconcerning total amortizable other intangible assets at June 30, 2009 isas follows:

 
| ** **                         | ** ** | ** **                  | ** **  | ** **                    | ** ** | **Wealth Management**       | ** ** | ** **                    | ** ** | ** **                  | ** ** |
|------------------------------------|------------|-----------------------------|-------------|-------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Mortgage Banking**        | ** **  | **and Trust Services**        | ** ** | **Total**                   | ** ** |
| **(In thousands)**                 | ** ** | **Gross  Carrying  Amount** | ** **  | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Balance  at December 31, 2008 |       | $                           |  1,781 |                          | $          |  841                   |       | $                             |  795  |                        | $          |  536 |   | $ |  2,576 |   | $ |  1,377 |   |
| 2009  activity:                    |       |                        |        |                          |       |                        |       |                          |       |                        |       |   |   |
| Customer  relationship intangibles |       | —                      |        | 99                            |       | —                      |       | 20                            |       | —                      |       | 119 |   |
| Balance  at June 30, 2009     |       | $                           |  1,781 |                          | $          |  940                   |       | $                             |  795  |                        | $          |  556 |   | $ |  2,576 |   | $ |  1,496 |   |

 

Theaggregate amortization expense was $60,000 and $63,000 for the three monthsended June 30, 2009 and 2008 respectively. For the six months ended June 30,2009 and 2008, the aggregate amortization expense was $119,000 and $127,000respectively.

 

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

 

**(In thousands)**

 
| 2009 (July – December) |   | $   |  119 |   |
|----------------------------------|--------|-----|-----------|--------|
| 2010                             |   | 238 |      |
| 2011                             |   | 238 |      |
| 2012                             |   | 238 |      |
| 2013                             |   | 189 |      |
| 2014 and thereafter              |   | 58  |      |

 

Thecarrying amount of goodwill at June 30, 2009 was as follows:

 

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

 

Goodwillof each of the Company’s business segments is tested for impairment on anannual basis or more frequently if events or circumstances warrant. During theperiod ended June 30, 2009, the Company performed an evaluation of thegoodwill associated with its acquisition of Wilson/Bennett, part of the wealthmanagement and trust services segment. In performing the first step of the impairment analysis, the Companyused the income approach.  Based on theresults of the analysis, the fair value of Wilson/Bennett exceeded its carryingvalue.  As a result, no impairment wasindicated.

 

Note8

 

*Commitmentsand Contingencies*

 

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

 

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

 

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

 

AtJune 30, 2009, commitments to extend credit were $421.5 million andstandby letters of credit were $12.2 million. The fair value of the liabilityassociated with standby letters of credit at June 30, 2009 was notsignificant. Commitments to extend credit of $93.0 million as of June 30,2009 are related to the mortgage banking segment’s pipeline and are of a shortterm nature.

 

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

 

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

 

GeorgeMason has a reserve for its estimated exposure to repurchase loans previouslysold to investors for which borrowers failed to provide full and accurateinformation on their loan application or for which appraisals have not beenacceptable or where the loan was not underwritten in accordance with the loanprogram specified by the loan investor. At June 30, 2009, this reserve hada balance of $770,000. The Company evaluates the merits of each claim andestimates its reserve based on actual and expected claims received andconsiders the historical amounts paid to settle such claims.  The Company has worked over the past twelve monthsto reduce and limit its exposure to loan repurchases and claims from investors.

 

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

 

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

 

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

 

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Note9

 

*FairValue Measurements*

 

EffectiveJanuary 1, 2008, the Company adopted a framework for measuring fair valuein accordance with U.S. generally accepted accounting principles, and hasexpanded the disclosures about its fair value measurements.

 

Thisframework defines fair value as the exchange price that would be received foran asset or paid to transfer a liability (an exit price) in the principal ormost advantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date.  It also establishes a fair value hierarchywhich requires an entity to maximize the use of observable inputs and minimizethe use of unobservable inputs when measuring the fair value.  There are three levels of inputs that may beused to measure fair value:

 

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

 

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

 

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

 

RecurringFair Value Measurements

 

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

 

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

 

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

 

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

 

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

 
| ** **                                             | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                            | ** ** |
|--------------------------------------------------------|------------|-------------|------------|------------------------------------------------------------------------------|------------|
| **Description**                                        | ** ** | **Balance** | ** ** | **Quoted Prices in  Active markets  for Identical  Assets********(Level 1)** | ** ** | **Significant  Other  Observable  Inputs********(Level 2)** | ** ** | **Significant  Unobservable  Inputs********(Level 3)** | ** ** |
| Investment securities available-for-sale               |       | $           | 240,158    |                                                                         |       |   | $ | 240,158 |   |   |   |
| Loans receivable                                       |       | 18,645      |       |                                                                         |       | 18,645 |   |   |   |
| Derivative asset – interest rate swaps            |       | 38          |       |                                                                         |       | 38 |   |   |   |
| Derivative liability – interest rate swaps        |       | 1,478       |       |                                                                         |       | 1,478 |   |   |   |
| Derivative asset – forward loan sales commitments |       | 3,053       |       |                                                                         |       | 3,053 |   |   |   |
| Derivative liability - forward loan sales  commitments |       | 2,161       |       |                                                                         |       | 2,161 |   |   |   |
|                                                        |            |             |            |                                                                              |            |  |  |  |  |  |  |

 

Thefair value of the Company’s interest rate lock commitments and forward loansales is included in the above table.  In the normalcourse of business, George Mason enters into contractual interest rate lockcommitments to extend credit to borrowers with fixed expiration dates.  The commitments become effective when theborrowers “lock-in” a specified interest rate within the time framesestablished by George Mason.  Allborrowers are evaluated for credit worthiness prior to the extension of thecommitment.  Market risk arises ifinterest rates move adversely between the time of the interest rate lock by theborrower and the sale date of the loan to an investor.  To mitigate the effect of the interest raterisk inherent in providing rate lock commitments to borrowers, George Masonenters into best efforts forward sales contracts to sell loans to investors.  The forward sales contracts lock in aninterest rate and price for the sale of loans similar to the specific rate lockcommitments.  Both the rate lockcommitments to the borrowers and the forward sales contracts to investors areundesignated derivatives**andaccordingly, are marked to fair value through earnings.

 

Theexpected cash flows related to the servicing of a loan are included in the fairvalue measurement of a derivative loan commitment.

 

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

 
| **(in  thousands)**     | ** ** | **Notional  or  Principal  Amount** | ** ** | **Expected  Premium  (Discount)********to Par** | ** ** | **Movement********of  Interest  Rates** | ** ** | **Security********Price********Change** | ** ** | **Total Fair  Value  Adjustment** | ** ** |
|-------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|
| Rate lock commitments   |       | $                                   | 88,843     |                                            | $          | 508                                     |       | $                                       | 105        |                              | $          | — |   | $ | 613 |   |
| Forward sales contracts |       | 181,772                             |       | —                                          |       | —                                  |       | (207                                    | )          | (207                              | )          |
|                         |            |                                     |            |                                                 |            |                                         |            |                                         |            |                                   |            |  |  |  |  |  |

 

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

 

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

 

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

 

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

 

Forthe three months ended June 30, 2009, the change in fair value of theinterest rate lock commitments, loans held for sale, and forward loan salescontracts based only on changes in market interest rates was $207,000.   Interest rate movements have an offsettingimpact on the security prices that serve to measure the fair value of theseinstruments.

 

George Mason serves as apass through conduit for the managed companies to sell loans to investors onthe secondary market.  Concurrent withentering into a rate lock agreement with a borrower, the managed company loanis sold forward to an investor in the secondary market.  After the managed company closes the loan, itis assigned to George Mason.  GeorgeMason then facilitates the transfer of the loan to the investor.  George Mason does not earn any spread or otherfees from the loan assignment nor from the transfer to the investor.  All gains in the loan sale are earned by themanaged company.  At June 30, 2009,loans held for sale includes $93.4 million of loans originated by the managedcompanies that will be delivered to the investors by George Mason.  Any change in the fair value of the loansheld for sale originated by the managed company will result in an equal andoffsetting change in liability to the managed company.

 

NonrecurringFair Value Measurements

 

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

 

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

 
| ** **                     | ** ** | ** **  | ** ** | **Fair Value Measurements Using**                                      | ** ** |
|--------------------------------|------------|-------------|------------|------------------------------------------------------------------------|------------|
| **Description**                | ** ** | **Balance** | ** ** | **Quoted Prices  in Active  markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs********(Level 2)** | ** ** | **Significant  Unobservable  Inputs********(Level 3)** | ** ** |
| Goodwill – Wilson/Bennett |       | $           | 2,652      |                                                                   |       |   |   |   | $ | 2,652 |   |
| Corporate bonds                |       | $           | 4,308      |                                                                   |       |   | $ | 4,308 |   |   |   |
|                                |            |             |            |                                                                        |            |  |  |  |  |  |  |  |

 

Duringthe second quarter of 2009, the Company performed its annual assessment of thegoodwill related to its Wilson/Bennett subsidiary.  The Company estimated the fair value of thisusing a multi-scenario discounted cash flow approach.  Those scenarios that more closely reflectactual results were weighted more heavily than scenarios that vary from recentexperience.  Cash flows were projectedwith growth in assets under management being a primary input.  Varying levels of expenses were alsoconsidered.  Additionally, a terminalvalue, or ending cash value, was assigned to each scenario based upon values ofother asset management firms.  Inparticular, the terminal value was projected based upon market values of theseother firms as represented by market capitalization multiples of asset undermanagements, revenues and net income.  The average multiples were then applied toWilson Bennett’s projected assets under management, revenues and net income toestimate a terminal value.  Based uponthis analysis, the fair value of Wilson Bennett exceeded it current book value,and no further impairment testing was necessary.

 

TheCompany’s corporate bond portfolio consists of four pooled trust preferredsecurities, with a total par value of $8.0 million at June 30, 2009 (eachsecurity has a par value of $2.0 million). The Company estimated the fair value of these securities through the useof internal calculations and compared the results to information provided byexternal pricing sources.  The analysisyielded a result that fell within the range of values provided by externalpricing sources.

 

FairValue of Financial Instruments

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

 

Althoughmanagement uses its best judgment in estimating the fair value of financialinstruments, there are inherent limitations in any estimation technique.  Therefore, these fair value estimates are notnecessarily indicative of the amounts the Company would realize in a markettransaction.  Because of the wide rangeof valuation techniques and the numerous estimates and assumptions which mustbe made, it may be difficult to make reasonable comparisons between the Company’sfair value information and that of other banking institutions.  It is important that the many uncertaintiesbe considered when using the estimated fair value disclosures and that, becauseof these uncertainties, the aggregate fair value amount should not be construedas representative of the underlying value of the Company.

 

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

 

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*Cashand Cash Equivalents*

 

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

 

*InvestmentSecurities Held-to-Maturity and Other Investments*

 

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

 

*LoansReceivable, Net*

 

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

 

*Deposits*

 

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

 

*OtherBorrowed Funds*

 

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

 

*OtherCommitments to Extend Credit*

 

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

 

*AccruedInterest Receivable*

 

Thecarrying amount of accrued interest receivable approximates its fair value.

 

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

 

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| ** **                                                    | ** ** | **June 30, 2009** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **Carrying**           | ** ** | **Estimated** | ** ** |
| **(In  thousands)**                                           | ** ** | **Amount**             | ** ** | **Fair Value** | ** ** |
| Financial  assets:                                            |       |                   |       |   |   |
| Cash  and cash equivalents                                    |       | $                      | 60,813     |   | $ | 60,813 |   |
| Investment  securities held-to-maturity and other investments |       | 57,377                 |       | 54,384 |   |
| Loans  receivable, net                                        |       | 1,198,671              |       | 1,194,349 |   |
| Accrued  interest receivable                                  |       | 5,664                  |       | 5,664 |   |
|                                                          |       |                   |       |   |   |
| Financial  liabilities:                                       |       |                   |       |   |   |
| Demand  deposits                                              |       | $                      | 158,540    |   | $ | 158,540 |   |
| Interest  checking                                            |       | 122,505                |       | 122,505 |   |
| Money  market and statement savings                           |       | 339,162                |       | 339,162 |   |
| Certificates  of deposit                                      |       | 621,373                |       | 631,003 |   |
| Other  borrowed funds                                         |       | 380,906                |       | 402,162 |   |
| Mortgage  funding checks                                      |       | 19,042                 |       | 19,042 |   |
| Accrued  interest payable                                     |       | 1,717                  |       | 1,717 |   |
|                                                          |       |                   |       |   |   |
| Other:                                                        |       |                   |       |   |   |
| Commitments  to extend credit                                 |       | $                      | —     |   | $ | — |   |

 

Note10

 

*FairValue of Derivative Instruments and Hedging Activities*

 

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

 

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**DerivativeInstruments and Hedging Activities**

**At of June 30, 2009**

**(in thousands)**

 
| ** **                                                  | ** ** | **Asset  Derivatives**                        | ** ** | **Liability  Derivatives** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                                  | ** ** | **Balance  Sheet  Location**                  | ** ** | **Fair  Value**            | ** ** | **Balance  Sheet  Location** | ** ** | **Fair  Value** | ** ** |
| **Derivatives Designated as Hedging Instruments**           |       |                                          |       |                       |       |   |   |   |   |
| Interest  Rate Swaps                                        |       | Accrued Interest Receivable  and Other Assets |       | $                          | 38         |   | Accrued Interest Payable  and Other Liabilities |   | $ | 1,478 |   |
| Forward  Loan Sales Commitments                             |       | Accrued Interest Receivable  and Other Assets |       | 2,338                      |       | Accrued Interest Payable  and Other Liabilities |   | 1,954 |   |
| **Total Derivatives Designated as Hedging Instruments**     |       |                                          |       | 2,376                      |       |   |   | 3,432 |   |
|                                                        |       |                                          |       |                       |       |   |   |   |   |
| **Derivatives Not Designated as Hedging Instruments**       |       |                                          |       |                       |       |   |   |   |   |
| Forward  Rate Lock Commitments                              |       | Accrued Interest Receivable  and Other Assets |       | 715                        |       | Accrued Interest Payable  and Other Liabilities |   | 207 |   |
| **Total Derivatives Not Designated as Hedging Instruments** |       |                                          |       | 715                        |       |   |   | 207 |   |
|                                                        |       |                                          |       |                       |       |   |   |   |   |
| **Total Derivatives**                                       |       |                                          |       | $                          | 3,091      |   |   |   | $ | 3,639 |   |

 

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

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

**(in thousands)**

 
| **Derivatives in Fair Value Hedging  Relationships** | ** ** | **Locations  of Gain  (Loss) Recognized in  Income on Derivative** | ** ** | **Amount  of Gain  (Loss) Recognized in  Income on Derivative** | ** ** | **Location  of Gain  (Loss) Recognized  in Income on  Hedged Item** | ** **   | **Amount  of Gain  (Loss) Recognized  in Income on  Hedged Item** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------------|--------------|-------------------------------------------------------------------|------------|
|                                                 |       |                                                               |       |                                                            |       |                                                                |         |                                                              |       |
| Interest Rate Swaps                                  |       | Other Income                                                       |       | $                                                               | 151        |                                                                | Other Income |                                                              | $          | (151 | ) |
| **Total**                                            |       |                                                               | ** ** | **$**                                                           | **151**    |                                                                |         | ** **                                                        | **$**      | **(151** | **)** |

 
| **Derivatives in Cash Flow Hedging  Relationships** | ** ** | **Amount  of Gain  (Loss) Recognized in  Other  Comprehensive  Income on Derivative  (Effective Portion)** | ** ** | **Location  of Gain  (Loss) Reclassified  from Accumulated  Other Comprehensive  Income into Income  (Effective Portion)** | ** **   | **Amount  of Gain  (Loss) Reclassified  from Accumulated  Other  Comprehensive  Income into Income  (Effective Portion)** | ** ** | **Location  of Gain  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** | **Amount  of Gain  (Loss) Recognized  in Income on  Derivative  (Ineffective Portion  and Amount  Excluded from  Effectiveness  Testing)** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|--------------|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                |       |                                                                                                       |       |                                                                                                                       |         |                                                                                                                      |       |                                                                                                                                         |       |                                                                                                                                       |       |
| Interest Rate Swaps                                 |       | $                                                                                                          | (37        | )                                                                                                                          | Other Income |                                                                                                                      | $          | —                                                                                                                                       |       | Other Income                                                                                                                               |       | $ | — |   |
|                                                |       |                                                                                                       |       |                                                                                                                       |         |                                                                                                                      |       |                                                                                                                                         |       |                                                                                                                                       |       |
| Forward Loan Sales Commitments                      |       | (491                                                                                                       | )          | Other Income                                                                                                               |         | 571                                                                                                                       |       | Other Income                                                                                                                                 |       | (571                                                                                                                                       | )          |
| **Total**                                           | ** ** | **$**                                                                                                      | **(528**   | **)**                                                                                                                      |         | ** **                                                                                                                | **$**      | **571**                                                                                                                                      |       |                                                                                                                                       | ** ** | **$** | **(571** | **)** |

 

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Note 11

 

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

 

During the three monthsended March 31, 2009, the Company sold all shares of its Fannie Maeperpetual preferred stock for a loss of $217,000.  The Company elected to sell these shares as aresult of these shares being traded well below their par value following theplacement of Fannie Mae into conservatorship by federal regulators during2008.  The Company recognized another-than-temporary impairment of $4.4 million on this investment in2008.  Because of the minimal likelihoodthat these shares would recover, the Company made the decision to exit thistype of investment security and no longer owns any similar equity investment inits investment securities portfolio.

 

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

 

Additionally,for the three months ended June 30, 2009, the Company had trading gains of$111,000 and for the six months ended June 30, 2009, trading losses of$520,000 as a result of the purchase of investments to economically hedgeagainst fair value changes of the Company’s nonqualified deferred compensationplan liability.  Those investments weredesignated as trading securities, and as such, the changes in fair value arereflected in earnings.  The tradinglosses for the six months ended June 30, 2009 were primarily the result oflower stock prices and were partially offset by a reduction in the period’scompensation expense associated with this benefit plan.  These investment securities economicallyhedge changes in the fair value of the Company’s deferred compensation planobligation and are not listed in the tables included in the investmentsecurities disclosure in Note 5 above.  Thefair value of these trading securities is $3.9 million at June 30, 2009 and areincluded in Other Assets on the statement of condition.

 

Note 12

 

*Common Stock Issued to EmployeeBenefit Plans*

 

The Company issued 287,000shares of common stock during the six month period ended June 30, 2009.  These shares were issued to fund the Company’sobligation to its participants that had elected the Cardinal Common Stockinvestment option in its various nonqualified deferred compensation plans.  These shares were issued at $5.45 per sharefor a total addition to shareholders’ equity of $1.6 million.

 

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

 

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

 

**CautionAbout Forward-Looking Statements**

 

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

 

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

 

·                  the effects of future economic, business and marketconditions;

·                  governmental monetary and fiscal policies;

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

·                  changes in accounting policies, rules andpractices;

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

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

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

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

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

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

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

 

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

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

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

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

·                  maintaining capital levels adequate to support ourgrowth;

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

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

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

·                  risks anduncertainties related to future trust operations;

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

·                  demand, development and acceptance of new products andservices;

·                  problems with technology utilized by us;

·                  changing trends in customer profiles and behavior; and

·                  other factors described from time to time in ourreports filed with the SEC, which we have incorporated by reference in thisQuarterly Report on Form 10-Q.

 

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

 

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

 

**Overview**

 

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

 

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

 

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

 

Netinterest income is our primary source of revenue. We define revenue as netinterest income plus noninterest income. As discussed further in the interestrate sensitivity section, we manage our balance sheet and interest rate riskexposure to maximize, and concurrently stabilize, net interest income. We dothis by monitoring our liquidity position and the spread between the interestrates earned on interest-earning assets and the interest rates paid oninterest-bearing liabilities. We attempt to minimize our exposure to interestrate risk, but are unable to eliminate it entirely.  In addition to management of interest raterisk, we analyze our loan portfolio for exposure to credit risk. Loan defaultsand foreclosures are inherent risks in the banking industry, and we attempt tolimit our exposure to these risks by carefully underwriting and then monitoringour extensions of credit. In addition to net interest income, noninterestincome is an important source of revenue for us and includes, among otherthings, service charges on deposits and loans, investment fee income, whichincludes trust revenues, gains and losses on sales of investment securitiesavailable-for-sale, gains on sales of mortgage loans, and management feeincome.

 

**CriticalAccounting Policies**

 

*General*

 

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

 

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

 

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

 

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

** **

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** **

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

 

Forpurposes of our analysis, we categorize our loans into one of five categories:  commercial and industrial, commercial realestate (including construction), home equity lines of credit, residentialmortgages, and consumer loans. In the absence of meaningful historical lossfactors, peer group loss factors are applied and are adjusted by thequalitative factors mentioned above. The indicated loss factors resulting fromthis analysis are applied for each of the five categories of loans. Inaddition, we individually assign loss factors to all loans that have been identifiedas having loss attributes, as indicated by deterioration in the financialcondition of the borrower or a decline in underlying collateral value if theloan is collateral dependent. Since we have limited historical data on which tobase loss factors for classified loans, we typically apply, in accordance withregulatory guidelines, a 5% loss factor to loans classified as special mention,a 15% loss factor to loans classified as substandard and a 50% loss factor toloans classified as doubtful. Loans classified as loss loans are fully reservedor charged off.   In certain instances,we evaluate the impairment of certain loans on a loan by loan basis.  For these loans, we analyze the fair value ofthe collateral underlying the loan and consider estimated costs to sell thecollateral.  If the net collateral valueis less than the loan balance (including accrued interest and any unamortizedpremium or discount associated with the loan) we recognize an impairment andestablish a specific reserve for the impaired loan.

 

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

 

*FairValue Measurements*

 

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

 

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

 

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

 

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

 

*Accountingfor Economic Hedging Activities*

 

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

 

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

 

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

 

Tomitigate the effect of the interest rate risk inherent in providing rate lockcommitments, we economically hedge our commitments by entering into bestefforts delivery forward loan sales contracts. During the rate lock commitmentperiod, these forward loan sales contracts are marked to market throughearnings and are not designated as accounting hedges. The fair values of loan commitmentsand the fair values of forward loan sales contracts generally move in oppositedirections, and the net impact of changes of these valuations on net incomeduring the loan commitment period is generally inconsequential. At the closingof the loan, the loan commitment derivative expires and we record a loan heldfor sale and continue to be obligated under the same forward loan salescontract.   The forward sales contract isthen designated as a hedge against the variability in cash to be received fromthe loan sale.  Loans held for sale areaccounted for at the lower of cost or fair value*.*

 

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*Accounting for Impairment Testingof Goodwill*

 

Goodwillis not be amortized but is be tested on at least an annual basis forimpairment.

 

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

 

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

 

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

 

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

#### ** **

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

 

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

 

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

 

Effective January 1,2009, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 161,*Disclosures about Derivative Instruments andHedging Activities. *SFAS No. 161amends SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities,* requires companies withderivative instruments to disclose information about how and why a company usesderivative instruments, how derivative instruments and related hedged items are

 

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accounted for under SFAS No. 133,and how derivative instruments and related hedged items affect a company’sfinancial position, financial performance, and cash flows.  The required disclosures include the fairvalue of derivative instruments and their gains and losses in tabular format,information about credit-risk-related contingent features in derivativeagreements, counterparty credit risk, and the Company’s strategies andobjectives for using derivative instruments. SFAS No. 161 is effective prospectively for periods beginning on orafter November 15, 2008.  Theadoption provided for enhanced disclosure but otherwise did not have a materialimpact on our consolidated financial condition or results of operations

##### ** **

##### **In April 2009, the FinancialAccounting Standards Board (“FASB”) issued FSP FAS 115-2 and FAS 124-2, *Recognition and Presentation of Other-Than-Temporary Impairments*(the“FSP”).  This standard modified theindicator of other-than-temporary impairment for debt securities.  In addition, it amended the amount of another-than-temporary impairment that is recognized in earnings when there arecredit losses on a debt security for which management does not intend to selland for which it is more likely than not that the entity will not have to sellprior to recovery of the amortized cost basis of the debt security.  In those situations, the portion of the totalimpairment that is attributable to the credit loss would be recognized inearnings, and the remaining difference between the debt security’s amortizedcost basis and its fair value would be included in other comprehensiveincome.  The FSP is effective for interimand annual periods ending after June 15, 2009. **Theadoption of this standard did not have a material impact on our consolidatedfinancial condition or results of operations.

 

In April 2009, the FASBissued FSP FAS 157-4, *Determining When a Marketfor an Asset or a Liability is Active or Inactive and Determining When aTransaction is Distressed.* This standard reaffirmed the exit price objective of fair valuemeasurements and provides guidance on inactive markets and distressedtransactions.  This standard is to beapplied prospectively and is effective for interim and annual periods ending June 15,2009.  The adoption of this standard didnot have a material impact on our consolidated financial condition or resultsof operations.

 

In April 2009, the FASBissued FSP FAS 107-1 and APB 28-1, *Interim Disclosures aboutFair Value of Financial Instruments. *Thisstatement amends FASB Statement No. 107, *Disclosuresabout Fair Value of Financial Instruments,*to require disclosuresabout fair value of financial instruments for interim reporting periods ofpublicly traded companies as well as in annual financial statements.  This statement also amends APB Opinion No. 28,*Interim Financial Reporting,* to requirethose disclosures in summarized financial information at interim reportingperiods.  This standard is effective forinterim reporting periods ending after June 15, 2009.  The adoption provided for enhanced disclosurebut otherwise did not have a material impact on our consolidated financialcondition or results of operations.

##### ** **

##### **On July 1,2009, the FASB issued SFAS No. 168, *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples,* the “Codification.” The Codification will become the exclusive authoritative reference fornongovernmental U.S. GAAP for use in financial statements issued for interimand annual periods ending after September 15, 2009, except for SEC rules andinterpretive releases, which are also authoritative GAAP for SECregistrants.  The Codification willsupersede all existing non-SEC accounting and reporting standards.**

 

##### **2009 EconomicEnvironment**

 

Our credit quality remainsstrong despite the challenges we face during the current economicenvironment.  At June 30, 2009, wehave non-accrual loans totaling $7.6 million and 

 

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no loans contractually past due 90 days or more as toprincipal or interest.  Net charge-offswere 0.18% of our average loans receivable for the six months ended June 30,2009. Our mortgage banking segment has profited from the recent actions takenby the Federal Reserve to reduce interest rates which has spurred an increasein mortgage activity as homeowners have reacted by applying to refinance theircurrent mortgages and other consumers have seen an opportunity to purchasehousing as it has become more affordable. Net income from our mortgage bankingsegment increased to $1.4 million and $2.7 million for the three and six monthsended June 30, 2009, respectively, compared to losses of $1.2 million and$695,000 for the three and six months periods of 2008.  In addition, during the second quarter of2009, we successfully raised $31.6 million in common equity capital to furthercapitalize the Company, to further penetrate our existing footprint and takeadvantage of bank consolidation opportunities.

 

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

 

Therecessionary conditions together with deterioration in the overall economy maycontinue to affect these and other markets in which we do business and couldadversely impact our results for the remaining six months of 2009. The degreeof the impact is dependent upon the duration and severity of the aforementionedconditions.

 

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

 

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

 

 In addition to EESA, the U.S. government hascontinued to respond to the ongoing financial crisis and economic slowdown byenacting new legislation and expanding or establishing a number of programs andinitiatives.  The recently enactedAmerican Recovery and Reinvestment Act (“ARRA”) is intended to expand andestablish government spending programs and provide tax cuts to stimulate theeconomy.  Congress and the U.S.government continue to evaluate and develop various programs and initiativesdesigned to stabilize the financial and housing markets and stimulate theeconomy, including the U.S. Treasury’s recently announced Financial StabilityPlan and the U.S. government’s recently announced foreclosure prevention

 

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program.  There can be no assurance as to the impactthese programs will have on the financial markets, including the extreme levelsof volatility and limited credit availability currently being experienced.  The failure of these efforts to stabilize thefinancial markets and a continuation or worsening of current or financialmarket conditions could materially and adversely affect our business, financialcondition, results of operations, access to credit, our regulatory capitalposition or the trading price of our common stock.

 

In May 2009,the FDIC adopted a final rule imposing a 5 basis point special assessmenton each insured financial institution’s total assets minus its tier 1capital.  This special assessment is toassist in the replenishment of the Deposit Insurance Fund as a result of theincrease in financial institution failures over the past year.  The FDIC may impose an additional specialassessment during 2009 if the FDIC believes that the reserve ratio of theDeposit Insurance Fund is estimated to fall to a level that would adverselyaffect public confidence or to a level which shall be close to or belowzero.  The latest possible date forimposing an additional special assessment would be December 31, 2009.  An additional special assessment is probablefor 2009.

 

##### **Statements ofIncome**

##### ** **

*General*

 

Forthe three months ended June 30, 2009 and 2008, we reported net income of$2.1 million and $874,000, respectively, an increase of $1.3 million, or145%.  Net interest income after theprovision for loan losses increased $203,000 to $10.5 million for the threemonths ended June 30, 2009 compared to $10.3 million for the three monthsended June 30, 2008.  The increasein net interest income after provision for loan losses is a direct result of anincrease in our net interest income of $918,000 to $12.0 million for the threemonths ended June 30, 2009, despite an increase in our provision for loanlosses.  Provision for loan losses forthe three months ended June 30, 2009 was $1.5 million, an increase of$715,000 compared to $769,000 for the same period of 2008.  Noninterest income for the three months endedJune 30, 2009 was $6.3 million, an increase of $1.9 million, or 43%,compared to $4.4 million for the three months ended June 30, 2008.  The increase in noninterest income isprimarily due to an increase in realized and unrealized gains on mortgagebanking activities, which increased $1.8 million to $3.4 million for the threemonths ended June 30, 2009 compared to $1.6 million for the quarter ended June 30,2008.  For the three months ended June 30,2009, noninterest expense remained constant at $13.7 million, compared to $13.6million for the same period of 2008.

 

Forthe three months ended June 30, 2009, basic and diluted income per commonshare were each $0.08.  Basic and dilutedincome per common share for the three months ended June 30, 2008 were each$0.04.  Weighted average fully dilutedshares outstanding for the three months ended June 30, 2009 and 2008 were26,462,234 and 24,858,450, respectively.

 

Returnon average assets for the three months ended June 30, 2009 and 2008 was0.48% and 0.21%, respectively. Return on average equity for the three monthsended June 30, 2009 and 2008 was 4.82% and 2.14%, respectively.

 

Netincome for the six months ended June 30, 2009 and 2008 was $4.3 millionand $2.9 million, respectively, an increase of $1.4 million, or 48%.  Net interest income after the provision forloan losses for the six months ended June 30, 2009 decreased $408,000 to$19.9 million down from $20.3 million for the six months ended June 30,2008.  The decrease in net interestincome after provision for loan losses is directly related to our increase inprovision for loan losses for the periods presented.  Provision for loan losses for the six monthsended June 30, 2009 and 2008 

 

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was$2.7 million and $1.1 million, respectively, an increase of $1.6 million, or148%.  Net interest income increased $1.2million to $22.6 million for the six months ended June 30, 2009 comparedto $21.4 million for the same period of 2008. Noninterest income was $12.0 million for the six months ended June 30,2009, an increase of $3.0 million, or 34%, from $9.0 million for the six monthsended June 30, 2008.  The increasein noninterest income is primarily a result of the increase in realized andunrealized gains on mortgage banking activities, which increased $2.9 millionto $6.7 million for the six months ended June 30, 2009.  Noninterest expense remained fairly constantfor the six months ended June 30, 2009 as compared to the same period of2008.  Noninterest expense was $25.7million and $25.5 million for the six months ended June 30, 2009 and 2008,respectively.

 

Forthe six months ended June 30, 2009, basic and diluted income per commonshare were each $0.17.  Basic and dilutedincome per common share for the six months ended June 30, 2008 were each$0.12.  Weighted average fully dilutedshares outstanding for the six months ended June 30, 2009 and 2008 were25,787,621 and 24,867,818, respectively.

 

Returnon average assets for the six months ended June 30, 2009 and 2008 was0.49% and 0.35%, respectively. Return on average equity for the six monthsended June 30, 2009 and 2008 was 5.08% and 3.59%, respectively.

 

*General—Business Segments*

 

Net income attributable tothe commercial banking segment for the three months ended June 30, 2009and 2008 was $1.2 million and $2.7 million, respectively.  The 2009 results reported were impacted by anincrease in our provision for loan losses of $811,000 to $1.4 million ascompared to $605,000 for the three months ended June 30, 2008.  The increase in provision expense is relatedto current economic and market conditions and modest loan charge-offs for thefirst half of 2009.  Net interest incomeincreased $975,000 to $11.4 million for the three months ended June 30,2009, compared to $10.4 million for the same period of 2008.  Noninterest income decreased to $820,000 forthe three months ended June 30, 2009 compared to $1.4 million for thethree months ended June 30, 2008. During the second quarter of 2009, there were no gains recorded on salesof investment securities available-for-sale or for any extinguishment of debt,which totaled $466,000 for the three months ended June 30, 2008.  Noninterest expense increased $1.9 million to$9.2 million for the three months ended June 30, 2009, compared to $7.4million for the same period of 2008.  Theincrease is primarily due to the increase in FDIC insurance premiums of $1.1million and an increase in bonus and incentive accruals due to better than expectedearnings for the Bank for 2009.  For thesix months ended June 30, 2009, net income for the commercial bankingsegment was $2.9 million compared to $4.9 million for the six months ended June 30,2008.  The decrease in net income isdirectly related to the increase in the provision for loan losses of $1.7million to $2.6 million for the six months ended June 30, 2009 as comparedto $925,000 for the same period of 2008. Also contributing to the decrease is an increase in FDIC insurancepremiums of $1.4 million to $1.7 million for the six months ended June 30,2009 compared to $360,000 for the same six month period of 2008.

 

Themortgage banking segment reported net income of $1.4 million for the threemonths ended June 30, 2009 compared to a net loss of $1.2 million for thethree months ended June 30, 2008. The increase in net income for the three months ended June 30, 2009was primarily attributable to an increase in loan origination volume due to thedecrease in mortgage interest rates and more affordable housing prices.  In addition, during the second quarter of2008, the mortgage banking segment recorded a settlement with a mortgagecorrespondent of $1.8 million

 

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whichcontributed to the loss reported in 2008. Expenses related to loan repurchase settlements in future periods shouldbe minimal as we have worked to limit our exposure to loan repurchases.  For the six months ended June 30, 2009,this segment reported net income of $2.7 million compared to a loss of $695,000for the same six month period of 2008. Again, the increase in net income is primarily related to the increasein loan origination volume during 2009 as compared to 2008, and theaforementioned settlement with a mortgage correspondent recorded during 2008.

 

Thewealth management and trust services segment, which includes CWS,Wilson/Bennett and the trust division of the Bank, recorded net income of$66,000 and $51,000 for the three month periods ended June 30, 2009 and2008, respectively.  For the six monthsended June 30, 2009 and 2008, net income from this reporting segment was$76,000 and $68,000, respectively.

 

*NetInterest Income*

 

Netinterest income represents the difference between interest and fees earned oninterest -earning assets and the interest paid on deposits and otherinterest-bearing liabilities. The level of net interest income is impactedprimarily by variations in the volume and mix of these assets and liabilities,as well as changes in interest rates. Net interest income for the three monthsended June 30, 2009 and 2008 was $12.0 million and $11.0 million,respectively, a period-to-period increase of $918,000, or 8%. For the sixmonths ended June 30, 2009 and 2008, net interest income was $22.6 millionand $21.4 million, respectively, an increase of $1.2 million, or 6%.  The yields on both our assets and liabilitiesfell during the quarter and year-to-date periods as interest ratesdecreased.  The increase in net interestincome is primarily the result of a greater decrease in our cost ofinterest-bearing liabilities than our decrease in the yields earned for averageearning assets.

 

Specifically,interest income on loans receivable increased $301,000 for the three monthsended June 30, 2009 compared to the same three month period of 2008.  Interest income on loans held for saleincreased $241,000 to $2.2 million for the three months ended June 30,2009.  The increase in average volume forboth loans receivable and loans held for sale negated the impact of thedecreases in rates.  Interest income oninvestment securities decreased $1.2 million for the three months ended June 30,2009 as compared to the three months ended June 30, 2008.  The decrease in interest income on investmentsecurities is principally related to the lower balances of investmentsecurities we hold due to the securities sales and calls that have occurredover the past year.  Total interestexpense has decreased $2.0 million for the three months ended June 30,2009 as compared to the same period of 2008. The decrease in total interest expense is mostly related to thedecreases we have taken in the interest rates we pay on our interest checkingand savings deposit accounts.

 

Forthe year-to-date June 30, 2009, interest income on loans receivabledecreased $982,000 to $31.4 million compared to $32.4 million for the same 2008period.  Interest income on investmentsecurities decreased $1.9 million for the six months ended June 30, 2009as compared to the six month period ended June 30, 2008.  These decreases when comparing theyear-to-date June 30, 2009 and 2008 periods are principally related to thedecreased interest rate environment.

 

Wehave certain loans and investment securities for which a portion of the incomerealized is tax-exempt.  Net interestincome on a tax equivalent basis for the three months ended 

 

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June 30,2009 and 2008 was $12.1 million and $11.2 million, respectively.  For the six months ended June 30, 2009and 2008, net interest income on a tax equivalent basis was $22.8 million and$21.6 million, respectively.

 

Ournet interest margin, which equals net interest income divided by averageinterest earning assets, was 2.84% and 2.85% for the three months ended June 30,2009 and 2008, respectively.  For the sixmonths ended June 30, 2009 and 2008, our net interest margin was 2.73% and2.77%, respectively.  The decrease in thenet interest margin for the three and six months ended June 30, 2009compared to the same periods of 2008 is again attributable to the currentinterest rate environment.  Tables 1through 4 present an analysis of average earning assets and interest-bearingliabilities with related components of interest income and interest expense ona tax equivalent basis.

 

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

Three Months Ended June 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                                  | ** ** | **2009**    | ** ** | **2008**     | ** ** | **2007**    | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                                  | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                                  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                  | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                                  |       | $           | 158,159    |         | $          | 1,849       |       | 4.67 | % | $ | 126,374 |   | $ | 1,882 |   | 5.96 | % | $ | 108,566 |   | $ | 2,063 |   | 7.60 | % |
| Real estate - commercial                                    |       | 538,079     |       | 8,440        |       | 6.27        | %          | 428,435 |   | 7,018 |   | 6.55 | % | 353,679 |   | 5,920 |   | 6.70 | % |
| Real estate -  construction                                 |       | 174,903     |       | 2,078        |       | 4.75        | %          | 191,377 |   | 2,799 |   | 5.85 | % | 160,565 |   | 3,371 |   | 8.40 | % |
| Real estate -  residential                                  |       | 197,985     |       | 2,670        |       | 5.39        | %          | 213,725 |   | 2,984 |   | 5.58 | % | 199,420 |   | 2,732 |   | 5.48 | % |
| Home equity lines                                           |       | 109,430     |       | 994          |       | 3.64        | %          | 90,352 |   | 1,049 |   | 4.66 | % | 64,210 |   | 1,183 |   | 7.39 | % |
| Consumer                                                    |       | 2,426       |       | 39           |       | 6.61        | %          | 2,675 |   | 39 |   | 5.85 | % | 7,920 |   | 165 |   | 8.28 | % |
| Total loans                                                 |       | 1,180,982   |       | 16,070       |       | 5.44        | %          | 1,052,938 |   | 15,771 |   | 5.99 | % | 894,360 |   | 15,434 |   | 6.90 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                         |       | 202,499     |       | 2,196        |       | 4.34        | %          | 141,583 |   | 1,955 |   | 5.52 | % | 302,075 |   | 5,319 |   | 7.04 | % |
| Investment securities  available-for-sale                   |       | 198,129     |       | 2,533        |       | 5.11        | %          | 269,136 |   | 3,572 |   | 5.31 | % | 257,238 |   | 3,158 |   | 4.91 | % |
| Investment securities  held-to-maturity                     |       | 44,753      |       | 419          |       | 3.75        | %          | 59,631 |   | 628 |   | 4.21 | % | 92,133 |   | 960 |   | 4.17 | % |
| Other investments                                           |       | 15,728      |       | —       |       | 0.00        | %          | 15,066 |   | 215 |   | 5.72 | % | 9,985 |   | 149 |   | 5.99 | % |
| Federal funds sold                                          |       | 56,997      |       | 31           |       | 0.22        | %          | 31,348 |   | 178 |   | 2.29 | % | 9,641 |   | 138 |   | 5.75 | % |
| Total interest-earning  assets and interest income (2) |       | 1,699,088   |       | 21,249       |       | 5.00        | %          | 1,569,702 |   | 22,319 |   | 5.69 | % | 1,565,432 |   | 25,158 |   | 6.43 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning assets:                                 |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                     |       | $           | 1,762      |         |       |        |       |   | $ | 6,710 |   |   |   |   |   | $ | 6,883 |   |   |   |   |   |
| Premises and equipment,  net                                |       | 15,907      |       |         |       |        |       | 17,743 |   |   |   |   |   | 19,989 |   |   |   |   |   |
| Goodwill and other  intangibles, net                        |       | 14,093      |       |         |       |        |       | 17,147 |   |   |   |   |   | 17,401 |   |   |   |   |   |
| Accrued interest and  other assets                          |       | 61,305      |       |         |       |        |       | 53,573 |   |   |   |   |   | 47,139 |   |   |   |   |   |
| Allowance for loan  losses                                  |       | (15,733     | )          |         |       |        |       | (12,005 | ) |   |   |   |   | (10,022 | ) |   |   |   |   |
| Total assets                                                |       | $           | 1,776,422  |         |       |        |       |   | $ | 1,652,870 |   |   |   |   |   | $ | 1,646,822 |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**              |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing  liabilities:                            |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing  deposits:                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                           |       | 123,000     |       | 302          |       | 0.98        | %          | 124,892 |   | 661 |   | 2.12 | % | 125,675 |   | 914 |   | 2.92 | % |
| Money markets                                               |       | 49,553      |       | 137          |       | 1.11        | %          | 39,825 |   | 242 |   | 2.44 | % | 55,816 |   | 353 |   | 2.54 | % |
| Statement savings                                           |       | 282,285     |       | 1,103        |       | 1.57        | %          | 378,143 |   | 2,632 |   | 2.79 | % | 361,438 |   | 4,247 |   | 4.71 | % |
| Certificates of deposit                                     |       | 618,865     |       | 4,505        |       | 2.92        | %          | 455,095 |   | 4,324 |   | 3.81 | % | 528,016 |   | 6,226 |   | 4.73 | % |
| Total interest - bearing  deposits                          |       | 1,073,703   |       | 6,047        |       | 2.26        | %          | 997,955 |   | 7,859 |   | 3.16 | % | 1,070,945 |   | 11,740 |   | 4.40 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                        |       | 353,883     |       | 3,120        |       | 3.54        | %          | 347,775 |   | 3,273 |   | 3.77 | % | 272,844 |   | 3,076 |   | 4.52 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities and interest expense    |       | 1,427,586   |       | 9,167        |       | 2.58        | %          | 1,345,730 |   | 11,132 |   | 3.32 | % | 1,343,789 |   | 14,816 |   | 4.42 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                           |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                             |       | 148,407     |       |         |       |        |       | 124,757 |   |   |   |   |   | 124,122 |   |   |   |   |   |
| Other liabilities                                           |       | 22,515      |       |         |       |        |       | 18,998 |   |   |   |   |   | 20,756 |   |   |   |   |   |
| Common shareholders’  equity                           |       | 177,914     |       |         |       |        |       | 163,385 |   |   |   |   |   | 158,155 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity            |       | $           | 1,776,422  |         |       |        |       |   | $ | 1,652,870 |   |   |   |   |   | $ | 1,646,822 |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and  net interest margin (2)            |       |        |       | $            | 12,082     |        | 2.84       | % |   |   | $ | 11,187 |   | 2.85 | % |   |   | $ | 10,342 |   | 2.64 | % |

 

----

(1) Non-accrualloans are included in average balances and do not have a material effect on theaverage yield. Interest income on non-accruing loans was not material for theperiods presented.

(2) Interest incomefor loans receivable, investment securities available-for-sale and fed fundssold (which includes investments in money market preferred stock) is reportedon a fully taxable-equivalent basis at a rate of 34%.

 

39

----

Table ofContents

 

**Rate andVolume Analysis**

Three Months Ended June 30, 2009, 2008 and 2007

(In thousands)

 
| ** **                                | ** ** | **2009  Compared to 2008** | ** ** | **2008  Compared to 2007** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **Change  Due to**         | ** ** | ** **                 | ** ** | **Change  Due to** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Average**                | ** ** | **Average**                | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume (3)**             | ** ** | **Rate**                   | ** ** | **(Decrease)** | ** ** | **Volume (3)** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                          | 477        |                       | $          | (510 | ) | $ | (33 | ) | $ | 338 |   | $ | (519 | ) | $ | (181 | ) |
| Real estate -  commercial                 |       | 1,796                      |       | (374                       | )          | 1,422 |   | 1,251 |   | (153 | ) | 1,098 |   |
| Real estate -  construction               |       | (241                       | )          | (480                       | )          | (721 | ) | 647 |   | (1,219 | ) | (572 | ) |
| Real estate -  residential                |       | (220                       | )          | (94                        | )          | (314 | ) | 196 |   | 56 |   | 252 |   |
| Home equity lines                         |       | 223                        |       | (278                       | )          | (55 | ) | 480 |   | (614 | ) | (134 | ) |
| Consumer                                  |       | (5                         | )          | 5                          |       | (0 | ) | (110 | ) | (16 | ) | (126 | ) |
| Total loans                               |       | 2,030                      |       | (1,731                     | )          | 299 |   | 2,802 |   | (2,465 | ) | 337 |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Loans held for sale                       |       | 841                        |       | (600                       | )          | 241 |   | (2,826 | ) | (538 | ) | (3,364 | ) |
| Investment securities  available-for-sale |       | (942                       | )          | (97                        | )          | (1,039 | ) | 146 |   | 268 |   | 414 |   |
| Investment securities  held-to-maturity   |       | (157                       | )          | (52                        | )          | (209 | ) | (339 | ) | 7 |   | (332 | ) |
| Other investments                         |       | 10                         |       | (225                       | )          | (215 | ) | 76 |   | (10 | ) | 66 |   |
| Federal funds sold                        |       | 148                        |       | (295                       | )          | (147 | ) | 310 |   | (270 | ) | 40 |   |
| Total interest income  (2)                |       | 1,930                      |       | (3,000                     | )          | (1,070 | ) | 169 |   | (3,008 | ) | (2,839 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:              |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | (10                        | )          | (349                       | )          | (359 | ) | (6 | ) | (247 | ) | (253 | ) |
| Money markets                             |       | 59                         |       | (164                       | )          | (105 | ) | (101 | ) | (10 | ) | (111 | ) |
| Statement savings                         |       | (667                       | )          | (862                       | )          | (1,529 | ) | 196 |   | (1,811 | ) | (1,615 | ) |
| Certificates of deposit                   |       | 1,556                      |       | (1,375                     | )          | 181 |   | (860 | ) | (1,042 | ) | (1,902 | ) |
| Total interest -  bearing deposits        |       | 938                        |       | (2,750                     | )          | (1,812 | ) | (771 | ) | (3,110 | ) | (3,881 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                      |       | 57                         |       | (210                       | )          | (153 | ) | 845 |   | (648 | ) | 197 |   |
| Total interest expense                    |       | 995                        |       | (2,960                     | )          | (1,965 | ) | 74 |   | (3,758 | ) | (3,684 | ) |
|                                      |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                   |       | $                          | 935        |                       | $          | (40 | ) | $ | 895 |   | $ | 95 |   | $ | 750 |   | $ | 844 |   |

 

----

(1) Non-accrualloans are included in average balances and do not have a material effect on theaverage yield.  Interest income onnon-accruing loans was not material for the periods presented.

(2) Interest incomefor loans receivable, investment securities available-for-sale and fed fundssold (which includes investments in money market preferred stock) is reportedon a fully taxable-equivalent basis at a rate of 34%.

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

 

40

----

Table ofContents

 

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

Six Months Ended June 30,2009, 2008 and 2007

(In thousands)

 
| ** **                                                  | ** ** | **2009**    | ** ** | **2008**     | ** ** | **2007**    | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                                  | ** ** | ** **  | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                                  | ** ** | **Average** | ** ** | **Income/**  | ** ** | **Yield/**  | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                  | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                                  |       | $           | 164,302    |         | $          | 3,941       |       | 4.80 | % | $ | 131,455 |   | $ | 4,237 |   | 6.45 | % | $ | 106,001 |   | $ | 4,011 |   | 7.57 | % |
| Real estate - commercial                                    |       | 514,029     |       | 16,091       |       | 6.26        | %          | 422,046 |   | 13,857 |   | 6.57 | % | 339,127 |   | 11,260 |   | 6.64 | % |
| Real estate -  construction                                 |       | 177,292     |       | 3,844        |       | 4.34        | %          | 191,130 |   | 6,021 |   | 6.30 | % | 160,456 |   | 6,754 |   | 8.42 | % |
| Real estate -  residential                                  |       | 202,455     |       | 5,498        |       | 5.43        | %          | 212,845 |   | 5,986 |   | 5.62 | % | 198,605 |   | 5,408 |   | 5.45 | % |
| Home equity lines                                           |       | 107,659     |       | 1,970        |       | 3.69        | %          | 87,761 |   | 2,208 |   | 5.06 | % | 64,019 |   | 2,350 |   | 7.40 | % |
| Consumer                                                    |       | 2,469       |       | 75           |       | 6.21        | %          | 2,717 |   | 89 |   | 6.59 | % | 6,409 |   | 258 |   | 8.08 | % |
| Total loans                                                 |       | 1,168,206   |       | 31,419       |       | 5.38        | %          | 1,047,954 |   | 32,398 |   | 6.18 | % | 874,617 |   | 30,041 |   | 6.87 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                         |       | 187,241     |       | 4,021        |       | 4.29        | %          | 140,459 |   | 4,084 |   | 5.81 | % | 275,665 |   | 9,698 |   | 7.04 | % |
| Investment securities -  trading                            |       | —      |       | —       |       | 0.00        | %          | — |   | — |   | 0.00 | % | 22 |   | 1 |   | 4.58 | % |
| Investment securities  available-for-sale                   |       | 215,140     |       | 5,521        |       | 5.13        | %          | 267,192 |   | 6,978 |   | 5.22 | % | 249,354 |   | 6,053 |   | 4.85 | % |
| Investment securities  held-to-maturity                     |       | 46,894      |       | 904          |       | 3.86        | %          | 65,065 |   | 1,377 |   | 4.23 | % | 94,134 |   | 1,963 |   | 4.17 | % |
| Other investments                                           |       | 15,681      |       | (19          | )          | -0.25       | %          | 14,840 |   | 433 |   | 5.84 | % | 9,360 |   | 276 |   | 5.91 | % |
| Federal funds sold                                          |       | 40,173      |       | 44           |       | 0.22        | %          | 25,022 |   | 316 |   | 2.54 | % | 44,582 |   | 1,163 |   | 5.26 | % |
| Total interest-earning  assets and interest income (2) |       | 1,673,335   |       | 41,890       |       | 5.01        | %          | 1,560,532 |   | 45,586 |   | 5.84 | % | 1,547,734 |   | 49,195 |   | 6.36 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning  assets:                                |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                     |       | $           | 931        |         |       |        |       |   | $ | 7,671 |   |   |   |   |   | $ | 8,130 |   |   |   |   |   |
| Premises and equipment,  net                                |       | 16,106      |       |         |       |        |       | 18,011 |   |   |   |   |   | 20,084 |   |   |   |   |   |
| Goodwill and other  intangibles, net                        |       | 14,123      |       |         |       |        |       | 17,180 |   |   |   |   |   | 17,435 |   |   |   |   |   |
| Accrued interest and  other assets                          |       | 59,293      |       |         |       |        |       | 52,827 |   |   |   |   |   | 46,900 |   |   |   |   |   |
| Allowance for loan  losses                                  |       | (15,233     | )          |         |       |        |       | (11,903 | ) |   |   |   |   | (9,884 | ) |   |   |   |   |
| Total assets                                                |       | $           | 1,748,555  |         |       |        |       |   | $ | 1,644,318 |   |   |   |   |   | $ | 1,630,399 |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**              |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing  liabilities:                            |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing  deposits:                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                           |       | 121,098     |       | 678          |       | 1.13        | %          | 124,864 |   | 1,496 |   | 2.41 | % | 127,453 |   | 1,834 |   | 2.90 | % |
| Money markets                                               |       | 46,945      |       | 284          |       | 1.22        | %          | 41,076 |   | 534 |   | 2.61 | % | 59,755 |   | 732 |   | 2.47 | % |
| Statement savings                                           |       | 271,925     |       | 2,288        |       | 1.70        | %          | 376,582 |   | 5,933 |   | 3.17 | % | 356,308 |   | 8,415 |   | 4.76 | % |
| Certificates of deposit                                     |       | 612,760     |       | 9,554        |       | 3.14        | %          | 452,793 |   | 9,244 |   | 4.11 | % | 548,347 |   | 12,828 |   | 4.72 | % |
| Total interest - bearing  deposits                          |       | 1,052,728   |       | 12,804       |       | 2.45        | %          | 995,315 |   | 17,207 |   | 3.48 | % | 1,091,863 |   | 23,809 |   | 4.40 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                        |       | 363,946     |       | 6,263        |       | 3.47        | %          | 343,719 |   | 6,745 |   | 3.95 | % | 236,486 |   | 5,116 |   | 4.36 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities and interest expense    |       | 1,416,674   |       | 19,067       |       | 2.71        | %          | 1,339,034 |   | 23,952 |   | 3.60 | % | 1,328,349 |   | 28,925 |   | 4.39 | % |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                           |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                             |       | 141,132     |       |         |       |        |       | 123,583 |   |   |   |   |   | 123,846 |   |   |   |   |   |
| Other liabilities                                           |       | 21,050      |       |         |       |        |       | 19,327 |   |   |   |   |   | 20,628 |   |   |   |   |   |
| Common shareholders’  equity                           |       | 169,699     |       |         |       |        |       | 162,374 |   |   |   |   |   | 157,576 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity            |       | $           | 1,748,555  |         |       |        |       |   | $ | 1,644,318 |   |   |   |   |   | $ | 1,630,399 |   |   |   |   |   |
|                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and  net interest margin (2)            |       |        |       | $            | 22,823     |        | 2.73       | % |   |   | $ | 21,634 |   | 2.77 | % |   |   | $ | 20,270 |   | 2.62 | % |

 

----

(1) Non-accrualloans are included in average balances and do not have a material effect on theaverage yield.  Interest income onnon-accruing loans was not material for the periods presented.

(2) Interest incomefor loans receivable, investment securities available-for-sale and fed fundssold (which includes investments in money market preferred stock) is reportedon a fully taxable-equivalent basis at a rate of 34%.

 

41

----

Table ofContents

 

**Rate andVolume Analysis**

Six Months Ended June 30, 2009, 2008 and 2007

(In thousands)

 
| ** **                                | ** ** | **2009 Compared to 2008** | ** ** | **2008  Compared to 2007** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **Change Due to**         | ** ** | ** **                 | ** ** | **Change Due to** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Average**               | ** ** | **Average**                | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume (3)**            | ** ** | **Rate**                   | ** ** | **(Decrease)** | ** ** | **Volume (3)** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |       | $                         | 1,059      |                       | $          | (1,355 | ) | $ | (296 | ) | $ | 963 |   | $ | (737 | ) | $ | 226 |   |
| Real estate -  commercial                 |       | 3,020                     |       | (786                       | )          | 2,234 |   | 2,753 |   | (156 | ) | 2,597 |   |
| Real estate -  construction               |       | (436                      | )          | (1,741                     | )          | (2,177 | ) | 1,291 |   | (2,024 | ) | (733 | ) |
| Real estate -  residential                |       | (292                      | )          | (196                       | )          | (488 | ) | 388 |   | 190 |   | 578 |   |
| Home equity lines                         |       | 495                       |       | (733                       | )          | (238 | ) | 879 |   | (1,021 | ) | (142 | ) |
| Consumer                                  |       | (9                        | )          | (5                         | )          | (14 | ) | (149 | ) | (20 | ) | (169 | ) |
| Total loans                               |       | 3,837                     |       | (4,816                     | )          | (979 | ) | 6,125 |   | (3,768 | ) | 2,357 |   |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Loans held for sale                       |       | 1,351                     |       | (1,414                     | )          | (63 | ) | (4,750 | ) | (864 | ) | (5,614 | ) |
| Investment securities -  trading          |       | —                    |       | —                     |       | — |   | (1 | ) | — |   | (1 | ) |
| Investment securities  available-for-sale |       | (1,359                    | )          | (98                        | )          | (1,457 | ) | 433 |   | 492 |   | 925 |   |
| Investment securities  held-to-maturity   |       | (385                      | )          | (88                        | )          | (473 | ) | (606 | ) | 20 |   | (586 | ) |
| Other investments                         |       | 25                        |       | (477                       | )          | (452 | ) | 162 |   | (5 | ) | 157 |   |
| Federal funds sold                        |       | 189                       |       | (461                       | )          | (272 | ) | (508 | ) | (339 | ) | (847 | ) |
| Total interest income  (2)                |       | 3,658                     |       | (7,354                     | )          | (3,696 | ) | 855 |   | (4,464 | ) | (3,609 | ) |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Interest - bearing  deposits:             |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | (49                       | )          | (769                       | )          | (818 | ) | (32 | ) | (306 | ) | (338 | ) |
| Money markets                             |       | 75                        |       | (325                       | )          | (250 | ) | (227 | ) | 29 |   | (198 | ) |
| Statement savings                         |       | (1,661                    | )          | (1,984                     | )          | (3,645 | ) | 504 |   | (2,986 | ) | (2,482 | ) |
| Certificates of deposit                   |       | 3,231                     |       | (2,921                     | )          | 310 |   | (2,206 | ) | (1,378 | ) | (3,584 | ) |
| Total interest -  bearing deposits        |       | 1,596                     |       | (5,999                     | )          | (4,403 | ) | (1,961 | ) | (4,641 | ) | (6,602 | ) |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                      |       | 377                       |       | (859                       | )          | (482 | ) | 2,340 |   | (711 | ) | 1,629 |   |
| Total interest expense                    |       | 1,973                     |       | (6,858                     | )          | (4,885 | ) | 379 |   | (5,352 | ) | (4,973 | ) |
|                                      |       |                      |       |                       |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                   |       | $                         | 1,685      |                       | $          | (496 | ) | $ | 1,189 |   | $ | 476 |   | $ | 888 |   | $ | 1,364 |   |

 

----

(1) Non-accrualloans are included in average balances and do not have a material effect on theaverage yield.  Interest income onnon-accruing loans was not material for the periods presented.

(2) Interest incomefor loans receivable, investment securities available-for-sale and fed fundssold (which includes investments in money market preferred stock) is reportedon a fully taxable-equivalent basis at a rate of 34%.

(3) Changes attributableto rate/volume have been allocated to volume.

 

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*Provisionfor Loan Losses*

 

Theprovision for loan losses for the three months ended June 30, 2009 and2008 was $1.5 million and $769,000, respectively. For the six months ended June 30,2009 and 2008, provision for loan losses was $2.7 million and $1.1 million,respectively.  The increase in ourprovision expense for the 2009 periods compared to the same periods of 2008 isa direct result of changes we have made to certain factors in our allowance forloan loss calculation because of current ongoing negative economic conditions.  While we continue to report strong creditquality in our loan portfolio, we have experienced increases in our watch listcredits and net charge-offs.  Ourprovision expense was also impacted by net new loan growth in addition to ourevaluation of the credit quality in our loan portfolio and the qualitativefactors we use to determine the adequacy of our loan loss reserves as describedabove in “Critical Accounting Policies—Allowance for Loan Losses.”

 

Duringthe first half of 2009, we charged off three residential loans held at GeorgeMason totaling $454,000 and four residential loans at the Bank totaling$601,000.  In addition, installment loansat the Bank totaling $3,000 have been charged-off during the first six monthsof 2009.  The Bank recorded a partialcharge-off of a commercial loan totaling $15,000 during the second quarter of2009.  All of these charge-offs weretaken against our allowance for loan losses.

 

Theallowance for loan losses at June 30, 2009 and December 31, 2008 was$16.2 million and $14.5 million, respectively. Our allowance for loan lossesratio to loans receivable, net was 1.35% and 1.27% at June 30, 2009 and December 31,2008, respectively.  Nonperforming loansat June 30, 2009 and December 31, 2008, were $7.6 million and $5.1million, respectively.

 

Whileour loan growth was strong during the first half of 2009, continuedrecessionary economic conditions are likely to adversely affect our loanportfolio, including causing increases in delinquencies and default rates,which we expect could impact our charge-offs and provision for loanlosses.  Continued deterioration in realestate values and household incomes could result in higher credit losses forus.  Also, in the ordinary course of business,we may also be subject to a concentration of credit risk to a particularindustry, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particularindustry or a failure or downgrade of, or default by, any particular entity orgroup of entities could negatively impact our businesses, perhaps materially,and the systems by which we set limits and monitor the level of our creditexposure to individual entities and industries, may not function as we haveanticipated.

 

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Additionalinformation on the allowance for loan losses, its allocation to the loansreceivable portfolio and information on nonperforming loans can be found in Tables5, 6 and 7, respectively.

 

**Allowance for Loan Losses**

Six Months Ended June 30, 2009 and 2008

(In thousands)

 
| ** **                          | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance,  January 1, |       | $        | 14,518     |     | $          | 11,641 |   |
|                                |       |     |       |     |       |
| Provision for loan  losses          |       | 2,700    |       | 1,089    |       |
|                                |       |     |       |     |       |
| Loans charged off:                  |       |     |       |     |       |
| Commercial and  industrial          |       | (15      | )          | (16      | )          |
| Residential                         |       | (1,055   | )          | (311     | )          |
| Consumer                            |       | (3       | )          | (36      | )          |
| Total loans charged off             |       | (1,073   | )          | (363     | )          |
|                                |       |     |       |     |       |
| Recoveries:                         |       |     |       |     |       |
| Commercial and  industrial          |       | 5        |       | 3        |       |
| Consumer                            |       | —   |       | 20       |       |
| Total recoveries                    |       | 5        |       | 23       |       |
|                                |       |     |       |     |       |
| Net (charge offs)  recoveries       |       | (1,068   | )          | (340     | )          |
|                                |       |     |       |     |       |
| Ending balance,  June 30,      |       | $        | 16,150     |     | $          | 12,390 |   |

 
| ** **                                                  | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                  | ** ** | **2009**          | ** ** | **2008**          | ** ** |
| Loans:                                                      |       |              |       |              |       |
| Balance at period end                                       |       | $                 | 1,198,671  |              | $          | 1,070,754 |   |
| Allowance for loan  losses to loans receivable, net of fees |       | 1.35              | %          | 1.16              | %          |
| Annualized net  charge-offs to average loans receivable     |       | 0.18              | %          | 0.06              | %          |
|                                                             |            |                   |            |                   |            |  |  |

 

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**Allocation of the Allowance for LoanLosses**

At June 30, 2009 and December 31, 2008

(In thousands)

 
| ** **                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                       | ** ** | **Allocation**    | ** ** | **% of Total***       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       | $                 | 1,992      |                  | 12.35      | % | $ | 2,129 |   | 14.12 | % |
| Real estate - commercial         |       | 8,549             |       | 46.70                 | %          | 6,110 |   | 41.41 | % |
| Real estate -  construction      |       | 2,673             |       | 15.39                 | %          | 3,118 |   | 16.53 | % |
| Real estate -  residential       |       | 1,764             |       | 16.06                 | %          | 2,138 |   | 18.57 | % |
| Home equity lines                |       | 1,115             |       | 9.30                  | %          | 965 |   | 9.16 | % |
| Consumer                         |       | 57                |       | 0.20                  | %          | 58 |   | 0.21 | % |
|                             |       |              |       |                  |       |   |   |   |   |
| Total allowance for  loan losses |       | $                 | 16,150     |                  | 100.00     | % | $ | 14,518 |   | 100.00 | % |

 

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* Percentage of loan typeto the total loan portfolio.

 

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**Nonperforming Loans Receivable**

At June 30,2009 and December 31, 2008

(Inthousands)

 
| ** **                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Nonaccruing loans                                                |       | $                 | 7,567      |                  | $          | 4,671 |   |
|                                                             |       |              |       |                  |       |
| Loans contractually  past-due 90 days or more and still accruing |       | —            |       | 379                   |       |
|                                                             |       |              |       |                  |       |
| Total nonperforming  loans receivable                            |       | $                 | 7,567      |                  | $          | 5,050 |   |

 

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*NoninterestIncome*

 

Noninterestincome includes service charges on deposits and loans, realized and unrealizedgains on mortgage banking activities, investment fee income, and management feeincome, and continues to be an important factor in our operating results.Noninterest income for the three months ended June 30, 2009 and 2008 was$6.3 million and $4.4 million, respectively, an increase of $1.9 million, or43%.   Realized and unrealized gains onmortgage banking activities by our mortgage banking segment for the three monthsended June 30, 2009 and 2008 were $3.4 million and $1.6 million,respectively, an increase of $1.8 million, or 116%.  Included in realized and unrealized gains onmortgage banking activities are any origination, underwriting, and discountpoints and other funding fees received and deferred at loan origination. Costsinclude direct costs associated with the loan origination, such as commissionsand salaries that are deferred at the time of origination.  Income from loan services charges increased$471,000 to $825,000 for the three months ended June 30, 2009, compared to$354,000 for the same period of 2008. Management fee income for the three months ended June 30, 2009 and2008 was $383,000 and $302,000, respectively, an increase of $81,000.Management fee income represents the income earned for services George Masonprovides to other mortgage companies owned by local home builders and generallyfluctuates based on the volume of loan sales. The increases in realized andunrealized gains on mortgage banking activities, loan service charges andmanagement fee income is directly related to the increase in loan originationactivity and sales volume occurring in the mortgage banking segment as a resultof the decreases in mortgage rates and more affordable home prices during thefirst half of 2009.

 

Servicecharges on deposit accounts decreased $39,000 to $496,000 for the three monthsended June 30, 2009 compared to $535,000 for the same period of 2008.

 

Investmentfee income decreased $42,000 to $880,000 for the three months ended June 30,2009 compared to $922,000 for the same period of 2008. The decrease ininvestment fee income is attributable to the decrease in net commissions earnedat CWS as a result of employee turnover in that subsidiary and decreased feeincome at our trust division due to the loss of low margin custodyrelationships with two clients.

 

Forthe six months ended June 30, 2009 and 2008, noninterest income was $12.0million and $9.0 million, respectively, an increase of $3.0 million, or34%.  Realized and unrealized gains onmortgage banking activities by our mortgage banking segment for the six monthsended June 30, 2009 and 2008 were $6.7 million and $3.9 million,respectively, an increase of $2.9 million, or 73%.  Income from loan services charges increased$994,000 to $1.7 million for the six months ended June 30, 2009, comparedto $664,000 for the same period of 2008. Management fee income for the six months ended June 30, 2009 and2008 was $714,000 and $386,000, respectively, an increase of $328,000. Theincreases in realized and unrealized gains on mortgage banking activities, loanservice charges and management fee income is again directly related to theincrease in loan origination activity and sales volume occurring in themortgage banking segment.

 

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Servicecharges on deposit accounts decreased $94,000 to $968,000 for the year-to-dateperiod ended June 30, 2009 compared to $1.1 million for the same period of2008.   Investment fee income decreased$132,000 to $1.7 million for the six months ended June 30, 2009 comparedto $1.8 million for the same period of 2008.

 

Theincrease in the cash surrender value of our bank-owned life insurance for thethree months ended June 30, 2009 and 2008 was $157,000 and $252,000,respectively, a decrease of $95,000.  Forthe year-to-date June 30, 2009 and 2008, the increase in the cashsurrender value was $233,000 and $575,000, respectively, a decrease of$342,000.  The decreases are directlyrelated to the decreases in the underlying value of the investments due to thecurrent economic environment.

 

Forthe three month period ended June 30, 2009, we recorded no net gains onsales of investment securities available-for-sale where as for the three monthsended June 30, 2008 we recorded net gains of $214,000.  For the six month ended June 30, 2009and 2008, we recorded net gains on sales of investment securitiesavailable-for-sale of $552,000 and $214,000, respectively.  Included in the net gains for theyear-to-date period of 2009, were losses on sales of investment securitiesavailable-for-sale of $217,000 which resulted from the sale of all of our sharesof Fannie Mae perpetual preferred stock. Additionally, we had trading losses of $520,000 for the six month ended June 30,2009 as a result of our purchase of investments to economically hedge againstfair value changes of the Company’s nonqualified deferred compensation planliability.  These investments total $3.9million at June 30, 2009 and are included in Other Assets on the statement ofcondition at June 30, 2009.  Thetrading losses were primarily the result of lower stock prices and werepartially offset by a reduction in the period’s compensation expense associatedwith this benefit plan.

 

Noninterestincome represented 34% and 28% of our total revenues for the three months endedJune 30, 2009 and 2008, respectively. For the six months ended June 30, 2009 and 2008, noninterest incomerepresented 35% and 30%, respectively, of our total revenues.

 

*NoninterestExpense*

 

Noninterestexpense includes salaries and benefits, occupancy costs, professional fees,depreciation, data processing, telecommunications and miscellaneous expenses.Noninterest expense for the three months ended June 30, 2009 was $13.7million, compared to $13.6 million for the same period of 2008, a modestincrease of $66,000.  For the six monthsended June 30, 2009 and 2008, noninterest expense was $25.7 million and $25.5million, respectively.

 

Forthe quarter ended June 30, 2009, salaries and benefits expense increasedto $6.2 million, from $5.5 million for the quarter ended June 30,2008.  The increase in salaries andbenefits expense is mostly related to an increase in incentive pay due tobetter than expected results for the quarter and first six months of theyear.  For the six months ended June 30,2009 and 2008, salaries and benefits expense was $11.7 million and $11.5million, respectively.

 

During2009, our FDIC insurance assessment has increased significantly due to changesin the assessment calculation and a special assessment imposed during thesecond quarter of 2009.  The increase inassessment is a result of the FDIC’s efforts in replenishing the levels of theDeposit Institution Fund as a result of recent bank failures.  FDIC insurance assessments for the threemonths ended June 30, 2009 and 2008 were $1.3 million and $180,000,respectively.  For the year-to-dateperiods ended June 30, 2009 and 2008, the expense related to FDICinsurance assessments was $1.7 million and $360,000, respectively.  Included in the three and six months periodsended June 30, 2009, is the FDIC imposed special assessment which totaled$850,000.

 

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Chargesrelated to George Mason’s repurchases of mortgage loans previously sold toinvestors decreased to $594,000 for the three months ended June 30, 2009compared to $640,000 for the same period of 2008.  For the six months ended June 30, 2009,repurchase reserves were $1.2 million, an increase of $535,000 from $640,000for the six months ended June 30, 2008. These charges are included in Other Operating Expenses on theconsolidated statements of income, and account for the majority of the increasein this category for the six months periods presented.  We have worked over the past twelve months toreduce and limit our exposure to loan repurchases and claims from investors andbelieve that any additional expense recorded will be minimal in futureperiods.  During the second quarter of2008, George Mason made a cash settlement with one of its mortgagecorrespondents related to the loan purchase agreement between the twoparties.  This settlement provided forthe release of known and unknown claims by the mortgage correspondent inexchange for the cash settlement.  Theexpense associated with this settlement was $1.8 million, and is presentedseparately on our consolidated statement of income.

 

*IncomeTaxes*

 

Forthe three months ended June 30, 2009, we recorded a provision for incometaxes of $883,000, compared to $138,000 for the same period of 2008.  Our effective tax rates for the three monthsended June 30, 2009 and 2008 were 29.2% and 13.6%, respectively.  For the six months ended June 30, 2009and 2008, we recorded a provision for income taxes of $1.8 million and$900,000, respectively.  Our effectivetax rates for the six months ended June 30, 2009 and 2008 were 29.9% and23.6%, respectively.  The increase in oureffective tax rates is primarily a result of the tax benefit recorded for themortgage correspondent settlement during 2008 which was recorded at the Company’sstatutory rate of 34.5%.  See also “CriticalAccounting Policies — Valuation of Deferred Tax Assets.”

 

**Statementsof Condition**

 

Totalassets were $1.86 billion and $1.74 billion at June 30, 2009 and December 31,2008, respectively.  The increase in ourtotal assets was primarily driven by the increase in total deposits.  Total deposits increased $61.7 million to$1.24 billion at June 30, 2009 compared to $1.18 billion at December 31,2008.  In addition, during the secondquarter of 2009, we raised $31.6 million in additional common equity capital, alsocontributing to our increase in total assets at June 30, 2009.

 

*InvestmentSecurities*

 

Investmentsecurities were $281.1 million at June 30, 2009, compared to $315.5million at December 31, 2008, a decrease of $34.5 million. The decrease ininvestment securities is primarily due to sales, calls and maturities ofcertain of our U.S. government sponsored agency and mortgage-backed securities,which was primarily reinvested in our loan portfolios.  The investment securities portfolio consistsof investment securities available-for-sale and investment securitiesheld-to-maturity. Investment securities available-for-sale are those securitiesthat we intend to hold for an indefinite period of time, but not necessarilyuntil maturity. These securities are carried at fair value and may be sold aspart of an asset/liability strategy, liquidity management or regulatory capitalmanagement.  Investment securitiesheld-to-maturity are those securities that we have the intent and ability tohold to maturity and are carried at amortized cost. At June 30, 2009,investment securities available-for-sale were $240.2 million and investmentsecurities held-to-maturity were $40.9 million. At December 31, 2008,investment securities 

 

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available-for-salewere $265.4 million and investment securities held-to-maturity were $50.2million.  See Table 8 for additionalinformation on our investment securities portfolio.

 

Wecomplete reviews for other-than-temporary impairment at least quarterly.  As of June 30, 2009, 86% of the parvalue of our investment securities portfolio consisted of securities rated AAAby a leading rating agency.  Investmentsecurities which carry a AAA rating are judged to be of the best quality andcarry the smallest degree of investment risk. At June 30, 2009, 95% of our mortgage-backed investment securitiesportfolio are guaranteed by the Federal National Mortgage Association (FNMA),the Federal Home Loan Mortgage Corporation (FHLMC) and the Government NationalMortgage Association (GNMA).  During thethird quarter of 2008, FNMA and FHLMC were placed into conservatorship by federalregulators.  We expect to receive fullpayment of interest and principal on the securities in the investmentportfolio.

 

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

 

AtJune 30, 2009 certain of our investment grade securities were in anunrealized loss position.  Investmentsecurities with unrealized losses have interest rates that are less thancurrent market interest rates and, therefore, the indicated decrease in valuesare not a result of permanent credit impairment. Municipal securities, with anamortized cost totaling $33.7 million at June 30, 2009, are the primarycomponent of the unrealized losses in the available-for-sale investmentsecurities portfolio at June 30, 2009. The majority of our municipal securities have been downgraded to AA orsingle A from AAA due to the downgrades of the monoline insurance companiesthat insured those bonds.  The downgradedbonds remain general obligations of the municipalities and while prices forthese municipal securities are generally below book value, we expect to receivepayment of all principal amounts due to us. 

 

Inaddition, our held-to-maturity portfolio includes investments in four pooledtrust preferred securities, totaling $8.0 million of par value at June 30,2009 (each security has a par value of $2.0 million).  The collateral underlying these structuredsecurities are instruments issued by financial institutions or insurers.  We own the A-3 tranches in each issuance.  Each of the bonds are rated by more than onerating agency.  Two of the securitieshave a composite rating of AA and two of the securities have a composite ratingof BBB.  These ratings are consistentwith the grades from the other rating agencies. There is minimal observable trading activity for these types ofsecurities.  We have estimated the fairvalue of these securities through the use of internal calculations and comparedour results to information provided by external pricing services.  Given the level of subordination below ourA-3 tranches, and the actual and expected performance of the underlyingcollateral, we expect to receive all contractual interest and principalpayments recovering the amortized cost basis of each of the four securities andhave concluded that these securities are not other-than-temporarily impaired.

 

Noother-than-temporary impairment has been recognized on the securities in ourinvestment portfolio for the periods presented.

 

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

 

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Wehold $15.7 million in FHLB stock at June 30, 2009.  In September 2008, the FHLB announced achange in their dividend declaration and payment schedule beginning during thefourth quarter of 2008.  The change wasinitiated so that the dividend can be declared and paid to member banks afterthe FHLB has calculated their net income for the preceding quarter.  It was announced that the fourth quarterdividend would be declared and paid at the end of January 2009.  On March 31, 2009, the Board ofDirectors announced that no dividend would be declared for the fourth quarterof 2008.  In addition, there was nodividend declared for the first quarter of 2009.

 

**Investment Securities**

At June 30, 2009 and December 31, 2008

(In thousands)

 
| ** **                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at  June 30, 2009**        | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies              |       |          |       |      |       |        |       |
| One to five years                               |       | $             | 5,348      |      | $          | 5,342       |       | 2.92 | % |
| Five to ten years                               |       | 16,175        |       | 16,317    |       | 3.83        | %          |
| Total U.S. government-sponsored agencies        |       | 21,523        |       | 21,659    |       | 3.60        | %          |
|                                            |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                  |       |          |       |      |       |        |       |
| One to five years                               |       | 9             |       | 9         |       | 8.95        | %          |
| Five to ten years                               |       | 21,821        |       | 22,479    |       | 4.76        | %          |
| After ten years                                 |       | 150,834       |       | 154,499   |       | 5.15        | %          |
| Total mortgage-backed securities                |       | 172,664       |       | 176,987   |       | 5.10        | %          |
|                                            |       |          |       |      |       |        |       |
| Municipal securities (2)                        |       |          |       |      |       |        |       |
| Five to ten years                               |       | 478           |       | 478       |       | 3.05        | %          |
| After ten years                                 |       | 33,268        |       | 31,346    |       | 4.09        | %          |
| Total municipal securities                      |       | 33,746        |       | 31,824    |       | 4.08        | %          |
|                                            |       |          |       |      |       |        |       |
| U. S. treasury securities                       |       |          |       |      |       |        |       |
| One to five years                               |       | 4,890         |       | 4,852     |       | 2.36        | %          |
| Five to ten years                               |       | 4,781         |       | 4,836     |       | 3.66        | %          |
| Total U.S. treasury securities                  |       | 9,671         |       | 9,688     |       | 3.00        | %          |
| Total investment securities  available-for-sale |       | $             | 237,604    |      | $          | 240,158     |       | 4.73 | % |

 
| ** **                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at June  30, 2009**        | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| Mortgage-backed securities (1)                |       |          |       |      |       |        |       |
| One to five years                             |       | $             | 2,114      |      | $          | 2,158       |       | 4.28 | % |
| Five to ten years                             |       | 7,473         |       | 7,699     |       | 4.59        | %          |
| After ten years                               |       | 23,319        |       | 23,752    |       | 4.42        | %          |
| Total mortgage-backed securities              |       | 32,906        |       | 33,609    |       | 4.45        | %          |
|                                          |       |          |       |      |       |        |       |
| Corporate bonds                               |       |          |       |      |       |        |       |
| After ten years                               |       | 8,004         |       | 4,308     |       | 1.89        | %          |
| Total corporate bonds                         |       | 8,004         |       | 4,308     |       | 1.89        | %          |
| Total investment securities  held-to-maturity |       | 40,910        |       | 37,917    |       | 3.96        | %          |
|                                          |       |          |       |      |       |        |       |
| Total investment securities                   |       | $             | 278,514    |      | $          | 278,075     |       | 4.62 | % |

 

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

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

 

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(1)  Based oncontractual maturities.

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

 

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*LoansReceivable*

 

Loansreceivable, net of deferred fees and costs, were $1.20 billion at June 30,2009 and $1.14 billion at December 31, 2008, an increase of $59.3million.  See Table 9 for details on theloans receivable portfolio. During 2009, the mix of our loan portfolio changedslightly, with decreases in commercial and industrial loans, increases in commercialreal estate loans and home equity lines, decreases in real estate constructionand real estate residential loans.  Loansheld for sale at June 30, 2009 was $232.2 million compared to $157.0million at December 31, 2008, an increase of $75.2 million.  Loans held for sale are valued at the lowerof cost or fair value. The increase in loans held for sale at June 30,2009 compared to December 31, 2008 is due to the decreased mortgageinterest rate environment and consumers taking advantage of the affordablehousing market.

 

**LoansReceivable**

At June 30, 2009 andDecember 31, 2008

(In thousands)

 
| ** **                       | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                             |       |                    |       |                        |       |   |   |   |   |
|                             |       |                    |       |                        |       |   |   |   |   |
| Commercial and  industrial       |       | $                       | 148,071    |                        | 12.35      | % | $ | 160,989 |   | 14.12 | % |
| Real estate -  commercial        |       | 560,101                 |       | 46.70                       | %          | 472,131 |   | 41.41 | % |
| Real estate - construction       |       | 184,591                 |       | 15.39                       | %          | 188,484 |   | 16.53 | % |
| Real estate -  residential       |       | 192,571                 |       | 16.06                       | %          | 211,651 |   | 18.57 | % |
| Home equity lines                |       | 111,546                 |       | 9.30                        | %          | 104,370 |   | 9.16 | % |
| Consumer                         |       | 2,476                   |       | 0.20                        | %          | 2,393 |   | 0.21 | % |
|                             |       |                    |       |                        |       |   |   |   |   |
| Gross loans                      |       | $                       | 1,199,356  |                        | 100.00     | % | $ | 1,140,018 |   | 100.00 | % |
|                             |       |                    |       |                        |       |   |   |   |   |
| Net deferred (fees)  costs       |       | (685                    | )          |                        |       | (670 | ) |   |   |
| Less: allowance for  loan losses |       | (16,150                 | )          |                        |       | (14,518 | ) |   |   |
|                             |       |                    |       |                        |       |   |   |   |   |
| Loans receivable, net            |       | $                       | 1,182,521  |                        |       |   | $ | 1,124,830 |   |   |   |

 

*Deposits*

 

Totaldeposits were $1.24 billion at June 30, 2009 compared to $1.18billion at December 31, 2008. We had increases in our noninterest bearingchecking products, interest bearing and money market checking accounts, savingsaccounts and certificates of deposit. Overall, deposit balances increased ascustomers are seeking smaller financial institutions to deposit their moneywith as a result of the current economic turmoil and are increasing thebalances held with financial institutions as a result of the increasedprotection of their money by the FDIC. See Table 10 for details on certificates of deposit with balances of$100,000 or more. During 2008, we joined the Certificates of Deposit AccountRegistry Service (“CDARS”).   CDARSallows our customers to access FDIC insurance protection on multi-milliondollar certificates of deposit through our Bank.  When a customer places a large depositthrough CDARS, we place their funds into certificates of deposit with otherbanks in the CDARS network in increments of less than $250,000 so thatprincipal and interest are eligible for FDIC insurance protection.  At June 30, 2009 and December 31,2008, we had $53.8 million and $53.5 million, respectively, in CDARS deposits,which are considered to be brokered deposits. Brokered certificates of deposit not in the CDARS network were $38.2million and $35.7 million at June 30, 2009 and December 31, 2008,respectively.

 

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

At June 30, 2009

(In thousands)

 
| **Maturities:**                        | ** ** | **Fixed Term** | ** **    | **No-Penalty*** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------|---------------|-----------------|------------|-----------|------------|
| Three months or less                   |       | $              | 24,617        |            | $          | 33,040    |       | $ | 57,657 |   |
| Over three months  through six months  |       | 17,894         |          | 30,584          |       | 48,478    |       |
| Over six months through  twelve months |       | 67,288         |          | 3,853           |       | 71,141    |       |
| Over twelve months                     |       | 61,305         |          | 4,581           |       | 65,886    |       |
|                                   |       | $              |  171,104 |            | $          | 72,058    |       | $ | 243,162 |   |

 

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

 

*Borrowings*

 

Otherborrowed funds increased $13.7 million to $380.9 million at June 30, 2009,compared to $367.2 million at December 31, 2008.  Treasury, Tax & Loan Note option

 

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borrowingsincreased $1.0 million to $1.7 million at June 30, 2009 compared to$692,000 at December 31, 2008.  FHLBadvances remained at $280.0 million at June 30, 2009 compared to December 31,2008. Customer repurchase agreements increased $12.7 million to $78.6 millionat June 30, 2009 compared to $65.9 million at December 31, 2008.  We had no federal funds purchased at each of June 30,2009 and December 31, 2008.  Table11 provides information on our borrowings.

 

**Short-TermBorrowings and Other Borrowed Funds**

At June 30, 2009

(In thousands)

 
| ** **                                                     | ** ** | ** ** | ** ** | **Amount** | ** **  |
|----------------------------------------------------------------|------------|------------|------------|------------|-------------|
| **Short-term  borrowed funds:**                                | ** ** | ** ** | ** ** | ** ** | ** **  |
| TT&L note option                                           |       | 0.16       | %          | $          | 1,699       |   |
| Customer repurchase  agreements                                |       | 0.54       | %          | 78,588     |        |
| **Total  short-term borrowed funds and weighted average rate** | ** ** | **0.53**   | **%**      | **$**      | **80,287**  | ** ** |
| **Other  borrowed funds:**                                     |       |       |       |       |        |
| Trust preferred                                                |       | 4.60       | %          | $          | 20,619      |   |
| FHLB advances - long  term                                     |       | 3.98       | %          | 280,000    |        |
| **Other  borrowed funds and weighted average rate**            | ** ** | **4.02**   | **%**      | **$**      | **300,619** | ** ** |
|                                                           |       |       |       |       |        |
| **Total  other borrowed funds and weighted average rate**      | ** ** | **3.29**   | **%**      | **$**      | **380,906** | ** ** |

 

*Shareholders’Equity*

 

Shareholders’equity at June 30, 2009 was $196.6 million compared to $158.0 million at December 31,2008, an increase of $38.6 million, or 24%. During the second quarter of 2009,we issued 4.4 million shares of our common stock for total common equitycapital raised of $31.6 million.  Thisadditional capital will allow us to continue to penetrate our existing footprintand take full advantage of bank consolidation opportunities.  During the three months ended March 31,2009, we issued 287,000 shares of our common stock to employee benefit plansfor a total addition of $1.6 million to shareholder’s equity.  In addition, our accumulated othercomprehensive income increased $1.3 million for the year to date June 30,2009, which was primarily related to the change in the market value of ouravailable-for-sale investment securities. Net income of $4.3 million for the six months ended June 30, 2009also contributed to our increase in shareholders’ equity.  Book value per share at June 30, 2009was $6.85 compared to $6.58 at December 31, 2008. Tangible book value pershare (which is book value per share adjusted for changes in othercomprehensive income, less goodwill and other intangible assets) at June 30,2009 was $6.32 compared to $6.00 at December 31, 2008.

 

##### **Business SegmentOperations**

 

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

 

*Commercial Banking*

 

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

 

Forthe three months ended June 30, 2009, the commercial banking segmentrecorded net income of $1.2 million compared to net income of $2.7 million forthe same period of 2008. For the six months ended June 30, 2009 and 2008,net income for this business segment was $2.9 million and $4.9 million,respectively.  See “**Statementsof Income** — *General—Business**Segments*” above for additionalinformation regarding the operating results for the commercial banking segmentfor the periods presented.  At June 30,2009, total assets for this segment were $1.82 billion, loans receivable, netof deferred fees and costs, were $1.20 billion and total deposits were $1.24billion. At June 30, 2008, total assets were $1.70 billion, loansreceivable, net of deferred fees and costs, were $1.07 billion and total depositswere $1.11 billion.

 

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*MortgageBanking*

 

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

 

Forthe three months ended June 30, 2009 and 2008, the mortgage bankingsegment recorded net income of $1.4 million and a loss of $1.2 million,respectively. For the six months ended June 30, 2009 and 2008, net incomewas $2.7 million and a loss of $695,000, respectively.  The increase in net income is primarilyattributable to the decrease in mortgage interest rates and the availability ofaffordable housing for consumers in our market. See “**Statements of Income** — *General—Business**Segments*” abovefor additional information regarding the operating results for the mortgagebanking segment for the periods presented. At June 30, 2009, total assets for this segment were $259.7million; loans held for sale were $232.2 million and mortgage funding checkswere $19.0 million. At June 30, 2008, total assets were $173.0 million;loans held for sale were $156.1 million and mortgage funding checks were $7.9million.

 

*Wealth Management and Trust Services*

 

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

 

Forthe three months ended June 30, 2009 and 2008, the wealth management andtrust services segment recorded net income of $66,000 and $51,000,respectively. For the six months ended June 30, 2009 and 2008, net incomefor this business segment was $76,000 and $68,000, respectively.  For the three months ended June 30, 2009and 2008, noninterest income was $885,000 and $922,000, respectively.  Noninterest expense for the three monthsended June 30, 2009 and 2008 was $784,000 and $844,000, respectively.  For the six months ended June 30, 2009and 2008, noninterest income was $1.7 million and $1.8 million,respectively.  Noninterest expense forthe six months ended June 30, 2009 and 2008 was $1.6 million and $1.7million, respectively.  At June 30,2009, total assets were $3.4 million and managed and custodial assets were $2.9billion. At June 30, 2008, total assets for this segment were $3.6 millionand managed and custodial assets were $3.4 billion. The decrease in managed andcustodial assets and the related noninterest income is primarily attributableto a decrease in managed assets at our trust division due to the loss of lowmargin custody relationships with two clients and the departure of certainpersonnel at CWS.

 

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

 

## **Capital Resources**

 

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

 

Regulatoryagencies measure capital adequacy utilizing a formula that takes into accountthe individual risk profile of the financial institution. The guidelines definecapital as both Tier 1

 

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(which includes common shareholders’ equity,defined to include certain debt obligations) and Tier 2 (which includes certainother debt obligations, a portion of the allowance for loan losses, and 45% ofany unrealized gains in equity securities).

 

At June 30, 2009, ourTier 1 and total (Tier 1 and Tier 2) risk-based capital ratios were 13.43% and14.52%, respectively. Our regulatory capital levels for the Bank and bankholding company meet those established for well-capitalized institutions.  The increase in our risk-based capital ratioswas primarily a result of our raising $31.6 million in common equity capitalduring the second quarter of 2009.  Thisadditional capital will help us to further penetrate our existing footprint andtake advantage of bank consolidation opportunities.

 

At December 31, 2008,our Tier 1 and total risk-based capital ratios were 11.67% and 12.72%,respectively.  Table 12 provides additionalinformation pertaining to our capital ratios.

 

**Capital Components**

AtJune 30, 2009 and December 31, 2008

(Inthousands)

 
| ** **                                                        | ** ** | ** ** | ** ** | ** **             | ** ** | **To Be Well**         | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | ** ** | ** ** | ** **             | ** ** | **Capitalized  Under** | ** ** |
| ** **                                                        | ** ** | ** ** | ** ** | **For  Capital**       | ** ** | **Prompt  Corrective** | ** ** |
| ** **                                                        | ** ** | **Actual** | ** ** | **Adequacy  Purposes** | ** ** | **Action  Provisions** | ** ** |
| **Cardinal Financial Corporation (Consolidated):** | ** ** | **Amount** | ** ** | **Ratio**              | ** ** | **Amount**             | ** ** | ** ** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
|                                                              |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| **At  June 30, 2009**                                        |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital/Total capital to risk-weighted assets   |       | $          | 217,757    |                   | 14.52      | %                 | $          | 119,980 |   | >  |   | 8.00 | %  | $ | 149,975 |   | >  |   | 10.00 | % |
| Tier I capital/Tier I  capital to risk-weighted assets            |       | 201,407    |       | 13.43                  | %          | 59,990                 |       | >  |   | 4.00 | % | 89,985 |   | >  |   | 6.00 | % |
| Tier I capital/Total  capital to average assets                   |       | 201,407    |       | 11.43                  | %          | 70,494                 |       | >  |   | 4.00 | % | 88,117 |   | >  |   | 5.00 | % |
|                                                              |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| **At  December 31, 2008**                                    |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital/Total capital to risk-weighted assets   |       | $          | 178,420    |                   | 12.72      | %                      | $          | 112,207 |   | >  |   | 8.00 | %  | $ | 140,259 |   | >  |   | 10.00 | % |
| Tier I capital/Tier I  capital to risk-weighted assets            |       | 163,716    |       | 11.67                  | %          | 56,104                 |       | >  |   | 4.00 | % | 84,156 |   | >  |   | 6.00 | % |
| Tier I capital/Total  capital to average assets                   |       | 163,716    |       | 9.90                   | %          | 66,168                 |       | >  |   | 4.00 | % | 82,711 |   | >  |   | 5.00 | % |
|                                                              |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
|                                                              | ** ** | ** ** | ** ** | ** **             | ** ** | **To Be Well**         | ** ** |
|                                                              | ** ** | ** ** | ** ** | ** **             | ** ** | **Capitalized Under**  | ** ** |
|                                                              | ** ** | ** ** | ** ** | **For Capital**        | ** ** | **Prompt Corrective**  | ** ** |
|                                                              | ** ** | **Actual** | ** ** | **Adequacy Purposes**  | ** ** | **Action Provisions**  | ** ** |
| **Cardinal Bank:**                                                | ** ** | **Amount** | ** ** | **Ratio**              | ** ** | **Amount**             | ** ** | ** ** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
|                                                              |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| **At  June 30, 2009**                                        |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital/Total capital to risk-weighted assets   |       | $          | 181,562    |                   | 12.17      | %                      | $          | 119,392 |   | >  |   | 8.00 | %  | $ | 149,240 |   | >  |   | 10.00 | % |
| Tier I capital/Tier I  capital to risk-weighted assets            |       | 165,212    |       | 11.07                  | %          | 59,696                 |       | >  |   | 4.00 | % | 89,544 |   | >  |   | 6.00 | % |
| Tier I capital/Total  capital to average assets                   |       | 165,212    |       | 9.42                   | %          | 70,156                 |       | >  |   | 4.00 | % | 87,695 |   | >  |   | 5.00 | % |
|                                                              |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| **At  December 31, 2008**                                    |       |       |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Total risk-based  capital/Total capital to risk-weighted assets   |       | $          | 168,513    |                   | 12.04      | %                      | $          | 111,957 |   | >  |   | 8.00 | % | $ | 139,946 |   | >  |   | 10.00 | % |
| Tier I capital/Tier I  capital to risk-weighted assets            |       | 153,810    |       | 10.99                  | %          | 55,978                 |       | >  |   | 4.00 | % | 83,968 |   | >  |   | 6.00 | % |
| Tier I capital/Total  capital to average assets                   |       | 153,810    |       | 9.32                   | %          | 66,018                 |       | >  |   | 4.00 | % | 82,523 |   | >  |   | 5.00 | % |

 

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**Contractual Obligations**

 

We have entered into anumber of long-term contractual obligations to support our ongoing businessactivities. These contractual obligations will be funded through operatingrevenues and liquidity sources held or available to us and exclude contractualinterest costs, where applicable. The required payments under such obligationsare detailed in Table 13.

 

**Contractual Obligations**

At June 30, 2009

(In thousands)

 
| ** **                                          | ** ** | **Payments  Due by Period** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | **Total**                   | ** ** | **Less than  1  Year** | ** ** | **1 - 2  Years** | ** ** | **3 - 5 Years** | ** ** | **More than  5  Years** | ** ** |
| Long-Term Debt Obligations:                         | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit                             |       | $                           | 529,444    |   | $ | 390,686 |   | $ | 51,680 |   | $ | 86,463 |   | $ | 615 |   |
|                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Brokered certificates of deposit                    |       | 91,929                      |       | 84,556 |   | 7,373 |   | — |   | — |   |
|                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Advances from the Federal Home Loan Bank of Atlanta |       | 280,000                     |       | 10,000 |   | 35,000 |   | 80,000 |   | 155,000 |   |
|                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Trust preferred securities                          |       | 20,619                      |       | — |   | — |   | — |   | 20,619 |   |
|                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Operating lease obligations                         |       | 15,243                      |       | 4,508 |   | 2,319 |   | 5,371 |   | 3,045 |   |
|                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Total                                               |       | $                           | 937,235    |   | $ | 489,750 |   | $ | 96,372 |   | $ | 171,834 |   | $ | 179,279 |   |

 

**Financial Instruments withOff-Balance-Sheet Risk and Credit Risk**

 

We are a party to financialinstruments with off-balance sheet risk to meet the financing needs of ourcustomers. These financial instruments include commitments to extend credit andstandby letters of credit. Those instruments involve, to varying degrees,elements of credit risk in excess of the amount recognized on the balancesheet.

 

The Bank’s maximum exposureto credit loss in the event of nonperformance by the other party to thefinancial instrument for commitments to extend credit and standby letters ofcredit is represented by the contractual amount of those instruments. The Bankuses the same credit policies in making commitments and conditional obligationsas it does for on-balance sheet instruments.

 

Commitments to extend creditare agreements to lend to a customer as long as there is no violation of anycondition established in the agreement. Commitments generally have expirationdates or other termination clauses and may require payment of a fee. Since manyof the commitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future funding requirements. Weevaluate each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained is based onmanagement’s credit evaluation of the counterparty.  Collateral held varies but may includeaccounts receivable, inventory, property and equipment, and income-producingcommercial properties.

 

Unfunded commitments underlines of credit are commitments for possible future extensions of credit toexisting customers.  Those lines ofcredit may not be drawn upon to the total extent to which we have committed.

 

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Standby letters of creditare conditional commitments we issued to guarantee the performance of thecontractual obligations by a customer to a third party. Those guarantees areprimarily issued to support public and private borrowing arrangements,including commercial paper, bond financing, and similar transactions. Thecredit risk involved in issuing standby letters of credit is essentially thesame as that involved in extending loan facilities to customers. We holdcertificates of deposit, deposit accounts, real estate or other appropriateforms of collateral supporting those commitments for which collateral is deemednecessary.

 

At June 30, 2009,commitments to extend credit were $421.5 million and standby letters of creditwere $12.2 million. The fair value of the liability associated with standbyletters of credit at June 30, 2009 was not significant.  Commitments to extend credit of $92.9 millionas of June 30, 2009 are related to the mortgage banking segment’s pipelineand are of a short term nature.

 

We have counter-party riskwhich may arise from the possible inability of George Mason’s third-partyinvestors to meet the terms of their forward sales contracts. George Masonworks with third-party investors that are generally well-capitalized, areinvestment grade and exhibit strong financial performance to mitigate thisrisk.  We do not expect any third-partyinvestor to fail to meet its obligation. In addition, we have derivative counterparty risk relating to certaininterest rate swaps we have with third parties. This risk may arise from the inability of the third party to meet theterms of the contract.  We continuouslymonitor the financial condition of these third parties.  We do not expect these third parties to failto meet their obligations.

 

George Mason estimates a reserve(early pay-off reserve) for mortgage loans sold that are repaid by the borrowerwithin a certain number of days following the loan sale, thereby requiring thatGeorge Mason refund part of the service release premium and/or premium pricingreceived from the investor pursuant to the loan sale agreement.  The reserve at June 30, 2009 wasinconsequential.

 

George Mason has a reserve for itsestimated exposure to repurchase loans previously sold to investors for whichborrowers failed to provide full and accurate information on their loanapplication or for which appraisals have not been acceptable or when the loanwas not underwritten in accordance with the loan program specified by the loaninvestor. At June 30, 2009, this reserve had a balance of $770,000.  We evaluate the merits of each claim andestimate the reserve based on actual and expected claims received and considerthe historical amounts paid to settle such claims.

 

In addition, George Mason, as partof the service it provides to its managed companies, purchases the loansoriginated by managed companies at the time of origination.  These loans are then sold by George Mason toinvestors.  George Mason has agreementswith its managed companies requiring that, for any loans that were originatedby a managed company and for which investors have requested George Mason torepurchase due to the borrowers failure to provide full and accurateinformation on or related to their loan application or for which appraisalshave not been acceptable, the managed company be responsible for buying backthe loan.  In the event that the managedcompany’s financial condition deteriorates and it is unable to fund therepurchase of such loans, George Mason may have to provide the funds torepurchase these loans from investors. In this instance, George Mason would establish an allowance on thereceivable from the managed company. There is no such allowance recorded at June 30, 2009 as managementexpects to fully recover amounts owed by managed companies as of June 30,2009.

 

During the second quarter of2008, George Mason entered into an agreement with a mortgage correspondent relatedto the loan purchase agreement between the two parties.  The 

 

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agreement provided for the release of known and unknown claims by themortgage correspondent in exchange for a $1.8 million payment made by GeorgeMason to the correspondent.  The terms ofthis agreement require that we may be obligated to make additional payments tothe correspondent in future periods based on certain conditions.  We believe the additional exposure under thisagreement is not material.  The amount ofthe exposure declines with the passage of time.

 

## **Liquidity**

 

Liquidity in the bankingindustry is defined as the ability to meet the demand for funds of bothdepositors and borrowers. We must be able to meet these needs by obtainingfunding from depositors or other lenders or by converting noncash items intocash.  The objective of our liquidity managementprogram is to ensure that we always have sufficient resources to meet thedemands of our depositors and borrowers. Stable core deposits and a strongcapital position provide the base for our liquidity position. We believe wehave demonstrated our ability to attract deposits because of our convenientbranch locations, personal service and pricing.

 

In addition to deposits, wehave access to various wholesale funding markets. These markets include thebrokered CD market, the repurchase agreement market and the federal fundsmarket. During 2008, we joined the Certificates of Deposit Account RegistryService (“CDARS”).  CDARS allows ourcustomers to access FDIC insurance protection on multi-million dollarcertificates of deposit through our Bank. When a customer places a large deposit through CDARS, we place theirfunds into certificates of deposit with other banks in the CDARS network inincrements of less than $250,000 so that principal and interest are eligiblefor FDIC insurance protection.  We alsomaintain secured lines of credit with the Federal Reserve Bank of Richmond andthe Federal Home Loan Bank of Atlanta. Having diverse funding alternativesreduces our reliance on any one source for funding.

 

Cash flow from amortizingassets or maturing assets can also provide funding to meet the needs ofdepositors and borrowers.

 

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

 

Liquid assets, which includecash and due from banks, federal funds sold and investment securities availablefor sale, totaled $301.0 million at June 30, 2009 or 16% of total assets.We held investments that are classified as held-to-maturity in the amount of$40.9 million at June 30, 2009. To maintain ready access to the Bank’ssecured lines of credit, the Bank has pledged roughly half of its investmentsecurities and a portion of its residential real estate loan portfolio to theFederal Home Loan Bank of Atlanta with additional investment securities andcertain loans in its commercial real estate and commercial &industrial portfolios pledged to the Federal Reserve Bank of Richmond.Additional borrowing capacity at the Federal Home Loan Bank of Atlanta at June 30,2009 was $5 million. Borrowing capacity with the Federal Reserve Bank ofRichmond was $368 million at June 30, 2009. We anticipate maintainingliquidity at a level sufficient to

 

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protect depositors, provide for reasonablegrowth and fully comply with all regulatory requirements.

 

##### **Interest RateSensitivity**

 

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

 

We employ an independentconsulting firm to model our interest rate sensitivity.  We use a net interest income simulation modelas our primary tool to measure interest rate sensitivity. Many assumptions aredeveloped based on expected activity in the balance sheet. For maturing assets,assumptions are created for the redeployment of these assets. For maturingliabilities, assumptions are developed for the replacement of these fundingsources. Assumptions are also developed for assets and liabilities that couldreprice during the modeled time period. These assumptions also cover how weexpect rates to change on non-maturity deposits such as interest checking,money market checking, savings accounts as well as certificates of deposit.With the funding markets still lacking liquidity, forecasts for deposit ratemovements carry greater uncertainty than when this market is functioningnormally.  Based on inputs that includethe current balance sheet, the current level of interest rates and thedeveloped assumptions, the model then produces an expected level of net interestincome assuming that market rates remain unchanged. This is considered the basecase. Next, the model determines what net interest income would be based onspecific changes in interest rates. The rate simulations are performed for atwo year period and include ramped rate changes of down 100 basis points and up200 basis points. The down 200 basis point scenario was discontinued given thecurrent level of interest rates.  In theramped down rate change, the model moves rates gradually down 100 basis pointsover the first year and then rates remain flat in the second year.

 

For the up 200 basis pointscenario, rates are gradually moved up 200 basis points in the first year andthen rates remain flat in the second year. In both the up and down scenarios, themodel assumes a parallel shift in the yield curve. The results of thesesimulations are then compared to the base case.

 

At June 30, 2009, wewere asset sensitive for the entire two year simulation period.   Asset sensitive means that yields on theBank’s interest-earning assets will rise faster than interest-bearing liabilitycosts in a rising rate environment.  Fora declining rate environment, asset yields will fall faster thaninterest-bearing liability costs.  Beingasset sensitive our net interest income should increase in a rising ratescenario.  In the up 200 basis pointscenario, our net interest income would improve by not more than 2.9% for theone year period and by not more than 4.8% over the two year time horizon.  In the down 100 basis point scenario theinterest rate risk model indicates that our net interest income will be nearlyunchanged from the base case over the one year period and the two year timehorizon.

 

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**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

Our Asset/LiabilityCommittee is responsible for reviewing our liquidity requirements andmaximizing our net interest income consistent with capital requirements,liquidity, interest rate and economic outlooks, competitive factors andcustomer needs. Interest rate risk arises because the assets of the Bank andthe liabilities of the Bank have different maturities and characteristics. Inorder to measure this interest rate risk, we use a simulation process thatmeasures the impact of changing interest rates on net interest income. Thismodel is run for the Bank by an independent consulting firm. The simulationsincorporate assumptions related to expected activity in the balance sheet. Formaturing assets, assumptions are developed for the redeployment of theseassets. For maturing liabilities, assumptions are developed for the replacementof these funding sources. Assumptions are also developed for assets andliabilities that reprice during the modeled time period. These assumptions alsocover how we expect rates to change on non-maturity deposits such as interestchecking, money market checking, savings accounts as well as certificates ofdeposit. With the funding markets still lacking liquidity, forecasts fordeposit rate movements carry greater uncertainty than when this market isfunctioning normally.  Based on inputsthat include the most recent period end balance sheet, the current level ofinterest rates and the developed assumptions, the model then produces anexpected level of net interest income assuming that interest rates remainunchanged. This becomes the base case. Next, the model determines the impact onnet interest income given specified changes in interest rates. The ratesimulations are performed for a two year period and include ramped rate changesof down 100 basis points and up 200 basis points. The down 200 basis pointscenario was discontinued given the current level of interest rates.  In the ramped down rate change, the modelmoves rates gradually down 100 basis points over the first year and then ratesremain flat in the second year.

 

For the up 200 basis pointscenario, rates are gradually increased by 200 basis points in the first yearand remain flat in the second year. In both the up and down scenarios, themodel assumes a parallel shift in the yield curve. The results of thesesimulations are then compared to the base case.

 

At June 30, 2009, wewere asset sensitive for the entire two year simulation period.   Asset sensitive means that yields on theBank’s interest-earning assets will rise faster than interest-bearing liabilitycosts in a rising rate environment.  Fora declining rate environment, asset yields will fall faster thaninterest-bearing liability costs.  Beingasset sensitive our net interest income should increase in a rising rateenvironment.  In the up 200 basis pointscenario, our net interest income would improve by not more than 2.9% for theone year period and by not more than 4.8% over the two year time horizon.  In the down 100 basis point scenario theinterest rate risk model indicates that our net interest income will be nearlyunchanged from the base case over the one year period and the two year timehorizon.

 

See also “Interest RateSensitivity” in Item 2 above for a discussion of our interest rate risk.

 

We have counter-party riskthat may arise from the possible inability of George Mason’s third partyinvestors to meet the terms of their forward sales contracts.  George Mason works with third-party investorsthat are generally well-capitalized, are investment grade and exhibit strongfinancial performance to mitigate this risk. We do not expect any third-party investor to fail to meet itsobligation.  In addition, we havederivative counterparty risk relating to certain interest rate swaps we havewith a third party.  This risk may arisefrom the inability of the third party to

 

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meet the terms of the contracts.  We monitor the financial condition of thisthird party on an annual basis.  We donot expect this third party to fail to meet its obligation.

 

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**Item 4. Controls and Procedures**

 

The Company maintainsdisclosure controls and procedures that are designed to ensure that theinformation required to be disclosed by it in the reports that it files orsubmits under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods required by theSecurities and Exchange Commission, including, without limitation, thosecontrols and procedures designed to ensure that such information is accumulatedand communicated to the Company’s management to allow timely decisionsregarding required disclosures.

 

As of the end of the periodcovered by this report, an evaluation of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures was carried outunder the supervision and with the participation of the Company’s management,including its chief executive officer and chief financial officer. Based on andas of the date of such evaluation, these officers concluded that the Company’sdisclosure controls and procedures were effective.

 

The Company also maintains asystem of internal accounting controls that is designed to provide assurancethat assets are safeguarded and that transactions are executed in accordancewith management’s authorization and are properly recorded. This system iscontinually reviewed and is augmented by written policies and procedures, thecareful selection and training of qualified personnel and an internal auditprogram to monitor its effectiveness. There were no changes in our internalcontrol over financial reporting identified in connection with our evaluationof it that occurred during our last fiscal quarter that materially affected, orare likely to materially affect, our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

In the ordinary course ofour operations, we become party to various legal proceedings.  Currently, we are not party to any materiallegal proceedings, and no such proceedings are, to management’s knowledge,threatened against us.

 

**Item1A.  Risk Factors**

 

Our operations are subjectto many risks that could adversely affect our future financial condition andperformance and, therefore, the market value of our securities.  The risk factors that are applicable to usare outlined in our Annual Report on Form 10-K for the year ended December 31,2008.  Except as noted below, therehave been no material changes in our risk factors from those disclosed in ourAnnual Report on Form 10-K for the year ended December 31, 2008.

 

***Our ability to pay dividends is limited and we may be unable to payfuture dividends.***

 

Our ability to pay dividendsis limited by regulatory restrictions and the need to maintain sufficientconsolidated capital in the Company and in our subsidiaries.  The ability of our bank subsidiary to paydividends to us is limited by their obligations to maintain sufficient capital,earnings and liquidity and by other general restrictions on their dividendsunder federal and state bank regulatory requirements.

 

In addition, as a bankholding company, our ability to declare and pay dividends is subject to theguidelines of the Board of Governors of the Federal Reserve System, or theFederal Reserve, regarding capital adequacy and dividends.  The Federal Reserve guidelines generallyrequire us to review the effects of the cash payment of dividends on commonstock and other Tier 1 capital instruments (i.e., perpetual preferred stock andtrust preferred debt) on our financial condition.  These guidelines also require that we reviewour net income for the current and past four quarters, and the level ofdividends on common stock and other Tier 1 capital instruments for thoseperiods, as well as our projected rate or earnings retention.

 

Under the Federal Reserve’spolicy, the board of directors of a bank holding company should also considerdifferent factors to ensure that its dividend level is prudent relative to theorganization’s financial position and is not based on overly optimisticearnings scenarios such as any potential events that may occur before thepayment date that could affect its ability to pay while still maintaining astrong financial position.  As a generalmatter, the Federal Reserve has indicated that the board of directors of a bankholding company should consult with the Federal Reserve and eliminate, defer,or significantly reduce bank holding company’s dividends if: (i) its netincome available to shareholders for the past four quarters, net of dividendspreviously paid during that period, is not sufficient to fully fund thedividends; (ii) its prospective rate of earnings retention is notconsistent with its capital needs and overall current and prospective financialcondition; or (iii) it will not meet, or is in danger of not meeting, itsminimum regulatory capital adequacy ratios. If we do not satisfy these regulatory requirements or the FederalReserve’s policies, we will be unable to pay dividends on our common stock.

 

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***Commercial real estate and business loansincrease our exposure to credit risks.***

 

AtJune 30, 2009, our portfolio of commercial and industrial and commercialreal estate (including construction) totaled $892.8 million, or 74% oftotal loans. We plan to continue to emphasize the origination of loans to smalland medium-sized businesses as well as government contractors, professionals,such as physicians, accountants and attorneys, and commercial real estatedevelopers and builders, which generally exposes us to a greater risk ofnonpayment and loss than residential real estate loans because repayment ofsuch loans often depends on the successful operations and cash flows of theborrowers. Additionally, such loans typically involve larger loan balances tosingle borrowers or groups of related borrowers compared to residential realestate loans. Also, many of our borrowers have more than one commercial loanoutstanding. Consequently, an adverse development with respect to one loan orone credit relationship can expose us to a significantly greater risk of losscompared to an adverse development with respect to a residential real estateloan.  In addition, these small tomedium-sized businesses generally have fewer financial resources in terms ofcapital or borrowing capacity than larger entities. If general economicconditions negatively impact these businesses, our results of operations andfinancial condition may be adversely affected. This concentration also exposes us more to the market risks of realestate sales leasing and other activity in the areas we serve.  An adverse change in local real estateconditions and markets could materially adversely affect the values of ourloans and the real estate held as collateral for such loans, and materiallyaffect our results of operation and financial condition.

 

During2006, the federal bank regulatory agencies released guidance on “Concentrationsin Commercial Real Estate Lending” (the “Guidance”).  The Guidance defines commercial real estate (“CRE”)loans as exposures secured by raw land, land development and construction(including 1-4 family residential construction), multi-family property, andnon-farm nonresidential property where the primary or a significant source ofrepayment is derived from rental income associated with the property (that is,loans for which 50% or more of the source of repayment comes from third party,non-affiliated, rental income) or the proceeds of the sale, refinancing, orpermanent financing of the property.  TheGuidance requires that appropriate processes be in place to identify, monitorand control risks associated with real estate lending concentrations.  This could include enhanced strategicplanning, CRE underwriting policies, risk management, internal controls,portfolio stress testing and risk exposure limits as well as appropriatelydesigned compensation and incentive programs. Higher allowances for loan losses and capital levels may also berequired.  The Guidance is triggered whenCRE loan concentrations exceed either:

 

·                  Total reported loans for construction, landdevelopment, and other land of 100% or more of a bank’s total capital; or

·                  Total reported loans secured by multifamilyand nonfarm nonresidential properties and loans for construction, landdevelopment, and other land of 300% or more of a bank’s capital.

 

TheGuidance applies to our CRE lending activities. Although our regulators have not required us to maintain elevated levelsof capital or liquidity due to our CRE concentrations, the regulators may do soin the future, especially if there is a material downturn in our local realestate markets.

 

***A substantial decline in the value of ourFederal Home Loan Bank of Atlanta common stock may result in another-than-temporary impairment charge.***

 

Weare a member of the Federal Home Loan Bank of Atlanta, or FHLB, which enablesus to borrow funds under the Federal Home Loan Bank advance program.  As a FHLB member, we 

 

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are required to own FHLBcommon stock, the amount of which increases with the level of our FHLBborrowings. The carrying value of our FHLB common stock was $15.6 millionas of December 31, 2008. On January 30, 2009, the FHLB announced thatin light of the FHLB’s other-than-temporary impairment analysis it was stillcompleting for the fourth quarter of 2008, the FHLB deferred the declaration ofthe fourth quarter dividend.   The FHLBhas also suspended daily repurchases of FHLB common stock, which adverselyaffects the liquidity of these shares. Consequently, there is a risk that our investment could be deemedother-than-temporarily impaired at some time in the future.

 

***Increases in FDIC insurance premiums may cause our earnings todecrease.***

 

The Emergency EconomicStabilization Act of 2008 temporarily increased the limit on FDIC coverage to$250,000 for all accounts through December 31, 2009. We are participatingin the FDIC’s Temporary Liquidity Guarantee Program, or TLG, fornoninterest-bearing transaction deposit accounts.  The FDIC almost doubled its assessment rateon well-capitalized institutions by raising the assessment rate 7 basis pointsat the beginning of 2009. In May 2009, the FDIC issued a final rule regardinga special assessment of 5 basis points on an institution’s total assets minusits Tier 1 capital as of June 30, 2009. It also granted the FDIC the authority to impose up to a further 5 basispoints special assessment at any time during the remainder of 2009 whenever theestimated Deposit Insurance Fund falls to a level that the FDIC’s board ofdirectors believes would adversely affect public confidence or to a level closeto zero or negative. The FDIC has adopted another final rule effective April 1,2009, to change the way that the FDIC’s assessment system differentiates forrisk, make corresponding changes to assessment rates beginning with the secondquarter of 2009, as well as other changes to the deposit insurance assessmentrules. Banks that participate in the TLG’s noninterest bearing transactionaccount guarantee will pay the FDIC an annual assessment of 10 basis points onthe amounts in such accounts above the amounts covered by FDIC depositinsurance. To the extent that these TLG assessments are insufficient to coverany loss or expenses arising from the TLG program, the FDIC is authorized to imposean emergency special assessment on FDIC-insured depository institutions.Legislation has been proposed to give the FDIC authority to impose charges forthe TLG program upon depository institution holding companies, as well. Thesechanges will cause the premiums and TLG assessments charged by the FDIC toincrease. These actions could significantly increase our noninterest expense in2009 and for the foreseeable future.

 

***Legislative and regulatory changes could materially change our businessand adversely affect our results of operations and financial condition.***

 

Congress and the U.S.government continue to evaluate and develop various programs and initiativesdesigned to stabilize the financial and housing markets and stimulate theeconomy, including the Treasury’s Financial Stability Plan and variouslegislation and programs reduce residential mortgage foreclosures and stabilizethe housing market.

 

Legislative and regulatoryproposals regarding changes in banking, and the regulation of banks, thrifts,mortgage lenders and other financial institutions are being considered by theexecutive branch of the Federal government, Congress and various stategovernments. Certain of these proposals, if adopted, could significantly changetheregulation or operations of banks and the financial services industry.New regulations and statutes are regularly proposed that contain wide-rangingproposals for altering the structures, regulations and competitiverelationships of the nation’s financial institutions and markets. Anotherchange under discussion includes the regulation of compensation in thefinancial services industry, generally. We cannot predict whether or in whatform any proposed law or regulation will be adopted or the extent to which

 

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our business may be affected by any new law or regulation. The currentstresses on the financial system and the economy generally, the powers grantedto the Treasury under EESA and the ARRA, the expansion and supervision ofgovernment sponsored financial programs make the nature and extent of futurelegislative and regulatory changes affecting financial institutions areunpredictable and subject to rapid changes.

 

These changes are rapid andunpredictable. Any of these changes could materially change our business andadversely affect our results of operations and financial condition.

 

***Changes in the automobile industry could adversely affect our trustbusiness.***

 

Ourlargest trust customer is an association of automobile dealers. Recently, aspart of their restructuring plans under government supervision, General Motorsand Chrysler have begun terminating substantial numbers of their dealers, andother dealers have failed or been sold due to declines in auto sales. We cannotpredict the timing or monetary effect that these changes in the auto dealerindustry could have upon our trust revenue or our trust department’scontribution to our net income. However, both could be adversely affected overtime.

 

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

 

(a)  None.

(b)  Not applicable.

(c)  For the three months ended June 30, 2009,we did not purchase shares of our common stock.

 

**Item 3.  Defaults Upon Senior Securities**

 

(a)  None.

(b)  None.

 

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

 

(a)  The Company’s Annual Meeting of Shareholderswas held on April 24, 2009.

(b)  Not applicable.

(c)  At the Annual Meeting of Shareholders, thefollowing persons were elected as directors for a term expiring in 2012:

 
| ** **           | ** ** | **Votes**  | ** ** |
|----------------------|------------|------------|------------|
| **Director**         | ** ** | **For**    | ** ** | **Withheld** | ** ** |
| Bernard H. Clineburg |       | 15,978,194 |       | 5,301,123 |   |
| James D. Russo       |       | 18,906,520 |       | 2,372,797 |   |
| George P. Shafran    |       | 19,991,327 |       | 1,287,990 |   |

 

(d)  None.

 

**Item 5.  Other Information**

 

(a)  None.

(b)  None.

 

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**Item 6.  Exhibits**

 
| 10.1 | Amendment to Executive Employment Agreement of Bernard  H. Clineburg (incorporated by reference to Exhibit 10.1 to the Current  Report on Form 8-K filed July 23, 2009).                                                                                                                                                  |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 | Underwriting  Agreement dated May 21, 2009 between Cardinal Financial Corporation and  Raymond James & Associates, Inc. as Representative of the  Several Underwriters named in Schedule I thereto (incorporated by reference  to Exhibit 10.1 to the Current Report on Form 8-K filed  May 22, 2009). |
| 31.1 | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                                                                                                                                                                                       |
| 31.2 | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                                                                                                                                                                                       |
| 32.1 | Statement of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350                                                                                                                                                                                                                                                            |
| 32.2 | Statement of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350                                                                                                                                                                                                                                                            |

 

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**SIGNATURES**

 

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

 
|                      | CARDINAL FINANCIAL  CORPORATION                       |
|---------------------------|-------------------------------------------------------|
|                      | (Registrant)                                          |
|                      |                                                  |
| Date: August 7, 2009 | /s/ Bernard H. Clineburg                              |
|                      | Bernard H. Clineburg                                  |
|                      | Chairman and Chief  Executive Officer                 |
|                      | (Principal Executive  Officer)                        |
|                      |                                                  |
|                      |                                                  |
| Date: August 7, 2009 | /s/ Mark A. Wendel                                    |
|                      | Mark A. Wendel                                        |
|                      | Executive Vice President  and Chief Financial Officer |
|                      | (Principal Financial  Officer)                        |
|                      |                                                  |
|                      |                                                  |
| Date: August 7, 2009 | /s/ Jennifer L. Deacon                                |
|                      | Jennifer L. Deacon                                    |
|                      | Senior Vice President and  Controller                 |
|                      | (Principal Accounting  Officer)                       |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                           |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1            |       | Amendment to Executive Employment Agreement of Bernard  H. Clineburg (incorporated by reference to Exhibit 10.1 to the Current Report  on Form 8-K filed July 23, 2009).                                                                                                                                  |
| 10.2            |       | Underwriting  Agreement dated May 21, 2009 between Cardinal Financial Corporation and  Raymond James & Associates, Inc. as Representative of the Several  Underwriters named in Schedule I thereto (incorporated by reference to  Exhibit 10.1 to the Current Report on Form 8-K filed May 22, 2009). |
| 31.1            |       | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                                                                                                                                                                  |
| 31.2            |       | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                                                                                                                                                                  |
| 32.1            |       | Statement of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350                                                                                                                                                                                                                                  |
| **32.2**        | ** ** | **Statement of Chief Financial  Officer Pursuant to 18 U.S.C. Section 1350**                                                                                                                                                                                                                              |

 

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