Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**x****Quarterly Report Pursuant to Section 13or 15(d)**

**of the Securities Exchange Act of 1934**

 

**For thequarterly period ended June 30, 2008**

 

**or**

 

**o****Transition Report Pursuant to Section 13or 15(d)**

**of theSecurities Exchange Act of 1934**

 

**For thetransition period from                 to                 **

 

**CommissionFile Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant as specified in itscharter)

 

| **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, includingarea 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 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   | (Do  not check if a smaller reporting company) |   | Smaller  reporting company  o |
|                                       |                                                |        |                                         |  |

 

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:

 

24,106,985 shares of common stock, par value $1.00 per share,

outstanding as of August** **4, 2008

 

 

 

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Tableof Contents

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I – FINANCIAL INFORMATION**                                                                                      |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                              |   |   |
| Item 1. Financial Statements:                                                                                                     |   |   |
|                                                                                                                              |   |   |
| Consolidated Statements of ConditionAt June 30, 2008  (unaudited) and December 31, 2007                                 |   | 3      |
|                                                                                                                              |   |   |
| Consolidated Statements of IncomeFor the three and six months  ended June 30, 2008 and 2007 (unaudited)                      |   | 4      |
|                                                                                                                              |   |   |
| Consolidated Statements of Comprehensive  IncomeFor the three and six months  ended June 30, 2008 and 2007 (unaudited)       |   | 5      |
|                                                                                                                              |   |   |
| Consolidated Statements of Changes in  Shareholders’ EquityFor the six months ended  June 30, 2008 and 2007 (unaudited) |   | 6      |
|                                                                                                                              |   |   |
| Consolidated Statements of Cash FlowsFor the six months ended  June 30, 2008 and 2007 (unaudited)                            |   | 7      |
|                                                                                                                              |   |   |
| Notes to Consolidated Financial Statements  (unaudited)                                                                           |   | 8      |
|                                                                                                                              |   |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition andResults  of Operations                               |   | 20     |
|                                                                                                                              |   |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                                               |   | 48     |
|                                                                                                                              |   |   |
| Item 4. Controls and Procedures                                                                                                   |   | 49     |
|                                                                                                                              |   |   |
| **PART II – OTHER INFORMATION**                                                                                         |   | 50     |
|                                                                                                                              |   |   |
| Item 1. Legal Proceedings                                                                                                         |   | 50     |
| Item 1A. Risk Factors                                                                                                             |   | 50     |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds                                                              |   | 50     |
| Item 3. Defaults Upon Senior Securities                                                                                           |   | 50     |
| Item 4. Submission of Matters to a Vote of  Security Holders                                                                      |   | 51     |
| Item 5. Other Information                                                                                                         |   | 51     |
| Item 6. Exhibits                                                                                                                  |   | 51     |
|                                                                                                                              |   |   |
| **SIGNATURES**                                                                                                                    |   | 52     |

 

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Tableof Contents

 

**PART I– FINANCIAL INFORMATION**

** **

**Item 1. Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCONDITION

 

June 30, 2008 and December 31, 2007

 

(In thousands, except share data)

 
| ** **                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                    |       |              |       |                  |       |
| Cash and due from banks                                                                                                                       |       | $                 | 18,731     |                  | $          | 20,622 |   |
| Federal funds sold                                                                                                                            |       | 11,299            |       | 1,799                 |       |
|                                                                                                                                          |       |              |       |                  |       |
| Total cash and cash equivalents                                                                                                               |       | 30,030            |       | 22,421                |       |
| Investment securities available-for-sale                                                                                                      |       | 318,015           |       | 285,998               |       |
| Investment securities held-to-maturity  (market value of $54,371 and $78,168 at June 30, 2008 and  December 31, 2007, respectively) |       | 55,550            |       | 78,948                |       |
|                                                                                                                                          |       |              |       |                  |       |
| Total investment securities                                                                                                                   |       | 373,565           |       | 364,946               |       |
|                                                                                                                                          |       |              |       |                  |       |
| Other investments                                                                                                                             |       | 16,383            |       | 14,188                |       |
| Loans held for sale                                                                                                                           |       | 156,077           |       | 170,487               |       |
| Loans receivable, net of deferred fees and  costs                                                                                             |       | 1,070,754         |       | 1,039,684             |       |
| Allowance for loan losses                                                                                                                     |       | (12,390           | )          | (11,641               | )          |
|                                                                                                                                          |       |              |       |                  |       |
| Loans receivable, net                                                                                                                         |       | 1,058,364         |       | 1,028,043             |       |
|                                                                                                                                          |       |              |       |                  |       |
| Premises and equipment, net                                                                                                                   |       | 17,418            |       | 18,463                |       |
| Deferred tax asset                                                                                                                            |       | 7,503             |       | 6,638                 |       |
| Goodwill and intangibles, net                                                                                                                 |       | 17,113            |       | 17,239                |       |
| Bank-owned life insurance                                                                                                                     |       | 32,891            |       | 32,316                |       |
| Accrued interest receivable and other  assets                                                                                                 |       | 16,989            |       | 15,290                |       |
|                                                                                                                                          |       |              |       |                  |       |
| Total assets                                                                                                                                  |       | $                 | 1,726,333  |                  | $          | 1,690,031 |   |
|                                                                                                                                          |       |              |       |                  |       |
| **Liabilities and Shareholders’ Equity**                                                                                                 |       |              |       |                  |       |
| ** **                                                                                                                                    |       |              |       |                  |       |
| Noninterest bearing deposits                                                                                                                  |       | $                 | 138,524    |                  | $          | 123,994 |   |
| Interest bearing deposits                                                                                                                     |       | 975,069           |       | 972,931               |       |
|                                                                                                                                          |       |              |       |                  |       |
| Total deposits                                                                                                                                |       | 1,113,593         |       | 1,096,925             |       |
|                                                                                                                                          |       |              |       |                  |       |
| Other borrowed funds                                                                                                                          |       | 425,495           |       | 400,060               |       |
| Mortgage funding checks                                                                                                                       |       | 7,912             |       | 9,403                 |       |
| Escrow liabilities                                                                                                                            |       | 1,423             |       | 1,016                 |       |
| Accrued interest payable and other  liabilities                                                                                               |       | 18,308            |       | 23,164                |       |
|                                                                                                                                          |       |              |       |                  |       |
| Total liabilities                                                                                                                             |       | 1,566,731         |       | 1,530,568             |       |

 
|                          |   | **2008**   | ** ** | **2007**   |   |   |   |   |   |
|-------------------------------|--------|------------|------------|------------|--------|--------|--------|--------|--------|
| Common stock, $1 par value    |   |       |       |       |   |   |   |   |   |
| Shares authorized             |   | 50,000,000 |       | 50,000,000 |   |   |   |   |   |
| Shares issued and outstanding |   | 24,106,985 |       | 24,201,561 |   | 24,107 |   | 24,202 |   |

 
| Additional paid-in capital                      |   | 131,033 |      | 131,516 |   |
|-------------------------------------------------|--------|---------|-----------|---------|--------|
| Retained earnings                               |   | 6,549   |      | 4,213   |   |
| Accumulated other comprehensive loss, net       |   | (2,087  | )         | (468    | )      |
|                                            |   |    |      |    |   |
| Total shareholders’ equity                 |   | 159,602 |      | 159,463 |   |
|                                            |   |    |      |    |   |
| Total liabilities and shareholders’ equity |   | $       | 1,726,333 |    | $      | 1,690,031 |   |
|                                                 |        |         |           |         |        |  |  |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFINCOME

 

Three and six months ended June 30, 2008 and 2007

(In thousands, except share data)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                     | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest income:                                               |       |                                                |       |                                              |       |   |   |   |   |
| Loans receivable                                               |       | $                                                   | 15,754     |                                              | $          | 15,421 |   | $ | 32,366 |   | $ | 30,017 |   |
| Loans held for sale                                            |       | 1,955                                               |       | 5,319                                             |       | 4,084 |   | 9,698 |   |
| Federal funds sold                                             |       | 178                                                 |       | 96                                                |       | 316 |   | 1,094 |   |
| Investment securities available-for-sale                       |       | 3,447                                               |       | 3,069                                             |       | 6,755 |   | 5,889 |   |
| Investment securities held-to-maturity                         |       | 628                                                 |       | 960                                               |       | 1,377 |   | 1,963 |   |
| Other investments                                              |       | 215                                                 |       | 183                                               |       | 433 |   | 332 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Total interest income                                          |       | 22,177                                              |       | 25,048                                            |       | 45,331 |   | 48,993 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense:                                              |       |                                                |       |                                              |       |   |   |   |   |
| Deposits                                                       |       | 7,859                                               |       | 11,740                                            |       | 17,207 |   | 23,809 |   |
| Other borrowed funds                                           |       | 3,273                                               |       | 3,076                                             |       | 6,745 |   | 5,116 |   |
| Total interest expense                                         |       | 11,132                                              |       | 14,816                                            |       | 23,952 |   | 28,925 |   |
| Net interest income                                            |       | 11,045                                              |       | 10,232                                            |       | 21,379 |   | 20,068 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Provision for loan losses                                      |       | 769                                                 |       | 475                                               |       | 1,089 |   | 755 |   |
| Net interest income after provision for  loan losses           |       | 10,276                                              |       | 9,757                                             |       | 20,290 |   | 19,313 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Noninterest income:                                            |       |                                                |       |                                              |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 535                                                 |       | 502                                               |       | 1,062 |   | 968 |   |
| Loan service charges                                           |       | 354                                                 |       | 436                                               |       | 664 |   | 822 |   |
| Investment fee income                                          |       | 922                                                 |       | 1,111                                             |       | 1,823 |   | 2,135 |   |
| Realized and unrealized gains on mortgage  banking activities  |       | 1,576                                               |       | 2,435                                             |       | 3,893 |   | 5,065 |   |
| Net realized gain on investment securities  available-for-sale |       | 214                                                 |       | —                                            |       | 214 |   | 14 |   |
| Net realized loss on investment securities  trading            |       | (5                                                  | )          | (3                                                | )          | (9 | ) | (11 | ) |
| Management fee income                                          |       | 302                                                 |       | 348                                               |       | 386 |   | 670 |   |
| Litigation recovery on previously impaired  investment         |       | —                                              |       | 33                                                |       | 190 |   | 66 |   |
| Other income                                                   |       | 477                                                 |       | 447                                               |       | 764 |   | 890 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Total noninterest income                                       |       | 4,375                                               |       | 5,309                                             |       | 8,987 |   | 10,619 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Noninterest expense:                                           |       |                                                |       |                                              |       |   |   |   |   |
| Salary and benefits                                            |       | 5,493                                               |       | 6,049                                             |       | 11,495 |   | 12,645 |   |
| Occupancy                                                      |       | 1,377                                               |       | 1,337                                             |       | 2,776 |   | 2,627 |   |
| Professional fees                                              |       | 615                                                 |       | 426                                               |       | 1,198 |   | 916 |   |
| Depreciation                                                   |       | 593                                                 |       | 797                                               |       | 1,239 |   | 1,597 |   |
| Data processing                                                |       | 413                                                 |       | 355                                               |       | 855 |   | 699 |   |
| Telecommunications                                             |       | 252                                                 |       | 286                                               |       | 486 |   | 578 |   |
| Amortization of intangibles                                    |       | 63                                                  |       | 63                                                |       | 127 |   | 127 |   |
| Settlement with mortgage correspondent                         |       | 1,800                                               |       | —                                            |       | 1,800 |   | — |   |
| Other operating expenses                                       |       | 3,033                                               |       | 2,995                                             |       | 5,485 |   | 5,483 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Total noninterest expense                                      |       | 13,639                                              |       | 12,308                                            |       | 25,461 |   | 24,672 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Net income before income taxes                                 |       | 1,012                                               |       | 2,758                                             |       | 3,816 |   | 5,260 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Provision for income taxes                                     |       | 138                                                 |       | 816                                               |       | 900 |   | 1,553 |   |
| Net income                                                     |       | $                                                   | 874        |                                              | $          | 1,942 |   | $ | 2,916 |   | $ | 3,707 |   |
| Earnings per common share - basic                              |       | $                                                   | 0.04       |                                              | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |
| Earnings per common share - diluted                            |       | $                                                   | 0.04       |                                              | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |
| Weighted-average common shares outstanding  - basic            |       | 24,370,905                                          |       | 24,448,103                                        |       | 24,426,234 |   | 24,478,817 |   |
| Weighted-average common shares outstanding  - diluted          |       | 24,858,450                                          |       | 24,975,595                                        |       | 24,867,818 |   | 25,000,523 |   |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (LOSS)

Three and six months ended June 30, 2008 and 2007

(In thousands)

(Unaudited)

 
| ** **                                                                                                                                                                                                                                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                          | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                                                                                                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Net income                                                                                                                                                                                                                                                          |       | $                                                   | 874        |                                              | $          | 1,942 |   | $ | 2,916 |   | $ | 3,707 |   |
| Other comprehensive loss:                                                                                                                                                                                                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized loss on available-for-sale investment  securities:                                                                                                                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized holding loss arising during the  period, net of tax benefit of $1.9 million and $750,000 for the three and six  months ended June 30, 2008 and tax benefit of $1.1 million and $1.0  million for the three and six months ended June 30, 2007  |       | (3,341                                              | )          | (2,168                                            | )          | (1,270 | ) | (1,923 | ) |
|                                                                                                                                                                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Less: reclassification adjustment for gains  included in net income net of tax expense of $73 thousand in 2008 and  $5 thousand in 2007                                                                                                                        |       | (141                                                | )          | —                                            |       | (141 | ) | (9 | ) |
|                                                                                                                                                                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
|                                                                                                                                                                                                                                                                |       | (3,482                                              | )          | (2,168                                            | )          | (1,411 | ) | (1,932 | ) |
|                                                                                                                                                                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized gain (loss) on derivative  instruments designated as cash flow hedges, net of tax benefit of $29 and  $114 for the three and six months ended June 30, 2008 and tax expense of  $133 and $112 for the three and six months ended June 30, 2007 |       | 32                                                  |       | (240                                              | )          | (208 | ) | (202 | ) |
|                                                                                                                                                                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Comprehensive income (loss)                                                                                                                                                                                                                                         |       | $                                                   | (2,576     | )                                                 | $          | (466 | ) | $ | 1,297 |   | $ | 1,573 |   |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY

Six months ended June 30, 2008 and 2007

(In thousands)

(Unaudited)

 
| ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                                  | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                  | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Loss**          | ** ** | **Total**  | ** ** |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance, December 31, 2006                                                             |       | 24,459     |       | $          | 24,459     |           | $          | 132,985      |       | $                 | 705        |       | $          | (2,276 | ) | $ | 155,873 |   |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock options exercised                                                                     |       | 15         |       | 15         |       | 53             |       | —       |       | —            |       | 68         |       |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Payment of deferred compensation shares                                                     |       | —     |       | —     |       | 4              |       | —       |       | —            |       | 4          |       |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Purchase and retirement of common stock                                                     |       | (224       | )          | (224       | )          | (1,966         | )          | —       |       | —            |       | (2,190     | )          |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Dividends on common stock of $0.02 per  share                                               |       | —     |       | —     |       | —         |       | (490         | )          | —            |       | (490       | )          |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Change in accumulated other comprehensive  loss                                             |       | —     |       | —     |       | —         |       | —       |       | (2,134            | )          | (2,134     | )          |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Net income                                                                                  |       | —     |       | —     |       | —         |       | 3,707        |       | —            |       | 3,707      |       |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Balance, June 30, 2007                                                                 |       | 24,250     |       | $          | 24,250     |           | $          | 131,076      |       | $                 | 3,922      |       | $          | (4,410 | ) | $ | 154,838 |   |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |   |   |   |   |   |
| Balance, December 31, 2007                                                             |       | 24,202     |       | $          | 24,202     |           | $          | 131,516      |       | $                 | 4,213      |       | $          | (468 | ) | $ | 159,463 |   |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Stock compensation expense, net of tax  benefits                                            |       | —     |       | —     |       | 197            |       | —       |       | —            |       | 197        |       |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| Cumulative effect adjustment at  January 1, 2008 for the adoption of SFAS No. 157 |       | —     |       | —     |       | —         |       | (96          | )          | —            |       | (96        | )          |
|                                                                                        |       |       |       |       |       |           |       |         |       |              |       |       |       |
| 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 |   |

 

See accompanying notes to consolidated financial statements.

 

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCASH FLOWS

 

Six months ended June 30, 2008 and 2007

 

(In thousands)

 

(Unaudited)

 
| ** **                                                                                   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                        |       |       |       |       |       |
| Net income                                                                                   |       | $          | 2,916      |       | $          | 3,707 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |       |       |       |       |
| Depreciation                                                                                 |       | 1,239      |       | 1,597      |       |
| Amortization of premiums, discounts and  intangibles                                         |       | 203        |       | 327        |       |
| Provision for loan losses                                                                    |       | 1,089      |       | 755        |       |
| Loans held for sale originated                                                               |       | (687,458   | )          | (1,316,041 | )          |
| Proceeds from the sale of loans held for  sale                                               |       | 705,761    |       | 1,306,910  |       |
| Gain on sales of loans held for sale                                                         |       | (3,893     | )          | (5,065     | )          |
| Proceeds from sale, maturity and call of  investment securities trading                      |       | 7,848      |       | 3,988      |       |
| Purchase of investment securities trading                                                    |       | (7,856     | )          | (3,999     | )          |
| Loss on sale of investments securities  trading                                              |       | 8          |       | 11         |       |
| Gain on sale of investment securities  available-for-sale                                    |       | (214       | )          | (14        | )          |
| Increase in cash surrender value of  bank-owned life insurance                               |       | (575       | )          | (857       | )          |
| Stock compensation expense, net of tax  benefits                                             |       | 197        |       | —     |       |
| Increase in accrued interest receivable,  other assets and deferred tax asset                |       | (1,662     | )          | (4,891     | )          |
| Increase in accrued interest payable,  escrow liabilities and other liabilities              |       | 1,734      |       | 2,320      |       |
|                                                                                         |       |       |       |       |       |
| Net cash provided by (used in) operating  activities                                         |       | 19,337     |       | (11,252    | )          |
|                                                                                         |       |       |       |       |       |
| Cash flows from investing activities:                                                        |       |       |       |       |       |
| Purchases of premises and equipment                                                          |       | (194       | )          | (1,175     | )          |
| Proceeds from sale, maturity and call of  investment securities available-for-sale           |       | 89,070     |       | 31,946     |       |
| Proceeds from maturity and call of  investment securities held-to-maturity                   |       | 16,492     |       | 2,000      |       |
| Proceeds from sale of other investments                                                      |       | 911        |       | 2,000      |       |
| Purchase of investment securities  available-for-sale                                        |       | (110,216   | )          | (63,142    | )          |
| Purchase of mortgage-backed securities  available-for-sale                                   |       | (34,758    | )          | (30,940    | )          |
| Purchase of other investments                                                                |       | (3,106     | )          | (4,063     | )          |
| Redemptions of investment securities  available-for-sale                                     |       | 15,563     |       | 11,269     |       |
| Redemptions of investment securities  held-to-maturity                                       |       | 6,820      |       | 7,040      |       |
| Net increase in loans receivable, net of  deferred fees and costs                            |       | (31,410    | )          | (83,234    | )          |
|                                                                                         |       |       |       |       |       |
| Net cash used in investing activities                                                        |       | (50,828    | )          | (128,299   | )          |
|                                                                                         |       |       |       |       |       |
| Cash flows from financing activities:                                                        |       |       |       |       |       |
| Net increase (decrease) in deposits                                                          |       | 16,668     |       | (33,049    | )          |
| Net increase (decrease) in other borrowed  funds - short term                                |       | (23,315    | )          | 132,236    |       |
| Net decrease in mortgage funding checks                                                      |       | (1,491     | )          | (12,271    | )          |
| Proceeds from FHLB advances - long term                                                      |       | 80,000     |       | 65,000     |       |
| Repayments of FHLB advances - long term                                                      |       | (31,250    | )          | (20,250    | )          |
| Gain from early extinguishment of long term  FHLB advance                                    |       | (253       | )          | —     |       |
| Stock options exercised                                                                      |       | 1          |       | 68         |       |
| Purchase and retirement of common stock                                                      |       | (776       | )          | (2,190     | )          |
| Deferred compensation payments                                                               |       | —     |       | 4          |       |
| Dividends on common stock                                                                    |       | (484       | )          | (490       | )          |
|                                                                                         |       |       |       |       |       |
| Net cash provided by financing activities                                                    |       | 39,100     |       | 129,058    |       |
|                                                                                         |       |       |       |       |       |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 7,609      |       | (10,493    | )          |
|                                                                                         |       |       |       |       |       |
| Cash and cash equivalents at beginning of  the period                                        |       | 22,421     |       | 36,076     |       |
|                                                                                         |       |       |       |       |       |
| Cash and cash equivalents at end of the  period                                              |       | $          | 30,030     |       | $          | 25,583 |   |
|                                                                                         |       |       |       |       |       |
| **Supplemental disclosure of cash flow  information:**                                       |       |       |       |       |       |
| Cash paid during the period for interest                                                     |       | $          | 23,952     |       | $          | 28,626 |   |
| Cash paid for income taxes                                                                   |       | 3,336      |       | 3,725      |       |
|                                                                                         |       |       |       |       |       |
| **Supplemental schedule of noncash investing  and financing activities:**                    |       |       |       |       |       |
| Unsettled purchases of investment  securities available-for-sale                             |       | $          | —     |       | $          | 6,968 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)

 

Note 1

 

*Organization*

 

CardinalFinancial Corporation (the “Company”) is incorporated under the laws ofthe Commonwealth of Virginia as a financial holding company whose activitiesconsist of investment in its wholly-owned subsidiaries. The principal operatingsubsidiary of the Company is Cardinal Bank (the “Bank”), a state-charteredinstitution and its subsidiary, George Mason Mortgage, LLC (“George Mason”), amortgage banking company based in Fairfax, Virginia. The Company also ownsWilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), an assetmanagement firm and Cardinal Wealth Services, Inc. (“CWS”), an investmentservices subsidiary.  The Bank also has atrust division, Cardinal Trust and Investment Services.

 

*Basis of Presentation*

 

Inthe opinion of management, the accompanying consolidated financial statementshave been prepared in accordance with the requirements of Regulation S-X, Article 10.Accordingly, they do not include all of the information and footnotes requiredby U.S. generally accepted accounting principles for complete financialstatements. However, all adjustments that are, in the opinion of management,necessary for a fair presentation have been included. The results of operationsfor the three and six months ended June 30, 2008 are not necessarilyindicative of the results to be expected for the full year ending December 31,2008. 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, 2007.

 

**Note 2**

 

***Stock-Based Compensation***

** **

AtJune 30, 2008, 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. There were 671 shares of the Company’s common stock available forfuture grants in the Option Plan as of June 30, 2008.

 

In2002, the Company adopted the Equity Plan. The Equity Plan authorizes thegranting and award of incentive stock options, non-qualified stock options,stock appreciation rights, restricted stock awards, phantom stock awards andperformance share awards to directors, eligible officers and key employees ofthe Company.  The Equity Plan currentlyauthorizes grants and awards with respect to 2,420,000 shares of the Company’scommon stock.  There are 223,908 sharesof the Company’s common stock available for future grants and awards in theEquity Plan as of June 30, 2008.

 

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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 have ten year terms and vest and becomefully exercisable in 20% increments beginning 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. During 2005, certainstock options granted to employees had ten year terms and vested and becamefully exercisable immediately.

 

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, 2008 and 2007 was $122,000 and $79,000,respectively. Total stock compensation expense for the six months ended June 30,2008 and 2007 was $197,000 and $179,000, respectively.  The total income tax benefit recognized inthe income statement for share-based compensation arrangements was $41,000 and$28,000 for the three months ended June 30, 2008 and 2007,respectively.  For the six months ended June 30,2008 and 2007, the total income tax benefit recognized in the income statementfor share-based compensation was $67,000 and $63,000, respectively.

 

Optionsgranted for each of the three and six months ended June 30, 2008 were16,200. Options granted during the three and six months ended June 30,2007 were none and 500, respectively. The weighted average per share fair value of stock option grants duringthe three months ended June 30, 2008 was $3.08.  The weighted average per share fair value ofstock option grants made for the six months ended June 30, 2007 was $4.89.  The fair values of the options granted duringall periods for 2008 and 2007 were estimated as of the grant date using theBlack-Scholes option-pricing model based on the following weighted averageassumptions:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **              | ** ** | **2008**                         | ** ** | **2008**                       | ** ** | **2007** | ** ** |
|                    |       |                             |       |                           |       |   |   |
| Estimated option life   |       | 6.5 years                        |       | 6.5 years                      |       | 6.5 years |   |
| Risk free interest rate |       | 3.44                             | %          | 3.44                           | %          | 4.81 | % |
| Expected volatility     |       | 40.50                            | %          | 40.50                          | %          | 42.10 | % |
| Expected dividend yield |       | 0.56                             | %          | 0.56                           | %          | 0.40 | % |

 

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

 

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Stockoption activity during the six months ended June 30, 2008 is summarized asfollows:

** **
| ** **                                | ** ** | ** **         | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|-------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                | ** ** | ** **         | ** ** | **Weighted** | ** ** | **Average**           | ** ** | **Aggregate** | ** ** |
| ** **                                | ** ** | ** **         | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Intrinsic** | ** ** |
| ** **                                | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Value**     | ** ** |
| ** **                                | ** ** | **Shares**         | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **($000)**    | ** ** |
| Outstanding at December 31, 2007     |       | 2,428,353          |       | $            | 8.53       |                  |       |          |       |   |
| Granted                                   |       | 16,200             |       | 7.08         |       |                  |       |          |       |
| Exercised                                 |       | (200               | )          | 5.44         |       |                  |       |          |       |
| Forfeited                                 |       | (7,350             | )          | 10.24        |       |                  |       |          |       |
| Outstanding at June 30, 2008         |       | 2,437,003          |       | $            | 8.72       |                  | 6.26       |          | $          | (5,987 | ) |
| Options exercisable at June 30, 2008 |       | 2,204,503          |       | $            | 8.44       |                  | 6.06       |          | $          | (4,802 | ) |

 

Total intrinsic value of options exercised for each of the three andsix months ended June 30, 2008 were less than $1,000.  For the options exercised during the threeand six months ended June 30, 2007, the intrinsic values were $26,000 and$75,000, respectively.

 

A summary of the status of the Company’s non-vested stock options andchanges during the six months ended June 30, 2008 is as follows:

 
| ** **                        | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|-----------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                        | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Grant Date** | ** ** |
| ** **                        | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
| Balance at December 31, 2007 |       | 292,028            |       | $                   | 5.30       |   |
| Granted                           |       | 16,200             |       | 3.08                |       |
| Vested                            |       | (75,628            | )          | 4.56                |       |
| Forfeited                         |       | (100               | )          | 3.05                |       |
| Balance at June 30, 2008     |       | 232,500            |       | $                   | 5.39       |   |

 

AtJune 30, 2008, there was $1.6 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 3.0 years. The total fair value of shares that vested during the threemonths ended June 30, 2008 and 2007 was $110,000 and $165,000,respectively. For the six months ended June 30, 2008 and 2007, the totalfair value of shares that vested was $278,000 and $525,000, respectively.

 

Note 3

 

*SegmentInformation*

#  

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

 

Thecommercial banking segment includes both commercial and consumer lending andprovides customers with such products as commercial loans, real estate loans,business financing and consumer loans. In addition, this segment providescustomers with several choices of deposit products including demand depositaccounts, savings accounts and certificates of deposit. The mortgage bankingsegment engages primarily in the origination and acquisition of residential 

 

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mortgagesfor sale into the secondary market on a best efforts basis. The wealthmanagement and trust services segment provides investment and financialadvisory services to businesses and individuals, including financial planning,retirement/estate planning, trust, estates, custody, investment management,escrows, and retirement plans.

 

Informationabout the reportable segments and reconciliation of this information to theconsolidated financial statements at and for the three and six months ended June 30,2008 and 2007 is as follows:

 

**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 Three Months Ended June 30, 2007 (inthousands):**

 
| ** **                 | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------|------------|----------------|------------|--------------|------------|----------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                    | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                 | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest income        |       | $9,720         |       | $801         |       | $—                    |       | $(289      | )          | $—          |       | $10,232          |       |
| Provision for loan losses  |       | 475            |       | —       |       | —                     |       | —     |       | —           |       | 475              |       |
| Non-interest income        |       | 1,027          |       | 3,159        |       | 1,111                      |       | 12         |       | —           |       | 5,309            |       |
| Non-interest expense       |       | 7,671          |       | 3,155        |       | 863                        |       | 619        |       | —           |       | 12,308           |       |
| Provision for income taxes |       | 851            |       | 288          |       | (14                        | )          | (309       | )          | —           |       | 816              |       |
| Net income (loss)          |       | $1,750         |       | $517         |       | $262                       |       | $(587      | )          | $—          |       | $1,942           |       |
|                       |       |           |       |         |       |                       |       |       |       |             |       |             |       |
| Total Assets               |       | $1,720,894     |       | $372,418     |       | $4,516                     |       | $173,312   |       | $(493,252        | )          | $1,777,888       |       |
| Average Assets             |       | $1,636,066     |       | $303,576     |       | $4,460                     |       | $172,103   |       | $(469,383        | )          | $1,646,822       |       |

 

**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       |       |

 

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** **

**At and for the Six Months Ended June 30, 2007 (inthousands):**

 
| ** **                 | ** ** | ** **     | ** ** | ** **   | ** ** | **Wealth Management** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------|------------|----------------|------------|--------------|------------|----------------------------|------------|------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **Commercial** | ** ** | **Mortgage** | ** ** | **and**                    | ** ** | ** ** | ** ** | **Intersegment** | ** ** | ** **       | ** ** |
| ** **                 | ** ** | **Banking**    | ** ** | **Banking**  | ** ** | **Trust Services**    | ** ** | **Other**  | ** ** | **Elimination**  | ** ** | **Consolidated** | ** ** |
| Net interest income        |       | $19,086        |       | $1,552       |       | $—                    |       | $(570      | )          | $—          |       | $20,068          |       |
| Provision for loan losses  |       | 755            |       | —       |       | —                     |       | —     |       | —           |       | 755              |       |
| Non-interest income        |       | 2,025          |       | 6,435        |       | 2,135                      |       | 24         |       | —           |       | 10,619           |       |
| Non-interest expense       |       | 15,160         |       | 6,347        |       | 1,904                      |       | 1,261      |       | —           |       | 24,672           |       |
| Provision for income taxes |       | 1,650          |       | 587          |       | (61                        | )          | (623       | )          | —           |       | 1,553            |       |
| Net income (loss)          |       | $3,546         |       | $1,053       |       | $292                       |       | $(1,184    | )          | $—          |       | $3,707           |       |
|                       |       |           |       |         |       |                       |       |       |       |             |       |             |       |
| Total Assets               |       | $1,720,894     |       | $372,418     |       | $4,516                     |       | $173,312   |       | $(493,252        | )          | $1,777,888       |       |
| Average Assets             |       | $1,617,736     |       | $278,475     |       | $4,900                     |       | $167,955   |       | $(438,667        | )          | $1,630,399       |       |

 

AtJune 30, 2008, the Company did not have any operating segments other thanthose reported. Parent company financial information is included in the “Other”category and represents an overhead function rather than an operating segment.The parent company’s most significant assets are its net investments in itssubsidiaries. The parent company’s net interest expense is comprised ofinterest income from short-term investments and interest expense on trust preferredsecurities. The parent company’s non-interest expense is primarilynon-allocable executive salaries and professional services related to theCompany’s regulatory requirements.

 

Note 4

 

*EarningsPer Share*

 

Thefollowing is the calculation of basic and diluted earnings per share for thethree and six months ended June 30, 2008 and 2007. Stock options issuedthat were not included in the calculation of diluted earnings per share becausethe exercise prices were greater than the average market price were 242,715 and54,905 for the three months ended June 30, 2008 and 2007, respectively.For the six months ended June 30, 2008 and 2007, stock options issued thatwere excluded from the diluted earnings per share calculation because theexercise prices were greater than the average market price were 232,881 and41,867, respectively.

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands,**                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **except per share data)**    | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                   | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  available to common shareholders |       | $                                | 874        |                           | $          | 1,942 |   | $ | 2,916 |   | $ | 3,707 |   |
| ** **                                   |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares - basic       |       | 24,371                           |       | 24,448                         |       | 24,426 |   | 24,479 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares - diluted     |       | 24,858                           |       | 24,976                         |       | 24,868 |   | 25,001 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Earnings per common share - basic            |       | $                                | 0.04       |                           | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Earnings per common share - diluted          |       | $                                | 0.04       |                           | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |

 

Basicearnings per share is impacted by the number of shares required to be issuedunder the Company’s various deferred compensation plans, and diluted earningsper share is impacted by those common shares which may be, but are not requiredto be, issued (depending on the elections of the participants) under theseplans.

 

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Thefollowing shows the composition of basic outstanding shares for the three andsix months ended June 30, 2008 and 2007:

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(in thousands)**                                                  | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares outstanding                               |       | 24,144                           |       | 24,393                         |       | 24,166 |   | 24,428 |   |
| Weighted average shares attributable to the  deferred compensation plans |       | 227                              |       | 55                             |       | 260 |   | 51 |   |
| Total weighted average shares - basic                                    |       | 24,371                           |       | 24,448                         |       | 24,426 |   | 24,479 |   |

 

Thefollowing shows the composition of diluted outstanding shares for the three andsix months ended June 30, 2008 and 2007:

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(in thousands)**                                                          | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                             |       |                             |       |                           |       |   |   |   |   |
| Weighted average shares outstanding - basic  (from above)                        |       | 24,371                           |       | 24,448                         |       | 24,426 |   | 24,479 |   |
| Incremental weighted average shares  attributable to deferred compensation plans |       | 330                              |       | 264                            |       | 283 |   | 253 |   |
| Weighted average shares attributable to  vested stock options                    |       | 157                              |       | 264                            |       | 159 |   | 269 |   |
| Incremental shares attributable to unvested  stock options                       |       | —                           |       | —                         |       | — |   | — |   |
| Total weighted average shares - diluted                                          |       | 24,858                           |       | 24,976                         |       | 24,868 |   | 25,001 |   |

 

#### **Note 5**

#### *** ***

##### ***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 loansthat are held for sale.

 

TheCompany designates these derivatives as cash flow hedges in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 133, *Accounting for Derivative Instruments and Hedging Activities*,as amended. These hedges are recorded at fair value in the statement ofcondition as an other asset or other liability with a corresponding offset toaccumulated other comprehensive income in shareholders’ equity. Amounts arereclassified from accumulated other comprehensive income to the incomestatement in the period or periods that the loan sale is reflected in income.

 

AtJune 30, 2008, accumulated other comprehensive income included anafter-tax unrealized gain of $519,000 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, 2008 that is related to the Company’scash flow hedges will be recognized in earnings during the third quarter of2008. For the three and six months ended June 30, 2008, the hedgeineffectiveness recorded through earnings was immaterial.

 

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AtJune 30, 2008, the Company had $67.3 million in loan commitments andassociated forward sales and had $115.1 million in forward sales associatedwith $115.1 million of loans held for sale contracts. Loans held for sale thatare classified as construction-to-permanent total $43.2 million at June 30,2008 and are not sold forward until the construction phase has beencompleted.  At June 30, 2008, thederivative asset was $3.2 million and the derivative liability was $3.5million.

 

#### **Note 6**

#### ** **

*Goodwill and Other Intangibles*

 

Informationconcerning total amortizable other intangible assets at June 30, 2008 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, 2007 |       | $                           | 1,781      |                             | $          | 643                         |       | $ | 795 |   | $ | 489 |   | $ | 2,576 |   | $ | 1,132 |   |
| 2008 activity:                    |       |                        |       |                             |       |                        |       |   |   |   |   |   |   |
| Customer relationship intangibles |       | —                      |       | 99                               |       | —                      |       | 20 |   | — |   | 119 |   |
| Trade name                        |       | —                      |       | —                           |       | —                      |       | 8 |   | — |   | 8 |   |
| Balance at June 30, 2008     |       | $                           | 1,781      |                             | $          | 742                         |       | $ | 795 |   | $ | 517 |   | $ | 2,576 |   | $ | 1,259 |   |

 

Theaggregate amortization expense was $63,000 for each of the three months ended June 30,2008 and 2007.    For each of the sixmonths ended June 30, 2008 and 2007, the aggregate amortization expensewas $127,000.

 

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

 
| ** **                       | ** ** | **(In thousands)** | ** ** |
|----------------------------------|------------|-------------------------|------------|
| 2008 (July – December) |       | $                       | 119        |   |
| 2009                             |       | 238                     |       |
| 2010                             |       | 238                     |       |
| 2011                             |       | 238                     |       |
| 2012                             |       | 238                     |       |
| 2013 and thereafter              |       | 246                     |       |
|                                  |            |                         |            |  |

 

Thecarrying amount of goodwill at June 30, 2008 was as follows:

 
| **(In thousands)**           | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Wealth  Management  and Trust  Services** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------------------------------|------------|-----------|------------|
| Balance at December 31, 2007 |       | $                       | 22         |                  | $          | 12,941                                           |       | $         | 2,832      |   | $ | 15,795 |   |
| 2008 activity                     |       | —                  |       | —                |       | —                                           |       | —    |       |
| Balance at June 30, 2008     |       | $                       | 22         |                  | $          | 12,941                                           |       | $         | 2,832      |   | $ | 15,795 |   |

 

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 ending June 30, 2008, the Company performed an evaluation of thegoodwill associated with its acquisition of Wilson/Bennett, part of the wealthmanagement and trust services segment, and no impairment was indicated.

 

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Note 7

 

*Commitments and 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.  Commitmentsgenerally have fixed expiration dates up to one year or other terminationclauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawnupon, the total commitment amounts do not necessarily represent future fundingrequirements.

 

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 theseguarantees extend until satisfactory completion of the customer’s contractualobligations. These instruments represent obligations of the Company to extendcredit or guarantee borrowings and are not recorded on the consolidatedstatements of financial condition.  Therates and terms of these instruments are competitive with others in the marketin which the Company operates.  TheCompany uses the same credit policies in making commitments and conditionalobligations as it does for on-balance-sheet instruments.  The Company evaluates each customer’screditworthiness on a case-by-case basis and requires collateral to supportfinancial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based onmanagement’s evaluation of the counterparty. Collateral held varies but may include deposits held by the Company,marketable securities, accounts receivable, inventory, property, plant andequipment, and income-producing commercial properties.

 

AtJune 30, 2008, commitments to extend credit were $409.4 million andstandby letters of credit were $7.7 million. The Company has a liability of$9,000 associated with standby letters of credit at June 30, 2008. Themajority of standby letters of credit outstanding at June 30, 2008 arecollateralized.  Commitments to extendcredit of $67.3 million as of June 30, 2008 are related to George Mason’spipeline and are of a short term nature.

 

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

 

GeorgeMason maintains a reserve for loans sold that pay off earlier than thecontractual agreed upon period, thereby requiring that George Mason refund partof the service release premium and/or premium pricing received from theinvestor.  The reserve as of June 30,2008 was $14,000.

 

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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.  In addition, George Mason,as part of the service it provides to its managed companies, purchases theloans managed companies originate 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 to repurchasethese loans from investors.

 

During the second quarter of 2008, GeorgeMason entered into an agreement with a mortgage correspondent related to theloan purchase agreement between the two parties.  This agreement provided for the release ofknown and unknown claims by the mortgage correspondent in exchange for a $2.8million payment to the correspondent.  Inaddition, while the Company believes there is immaterial exposure under thisagreement, over the course of the next two years there is a potential paymentof no more than $0.03 diluted earnings per share in total on a declining basisover the two year period.  In conjunction with the agreement, GeorgeMason entered into similar agreements with certain managed companies, fromwhich George Mason purchased loans and subsequently sold to this mortgagecorrespondent.  These settlementagreements provided for a total payment of $1.0 million to George Mason bythose managed companies of which $400,000 has already been paid. 

 

GeorgeMason’s reserve for possible loan repurchases was $260,000 at June 30,2008.  George Mason funded a repurchasedloan that was originated by a managed company, for which the managed company ispaying back George Mason.

 

TheCompany has derivative counter-party risk that may arise from the possibleinability of George Mason’s third party investors to meet the terms of theirforward sales contracts.  George Masonworks with third-party investors that are generally well-capitalized, areinvestment grade and exhibit strong financial performance to mitigate thisrisk.  The Company does not expect anythird-party investor to fail to meet its obligation.

 

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Note8

 

*FairValue Measurements*

 

EffectiveJanuary 1, 2008, the Company adopted SFAS No. 157, *Fair Value Measurements,*which established a framework formeasuring fair value in accordance with U.S. generally accepted accountingprinciples, and expands disclosures about fair value measurements.  In addition, the Company adopted SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities – including an amendment of FAS 115. *SFAS No. 159 allows entitiesto choose, at specified election dates, to measure eligible financial assetsand liabilities at fair value that are not otherwise required to be measured atfair value.

 

SFASNo. 157 defines fair value as the exchange price that would be receivedfor an asset or paid to transfer a liability (an exit price) in the principalor most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date.  SFAS No. 157 also establishes a fairvalue hierarchy which requires an entity to maximize the use of observable inputsand minimize the 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.

 

Uponadoption or at any point during the six months ended June 30, 2008, theCompany did not designate any asset or liability to be measured at fair valueunder SFAS No. 159.

 

FairValue of Investment Securities Available-for-Sale and Interest Rate SwapDerivatives

 

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’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.

 

Informationpertaining to the Company’s investment securities available-for-sale portfolioand interest rate swap derivatives as of June 30, 2008 is shown below:

 

**At June 30, 2008 (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   |       | $           | 318,015    |                                                                                           |       |   | $ | 318,015 |   |   |   |
| Derivative asset - interest rate swaps     |       | 720         |       |                                                                                           |       | 720 |   |   |   |
| Derivative liability - interest rate swaps |       | 563         |       |                                                                                           |       | 563 |   |   |   |
|                                            |            |             |            |                                                                                                |            |  |  |  |  |  |  |

 

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FairValue of Interest Rate Lock Commitments, Forward Loan Sales and Mortgage LoansHeld for Sale

 

Inthe normal course of business, George Mason enters into contractual interestrate lock commitments to extend credit to borrowers with fixed expirationdates.  The commitments become effectivewhen the borrowers “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 pursuant to the requirements of SFAS No. 133*,*and, accordingly, are marked to fair value throughearnings.

 

StaffAccounting Bulletin No. 109, *Written Loan CommitmentsRecorded at Fair Value Through Earnings,* (“SAB No. 109”) waseffective for written loan commitments initiated on or after January 1,2008.  SAB No. 109 requires that theexpected cash flows related to the servicing of a loan be included in the fairvalue measurement of a derivative loan commitment.  SAB No. 109 replaces Staff AccountingBulletin No. 105, *Application of AccountingPrinciples to Loan Commitments,*which precluded the consideration ofservicing cash flows in determining the fair value of a written loancommitment.

 

Theeffects of fair value measurements for the interest rate lock commitmentderivatives and forward sales contract derivatives on earnings in the sixmonths ended June 30, 2008 were as follows and were all based on Level 2inputs:

 
| **(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   |       | $                                   | 137,415    |                                           | $          | 628                                   |       | $                           | 233        |                                   | $          | — |   | $ | 861 |   |
| Forward sales contracts |       | 254,200                             |       | —                                         |       | —                                |       | 184                         |       | 184                                    |       |
| Loans held for sale     |       | 116,785                             |       | 1,052                                          |       | (417                                  | )          | —                      |       | 635                                    |       |
|                    |       |                                |       | $                                              | 1,680      |                                  | $          | (184                        | )          | $                                      | 184        |   | $ | 1,680 |   |
|                         |            |                                     |            |                                                |            |                                       |            |                             |            |                                        |            |  |  |  |  |  |

 

Forthe three months ended March 31, 2008 (the period of adoption), theeffects of fair value measurements for the interest rate lock commitmentderivatives and forward sales contract derivatives on earnings were as followsand were all based on Level 2 inputs:

 
| **(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   |       | $                                   | 70,066     |                                           | $          | 376                                   |       | $                           | 172        |                                   | $          | — |   | $ | 548 |   |
| Forward sales contracts |       | 121,422                             |       | —                                         |       | —                                |       | (307                        | )          | (307                                   | )          |
| Loans held for sale     |       | 51,356                              |       | 439                                            |       | 135                                   |       | —                      |       | 574                                    |       |
|                    |       |                                |       | $                                              | 815        |                                  | $          | 307                         |       | $                                      | (307       | ) | $ | 815 |   |
|                         |            |                                     |            |                                                |            |                                       |            |                             |            |                                        |            |  |  |  |  |  |

 

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.

 

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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.

 

Priorto the adoption of SAB No. 109 and SFAS No. 157, the fair valuecalculation for interest rate lock commitments and forward sales contracts onlyconsidered the effects of interest rate changes between the date of the ratelock and either the loan closing date or the balance sheet date.  For the three months ended June 30,2008, the change in fair value of the interest rate lock commitments, loansheld for sale, and forward loan sales contracts based only on changes in marketinterest rates was $491,000.   Interestrate movements have an offsetting impact on the security prices that serve tomeasure the fair value of these instruments.

 

SFASNo. 157 Adoption Adjustment

 

Thetransition provisions of SFAS No. 157 provide for retrospectiveapplication to financial instruments that were measured at fair value atinitial recognition using a transaction pricing in accordance with specificaccounting literature.  The Company’sinterest rate lock commitments were measured at inception at the transactionprice.  SFAS No. 157 provides thatat the date of adoption (January 1, 2008) a difference between thecarrying amounts and the fair values of these instruments should be recognizedas a cumulative effect adjustment to the opening balance of retainedearnings.  The amount of this cumulativeeffect adjustment was $96,000.

 

ManagedCompany Loans

 

George Mason serves as a pass through conduitfor the managed companies to sell loans to investors on the secondarymarket.  Concurrent with entering into arate lock agreement with a borrower, the managed company loan is sold forwardto an investor in the secondary market. After the managed company closes the loan, it is assigned to GeorgeMason.  George Mason then facilitates thetransfer of the loan to the investor. George Mason does not earn any spread or other fees from the loanassignment nor from the transfer to the investor.  All gains in the loan sale are earned by themanaged company.  At June 30, 2008,loans held for sale includes $50.4 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.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

Thefollowing presents management’s discussion and analysis of our consolidatedfinancial condition at June 30, 2008 and December 31, 2007 and theunaudited results of our operations for the three and six months ended June 30,2008 and 2007. 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, 2007.

 

**Caution About Forward-Looking Statements**

 

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

 

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

 

·                  the ability tosuccessfully manage our growth or implement our growth strategies if we areunable to identify attractive markets, locations or opportunities to expand inthe future;

·                  changes ininterest rates and the successful management of interest rate risk;

·                  risks inherentin making loans such as repayment risks and fluctuating collateral values;

·                  maintaining costcontrols and asset quality as we open or acquire new branches;

·                  maintainingcapital levels adequate to support our growth;

·                  reliance on ourmanagement team, including our ability to attract and retain key personnel;

·                  competition withother banks and financial institutions, and companies outside of the bankingindustry, including those companies that have substantially greater access tocapital and other resources;

·                  changes ingeneral economic and business conditions in our market area including the localand national economy;

·                  risks and uncertainties related to futuretrust operations;

·                  changesin the operations of Wilson/Bennett Capital Management, Inc., its customerbase and assets under management and any associated impact on the fair value ofgoodwill in the future;

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

·                  problems withtechnology utilized by us;

·                  changing trendsin customer profiles and behavior; and

·                  changes inbanking and other laws and regulations applicable to us.

 

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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.

 

In addition,this section should be read in conjunction with the description of our “RiskFactors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31,2007.

 

**Overview**

 

Weare a locally managed financial holding company headquartered in Tysons Corner,Virginia, committed to providing superior customer service, a diversified mixof financial products and services, and convenient banking to our retail andbusiness customers. We own Cardinal Bank (the “Bank”), a Virginiastate-chartered community bank, Cardinal Wealth Services, Inc. (“CWS”), aninvestment services subsidiary, and Wilson/Bennett Capital Management, Inc.(“Wilson/Bennett”), an asset management firm. Through these three subsidiariesand George Mason Mortgage, LLC (“George Mason”), a mortgage banking subsidiaryof the Bank, we offer a wide range of traditional banking products and servicesto both our commercial and retail customers. Our commercial relationshipmanagers focus on attracting small and medium-sized businesses as well as governmentcontractors, commercial real estate developers and builders and professionals,such as physicians, accountants and attorneys. We have 25 branch officelocations and six mortgage banking office locations and provide competitiveproducts and services. We complement our core banking operations by offering afull range of investment products and services to our customers through ourthird-party brokerage relationship with Raymond James Financial Services, Inc.,asset management services through Wilson/Bennett and services through our trustdivision which include trust, estates, custody, investment management, escrows,and retirement plans. The trust division is included, along with CWS andWilson/Bennett, in the wealth management and trust services segment.

 

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

 

**Critical Accounting 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, judgments andestimates when applying these principles where precise measurements are notpossible or practical.  These policiesare critical because they are highly

 

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dependent upon subjective or complex judgments, assumptions andestimates.  Changes in such judgments,assumptions and estimates may have a significant impact on the consolidatedfinancial statements.  Actual results, infact, could differ from initial estimates.

 

The accounting policieswe view as critical are those relating to judgments, assumptions and estimatesregarding the determination of the allowance for loan losses, accounting foreconomic hedging activities, accounting for business combinations andimpairment testing of goodwill, accounting for the impairment of amortizingintangible assets and other long-lived assets, and the valuation of deferredtax assets.

 

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

#### ** **

**We maintain the allowance for loan losses ata level that represents management’s best estimate of known and inherent lossesin our loan portfolio.  Both the amountof the provision expense and the level of the allowance for loan losses areimpacted by many factors, including general and industry-specific economicconditions, actual and expected credit losses, historical trends and specificconditions of individual borrowers. Unusual and infrequently occurring events, such as weather-relateddisasters, may impact our assessment of possible credit losses.  As a part of our analysis, we use comparativepeer group data and qualitative factors such as levels of and trends indelinquencies and nonaccrual loans, national and local economic trends andconditions and concentrations of loans exhibiting similar risk profiles tosupport our estimates.**

** **

Forpurposes of our analysis, we categorize our loans into one of fivecategories:  commercial and industrial, commercial real estate (includingconstruction), home equity lines of credit, residential mortgages, and consumerloans. In the absence of meaningful historical loss factors, peer group lossfactors are applied and are adjusted by the qualitative factors mentionedabove. The indicated loss factors resulting from this analysis are applied foreach of the five categories of loans. In addition, we individually assign lossfactors to all loans that have been identified as having loss attributes, asindicated by deterioration in the financial condition of the borrower or adecline in underlying collateral value if the loan is collateral dependent.Since we have limited historical data on which to base loss factors forclassified loans, we typically apply, in accordance with regulatory guidelines,a 5% loss factor to loans classified as special mention, a 15% loss factor toloans classified as substandard and a 50% loss factor to loans classified asdoubtful. Loans classified as loss loans are fully reserved or chargedoff.   In certain instances, we evaluatethe 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 on a discounted basis.  If thenet collateral value is less than the loan balance (including accrued interestand any unamortized premium or discount associated with the loan) we recognizean impairment and establish 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.

 

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*Accountingfor Economic Hedging Activities*

 

Weaccount for our derivatives and hedging activities in accordance with Statementof Financial Accounting Standards (“SFAS”) No. 133, *Accountingfor Derivative Instruments and Certain Hedging Activities,* asamended, which requires that all derivative instruments be recorded on thestatement of condition at their fair values*.*We do not enter intoderivative transactions for speculative purposes. For derivatives designated ashedges, we contemporaneously document the hedging relationship, including therisk management objective and strategy for undertaking the hedge, howeffectiveness will be assessed at inception and at each reporting period andthe method for measuring ineffectiveness. We evaluate the effectiveness of these transactions at inception and onan ongoing basis.  Ineffectiveness isrecorded through earnings.  Forderivatives designated as cash flow hedges, the fair value adjustment isrecorded as a component of other comprehensive income, except for theineffective portion which is recorded in earnings.  For derivatives designated as fair valuehedges, the fair value adjustments for both the hedged item and the hedginginstrument are recorded through the income statement with any differenceconsidered the ineffective portion of the hedge.

 

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

 

Inthe normal course of business, we enter into contractual commitments, includingrate lock commitments, to finance residential mortgage loans. Thesecommitments, which contain fixed expiration dates, offer the borrower aninterest rate guarantee provided the loan meets underwriting guidelines andcloses within the time frame established by us. Interest rate risk arises onthese commitments and subsequently closed loans if interest rates changebetween the time of the interest rate lock and the delivery of the loan to theinvestor. Loan commitments related to residential mortgage loans intended to besold are considered 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 under SFAS No. 133,as amended. The fair values of loan commitments and the fair values of forwardloan sales contracts generally move in opposite directions, and the net impactof changes of these valuations on net income during the loan commitment periodis generally inconsequential. At the closing of the loan, the loan commitmentderivative expires and we record a loan held for sale and continue to beobligated under the same forward loan sales contract.   The forward sales contract is thendesignated as a hedge against the variability in cash to be received from theloan sale.  Loans held for sale areaccounted for at the lower of cost or market in accordance with SFAS No. 65,*Accounting for Certain Mortgage BankingActivities.*

 

*Accounting for BusinessCombinations and Impairment Testing of Goodwill*

 

Weaccount for acquisitions of other businesses in accordance with SFAS No. 141,*Business Combinations*. Thisstatement mandates the use of purchase accounting and, accordingly, assets andliabilities, including previously unrecorded assets and liabilities, arerecorded at fair values as of the acquisition date. We utilize a variety ofvaluation methods to

 

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estimatefair value of acquired assets and liabilities. To support our purchaseallocations, we have utilized independent consultants to identify and valueidentifiable purchased intangibles. The difference between the fair value of assetsacquired and the liabilities assumed is recorded as goodwill. Goodwill andother intangible assets are accounted for in accordance with SFAS No. 142,*Goodwill and Other Intangible Assets*.In accordance with this statement, goodwill will not be amortized but will betested on at least an annual basis for impairment.

 

Totest goodwill for impairment, we perform an analysis to compare the fair valueof the reporting unit to which the goodwill is assigned to the carrying valueof the reporting unit. We make estimates of the discounted cash flows from theexpected future operations of the reporting unit. If the analysis indicatesthat the fair value of the reporting unit is less than its carrying value, wedo an analysis to compare the implied fair value of the reporting unit’sgoodwill with the carrying amount of that goodwill. The implied fair value ofthe goodwill is determined by allocating the fair value of the reporting unitto all 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*

 

Inaccordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, we continuallyreview our long-lived assets for impairment whenever events or changes incircumstances indicate that the remaining estimated useful life of such assetsmight warrant revision or that the balances may not be recoverable. We evaluatepossible impairment by comparing estimated future cash flows, before interestexpense and on an undiscounted basis, with the net book value of long-termassets, including amortizable intangible assets. If undiscounted cash flows areinsufficient to recover assets, further analysis is performed in order todetermine 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.

 

*Valuationof 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**

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair ValueMeasurements.*  SFAS No. 157defines fair value, establishes a framework for measuring fair value inaccordance with U.S. generally accepted accounting principles, and expandsdisclosures about fair value measurements. The statement clarifies that the exchange price is the price in anorderly transaction between market participants to sell an asset or transfer aliability at the measurement date.  Thestatement emphasizes that fair value is a market-based measurement and not an 

 

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entity-specificmeasurement.  It also establishes a fairvalue hierarchy used in fair value measurements and expands the requireddisclosures of assets and liabilities measured at fair value.  This standard is effective for fiscal yearsbeginning after December 15, 2007. See Note 8 to the notes to the consolidated financial statements above.

 

InFebruary 2007, the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities – including anamendment of FAS 115.*  SFAS No. 159allows entities to choose, at specified election dates, to measure eligiblefinancial assets and liabilities at fair value that are not otherwise requiredto be measured at fair value.  If acompany elects the fair value option for an eligible item, changes in that item’sfair value in subsequent reporting periods must be recognized in currentearnings.  SFAS No. 159 also establishespresentation and disclosure requirements designed to draw comparison betweenentities that elect different measurement attributes for similar assets andliabilities.  SFAS No. 159 iseffective for fiscal years beginning after November 15, 2007.  We have not designated any instruments to beaccounted for under SFAS No. 159.

 

InNovember 2007, the SEC issued Staff Accounting Bulletin No. 109 (“SABNo. 109”), *Written Loan Commitments Recorded at FairValue Through Earnings*.  SAB No. 109requires fair value measurements of derivatives or other written loancommitments recorded through earnings to include the future cash flows relatedto the loan’s servicing rights.  SAB No. 109also states that internally developed intangible assets should be excluded fromthese measurements.  SAB No. 109,which supersedes SAB No. 105, *Application of AccountingPrinciples to Loan Commitments*, applies to all loan commitments thatare accounted for at fair value through earnings.  Previously, SAB No. 105 applied to only derivativeloan commitments accounted for at fair value through earnings.  SAB No. 109 should be appliedprospectively to derivative loan commitments issued or modified in fiscalquarters beginning after December 15, 2007.  See Note 8 to the notes to the consolidatedfinancial statements above.

 

InDecember 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SABNo. 110”), *Certain Assumptions Used in ValuationMethods. *SAB No. 110extends the use of the “simplified” method, under certain circumstances, indeveloping an estimate of expected term of “plain vanilla” share options inaccordance with SFAS No. 123R, *Share-Based Payment. *Prior to the issuance of SAB No. 110,SAB No. 107 stated that the simplified method was only available forgrants made up to December 31, 2007. We are continuing the use of the simplified method.

 

In March 2008, the FASBissued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities. *SFAS No. 161 amends SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities,*requires companies with derivative instruments to disclose information abouthow and why a company uses derivative instruments, how derivative instrumentsand related hedged items are accounted for under SFAS No. 133, and howderivative instruments and related hedged items affect a company’s financialposition, 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 of this standard is not expected to have a material impact on ourconsolidated financial condition or results of operations.

 

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**Statementsof Income**

* *

*General*

 

Net income for the threemonths ended June 30, 2008 and 2007 was $874,000 and $1.9 million,respectively, a decrease of $1.1 million, or 55%.  The decrease in net income is primarily aresult of a one-time cash settlement with one of George Mason’s mortgagecorrespondents related to the loan purchase agreement between the twoparties.  This one-time settlementagreement provided for the release of known and unknown claims by the mortgagecorrespondent in exchange for a $2.8 million payment to the correspondent.  George Mason also entered into similaragreements with certain third party mortgage companies from which George Masonpurchased mortgage loans and subsequently sold to this mortgagecorrespondent.  These settlementagreements provided for a total payment of $1.0 million to George Mason bythose third party mortgage companies. Excluding the one-time cash settlement, we would have recorded netincome of $2.1 million for the three months ended June 30, 2008, anincrease of $111,000 as compared to the second quarter of 2007. We believe thiscash settlement is a one-time event and we do not expect future similarsettlements. A reconciliation of this non-GAAP financial measure to our GAAPfinancial information is presented in Table 1 below.

 

Net income for the sixmonths ended June 30, 2008 and 2007 was $2.9 million and $3.7 million,respectively, a decrease of $791,000, or 21%. Again, our six months ended June 30, 2008 was impacted by the abovereferenced cash settlement with a mortgage correspondent.  Excluding this settlement, net income for thesix months ended June 30, 2008 was $4.1 million, an increase of $388,000as compared to the six months ended June 30, 2007. A reconciliation ofthis non-GAAP financial measure to our GAAP financial information is presentedin Table 1 below.

 

Netinterest income after the provision for loan losses increased $519,000 to $10.3million for the three months ended June 30, 2008 compared to $9.8 millionfor the three months ended June 30, 2007. The increase in net interest income after provision for loan losses is adirect result of a decrease in our interest expense for the three months ended June 30,2008 of $3.7 million, offset by a decrease in interest income of $2.9 millionand an increase in provision for loan losses of $294,000 all as compared to thesame period of 2007.

 

Forthe six months ended June 30, 2008 and 2007, net interest income afterprovision for loan losses was $20.3 million and $19.3 million, respectively, anincrease of $977,000, or 5%.  Theincrease in net interest income after provision for loan losses is a directresult of a decrease in our interest expense for the six months ended June 30,2008 of $5.0 million, offset by a decrease in interest income of $3.7 millionand an increase in provision for loan losses of $334,000 all as compared to thesame year to date period of 2007.

 

Noninterestincome for the three months ended June 30, 2008 was $4.4 million, adecrease of $934,000, or 18%, compared to $5.3 million for the three monthsended June 30, 2007.  For the sixmonths ended June 30, 2008, noninterest income decreased $1.6 million, or15%, to $9.0 million from $10.6 million for the six months ended June 30,2007.   The decrease in noninterestincome is primarily due to the decrease in realized and unrealized gains onmortgage banking activities of $859,000 and $1.2 million for the three and sixmonths ended June 30, 2008, respectively, as compared to the same threeand six month periods of 2007. Management fee income also decreased to $302,000 and $386,000 for thethree and six months ended June 30, 2008, compared to $348,000 and$670,000 for the three and six month periods of 

 

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2007.  These decreases are a result of thetightening credit conditions within the mortgage industry and the slowdown inthe regional housing market.

 

Noninterest expenseincreased $1.3 million, or 11%, to $13.6 million for the three months ended June 30,2008, compared to $12.3 million for the same period of 2007.  For the six months ended June 30, 2008 and2007, noninterest expense was $25.5 million and $24.7 million, respectively, anincrease of $789,000, or 3%.  Theincrease in noninterest expense for both the three and six months ended June 30,2008 as compared to the same periods of 2007, was a result of the abovereferenced cash settlement with a mortgage correspondent.  Excluding this one-time settlement,noninterest expense for the three and six months ended June 30, 2008 was$11.8 million and $23.7 million, respectively, a decrease of $469,000 and $1.0million for the three and six months ended June 30, 2008, respectively, ascompared to the same periods of 2007.  Areconciliation of this non-GAAP financial measure to our GAAP financialinformation is presented in Table 1 below. The decrease in noninterest expense before the cash settlement isprimarily attributable to a decrease in salary and benefits expense of $556,000for the three months ended June 30, 2008 compared to the same period of2007 due to the decrease in the level of staffing and commissions paid at ourmortgage banking subsidiary.  For the sixmonths ended June 30, 2008, salaries and benefits expense decreased $1.2million when compared to the six months ended June 30, 2007, again due todecreases in staffing levels and commissions paid at our mortgage bankingsubsidiary.

 

Basicand diluted earnings per common share were each $0.04 for the three monthsended June 30, 2008.  Basic anddiluted earnings per common share for the three months ended June 30, 2007were each $0.08.  For the six monthsended June 30, 2008, basic and diluted earnings per share were each $0.12and for the six months ended June 30, 2007, basic and diluted earnings pershare were each $0.15.  Weighted averagefully diluted shares outstanding for the three months ended June 30, 2008and 2007 were 24,858,450 and 24,975,595, respectively.  For the six months ended June 30, 2008and 2007, weighted average fully diluted shares outstanding were 24,867,818 and25,000,523, respectively.

 

Returnon average assets for the three months ended June 30, 2008 and 2007 was0.21% and 0.47%, respectively. Return on average equity for the three monthsended June 30, 2008 and 2007 was 2.14% and 4.91%, respectively. For thesix months ended June 30, 2008 and 2007, return on average assets was0.35% and 0.45%, respectively.  For thesix months ended June 30, 2008 and 2007, return on average equity was3.59% and 4.71%, respectively.

 

Netincome attributable to the commercial banking segment for the three monthsended June 30, 2008 and 2007 was $2.7 million and $1.8 million,respectively.  For the six months ended June 30,2008 and 2007, net income from the commercial banking segment was $4.9 millionand $3.5 million, respectively.  Theincrease in net income for the three and six months ended June 30, 2008compared to the same periods of 2007 in the commercial banking segment isprimarily attributable to increases in net interest income and noninterestincome.

 

The mortgage banking segmentreported a net loss of $1.2 million for the three months ended June 30,2008 compared to net income of $517,000 for the three months ended June 30,2007.  The net loss for the three monthsended June 30, 2008 was primarily attributable to the previously mentionedone-time cash settlement to a mortgage correspondent and decreases innoninterest income due to decreased loan sale volume when comparing theperiods.  For the six months ended June 30,2008, the mortgage banking segment reported a net loss of $695,000 compared tonet income of $1.1 million for the six months ended June 30, 2007.  Excluding the one-time cash settlement, themortgage banking segment would have recorded a net loss of 

 

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$58,000 for the three monthsended June 30, 2008 and net income of $484,000 for the six months ended June 30,2008.  A reconciliation of this non-GAAPfinancial measure to our GAAP financial information is presented in Table 1 below.

 

Thewealth management and trust services segment, which includes CWS,Wilson/Bennett and the trust division of the Bank, recorded net income of$51,000 and $262,000 for the three month periods ended June 30, 2008 and2007, respectively.  For the six monthsended June 30, 2008 and 2007, this business segment reported net income of$68,000 and $292,000, respectively.

 

Table 1.

 

**Reconciliationof GAAP to Non-GAAP Financial Measures**

For the Three andSix Months Ended June 30, 2008 and 2007

(Dollars in thousands,except per share data)

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                               | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| GAAP reported non-interest expense                                       |       | $                                | 13,639     |                           | $          | 12,308 |   | $ | 25,461 |   | $ | 24,672 |   |
| Less nonrecurring expenses, pretax                                       |       |                             |       |                           |       |   |   |   |   |
| Settlement with mortgage correspondent                                   |       | 1,800                            |       | —                         |       | 1,800 |   | — |   |
| Non-interest expense without nonrecurring expenses                       |       | $                                | 11,839     |                           | $          | 12,308 |   | $ | 23,661 |   | $ | 24,672 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| GAAP reported net income                                                 |       | $                                | 874        |                           | $          | 1,942 |   | $ | 2,916 |   | $ | 3,707 |   |
| Less nonrecurring expenses, after tax                                    |       |                             |       |                           |       |   |   |   |   |
| Settlement with mortgage correspondent                                   |       | 1,179                            |       | —                         |       | 1,179 |   | — |   |
| Net income without nonrecurring expenses                                 |       | $                                | 2,053      |                           | $          | 1,942 |   | $ | 4,095 |   | $ | 3,707 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| GAAP reported net income per common share, basic                         |       | $                                | 0.04       |                           | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |
| Less nonrecurring expenses, after tax:                                   |       |                             |       |                           |       |   |   |   |   |
| Settlement with mortgage correspondent                                   |       | 0.04                             |       | —                         |       | 0.04 |   | — |   |
| Earnings per common share without nonrecurring expenses - basic          |       | $                                | 0.08       |                           | $          | 0.08 |   | $ | 0.16 |   | $ | 0.15 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| GAAP reported net income per common share, fully diluted                 |       | $                                | 0.04       |                           | $          | 0.08 |   | $ | 0.12 |   | $ | 0.15 |   |
| Less nonrecurring expenses, after tax:                                   |       |                             |       |                           |       |   |   |   |   |
| Settlement with mortgage correspondent                                   |       | 0.04                             |       | —                         |       | 0.04 |   | — |   |
| Earnings per common share without nonrecurring expenses - fully  diluted |       | $                                | 0.08       |                           | $          | 0.08 |   | $ | 0.16 |   | $ | 0.15 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| **Mortgage Banking Business Segment**                                    |       |                             |       |                           |       |   |   |   |   |
| GAAP reported net income                                                 |       | $                                | (1,237     | )                              | $          | 517 |   | $ | (695 | ) | $ | 1,053 |   |
| Less nonrecurring expenses, after tax                                    |       |                             |       |                           |       |   |   |   |   |
| Settlement with mortgage correspondent                                   |       | 1,179                            |       | —                         |       | 1,179 |   | — |   |
| Net income without nonrecurring expenses                                 |       | $                                | (58        | )                              | $          | 517 |   | $ | 484 |   | $ | 1,053 |   |

 

*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, 2008 and 2007 was $11.0 million and $10.2 million,respectively, a period-to-period increase of $813,000, or 8%. For the sixmonths ended June 30, 2008 and 2007, net interest income was $21.4 millionand $20.1 million, respectively, an increase of $1.3 million, or 7%.  The increase in net interest income isprimarily the result of a greater decrease in our cost of interest-bearingliabilities than our decrease in the yields earned for average earningassets.  We have certain loans andinvestment securities for which a portion of the income realized istax-exempt.  Net interest income on a taxequivalent basis for the three months ended June 30, 2008 and 2007 was$11.2 million and $10.3 million, respectively. For the six months ended June 30, 2008 and 2007, net interestincome on a tax equivalent basis was $21.6 million and $20.3 million,respectively.

 

Ournet interest margin, which equals net interest income divided by averageearning assets, was 2.85% and 2.64% for the three months ended June 30,2008 and 2007, respectively.  For theyear to date June 30, 2008 and 2007, our net interest margin was 2.77% and2.62%, respectively.  The increase in thenet interest margin for the three and six months ended June 30, 2008compared to the same periods of 2007 is a result of a greater decrease in thecost of interest-bearing liabilities than the decrease in yields earned foraverage earning assets.  Tables 2 through5 present an analysis of average earning assets and interest-bearing liabilitieswith related components of interest income and interest expense on a taxequivalent basis.

 

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Table 2.

 

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

Three Months EndedJune 30, 2008, 2007 and 2006

(In thousands)

 
| ** **                                               | ** ** | **2008**    | ** ** | **2007**     | ** ** | **2006**    | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **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                               |       | $           | 126,374    |         | $          | 1,882       |       | 5.96 | % | $ | 108,566 |   | $ | 2,063 |   | 7.60 | % | $ | 83,055 |   | $ | 1,456 |   | 7.01 | % |
| Real estate -  commercial                                |       | 428,435     |       | 7,018        |       | 6.55        |       | 353,679 |   | 5,920 |   | 6.70 |   | 278,813 |   | 4,667 |   | 6.70 |   |
| Real estate -  construction                              |       | 191,377     |       | 2,799        |       | 5.85        |       | 160,565 |   | 3,371 |   | 8.40 |   | 138,175 |   | 2,843 |   | 8.23 |   |
| Real estate -  residential                               |       | 213,725     |       | 2,984        |       | 5.58        |       | 199,420 |   | 2,732 |   | 5.48 |   | 167,753 |   | 2,151 |   | 5.13 |   |
| Home equity lines                                        |       | 90,352      |       | 1,049        |       | 4.66        |       | 64,210 |   | 1,183 |   | 7.39 |   | 77,150 |   | 1,320 |   | 6.86 |   |
| Consumer                                                 |       | 2,675       |       | 39           |       | 5.85        |       | 7,920 |   | 165 |   | 8.28 |   | 4,469 |   | 85 |   | 7.61 |   |
| Total loans                                              |       | 1,052,938   |       | 15,771       |       | 5.99        |       | 894,360 |   | 15,434 |   | 6.90 |   | 749,415 |   | 12,522 |   | 6.68 |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale                                     |       | 141,583     |       | 1,955        |       | 5.52        |       | 302,075 |   | 5,319 |   | 7.04 |   | 285,071 |   | 5,276 |   | 7.40 |   |
| Investment  securities - trading                         |       | —      |       | —       |       | 0.00        |       | — |   | — |   | 0.00 |   | — |   | — |   | 0.00 |   |
| Investment  securities available-for-sale                |       | 269,136     |       | 3,572        |       | 5.31        |       | 257,238 |   | 3,158 |   | 4.91 |   | 232,614 |   | 2,670 |   | 4.59 |   |
| Investment  securities held-to-maturity                  |       | 59,631      |       | 628          |       | 4.21        |       | 92,133 |   | 960 |   | 4.17 |   | 108,814 |   | 1,102 |   | 4.05 |   |
| Other investments                                        |       | 15,066      |       | 215          |       | 5.72        |       | 9,985 |   | 149 |   | 5.99 |   | 6,319 |   | 88 |   | 5.58 |   |
| Federal funds  sold                                      |       | 31,348      |       | 178          |       | 2.29        |       | 9,641 |   | 138 |   | 5.75 |   | 6,360 |   | 85 |   | 5.38 |   |
| Total interest-earning  assets and interest income (2)   |       | 1,569,702   |       | 22,319       |       | 5.69        |       | 1,565,432 |   | 25,158 |   | 6.43 |   | 1,388,593 |   | 21,743 |   | 6.26 |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest  earning assets:                             |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | $           | 6,710      |         |       |        |       |   | $ | 6,883 |   |   |   |   |   | $ | 8,079 |   |   |   |   |   |
| Premises and  equipment, net                             |       | 17,743      |       |         |       |        |       | 19,989 |   |   |   |   |   | 19,971 |   |   |   |   |   |
| Goodwill and  other intangibles, net                     |       | 17,147      |       |         |       |        |       | 17,401 |   |   |   |   |   | 20,647 |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 53,573      |       |         |       |        |       | 47,139 |   |   |   |   |   | 11,882 |   |   |   |   |   |
| Allowance for  loan losses                               |       | (12,005     | )          |         |       |        |       | (10,022 | ) |   |   |   |   | (8,631 | ) |   |   |   |   |
| Total assets                                             |       | $           | 1,652,870  |         |       |        |       |   | $ | 1,646,822 |   |   |   |   |   | $ | 1,440,541 |   |   |   |   |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**           |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing liabilities:                         |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:                            |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 124,892     |       | 661          |       | 2.12        | %          | 125,675 |   | 914 |   | 2.92 | % | 160,171 |   | 1,177 |   | 2.95 | % |
| Money markets                                            |       | 39,825      |       | 242          |       | 2.44        |       | 55,816 |   | 353 |   | 2.54 |   | 125,196 |   | 777 |   | 2.48 |   |
| Statement savings                                        |       | 378,143     |       | 2,632        |       | 2.79        |       | 361,438 |   | 4,247 |   | 4.71 |   | 77,590 |   | 869 |   | 4.49 |   |
| Certificates of  deposit                                 |       | 455,095     |       | 4,324        |       | 3.81        |       | 528,016 |   | 6,226 |   | 4.73 |   | 618,850 |   | 6,313 |   | 4.08 |   |
| Total interest -  bearing deposits                       |       | 997,955     |       | 7,859        |       | 3.16        |       | 1,070,945 |   | 11,740 |   | 4.40 |   | 981,807 |   | 9,136 |   | 3.73 |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed  funds                                    |       | 347,775     |       | 3,273        |       | 3.77        |       | 272,844 |   | 3,076 |   | 4.52 |   | 172,868 |   | 1,853 |   | 4.30 |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities and interest expense |       | 1,345,730   |       | 11,132       |       | 3.32        |       | 1,343,789 |   | 14,816 |   | 4.42 |   | 1,154,675 |   | 10,989 |   | 3.82 |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 124,757     |       |         |       |        |       | 124,122 |   |   |   |   |   | 114,798 |   |   |   |   |   |
| Other liabilities                                        |       | 18,998      |       |         |       |        |       | 20,756 |   |   |   |   |   | 19,949 |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 163,385     |       |         |       |        |       | 158,155 |   |   |   |   |   | 151,119 |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $           | 1,652,870  |         |       |        |       |   | $ | 1,646,822 |   |   |   |   |   | $ | 1,440,541 |   |   |   |   |   |
|                                                     |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |        |       | $            | 11,187     |        | 2.85       | % |   |   | $ | 10,342 |   | 2.64 | % |   |   | $ | 10,754 |   | 3.10 | % |

 

----

(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) Interestincome for loans receivable, investment securities available-for-sale and fedfunds sold (which includes investments in money market preferred stock) isreported on a fully taxable-equivalent basis at a rate of 34%.

 

29

----

Table ofContents

 

Table 3.

 

**Rateand Volume Analysis**

Three Months EndedJune 30, 2008, 2007 and 2006

(In thousands)

 
| ** **                               | ** ** | **2008 Compared to 2007** | ** ** | **2007 Compared to 2006** | ** ** |
|------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **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                |       | $                                        | 338        |                                     | $          | (519 | ) | $ | (181 | ) | $ | 447 |   | $ | 160 |   | $ | 607 |   |
| Real estate - commercial                 |       | 1,251                                    |       | (153                                     | )          | 1,098 |   | 1,253 |   | (0 | ) | 1,253 |   |
| Real estate - construction               |       | 647                                      |       | (1,219                                   | )          | (572 | ) | 461 |   | 67 |   | 528 |   |
| Real estate - residential                |       | 196                                      |       | 56                                       |       | 252 |   | 406 |   | 175 |   | 581 |   |
| Home equity lines                        |       | 480                                      |       | (614                                     | )          | (134 | ) | (222 | ) | 85 |   | (137 | ) |
| Consumer                                 |       | (110                                     | )          | (16                                      | )          | (126 | ) | 67 |   | 13 |   | 80 |   |
| Total loans                              |       | 2,802                                    |       | (2,465                                   | )          | 337 |   | 2,412 |   | 500 |   | 2,912 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans held for sale                      |       | (2,826                                   | )          | (538                                     | )          | (3,364 | ) | 315 |   | (272 | ) | 43 |   |
| Investment securities - trading          |       | —                                   |       | —                                   |       | — |   | — |   | — |   | — |   |
| Investment securities available-for-sale |       | 146                                      |       | 268                                      |       | 414 |   | 283 |   | 205 |   | 488 |   |
| Investment securities held-to-maturity   |       | (339                                     | )          | 7                                        |       | (332 | ) | (169 | ) | 27 |   | (142 | ) |
| Other investments                        |       | 76                                       |       | (10                                      | )          | 66 |   | 51 |   | 10 |   | 61 |   |
| Federal funds sold                       |       | 310                                      |       | (270                                     | )          | 40 |   | 44 |   | 9 |   | 53 |   |
| Total interest income (2)                |       | 169                                      |       | (3,008                                   | )          | (2,839 | ) | 2,936 |   | 479 |   | 3,415 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest checking                        |       | (6                                       | )          | (247                                     | )          | (253 | ) | (253 | ) | (10 | ) | (263 | ) |
| Money markets                            |       | (101                                     | )          | (10                                      | )          | (111 | ) | (432 | ) | 8 |   | (424 | ) |
| Statement savings                        |       | 196                                      |       | (1,811                                   | )          | (1,615 | ) | 3,177 |   | 201 |   | 3,378 |   |
| Certificates of deposit                  |       | (860                                     | )          | (1,042                                   | )          | (1,902 | ) | (941 | ) | 854 |   | (87 | ) |
| Total interest - bearing deposits        |       | (771                                     | )          | (3,110                                   | )          | (3,881 | ) | 1,551 |   | 1,053 |   | 2,604 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |       | 845                                      |       | (648                                     | )          | 197 |   | 1,072 |   | 151 |   | 1,223 |   |
| Total interest expense                   |       | 74                                       |       | (3,758                                   | )          | (3,684 | ) | 2,623 |   | 1,204 |   | 3,827 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                  |       | $                                        | 95         |                                     | $          | 750 |   | $ | 845 |   | $ | 313 |   | $ | (725 | ) | $ | (412 | ) |

 

----

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

(2) Interest income for loans receivable, investment securitiesavailable-for-sale and fed funds sold (which includes investments in money marketpreferred stock) is reported on a fully taxable-equivalent basis at a rate of34%.

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

 

30

----

Table of Contents

 

Table 4.

 

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

Six Months Ended June 30,2008, 2007 and 2006

(In thousands)

 
| ** **                                               | ** ** | **2008**     | ** ** | **2007**    | ** ** | **2006**   | ** ** |
|----------------------------------------------------------|------------|--------------|------------|-------------|------------|------------|------------|
| ** **                                               | ** ** | **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                               |       | $            | 131,455    |        | $          | 4,237      |       | 6.45 | % | $ | 106,001 |   | $ | 4,011 |   | 7.57 | % | $ | 78,104 |   | $ | 2,761 |   | 7.07 | % |
| Real estate -  commercial                                |       | 422,046      |       | 13,857      |       | 6.57       |       | 339,127 |   | 11,260 |   | 6.64 |   | 274,950 |   | 9,059 |   | 6.59 |   |
| Real estate -  construction                              |       | 191,130      |       | 6,021       |       | 6.30       |       | 160,456 |   | 6,754 |   | 8.42 |   | 133,626 |   | 5,382 |   | 8.06 |   |
| Real estate -  residential                               |       | 212,845      |       | 5,986       |       | 5.62       |       | 198,605 |   | 5,408 |   | 5.45 |   | 162,923 |   | 4,155 |   | 5.10 |   |
| Home equity lines                                        |       | 87,761       |       | 2,208       |       | 5.06       |       | 64,019 |   | 2,350 |   | 7.40 |   | 76,802 |   | 2,491 |   | 6.54 |   |
| Consumer                                                 |       | 2,717        |       | 89          |       | 6.59       |       | 6,409 |   | 258 |   | 8.08 |   | 4,732 |   | 179 |   | 7.57 |   |
| Total loans                                              |       | 1,047,954    |       | 32,398      |       | 6.18       |       | 874,617 |   | 30,041 |   | 6.87 |   | 731,137 |   | 24,027 |   | 6.57 |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale                                     |       | 140,459      |       | 4,084       |       | 5.81       |       | 275,665 |   | 9,698 |   | 7.04 |   | 259,458 |   | 9,553 |   | 7.36 |   |
| Investment  securities - trading                         |       | —       |       | —      |       | 0.00       |       | 22 |   | 1 |   | 4.58 |   | — |   | — |   | 0.00 |   |
| Investment securities  available-for-sale                |       | 267,192      |       | 6,978       |       | 5.22       |       | 249,354 |   | 6,053 |   | 4.85 |   | 212,472 |   | 4,742 |   | 4.46 |   |
| Investment  securities held-to-maturity                  |       | 65,065       |       | 1,377       |       | 4.23       |       | 94,134 |   | 1,963 |   | 4.17 |   | 111,041 |   | 2,227 |   | 4.01 |   |
| Other investments                                        |       | 14,840       |       | 433         |       | 5.84       |       | 9,360 |   | 276 |   | 5.91 |   | 6,440 |   | 177 |   | 5.51 |   |
| Federal funds  sold                                      |       | 25,022       |       | 316         |       | 2.54       |       | 44,582 |   | 1,163 |   | 5.26 |   | 32,818 |   | 735 |   | 4.51 |   |
| Total  interest-earning assets and interest income (2)   |       | 1,560,532    |       | 45,586      |       | 5.84       |       | 1,547,734 |   | 49,195 |   | 6.36 |   | 1,353,366 |   | 41,461 |   | 6.13 |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest  earning assets:                             |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | $            | 7,671      |        |       |       |       |   | $ | 8,130 |   |   |   |   |   | $ | 7,681 |   |   |   |   |   |
| Premises and  equipment, net                             |       | 18,011       |       |        |       |       |       | 20,084 |   |   |   |   |   | 19,069 |   |   |   |   |   |
| Goodwill and other  intangibles, net                     |       | 17,180       |       |        |       |       |       | 17,435 |   |   |   |   |   | 20,560 |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 52,827       |       |        |       |       |       | 46,900 |   |   |   |   |   | 11,577 |   |   |   |   |   |
| Allowance for  loan losses                               |       | (11,903      | )          |        |       |       |       | (9,884 | ) |   |   |   |   | (8,529 | ) |   |   |   |   |
| Total assets                                             |       | $            | 1,644,318  |        |       |       |       |   | $ | 1,630,399 |   |   |   |   |   | $ | 1,403,724 |   |   |   |   |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**           |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing liabilities:                         |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:                            |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 124,864      |       | 1,496       |       | 2.41       | %          | 127,453 |   | 1,834 |   | 2.90 | % | 142,824 |   | 1,899 |   | 2.68 | % |
| Money markets                                            |       | 41,076       |       | 534         |       | 2.61       |       | 59,755 |   | 732 |   | 2.47 |   | 155,368 |   | 1,963 |   | 2.53 |   |
| Statement savings                                        |       | 376,582      |       | 5,933       |       | 3.17       |       | 356,308 |   | 8,415 |   | 4.76 |   | 43,721 |   | 901 |   | 4.16 |   |
| Certificates of  deposit                                 |       | 452,793      |       | 9,244       |       | 4.11       |       | 548,347 |   | 12,828 |   | 4.72 |   | 619,482 |   | 12,164 |   | 3.93 |   |
| Total interest -  bearing deposits                       |       | 995,315      |       | 17,207      |       | 3.48       |       | 1,091,863 |   | 23,809 |   | 4.40 |   | 961,395 |   | 16,927 |   | 3.55 |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed  funds                                    |       | 343,719      |       | 6,745       |       | 3.95       |       | 236,486 |   | 5,116 |   | 4.36 |   | 159,062 |   | 3,377 |   | 4.28 |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities and interest expense |       | 1,339,034    |       | 23,952      |       | 3.60       |       | 1,328,349 |   | 28,925 |   | 4.39 |   | 1,120,457 |   | 20,304 |   | 3.65 |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 123,583      |       |        |       |       |       | 123,846 |   |   |   |   |   | 112,572 |   |   |   |   |   |
| Other liabilities                                        |       | 19,327       |       |        |       |       |       | 20,628 |   |   |   |   |   | 20,393 |   |   |   |   |   |
| Common  shareholders’ equity                        |       | 162,374      |       |        |       |       |       | 157,576 |   |   |   |   |   | 150,302 |   |   |   |   |   |
| Total liabilities  and shareholders’ equity         |       | $            | 1,644,318  |        |       |       |       |   | $ | 1,630,399 |   |   |   |   |   | $ | 1,403,724 |   |   |   |   |   |
|                                                     |       |         |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |         |       | $           | 21,634     |       | 2.77       | % |   |   | $ | 20,270 |   | 2.62 | % |   |   | $ | 21,157 |   | 3.13 | % |

 

----

(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) Interestincome for loans receivable, investment securities available-for-sale and fedfunds sold (which includes investments in money market preferred stock) isreported on a fully taxable-equivalent basis at a rate of 34%.

 

31

----

Table ofContents

 

Table 5.

 

**Rateand Volume Analysis**

Six Months Ended June 30,2008, 2007 and 2006

(In thousands)

 
| ** **                               | ** ** | **2008 Compared to 2007** | ** ** | **2007 Compared to 2006** | ** ** |
|------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **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                |       | $                                        | 963        |                                     | $          | (737 | ) | $ | 226 |   | $ | 986 |   | $ | 264 |   | $ | 1,250 |   |
| Real estate - commercial                 |       | 2,753                                    |       | (156                                     | )          | 2,597 |   | 2,115 |   | 86 |   | 2,201 |   |
| Real estate - construction               |       | 1,291                                    |       | (2,024                                   | )          | (733 | ) | 1,084 |   | 288 |   | 1,372 |   |
| Real estate - residential                |       | 388                                      |       | 190                                      |       | 578 |   | 909 |   | 344 |   | 1,253 |   |
| Home equity lines                        |       | 879                                      |       | (1,021                                   | )          | (142 | ) | (418 | ) | 277 |   | (141 | ) |
| Consumer                                 |       | (149                                     | )          | (20                                      | )          | (169 | ) | 63 |   | 16 |   | 79 |   |
| Total loans                              |       | 6,125                                    |       | (3,768                                   | )          | 2,357 |   | 4,739 |   | 1,275 |   | 6,014 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans held for sale                      |       | (4,750                                   | )          | (864                                     | )          | (5,614 | ) | 591 |   | (446 | ) | 145 |   |
| Investment securities - trading          |       | (1                                       | )          | —                                   |       | (1 | ) | 1 |   | (0 | ) | 1 |   |
| Investment securities available-for-sale |       | 433                                      |       | 492                                      |       | 925 |   | 819 |   | 492 |   | 1,311 |   |
| Investment securities held-to-maturity   |       | (606                                     | )          | 20                                       |       | (586 | ) | (340 | ) | 76 |   | (264 | ) |
| Other investments                        |       | 162                                      |       | (5                                       | )          | 157 |   | 80 |   | 19 |   | 99 |   |
| Federal funds sold                       |       | (508                                     | )          | (339                                     | )          | (847 | ) | 262 |   | 166 |   | 428 |   |
| Total interest income (2)                |       | 855                                      |       | (4,464                                   | )          | (3,609 | ) | 6,152 |   | 1,582 |   | 7,734 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest checking                        |       | (32                                      | )          | (306                                     | )          | (338 | ) | (205 | ) | 140 |   | (65 | ) |
| Money markets                            |       | (227                                     | )          | 29                                       |       | (198 | ) | (1,213 | ) | (18 | ) | (1,231 | ) |
| Statement savings                        |       | 504                                      |       | (2,986                                   | )          | (2,482 | ) | 6,449 |   | 1,065 |   | 7,514 |   |
| Certificates of deposit                  |       | (2,206                                   | )          | (1,378                                   | )          | (3,584 | ) | (1,478 | ) | 2,142 |   | 664 |   |
| Total interest - bearing deposits        |       | (1,961                                   | )          | (4,641                                   | )          | (6,602 | ) | 3,553 |   | 3,329 |   | 6,882 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |       | 2,340                                    |       | (711                                     | )          | 1,629 |   | 1,642 |   | 97 |   | 1,739 |   |
| Total interest expense                   |       | 379                                      |       | (5,352                                   | )          | (4,973 | ) | 5,195 |   | 3,426 |   | 8,621 |   |
|                                     |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                  |       | $                                        | 476        |                                     | $          | 888 |   | $ | 1,364 |   | $ | 957 |   | $ | (1,844 | ) | $ | (887 | ) |

 

----

(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) Changesattributable to rate/volume have been allocated to volume.

 

*Provisionfor Loan Losses*

 

Theprovision for loan losses for the three months ended June 30, 2008 and2007 was $769,000 and $475,000, respectively. For the six months ended June 30,2008 and 2007, the provision for loan losses was $1.1 million and $755,000,respectively.  The increase in provisionexpense for the three and six months ended June 30, 2008 compared to thesame periods of 2007 is primarily the result of our charging-off home equityloans totaling $347,000 and one commercial loan totaling $16,000, and net newloan growth in addition to our evaluation of the credit quality in our loanportfolio and the qualitative factors we use to determine the adequacy of ourloan loss reserves as described above in “Critical AccountingPolicies—Allowance for Loan Losses.” The allowance for loan losses at June 30,2008 and December 31, 2007 was $12.4

** **

**32**

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millionand $11.6 million, respectively. Our allowance for loan losses ratio to loansreceivable, net was 1.16% and 1.12% at June 30, 2008 and December 31,2007, respectively.  Nonperforming loansat June 30, 2008 and December 31, 2007, was $233,000 and $963,000,respectively.

 

Additionalinformation on the allowance for loan losses, its allocation to the loansreceivable portfolio and information on nonperforming loans can be found inTables 6, 7 and 8, respectively.

 

Table 6.

 

**Allowance for Loan Losses**

Six Months Ended June 30, 2008 and 2007

(In thousands)

 
| ** **                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance, January 1, |       | $        | 11,641     |     | $          | 9,638 |   |
|                               |       |     |       |     |       |
| Provision for loan losses          |       | 1,089    |       | 755      |       |
|                               |       |     |       |     |       |
| Loans charged off:                 |       |     |       |     |       |
| Commercial and industrial          |       | (16      | )          | (35      | )          |
| Consumer                           |       | (347     | )          | —   |       |
| Total loans charged off            |       | (363     | )          | (35      | )          |
|                               |       |     |       |     |       |
| Recoveries:                        |       |     |       |     |       |
| Commercial and industrial          |       | 3        |       | —   |       |
| Consumer                           |       | 20       |       | —   |       |
| Total recoveries                   |       | 23       |       | —   |       |
|                               |       |     |       |     |       |
| Net (charge offs) recoveries       |       | (340     | )          | (35      | )          |
|                               |       |     |       |     |       |
| Ending balance, June 30,      |       | $        | 12,390     |     | $          | 10,358 |   |

 
| ** **                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Loans:                                                      |       |              |       |                  |       |   |   |
| Balance at period end                                       |       | $                 | 1,070,754  |                  | $          | 1,039,684 |   |
| Allowance for loan losses to loans  receivable, net of fees |       | 1.16              | %          | 1.12                  | %          |
| Annualized net charge-offs to average loans  receivable     |       | 0.06              | %          | 0.06                  | %          |

 

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Table 7.

 

**Allocation of the Allowance for Loan Losses**

At June 30, 2008 and December 31, 2007

(In thousands)

 
| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                      | ** ** | **Allocation**    | ** ** | **% of Total***       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and industrial       |       | $                 | 1,537      |                  | 11.16      | % | $ | 1,956 |   | 13.51 | % |
| Real estate - commercial        |       | 5,554             |       | 42.19                 |       | 5,225 |   | 39.95 |   |
| Real estate - construction      |       | 2,316             |       | 17.80                 |       | 2,217 |   | 17.93 |   |
| Real estate - residential       |       | 1,981             |       | 20.02                 |       | 1,402 |   | 20.50 |   |
| Home equity lines               |       | 942               |       | 8.58                  |       | 772 |   | 7.81 |   |
| Consumer                        |       | 60                |       | 0.25                  |       | 69 |   | 0.30 |   |
|                            |       |              |       |                  |       |   |   |   |   |
| Total allowance for loan losses |       | $                 | 12,390     |                  | 100.00     | % | $ | 11,641 |   | 100.00 | % |

 

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* Percentage of loan type to the total loan portfolio.

 

Table 8.

 

**Nonperforming Loans Receivable**

At June 30, 2008 and December 31, 2007

(In thousands)

 
| ** **                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Nonaccruing loans                                                |       | $                 | —     |                  | $          | — |   |
|                                                             |       |              |       |                  |       |
| Loans contractually past-due 90 days or  more and still accruing |       | 233               |       | 963                   |       |
|                                                             |       |              |       |                  |       |
| Total nonperforming loans receivable                             |       | $                 | 233        |                  | $          | 963 |   |

 

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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, 2008 and 2007 was$4.4 million and $5.3 million, respectively, a decrease of $934,000, or18%.   Noninterest income for the six monthsended June 30, 2008 and 2007 was $9.0 million and $10.6 million,respectively.  Realized and unrealizedgains on mortgage banking activities by George Mason for the three months endedJune 30, 2008 and 2007 were $1.6 million and $2.4 million, respectively, adecrease of $859,000, or 35%.  For theyear to date June 30, 2008 and 2007, realized and unrealized gains onmortgage banking activities were $3.9 million and $5.1 million,respectively.  Included in realized andunrealized gains on mortgage banking activities are any origination,underwriting, and discount points and other funding fees received and deferredat loan origination. Costs include direct costs associated with the loanorigination, such as commissions and salaries that are deferred at the time oforigination. In addition, we adopted SFAS No. 157 and SAB No. 109during the first quarter of 2008. Additional information on the adoption of these standards can be foundin Note 8 to our notes to the consolidated financial statements.  Management fee income for the three monthsended June 30, 2008 and 2007 was $302,000 and $348,000, respectively, adecrease of $46,000, or 13%. The decrease in realized and unrealized gains onmortgage banking activities and management fee income is directly related tothe tightening credit conditions within the mortgage industry and the slowdownin the regional housing market. Management fee income represents the income earned for services GeorgeMason provides to other mortgage companies owned by local home builders andgenerally fluctuates based on the volume of loan sales.

 

Servicecharges on deposit accounts increased $33,000 to $535,000 for the three monthsended June 30, 2008 compared to $502,000 for the same period of 2007. Forthe year to date June 30, 2008 and 2007, service charges on depositaccounts were $1.1 million and $968,000, respectively, an increase of$94,000.  The increases in servicecharges on deposit accounts are primarily the result of an increased number ofdeposit accounts in 2008 compared to 2007. Loan service charge income decreased$82,000 to $354,000 for the three months ended June 30, 2008, compared to$436,000 for the same period of 2007 and is related to the decrease in servicecharges recorded in the mortgage banking segment, which is related to theslowdown in the regional housing market. For the six months ended June 30, 2008 and 2007, loan servicecharges were $664,000 and $822,000, respectively, a decrease of $158,000.

 

Investmentfee income decreased $189,000 to $922,000 for the three months ended June 30,2008 compared to $1.1 million for the same period of 2007. For the six monthsended June 30, 2008 and 2007, investment fee income was $1.8 million and$2.1 million, respectively, a decrease of $312,000.  The decrease in investment fee income isattributable to the decrease in net 

 

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commissionsearned at CWS as a result of employee turnover in that subsidiary and decreasedfee income at our trust division due to the loss of low margin custodyrelationships with two clients.

 

Noninterestincome represented 28% and 34% of our total revenues for the three months endedJune 30, 2008 and 2007, respectively. For the year to date June 30, 2008 and 2007, noninterest incomerepresented 30% and 35%, respectively, of our total revenues.

 

*NoninterestExpense*

 

Noninterestexpense includes salaries and benefits, occupancy costs, professional fees, depreciation,data processing, telecommunications and miscellaneous expenses. Noninterestexpense for the three months ended June 30, 2008 was $13.6 million,compared to $12.3 million for the same period of 2007, an increase of $1.3million, or 11%.  For the year to date June 30,2008 and 2007, noninterest expense was $25.5 million and $24.7 million,respectively, an increase of $789,000, or 3%. The increase in noninterest expense for the three and six months ended June 30,2008 as compared to the same periods of 2007 was primarily a result of theaforementioned one-time cash settlement George Mason made to a mortgagecorrespondent.  Excluding thissettlement, noninterest expense for the three and six months ended June 30,2008 was $11.8 million and $23.7 million, respectively, a decrease of $469,000and $1.0 million for the three and six months ended June 30, 2008,respectively, as compared to the same periods of 2007.  (See Table 1 for a reconciliation of thisnon-GAAP financial measure to our GAAP financial information.)  The decrease in noninterest expense isprimarily due to a decrease in our salaries and benefits expense attributableto a decrease in the level of staffing and commissions paid at our mortgagebanking subsidiary.

 

*IncomeTaxes*

 

For the three months ended June 30,2008, we recorded a provision for income tax expense of $138,000, compared to$816,000 for the same period of 2007. For the year to date June 30, 2008 and 2007, provision for incometax expense was $900,000 and $1.6 million, respectively.  Our effective tax rate for the three monthsended June 30, 2008 and 2007 was 13.6% and 29.6%, respectively.  The decrease in our effective tax rate forthe three months ended June 30, 2008 compared to the second quarter of2007 was due to the tax benefit recorded for the one-time cash settlement of$1.8 million which was recorded at our statutory rate of 34.5%.  For the year to date June 30, 2008 and2007, our effective tax rates were 23.6% and 29.5%, respectively.  The decrease in our effective tax rate overthe year is primarily a result of our increase in tax-exempt investments andour tax-exempt income being a larger percentage of our overall net income forthe six months ended June 30, 2008 compared to June 30, 2007.  See also “Critical Accounting Policies —Valuation of Deferred Tax Assets.”

 

**Statements of Condition**

 

Totalassets were $1.73 billion and $1.69 billion at June 30, 2008 and December 31,2007, respectively.  The increase in ourtotal assets was primarily driven by the increase in our loans receivableportfolio, which increased $31.1 million to $1.07 billion at June 30, 2008from $1.04 billion at December 31, 2007.

 

*InvestmentSecurities*

 

Investmentsecurities were $373.6 million at June 30, 2008, compared to $364.9million at December 31, 2007, an increase of $8.6 million. The investmentportfolio consists of 

 

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investmentsecurities available-for-sale and investment securities held-to-maturity.Investment securities available-for-sale are those securities that we intend tohold for an indefinite period of time, but not necessarily until maturity.These securities are carried at fair value and may be sold as part of anasset/liability strategy, liquidity management or regulatory capitalmanagement.  Investment securitiesheld-to-maturity are those securities that we have the intent and ability tohold to maturity and are carried at amortized cost. At June 30, 2008,investment securities available-for-sale were $318.0 million and investmentsecurities held-to-maturity were $55.6 million. See Table 9 for additionalinformation on our investment securities portfolio.

 

At June 30, 2008 andDecember 31, 2007, investment securities with unrealized losses areinvestment grade securities.  Investmentsecurities with unrealized losses have interest rates that are less thancurrent market interest rates and, therefore, the indicated temporary lossesare not a result of permanent credit impairment.  Mortgage-backed investment securities, whichare the primary component of the unrealized losses in the investment securitiesportfolio at those dates, are primarily comprised of securities issued by theFederal National Mortgage Association (FNMA), Federal Home Loan MortgageCorporation (FHLMC) and Government National Mortgage Association (GNMA).

 

Ourinvestment portfolio consists primarily of securities backed or guaranteed byFNMA or FHLMC.  For all non government or agency securities, we completereviews at least quarterly. As of June 30, 2008, 93% of our investmentsecurities portfolio consisted of AAA rated securities.  Investmentsecurities which carry a AAA rating are judged to be of the best quality andcarry the smallest degree of investment risk.   We expect to receivefull payment of interest and principal on the securities in the investmentportfolio. The various protective elements on our non agency securities maychange in the future if market conditions or the financial stability of creditinsurers changes, which could impact the ratings of our securities.

 

Ofthe $33.3 million in our municipal securities portfolio, $13.8 million remainAAA rated while approximately $19.5 million were downgraded during 2008 to AAor single A status due to the downgrades of the monoline insurance companiesthat insured those bonds.  The bondsremain general obligations of the municipalities and we expect to receiverepayment of all principal amounts due to us. There is no other than temporary impairment due to credit quality.

 

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Table 9.

 

**Investment Securities**

At June 30, 2008 and December 31, 2007

(In thousands)

 
| ** **                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at June 30, 2008**    | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies              |       |          |       |      |       |        |       |
| One to five years                               |       | $             | 50,997     |      | $          | 51,000      |       | 2.05 | % |
| Five to ten years                               |       | 48,997        |       | 49,297    |       | 5.66        |       |
| After ten years                                 |       | 4,844         |       | 4,780     |       | 8.53        |       |
| Total U.S. government-sponsored agencies        |       | 104,838       |       | 105,077   |       | 4.04        |       |
|                                            |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                  |       |          |       |      |       |        |       |
| One to five years                               |       | 3,097         |       | 3,120     |       | 4.28        |       |
| Five to ten years                               |       | 10,374        |       | 10,259    |       | 4.03        |       |
| After ten years                                 |       | 168,425       |       | 166,850   |       | 5.18        |       |
| Total mortgage-backed securities                |       | 181,896       |       | 180,229   |       | 5.10        |       |
|                                            |       |          |       |      |       |        |       |
| Municipal securities (2)                        |       |          |       |      |       |        |       |
| After ten years                                 |       | 33,263        |       | 32,112    |       | 4.09        |       |
| Total municipal securities                      |       | 33,263        |       | 32,112    |       | 4.09        |       |
|                                            |       |          |       |      |       |        |       |
| U. S. treasury securities                       |       |          |       |      |       |        |       |
| One to five years                               |       | 598           |       | 597       |       | 1.43        |       |
| Total U.S. treasury securities                  |       | 598           |       | 597       |       | 1.43        |       |
| Total investment securities  available-for-sale |       | $             | 320,595    |      | $          | 318,015     |       | 4.64 | % |

 
| ** **                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at June 30, 2008**    | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies            |       |          |       |      |       |        |       |
| One to five years                             |       | $             | 2,000      |      | $          | 1,993       |       | 4.30 | % |
| After ten years                               |       | 1,011         |       | 1,011     |       | 5.60        |       |
| Total U.S. government-sponsored agencies      |       | 3,011         |       | 3,004     |       | 4.74        |       |
|                                          |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                |       |          |       |      |       |        |       |
| One to five years                             |       | 1,179         |       | 1,182     |       | 4.66        |       |
| Five to ten years                             |       | 10,833        |       | 10,681    |       | 4.43        |       |
| After ten years                               |       | 32,523        |       | 32,375    |       | 4.59        |       |
| Total mortgage-backed securities              |       | 44,535        |       | 44,238    |       | 4.55        |       |
|                                          |       |          |       |      |       |        |       |
| Corporate bonds                               |       |          |       |      |       |        |       |
| After ten years                               |       | 8,004         |       | 7,129     |       | 3.79        |       |
| Total corporate bonds                         |       | 8,004         |       | 7,129     |       | 3.79        |       |
| Total investment securities  held-to-maturity |       | 55,550        |       | 54,371    |       | 4.45        |       |
|                                          |       |          |       |      |       |        |       |
| Total investment securities                   |       | $             | 376,145    |      | $          | 372,386     |       | 4.61 | % |

 

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| ** **                                       | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|--------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2007** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies               |       |          |       |      |       |        |       |
| One to five years                                |       | $             | 44,160     |      | $          | 44,161      |       | 5.59 | % |
| Five to ten years                                |       | 39,116        |       | 39,850    |       | 5.99        |       |
| Total U.S. government-sponsored agencies         |       | 83,276        |       | 84,011    |       | 5.78        |       |
|                                             |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                   |       |          |       |      |       |        |       |
| One to five years                                |       | 3,552         |       | 3,526     |       | 4.25        |       |
| Five to ten years                                |       | 10,902        |       | 10,746    |       | 3.89        |       |
| After ten years                                  |       | 154,435       |       | 153,912   |       | 5.13        |       |
| Total mortgage-backed securities                 |       | 168,889       |       | 168,184   |       | 5.03        |       |
|                                             |       |          |       |      |       |        |       |
| Municipal securities (2)                         |       |          |       |      |       |        |       |
| After ten years                                  |       | 33,671        |       | 33,219    |       | 4.09        |       |
| Total municipal securities                       |       | 33,671        |       | 33,219    |       | 4.09        |       |
|                                             |       |          |       |      |       |        |       |
| U. S. treasury securities                        |       |          |       |      |       |        |       |
| One to five years                                |       | 592           |       | 584       |       | 4.09        |       |
| Total U.S. treasury securities                   |       | 592           |       | 584       |       | 4.09        |       |
| Total investment securities  available-for-sale  |       | $             | 286,428    |      | $          | 285,998     |       | 5.14 | % |

 
| ** **                                     | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2007** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies             |       |          |       |      |       |        |       |
| One to five years                              |       | $             | 6,500      |      | $          | 6,468       |       | 3.63 | % |
| Five to ten years                              |       | 11,011        |       | 10,998    |       | 4.52        |       |
| After ten years                                |       | 2,000         |       | 2,002     |       | 5.30        |       |
| Total U.S. government-sponsored agencies       |       | 19,511        |       | 19,468    |       | 4.30        |       |
|                                           |       |          |       |      |       |        |       |
| Mortgage-backed securities (1)                 |       |          |       |      |       |        |       |
| One to five years                              |       | 379           |       | 383       |       | 4.71        |       |
| Five to ten years                              |       | 7,618         |       | 7,555     |       | 4.29        |       |
| After ten years                                |       | 43,436        |       | 43,133    |       | 4.52        |       |
| Total mortgage-backed securities               |       | 51,433        |       | 51,071    |       | 4.49        |       |
|                                           |       |          |       |      |       |        |       |
| Corporate bonds                                |       |          |       |      |       |        |       |
| After ten years                                |       | 8,004         |       | 7,629     |       | 4.56        |       |
| Total corporate bonds                          |       | 8,004         |       | 7,629     |       | 4.56        |       |
| Total investment securities  held-to-maturity  |       | 78,948        |       | 78,168    |       | 4.45        |       |
|                                           |       |          |       |      |       |        |       |
| Total investment securities                    |       | $             | 365,376    |      | $          | 364,166     |       | 4.99 | % |

 

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(1)  Based on contractual maturities.

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

 

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*Loans*

 

Loansreceivable, net of deferred fees and costs, were $1.07 billion at June 30,2008 and $1.04 billion at December 31, 2007, an increase of $31.1million.  See Table 10 for details on theloans receivable portfolio. During the first six months of 2008, the mix of ourloan portfolio changed slightly, with decreases in commercial and industrialloans and consumer loans, and increases in real estate commercial, real estateconstruction, real estate residential and home equity loans.  Loans held for sale at June 30, 2008 was$156.1 million compared to $170.5 million at December 31, 2007, a decreaseof $14.4 million.  Loans held for saleare valued at the lower of cost or market value. The decrease in loans held forsale at June 30, 2008 compared to December 31, 2007 is due todecreased loan origination volume as a result of the slowdown in the regionalhousing market and tightening credit conditions within the mortgage industry.

 

Table 10.

 

**Loans Receivable**

At June 30, 2008 and December 31, 2007

(In thousands)

 
| ** **                      | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------------|------------|
|                            |       |                   |       |                       |       |   |   |   |   |
| Commercial and industrial       |       | $                      | 119,536    |                       | 11.16      | % | $ | 140,531 |   | 13.51 | % |
| Real estate - commercial        |       | 451,977                |       | 42.19                      |       | 415,471 |   | 39.95 |   |
| Real estate - construction      |       | 190,727                |       | 17.80                      |       | 186,514 |   | 17.93 |   |
| Real estate - residential       |       | 214,474                |       | 20.02                      |       | 213,197 |   | 20.50 |   |
| Home equity lines               |       | 91,940                 |       | 8.58                       |       | 81,247 |   | 7.81 |   |
| Consumer                        |       | 2,665                  |       | 0.25                       |       | 3,129 |   | 0.30 |   |
|                            |       |                   |       |                       |       |   |   |   |   |
| Gross loans                     |       | $                      | 1,071,319  |                       | 100.00     | % | 1,040,089 |   | 100.00 | % |
|                            |       |                   |       |                       |       |   |   |   |   |
| Net deferred (fees) costs       |       | (565                   | )          |                       |       | (405 | ) |   |   |
| Less: allowance for loan losses |       | (12,390                | )          |                       |       | (11,641 | ) |   |   |
|                            |       |                   |       |                       |       |   |   |   |   |
| Loans receivable, net           |       | $                      | 1,058,364  |                       |       |   | $ | 1,028,043 |   |   |   |

 

*Deposits*

 

Totaldeposits were $1.11 billion at June 30, 2008 compared to $1.10billion at December 31, 2007. We had increases in our noninterest bearingchecking and savings products and decreases in our interest checking, moneymarket and certificates of deposit products. See Table 11 for details oncertificates of deposit with balances of $100,000 or more. Our savings depositscontinue to increase as a result of our Simply Savings product, which allowsnew customers to earn a yield of 2.81% on funds deposited with us.  We had brokered certificates of deposit of$22.6 million and $10.0 million at June 30, 2008 and December 31,2007, respectively.

 

Table 11.

 

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

At June 30, 2008

(In thousands)

 
| **Maturities:**                       | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|----------------|------------|-----------------|------------|-----------|------------|
| Three months or less                  |       | $              | 76,454     |            | $          | 6,255     |       | $ | 82,709 |   |
| Over three months through six months  |       | 33,648         |       | 16,007          |       | 49,655    |       |
| Over six months through twelve months |       | 22,162         |       | 7,147           |       | 29,309    |       |
| Over twelve months                    |       | 35,046         |       | 836             |       | 35,882    |       |
|                                  |       | $              | 167,310    |            | $          | 30,245    |       | $ | 197,555 |   |

 

----

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

 

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*Borrowings*

 

Otherborrowed funds increased $25.4 million to $425.5 million at June 30, 2008,compared to $400.1 million at December 31, 2007.  Federal funds purchased at June 30, 2008and December 31, 2007 was $59.0 million and $68.0 million, respectively, adecrease of $9.0 million.   Treasury, Tax &Loan Note option borrowings decreased $5.9 million to $5.3 million at June 30,2008 compared to $11.2 million at December 31, 2007.  FHLB advances increased $46.8 million to$280.2 million at June 30, 2008 compared to $233.5 million at December 31,2007. Customer repurchase agreements decreased $6.4 million to $60.4 million atJune 30, 2008 compared to $66.8 million at December 31, 2007.  The overall increase in our other borrowedfunds supported the loan growth we have had over the past six months andincreases in our investment securities portfolio.  Table 12 provides information on ourborrowings.

 

Table 12.

 

**Short-Term Borrowings and Other Borrowed Funds**

At June 30, 2008

(In thousands)

 
| ** **                                                           | ** ** | ** **          | ** ** | **Maturity or** | ** ** | ** **        | ** ** | **Amount**      | ** **  |
|----------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|-------------------|------------|-----------------|-------------|
| **Advance Date**                                                     | ** ** | **Term of Advance** | ** ** | **Call Date**   | ** ** | **Interest Rate** | ** ** | **Outstanding** | ** **  |
| **Short-term FHLB advances:**                                        |       |                |       |            |       |              |       |            |        |
| Jul-03                                                               |       | 5 year              |       | Jul-08          |       | 2.29              | %          | 208             |        |
| **Total short-term FHLB advances and weighted  average rate**        | ** ** | ** **          | ** ** | ** **      | ** ** | **2.29**          | **%**      | **$**           | **208**     | ** ** |
| ** **                                                           | ** ** | ** **          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **      | ** **  |
| **Other short-term borrowed funds:**                                 | ** ** | ** **          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **      | ** **  |
| TT&L note option                                                 |       |                |       |            |       | 3.01              | %          | $               | 5,255       |   |
| Customer repurchase agreements                                       |       |                |       |            |       | 2.35              | %          | 60,413          |        |
| Federal Funds Purchased                                              |       |                |       |            |       | 3.43              | %          | 59,000          |        |
| **Total other short-term borrowed funds and  weighted average rate** | ** ** | ** **          | ** ** | ** **      | ** ** | **2.89**          | **%**      | **$**           | **124,668** | ** ** |
| ** **                                                           | ** ** | ** **          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **      | ** **  |
| **Other borrowed funds:**                                            | ** ** | ** **          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **      | ** **  |
| Trust preferred                                                      |       |                |       |            |       | 6.29              | %          | $               | 20,619      |   |
| FHLB advances - long term                                            |       |                |       |            |       | 3.91              | %          | 280,000         |        |
| **Other borrowed funds and weighted average  rate**                  | ** ** | ** **          | ** ** | ** **      | ** ** | **4.07**          | **%**      | **$**           | **300,619** | ** ** |
|                                                                 |       |                |       |            |       |              |       |            |        |
| **Total other borrowed funds and weighted  average rate**            | ** ** | ** **          | ** ** | ** **      | ** ** | **3.73**          | **%**      | **$**           | **425,495** | ** ** |

 

*Shareholders’Equity*

 

Shareholders’equity at June 30, 2008 was $159.6 million compared to $159.5 million at December 31,2007. During the first six months of 2008, we repurchased 94,776 shares of ourcommon stock under our share repurchase plan for a cost of $776,000.  In addition, the change to our accumulatedother comprehensive income was a decrease of $1.6 million for the year to date June 30,2008 which was primarily related to the change in the market value of ouravailable-for-sale investment securities. These decreases in our shareholders’ equity were offset by our year todate net income of $2.9 million as of June 30, 2008.  Book value per share at June 30, 2008was $6.62 compared to $6.45 at December 31, 2007. Tangible book value pershare (which is book value per share adjusted for changes in othercomprehensive income, less goodwill and other intangible assets) at June 30,2008 was $6.00 compared to $5.82 at December 31, 2007.

 

##### **BusinessSegment Operations**

##### ** **

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

 

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financingand consumer loans. In addition, this segment also provides customers withvarious deposit products including demand deposit accounts, savings accounts andcertificates of deposit.

 

Forthe three months ended June 30, 2008, the commercial banking segmentrecorded net income of $2.7 million compared to $1.8 million for the sameperiod of 2007, an increase of $980,000. For the six months ended June 30,2008, this segment recorded net income of $4.9 million compared to $3.5 millionfor the year to date 2007, an increase of $1.4 million.  The increase in net income is primarilyrelated to increases in net interest margin. Provision for loan losses increased $130,000 to $605,000 for the threemonths ended June 30, 2008 compared to $475,000 for the three months endedJune 30, 2007.  For the six monthsended June 30, 2008 and 2007, provision for loan loss expense was $925,000and $755,000, respectively.  Noninterestincome increased $331,000 to $1.4 million for the three months ended June 30,2008 compared to $1.0 million for the three months ended June 30,2007.  For the year to date June 30,2008 and 2007, noninterest income was $2.4 million and $2.0 million, respectively.  The increase in noninterest income in boththe three and six months ended June 30, 2008 compared to the same periodsof 2007 were primarily related to gains recorded on sales of investmentsecurities held-for-sale.  Noninterestexpense decreased $316,000 to $7.4 million for the three months ended June 30,2008 compared to $7.7 million for the same period of 2007.  The decrease in noninterest expense for thesecond quarter of 2008 compared to the same period of 2007, was related todecreases in salaries and benefits expense, depreciation expense andadvertising expense.  For the six monthsended June 30, 2008 and 2007, noninterest expense was $15.1 million and$15.2 million, respectively.  At June 30,2008, total assets for this segment were $1.70 billion, loans receivable, netof deferred fees and costs, were $1.07 billion and total deposits were $1.11billion. At June 30, 2007, total assets were $1.72 billion, loansreceivable, net of deferred fees and costs, were $928.6 million and totaldeposits were $1.19 billion.

 

*MortgageBanking*

 

Theoperations of the mortgage banking segment are conducted through George Mason.George Mason engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis.

 

Forthe three months ended June 30, 2008 and 2007, the mortgage bankingsegment recorded a net loss of $1.2 million and net income of $517,000,respectively. For the six months ended June 30, 2008 and 2007, GeorgeMason recorded a net loss of $695,000 and net income of $1.1 million,respectively.  The decrease in net incomeis primarily attributable to the aforementioned one-time cash settlement of$1.8 million to a mortgage correspondent and decreases in net interest incomeand noninterest income due to decreased loan volume over the comparableperiods.  Noninterest income decreased$1.1 million to $2.1 million for the three months ended June 30, 2008compared to $3.2 million for the same three month period of 2007.  For the six months ended June 30, 2008and 2007, noninterest income was $4.7 million and $6.4 million,respectively.  Noninterest expenseincreased $1.5 million to $4.7 million for the three months ended June 30,2008 compared to $3.2 million for the same three month period of 2007.  For the six months ended June 30, 2008and 2007, noninterest expense was $7.3 million and $6.3 million,respectively.  At June 30, 2008,total assets for this segment were $173.0 million; loans held for sale were$156.1 million and mortgage funding checks were $7.9 million. At June 30,2007, total assets were $372.4 million; loans held for sale were $352.9 millionand mortgage funding checks were $33.9 million.

 

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*Wealth Management and Trust Services*

 

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

 

Forthe three months ended June 30, 2008 and 2007, the wealth management andtrust services segment recorded net income of $51,000 and $262,000,respectively. For the year to date June 30, 2008 and 2007, this businesssegment recorded net income $68,000 and $292,000, respectively.  For the three months ended June 30, 2008and 2007, noninterest income was $922,000 and $1.1 million, respectively.  For the six months ended June 30, 2008and 2007, noninterest income was $1.8 million and $2.1 million,respectively.  Noninterest expense forthe three months ended June 30, 2008 and 2007 was $844,000 and $863,000,respectively.  For the six months ended June 30,2008 and 2007, noninterest expense was $1.7 million and $1.9 million,respectively.  At June 30, 2008,total assets were $3.6 million and managed and custodial assets were $3.4billion. At June 30, 2007, total assets for this segment were $4.5 millionand managed and custodial assets were $6.4 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.

 

Informationpertaining to our business segments can be found in Note 3 to the notes toconsolidated 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 (which includes common shareholders’ equity, defined toinclude certain debt obligations) and Tier 2 (which includes certain other debtobligations, a portion of the allowance for loan losses, and 45% of anyunrealized gains in equity securities).

 

AtJune 30, 2008, our Tier 1 and total (Tier 1 and Tier 2) risk-based capitalratios were 11.95% and 12.87%, respectively. At December 31, 2007, ourTier 1 and total risk-based capital ratios were 12.10% and 12.98%,respectively.  Our regulatory capitallevels for the Bank and bank holding company meet those established forwell-capitalized institutions. Table 13 provides additional informationpertaining to our capital ratios.

 

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Table 13.

 

**Capital Components**

At June 30, 2008 and December 31, 2007

(In thousands)

 
| ** **                                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | **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, 2008**                                        |       |       |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets  |       | $          | 177,173    |                       | 12.87      | %                          | $          | 110,172                    |       | >  |   | 8.00 | % | $ | 137,715 |   | >  |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets           |       | 164,577    |       | 11.95                      |       | 55,086                     |       | >                  |       | 4.00 |   | 82,629 |   | >  |   | 6.00 |   |
| Tier I capital/  Total capital to average assets                  |       | 164,577    |       | 10.06                      |       | 65,429                     |       | >                  |       | 4.00 |   | 81,786 |   | >  |   | 5.00 |   |
|                                                              |       |       |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| **At  December 31, 2007**                                    |       |       |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets  |       | $          | 174,523    |                       | 12.98      | %                          | $          | 107,569                    |       | >  |   | 8.00 | % | $ | 134,461 |   | >  |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets           |       | 162,691    |       | 12.10                      |       | 53,785                     |       | >                  |       | 4.00 |   | 80,677 |   | >  |   | 6.00 |   |
| Tier I capital/  Total capital to average assets                  |       | 162,691    |       | 10.26                      |       | 63,456                     |       | >                  |       | 4.00 |   | 79,320 |   | >  |   | 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, 2008**                                       |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 165,020    |                       | 12.01      | %                          | $          | 109,904                    |       | >  |       | 8.00                       | %          | $ | 137,381 |   | >  |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 152,424    |       | 11.10                      |       | 54,952                     |       | >                  |       | 4.00       |       | 82,428                     |       | >  |   | 6.00 |   |
| Tier I capital/  Total capital to average assets                 |       | 152,424    |       | 9.33                       |       | 65,315                     |       | >                  |       | 4.00       |       | 81,644                     |       | >  |   | 5.00 |   |
|                                                             |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| **At  December 31, 2007**                                   |       |       |       |                       |       |                       |       |                       |       |       |       |                       |       |   |   |   |   |
| Total risk-based  capital/ Total capital to risk-weighted assets |       | $          | 159,745    |                       | 11.91      | %                          | $          | 107,308                    |       | >  |       | 8.00                       | %          | $ | 134,135 |   | >  |   | 10.00 | % |
| Tier I capital/  Tier I capital to risk-weighted assets          |       | 147,913    |       | 11.03                      |       | 53,654                     |       | >                  |       | 4.00       |       | 80,481                     |       | >  |   | 6.00 |   |
| Tier I capital/  Total capital to average assets                 |       | 147,913    |       | 9.34                       |       | 63,331                     |       | >                  |       | 4.00       |       | 79,163                     |       | >  |   | 5.00 |   |

 

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**ContractualObligations**

 

Wehave entered into a number of long-term contractual obligations to support ourongoing business activities. These contractual obligations will be fundedthrough operating revenues and liquidity sources held or available to us andexclude contractual interest costs, where applicable. The required paymentsunder such obligations are detailed in Table 14.

 

Table 14.

 

**ContractualObligations**

At June 30,2008

(In thousands)

 
| ** **                                          | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **Total**                                 | ** ** | **Less than 1   Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5   Years** | ** ** |
| Long-Term Debt Obligations:                         | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit                             |       | $                                         | 427,265    |   | $ | 322,753 |   | $ | 100,611 |   | $ | 3,901 |   | $ | — |   |
|                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Brokered certificates of deposit                    |       | 22,595                                    |       | 14,397 |   | 4,964 |   | 3,234 |   | — |   |
|                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Advances from the Federal Home Loan Bank of Atlanta |       | 280,208                                   |       | 208 |   | 10,000 |   | 120,000 |   | 150,000 |   |
|                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Trust preferred securities                          |       | 20,619                                    |       | — |   | — |   | — |   | 20,619 |   |
|                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating lease obligations                         |       | 18,935                                    |       | 4,885 |   | 4,207 |   | 5,411 |   | 4,432 |   |
|                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                                               |       | $                                         | 769,622    |   | $ | 342,243 |   | $ | 119,782 |   | $ | 132,546 |   | $ | 175,051 |   |

 

**Commitmentsand Contingencies**

 

Inthe normal course of business, we are a party to financial instruments withoff-balance sheet risk to meet the financing needs of our customers. Thesefinancial instruments include commitments to extend credit and standby lettersof credit. Those instruments involve, to varying degrees, elements of creditrisk in excess of the amount recognized on the balance sheet.

 

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

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the agreement. Commitments generallyhave expiration dates or other termination clauses and may require payment of afee. Since many of the commitments are expected to expire without being drawnupon, the total commitment amounts do not necessarily represent future fundingrequirements. We evaluate each customer’s credit worthiness on a case-by-casebasis.  The amount of collateral obtainedis based on management’s credit evaluation of the counterparty.  Collateral held varies but may includeaccounts receivable, inventory, property and equipment, and income-producingcommercial properties.

 

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

 

AtJune 30, 2008, commitments to extend credit were $409.4 million andstandby letters of credit were $7.7 million. The liability associated withstandby letters of credit at June 30, 2008 was $9,000.

 

GeorgeMason maintains a reserve for loans sold that pay off earlier than thecontractual agreed upon period, thereby requiring that George Mason refund partof the service release premium and/or premium pricing received from theinvestor.  The reserve as of June 30,2008 was $14,000.

 

GeorgeMason has a reserve for its estimated exposure to repurchase loans previouslysold to investors for which borrowers’ failed to provide full and accurateinformation on or related to their loan application or for which appraisalshave not been acceptable.  In addition,George Mason, as part of the service it provides to its managed companies,purchases the loans managed companies originate at the time oforigination.  These loans are then soldby George Mason to investors.  GeorgeMason has agreements with its managed companies requiring that, for any loansthat were originated by a managed company and for which investors haverequested George Mason to repurchase due to the borrowers’ failure to providefull and accurate information on or related to their loan application or forwhich appraisals have not been acceptable, the managed company be responsiblefor buying 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.

 

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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 $2.8 million payment to the correspondent.  In addition, while we believe there isimmaterial exposure under this agreement, over the course of the next two yearsthere is a potential payment of no more than $0.03 diluted earnings per sharein total on a declining basis over the two year period.  In conjunction with the agreement, GeorgeMason entered into similar agreements with certain managed companies, fromwhich George Mason purchased loans and subsequently sold to this mortgagecorrespondent.  These settlementagreements provided for a total payment of $1.0 million to George Mason bythose managed companies of which $400,000 has already been paid.

 

GeorgeMason’s reserve for possible loan repurchases was $260,000 at June 30,2008.  George Mason funded a repurchasedloan that was originated by a managed company, for which the managed company ispaying back George Mason.

 

Wehave derivative counter-party risk that may arise from the possible inabilityof George Mason’s third party investors to meet the terms of their forwardsales contracts.  George Mason works withthird-party investors that are generally well-capitalized, are investment gradeand exhibit strong financial performance to mitigate this risk.  We do not expect any third-party investor tofail to meet its obligation.

 

## **Liquidity**

## ** **

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

 

Inaddition to deposits, we have access to various wholesale funding markets.These markets include the brokered CD market, the repurchase agreement marketand the federal funds market. We also maintain secured lines of credit with theFederal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta.Having diverse funding alternatives reduces our reliance on any one source forfunding.

 

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

 

Wehave established a formal liquidity contingency plan which establishes aliquidity management team and provides guidelines for liquidity management. Forour liquidity management program, we first determine our current liquidityposition and then forecast liquidity based on anticipated changes in thebalance sheet. In this forecast, we expect to maintain a liquidity cushion. Wealso stress test our liquidity position under several different stressscenarios. Guidelines for the forecasted liquidity cushion and for liquiditycushions for each stress scenario have been established. In addition, onestress test combines all other stress tests to see how liquidity would react toseveral negative scenarios occurring at the same time. We believe that we havesufficient resources to meet our liquidity needs.

 

Liquidassets, which include cash and due from banks, federal funds sold andinvestment securities available for sale, totaled $348.0 million at June 30,2008 or 20% of total assets. We held investments that are classified asheld-to-maturity in the amount of $55.6 million at June 30, 2008. Tomaintain ready access to the Bank’s secured lines of credit, the Bank haspledged roughly a third of its investment securities to the Federal Home LoanBank of Atlanta with additional investment securities pledged to the FederalReserve Bank of Richmond. Additional borrowing capacity at the Federal HomeLoan Bank of Atlanta at June 30, 2008 was $80.2 million. Borrowingcapacity with the Federal Reserve Bank of Richmond was $61.2 million at June 30,2008. We anticipate maintaining liquidity at a level sufficient to protectdepositors, provide for reasonable growth and fully comply with all regulatoryrequirements.

 

##### **Interest RateSensitivity**

##### ** **

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

 

Weemploy an independent consulting firm to model our interest ratesensitivity.  We use a net interestincome simulation model as our primary tool to measure interest ratesensitivity. Many assumptions are developed based on expected activity in thebalance sheet. For maturing assets, assumptions are created for theredeployment of these assets. For maturing liabilities, assumptions aredeveloped for the replacement of these funding sources. Assumptions are alsodeveloped for assets and liabilities that could reprice during the modeled timeperiod. These assumptions also cover how we expect rates to change onnon-maturity deposits such as interest checking, money market checking, savingsaccounts as well as certificates of deposit. Based on inputs that include thecurrent balance sheet, the current level of interest rates and the developedassumptions, the model then produces an expected level of net interest incomeassuming that market rates remain unchanged. This is considered the base case.Next, the model determines what net interest income would be based on specificchanges in interest rates. The rate simulations are performed for a two yearperiod and include ramped rate changes of down 100 basis points and up 200basis points. The down 200 basis point scenario was discontinued given thecurrent level of interest rates. In the ramped down rate change, the modelmoves rates gradually down 100 basis points over the first year and then ratesremain flat in the second year. 

 

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

 

AtJune 30, 2008, we were liability sensitive for the entire two yearsimulation period.   Liability sensitivemeans that we had more liabilities repricing than assets. We have more of ourliabilities in non-maturity or short-term deposit products than we have infloating rate assets.  In a decreasinginterest rate environment, net interest income would grow for a liabilitysensitive bank.  In the down 100 basispoint scenario, net interest income improves by not more than 2.9% for the oneyear period and by not more than 3.5% over the two year time horizon. In the up200 basis point scenario, for a liability sensitive bank, net interest incomeshould contract in a rising rate environment. In the up 200 basis point scenario, net interest income decreases by notmore than 2.2% in the first year and decreases by not more than 2.3% over thetwo year time horizon compared to the base case.

 

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

 

OurAsset/Liability Committee is responsible for reviewing our liquidityrequirements and maximizing our net interest income consistent with capitalrequirements, liquidity, interest rate and economic outlooks, competitivefactors and customer needs. Interest rate risk arises because the assets of theBank and the liabilities of the Bank have different maturities andcharacteristics. In order to measure this interest rate risk, we use asimulation process that measures the impact of changing interest rates on netinterest income. This model is run for the Bank by an independent consultingfirm. The simulations incorporate assumptions related to expected activity inthe balance sheet. For maturing assets, assumptions are developed for theredeployment of these assets. For maturing liabilities, assumptions aredeveloped for the replacement of these funding sources. Assumptions are alsodeveloped for assets and liabilities that reprice during the modeled timeperiod. These assumptions also cover how we expect rates to change onnon-maturity deposits such as interest checking, money market checking, savingsaccounts as well as certificates of deposit. Based on inputs that include themost recent period end balance sheet, the current level of interest rates andthe developed assumptions, the model then produces an expected level of netinterest income assuming that interest rates remain unchanged. This becomes thebase case. Next, the model determines the impact on net interest income givenspecified 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 giventhe 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 point scenario, rates aregradually increased by 200 basis points in the first year and remain flat inthe second year. In both the up and down scenarios, the model assumes aparallel shift in the yield curve. The results of these simulations are thencompared to the base case.

 

AtJune 30, 2008, we were liability sensitive for the entire two yearsimulation period.   Liability sensitivemeans that we had more liabilities repricing than assets. We have more of ourliabilities in non-maturity or short-term deposit products than we have infloating rate assets.  In a decreasinginterest rate environment, net interest income would grow for a liability sensitivebank.  In the down 100 basis pointscenario, net interest income improves by not more than 2.9% for the one yearperiod and by not more than 3.5% over the two year time horizon.  In the up 200 basis point scenario, for aliability sensitive bank, net interest income should contract in a rising rateenvironment.  In the up 200 basis pointscenario, net interest income decreases by not more than 2.2% in the first yearand decreases by not more than 2.3% over the two year time horizon compared tothe base case.

 

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

 

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**Item 4.  Controls and Procedures**

 

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

 

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

 

TheCompany also maintains a system of internal accounting controls that isdesigned to provide assurance that assets are safeguarded and that transactionsare executed in accordance with management’s authorization and are properly recorded.This system is continually reviewed and is augmented by written policies andprocedures, the careful selection and training of qualified personnel and aninternal audit program to monitor its effectiveness. There were no changes inour internal control over financial reporting identified in connection with ourevaluation of it that occurred during our last fiscal quarter that materiallyaffected, or are likely to materially affect, our internal control overfinancial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Inthe ordinary course of our operations, we may become party to legal proceedings.

 

On February 28, 2008, OneBeacon MidwestCompany (“OneBeacon”) filed a complaint for declaratory judgment in the U.S.District Court for the Eastern District of Virginia.  OneBeacon provides insurance coverage for usand we have filed an insurance claim and proof of loss to recover the $3.5million attributable to the loss recorded in 2007 on the escrow arrangementbetween Liberty Growth Fund LP and AIMS Worldwide, Inc.  We counter claimed and both Cardinal and OneBeacon areseeking a court determination of whether the Financial Institution Bond providescoverage for our claim.

 

**Item 1A.  Risk Factors**

 

Ouroperations are subject to many risks that could adversely affect our futurefinancial condition and performance and, therefore, the market value of oursecurities.  The risk factors that areapplicable to us are outlined in our Annual Report on Form 10-K for theyear ended December 31, 2007.  Theserisk factors have not materially changed as of the date of this report.

 

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

** **

(a)          None.

(b)         Notapplicable.

(c)          Forthe three months ended June 30, 2008, we purchased 57,276 shares of ourcommon stock at a total cost of $487,000. All of these shares have been cancelled and retired.

 
| **Period**                              | ** ** | **(a) Total  Number of  Shares  Purchased** | ** ** | **(b) Average  Price Paid per   Share ($)** | ** ** | **(c) Total  Number of  Shares  Purchased as  Part of Publicly  Announced  Program** | ** ** | **(d) Maximum   Number of  Shares that May  Yet Be  Purchased  Under the  Program** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
| April 1 – April 30, 2008 |       | —                                                |       | —                                                               |       | —                                                                                                        |       | 684,360                                                                                                                |       |
| May 1 – May 31, 2008     |       | 32,078                                                |       | 8.47                                                                 |       | 32,078                                                                                                        |       | 652,282                                                                                                                |       |
| June 1 – June 30, 2008   |       | 25,198                                                |       | 8.44                                                                 |       | 25,198                                                                                                        |       | 627,084                                                                                                                |       |
| **Total**                               | ** ** | **57,276**                                            | ** ** | **8.46**                                                             | ** ** | **57,276**                                                                                                    | ** ** | **627,084**                                                                                                            | ** ** |

 

On February 26, 2007, the Board of Directorsadopted a program to repurchase up to 1,000,000 shares of our commonstock.  The timing and amount ofrepurchases, if any, will depend on market conditions, share price, tradingvolume and other factors, and there is no assurance that we will purchaseshares during any period.  No terminationdate was set for the buyback program. Shares may be purchased in the openmarket or through privately negotiated transactions.

 

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**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 18, 2008.

(b)  Not applicable.

(c)  At the Annual Meeting of Shareholders, thefollowing persons were elected as directors for a term expiring in 2011:

 
| ** **                     | ** ** | **Votes**  | ** ** |
|--------------------------------|------------|------------|------------|
| **Director**                   | ** ** | **For**    | ** ** | **Withheld** | ** ** |
| William G. Buck                |       | 21,299,688 |       | 796,904 |   |
| Sidney O. Dewberry, P.E., L.S. |       | 21,293,660 |       | 802,932 |   |
| Alan G. Merten                 |       | 21,296,661 |       | 799,931 |   |
| William E. Peterson            |       | 15,267,595 |       | 6,828,997 |   |

 

In addition, the shareholders voted on and ratified theappointment of KPMG LLP, as the Company’s independent auditors for 2008 by avote of 21,791,404 for and 279,082 against, with 26,108 abstentions.

 

(d)  None.

 

**Item 5.  Other Information**

 

(a)  None

 

(b)  None.

 

**Item 6.  Exhibits**

 

31.1    Rule 13a-14(a) Certification ofChief Executive Officer

31.2    Rule 13a-14(a) Certification ofChief Financial Officer

32.1    Statement of Chief Executive OfficerPursuant to 18 U.S.C. Section 1350

32.2    Statement of Chief Financial OfficerPursuant to 18 U.S.C. Section 1350

 

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**SIGNATURES**

** **

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

** **
| ** **                          | **CARDINAL  FINANCIAL CORPORATION**                       |
|-------------------------------------|-----------------------------------------------------------|
| ** **                          | **(Registrant)**                                          |
| ** **                          | ** **                                                |
| **Date:  August 8, 2008** | **/s/**Bernard H. Clineburg                               |
| ** **                          | **Bernard  H. Clineburg**                                 |
| ** **                          | **Chairman  and Chief Executive Officer**                 |
| ** **                          | **(Principal  Executive Officer)**                        |
| ** **                          | ** **                                                |
| ** **                          | ** **                                                |
| **Date:  August 8, 2008** | **/s/**Mark A. Wendel                                     |
| ** **                          | **Mark A.  Wendel**                                       |
| ** **                          | **Executive  Vice President and Chief Financial Officer** |
| ** **                          | **(Principal  Financial Officer)**                        |
| ** **                          | ** **                                                |
| ** **                          | ** **                                                |
| **Date:  August 8, 2008** | **/s/**Jennifer L. Deacon                                 |
| ** **                          | **Jennifer  L. Deacon**                                   |
| ** **                          | **Senior  Vice President and Controller**                 |
| ** **                          | **(Principal  Accounting Officer)**                       |

 

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**ExhibitIndex**

** **

31.1    Rule 13a-14(a) Certification ofChief Executive Officer

31.2    Rule 13a-14(a) Certification ofChief Financial Officer

32.1    Statement of Chief Executive OfficerPursuant to 18 U.S.C. Section 1350

32.2    Statement of Chief Financial OfficerPursuant to 18 U.S.C. Section 1350

 

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