**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended March 31, 2004**

 

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

 

**For thetransition period from                to                **

 

**Commissionfile number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact Name of Registrantas Specified in its Charter)

 

| **Virginia**                                                     |   | **54-1874630**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **8270 Greensboro Drive, Suite 500  McLean, Virginia**           |   | **22102**                             |
| (Address of Principal  Executive Offices)                        |   | (Zip Code)                            |

 

**(703) 584-3400**

(Registrant’s TelephoneNumber, Including Area Code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes   ý   No   o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes   o   No   ý

 

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

 

18,371,395 shares ofcommon stock, par value $1.00 per share,outstanding as of April 12, 2004

 

 

----

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I –  FINANCIAL INFORMATION**                                                            | 3                                                                                                                    |
|-----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------|
|                                                                                                |                                                                                                                 |
| Item 1.   Financial Statements:                                                                | 3                                                                                                                    |
|                                                                                                |                                                                                                                 |
|                                                                                                | Consolidated  Statements of Condition  March 31, 2004 and December 31, 2003                                          | 3 |
|                                                                                                |                                                                                                                 |   |
|                                                                                                | Consolidated  Statements of Operations  For the three months ended March 31, 2004 and 2003                           | 4 |
|                                                                                                |                                                                                                                 |   |
|                                                                                                | Consolidated Statements of  Comprehensive Income (Loss)  For the three months ended March 31, 2004 and 2003          | 5 |
|                                                                                                |                                                                                                                 |   |
|                                                                                                | Consolidated Statements of Changes  In Shareholders’ Equity  For the three months ended March 31, 2004 and 2003 | 6 |
|                                                                                                |                                                                                                                 |   |
|                                                                                                | Consolidated Statements of Cash Flows  For the three months ended March 31, 2004 and 2003                            | 7 |
|                                                                                                |                                                                                                                 |   |
|                                                                                                | Notes to Consolidated Financial  Statements                                                                          | 8 |
|                                                                                                |                                                                                                                 |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 12                                                                                                                   |
|                                                                                                |                                                                                                                 |   |
| Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                 | 31                                                                                                                   |
|                                                                                                |                                                                                                                 |   |
| Item 4. Controls and Procedures                                                                     | 32                                                                                                                   |
|                                                                                                |                                                                                                                 |   |
|                                                                                                |                                                                                                                 |   |
| **PART II – OTHER INFORMATION**                                                                | 33                                                                                                                   |
|                                                                                                |                                                                                                                 |   |
| Item 1. Legal Proceedings                                                                           | 33                                                                                                                   |
| Item 2. Changes in Securities and  Use of Proceeds                                                  | 33                                                                                                                   |
| Item 3. Defaults Upon Senior Securities                                                             | 33                                                                                                                   |
| Item 4. Submission of Matters to a Vote  of Security Holders                                        | 33                                                                                                                   |
| Item 5. Other Information                                                                           | 33                                                                                                                   |
| Item 6. Exhibits and Reports on Form 8-K                                                            | 33                                                                                                                   |
|                                                                                                |                                                                                                                 |   |
| **SIGNATURES  AND CERTIFICATIONS**                                                                  | 34                                                                                                                   |

 

2

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**PART I****– FINANCIALINFORMATION**

 

**Item 1****.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OF CONDITION

 

At March 31,2004 and December 31, 2003

 

(Dollars inthousands, except share data)

 
|                                                                                                                                                                                |   | **March 31,  2004** |    | **December  31,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                                                                                                                                |   | **(Unaudited)**     |    |                    |   |
| **Assets**                                                                                                                                                                          |   |                |    |                    |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Cash and due  from banks                                                                                                                                                            |   | $                   | 10,350  |                    | $      | 9,555 |   |
| Federal funds  sold                                                                                                                                                                 |   | 11,381              |    | 3,528                   |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total cash and  cash equivalents                                                                                                                                                    |   | 21,731              |    | 13,083                  |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Investment  securities available-for-sale                                                                                                                                           |   | 167,981             |    | 130,762                 |   |
| Investment  securities held-to-maturity                                                                                                                                             |   | 154,140             |    | 142,852                 |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total investment  securities                                                                                                                                                        |   | 322,121             |    | 273,614                 |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Other  investments                                                                                                                                                                  |   | 3,986               |    | 3,517                   |   |
| Loans held for  sale                                                                                                                                                                |   | 688                 |    | —                  |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Loans receivable, net of fees                                                                                                                                                       |   | 334,476             |    | 336,002                 |   |
| Allowance for  loan losses                                                                                                                                                          |   | (4,347              | )       | (4,344                  | )      |
|                                                                                                                                                                                |   |                |    |                    |   |
| Loans  receivable, net                                                                                                                                                              |   | 330,129             |    | 331,658                 |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Premises and  equipment, net                                                                                                                                                        |   | 7,107               |    | 6,707                   |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Deferred tax  asset                                                                                                                                                                 |   | 4,111               |    | 4,473                   |   |
| Accrued interest  and other assets                                                                                                                                                  |   | 3,578               |    | 3,196                   |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total assets                                                                                                                                                                        |   | $                   | 693,451 |                    | $      | 636,248 |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| **Liabilities and Shareholders’  Equity**                                                                                                                                      |   |                |    |                    |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Deposits                                                                                                                                                                            |   | $                   | 525,931 |                    | $      | 474,129 |   |
| Other borrowed  funds                                                                                                                                                               |   | 71,758              |    | 74,457                  |   |
| Accrued interest  and other liabilities                                                                                                                                             |   | 2,422               |    | 2,250                   |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total  liabilities                                                                                                                                                                  |   | 600,111             |    | 550,836                 |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Preferred stock,  $1 par value, 10,000,000 shares authorized; Series A preferred stock,  cumulative convertible, 0 and 1,364,062 shares outstanding in 2004 and 2003,  respectively |   | —              |    | 1,364                   |   |
| Common stock, $1  par value, 50,000,000 shares authorized; 18,371,395 and 16,377,337 shares  outstanding in 2004 and 2003, respectively                                             |   | 18,371              |    | 16,377                  |   |
| Additional  paid-in capital                                                                                                                                                         |   | 92,552              |    | 86,790                  |   |
| Accumulated  deficit                                                                                                                                                                |   | (17,895             | )       | (18,614                 | )      |
| Accumulated  other comprehensive income (loss)                                                                                                                                      |   | 312                 |    | (505                    | )      |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total  shareholders’ equity                                                                                                                                                    |   | 93,340              |    | 85,412                  |   |
|                                                                                                                                                                                |   |                |    |                    |   |
| Total  liabilities and shareholders’ equity                                                                                                                                    |   | $                   | 693,451 |                    | $      | 636,248 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

Three months ended March 31, 2004 and 2003

(In thousands, except per share data)

(Unaudited)

 
|                                                           |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------|--------|----------|--------|----------|--------|
| Interest income:                                               |   |     |   |     |   |
| Loans receivable                                               |   | $        | 4,728  |     | $      | 4,031 |   |
| Federal funds  sold                                            |   | 28       |   | 39       |   |
| Investment  securities available-for-sale                      |   | 1,271    |   | 1,678    |   |
| Investment  securities held-to-maturity                        |   | 1,350    |   | —   |   |
| Other  investments                                             |   | 38       |   | 24       |   |
|                                                           |   |     |   |     |   |
| Total interest  income                                         |   | 7,415    |   | 5,772    |   |
|                                                           |   |     |   |     |   |
| Interest  expense:                                             |   |     |   |     |   |
| Deposits                                                       |   | 2,282    |   | 2,240    |   |
| Other borrowed  funds                                          |   | 300      |   | 73       |   |
|                                                           |   |     |   |     |   |
| Total interest  expense                                        |   | 2,582    |   | 2,313    |   |
|                                                           |   |     |   |     |   |
| Net interest  income                                           |   | 4,833    |   | 3,459    |   |
|                                                           |   |     |   |     |   |
| Provision for  loan losses                                     |   | 74       |   | 80       |   |
|                                                           |   |     |   |     |   |
| Net interest  income after provision for loan losses           |   | 4,759    |   | 3,379    |   |
|                                                           |   |     |   |     |   |
| Non-interest  income:                                          |   |     |   |     |   |
| Service charges  on deposit accounts                           |   | 170      |   | 134      |   |
| Loan service  charges                                          |   | 195      |   | 113      |   |
| Investment fee  income                                         |   | 178      |   | 126      |   |
| Net gain on  sales of loans                                    |   | 13       |   | 9        |   |
| Net realized  gain on investment securities available-for-sale |   | 241      |   | 493      |   |
| Other income                                                   |   | 80       |   | 101      |   |
|                                                           |   |     |   |     |   |
| Total  non-interest income                                     |   | 877      |   | 976      |   |
|                                                           |   |     |   |     |   |
| Non-interest expense:                                          |   |     |   |     |   |
| Salary and  benefits                                           |   | 2,140    |   | 1,649    |   |
| Occupancy                                                      |   | 496      |   | 480      |   |
| Professional  fees                                             |   | 154      |   | 369      |   |
| Depreciation                                                   |   | 310      |   | 196      |   |
| Other operating  expenses                                      |   | 1,455    |   | 1,171    |   |
|                                                           |   |     |   |     |   |
| Total  non-interest expense                                    |   | 4,555    |   | 3,865    |   |
|                                                           |   |     |   |     |   |
| Net income  before income taxes                                |   | 1,081    |   | 490      |   |
|                                                           |   |     |   |     |   |
| Provision for  income taxes                                    |   | 362      |   | —   |   |
|                                                           |   |     |   |     |   |
| Net income                                                     |   | $        | 719    |     | $      | 490 |   |
|                                                           |   |     |   |     |   |
| Dividends to  preferred shareholders                           |   | —   |   | 124      |   |
|                                                           |   |     |   |     |   |
| Net income to  common shareholders                             |   | $        | 719    |     | $      | 366 |   |
|                                                           |   |     |   |     |   |
| Earnings per  common share - basic                             |   | $        | 0.04   |     | $      | 0.04 |   |
|                                                           |   |     |   |     |   |
| Earnings per  common share - diluted                           |   | $        | 0.04   |     | $      | 0.04 |   |
|                                                           |   |     |   |     |   |
| Weighted-average  common shares outstanding - basic            |   | 17,461   |   | 10,046   |   |
|                                                           |   |     |   |     |   |
| Weighted-average  common shares outstanding - diluted          |   | 17,885   |   | 10,171   |   |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOME (LOSS)

Three monthsended March 31, 2004 and 2003

(Dollars inthousands)

(Unaudited)

 
|                                                                            |   | **2004** |   | **2003** |   |
|---------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                                            |   |     |   |     |   |
| Net income                                                                      |   | $        | 719    |     | $      | 490 |   |
| Other  comprehensive income (loss):                                             |   |     |   |     |   |
| Unrealized gain  (loss) on available-for-sale investment securities:            |   |     |   |     |   |
| Unrealized  holding gain (loss) arising during the quarter, net of tax          |   | 976      |   | (2,199   | )      |
| Less:  reclassification adjustment for gains included in net income, net of tax |   | 159      |   | 493      |   |
|                                                                            |   |     |   |     |   |
| Comprehensive  income (loss)                                                    |   | $        | 1,536  |     | $      | (1,216 | ) |

 

See accompanyingnotes to consolidated financial statements.

 

5

----

 

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Three months ended March 31, 2004 and 2003

(In thousands)

(Unaudited)

 
|                                                                          |   | **Preferred  Shares** |   | **Preferred  Stock** |   | **Common  Shares** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Total** |   |
|-------------------------------------------------------------------------------|--------|-----------------------|--------|----------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|------------------------------------------------------|--------|-----------|--------|
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, December 31, 2002                                                    |   | 1,365                 |   | $                    | 1,365  |               | 10,044 |              | $      | 10,044                           |   | $                        | 51,231 |                                                 | $      | (24,273   | )      | $ | 2,345 |   | $ | 40,712 |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Stock options exercised                                                       |   | —                |   | —               |   | 3                  |   | 3                 |   | 7                                |   | —                   |   | —                                               |   | 10        |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Dividends on preferred stock                                                  |   | —                |   | —               |   | —             |   | —            |   | —                           |   | (124                     | )      | —                                               |   | (124      | )      |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Change in unrealized gain (loss) on investment securities  available-for-sale |   | —                |   | —               |   | —             |   | —            |   | —                           |   | —                   |   | (1,706                                               | )      | (1,706    | )      |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Net income                                                                    |   | —                |   | —               |   | —             |   | —            |   | —                           |   | 490                      |   | —                                               |   | 490       |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, March 31, 2003                                                       |   | 1,365                 |   | $                    | 1,365  |               | 10,047 |              | $      | 10,047                           |   | $                        | 51,238 |                                                 | $      | (23,907   | )      | $ | 639 |   | $ | 39,382 |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, December 31, 2003                                                    |   | 1,364                 |   | $                    | 1,364  |               | 16,377 |              | $      | 16,377                           |   | $                        | 86,790 |                                                 | $      | (18,614   | )      | $ | (505 | ) | $ | 85,412 |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Stock options exercised                                                       |   | —                |   | —               |   | 23                 |   | 23                |   | 66                               |   | —                   |   | —                                               |   | 89        |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Public offering shares issued                                                 |   | —                |   | —               |   | 945                |   | 945               |   | 5,358                            |   | —                   |   | —                                               |   | 6,303     |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Preferred stock converted to common stock                                     |   | (1,364                | )      | (1,364               | )      | 1,026              |   | 1,026             |   | 338                              |   | —                   |   | —                                               |   | —    |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Change in unrealized gain (loss) on investment securities  available-for-sale |   | —                |   | —               |   | —             |   | —            |   | —                           |   | —                   |   | 817                                                  |   | 817       |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Net income                                                                    |   | —                |   | —               |   | —             |   | —            |   | —                           |   | 719                      |   | —                                               |   | 719       |   |
|                                                                          |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, March 31, 2004                                                       |   | —                |   | $                    | — |               | 18,371 |              | $      | 18,371                           |   | $                        | 92,552 |                                                 | $      | (17,895   | )      | $ | 312 |   | $ | 93,340 |   |

 

See accompanyingnotes to consolidated financial statements.

 

6

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

 

Three months ended March 31, 2004 and 2003

 

(Dollars in thousands)

 

(Unaudited)

 
|                                                                                         |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Cash flows from  operating activities:                                                       |   |     |   |     |   |
| Net income                                                                                   |   | $        | 719    |     | $      | 490 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |   |     |   |     |   |
| Depreciation                                                                                 |   | 310      |   | 196      |   |
| Amortization of  premiums and discounts                                                      |   | 503      |   | 427      |   |
| Provision for  loan losses                                                                   |   | 74       |   | 80       |   |
| Originations of  loans held for sale                                                         |   | (2,569   | )      | (172     | )      |
| Proceeds from  the sale of loans held for sale                                               |   | 1,894    |   | 172      |   |
| Gain on sale of  loans held for sale                                                         |   | (13      | )      | (9       | )      |
| Gain on sale of  investment securities available-for-sale                                    |   | (241     | )      | (493     | )      |
| (Increase)  decrease in accrued interest, other assets and deferred tax asset                |   | (20      | )      | 3,419    |   |
| Increase  (decrease) in accrued interest and other liabilities                               |   | 172      |   | (17,415  | )      |
|                                                                                         |   |     |   |     |   |
| Net cash  provided by (used in) operating activities                                         |   | 829      |   | (13,305  | )      |
|                                                                                         |   |     |   |     |   |
| Cash flows from  investing activities:                                                       |   |     |   |     |   |
| Purchase of  premises and equipment                                                          |   | (710     | )      | (448     | )      |
| Proceeds from  sale, maturity and call of investment securities available-for-sale           |   | 13,719   |   | 22,890   |   |
| Proceeds from  maturity and call of investment securities held-to-maturity                   |   | 3,490    |   | —   |   |
| Proceeds from  sale of other investments                                                     |   | 261      |   | —   |   |
| Purchase of  investment securities available-for-sale                                        |   | (55,485  | )      | (71,017  | )      |
| Purchase of  investment securities held-to-maturity                                          |   | (18,487  | )      | —   |   |
| Purchase of  other investments                                                               |   | (729     | )      | (1,023   | )      |
| Redemptions of  investment securities available-for-sale                                     |   | 3,602    |   | 11,537   |   |
| Redemptions of  investment securities held-to-maturity                                       |   | 5,389    |   | —   |   |
| Net (increase)  decrease in loans receivable                                                 |   | 1,274    |   | (2,781   | )      |
|                                                                                         |   |     |   |     |   |
| Net cash used in  investing activities                                                       |   | (47,676  | )      | (40,842  | )      |
|                                                                                         |   |     |   |     |   |
| Cash flows from  financing activities:                                                       |   |     |   |     |   |
| Net increase  (decrease) in deposits                                                         |   | 51,802   |   | (6,383   | )      |
| Net decrease in  other borrowed funds                                                        |   | (7,074   | )      | —   |   |
| Proceeds from  FHLB advances - long term                                                     |   | 5,000    |   | 25,000   |   |
| Repayments of  FHLB advances - long term                                                     |   | (625     | )      | (2,000   | )      |
| Proceeds from  public offering                                                               |   | 6,303    |   | —   |   |
| Stock options  exercised                                                                     |   | 89       |   | 10       |   |
| Dividends on  preferred stock                                                                |   | —   |   | (124     | )      |
|                                                                                         |   |     |   |     |   |
| Net cash  provided by financing activities                                                   |   | 55,495   |   | 16,503   |   |
|                                                                                         |   |     |   |     |   |
| Net increase  (decrease) in cash and cash equivalents                                        |   | 8,648    |   | (37,644  | )      |
|                                                                                         |   |     |   |     |   |
| Cash and cash  equivalents at beginning of the quarter                                       |   | 13,083   |   | 63,371   |   |
|                                                                                         |   |     |   |     |   |
| Cash and cash  equivalents at end of the quarter                                             |   | $        | 21,731 |     | $      | 25,727 |   |
|                                                                                         |   |     |   |     |   |
| **Supplemental  disclosure of cash flow information:**                                       |   |     |   |     |   |
| Cash paid during  the quarter for interest                                                   |   | $        | 2,574  |     | $      | 2,275 |   |

 

See accompanyingnotes to consolidated financial statements.

 

7

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CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

March 31, 2004

(Unaudited)

 

Note 1

 

*Organization*

 

Cardinal Financial Corporation (the ”Company”) was incorporated onNovember 24, 1997 under the laws of the Commonwealth of Virginia as a bankholding company whose activities consist of investment in its wholly-ownedsubsidiaries.  The Company openedCardinal Bank, N.A. in 1998 and Cardinal WealthServices, Inc., an investment services subsidiary, in 1999.  In 1999, the Company opened two additionalbanking subsidiaries and, in late 2000, completed an acquisition of HeritageBancorp, Inc. and its banking subsidiary, The Heritage Bank (“Heritage”).  These banking subsidiaries were consolidatedinto Cardinal Bank, N.A. as of March 1, 2002.

 

*Basisof Presentation*

 

In the opinion of management, the accompanying consolidated financialstatements have been prepared in accordance with the requirements of RegulationS-X, Article 10.  Accordingly, they donot include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements.  However, alladjustments that are, in the opinion of management, necessary for a fairpresentation have been included.  Theresults of operations for the three months ended March 31, 2004 are notnecessarily indicative of the results to be expected for the full year endingDecember 31, 2004.  The unauditedinterim financial statements should be read in conjunction with the auditedfinancial statements and notes to financial statements that are presented inthe Company’s Annual Report on Form 10-KSB for the year ended December 31, 2003(the “2003 Form 10-KSB”).

 

# *Stock-Based Compensation*

# * *

### At March 31, 2004, the Company had two stock-basedemployee compensation plans, the 1999 Stock Option Plan and the 2002 EquityCompensation Plan.  These plans aredescribed more fully in Footnote 14 of the 2003 Form 10-KSB.

###  

#### Aspermitted under Statement of Financial Accounting Standards (“SFAS”) No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure,* which amended SFAS No. 123, *Accounting for Stock-Based Compensation,*the Company has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation arrangements as defined byAccounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees,* and relatedinterpretations including Financial Accounting Standards Board InterpretationNo. 44, *Accounting for Certain TransactionsInvolving Stock Compensation,*an interpretation of APB No. 25.  The following table illustrates the effecton net income and earnings per common share as if the Company had applied thefair value recognition provisions of SFAS No. 123 to stock-based employeecompensation.

 

8

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|                                                                                                               |   | **Three Months Ended March 31,** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
| **(Dollars in thousands, except per share data)**                                                                  |   | **2004**                         |   | **2003** |   |
| Net income to  common shareholders                                                                                 |   | $                                | 719    |   | $ | 366 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value- based  method for all awards |   | (595                             | )      | (223 | ) |
| Pro forma net  income                                                                                              |   | $                                | 124    |   | $ | 143 |   |
|                                                                                                               |   |                             |   |   |   |
| Earnings per  common share:                                                                                        |   |                             |   |   |   |
| Basic - as reported                                                                                                |   | $                                | 0.04   |   | $ | 0.04 |   |
| Basic - as pro forma                                                                                               |   | 0.01                             |   | 0.01 |   |
| Diluted - as reported                                                                                              |   | 0.04                             |   | 0.04 |   |
| Diluted - as pro forma                                                                                             |   | 0.01                             |   | 0.01 |   |

 

Theweighted average per share fair values of grants made for the three monthsended March 31, 2004 and 2003 were $2.91 and $2.07, respectively.  The fair values of the options granted wereestimated on the grant date using the Black - Scholes option - pricing modelbased on the following weighted average assumptions:

 
|                     |   | **Three  Months Ended March 31,** |   |
|--------------------------|--------|-----------------------------------|--------|
|                     |   | **2004**                          |   | **2003** |   |
| Estimated option  life   |   | 10 years                          |   | 10 years |   |
| Risk free  interest rate |   | 3.99                              | %      | 4.25 | % |
| Expected  volatility     |   | 11.80                             | %      | 20.40 | % |
| Expected  dividend yield |   | 0.00                              | %      | 0.00 | % |

 

There were 286,518options granted during the three months ended March 31, 2004.  Of those grants, 175,204 immediately vestedon the grant date.

 

9

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### Note 2

###  

# *SegmentDisclosures*

# * *

The Company operates and reports in two business segments, commercialbanking and investment services.  Thecommercial banking segment includes both commercial and consumer lending andprovides customers such products as commercial loans, real estate loans, andother business financing and consumer loans. In addition, this segment also provides customers with several choicesof deposit products including demand deposit accounts, savings accounts andcertificates of deposit.  The investmentservices segment provides advisory services to businesses and individuals,including financial planning and retirement/estate planning.

 

Information about the reportable segments, and reconciliation of suchinformation to the consolidated financial statements as of and for the threemonths ended March 31, 2004 and 2003, follows:

 

**As ofand for the Three Months Ended March 31, 2004:**

 
| **(Dollars in  thousands)** |   | **Banking** |    | **Investment  Services** |   | **Intersegment  Elimination** |   | **Other** |    | **Consolidated** |   |
|-----------------------------|--------|-------------|---------|--------------------------|--------|-------------------------------|--------|-----------|---------|------------------|--------|
| Net interest income         |   | $           | 4,800   |                     | $      | —                        |   | $         | —  |             | $      | 33 |   | $ | 4,833 |   |
| Provision for loan losses   |   | 74          |    | —                   |   | —                        |   | —    |    | 74               |   |
| Non-interest income         |   | 699         |    | 178                      |   | —                        |   | —    |    | 877              |   |
| Non-interest expense        |   | 4,050       |    | 239                      |   | —                        |   | 266       |    | 4,555            |   |
| Provision for income taxes  |   | 462         |    | (21                      | )      |                          |   | (79       | )       | 362              |   |
| Net income (loss)           |   | $           | 913     |                     | $      | (40                           | )      | $         | —  |             | $      | (154 | ) | $ | 719 |   |
| Total assets                |   | $           | 687,543 |                     | $      | 741                           |   | $         | (88,338 | )                | $      | 93,505 |   | $ | 693,451 |   |

 

**As ofand for the Three Months Ended March 31, 2003:**

 
| **(Dollars in  thousands)** |   | **Banking** |    | **Investment  Services** |   | **Intersegment  Elimination** |   | **Other** |    | **Consolidated** |   |
|-----------------------------|--------|-------------|---------|--------------------------|--------|-------------------------------|--------|-----------|---------|------------------|--------|
| Net interest income         |   | $           | 3,432   |                     | $      | —                        |   | $         | —  |             | $      | 27 |   | $ | 3,459 |   |
| Provision for loan losses   |   | 80          |    | —                   |   | —                        |   | —    |    | 80               |   |
| Non-interest income         |   | 850         |    | 126                      |   | —                        |   | —    |    | 976              |   |
| Non-interest expense        |   | 3,389       |    | 168                      |   | —                        |   | 308       |    | 3,865            |   |
| Net income (loss)           |   | $           | 813     |                     | $      | (42                           | )      | $         | —  |             | $      | (281 | ) | $ | 490 |   |
| Total assets                |   | $           | 481,081 |                     | $      | 241                           |   | $         | (36,866 | )                | $      | 39,739 |   | $ | 484,195 |   |

 

The Company does not have any operating segments other than thosereported.  Parent company financialinformation is included in the “Other” category above and represents theoverhead function rather than an operating segment.  The parent company’s most significant assets are its netinvestments in its subsidiaries.  Theparent company’s net interest income is comprised of interest income fromfederal funds sold and other investments.

 

10

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#### Note 3

####  

##### *Earnings Per Common Share*

##### * *

The following is the calculation of basic and diluted earnings percommon share for the three months ended March 31, 2004 and 2003. Stock optionsoutstanding as of March 31, 2004 and 2003 were 1,108,835 and 873,412,respectively.  Stock options issued,which were not included in the calculation of diluted earnings per sharebecause the exercise prices were greater than the average market price, were10,000 and 291,667 for the three months ended March 31, 2004 and 2003,respectively.

 
| **(Dollars in thousands,  except share and per share data)** |     | **Three Months Ended March 31,** |     |
|--------------------------------------------------------------|----------|----------------------------------|----------|
|                                                         | **2004** |                             | **2003** |   |
|                                                         |     |                             |     |   |   |
| Net income                                                   |     | $                                | 719      |   | $ | 490 |   |
|                                                         |     |                             |     |   |   |
| Dividends to  preferred shareholders                         |     | —                           |     | 124 |   |
|                                                         |     |                             |     |   |   |
| Net income to  common shareholders                           |     | $                                | 719      |   | $ | 366 |   |
|                                                         |     |                             |     |   |   |
| Weighted average  common shares for basic                    |     | 17,461,000                       |     | 10,046,000 |   |
|                                                         |     |                             |     |   |   |
| Weighted average  common shares for diluted                  |     | 17,885,000                       |     | 10,171,000 |   |
|                                                         |     |                             |     |   |   |
| Basic earnings  per common share                             |     | $                                | 0.04     |   | $ | 0.04 |   |
|                                                         |     |                             |     |   |   |
| Diluted earnings  per common share                           |     | $                                | 0.04     |   | $ | 0.04 |   |

 

Note 4

 

##### *Goodwill*

##### * *

In 2001, the Company substantially eliminated the goodwill attributablefrom the acquisition of Heritage.  Theinitial investment in Heritage, which was subsequently renamed Cardinal Bank –Potomac, resulted in the Company recording $9.7 million of goodwill at the timeof the acquisition.  In the fourthquarter of 2001, an evaluation of 2001 losses and expectations of additionalfuture losses indicated a potential impairment in the Company’s investment inHeritage.  In compliance with SFAS No.121, the Company wrote down goodwill by $8.3 million based upon a valuationobtained from an independent third party consultant.  In 2003, the Company recognized the benefit of net operating losscarryforwards arising from the Heritage acquisition and, accordingly, this taxbenefit of $624,000 was utilized to reduce the Heritage goodwill.  Goodwill at March 31, 2004 and December 31,2003 was $22,000.

 

11

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

 

Thefollowing presents management’s discussion and analysis of our consolidatedfinancial condition as of March 31, 2004 and December 31, 2003 and the resultsof our operations for the three months ended March 31, 2004 and 2003.  This discussion should be read inconjunction with our unaudited consolidated financial statements and the notesthereto appearing elsewhere in this report.

 

**Overview**

 

Cardinal Financial Corporation, a financial servicesorganization headquartered in Tysons Corner, Virginia, is committed toproviding top quality customer service, a diversified product mix andconvenient avenues for banking to consumers and businesses.  We own Cardinal Bank, N.A., a nationallychartered community bank, and Cardinal Wealth Services, Inc., an investmentservices subsidiary.  Through these twosubsidiaries, we offer a wide range of banking products and services to bothour commercial and retail customers. Our commercial relationship managers focus on attracting small andmedium-sized business as well as commercial real estate developers and buildersand professionals, such as physicians, accountants and attorneys.  We have an expansive retail branch networkand develop competitive retail products and services.  We complement our core banking operations by offering investmentproducts and services to our customers through our third-party brokeragerelationship with Raymond James Financial Services, Inc.

 

Net interest income is our primary source ofincome.  As discussed further in ourinterest rate sensitivity section, we manage our balance sheet and interestrate risk to enhance our net interest income. We do this by monitoring the spread between the interest rates earned oninvestment securities and loans and the interest rates paid on deposits andother interest-bearing liabilities. Changes in interest rates will affect our operating performance andfinancial condition.  We attempt tominimize our exposure to interest rate risk, but are unable to eliminateit.   In addition to management ofinterest rate risk, we analyze our loan portfolio for exposure to creditrisk.  Risk of loan defaults andforeclosures are unavoidable in the banking industry, and we try to limit ourexposure to this risk by monitoring our extensions of credit carefully.  In addition to net interest income,non-interest income is a source of income for us and includes service chargeson deposits and loans, investment fee income and gains on sales on investmentsecurities available-for-sale.

** **

Our business strategy is to grow through geographicexpansion while maintaining strong asset quality and achieving sustainedprofitability.  We completed a secondarycommon stock offering that raised $41.7 million in capital in December 2003 andan additional $6.3 million in capital following the exercise of the underwriters’over-allotment option in January 2004. This capital is being used to support the expansion of our branch officenetwork and balance sheet growth.  Wewere able to increase our legal lending limit to over $12 million, which willallow us 

 

12

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to expand our commercialand real estate lending loan portfolios. We expect to increase our loan-to-deposit ratio and shift the mix of ourearning assets to higher yielding loans. We intend to increase our selection of banking products and financialservices in order to diversify our revenue base, increase fee income, andstrengthen customer relationships.

 

**CriticalAccounting Policies**

 

Accounting policies generally accepted in the United States are complexand require management to apply significant judgment to various accounting,reporting, and disclosure matters. Management must use assumptions and estimates to apply these principleswhere actual measurements are not possible or practical.  These policies are critical because they arehighly dependent upon subjective or complex judgments, assumptions andestimates.  Changes in such estimatesmay have a significant impact on the consolidated financial statements.  Actual results could differ from thoseestimates.

 

The accounting policies we view as critical to us are those relating toestimates and judgments regarding the determination of the allowance for loanlosses and the valuation of deferred tax assets.

 

#### *Allowance for Loan Losses*

 

We maintain the allowance for loan losses at a levelthat represents management’s best estimate of known and inherent losses in theloan portfolio.  Both the amount of theprovision expense and the level of the allowance for loan losses are impactedby many factors, including general economic conditions, actual and expectedcredit losses, historical trends and specific conditions of the individualborrower.  As a part of our analysis, weuse comparative peer group data, duration factors and qualitative factors suchas levels of and trends in delinquencies and nonaccrual loans, national andlocal economic trends and conditions and concentrations of loans exhibitingsimilar risk profiles to support our estimates.

** **

Credit losses are an inherent part of our businessand, although we believe the methodologies for determining the allowance forloan losses and the current level of the allowance are adequate, it is possiblethat there may be unidentified losses in the portfolio that may become evidentonly at a future date.  Additional provisionsfor such losses, if necessary, would be recorded in the commercial bankingsegment and would negatively impact earnings.

** **

For purposes of our analysis, we categorize our loansinto one of five categories:  commercialand industrial, commercial real estate, home equity lines of credit, residentialmortgages, and consumer.  Peer groupannual loss factors (in the absence of historical results) are applied to allcategories and are adjusted by the projected duration of the loans in aparticular category and by the qualitative factors mentioned above.  The indicated loss factors resulting fromthis analysis are applied to each of the loan categories to determine a reservelevel for each of the five categories of loans.  In addition, we individually assign loss factors to all loansthat have been identified as having loss attributes, as indicated bydeterioration in the financial condition of the borrower or a decline inunderlying collateral values.  Since wehave limited historical data on which to base loss factors for classifiedloans, we apply, in accordance with regulatory guidelines, a 5% loss factor toall special mention loans and a 15% loss factor to all substandard loans.

 

13

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#### *Valuation of Deferred Tax Assets*

 

Werecord a provision for income tax expense based on the amounts of current taxespayable (or refundable) and the change in net deferred tax assets orliabilities during the year.  Deferredtax assets and liabilities are recognized for the tax effects of differingcarrying values of assets and liabilities for tax and financial statementpurposes that will reverse in future periods. When substantial uncertainty exists concerning the recoverability of adeferred tax asset, the carrying value of the asset is reduced by a valuationallowance.

 

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

 

On March 9, 2004,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 105(“SAB No. 105”), *Application of AccountingPrinciples to Loan Commitments*. SAB No. 105 provides guidance regarding loan commitments accounted foras derivative instruments, and is effective for quarters beginning April 1,2004.  The Company is currentlyretaining substantially all of the loans it originates and therefore SAB No.105 is not expected to have a material impact.

##### * *

##### ***Statements of Operations***

 

Net income to common shareholders for the three months ended March 31,2004 and 2003 was $719,000 and $366,000, respectively, an improvement of$353,000, or 96.5%.  The increase in netincome to common shareholders is primarily a result of increased net interestincome.  In addition, on March 29, 2004,our preferred stock automatically converted to common stock.  As a result of the stock conversion, netincome to common shareholders for the first quarter of 2004 did not includeexpenses related to preferred stock dividends. Expenses for preferred dividends totaled $124,000 for the first quarterof 2003.  Net income for the firstquarter of 2004 also reflects an income tax provision of $362,000 compared tono tax provision for the same period in 2003. The 2003 results were not subject to a tax provision because ofavailable net operating loss carryforwards.

 

Basic and diluted earnings per common share were $0.04for each of the three months ended March 31, 2004 and 2003.  These results are presented after the effectof dividends paid to preferred shareholders in the 2003 period.  Dividends to preferred shareholders were $0and $124,000 for the three months ended March 31, 2004 and 2003,respectively.  Weighted average fullydiluted common shares outstanding for the three months ended March 31, 2004were 17,885,000 compared to 10,171,000 for the three months ended March 31,2003.

 

Return on average assets for the three months endedMarch 31, 2004 and 2003 was 0.43% and 0.42%, respectively.  Return on average equity for the threemonths ended March 31, 2004 and 2003 was 3.14% and 4.81%, respectively.  The decrease in the return on average equityis a result of the increased equity in 2004 compared to 2003 from our commonstock offering.

 

Net interest income represents the difference betweeninterest and fees earned on interest earning assets and the interest paid ondeposits and other interest bearing liabilities.  The level of net interest income is impacted primarily by variationsin the volume and mix of these assets and liabilities, as well as changes ininterest rates when compared to previous periods of operations.  Net interest income for the three monthsended March 31, 2004 and 2003 was $4.8 million and $3.5 million, respectively,a period-to-period increase of $1.4 million, or 39.7%.  The increase in net interest income is aresult of the increases in the average volume of investment securities andloans receivable, net of the impact of decreased yields, during 2004, comparedwith the same period of 2003.  Theseincreases were funded through the increases in total deposits, other borrowedfunds and proceeds from the common stock offering.

 

Our net interest margin for the three months endedMarch 31, 2004 and 2003 was 3.00% and 3.11%, respectively.  The decrease in the net interest margin wasa result of the change in the mix of earning assets towards lower yieldingearning assets and the decreased interest rate 

 

14

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environment.  Tables 1 and 2 present an analysis ofaverage earning assets, interest bearing liabilities and demand deposits withrelated components of interest income and interest expense.

 

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

Three MonthsEnded March 31, 2004, 2003 and 2002

(Dollars inthousands)

 
|                                                          |   | **2004**             |    | **2003**                       |   | **2002** |   |
|---------------------------------------------------------------|--------|----------------------|---------|--------------------------------|--------|----------|--------|
|                                                          |   | **Average  Balance** |    | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   |
| **Assets**                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                      |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Loans  (1):                                       |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                     |   | $                    | 59,327  |                           | $      | 796      |   | 5.37 | % | $ | 53,060 |   | $ | 833 |   | 6.28 | % | $ | 54,760 |   | $ | 964 |   | 7.04 | % |
| Real estate - commercial                                      |   | 137,776              |    | 2,223                          |   | 6.45     | %      | 115,685 |   | 2,064 |   | 7.14 | % | 86,345 |   | 1,744 |   | 8.08 | % |
| Real estate - construction                                    |   | 41,609               |    | 567                            |   | 5.45     | %      | 8,955 |   | 137 |   | 6.12 | % | 5,967 |   | 93 |   | 6.23 | % |
| Real estate - residential                                     |   | 42,871               |    | 617                            |   | 5.76     | %      | 34,284 |   | 577 |   | 6.73 | % | 17,655 |   | 357 |   | 8.09 | % |
| Home equity lines                                             |   | 44,829               |    | 363                            |   | 3.24     | %      | 28,352 |   | 241 |   | 3.40 | % | 21,615 |   | 226 |   | 4.18 | % |
| Consumer                                                      |   | 10,373               |    | 162                            |   | 6.25     | %      | 9,639 |   | 179 |   | 7.43 | % | 13,605 |   | 243 |   | 7.14 | % |
| Total loans                                                   |   | 336,785              |    | 4,728                          |   | 5.62     | %      | 249,975 |   | 4,031 |   | 6.45 | % | 199,947 |   | 3,627 |   | 7.26 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Investment securities available-for-sale          |   | 142,128              |    | 1,271                          |   | 3.58     | %      | 180,044 |   | 1,678 |   | 3.73 | % | 47,731 |   | 595 |   | 4.99 | % |
|   Investment securities held-to-maturity            |   | 150,016              |    | 1,350                          |   | 3.60     | %      | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|   Other investments                                 |   | 3,634                |    | 38                             |   | 4.18     | %      | 1,853 |   | 24 |   | 5.18 | % | 1,194 |   | 19 |   | 6.37 | % |
|   Federal funds sold                                |   | 12,146               |    | 28                             |   | 0.92     | %      | 13,503 |   | 39 |   | 1.16 | % | 37,961 |   | 154 |   | 1.62 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   Total interest-earning assets and interest income |   | 644,709              |    | 7,415                          |   | 4.60     | %      | 445,375 |   | 5,772 |   | 5.18 | % | 286,833 |   | 4,395 |   | 6.13 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                                  |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                       |   | 10,256               |    |                           |   |     |   | 14,720 |   |   |   |   |   | 13,280 |   |   |   |   |   |
| Premises and equipment, net                                   |   | 6,833                |    |                           |   |     |   | 5,007 |   |   |   |   |   | 5,015 |   |   |   |   |   |
| Accrued interest and other assets                             |   | 7,234                |    |                           |   |     |   | 5,113 |   |   |   |   |   | 1,836 |   |   |   |   |   |
| Allowance for loan losses                                     |   | (4,408               | )       |                           |   |     |   | (3,397 | ) |   |   |   |   | (3,103 | ) |   |   |   |   |
| Total assets                                                  |   | $                    | 664,624 |                           |   |     |   |   | $ | 466,818 |   |   |   |   |   | $ | 303,861 |   |   |   |   |   |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**                 |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                               |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                                  |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                             |   | 155,523              |    | 529                            |   | 1.36     | %      | 139,080 |   | 638 |   | 1.83 | % | 69,762 |   | 516 |   | 2.96 | % |
| Money markets                                                 |   | 24,470               |    | 36                             |   | 0.59     | %      | 26,131 |   | 69 |   | 1.06 | % | 25,947 |   | 133 |   | 2.05 | % |
| Statement savings                                             |   | 7,191                |    | 9                              |   | 0.50     | %      | 4,493 |   | 9 |   | 0.80 | % | 4,294 |   | 13 |   | 1.21 | % |
| Certificates of deposit                                       |   | 237,562              |    | 1,708                          |   | 2.88     | %      | 173,249 |   | 1,524 |   | 3.52 | % | 115,538 |   | 1,262 |   | 4.37 | % |
| Total interest - bearing deposits                             |   | 424,746              |    | 2,282                          |   | 2.15     | %      | 342,953 |   | 2,240 |   | 2.61 | % | 215,541 |   | 1,924 |   | 3.57 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                          |   | 73,545               |    | 300                            |   | 1.63     | %      | 14,957 |   | 73 |   | 1.95 | % | 9,398 |   | 97 |   | 4.13 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest expense       |   | 498,291              |    | 2,582                          |   | 2.07     | %      | 357,910 |   | 2,313 |   | 2.59 | % | 224,939 |   | 2,021 |   | 3.59 | % |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                              |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                               |   | 72,399               |    |                           |   |     |   | 66,638 |   |   |   |   |   | 55,985 |   |   |   |   |   |
| Other liabilities                                             |   | 2,204                |    |                           |   |     |   | 1,588 |   |   |   |   |   | 2,308 |   |   |   |   |   |
| Preferred shareholders’ equity                           |   | 6,391                |    |                           |   |     |   | 6,825 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common shareholders’ equity                              |   | 85,339               |    |                           |   |     |   | 33,857 |   |   |   |   |   | 13,804 |   |   |   |   |   |
| Total liabilities and shareholders’ equity               |   | $                    | 664,624 |                           |   |     |   |   | $ | 466,818 |   |   |   |   |   | $ | 303,861 |   |   |   |   |   |
|                                                          |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin (2)               |   |                 |    | $                              | 4,833  |     | 3.00   | % |   |   | $ | 3,459 |   | 3.11 | % |   |   | $ | 2,374 |   | 3.31 | % |

 

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(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 quarters presented.

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

 

15

----

 

**Rate and Volume Analysis**

Three MonthsEnded March 31, 2004, 2003 and 2002

(Dollars in thousands)

 
|                                      |   | **2004  Compared to 2003** |   | **2003  Compared to 2002** |   |
|-------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                      |   | **Change Due  to**         |   |                       |   | **Change Due  to** |   |   |   |
|                                      |   | **Average  Volume**        |   | **Average  Rate**          |   | **Increase  (Decrease)** |   | **Average  Volume** |   | **Average  Rate** |   | **Increase  (Decrease)** |   |
| **Interest  income:**                     |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Loans (1):                                |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                |   | $                          | 98     |                       | $      | (135 | ) | $ | (37 | ) | $ | (30 | ) | $ | (101 | ) | $ | (131 | ) |
| Real estate -  commercial                 |   | 394                        |   | (235                       | )      | 159 |   | 593 |   | (273 | ) | 320 |   |
| Real estate -  construction               |   | 500                        |   | (70                        | )      | 430 |   | 47 |   | (3 | ) | 44 |   |
| Real estate - residential                 |   | 145                        |   | (105                       | )      | 40 |   | 335 |   | (115 | ) | 220 |   |
| Home equity  lines                        |   | 140                        |   | (18                        | )      | 122 |   | 71 |   | (56 | ) | 15 |   |
| Consumer                                  |   | 14                         |   | (31                        | )      | (17 | ) | (71 | ) | 7 |   | (64 | ) |
| Total loans                               |   | 1,291                      |   | (594                       | )      | 697 |   | 945 |   | (541 | ) | 404 |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Investment  securities available-for-sale |   | (353                       | )      | (54                        | )      | (407 | ) | 1,649 |   | (566 | ) | 1,083 |   |
| Investment  securities held-to-maturity   |   | 1,350                      |   | —                     |   | 1,350 |   | — |   | — |   | — |   |
| Other  investments                        |   | 23                         |   | (9                         | )      | 14 |   | 10 |   | (5 | ) | 5 |   |
| Federal funds  sold                       |   | (4                         | )      | (7                         | )      | (11 | ) | (98 | ) | (17 | ) | (115 | ) |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Total interest  income                    |   | 2,307                      |   | (664                       | )      | 1,643 |   | 2,506 |   | (1,129 | ) | 1,377 |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:             |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Interest  checking                        |   | 75                         |   | (184                       | )      | (109 | ) | 521 |   | (399 | ) | 122 |   |
| Money markets                             |   | (4                         | )      | (29                        | )      | (33 | ) | 2 |   | (66 | ) | (64 | ) |
| Statement  savings                        |   | 5                          |   | (5                         | )      | — |   | 1 |   | (5 | ) | (4 | ) |
| Certificates of  deposit                  |   | 565                        |   | (381                       | )      | 184 |   | 656 |   | (394 | ) | 262 |   |
| Total interest -  bearing deposits        |   | 641                        |   | (599                       | )      | 42 |   | 1,180 |   | (864 | ) | 316 |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Other borrowed  funds                     |   | 286                        |   | (59                        | )      | 227 |   | 56 |   | (80 | ) | (24 | ) |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Total interest  expense                   |   | 927                        |   | (658                       | )      | 269 |   | 1,236 |   | (944 | ) | 292 |   |
|                                      |   |                       |   |                       |   |   |   |   |   |   |   |   |   |
| Net interest  income (2)                  |   | $                          | 1,380  |                       | $      | (6 | ) | $ | 1,374 |   | $ | 1,270 |   | $ | (185 | ) | $ | 1,085 |   |

 

----

(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 the quarterspresented.

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

 

16

----

 

Provision for loan losses for the three months endedMarch 31, 2004 and 2003 was $74,000 and $80,000, respectively.  The allowance for loan losses at each ofMarch 31, 2004 and December 31, 2003 was $4.3 million.    Our allowance for loan loss ratio at March31, 2004 was 1.30%, compared to 1.29% at December 31, 2003.  We continued to experience strong loanquality with annualized net charged-off loans equal to 0.08% to total loans forthe three months ended March 31, 2004, compared to 0.03% for the same period of2003.  Non-performing loans were equalto 0.07% of total loans at March 31, 2004, compared to 0.12% at December 31,2003.  Additional information on theallowance for loan losses, its allocation to the total loans receivableportfolio and information on nonperforming loans can be found in Tables 3, 4and 5.

 

**Allowance for Loan Losses**

Three Months Ended March 31, 2004 and 2003

(Dollars in thousands)

 
|                          |   | **2004** |   | **2003** |   |
|-------------------------------|--------|----------|--------|----------|--------|
| Beginning  balance, January 1 |   | $        | 4,344  |     | $      | 3,372 |   |
|                          |   |     |   |     |   |
| Provision for  loan losses    |   | 74       |   | 80       |   |
|                          |   |     |   |     |   |
| Loans charged  off:           |   |     |   |     |   |
| Commercial and  industrial    |   | (74      | )      | (60      | )      |
| Real estate -  commercial     |   | —   |   | —   |   |
| Real estate -  construction   |   | —   |   | —   |   |
| Real estate -  residential    |   | —   |   | —   |   |
| Home equity  lines            |   | —   |   | —   |   |
| Consumer                      |   | (1       | )      | (3       | )      |
| Total loans  charged off      |   | (75      | )      | (63      | )      |
|                          |   |     |   |     |   |
| Recoveries:                   |   |     |   |     |   |
| Commercial and  industrial    |   | 2        |   | 40       |   |
| Real estate -  commercial     |   | —   |   | —   |   |
| Real estate -  construction   |   | —   |   | —   |   |
| Real estate -  residential    |   | —   |   | —   |   |
| Home equity  lines            |   | —   |   | —   |   |
| Consumer                      |   | 2        |   | 2        |   |
| Total recoveries              |   | 4        |   | 42       |   |
|                          |   |     |   |     |   |
| Net (charge  offs) recoveries |   | (71      | )      | (21      | )      |
|                          |   |     |   |     |   |
| Ending balance                |   | $        | 4,347  |     | $      | 3,431 |   |

 
|                                                        |   | **March 31,  2004** | ** ** | **December  31,  2003** | ** ** |
|-------------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
| Loans:                                                      |   |                |       |                    |       |
| Balance at  period end                                      |   | $                   | 334,746    |                    | $          | 336,002 |   |
| Allowance for  loan losses to loans receivable, net of fees |   | 1.30                | %          | 1.29                    | %          |
| Annualized net  charge-offs to average loans receivable     |   | 0.08                | %          | 0.01                    | %          |
|                                                             |        |                     |            |                         |            |  |  |

 

17

----

 

**Allocation of theAllowance for Loan Losses**

At March 31, 2004 and December 31, 2003

(Dollars inthousands)

 
|                             |   | **March 31,  2004** |   | **December  31,  2003** |       |
|----------------------------------|--------|---------------------|--------|-------------------------|------------|
|                             |   | **Allocation**      |   | **% of  Total***        | ** ** | **Allocation** | ** ** | **% of  Total*** | ** ** |
| Commercial                       |   | $                   | 1,094  |                    | 16.35      | % | $ | 1,046 |   | 17.21 | % |
| Real estate -  commercial        |   | 1,532               |   | 40.81                   | %          | 1,662 |   | 41.56 | % |
| Real estate -  construction      |   | 552                 |   | 12.92                   | %          | 497 |   | 12.57 | % |
| Real estate -  residential       |   | 436                 |   | 12.93                   | %          | 418 |   | 12.64 | % |
| Home equity  lines               |   | 546                 |   | 14.06                   | %          | 486 |   | 12.84 | % |
| Consumer                         |   | 187                 |   | 2.93                    | %          | 235 |   | 3.18 | % |
|                             |   |                |   |                    |       |   |   |   |   |
| Total allowance  for loan losses |   | $                   | 4,347  |                    | 100.00     | % | $ | 4,344 |   | 100.00 | % |

 

----

* Percentage ofloan type to the total loan portfolio.

 

18

----

 

**Nonperforming LoansReceivable**

At March 31, 2004 and December 31, 2003

(Dollars in thousands)

 
|                                          |   | **March 31,  2004** |   | **December  31,  2003** |   |
|-----------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Nonaccruing  loans                            |   | $                   | 237    |                    | $      | 390 |   |
|                                          |   |                |   |                    |   |
| Loans  contractually past-due 90 days or more |   | 4                   |   | 4                       |   |
|                                          |   |                |   |                    |   |
| Troubled debt  restructurings                 |   | —              |   | —                  |   |
| Total  nonperforming loans receivable         |   | $                   | 241    |                    | $      | 394 |   |

 

19

----

 

Non-interest income for the three months ended March31, 2004 and 2003 was $877,000 and $976,000, respectively, a period-to-perioddecrease of $99,000, or 10.1%.  Thedecrease in non-interest income is primarily attributable to the decrease inrealized gains on sales of investment securities available-for-sale during thefirst quarter of 2004.  These gains wererecorded on sales of mortgage-backed securities with accelerated pre-paymentspeeds.  Excluding the realized gains onthe sale of investment securities of $241,000 and $493,000 for the firstquarters of 2004 and 2003, respectively, non-interest income would haveincreased $153,000 to $636,000 for the first quarter of 2004, compared to$483,000 for the first quarter of 2003. Service charges on deposit accounts increased $36,000 to $170,000 forthe three months ended March 31, 2004, compared to $134,000 for the same periodof 2003.  Loan service charge incomeincreased $82,000 to $195,000 for the three months ended March 31, 2004,compared to $113,000 for the same period of 2003.  Investment fee income increased to $178,000 for the three monthsended March 31, 2004, compared to $126,000 for the three months ended March 31,2003.

 

Non-interestexpense for the three months ended March 31, 2004 was $4.6 million, compared to$3.9 million for the same period of 2003, an increase of $690,000, or17.9%.  The increase is attributable tothe branch expansion we have completed over the past twelve months.  We opened our twelfth branch on February 27,2004 in Herndon, Virginia.  In addition,our Tysons Corner, Leesburg and Woodbridge branches opened during the third andfourth quarters of 2003 and are not included in the non-interest expense forthe three-month period of 2003. Expenses related to the branch expansion are represented in theincreases in our salaries and benefits expense, occupancy expense anddepreciation expense.  Other operatingexpenses on our statements of operations includes business development, dataprocessing and communications expenses, and office administration expenses.

 

The effective tax rate for the first quarter of 2004 was 33.5%, comparedto 0% for the same period of 2003.  Theincrease in the effective tax rate is a result of having recognized ourdeferred tax assets related to the net operating loss carryforwards during thefourth quarter of 2003.  We recorded aprovision for income tax expense of $362,000 for the three months ended March31, 2004, compared to none for the same three-month period of 2003.    For more information, see “CriticalAccounting Policies” above in this discussion.

 

20

----

 

**Statementsof Condition**

 

Total assets were $693.5 million at March 31, 2004,compared to $636.2 million at December 31, 2003, an increase of $57.3 millionor 9.0%.  This growth was driven byincreases in total deposits and the proceeds raised in the common stockoffering during December 2003 and the first quarter of 2004.

 

Investment securities were $322.1 million at March 31,2004, compared to $273.6 million at December 31, 2003, an increase of $48.5million or 17.7%.  The investmentportfolio consists of investment securities available-for-sale and investmentsecurities held-to-maturity.  Investmentsecurities held-to-maturity are those securities that we have the intent andability to hold to maturity and are carried at amortized cost.  These securities are utilized for pledgingof advances from the Federal Home Loan Bank and other borrowingactivities.  Investment securitiesavailable-for-sale are those securities that we intend to hold for anindefinite period of time, but not necessarily until maturity.  These securities are carried at fair valueand may be sold as part of an asset/liability strategy, liquidity management,interest rate risk management, regulatory capital management or similarfactors.  At March 31, 2004, investmentsecurities available-for-sale were $168.0 million and investment securitiesheld-to-maturity were $154.1 million. See Table 6 for additional information on our investment securitiesportfolio.

 

**InvestmentSecurities**

At March 31, 2004 and December 31, 2003

(Dollars in thousands)

 
| **Available-for-sale at March 31,  2004**                          |   | **Amortized  Cost** |    | **Fair  Value** |   | **Average  Yield** |   |
|--------------------------------------------------------------------|--------|---------------------|---------|-----------------|--------|--------------------|--------|
| Obligations of  U.S. government-sponsored agencies and enterprises |   |                |    |            |   |               |   |
| Five to ten  years                                                 |   | $                   | 4,000   |            | $      | 4,047              |   | 4.11 | % |
| Total U.S.  government-sponsored agencies                          |   | $                   | 4,000   |            | $      | 4,047              |   | 4.11 | % |
|                                                               |   |                |    |            |   |               |   |
| Mortgage-backed  securities*                                       |   |                |    |            |   |               |   |
| Five to ten  years                                                 |   | $                   | 15,659  |            | $      | 15,724             |   | 3.79 | % |
| After ten years                                                    |   | 135,805             |    | 136,108         |   | 3.79               | %      |
| Total  mortgage-backed securities                                  |   | $                   | 151,464 |            | $      | 151,832            |   | 3.79 | % |
|                                                               |   |                |    |            |   |               |   |
| Corporate bonds                                                    |   |                |    |            |   |               |   |
| After ten years                                                    |   | $                   | 10,000  |            | $      | 10,016             |   | 2.42 | % |
| Total corporate  bonds                                             |   | $                   | 10,000  |            | $      | 10,016             |   | 2.42 | % |
|                                                               |   |                |    |            |   |               |   |
| Treasury bonds                                                     |   |                |    |            |   |               |   |
| One to five  years                                                 |   | $                   | 2,044   |            | $      | 2,086              |   | 2.63 | % |
| Total treasury  bonds                                              |   | $                   | 2,044   |            | $      | 2,086              |   | 2.63 | % |
| Total investment  securities available-for-sale                    |   | $                   | 167,508 |            | $      | 167,981            |   | 3.70 | % |

 
| **Held-to-maturity at March 31, 2004**                             |   | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|--------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of  U.S. government-sponsored agencies and enterprises |   |                |       |            |       |               |       |
| One to five  years                                                 |   | $                   | 5,999      |            | $          | 6,041              |       | 3.26 | % |
| Five to ten  years                                                 |   | 16,977              |       | 17,119          |       | 4.51               | %          |
| After ten years                                                    |   | 2,999               |       | 2,993           |       | 4.20               | %          |
| Total U.S.  government-sponsored agencies                          |   | $                   | 25,975     |            | $          | 26,153             |       | 4.19 | % |
|                                                               |   |                |       |            |       |               |       |
| Mortgage-backed  securities*                                       |   |                |       |            |       |               |       |
| Five to ten  years                                                 |   | $                   | 9,069      |            | $          | 9,078              |       | 3.08 | % |
| After ten years                                                    |   | 111,096             |       | 111,141         |       | 3.83               | %          |
| Total  mortgage-backed securities                                  |   | $                   | 120,165    |            | $          | 120,219            |       | 3.77 | % |
|                                                               |   |                |       |            |       |               |       |
| Corporate bonds                                                    |   |                |       |            |       |               |       |
| After ten years                                                    |   | $                   | 8,000      |            | $          | 8,003              |       | 4.21 | % |
| Total corporate  bonds                                             |   | $                   | 8,000      |            | $          | 8,003              |       | 4.21 | % |
| Total investment  securities held-to-maturity                      |   | $                   | 154,140    |            | $          | 154,375            |       | 3.87 | % |
|                                                               |   |                |       |            |       |               |       |
| Total investment  securities                                       |   | $                   | 321,648    |            | $          | 322,356            |       | 3.78 | % |

 

----

* Based oncontractual maturities.

 

21

----

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

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

 

----

* Based oncontractual maturities.

 

22

----

 

Loansreceivable, net of fees, decreased slightly, by $1.5 million or 0.5%, to $334.5million at March 31, 2004 from $336.0 million at December 31, 2003 (see Table 7for details on the loans receivable portfolio). We experienced decreases in ourcommercial and commercial real estate loan portfolios offset by increases inour construction, residential real estate and home equity loan portfolios.  The decreases in our commercial andcommercial real estate loan portfolios are the result of more paydowns thanfundings in those loan categories.  Weexpect increases within these loan categories over the next three quarters of2004 due to our increased legal lending limit of $12.0 million and the volumeof loans we have scheduled for funding.

 

**Loans Receivable**

At March 31, 2004 and December 31, 2003

(Dollars in thousands)

 
|                             |   | **March 31,  2004** |    | **December  31, 2003** |   |
|----------------------------------|--------|---------------------|---------|------------------------|--------|
|                             |   |                |    |                   |   |   |   |   |   |
| Commercial                       |   | $                   | 54,723  |                   | 16.35  | % | $ | 57,854 |   | 17.21 | % |
| Real estate -  commercial        |   | 136,541             |    | 40.81                  | %      | 139,725 |   | 41.56 | % |
| Real estate -  construction      |   | 43,214              |    | 12.92                  | %      | 42,243 |   | 12.57 | % |
| Real estate -  residential       |   | 43,273              |    | 12.93                  | %      | 42,495 |   | 12.64 | % |
| Home equity  lines               |   | 47,049              |    | 14.06                  | %      | 43,176 |   | 12.84 | % |
| Consumer                         |   | 9,807               |    | 2.93                   | %      | 10,690 |   | 3.18 | % |
|                             |   |                |    |                   |   |   |   |   |   |
| Gross loans                      |   | $                   | 334,607 |                   | 100.00 | % | $ | 336,183 |   | 100.00 | % |
|                             |   |                |    |                   |   |   |   |   |   |
| Add: net  deferred (fees) costs  |   | (131                | )       |                   |   | (181 | ) |   |   |
| Less: allowance  for loan losses |   | (4,347              | )       |                   |   | (4,344 | ) |   |   |
|                             |   |                |    |                   |   |   |   |   |   |
| Loans  receivable, net           |   | $                   | 330,129 |                   |   |   | $ | 331,658 |   |   |   |

 

23

----

 

Total deposits increased $51.8 million, or 9.9%, to$525.9 million at March 31, 2004, compared to $474.1 million at December 31,2003 (see Table 8 for details on certificates of deposit with balances of $100,000or more).  We experienced increases innon-interest bearing demand deposits, money market and savings deposits andcertificates of deposit.  The increasein deposits is a result of new customers from our branch expansion andincreased advertising efforts.

 

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

At March 31, 2004

(Dollars in thousands)

 
| **Maturities:**                        |   |   |    |
|----------------------------------------|--------|--------|---------|
| Three months or  less                  |   | $      | 12,279  |   |
| Over three  months through six months  |   | 14,599 |    |
| Over six months  through twelve months |   | 25,362 |    |
| Over twelve months                     |   | 63,885 |    |
|                                   |   | $      | 116,125 |   |

 

24

----

 

Other borrowed funds decreased $2.7 million to $71.8 million at March 31,2004, compared to $74.5 million at December 31, 2003.  We had Federal Home Loan Bank advances that matured during thefirst quarter of 2004 and replaced them with lower cost borrowings from thetreasury, tax and loan note option of the Federal Reserve System.  Table 9 provides information on ourshort-term borrowings.

 

**Short-Term Borrowings**

At March 31, 2004

(Dollars in thousands)

 
| **Advance Date**            |   | **Interest  Rate** |   | **Term of  Advance** |   | **Date  Amount  Due** |   | **Outstanding** |   |
|-----------------------------|--------|--------------------|--------|----------------------|--------|-----------------------|--------|-----------------|--------|
| Dec-03                      |   | 1.23               | %      | 12 months            |   | Dec-04                |   | $               | 5,000  |   |
| Jan-04                      |   | 1.56               | %      | 12 months            |   | Jan-05                |   | 5,000           |   |
|                        |   | 1.40               | %      |                 |   |                  |   | $               | 10,000 |   |
| All other  borrowed funds   |   |               |   |                 |   |                  |   | 61,758          |   |
| Total other  borrowed funds |   |               |   |                 |   |                  |   | $               | 71,758 |   |

 

25

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Shareholders’ equity at March 31, 2004 was $93.3 million, an increase of$7.9 million, or 9.3%, compared to $85.4 million at December 31, 2003. Theincrease of $7.9 million from the prior year was primarily driven by theunderwriters’ exercise in January 2004 of their over allotment option from thesecondary offering in December 2003. The over-allotment exercise resulted in the issuance of an additional945,000 shares of the Company’s common stock and the receipt of $6.3 million intotal capital.  Net income of $719,000for the quarter ended March 31, 2004 also added to the increase inshareholders’ equity for the period.  Inaddition, the Company had a favorable market value adjustment of $817,000 oninvestment securities available-for-sale as of March 31, 2004.  Book value per common share at March 31,2004 was $5.08, compared to $4.80 at December 31, 2003.

 

**Business Segment Operations**

 

We provide banking and non-banking financial servicesand products through our subsidiaries. Management operates and reports on the results of our operations throughtwo business segments, commercial banking and investment services**.**

 

#### *Commercial Banking*

 

The commercial banking segment provides a wide range of banking servicesto small businesses and individuals through multiple delivery channels.  Services offered include commercial andconsumer lending, deposit products and banking via the Internet or telephone.

 

For the three months ended March 31, 2004, the commercial banking segmentrecorded net income of $913,000 compared to $813,000 for the three months endedMarch 31, 2003, an improvement of $100,000. The improvement in earnings is a result of increased net interestincome, due to increased volume of earning assets for this segment.  As of March 31, 2004, total assets were$687.5 million, loans receivable, net of fees, were $334.5 million and totaldeposits were $525.9 million.  As ofMarch 31, 2003, total assets were $481.1 million, loans receivable, net of feeswere $252.0 million and total deposits were $417.1 million.

 

#### *Investment Services*

 

The investment services segment provides investmentand financial services through an affiliation with a third party broker-dealer.

 

For the three months ended March 31, 2004, theinvestment services segment recorded a net loss of $40,000, compared to a lossof $42,000 during the same period of 2003, an improvement of $2,000.  As of March 31, 2004, total assets were $741,000and total assets under management were $175.8 million.  As of March 31, 2003, total assets were$241,000 and total assets under management were $84.6 million.  The revenues and assets under managementfrom this business segment have increased for the three months ended March 31,2004 compared to the same period of 2003 as a result of increased transactionactivity and accumulation of assets under management through new customers tothis business segment.  The financialresults of this business segment should continue to improve as the assets undermanagement increase.

 

Information pertaining to both business segments canbe found in Footnote 2 to the Notes to Consolidated Financial Statements.

 

26

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## ***Capital Resources***

 

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

 

Regulatory agencies measure capital adequacy utilizinga formula that takes into account the individual risk profile of a financialinstitution.  The guidelines definecapital as both tier 1 (primarily common shareholders’ equity, defined toinclude certain debt obligations) and tier 2 (certain other debt obligationsand a portion of the allowance for loan losses and 45% of unrealized gains inequity securities).

 

At March 31, 2004, our tier 1 and total (tier 1 andtier 2) risk-based capital ratios were 19.9% and 20.8%, respectively.  At December 31, 2003, our tier 1 and totalrisk-based capital ratios were 19.7% and 20.7%, respectively.  Our regulatory capital levels for the bankand bank holding company meet those established for well-capitalizedinstitutions. Table 10 provides additional information pertaining to ourcapital ratios.

 

**Capital Components**

At March 31,2004 and December 31, 2003

(Dollars inthousands)

 
|                                                  |   | **Actual** |   | **For  Capital  Adequacy Purposes** |   | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** |   |
|-------------------------------------------------------|--------|------------|--------|-------------------------------------|--------|-------------------------------------------------------------------------|--------|
|                                                  |   | **Amount** |   | **Ratio**                           |   | **Amount**                                                              |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                                  |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |
| **At  March 31, 2004**                                |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |
| Total risk based  capital to net risk-weighted assets |   | $          | 97,352 |                                | 20.84  | %                                                                       | $      | 37,363 | > | 8.00 | % | $ | 46,704 | > | 10.00 | % |
| Tier I capital  to net risk-weighted assets           |   | 93,006     |   | 19.91                               | %      | 18,682                                                                  | >   | 4.00 | % | 28,022 | > | 6.00 | % |
| Total risk based  capital to average total assets     |   | 97,352     |   | 14.65                               | %      | 26,585                                                                  | >   | 4.00 | % | 33,231 | > | 5.00 | % |
|                                                  |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |
| **At  December 31, 2003**                             |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |
| Total risk based  capital to net risk-weighted assets |   | $          | 90,239 |                                | 20.66  | %                                                                       | $      | 34,951 | > | 8.00 | % | $ | 43,688 | > | 10.00 | % |
| Tier I capital  to net risk-weighted assets           |   | 85,896     |   | 19.66                               | %      | 17,475                                                                  | >   | 4.00 | % | 26,213 | > | 6.00 | % |
| Total risk based  capital to average total assets     |   | 90,239     |   | 15.45                               | %      | 23,365                                                                  | >   | 4.00 | % | 29,206 | > | 5.00 | % |

 

27

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As of March 31, 2004, there were no material changes in our contractualobligations as presented in the 2003 Form 10-KSB.

 

## ***Liquidity***

 

The objective of liquidity management is to ensure thecontinuous availability of funds to meet the demands of depositors, investorsand borrowers.  Stable core deposits anda strong capital position are the current components of a solid foundation forour liquidity position.  In addition,the availability of regional and national wholesale funding sources includingfederal funds purchased, negotiable certificates of deposit, securities soldunder agreements to repurchase, and borrowings from the Federal Home Loan Bankenhance our liquidity.  Cash flows fromoperations, such as loan payments and payoffs are also a significant source ofliquidity.  We have a contingency planthat provides for continued monitoring of liquidity needs and available sourcesof liquidity.  We believe we have theability to meet our increased liquidity needs. Liquid assets, which include cash and due from banks, federal funds soldand investment securities available-for-sale totaled $189.7 million, or 27.4%of total assets, at March 31, 2004.  Wehad investment securities that are classified as held-to-maturity of $154.1million at March 31, 2004.  We also had$201.3 million of our total investment securities portfolio available ascollateral for additional Federal Home Loan Bank borrowings.  Management is committed to maintaining liquidityat a level sufficient to protect depositors, provide for reasonable growth andfully comply with all regulatory requirements.

 

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

 

Asset/liability management involves the monitoring ofour sensitivity to interest rate movements. In order to measure the effect of interest rates on our net interestincome, we take into consideration the expected cash flows from the loan andinvestment securities portfolios and the expected magnitude of the repricing ofspecific asset and liability categories. Management evaluates interest sensitivity risk and then formulatesguidelines to manage this risk based upon its outlook regarding the economy,forecasted interest rate movements and other business factors.

 

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Management’s goal is tomaximize and stabilize the net interest margin by limiting exposure to interestrate changes.

 

The data in Table 11 reflects the repricing orexpected maturities of various assets and liabilities at March 31, 2004.  This “gap” analysis represents thedifference between interest sensitive assets and liabilities in a specific timeinterval.  The interest sensitivity gapanalysis presents a position that existed at one particular point in time, andassumes that assets and liabilities with similar repricing characteristics willreprice at the same time and to the same degree.

 

**Interest Rate Sensitivity Gap Analysis**

At March 31,2004

(Dollars inthousands)

 
|                                                                         |   | **Immediate  Repricing** |    | **2-90  Days** |   | **91-180  Days** |   | **181-365  Days** |    | **1-3  Years** |   | **Over 3  Years** |   | **TOTAL** |    |
|------------------------------------------------------------------------------|--------|--------------------------|---------|----------------|--------|------------------|--------|-------------------|---------|----------------|--------|-------------------|--------|-----------|---------|
| **Assets**                                                                   |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| Total investment  securities and other investments                           |   | $                        | —  |           | $      | 11,447           |   | $                 | 13,477  |           | $      | 26,343            |   | $         | 106,091 |   | $ | 168,749 |   | $ | 326,107 |   |
| Federal funds  sold                                                          |   | 11,381                   |    | —         |   | —           |   | —            |    | —         |   | —            |   | 11,381    |    |
| Loans held for  sale                                                         |   | 688                      |    | —         |   | —           |   | —            |    | —         |   | —            |   | 688       |    |
| **Loans  Receivable, net of fees**                                           |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| Commercial &  industrial                                                 |   | 36                       |    | 174,364        |   | 39               |   | 188               |    | 2,865          |   | 13,641            |   | 191,133   |    |
| Residential                                                                  |   | —                   |    | 18,308         |   | 434              |   | 1,293             |    | 1,613          |   | 21,625            |   | 43,273    |    |
| Home equity lines                                                            |   | —                   |    | 42,040         |   | 3,929            |   | 1,080             |    | —         |   | —            |   | 47,049    |    |
| Construction                                                                 |   | —                   |    | 30,754         |   | 456              |   | 6,118             |    | 5,886          |   | —            |   | 43,214    |    |
| All other                                                                    |   | 1,002                    |    | 4,044          |   | 87               |   | 34                |    | 417            |   | 4,223             |   | 9,807     |    |
| **Total  loans receivable, net of fees**                                     |   | 1,038                    |    | 269,510        |   | 4,945            |   | 8,713             |    | 10,781         |   | 39,489            |   | 334,476   |    |
| **Total  earning assets**                                                    |   | 13,107                   |    | 280,957        |   | 18,422           |   | 35,056            |    | 116,872        |   | 208,238           |   | 672,652   |    |
| **Cumulative  rate sensitive assets**                                        |   | $                        | 13,107  |           | $      | 294,064          |   | $                 | 312,486 |           | $      | 347,542           |   | $         | 464,414 |   | $ | 672,652 |   |   |   |
|                                                                         |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| **Liabilities**                                                              |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| **Deposits**                                                                 |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| Noninterest-bearing  demand                                                  |   | $                        | —  |           | $      | —           |   | $                 | —  |           | $      | —            |   | $         | —  |   | $ | 81,466 |   | $ | 81,466 |   |
| Interest-bearing  transaction accounts                                       |   | 36,658                   |    | 18,329         |   | 18,329           |   | 18,329            |    | 18,329         |   | 73,316            |   | 183,290   |    |
| Certificates of  deposit - fixed                                             |   | 29                       |    | 12,842         |   | 12,766           |   | 23,528            |    | 48,102         |   | 14,288            |   | 111,555   |    |
| Certificates of  deposit - no penalty                                        |   | 273                      |    | 15,412         |   | 24,013           |   | 27,606            |    | 82,316         |   | —            |   | 149,620   |    |
| **Total  deposits**                                                          |   | 36,960                   |    | 46,583         |   | 55,108           |   | 69,463            |    | 148,747        |   | 169,070           |   | 525,931   |    |
| Other borrowed  funds                                                        |   | 24,425                   |    | 625            |   | 4,625            |   | 19,250            |    | 6,000          |   | 16,833            |   | 71,758    |    |
| **Total  deposits & other borrowed funds**                               |   | 61,385                   |    | 47,208         |   | 59,733           |   | 88,713            |    | 154,747        |   | 185,903           |   | 597,689   |    |
| **Cumulative  rate sensitive liabilities**                                   |   | $                        | 61,385  |           | $      | 108,593          |   | $                 | 168,326 |           | $      | 257,039           |   | $         | 411,786 |   | $ | 597,689 |   |   |   |
|                                                                         |   |                     |    |           |   |             |   |              |    |           |   |              |   |      |    |
| **Gap**                                                                      |   | $                        | (48,278 | )              | $      | 233,749          |   | $                 | (41,311 | )              | $      | (53,657           | )      | $         | (37,875 | ) | $ | 22,335 |   |   |   |
| **Cumulative  gap**                                                          |   | (48,278                  | )       | 185,471        |   | 144,160          |   | 90,503            |    | 52,628         |   | 74,963            |   |      |    |
| **Gap/  total assets**                                                       |   | -6.96                    | %       | 33.71          | %      | -5.96            | %      | -7.74             | %       | -5.46          | %      | 3.22              | %      |      |    |
| **Cumulative  gap/ total assets**                                            |   | -6.96                    | %       | 26.75          | %      | 20.79            | %      | 13.05             | %       | 7.59           | %      | 10.81             | %      |      |    |
| **Rate  sensitive assets/ rate sensitive liabilities**                       |   | 0.21                     |    | 5.95           |   | 0.31             |   | 0.40              |    | 0.76           |   | 1.12              |   |      |    |
| **Cumulative  rate sensitive assets/ cumulative rate sensitive liabilities** |   | 0.21                     |    | 2.71           |   | 1.86             |   | 1.35              |    | 1.13           |   | 1.13              |   |      |    |

 

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**Forward-LookingStatements**

 

This Quarterly Report contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934.  These forward-looking statements are not historical facts, butrather are predictions and generally can be identified by use of statementsthat include phrases such as “believe,” “expect,” “anticipate,” “estimate,”“intend,” “plan, “ “foresee” or other words or phrases of similar import.  Similarly, statements that describe ourfuture financial condition or results of operations, objectives, strategies,plans, goals or future performance and business also are forward-lookingstatements.  These forward-lookingstatements involve known and unknown risks, uncertainties and other factors,including those described in the 2003 Form 10-KSB under “Caution AboutForward-Looking Statements,” that could cause our actual results to differmaterially from those currently anticipated in these forward-lookingstatements.  In light of these risks anduncertainties, forward-looking events might or might not occur.

 

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

 

Our Asset/ Liability Committee is responsible forreviewing our liquidity requirements and maximizing our net interest income,consistent with capital requirements, liquidity, interest rate and economicoutlooks, competitive factors and customer needs.  One of thetools we use to determine our interest rate risk is gap analysis.  Gap analysis attempts to examine the volumeof interest rate sensitive assets less interest rate sensitive liabilities invarious time intervals.  The differenceis the interest sensitivity gap, which indicates how future changes in interestrates may affect net interest income. Interest sensitivity gap analysis presents a position that exists at oneparticular point in time and assumes that assets and liabilities with similarcharacteristics will re-price at the same time and to the same degree.  Under our asset/liability policies,regardless of whether interest rates are expected to increase or decrease, theobjective is to maintain a gap position that will minimize any changes in netinterest income.  A negative gap, orliability sensitive position, exists when we have more interest sensitive liabilitiesmaturing within a certain gap interval than interest sensitive assets.  Under this scenario, if interest rates wereto increase, it would tend to reduce interest income.

 

We can reprice our interestchecking, savings, and money market accounts at any time.  We carefully analyze the impact of anydecrease in interest rates on our deposits, as we may experience a runoff indeposit balances as a result of such changes in interest rates.  Based on the degree and frequency ofmovement being limited in practice, we have classified 20% of these deposits inour immediate gap interval, 10% of these deposits in each of the gap intervalsfrom 2-90 days through the 1-3 year gap interval, leaving the remaining portionor 40% of these deposits in the over 3 year gap interval.  We continue to analyze the activity in ourdeposit portfolio and make changes in our gap assumptions as the activitydictates. See Table 11 from our management’s discussion and analysis above,which reflects the repricing or expected maturities of various assets andliabilities at March 31, 2004.  This“gap” analysis represents the difference between interest sensitive assets andliabilities in a specific time interval. The interest sensitivity gap analysis presents a position that existedat one particular point in time, and assumes that assets and liabilities withsimilar repricing characteristics will reprice at the same time and to the samedegree.

 

We also use a simulationprocess to measure interest rate risk and the impact of rate fluctuations onnet interest income.  These simulationsincorporate assumptions regarding balance sheet growth and mix, and there-pricing and maturity characteristics of existing and projected balancesheets.  One of the ways we manage ourinterest rate risk is through an analysis of the relationship betweeninterest-earning assets and interest-bearing liabilities to measure the impactthat future changes in interest rates will have on net interest income.  Using this relationship analysis, changes ininterest rates and volumes are used to test the sensitivity of our net interestincome.  While we show liabilitysensitivity in the short term indicating that an increase in interest rates maynegatively affect short-term net interest income, we would likely take actionsto minimize our exposure to negative results and within a short period of timemake adjustments so that net interest income would not be materially impacted.

 

We expect our net interestincome will be greater over the longer term at higher prevailing interest ratelevels, although we may be negatively affected by rising rates in the shorterterm.  This is due to the largeproportion of low-cost core deposits such as demand, interest checking,savings, and money market accounts comprising our funding sources, which tendto be less sensitive to rising rates and can be invested in relatively higheryielding loans and investment securities.

 

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

 

The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed by it in the reports that it files or submits under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the time periods required by the Securities and ExchangeCommission, including, without limitation, those controls and proceduresdesigned to ensure that such information is accumulated and communicated to theCompany’s management to allow timely decisions regarding required disclosures.

** **

As of the end of the period covered by this report, anevaluation of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures was carried out under the supervision andwith the participation of the Company’s management, including the chiefexecutive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concludedthat the Company’s disclosure controls and procedures were effective.

** **

The Company also maintains a system of internalaccounting controls that is designed to provide assurance that assets aresafeguarded and that transactions are executed in accordance with management’sauthorization and properly recorded. This system is continually reviewed and is augmented by written policiesand procedures, the careful selection and training of qualified personnel andan internal audit program to monitor its effectiveness.  There were no changes in our internalcontrol over financial reporting identified in connection with our evaluationof it that occurred during our last fiscal quarter that materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II****– OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item2.  Changesin Securities and Use of Proceeds**

 

(a)  None.

(b)  None.

(c)  None.

(d)  Notapplicable.

(e)  None.

 

**Item 3.  Defaults Upon Senior Securities**

 

(a)  None

(b)  None

 

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

 

Nomatters were submitted to a vote of security holders, through the solicitationof proxies or otherwise, during the first quarter of 2004.

 

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

 

None

 

**Item 6****.  Exhibits andReports on Form 8-K**

 

(a)    Exhibits:

 
| 3.1  |   | Bylaws of Cardinal  Financial Corporation (restated in electronic format to reflect all  amendments through April 21, 2004) |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Rule  13a-14(a) Certification of Chief Executive Officer                                                                    |
| 31.2 |   | Rule  13a-14(a) Certification of Chief Financial Officer                                                                    |
| 32.1 |   | Statement  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350                                                    |
| 32.2 |   | Statement  of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350                                                    |

 

(b)    Reports on Form 8-K

 

OnJanuary 16, 2004 we furnished a Current Report on Form 8-K dated January 14,2004 to report under Item 12 our financial results for the year endedDecember 31, 2003.

 

33

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant caused this Report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|                     | CARDINAL FINANCIAL CORPORATION                    |
|--------------------------|---------------------------------------------------|
|                     | (Registrant)                                      |
|                     |                                              |   |
| Date:  May 6,  2004 | /s/ Bernard H. Clineburg****                      |   |
|                     | Bernard H. Clineburg                              |   |
|                     | Chairman, President and Chief Executive Officer   |
|                     | (Principal Executive Officer)                     |   |
|                     |                                              |   |
|                     |                                              |   |
| Date:  May 6,  2004 | /s/ Domingo  Rodriguez                            |   |
|                     | Domingo Rodriguez                                 |   |
|                     | Senior Vice President and Chief Financial Officer |
|                     | (Principal Financial Officer)                     |   |
|                     |                                              |   |
|                     |                                              |   |
| Date:  May 6,  2004 | /s/ Jennifer L.  Deacon                           |   |
|                     | Jennifer L. Deacon                                |   |
|                     | Vice President and Controller                     |   |
|                     | (Principal Accounting Officer)                    |   |

 

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