**U.S. SECURITIES AND EXCHANGE COMMISSION**

**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  June 30, 2004**                                                                                                                                                             |
| ** **                                                                                                                                                                                                         |
| **or**                                                                                                                                                                                                             |
|                                                                                                                                                                                                               |   |   |
| **o****Transition Report Pursuant to  Section 13 or 15(d)  of the Securities Exchange Act of 1934**                                                                                                           |
|                                                                                                                                                                                                               |   |   |
| **For the transition period from                  to                ** |
|                                                                                                                                                                                                               |   |   |
| **Commission File Number:  0-24557**                                                                                                                                                                          |

 

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

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.
| Yes  ý  No  o      |
|----------------------------------------------------------------------|

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act) 
| Yes  o  No  ý      |
|----------------------------------------------------------------------|

 

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

 

18,439,035 shares of common stock, par value$1.00 per share,outstanding as of August 2, 2004

 

 

----

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I – FINANCIAL INFORMATION**                                                                                    | 3      |
|----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                       |   |   |
| Item 1.  Financial Statements:                                                                                        |   | 3 |
|                                                                                                                       |   |
| Consolidated Statements of Condition At  June 30, 2004 (Unaudited) and December 31, 2003                         | 3      |
|                                                                                                                       |   |
| Consolidated Statements of Operations  (Unaudited) Three and six months ended June 30, 2004 and 2003                  | 4      |
|                                                                                                                       |   |
| Consolidated Statements of Comprehensive  Income (Loss) (Unaudited) Three and six months ended June 30, 2004 and 2003 | 5      |
|                                                                                                                       |   |
| Consolidated Statements of Changes In  Shareholders’ Equity (Unaudited) Six months ended June 30, 2004 and 2003  | 6      |
|                                                                                                                       |   |
| Consolidated Statements of Cash Flows  (Unaudited) Six months ended June 30, 2004 and 2003                            | 7      |
|                                                                                                                       |   |
| Notes to Consolidated Financial Statements  (Unaudited)                                                                    | 8      |
|                                                                                                                       |   |
| Item 2.  Management’s Discussion and Analysis of  Financial Condition and Results of Operations                  | 13     |
|                                                                                                                       |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                                        | 34     |
|                                                                                                                       |   |
| Item 4. Controls and Procedures                                                                                            | 35     |
|                                                                                                                       |   |
|                                                                                                                       |   |
| **PART II – OTHER INFORMATION**                                                                                       | 36     |
|                                                                                                                       |   |
| Item 1. Legal Proceedings                                                                                                  | 36     |
| Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases  of Equity Securities                                  | 36     |
| Item 3. Defaults Upon Senior Securities                                                                                    | 36     |
| Item 4. Submission of Matters to a Vote of  Security Holders                                                               | 36     |
| Item 5. Other Information                                                                                                  | 36     |
| Item 6. Exhibits and Reports on Form 8-K                                                                                   | 36     |
|                                                                                                                       |   |
| **SIGNATURES**                                                                                                             | 38     |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCONDITION

 

AtJune 30, 2004 and December 31, 2003 

 

(Dollarsin thousands, except share data)

 
| ** **                                                                                                                                                                         | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                         |       |                    |       |                        |       |
| Cash and due from banks                                                                                                                                                            |       | $                       | 12,023     |                        | $          | 9,555 |   |
| Federal funds sold                                                                                                                                                                 |       | 53,379                  |       | 3,528                       |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total cash and cash equivalents                                                                                                                                                    |       | 65,402                  |       | 13,083                      |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Investment securities available-for-sale                                                                                                                                           |       | 174,381                 |       | 130,762                     |       |
| Investment securities held-to-maturity                                                                                                                                             |       | 157,254                 |       | 142,852                     |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total investment securities                                                                                                                                                        |       | 331,635                 |       | 273,614                     |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Other investments                                                                                                                                                                  |       | 5,415                   |       | 3,517                       |       |
| Loans held for sale                                                                                                                                                                |       | 797                     |       | —                      |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Loans receivable, net of fees                                                                                                                                                      |       | 392,905                 |       | 336,002                     |       |
| Allowance for loan losses                                                                                                                                                          |       | (4,633                  | )          | (4,344                      | )          |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Loans receivable, net                                                                                                                                                              |       | 388,272                 |       | 331,658                     |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Premises and equipment, net                                                                                                                                                        |       | 10,805                  |       | 6,707                       |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Deferred tax asset                                                                                                                                                                 |       | 4,321                   |       | 4,473                       |       |
| Accrued interest and other assets                                                                                                                                                  |       | 3,375                   |       | 3,196                       |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total assets                                                                                                                                                                       |       | $                       | 810,022    |                        | $          | 636,248 |   |
|                                                                                                                                                                               |       |                    |       |                        |       |
| **Liabilities and Shareholders’ Equity**                                                                                                                                      |       |                    |       |                        |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Deposits                                                                                                                                                                           |       | $                       | 597,554    |                        | $          | 474,129 |   |
| Other borrowed funds                                                                                                                                                               |       | 120,751                 |       | 74,457                      |       |
| Accrued interest and other liabilities                                                                                                                                             |       | 975                     |       | 2,250                       |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total liabilities                                                                                                                                                                  |       | 719,280                 |       | 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; 18,432,935 and 16,377,337 shares outstanding in 2004 and  2003, respectively                                            |       | 18,433                  |       | 16,377                      |       |
| Additional paid-in capital                                                                                                                                                         |       | 92,762                  |       | 86,790                      |       |
| Accumulated deficit                                                                                                                                                                |       | (17,261                 | )          | (18,614                     | )          |
| Accumulated other comprehensive loss                                                                                                                                               |       | (3,192                  | )          | (505                        | )          |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total shareholders’ equity                                                                                                                                                    |       | 90,742                  |       | 85,412                      |       |
|                                                                                                                                                                               |       |                    |       |                        |       |
| Total liabilities and shareholders’ equity                                                                                                                                    |       | $                       | 810,022    |                        | $          | 636,248 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

3

----

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFOPERATIONS

 

Threeand six months ended June 30, 2004 and 2003

(Inthousands, except share and per share data)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest income:                                               |       |                                 |       |                               |       |   |   |   |   |
| Loans receivable                                               |       | $                                    | 4,871      |                               | $          | 4,100 |   | $ | 9,599 |   | $ | 8,133 |   |
| Federal funds sold                                             |       | 19                                   |       | 42                                 |       | 47 |   | 80 |   |
| Investment securities available-for-sale                       |       | 1,553                                |       | 1,614                              |       | 2,824 |   | 3,292 |   |
| Investment securities held-to-maturity                         |       | 1,478                                |       | —                             |       | 2,828 |   | — |   |
| Other investments                                              |       | 46                                   |       | 31                                 |       | 84 |   | 55 |   |
| Total interest income                                          |       | 7,967                                |       | 5,787                              |       | 15,382 |   | 11,560 |   |
|                                                           |       |                                 |       |                               |       |   |   |   |   |
| Interest expense:                                              |       |                                 |       |                               |       |   |   |   |   |
| Deposits                                                       |       | 2,498                                |       | 2,226                              |       | 4,780 |   | 4,466 |   |
| Other borrowed funds                                           |       | 471                                  |       | 117                                |       | 771 |   | 190 |   |
| Total interest expense                                         |       | 2,969                                |       | 2,343                              |       | 5,551 |   | 4,656 |   |
| Net interest income                                            |       | 4,998                                |       | 3,444                              |       | 9,831 |   | 6,904 |   |
| Provision for loan losses                                      |       | 314                                  |       | 166                                |       | 388 |   | 246 |   |
| Net interest income after provision for  loan losses           |       | 4,684                                |       | 3,278                              |       | 9,443 |   | 6,658 |   |
|                                                           |       |                                 |       |                               |       |   |   |   |   |
| Non-interest income:                                           |       |                                 |       |                               |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 262                                  |       | 234                                |       | 502 |   | 446 |   |
| Loan service charges                                           |       | 89                                   |       | 159                                |       | 285 |   | 270 |   |
| Investment fee income                                          |       | 158                                  |       | 162                                |       | 336 |   | 288 |   |
| Net gain on sales of loans                                     |       | 48                                   |       | 73                                 |       | 62 |   | 83 |   |
| Net realized gain on investment securities  available-for-sale |       | —                               |       | 417                                |       | 241 |   | 910 |   |
| Other income                                                   |       | 7                                    |       | 4                                  |       | 16 |   | 26 |   |
| Total non-interest income                                      |       | 564                                  |       | 1,049                              |       | 1,442 |   | 2,023 |   |
|                                                           |       |                                 |       |                               |       |   |   |   |   |
| Non-interest expense:                                          |       |                                 |       |                               |       |   |   |   |   |
| Salary and benefits                                            |       | 1,924                                |       | 1,541                              |       | 4,064 |   | 3,190 |   |
| Occupancy                                                      |       | 465                                  |       | 299                                |       | 961 |   | 777 |   |
| Professional fees                                              |       | 190                                  |       | 282                                |       | 344 |   | 651 |   |
| Depreciation                                                   |       | 322                                  |       | 259                                |       | 632 |   | 455 |   |
| Data processing                                                |       | 197                                  |       | 252                                |       | 391 |   | 455 |   |
| Other operating expenses                                       |       | 1,200                                |       | 1,025                              |       | 2,462 |   | 1,994 |   |
| Total non-interest expense                                     |       | 4,298                                |       | 3,658                              |       | 8,854 |   | 7,522 |   |
| Net income before income taxes                                 |       | 950                                  |       | 669                                |       | 2,031 |   | 1,159 |   |
| Provision for income taxes                                     |       | 316                                  |       | —                             |       | 678 |   | — |   |
| Net income                                                     |       | $                                    | 634        |                               | $          | 669 |   | $ | 1,353 |   | $ | 1,159 |   |
| Dividends to preferred shareholders                            |       | —                               |       | 124                                |       | — |   | 247 |   |
| Net income to common shareholders                              |       | $                                    | 634        |                               | $          | 545 |   | $ | 1,353 |   | $ | 912 |   |
| Earnings per common share - basic                              |       | $                                    | 0.03       |                               | $          | 0.05 |   | $ | 0.08 |   | $ | 0.09 |   |
| Earnings per common share - diluted                            |       | $                                    | 0.03       |                               | $          | 0.05 |   | $ | 0.07 |   | $ | 0.09 |   |
| Weighted-average common shares outstanding  - basic            |       | 18,401,199                           |       | 10,056,144                         |       | 17,931,094 |   | 10,051,132 |   |
| Weighted-average common shares outstanding  - diluted          |       | 18,797,570                           |       | 10,294,425                         |       | 18,326,609 |   | 10,208,542 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

4

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (LOSS)

Threeand six months ended June 30, 2004 and 2003

(Dollarsin thousands)

(Unaudited)

 
| ** **                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Net income                                                                      |       | $                                    | 634        |                               | $          | 669 |   | $ | 1,353 |   | $ | 1,159 |   |
| Other comprehensive income (loss):                                              |       |                                 |       |                               |       |   |   |   |   |
| Unrealized gain (loss) on  available-for-sale investment securities:            |       |                                 |       |                               |       |   |   |   |   |
| Unrealized holding gain (loss) arising  during the period, net of tax           |       | (3,402                               | )          | 1,303                              |       | (2,528 | ) | 1,730 |   |
| Less: reclassification adjustment for gains  included in net income, net of tax |       | —                               |       | 417                                |       | 159 |   | 910 |   |
|                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Comprehensive income (loss)                                                     |       | $                                    | (2,768     | )                                  | $          | 1,555 |   | $ | (1,334 | ) | $ | 1,979 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

5

----

 

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Six months ended June 30, 2004 and 2003

(In thousands)

(Unaudited)

 
| ** **                                                                    | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|-----------|------------|
| Balance, December 31, 2002                                               |       | 1,365                 |       | $                    | 1,365      |               | 10,044     |              | $          | 10,044                           |       | $                        | 51,231     |                                                 | $          | (24,273   | )          | $ | 2,345 |   | $ | 40,712 |   |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Stock options exercised                                                       |       | —                |       | —               |       | 25                 |       | 25                |       | 90                               |       | —                   |       | —                                               |       | 115       |       |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Dividends on preferred stock                                                  |       | —                |       | —               |       | —             |       | —            |       | —                           |       | (247                     | )          | —                                               |       | (247      | )          |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Preferred stock converted to common stock                                     |       | (1                    | )          | (1                   | )          | 1                  |       | 1                 |       | —                           |       | —                   |       | —                                               |       | —    |       |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Change in unrealized gain (loss) on investment  securities available-for-sale |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (820                                                 | )          | (820      | )          |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Net income                                                                    |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,159                    |       | —                                               |       | 1,159     |       |
| Balance, June 30, 2003                                                   |       | 1,364                 |       | $                    | 1,364      |               | 10,070     |              | $          | 10,070                           |       | $                        | 51,321     |                                                 | $          | (23,361   | )          | $ | 1,525 |   | $ | 40,919 |   |
| Balance, December 31, 2003                                               |       | 1,364                 |       | $                    | 1,364      |               | 16,377     |              | $          | 16,377                           |       | $                        | 86,790     |                                                 | $          | (18,614   | )          | $ | (505 | ) | $ | 85,412 |   |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Stock options exercised                                                       |       | —                |       | —               |       | 85                 |       | 85                |       | 276                              |       | —                   |       | —                                               |       | 361       |       |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Public offering shares issued                                                 |       | —                |       | —               |       | 945                |       | 945               |       | 5,358                            |       | —                   |       | —                                               |       | 6,303     |       |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Preferred stock converted to common stock                                     |       | (1,364                | )          | (1,364               | )          | 1,026              |       | 1,026             |       | 338                              |       | —                   |       | —                                               |       | —    |       |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Change in unrealized loss on investment securities  available-for-sale        |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (2,687                                               | )          | (2,687    | )          |
|                                                                          |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |      |       |
| Net income                                                                    |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,353                    |       | —                                               |       | 1,353     |       |
| Balance, June 30, 2004                                                   |       | —                |       | $                    | —     |               | 18,433     |              | $          | 18,433                           |       | $                        | 92,762     |                                                 | $          | (17,261   | )          | $ | (3,192 | ) | $ | 90,742 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

6

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCASH FLOWS

 

Six months endedJune 30, 2004 and 2003

 

(Dollars in thousands)

 

(Unaudited)

 
| ** **                                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                        |       |     |       |     |       |
| Net income                                                                                   |       | $        | 1,353      |     | $          | 1,159 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |     |       |     |       |
| Depreciation                                                                                 |       | 632      |       | 455      |       |
| Amortization of premiums and discounts                                                       |       | 1,072    |       | 1,051    |       |
| Provision for loan losses                                                                    |       | 388      |       | 246      |       |
| Originations of loans held for sale                                                          |       | (8,034   | )          | (9,750   | )          |
| Proceeds from the sale of loans held for  sale                                               |       | 7,175    |       | 9,542    |       |
| Gain on sale of loans held for sale                                                          |       | (62      | )          | (83      | )          |
| Gain on sale of investment securities  available-for-sale                                    |       | (241     | )          | (910     | )          |
| (Increase) decrease in accrued interest,  other assets and deferred tax asset                |       | (27      | )          | 3,471    |       |
| Decrease in accrued interest and other  liabilities                                          |       | (1,275   | )          | (18,220  | )          |
|                                                                                         |       |     |       |     |       |
| Net cash provided by (used in) operating  activities                                         |       | 981      |       | (13,039  | )          |
|                                                                                         |       |     |       |     |       |
| Cash flows from investing activities:                                                        |       |     |       |     |       |
| Purchase of premises and equipment                                                           |       | (4,730   | )          | (602     | )          |
| Proceeds from sale, maturity and call of  investment securities available-for-sale           |       | 13,719   |       | 61,989   |       |
| 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                                        |       | (78,959  | )          | (162,008 | )          |
| Purchase of investment securities  held-to-maturity                                          |       | (30,514  | )          | —   |       |
| Purchase of other investments                                                                |       | (2,159   | )          | (1,023   | )          |
| Redemptions of investment securities  available-for-sale                                     |       | 14,912   |       | 31,808   |       |
| Redemptions of investment securities  held-to-maturity                                       |       | 14,134   |       | —   |       |
| Net increase in loans receivable, net of  fees                                               |       | (55,199  | )          | (14,160  | )          |
|                                                                                         |       |     |       |     |       |
| Net cash used in investing activities                                                        |       | (125,045 | )          | (83,996  | )          |
|                                                                                         |       |     |       |     |       |
| Cash flows from financing activities:                                                        |       |     |       |     |       |
| Net increase in deposits                                                                     |       | 123,425  |       | 14,882   |       |
| Net increase in other borrowed funds                                                         |       | 2,544    |       | 27,018   |       |
| Proceeds from FHLB advances - long term                                                      |       | 45,000   |       | 9,000    |       |
| Repayments of FHLB advances - long term                                                      |       | (1,250   | )          | —   |       |
| Proceeds from public offering                                                                |       | 6,303    |       | —   |       |
| Stock options exercised                                                                      |       | 361      |       | 115      |       |
| Dividends on preferred stock                                                                 |       | —   |       | (247     | )          |
|                                                                                         |       |     |       |     |       |
| Net cash provided by financing activities                                                    |       | 176,383  |       | 50,768   |       |
|                                                                                         |       |     |       |     |       |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 52,319   |       | (46,267  | )          |
|                                                                                         |       |     |       |     |       |
| Cash and cash equivalents at beginning of  the period                                        |       | 13,083   |       | 63,371   |       |
|                                                                                         |       |     |       |     |       |
| Cash and cash equivalents at end of the  period                                              |       | $        | 65,402     |     | $          | 17,104 |   |
|                                                                                         |       |     |       |     |       |
| **Supplemental  disclosure of cash flow information:**                                       |       |     |       |     |       |
| Cash paid during the period for interest                                                     |       | $        | 5,377      |     | $          | 4,617 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

7

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CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 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 opened CardinalBank, N.A. (the “Bank”) in 1998 and Cardinal Wealth Services, Inc., an investment services subsidiary, in1999.  In 1999, the Company opened twoadditional banking subsidiaries and, in late 2000, completed an acquisition ofHeritage Bancorp, Inc. and its banking subsidiary, The Heritage Bank(“Heritage”).  These banking subsidiarieswere consolidated into the Bank as of March 1, 2002.  On April 15, 2004, the Company receivedapproval from the Federal Reserve Bank of Richmond to be a financial holding company.

 

*Basis of Presentation*

 

In the opinion of management, theaccompanying consolidated financial statements have been prepared in accordancewith the requirements of Regulation S-X, Article 10.  Accordingly, they do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. However, all adjustments that are, in the opinion of management,necessary for a fair presentation have been included.  The results of operations for the three andsix months ended June 30, 2004 are not necessarily indicative of theresults to be expected for the full year ending December 31, 2004.  The unaudited interim consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements and notes to consolidated financial statements that are presented in the Company’sAnnual Report on Form 10-KSB for the year ended December 31, 2003 (the“2003 Form 10-KSB”).

 

# *Reclassifications*

 

Certain amounts for the 2003 interim periods have been reclassified toconform to the presentation for the 2004 interim periods.

 

# *Stock-BasedCompensation*

 

### At June 30, 2004,the Company had two stock-based employee compensation plans, the 1999 StockOption Plan and the 2002 Equity Compensation Plan.  These plans are described more fully inFootnote 14 of the 2003 Form 10-KSB.

 

#### **As permitted under Statement of Financial AccountingStandards (“SFAS”) No. 148, *Accounting forStock-Based Compensation – Transition and Disclosure,* which amendedSFAS No. 123, *Accounting for Stock-BasedCompensation,* the Company has elected to continue to follow theintrinsic value method in accounting for its stock-based employee compensationarrangements as defined by Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees,*and related interpretations including Financial Accounting Standards BoardInterpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation,*an**

#### ** **

8

----

 

#### **interpretation of APB No. 25.  The following table illustrates the effect onnet income and earnings per common share as if the Company had applied the fairvalue recognition provisions of SFAS No. 123 to stock-based employeecompensation.**

 
| ** **                                                                                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands, except per share data)**                                                               | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income to common shareholders                                                                                |       | $                                    | 634        |                               | $          | 545 |   | $ | 1,353 |   | $ | 912 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value-based method for all awards |       | (79                                  | )          | (106                               | )          | (675 | ) | (328 | ) |
| Pro forma net income                                                                                             |       | $                                    | 555        |                               | $          | 439 |   | $ | 678 |   | $ | 584 |   |
|                                                                                                             |       |                                 |       |                               |       |   |   |   |   |
| Earnings per common share:                                                                                       |       |                                 |       |                               |       |   |   |   |   |
| Basic - as reported                                                                                              |       | $                                    | 0.03       |                               | $          | 0.05 |   | $ | 0.08 |   | $ | 0.09 |   |
| Basic - as pro forma                                                                                             |       | 0.03                                 |       | 0.04                               |       | 0.04 |   | 0.06 |   |
| Diluted - as reported                                                                                            |       | 0.03                                 |       | 0.05                               |       | 0.07 |   | 0.09 |   |
| Diluted - as pro forma                                                                                           |       | 0.03                                 |       | 0.04                               |       | 0.04 |   | 0.06 |   |

 

Theweighted average per share fair values of grants made for the three monthsended June 30, 2004 and 2003 were $3.38 and $2.72, respectively.  The weighted average per share values ofgrants made for the six months ended June 30, 2004 and 2003 were $2.91 and$2.10, respectively.  The fair values ofthe options granted were estimated on the grant date using the Black - Scholesoption - pricing model based on the following weighted average assumptions:

 
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Estimated option life   |       | 10 years                             |       | 10 years                           |       | 10 years |   | 10 years |   |
| Risk free interest rate |       | 4.79                                 | %          | 3.41                               | %          | 4.00 | % | 3.96 | % |
| Expected volatility     |       | 11.80                                | %          | 20.40                              | %          | 11.80 | % | 20.40 | % |
| Expected dividend yield |       | 0.00                                 | %          | 0.00                               | %          | 0.00 | % | 0.00 | % |

 

There were options to purchase 3,000 and 289,518 shares of common stockgranted during the three and six months ended June 30, 2004,respectively.  Of those grants, 0 and175,204 immediately vested on the grant date for the three and six months endedJune 30, 2004, respectively.

 

9

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### Note 2

 

# *SegmentDisclosures*

 

**For thefirst six months of 2004, the Company operated and reported in two businesssegments, commercial banking and investment services.  As of July 7, 2004, the Company beganoperating in a third business segment, mortgage banking, with the completion ofits acquisition of George Mason Mortgage, LLC (“GMM”).  The commercial banking segment includes bothcommercial and consumer lending and provides customers such products ascommercial loans, real estate loans, and other business financing and consumerloans.  In addition, this segment alsoprovides customers with several choices of deposit products including demanddeposit accounts, savings accounts and certificates of deposit.  The investment services segment providesadvisory services to businesses and individuals, including financial planningand retirement/estate planning.**

** **

**Informationabout the reportable segments, and reconciliation of such information to theconsolidated financial statements at and for the three and six months endedJune 30, 2004 and 2003, follows:**

 

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

 
| ** **                  | ** ** | ** **              | ** ** | ** **               | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **       | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|------------|------------|------------------|------------|
| **(Dollars in thousands)**  | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       | $                       | 4,976      |                     | $          | —                        |       | $          | —     |             | $          | 22 |   | $ | 4,998 |   |
| Provision for  loan losses  |       | 314                     |       | —                   |       | —                        |       | —     |       | 314              |       |
| Non-interest  income        |       | 406                     |       | 158                      |       | —                        |       | —     |       | 564              |       |
| Non-interest  expense       |       | 3,728                   |       | 185                      |       | —                        |       | 385        |       | 4,298            |       |
| Provision for  income taxes |       | 448                     |       | (8                       | )          |                          |       | (124       | )          | 316              |       |
| Net income  (loss)          |       | $                       | 892        |                     | $          | (19                           | )          | $          | —     |             | $          | (239 | ) | $ | 634 |   |
| Total assets                |       | $                       | 804,041    |                     | $          | 701                           |       | $          | (85,553    | )                | $          | 90,833 |   | $ | 810,022 |   |

 

**At and for the Three Months Ended June 30, 2003:**

 
| ** **                 | ** ** | ** **              | ** ** | ** **               | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **       | ** ** |
|----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|------------|------------|------------------|------------|
| **(Dollars in thousands)** | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income       |       | $                       | 3,418      |                     | $          | —                        |       | $          | —     |             | $          | 26 |   | $ | 3,444 |   |
| Provision for  loan losses |       | 166                     |       | —                   |       | —                        |       | —     |       | 166              |       |
| Non-interest  income       |       | 887                     |       | 162                      |       | —                        |       | —     |       | 1,049            |       |
| Non-interest  expense      |       | 3,217                   |       | 162                      |       | —                        |       | 279        |       | 3,658            |       |
| Net income  (loss)         |       | $                       | 922        |                     | $          | 0                             |       | $          | —     |             | $          | (253 | ) | $ | 669 |   |
| Total assets               |       | $                       | 516,238    |                     | $          | 245                           |       | $          | (38,500    | )                | $          | 41,227 |   | $ | 519,210 |   |

 

10

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**At and for the Six Months Ended June 30, 2004:**

 
| ** **                  | ** ** | ** **              | ** ** | ** **               | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **       | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|------------|------------|------------------|------------|
| **(Dollars in thousands)**  | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other**  | ** ** | **Consolidated** | ** ** |
| Net interest  income        |       | $                       | 9,777      |                     | $          | —                        |       | $          | —     |             | $          | 54 |   | $ | 9,831 |   |
| Provision for  loan losses  |       | 388                     |       | —                   |       | —                        |       | —     |       | 388              |       |
| Non-interest  income        |       | 1,106                   |       | 336                      |       | —                        |       | —     |       | 1,442            |       |
| Non-interest  expense       |       | 7,779                   |       | 424                      |       | —                        |       | 651        |       | 8,854            |       |
| Provision for  income taxes |       | 910                     |       | (30                      | )          |                          |       | (202       | )          | 678              |       |
| Net income  (loss)          |       | $                       | 1,806      |                     | $          | (58                           | )          | $          | —     |             | $          | (395 | ) | $ | 1,353 |   |
| Total assets                |       | $                       | 804,041    |                     | $          | 701                           |       | $          | (85,553    | )                | $          | 90,833 |   | $ | 810,022 |   |

 

**At and for the Six Months Ended June 30, 2003:**

 
| **(Dollars in thousands)** | ** ** | **Commercial  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income       |       | $                       | 6,851      |                     | $          | —                        |       | $         | —     |             | $          | 53 |   | $ | 6,904 |   |
| Provision for  loan losses |       | 246                     |       | —                   |       | —                        |       | —    |       | 246              |       |
| Non-interest  income       |       | 1,735                   |       | 288                      |       | —                        |       | —    |       | 2,023            |       |
| Non-interest  expense      |       | 6,606                   |       | 330                      |       | —                        |       | 586       |       | 7,522            |       |
| Net income  (loss)         |       | $                       | 1,734      |                     | $          | (42                           | )          | $         | —     |             | $          | (533 | ) | $ | 1,159 |   |
| Total assets               |       | $                       | 516,238    |                     | $          | 245                           |       | $         | (38,500    | )                | $          | 41,227 |   | $ | 519,210 |   |

 

**AtJune 30, 2004, the Company did not have any operating segments other thanthose reported.  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 assetsare its net investments in its subsidiaries. The parent company’s net interest income is comprised of interest incomefrom federal funds sold and other investments.**

 

#### **Note 3**

 

##### ***Earnings PerCommon Share***

 

**Thefollowing is the calculation of basic and diluted earnings per common share forthe three and six months ended June 30, 2004 and 2003. Stock optionsoutstanding as of June 30, 2004 and 2003 were 1,048,545 and 853,087,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 10,197 for the three months ended June 30, 2004 and 2003,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 22,886 for the six months ended June 30, 2004 and 2003,respectively.**

** **

**11**

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** **
| ** **                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(Dollars  in thousands, except share and per share data)** | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                   |       | $                                    | 634        |                               | $          | 669 |   | $ | 1,353 |   | $ | 1,159 |   |
| Dividends to preferred shareholders                          |       | —                               |       | 124                                |       | — |   | 247 |   |
|                                                         |       |                                 |       |                               |       |   |   |   |   |
| Net income to common shareholders                            |       | $                                    | 634        |                               | $          | 545 |   | $ | 1,353 |   | $ | 912 |   |
| Weighted average common shares for basic                     |       | 18,401,199                           |       | 10,056,144                         |       | 17,931,094 |   | 10,051,132 |   |
| Weighted average common shares for diluted                   |       | 18,797,570                           |       | 10,294,425                         |       | 18,326,609 |   | 10,208,542 |   |
| Basic earnings per common share                              |       | $                                    | 0.03       |                               | $          | 0.05 |   | $ | 0.08 |   | $ | 0.09 |   |
| Diluted earnings per common share                            |       | $                                    | 0.03       |                               | $          | 0.05 |   | $ | 0.07 |   | $ | 0.09 |   |

 

Note 4

 

##### ***Subsequent Events***

 

**EffectiveJuly 7, 2004, the Bank completed its acquisition of GMM from United Bank –Virginia, a wholly owned subsidiary of United Bankshares, Inc.  GMM was acquired in an all cash transactionfor $17.0 million.  GMM is operating as asubsidiary of the Bank.  Because we havenot yet completed the purchase accounting analysis, we are unable at this timeto assess the amount of goodwill that will result from this transaction.**

** **

**Inaddition, effective July 27, 2004, the Company completed a pooled trustpreferred offering of $20.0 million. This trust preferred, which is recorded as debt for purposes of U.S.generally accepted accounting principles, qualify as Tier 1 Capital forregulatory capital purposes, will be used to enhance the Bank’s capitalposition and offset the impact of the goodwill attributed to the acquisition ofGMM.**

 

12

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

Thefollowing presents management’s discussion and analysis of our consolidatedfinancial condition at June 30, 2004 and December 31, 2003 and theresults of our operations for the three and six months ended June 30, 2004and 2003.  This discussion should be readin conjunction with our unaudited consolidated financial statements and thenotes thereto 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 venues 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.  Ourcommercial relationship managers focus on attracting small and medium-sizedbusinesses as well as commercial real estate developers and builders andprofessionals, 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 byoffering investment products and services to our customers through ourthird-party brokerage relationship with Raymond James Financial Services, Inc.**

 

**On July 7, 2004, we acquired George Mason Mortgage,LLC (“GMM”), from United Bank – Virginia, a wholly owned subsidiary of UnitedBankshares, Inc., in an all cash transaction for $17.0 million.  GMM, based in Fairfax, Virginia, engagesprimarily in the origination and acquisition of residential mortgages for saleinto the secondary market on a best efforts basis through nine retail brancheslocated throughout the metropolitan Washington region.  GMM was started in 1990 as a wholly ownedsubsidiary of George Mason Bank.  In1998, United Bankshares acquired George Mason Bank, which was renamed UnitedBank – Virginia.  GMM has approximately200 employees and is licensed in eight states, including Virginia, Maryland andthe District of Columbia.  GMM is one ofthe leading residential mortgage lenders in the greater Washington metropolitanarea, reporting originations of over $4 billion in 2003 and $3 billion in 2002.**

** **

**Net interest income has been our primary source of income.  With the addition of GMM, we expect that oursources of non-interest income will significantly increase and diversify oursources of income.  As discussed furtherin our interest rate sensitivity section, we manage our balance sheet andinterest rate risk to enhance our net interest income.  We do this by monitoring the spread betweenthe interest rates earned on investment securities and loans and the interestrates paid on deposits and other interest-bearing liabilities.  Changes in interest rates will affect ouroperating performance and financial condition. We attempt to minimize our exposure to interest rate risk, but areunable to eliminate it.   In addition tomanagement of interest rate risk,**

** **

**13**

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** **

we analyze our loan portfolio for exposure to credit risk.  Risk of loan defaults and foreclosures areunavoidable in the banking industry, and we try to limit our exposure to thisrisk by monitoring our extensions of credit carefully.  In addition to net interest income,non-interest income is a source of income for us and includes service chargeson deposits and loans, investment fee income 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 inDecember 2003 and an additional $6.3 million in capital following theexercise of the underwriters’ over-allotment option in January 2004.  This capital is being used to support theexpansion of our branch office network and balance sheet growth.  We were able to increase our legal lendinglimit to over $12 million, which will allow us to expand our commercial andreal estate lending loan portfolios.  Weexpect to increase our loan-to-deposit ratio and shift the mix of our earningassets to higher yielding loans.  We used$17.0 million of the capital that was raised in December 2003 andJanuary 2004 to acquire GMM.  GMMadds to our plans to increase our selection of banking products and financialservices and diversify our revenue base, increase fee income, and strengthencustomer relationships.**

** **

**Critical Accounting Policies**

 

Accounting policies generally accepted in the UnitedStates are complex and require management to apply significant judgment tovarious accounting, reporting, and disclosure matters.  Management must use assumptions and estimatesto apply these principles where actual measurements are not possible orpractical.  These policies are criticalbecause they are highly dependent upon subjective or complex judgments,assumptions and estimates.  Changes insuch estimates may have a significant impact on the consolidated financialstatements.  Actual results could differfrom those estimates.

 

The accounting policies we view as critical to usare those relating to estimates and judgments regarding the determination ofthe allowance for loan losses and the valuation of deferred tax assets.

 

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

 

**We maintain the allowance for loan losses at a level thatrepresents management’s best estimate of known and inherent losses in the loanportfolio.  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 individualborrowers.  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 business and,although we believe the methodologies for determining the allowance for loanlosses and the current level of the allowance are adequate, it is possible thatthere may be unidentified losses in the portfolio that may become evident onlyat a future date.  Additional provisionsfor such losses, if necessary, would be recorded in the commercial bankingsegment and would negatively impact earnings.**

** **

**14**

----

** **

For purposes of our analysis, we categorize our loans into one of fivecategories:  commercial and industrial,commercial real estate, home equity lines of credit, residential mortgages, andconsumer.  Peer group annual loss factors(in the absence of historical results) are applied to all categories and areadjusted by the projected duration of the loans in a particular category and bythe qualitative factors mentioned above. The indicated loss factors resulting from this analysis are applied toeach of the loan categories to determine a reserve level for each of the fivecategories of loans.  In addition, weindividually assign loss factors to all loans that have been identified ashaving loss attributes, as indicated by deterioration in the financialcondition of the borrower or a decline in underlying collateral values.  Since we have limited historical data onwhich to base loss factors for classified loans, we apply, in accordance withregulatory guidelines, a 5% loss factor to all special mention loans and a 15%loss factor to all substandard loans.

 

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

 

We record aprovision for income tax expense based on the amounts of current taxes payable(or refundable) and the change in net deferred tax assets or liabilities duringthe year.  Deferred tax assets andliabilities are recognized for the tax effects of differing carrying values ofassets and liabilities for tax and financial statement purposes that willreverse in future periods.  Whensubstantial uncertainty exists concerning the recoverability of a deferred taxasset, the carrying value of the asset is reduced by a valuation allowance.

 

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

 

On March 9, 2004, the Securities and Exchange Commission issuedStaff Accounting Bulletin No. 105 (“SAB No. 105”), *Application of Accounting Principles to Loan Commitments.*  SAB No. 105 provides guidance regarding loancommitments accounted for as derivative instruments, and is effective forquarters beginning April 1, 2004. The Company retains substantially all of the loans it originates andtherefore SAB No. 105 has not had a material impact.  However, with the completion of ouracquisition of GMM, the requirements of SAB No. 105 are applicable to theoperations of the mortgage company, and therefore, we will be assessing theimpact SAB No. 105 has on GMM during the third quarter of 2004.

##### ** **

##### **Statements ofOperations**

 

Net income to common shareholders for the three months endedJune 30, 2004 and 2003 was $634,000 and $545,000, respectively, animprovement of $89,000, or 16.3%.  Netincome to common shareholders for the six months ended June 30, 2004 and2003 was $1.4 million and $912,000, respectively, an improvement of $441,000,or 48.4%.  The increase in net income tocommon 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 three and six months periods of 2004 didnot include expenses related to preferred stock dividends.  Expenses for preferred dividends totaled$124,000 and $247,000 for the three and six months ended June 30, 2003,respectively.  In addition, net incomefor the three and six months ended June 30, 2004 reflect an income taxprovision of $316,000 and $678,000, respectively, compared to no tax provisionfor the same periods of 2003.  The 2003results were not subject to a tax provision because of unrecognized availablenet operating loss carryforwards.

 

Basic and diluted earnings per common share were $0.03 and $0.05 forthe three months ended June 30, 2004 and 2003, respectively.  For the six months ended June 30, 2004and 2003,

 

15

----

 

basic earnings per share were $0.08 and $0.09, respectively. Dilutedearnings per share for the six months ended June 30, 2004 and 2003 were$0.07 and $0.09, respectively.  Theseresults are presented after the effect of dividends paid to preferredshareholders in the 2003 periods.  Weightedaverage fully diluted common shares outstanding for the three months endedJune 30, 2004 and 2003 were 18,797,570 and 10,294,425, respectively.  For the six months ended June 30, 2004and 2003, weighted average fully diluted common shares outstanding were18,326,609 and 10,208,542, respectively.

 

Return on average assets for the three months ended June 30, 2004and 2003 was 0.35% and 0.45%, respectively. Return on average assets for the six months ended June 30, 2004 and2003 was 0.39% and 0.38%, respectively. Return on average equity for the three months ended June 30, 2004and 2003 was 2.76% and 5.45%, respectively. Return on average equity for the six months ended June 30, 2004 and2003 was 2.95% and 4.52%, respectively. The decrease in the return on average equity is a result of theincreased equity from our common stock offering.

 

Net interest income represents the difference between interest and feesearned on interest earning assets and the interest paid on deposits and otherinterest bearing liabilities.  The levelof net interest income is impacted primarily by variations in the volume andmix of these assets and liabilities, as well as changes in interest rates whencompared to previous periods of operations. Net interest income for the three months ended June 30, 2004 and2003 was $5.0 million and $3.4 million, respectively, a period-to-periodincrease of $1.6 million, or 45.1%.  Netinterest income for the six months ended June 30, 2004 and 2003 was $9.8million and $6.9 million, respectively, an increase of $2.9 million, or42.4%.  The increase in net interestincome is a result of the increase in the average volume of investmentsecurities and loans receivable, net of the impact of decreased yields, during2004, compared with the same period of 2003. These increases were funded through the increases in total deposits,other borrowed funds and equity from the common stock offering.

 

Our net interest margin for the three months ended June 30, 2004and 2003 was 2.82% and 2.90%, respectively. For the six months ended June 30, 2004 and 2003, our net interestmargin was 2.90% and 3.00%, respectively. The decrease in the net interest margin was a result of the change inthe mix of earning assets towards lower yielding earning assets and the decreasedinterest rate environment.  Tables 1through 4 present an analysis of average earning assets, interest bearingliabilities and demand deposits with related components of interest income andinterest expense.

 

16

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

ThreeMonths Ended June 30, 2004, 2003 and 2002

(Dollarsin thousands)

 
| ** **                                               | ** ** | **2004**               | ** ** | **2003**                         | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|----------|------------|
| ** **                                               | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Loans  (1):                                        |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $                      | 57,385     |                             | $          | 755      |       | 5.26 | % | $ | 50,683 |   | $ | 817 |   | 6.45 | % | $ | 51,837 |   | $ | 933 |   | 7.20 | % |
| Real estate - commercial                                 |       | 151,236                |       | 2,340                            |       | 6.19     | %          | 114,892 |   | 2,032 |   | 7.07 | % | 88,135 |   | 1,777 |   | 8.07 | % |
| Real estate - construction                               |       | 45,947                 |       | 638                              |       | 5.55     | %          | 14,800 |   | 214 |   | 5.78 | % | 5,914 |   | 89 |   | 6.01 | % |
| Real estate - residential                                |       | 42,496                 |       | 586                              |       | 5.51     | %          | 37,211 |   | 604 |   | 6.49 | % | 15,536 |   | 308 |   | 7.93 | % |
| Home equity lines                                        |       | 51,027                 |       | 407                              |       | 3.20     | %          | 31,890 |   | 263 |   | 3.31 | % | 23,811 |   | 252 |   | 4.25 | % |
| Consumer                                                 |       | 9,336                  |       | 145                              |       | 6.21     | %          | 9,099 |   | 170 |   | 7.49 | % | 13,098 |   | 246 |   | 7.51 | % |
| Total loans                                              |       | 357,427                |       | 4,871                            |       | 5.45     | %          | 258,575 |   | 4,100 |   | 6.34 | % | 198,331 |   | 3,605 |   | 7.27 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Investment securities available-for-sale           |       | 181,147                |       | 1,553                            |       | 3.43     | %          | 199,129 |   | 1,614 |   | 3.24 | % | 99,680 |   | 1,218 |   | 4.89 | % |
|  Investment securities held-to-maturity             |       | 157,827                |       | 1,478                            |       | 3.75     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|  Other investments                                  |       | 4,566                  |       | 46                               |       | 4.03     | %          | 2,576 |   | 31 |   | 4.81 | % | 1,196 |   | 17 |   | 5.69 | % |
|  Federal funds sold                                 |       | 8,586                  |       | 19                               |       | 0.90     | %          | 14,458 |   | 42 |   | 1.16 | % | 47,954 |   | 200 |   | 1.65 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Total interest-earning assets and interest  income |       | 709,553                |       | 7,967                            |       | 4.49     | %          | 474,738 |   | 5,787 |   | 4.88 | % | 347,161 |   | 5,040 |   | 5.81 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                             |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                  |       | 10,958                 |       |                             |       |     |       | 8,097 |   |   |   |   |   | 17,652 |   |   |   |   |   |
| Premises and equipment, net                              |       | 8,065                  |       |                             |       |     |       | 5,219 |   |   |   |   |   | 4,839 |   |   |   |   |   |
| Accrued interest and other assets                        |       | 5,357                  |       |                             |       |     |       | 4,716 |   |   |   |   |   | 1,905 |   |   |   |   |   |
| Allowance for loan losses                                |       | (4,417                 | )          |                             |       |     |       | (3,483 | ) |   |   |   |   | (3,002 | )  |   |   |   |   |
| Total assets                                             |       | $                      | 729,516    |                             |       |     |       |   | $ | 489,287 |   |   |   |   |   | $ | 368,555 |   |   |   |   |   |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity**           |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                          |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                             |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 150,689                |       | 506                              |       | 1.35     | %          | 146,086 |   | 665 |   | 1.83 | % | 112,517 |   | 832 |   | 2.96 | % |
| Money markets                                            |       | 26,703                 |       | 39                               |       | 0.58     | %          | 24,838 |   | 56 |   | 0.90 | % | 26,655 |   | 139 |   | 2.09 | % |
| Statement savings                                        |       | 7,583                  |       | 12                               |       | 0.63     | %          | 5,382 |   | 10 |   | 0.73 | % | 4,245 |   | 13 |   | 1.24 | % |
| Certificates of deposit                                  |       | 275,287                |       | 1,941                            |       | 2.82     | %          | 174,336 |   | 1,495 |   | 3.44 | % | 126,737 |   | 1,324 |   | 4.19 | % |
| Total interest - bearing deposits                        |       | 460,262                |       | 2,498                            |       | 2.18     | %          | 350,642 |   | 2,226 |   | 2.55 | % | 270,154 |   | 2,308 |   | 3.39 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 94,650                 |       | 471                              |       | 2.00     | %          | 28,563 |   | 117 |   | 1.64 | % | 7,000 |   | 71 |   | 4.04 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest  expense |       | 554,912                |       | 2,969                            |       | 2.15     | %          | 379,205 |   | 2,343 |   | 2.48 | % | 277,154 |   | 2,379 |   | 3.44 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                         |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 80,991                 |       |                             |       |     |       | 67,737 |   |   |   |   |   | 57,554 |   |   |   |   |   |
| Other liabilities                                        |       | 1,574                  |       |                             |       |     |       | 2,315 |   |   |   |   |   | 3,559 |   |   |   |   |   |
| Preferred shareholders’ equity                      |       | —                 |       |                             |       |     |       | 6,824 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common shareholders’ equity                         |       | 92,039                 |       |                             |       |     |       | 33,206 |   |   |   |   |   | 23,463 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $                      | 729,516    |                             |       |     |       |   | $ | 489,287 |   |   |   |   |   | $ | 368,555 |   |   |   |   |   |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin (2)          |       |                   |       | $                                | 4,998      |     | 2.82       | % |   |   | $ | 3,444 |   | 2.90 | % |   |   | $ | 2,661 |   | 3.07 | % |

 

----

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

(2) We do not have investments that have taxbenefit attributes; therefore, there are no tax equivalent adjustments to ournet interest income.

 

17

----

 

**Rate and Volume Analysis**

Three Months Ended June 30, 2004, 2003and 2002

(Dollars in thousands)

 
| ** **                               | ** ** | **Three Months Ended June 30,  2004 Compared to 2003** | ** ** | **Three Months Ended June 30,  2003 Compared to 2002** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                               | ** ** | **Average  Volume**                                         | ** ** | **Average  Rate**                                           | ** ** | **Increase  (Decrease)** | ** ** | **Average  Volume** | ** ** | **Average  Rate** | ** ** | **Increase  (Decrease)** | ** ** |
| **Interest income:**                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Loans (1):                               |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                |       | $                                                           | 108        |                                                        | $          | (170 | ) | $ | (62 | ) | $ | (21 | ) | $ | (95 | ) | $ | (116 | ) |
| Real estate - commercial                 |       | 643                                                         |       | (335                                                        | )          | 308 |   | 542 |   | (287 | ) | 255 |   |
| Real estate - construction               |       | 450                                                         |       | (26                                                         | )          | 424 |   | 133 |   | (8 | ) | 125 |   |
| Real estate - residential                |       | 86                                                          |       | (104                                                        | )          | (18 | ) | 429 |   | (133 | ) | 296 |   |
| Home equity lines                        |       | 158                                                         |       | (14                                                         | )          | 144 |   | 86 |   | (75 | ) | 11 |   |
| Consumer                                 |       | 5                                                           |       | (30                                                         | )          | (25 | ) | (76 | ) | (0 | ) | (76 | ) |
| Total loans                              |       | 1,450                                                       |       | (679                                                        | )          | 771 |   | 1,093 |   | (598 | ) | 495 |   |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Investment securities available-for-sale |       | (146                                                        | )          | 85                                                          |       | (61 | ) | 1,215 |   | (819 | ) | 396 |   |
| Investment securities held-to-maturity   |       | 1,478                                                       |       | —                                                      |       | 1,478 |   | — |   | — |   | — |   |
| Other investments                        |       | 24                                                          |       | (9                                                          | )          | 15 |   | 20 |   | (6 | ) | 14 |   |
| Federal funds sold                       |       | (17                                                         | )          | (6                                                          | )          | (23 | ) | (140 | ) | (18 | ) | (158 | ) |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Total interest income                    |       | 2,789                                                       |       | (609                                                        | )          | 2,180 |   | 2,188 |   | (1,441 | ) | 747 |   |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest checking                        |       | 20                                                          |       | (179                                                        | )          | (159 | ) | 245 |   | (412 | ) | (167 | ) |
| Money markets                            |       | 4                                                           |       | (21                                                         | )          | (17 | ) | (9 | ) | (74 | ) | (83 | ) |
| Statement savings                        |       | 4                                                           |       | (2                                                          | )          | 2 |   | 4 |   | (7 | ) | (3 | ) |
| Certificates of deposit                  |       | 871                                                         |       | (425                                                        | )          | 446 |   | 497 |   | (326 | ) | 171 |   |
| Total interest - bearing deposits        |       | 899                                                         |       | (627                                                        | )          | 272 |   | 737 |   | (819 | ) | (82 | ) |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |       | 269                                                         |       | 85                                                          |       | 354 |   | 219 |   | (173 | ) | 46 |   |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Total interest expense                   |       | 1,168                                                       |       | (542                                                        | )          | 626 |   | 956 |   | (992 | ) | (36 | ) |
|                                     |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                  |       | $                                                           | 1,621      |                                                        | $          | (67 | ) | $ | 1,554 |   | $ | 1,232 |   | $ | (449 | ) | $ | 783 |   |

 

----

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

(2) We do not have investments that have taxbenefit attributes; therefore, there are no tax equivalent adjustments to ournet interest income.

 

18

----

 

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

SixMonths Ended June 30, 2004, 2003 and 2002

(Dollarsin thousands)

 
| ** **                                               | ** ** | **2004**               | ** ** | **2003**                         | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|----------|------------|
| ** **                                               | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** | **Average****Balance** | ** ** | **Interest  Income/****Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Loans (1):                                         |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $                      | 58,356     |                             | $          | 1,551    |       | 5.32 | % | $ | 51,866 |   | $ | 1,650 |   | 6.36 | % | $ | 53,322 |   | $ | 1,896 |   | 7.11 | % |
| Real estate - commercial                                 |       | 144,506                |       | 4,563                            |       | 6.32     | %          | 115,287 |   | 4,097 |   | 7.11 | % | 87,215 |   | 3,521 |   | 8.07 | % |
| Real estate - construction                               |       | 43,778                 |       | 1,204                            |       | 5.50     | %          | 11,894 |   | 351 |   | 5.90 | % | 5,940 |   | 182 |   | 6.13 | % |
| Real estate - residential                                |       | 42,683                 |       | 1,203                            |       | 5.64     | %          | 35,755 |   | 1,181 |   | 6.61 | % | 16,590 |   | 665 |   | 8.01 | % |
| Home equity lines                                        |       | 47,928                 |       | 770                              |       | 3.22     | %          | 30,131 |   | 503 |   | 3.37 | % | 22,719 |   | 478 |   | 4.24 | % |
| Consumer                                                 |       | 9,855                  |       | 308                              |       | 6.25     | %          | 9,367 |   | 351 |   | 7.56 | % | 13,349 |   | 489 |   | 7.33 | % |
| Total loans                                              |       | 347,106                |       | 9,599                            |       | 5.53     | %          | 254,300 |   | 8,133 |   | 6.40 | % | 199,135 |   | 7,231 |   | 7.26 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Investment securities available-for-sale           |       | 161,637                |       | 2,824                            |       | 3.50     | %          | 189,640 |   | 3,292 |   | 3.47 | % | 73,821 |   | 1,813 |   | 4.91 | % |
|  Investment securities held-to-maturity             |       | 153,922                |       | 2,828                            |       | 3.67     | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|  Other investments                                  |       | 4,100                  |       | 84                               |       | 4.10     | %          | 2,216 |   | 55 |   | 4.96 | % | 1,194 |   | 36 |   | 6.03 | % |
|  Federal funds sold                                 |       | 10,366                 |       | 47                               |       | 0.90     | %          | 13,983 |   | 80 |   | 1.14 | % | 42,985 |   | 353 |   | 1.66 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|  Total interest-earning assets and interest  income |       | 677,131                |       | 15,382                           |       | 4.54     | %          | 460,139 |   | 11,560 |   | 5.02 | % | 317,135 |   | 9,433 |   | 5.95 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                             |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                  |       | 10,607                 |       |                             |       |     |       | 11,390 |   |   |   |   |   | 15,706 |   |   |   |   |   |
| Premises and equipment, net                              |       | 7,449                  |       |                             |       |     |       | 5,114 |   |   |   |   |   | 4,926 |   |   |   |   |   |
| Accrued interest and other assets                        |       | 6,296                  |       |                             |       |     |       | 4,912 |   |   |   |   |   | 1,672 |   |   |   |   |   |
| Allowance for loan losses                                |       | (4,413                 | )          |                             |       |     |       | (3,440 | )  |   |   |   |   | (3,052 | )  |   |   |   |   |
| Total assets                                             |       | $                      | 697,070    |                             |       |     |       |   | $ | 478,115 |   |   |   |   |   | $ | 336,387 |   |   |   |   |   |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity**           |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                          |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                             |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 153,106                |       | 1,034                            |       | 1.35     | %          | 142,602 |   | 1,303 |   | 1.84 | % | 91,258 |   | 1,348 |   | 2.98 | % |
| Money markets                                            |       | 25,586                 |       | 75                               |       | 0.59     | %          | 25,481 |   | 125 |   | 0.99 | % | 26,303 |   | 272 |   | 2.09 | % |
| Statement savings                                        |       | 7,387                  |       | 21                               |       | 0.58     | %          | 4,940 |   | 19 |   | 0.78 | % | 4,269 |   | 26 |   | 1.24 | % |
| Certificates of deposit                                  |       | 256,425                |       | 3,650                            |       | 2.85     | %          | 173,796 |   | 3,019 |   | 3.50 | % | 121,168 |   | 2,586 |   | 4.31 | % |
| Total interest - bearing deposits                        |       | 442,504                |       | 4,780                            |       | 2.17     | %          | 346,819 |   | 4,466 |   | 2.60 | % | 242,998 |   | 4,232 |   | 3.51 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 84,098                 |       | 771                              |       | 1.84     | %          | 21,798 |   | 190 |   | 1.76 | % | 8,192 |   | 168 |   | 4.08 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest  expense |       | 526,602                |       | 5,551                            |       | 2.11     | %          | 368,617 |   | 4,656 |   | 2.55 | % | 251,190 |   | 4,400 |   | 3.53 | % |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                         |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 76,695                 |       |                             |       |     |       | 67,191 |   |   |   |   |   | 56,774 |   |   |   |   |   |
| Other liabilities                                        |       | 1,889                  |       |                             |       |     |       | 1,953 |   |   |   |   |   | 2,938 |   |   |   |   |   |
| Preferred shareholders’ equity                      |       | —                 |       |                             |       |     |       | 6,824 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common shareholders’ equity                         |       | 91,884                 |       |                             |       |     |       | 33,530 |   |   |   |   |   | 18,660 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $                      | 697,070    |                             |       |     |       |   | $ | 478,115 |   |   |   |   |   | $ | 336,387 |   |   |   |   |   |
|                                                     |       |                   |       |                             |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin (2)          |       |                   |       | $                                | 9,831      |     | 2.90       | % |   |   | $ | 6,904 |   | 3.00 | % |   |   | $ | 5,033 |   | 3.18 | % |

 

----

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

(2) We do not have investments that have taxbenefit attributes; therefore, there are no tax equivalent adjustments to ournet interest income.

 

19

----

 

**Rate and Volume Analysis**

SixMonths Ended June 30, 2004, 2003 and 2002

(Dollarsin thousands)

 
| ** **                               | ** ** | **Six Months Ended June 30,  2004 Compared to 2003** | ** ** | **Six Months Ended June 30,  2003 Compared to 2002** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                               | ** ** | **Average****Volume**                                     | ** ** | **Average****Rate**                                       | ** ** | **Increase****(Decrease)** | ** ** | **Average****Volume** | ** ** | **Average****Rate** | ** ** | **Increase****(Decrease)** | ** ** |
| **Interest income:**                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Loans (1):                               |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                |       | $                                                         | 206        |                                                      | $          | (305 | ) | $ | (99 | ) | $ | (52 | ) | $ | (194 | ) | $ | (246 | ) |
| Real estate - commercial                 |       | 1,038                                                     |       | (572                                                      | )          | 466 |   | 1,133 |   | (557 | ) | 576 |   |
| Real estate - construction               |       | 941                                                       |       | (88                                                       | )          | 853 |   | 182 |   | (13 | ) | 169 |   |
| Real estate - residential                |       | 229                                                       |       | (207                                                      | )          | 22 |   | 766 |   | (250 | ) | 516 |   |
| Home equity lines                        |       | 302                                                       |       | (35                                                       | )          | 267 |   | 156 |   | (131 | ) | 25 |   |
| Consumer                                 |       | 22                                                        |       | (65                                                       | )          | (43 | ) | (149 | ) | 11 |   | (138 | ) |
| Total loans                              |       | 2,738                                                     |       | (1,272                                                    | )          | 1,466 |   | 2,036 |   | (1,134 | ) | 902 |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Investment securities available-for-sale |       | (490                                                      | )          | 22                                                        |       | (468 | ) | 2,844 |   | (1,365 | ) | 1,479 |   |
| Investment securities held-to-maturity   |       | 2,828                                                     |       | —                                                    |       | 2,828 |   | — |   | — |   | — |   |
| Other investments                        |       | 47                                                        |       | (18                                                       | )          | 29 |   | 31 |   | (12 | ) | 19 |   |
| Federal funds sold                       |       | (20                                                       | )          | (13                                                       | )          | (33 | ) | (238 | ) | (35 | ) | (273 | ) |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Total interest income                    |       | 5,103                                                     |       | (1,281                                                    | )          | 3,822 |   | 4,673 |   | (2,546 | ) | 2,127 |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Interest checking                        |       | 102                                                       |       | (371                                                      | )          | (269 | ) | 758 |   | (803 | ) | (45 | ) |
| Money markets                            |       | 1                                                         |       | (51                                                       | )          | (50 | ) | (9 | ) | (138 | ) | (147 | ) |
| Statement savings                        |       | 9                                                         |       | (7                                                        | )          | 2 |   | 4 |   | (11 | ) | (7 | ) |
| Certificates of deposit                  |       | 1,457                                                     |       | (826                                                      | )          | 631 |   | 1,129 |   | (696 | ) | 433 |   |
| Total interest - bearing deposits        |       | 1,569                                                     |       | (1,255                                                    | )          | 314 |   | 1,882 |   | (1,648 | ) | 234 |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |       | 545                                                       |       | 36                                                        |       | 581 |   | 274 |   | (252 | ) | 22 |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Total interest expense                   |       | 2,114                                                     |       | (1,219                                                    | )          | 895 |   | 2,156 |   | (1,900 | ) | 256 |   |
|                                     |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                  |       | $                                                         | 2,989      |                                                      | $          | (62 | ) | $ | 2,927 |   | $ | 2,517 |   | $ | (646 | ) | $ | 1,871 |   |

 

----

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

(2) We do not have investments that have taxbenefit attributes; therefore, there are no tax equivalent adjustments to ournet interest income.

 

20

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Provision for loan losses for the three months ended June 30, 2004and 2003 was $314,000 and $166,000, respectively.  For the six months ended June 30, 2004and 2003, provision for loan losses was $388,000 and $246,000,respectively.  The allowance for loanlosses at June 30, 2004 and December 31, 2003 was $4.6 million and$4.3 million, respectively.    Ourallowance for loan loss ratio at June 30, 2004 was 1.18%, compared to1.29% at December 31, 2003.  Wecontinued to experience strong loan quality with annualized net charged-offloans equal to 0.06% to total loans for the six months ended June 30,2004, compared to 0.01% for the same period of 2003.  Non-performing loans were equal to 0.02% of totalloans at June 30, 2004, compared to 0.12% at December 31, 2003.  Additional information on the allowance forloan losses, its allocation to the total loans receivable portfolio andinformation on nonperforming loans can be found in Tables 5, 6 and 7.

 

**Allowancefor Loan Losses**

Six Months Ended June 30,2004 and 2003

(Dollars in thousands)

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Beginning balance, January 1 |       | $        | 4,344      |     | $          | 3,372 |   |
|                              |       |     |       |     |       |
| Provision for loan losses         |       | 388      |       | 246      |       |
|                              |       |     |       |     |       |
| Loans charged off:                |       |     |       |     |       |
| Commercial and industrial         |       | (100     | )          | (74      | )          |
| Real estate - commercial          |       | —   |       | —   |       |
| Real estate - construction        |       | —   |       | —   |       |
| Real estate - residential         |       | —   |       | —   |       |
| Home equity lines                 |       | —   |       | —   |       |
| Consumer                          |       | (4       | )          | (6       | )          |
| Total loans charged off           |       | (104     | )          | (80      | )          |
|                              |       |     |       |     |       |
| Recoveries:                       |       |     |       |     |       |
| Commercial and industrial         |       | 3        |       | 41       |       |
| Real estate - commercial          |       | —   |       | —   |       |
| Real estate - construction        |       | —   |       | —   |       |
| Real estate - residential         |       | —   |       | —   |       |
| Home equity lines                 |       | —   |       | —   |       |
| Consumer                          |       | 2        |       | 3        |       |
| Total recoveries                  |       | 5        |       | 44       |       |
|                              |       |     |       |     |       |
| Net (charge offs) recoveries      |       | (99      | )          | (36      | )          |
|                              |       |     |       |     |       |
| Ending balance                    |       | $        | 4,633      |     | $          | 3,582 |   |

 
| ** **                                                  | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Loans:                                                      | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Balance at period end                                       |       | $                       | 392,905    |                        | $          | 336,002 |   |
| Allowance for loan losses to loans  receivable, net of fees |       | 1.18                    | %          | 1.29                        | %          |
| Annualized net charge-offs to average loans  receivable     |       | 0.06                    | %          | 0.01                        | %          |
|                                                             |            |                         |            |                             |            |  |  |

 

21

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**Allocationof the Allowance for Loan Losses**

At June 30, 2004 andDecember 31, 2003

(Dollarsin thousands)

 
| ** **                      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **Allocation**          | ** ** | **% of Total***             |       | **Allocation** |   | **% of Total*** |   |
| Commercial                      |       | $                       | 980        |                        | 14.53      | % | $ | 1,046 |   | 17.21 | % |
| Real estate - commercial        |       | 2,145                   |       | 45.96                       | %          | 1,662 |   | 41.56 | % |
| Real estate - construction      |       | 532                     |       | 13.60                       | %          | 497 |   | 12.57 | % |
| Real estate - residential       |       | 307                     |       | 10.28                       | %          | 418 |   | 12.64 | % |
| Home equity lines               |       | 476                     |       | 13.45                       | %          | 486 |   | 12.84 | % |
| Consumer                        |       | 193                     |       | 2.18                        | %          | 235 |   | 3.18 | % |
|                            |       |                    |       |                        |       |   |   |   |   |
| Total allowance for loan losses |       | $                       | 4,633      |                        | 100.00     | % | $ | 4,344 |   | 100.00 | % |

 

----

* Percentage of loan type to the total loanportfolio.

 

 

**NonperformingLoans Receivable**

At June 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Nonaccruing loans                             |       | $                       | 200        |                        | $          | 390 |   |
|                                          |       |                    |       |                        |       |
| Loans contractually past-due 90 days or  more |       | —                  |       | 4                           |       |
|                                          |       |                    |       |                        |       |
| Troubled debt restructurings                  |       | —                  |       | —                      |       |
| Total nonperforming loans receivable          |       | $                       | 200        |                        | $          | 394 |   |

 

22

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Non-interest income for the three months endedJune 30, 2004 and 2003 was $564,000 and $1.0 million, respectively, aperiod-to-period decrease of $485,000, or 46.2%.  Non-interest income for the six months endedJune 30, 2004 and 2003 was $1.4 million compared to $2.0 million, adecrease of $581,000 or 28.7%.  Thedecrease in non-interest income is primarily attributable to the decrease inrealized gains on sales of investment securities available-for-sale during thethree and six months ended June 30, 2004 when compared to the same periodsof 2003.  These gains were recorded onsales of mortgage-backed securities with accelerated pre-payment speeds.  Excluding the realized gains on the sale ofinvestment securities of $0 and $417,000 for the second quarters of 2004 and2003, respectively, non-interest income would have decreased $68,000 to$564,000 for the second quarter of 2004, compared to $632,000 for the secondquarter of 2003.  Excluding the realizedgains on the sale of investment securities of $241,000 and $910,000 for the sixmonths ended June 30, 2004 and 2003, respectively, non-interest incomewould have increased $88,000 to $1.2 million for the year to date 2004,compared to $1.1 million for the same period of 2003.

 

Service charges on deposit accounts increased$28,000 to $262,000 for the three months ended June 30, 2004, compared to$234,000 for the same period of 2003. For the six months ended June 30, 2004, service charges on depositaccounts increased $56,000 to $502,000, compared to $446,000 for the samesix-month period of 2003.  Increases inservice charges on deposit accounts during 2004 are a direct result of theincrease in total deposits.  Loan servicecharge income decreased $70,000 to $89,000 for the three months endedJune 30, 2004, compared to $159,000 for the same period of 2003.  Loan service charge income for the six monthsended June 30, 2004 and 2003 were $285,000 and $270,000, respectively, anincrease of $15,000 or 5.6%.  Theincrease in loan service charges during 2004 is a result of the loan volumeexperienced during the year.  Investmentfee income decreased to $158,000 for the three months ended June 30, 2004,compared to $162,000 for the three months ended June 30, 2003.  For the six months ended June 30, 2004and 2003, investment fee income was $336,000 and $288,000, respectively, anincrease of $48,000, or 16.7%.  Theincrease in investment fee income is due to the increase in assets undermanagement and transaction activity in our investments services businesssegment.

 

Non-interestexpense for the three and six months ended June 30, 2004 was $4.3 millionand $8.9 million, respectively, compared to $3.7 million and $7.5 million forthe same three and six months periods of 2003, respectively.  We saw period-to-period increases of $640,000and $1.3 million for the comparable three and six month periods ofJune 30, 2004 and 2003, respectively. These increases are attributable to the branch expansion we havecompleted over the past twelve months. We opened our twelfth branch on February 27, 2004 in Herndon,Virginia.  On June 1, 2004, weopened our thirteenth branch in Fairfax, Virginia.  In addition, our Tysons Corner, Leesburg andWoodbridge branches opened during the third and fourth quarters of 2003 and arenot included in the non-interest expense for the six-month period of 2003.  Expenses related to the branch expansion arerepresented in the increases in our salaries and benefits expense, occupancy expenseand depreciation expense.  Otheroperating expenses on our statements of operations include businessdevelopment, data processing and communications expenses, and officeadministration expenses.

 

The effective tax rate for the three and six months ended June 30,2004 was 33.3% and 33.4%, respectively, compared to 0% and 0% for the sameperiods of 2003.  The increase in theeffective tax rate is a result of having recognized our deferred tax assets inDecember 2003, which are primarily attributable to net operating losscarryforwards.  We recorded a provisionfor income tax expense of $316,000 and $678,000 for the three and six monthsended June 30, 2004,

 

23

----

 

respectively, compared to $0 and $0 for the same three and six monthperiods of 2003, respectively.    Formore information, see “Critical Accounting Policies” above in this discussion.

 

**Statements of Condition**

 

Total assets were $810.0 million at June 30, 2004, compared to$636.2 million at December 31, 2003, an increase of $173.8 million or27.3%.  This growth was driven byincreases in total loans, total deposits and the equity raised in the commonstock offering during January 2004.

 

Investment securities were $331.6 million at June 30, 2004, comparedto $273.6 million at December 31, 2003, an increase of $58.0 million or21.2%.  The investment portfolio consistsof investment securities available-for-sale and investment securitiesheld-to-maturity.  Investment securitiesheld-to-maturity are those securities that we have the intent and ability tohold to maturity and are carried at amortized cost.  These securities are utilized for pledging ofadvances from the Federal Home Loan Bank and other borrowing activities.  Investment securities available-for-sale arethose securities that we intend to hold for an indefinite period of time, butnot necessarily until maturity.  Thesesecurities are carried at fair value and may be sold as part of anasset/liability strategy, liquidity management, interest rate risk management,regulatory capital management or similar factors.  At June 30, 2004, investment securitiesavailable-for-sale were $174.4 million and investment securitiesheld-to-maturity were $157.3 million. See Table 8 for additional information on our investment securitiesportfolio.

 

**InvestmentSecurities**

At June 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                                                         | ** ** | ** **          | ** ** | ** **      | ** ** | ** **         | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| **Available-for-sale  at June 30, 2004**                      | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
| Obligations of U.S. government-sponsored agencies  and enterprises |       |                |       |            |       |               |       |
| One to five years                                                  |       | $                   | 2,000      |            | $          | 1,930              |       | 3.50 | % |
| Five to ten years                                                  |       | 4,000               |       | 3,910           |       | 4.09               | %          |
| Total U.S. government-sponsored agencies                           |       | $                   | 6,000      |            | $          | 5,840              |       | 3.89 | % |
|                                                               |       |                |       |            |       |               |       |
| Mortgage-backed securities*                                        |       |                |       |            |       |               |       |
| Five to ten years                                                  |       | $                   | 16,658     |            | $          | 16,322             |       | 3.90 | % |
| After ten years                                                    |       | 144,675             |       | 140,166         |       | 4.06               | %          |
| Total mortgage-backed securities                                   |       | $                   | 161,333    |            | $          | 156,488            |       | 4.05 | % |
|                                                               |       |                |       |            |       |               |       |
| Corporate bonds                                                    |       |                |       |            |       |               |       |
| After ten years                                                    |       | $                   | 10,000     |            | $          | 10,032             |       | 2.36 | % |
| Total corporate bonds                                              |       | $                   | 10,000     |            | $          | 10,032             |       | 2.36 | % |
|                                                               |       |                |       |            |       |               |       |
| Treasury bonds                                                     |       |                |       |            |       |               |       |
| One to five years                                                  |       | $                   | 2,040      |            | $          | 2,021              |       | 2.63 | % |
| Total treasury bonds                                               |       | $                   | 2,040      |            | $          | 2,021              |       | 2.63 | % |
| Total investment securities  available-for-sale                    |       | $                   | 179,373    |            | $          | 174,381            |       | 3.93 | % |

 
| **Held-to-maturity  at June 30, 2004**                        | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| Obligations of U.S. government-sponsored  agencies and enterprises |       |                |       |            |       |               |       |
| One to five years                                                  |       | $                   | 5,999      |            | $          | 5,842              |       | 3.26 | % |
| Five to ten years                                                  |       | 22,978              |       | 22,417          |       | 4.65               | %          |
| After ten years                                                    |       | 2,999               |       | 2,900           |       | 4.22               | %          |
| Total U.S. government-sponsored agencies                           |       | $                   | 31,976     |            | $          | 31,159             |       | 4.35 | % |
|                                                               |       |                |       |            |       |               |       |
| Mortgage-backed securities*                                        |       |                |       |            |       |               |       |
| Five to ten years                                                  |       | $                   | 10,327     |            | $          | 10,117             |       | 4.03 | % |
| After ten years                                                    |       | 106,951             |       | 104,234         |       | 4.18               | %          |
| Total mortgage-backed securities                                   |       | $                   | 117,278    |            | $          | 114,351            |       | 4.17 | % |
|                                                               |       |                |       |            |       |               |       |
| Corporate bonds                                                    |       |                |       |            |       |               |       |
| After ten years                                                    |       | $                   | 8,000      |            | $          | 7,795              |       | 4.21 | % |
| Total corporate bonds                                              |       | $                   | 8,000      |            | $          | 7,795              |       | 4.21 | % |
| Total investment securities  held-to-maturity                      |       | $                   | 157,254    |            | $          | 153,305            |       | 4.21 | % |
|                                                               |       |                |       |            |       |               |       |
| Total investment securities                                        |       | $                   | 336,627    |            | $          | 327,686            |       | 4.06 | % |

 

----

* Based on contractual maturities.

 

24

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

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

 

----

* Based on contractual maturities.

 

25

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Loansreceivable, net of fees, increased by $56.9 million, or 16.9%, to $392.9million at June 30, 2004 from $336.0 million at December 31, 2003(see Table 9 for details on the loans receivable portfolio). We experiencedincreases in our commercial real estate, construction, and home equity loanportfolios offset by decreases in our commercial and residential real estateloan portfolios.  These decreases are theresult of more paydowns than fundings in those loan categories and a result ofportfolio seasonality.  We expectincreases within these loan categories over the next two quarters of 2004 dueto our increased legal lending limit of $12.0 million and the volume of loanswe have scheduled for funding.

 

**Loans Receivable**

At June 30, 2004 andDecember 31, 2003

(Dollarsin thousands)

 
| ** **                      | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Commercial                      |       | $                      | 57,143     |                       | 14.53      | % | $ | 57,854 |   | 17.21 | % |
| Real estate - commercial        |       | 180,722                |       | 45.96                      | %          | 139,725 |   | 41.56 | % |
| Real estate - construction      |       | 53,496                 |       | 13.60                      | %          | 42,243 |   | 12.57 | % |
| Real estate - residential       |       | 40,412                 |       | 10.28                      | %          | 42,495 |   | 12.64 | % |
| Home equity lines               |       | 52,896                 |       | 13.45                      | %          | 43,176 |   | 12.84 | % |
| Consumer                        |       | 8,546                  |       | 2.18                       | %          | 10,690 |   | 3.18 | % |
|                            |       |                   |       |                       |       |   |   |   |   |
| Gross loans                     |       | $                      | 393,215    |                       | 100.00     | % | $ | 336,183 |   | 100.00 | % |
|                            |       |                   |       |                       |       |   |   |   |   |
| Add: net deferred (fees) costs  |       | (310                   | )          |                       |       | (181 | ) |   |   |
| Less: allowance for loan losses |       | (4,633                 | )          |                       |       | (4,344 | ) |   |   |
|                            |       |                   |       |                       |       |   |   |   |   |
| Loans receivable, net           |       | $                      | 388,272    |                       |       |   | $ | 331,658 |   |   |   |

 

Total deposits increased $123.4 million, or 26.0%, to $597.6 million atJune 30, 2004, compared to $474.1 million at December 31, 2003 (seeTable 10 for details on certificates of deposit with balances of $100,000 ormore).  We experienced increases innon-interest bearing demand deposits, money market and savings deposits andcertificates of deposit.  The increase indeposits is a result of new customers from our branch expansion and increasedadvertising efforts.

 

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

At June 30, 2004

(Dollars in thousands)

 
| **Maturities:**                       |   |    |    |
|---------------------------------------|--------|---------|---------|
| Three months or less                  |   | $       | 16,604  |   |
| Over three months through six months  |   | 13,591  |    |
| Over six months through twelve months |   | 11,328  |    |
| Over twelve months                    |   | 100,195 |    |
|                                  |   | $       | 141,718 |   |

 

26

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Other borrowed funds increased $46.3 million to $120.8 million atJune 30, 2004, compared to $74.5 million at December 31, 2003.  We added Federal Home Loan Bank advancesduring the second quarter of 2004 to leverage against some of our largercommercial real estate loan fundings.  Inaddition, borrowings from the treasury, tax and loan note option of the FederalReserve System increased to $12.8 million at June 30, 2004.  Table 11 provides information on ourshort-term borrowings.

 

**Short-Term Borrowings**

AtJune 30, 2004

(Dollarsin thousands)

 
| **Advance  Date**                                          | ** ** | **Original  Term of Advance** | ** ** | **Date Amount  Due** | ** ** | **Interest Rate** | ** ** | **Outstanding** | ** ** |
|------------------------------------------------------------|------------|-------------------------------|------------|----------------------|------------|-------------------|------------|-----------------|------------|
| Jan-03                                                     |       | 18 months                     |       | Jul-04               |       | 1.81              | %          | $               | 2,000      |   |
| Jan-03                                                     |       | 18 months                     |       | Jul-04               |       | 1.96              | %          | 2,000           |       |
| Mar-03                                                     |       | 18 months                     |       | Sep-04               |       | 1.77              | %          | 1,000           |       |
| Mar-03                                                     |       | 18 months                     |       | Sep-04               |       | 1.86              | %          | 1,000           |       |
| Dec-03                                                     |       | 12 months                     |       | Dec-04               |       | 1.41              | %          | 5,000           |       |
| Jan-04                                                     |       | 12 months                     |       | Jan-05               |       | 1.56              | %          | 5,000           |       |
| Mar-03                                                     |       | 24 months                     |       | Mar-05               |       | 1.82              | %          | 1,000           |       |
| **Total short-term  borrowings and weigthed average rate** |       | ** **                    | ** ** | ** **           |       | **1.64**          | **%**      | **$**           | **17,000** |   |
|                                                       |       |                          |       |                 |       |              |       |            |       |
| All other borrowed funds                                   |       |                          |       |                 |       |              |       | 103,751         |       |
| Total other borrowed funds                                 |       |                          |       |                 |       |              |       | $               | 120,751    |   |

 

27

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Shareholders’ equity at June 30, 2004 was $90.7 million, anincrease of $5.3 million, or 6.2%, compared to $85.4 million atDecember 31, 2003. The increase of $5.3 million from the prior year wasprimarily driven by the underwriters’ exercise in January 2004 of theirover allotment option from the secondary offering in December 2003.  The over-allotment exercise resulted in theissuance of an additional 945,000 shares of the Company’s common stock and thereceipt of $6.3 million in total capital. Net income of $1.4 million for the year to date June 30, 2004 alsoadded to the increase in shareholders’ equity for the period.  Offsetting these increases, the Company hadan unfavorable market value adjustment of $2.7 million on investment securitiesavailable-for-sale as of June 30, 2004. Book value per common share at June 30, 2004 was $4.92, compared to$4.80 at December 31, 2003.

 

##### **Business SegmentOperations**

 

**We provide banking and non-banking financial services andproducts through our subsidiaries.  Priorto July 7, 2004, management operated and reported on the results of ouroperations through two business segments, commercial banking and investmentservices.  With the completion of ouracquisition of GMM, we will operate and report on three business segmentsbeginning in the third quarter of 2004.**

 

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

 

The commercial banking segment provides a wide range of bankingservices to small businesses and individuals through multiple deliverychannels.  Services offered includecommercial and consumer lending, deposit products and banking via the Internetor telephone.

 

For the three months ended June 30, 2004 and 2003, the commercialbanking segment recorded net income of $892,000 and $922,000,respectively.  For the six months endedJune 30, 2004 and 2003, the commercial banking segment recorded net incomeof $1.8 million and $1.7 million, respectively. The decrease in earnings in the three months ended June 30, 2004compared to the same three-month period of 2003 is a result of decreased gainson sales of investment securities available-for-sale.  Offsetting this decrease is increased net interestincome, due to increased volume of earning assets for this segment.  As of June 30, 2004, total assets were$804.0 million, loans receivable, net of fees, were $392.9 million and totaldeposits were $597.6 million.  As ofJune 30, 2003, total assets were $516.2 million, loans receivable, net offees were $264.2 million and total deposits were $438.4 million.

 

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

 

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

 

For the three months ended June 30, 2004 and 2003, the investmentservices segment recorded a net loss of $19,000 and $0, respectively.  For the six months ended June 30, 2004and 2003, the investment services segment recorded a net loss of $58,000 and$42,000, respectively.  The increase inthe net loss in both the three and six months ended June 30, 2004,compared to

 

28

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the same periods of 2003, is due to management reorganization thissegment has experienced over the past twelve months.  As of June 30, 2004, total assets were$701,000 and total assets under management were $186.3 million.  As of June 30, 2003, total assets were$245,000 and total assets under management were $92.9 million.  The revenues and assets under management fromthis business segment have increased for the six months ended June 30,2004 compared to the same period of 2003 as a result of increased transactionactivity and accumulation of assets under management through new customers tothis segment.  We expect the financialresults of this segment to improve as the assets under management increase.

 

Informationpertaining to both business segments can be found in Note 2 to the Notes toConsolidated Financial Statements.

 

## **Capital Resources**

 

Capital adequacy is an important measure of financial stability andperformance.  Our objectives are tomaintain a level of capitalization that is sufficient to sustain asset growthand promote depositor and investor confidence.

 

Regulatory agencies measure capital adequacy utilizing a formula thattakes into account the individual risk profile of a financial institution.  The guidelines define capital as both tier 1(primarily common shareholders’ equity, defined to include certain debt obligations)and tier 2 (certain other debt obligations and a portion of the allowance forloan losses and 45% of unrealized gains in equity securities).

 

At June 30, 2004, our tier 1 and total (tier 1 and tier 2)risk-based capital ratios were 17.2% and 18.0%, respectively.  At December 31, 2003, our tier 1 andtotal risk-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 12 provides additional information pertaining to ourcapital ratios.

 

**Capital Components**

At June 30, 2004 and December 31, 2003

(Dollars in thousands)

 
| ** **                                            | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                              | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **At June 30,  2004**                            |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total risk based capital to net  risk-weighted assets |       | $          | 98,647     |                               | 18.00      | %                                                                       | $          | 43,832 | 3 | 8.00 | % | $ | 54,790 | 3 | 10.00 | % |
| Tier I capital to net risk-weighted assets            |       | 94,014     |       | 17.16                              | %          | 21,916                                                                  | 3     | 4.00 | % | 32,874 | 3 | 6.00 | % |
| Total risk based capital to average total  assets     |       | 98,647     |       | 13.52                              | %          | 29,181                                                                  | 3     | 4.00 | % | 36,476 | 3 | 5.00 | % |
|                                                  |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| **At  December 31, 2003**                        |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total risk based capital to net  risk-weighted assets |       | $          | 90,239     |                               | 20.66      | %                                                                       | $          | 34,951 | 3 | 8.00 | % | $ | 43,688 | 3 | 10.00 | % |
| Tier I capital to net risk-weighted assets            |       | 85,896     |       | 19.66                              | %          | 17,475                                                                  | 3     | 4.00 | % | 26,213 | 3 | 6.00 | % |
| Total risk based capital to average total  assets     |       | 90,239     |       | 15.45                              | %          | 23,365                                                                  | 3     | 4.00 | % | 29,206 | 3 | 5.00 | % |

 

29

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**Contractual Obligations**

 

We have entered into a number of long-termcontractual obligations to support our ongoing activities.  These contractual obligations will be fundedthrough operating revenues and liquidity sources held or available to us.  The required payments under such obligationsare detailed in Table 13.  In addition,the Company is a party to financial instruments with off-balance sheet risk inthe normal course of business to meet the financing needs of itscustomers.  These financial instrumentsinclude commitments to extend credit and standby letters of credit andfinancial guarantees.  At June 30,2004, commitments to extend credit totaled $147.5 million and standby lettersof credit totaled $4.8 million.

 

**ContractualObligations**

At June 30, 2004

(Dollars in thousands)

 
| ** **                                           | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** | ** **      | ** ** |
|------------------------------------------------------|------------|------------|------------|----------------------------|------------|-----------------|------------|
| ** **                                           | ** ** | **Total**  | ** ** | **Less than 1  Year**      | ** ** | **1 - 2 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
| Certificates of deposit of $100,000 or more          |       | $          | 141,718    |                       | $          | 41,523          |       | $ | 61,082 |   | $ | 39,113 |   | $ | — |   |
| Advances from the Federal Home Loan Bank of  Atlanta |       | 86,708     |       | 19,496                     |       | 23,242          |       | 43,970 |   | — |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Operating lease obligations                          |       | 11,154     |       | 2,159                      |       | 4,188           |       | 4,282 |   | 525 |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Total                                                |       | $          | 239,580    |                       | $          | 63,178          |       | $ | 88,512 |   | $ | 87,365 |   | $ | 525 |   |

 

## **Liquidity**

 

The objective of liquidity management is to ensure the continuousavailability of funds to meet the demands of depositors, investors andborrowers.  Stable core deposits and astrong capital position are the current components of a solid foundation forour liquidity position.  In addition, theavailability of regional and national wholesale funding sources includingfederal

 

30

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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 $239.8 million, or 29.6%of total assets, at June 30, 2004. We had investment securities that are classified as held-to-maturity of$157.3 million at June 30, 2004.  Wealso had $210.9 million of our total investment securities portfolio availableas collateral for additional Federal Home Loan Bank borrowings.  Management is committed to maintainingliquidity at a level sufficient to protect depositors, provide for reasonablegrowth and fully comply with all regulatory requirements.

 

##### **Interest RateSensitivity**

 

Asset/liability management involves the monitoring of our sensitivityto interest rate movements.  In order tomeasure the effect of interest rates on our net interest income, we take intoconsideration the expected cash flows from the loan and investment securitiesportfolios and the expected magnitude of the repricing of specific asset andliability categories.  Managementevaluates interest sensitivity risk and then formulates guidelines to managethis risk based upon its outlook regarding the economy, forecasted interestrate movements and other business factors. Management’s goal is to maximize and stabilize the net interest marginby limiting exposure to interest rate changes.

 

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

 

**Interest Rate Sensitivity Gap Analysis**

AtJune 30, 2004

(Dollarsin thousands)

 
| ** **                                                                   | ** ** | **Immediate  Repricing** | ** ** | **2-90  Days** | ** ** | **91-180  Days** | ** ** | **181-365  Days** | ** ** | **1-3  Years** | ** ** | **Over 3  Years** | ** ** | **TOTAL** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------|------------|----------------|------------|------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|-----------|------------|
| **Assets**                                                                   |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Total investment securities and other  investments                           |       | $                        | —     |           | $          | 9,104            |       | $                 | 8,562      |           | $          | 19,637            |       | $         | 97,337     |   | $ | 202,410 |   | $ | 337,050 |   |
| Federal funds sold                                                           |       | 53,379                   |       | —         |       | —           |       | —            |       | —         |       | —            |       | 53,379    |       |
| Loans held for sale                                                          |       | 797                      |       | —         |       | —           |       | —            |       | —         |       | —            |       | 797       |       |
| **Loans receivable,  net of fees**                                           |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Commercial & industrial                                                  |       | 3,144                    |       | 20,700         |       | 6,323            |       | 8,863             |       | 29,470         |       | 169,056           |       | 237,556   |       |
| Residential                                                                  |       | 21                       |       | 1,072          |       | 665              |       | 1,793             |       | 4,303          |       | 32,558            |       | 40,412    |       |
| Home equity lines                                                            |       | 3,362                    |       | 45,527         |       | 3,731            |       | 275               |       | —         |       | —            |       | 52,895    |       |
| Construction                                                                 |       | 940                      |       | 9,377          |       | 8,502            |       | 19,948            |       | 14,729         |       | —            |       | 53,496    |       |
| All other                                                                    |       | 83                       |       | 163            |       | 9                |       | 257               |       | 693            |       | 7,341             |       | 8,546     |       |
| **Total loans  receivable, net of fees**                                     |       | 7,550                    |       | 76,839         |       | 19,230           |       | 31,136            |       | 49,195         |       | 208,955           |       | 392,905   |       |
| **Total earning  assets**                                                    |       | 61,726                   |       | 85,943         |       | 27,792           |       | 50,773            |       | 146,532        |       | 411,365           |       | 784,131   |       |
| **Cumulative rate  sensitive assets**                                        |       | $                        | 61,726     |           | $          | 147,669          |       | $                 | 175,461    |           | $          | 226,234           |       | $         | 372,766    |   | $ | 784,131 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Liabilities**                                                              |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Deposits**                                                                 |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| Noninterest-bearing demand                                                   |       | $                        | —     |           | $          | —           |       | $                 | —     |           | $          | —            |       | $         | —     |   | $ | 93,991 |   | $ | 93,991 |   |
| Interest-bearing transaction accounts                                        |       | 38,001                   |       | 19,001         |       | 19,001           |       | 19,001            |       | 19,001         |       | 76,000            |       | 190,005   |       |
| Certificates of deposit - fixed                                              |       | 282                      |       | 12,688         |       | 11,303           |       | 25,558            |       | 58,175         |       | 14,874            |       | 122,880   |       |
| Certificates of deposit - no penalty                                         |       | 71                       |       | 25,327         |       | 18,545           |       | 5,574             |       | 141,161        |       | —            |       | 190,678   |       |
| **Total deposits**                                                           |       | 38,354                   |       | 57,016         |       | 48,849           |       | 50,133            |       | 218,337        |       | 184,865           |       | 597,554   |       |
| Other borrowed funds                                                         |       | 34,043                   |       | 4,417          |       | 2,625            |       | 3,250             |       | 23,250         |       | 53,166            |       | 120,751   |       |
| **Total deposits  & other borrowed funds**                               |       | 72,397                   |       | 61,433         |       | 51,474           |       | 53,383            |       | 241,587        |       | 238,031           |       | 718,305   |       |
| **Cumulative rate  sensitive liabilities**                                   |       | $                        | 72,397     |           | $          | 133,830          |       | $                 | 185,304    |           | $          | 238,687           |       | $         | 480,274    |   | $ | 718,305 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |      |       |
| **Gap**                                                                      |       | $                        | (10,671    | )              | $          | 24,510           |       | $                 | (23,682    | )              | $          | (2,610            | )          | $         | (95,055    | ) | $ | 173,334 |   |   |   |
| **Cumulative gap**                                                           |       | (10,671                  | )          | 13,839         |       | (9,843           | )          | (12,453           | )          | (107,508       | )          | 65,826            |       |      |       |
| **Gap/ total assets**                                                        |       | -1.32                    | %          | 3.03           | %          | -2.92            | %          | -0.32             | %          | -11.73         | %          | 21.40             | %          |      |       |
| **Cumulative gap/  total assets**                                            |       | -1.32                    | %          | 1.71           | %          | -1.22            | %          | -1.54             | %          | -13.27         | %          | 8.13              | %          |      |       |
| **Rate sensitive  assets/ rate sensitive liabilities**                       |       | 0.85                     |       | 1.40           |       | 0.54             |       | 0.95              |       | 0.61           |       | 1.73              |       |      |       |
| **Cumulative rate  sensitive assets/ cumulative rate sensitive liabilities** |       | 0.85                     |       | 1.10           |       | 0.95             |       | 0.95              |       | 0.78           |       | 1.09              |       |      |       |

 

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**Caution About Forward-Looking Statements**

 

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

 

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

 

•                  the ability to successfully manage ourgrowth or implement our growth strategies if we are unable to identifyattractive markets, locations or opportunities to expand in the future;

•                  changes in interest rates and interestrate policies;

•                  risks inherent in making loans such asrepayment risks and fluctuating collateral values;

•                  the successful management of interestrate risk;

 

32

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•                  maintaining cost controls and assetqualities as we open or acquire new branches;

•                  maintaining capital levels adequate tosupport our growth;

•                  our ability to successfully integrate GMMinto the organization 

•                  impact of increased economic activity andinterest rates on GMM’s performance in future periods

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

•                  competition with other banks andfinancial institutions, and companies outside of the banking industry,including those companies that have substantially greater access to capital andother resources;

•                  changes in general economic and businessconditions in our market area;

•                  demand, development and acceptance of newproducts and services;

•                  problems with technology utilized by us;

•                  changing trends in customer profiles andbehavior; and

•                  changes in banking and other laws andregulations applicable to us.

 

Because of these uncertainties, ouractual future results may be materially different from the results indicated bythese forward-looking statements.  Inaddition, our past results of operations do not necessarily indicate our futureresults.

 

33

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

 

Our Asset/Liability Committee is responsible for reviewing ourliquidity requirements and maximizing our net interest income, consistent withcapital requirements, liquidity, interest rate and economic outlooks,competitive factors and customer needs.  One of the tools we use to determine ourinterest rate risk is gap analysis.  Gapanalysis attempts to examine the volume of interest rate sensitive assets lessinterest rate sensitive liabilities in various time intervals.  The difference is the interest sensitivitygap, which indicates how future changes in interest rates may affect netinterest income.  Interest sensitivitygap analysis presents a position that exists at one particular point in timeand assumes that assets and liabilities with similar characteristics willre-price at the same time and to the same degree.  Under our asset/liability policies, regardlessof whether interest rates are expected to increase or decrease, the objectiveis to maintain a gap position that will minimize any changes in net interestincome.  A negative gap, or liabilitysensitive 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.

 

Wehave the ability to reprice our interest checking, savings, and money marketaccounts at any time.  We carefullyanalyze the impact of any decrease in interest rates on our deposits, as we mayexperience a runoff in deposit balances as a result of such changes in interestrates.  Based on the degree and frequencyof movement being limited in practice, we have classified 20% of these depositsin our immediate gap interval, 10% of these deposits in each of the gapintervals from 2-90 days through the 1-3 year gap interval, leaving theremaining portion or 40% of these deposits in the over 3 year gapinterval.  We continue to analyze theactivity in our deposit portfolio and make changes in our gap assumptions asthe activity dictates. See Table 14 from our management’s discussion and analysis,which reflects the repricing or expected maturities of various assets andliabilities at June 30, 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.

 

Wealso use a simulation process to measure interest rate risk and the impact ofrate fluctuations on net interest income. These simulations incorporate assumptions regarding balance sheet growthand mix, and the re-pricing and maturity characteristics of existing andprojected balance sheets.  One of theways we manage our interest rate risk is through an analysis of therelationship between interest-earning assets and interest-bearing liabilitiesto measure the impact that future changes in interest rates will have on netinterest income.  Using this relationshipanalysis, changes in interest rates and volumes are used to test thesensitivity of our net interest income. While we show liability sensitivity in the short term indicating that anincrease in interest rates may negatively affect short-term net interestincome, we would likely take actions to minimize our exposure to negativeresults and within a short period of time make adjustments so that net interestincome would not be materially impacted.

 

Weexpect our net interest income will be greater over the longer term at higherprevailing interest rate levels, although we may be negatively affected byrising rates in the shorter term.  Thisis due to the large proportion of low-cost core deposits such as demand,interest checking, savings, and money market accounts comprising our fundingsources, which tend to be less sensitive to rising rates and can be invested inrelatively higher yielding loans and investment securities.

 

34

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**Item 4.  Controls and Procedures**

 

**The Company maintains disclosure controls and proceduresthat are designed to ensure that information required to be disclosed by it inthe reports that it files or submits under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported within the timeperiods required by the Securities and Exchange Commission, including, withoutlimitation, those controls and procedures designed to ensure that suchinformation is accumulated and communicated to the Company’s management to allowtimely 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 internal accountingcontrols that is designed to provide assurance that assets are safeguarded andthat transactions are executed in accordance with management’s authorizationand properly recorded.  This system iscontinually reviewed and is augmented by written policies and procedures, thecareful selection and training of qualified personnel and an internal auditprogram to monitor its effectiveness. There were no changes in our internal control over financial reportingidentified in connection with our evaluation of it that occurred during ourlast fiscal quarter that materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.**

 

35

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**PART II – OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item 2.**  Changes inSecurities, Use of Proceeds, and Issuer Purchases of Equity Securities

 

(a) None.

(b) None.

(c) None.

(d) Not applicable.

(e) None.

 

**Item 3.  Defaults Upon SeniorSecurities**

 

(a) None

(b) None

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

 

(a) The Company’s Annual Meeting ofShareholders was held on April 21, 2004.

(b) Not applicable.

(c) The following persons were elected asdirectors for terms expiring in 2007:

 
|                |       | **Votes**  |
|---------------------|------------|------------|
| **Director**        | ** ** | **For**    | ** ** | **Withheld** |
| B.G. Beck           |       | 15,894,751 |   | 126,330 |
| Michael A. Garcia   |       | 12,549,467 |   | 3,471,614 |
| J. Hamilton Lambert |       | 15,894,751 |   | 126,330 |
| Alice M. Starr      |       | 15,892,971 |   | 128,110 |

 

In addition, the shareholders voted on andapproved the Company’s 2002 Equity Compensation Plan, as amended and restated,by a vote of 6,184,399 for, 3,535,617 against, with 305,131 abstentions and5,995,934 broker non-votes.

 

Finally, the shareholders voted on andratified the appointment of KPMG LLP as the Company’s independent auditors for2004 by a vote of 15,916,480 for, 67,741 against, with 36,860 abstentions and 0broker non-votes.

 

(d) None

 

**Item 5.  Other Information**

 

None

 

**Item 6.  Exhibits and Reports onForm 8-K**

 

(a)   Exhibits

 

36

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31.1                           Rule 13a-14(a) Certification of ChiefExecutive Officer

31.2                           Rule 13a-14(a) Certification of ChiefFinancial Officer

32.1         Statement of ChiefExecutive Officer Pursuant to 18 U.S.C. Section 1350

32.2         Statement of ChiefFinancial Officer Pursuant to 18 U.S.C. Section 1350

 

(b)   Reports on Form 8-K

 

On April 21, 2004, we furnished a Current Report on Form8-K dated April 14, 2004 to report under Item 12 our financial results forthe quarter ended March 31, 2004.

 

37

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**SIGNATURES**

** **

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

** **
| ** **                           | **CARDINAL  FINANCIAL CORPORATION**                       |
|--------------------------------------|-----------------------------------------------------------|
| ** **                           | **(Registrant)**                                          |
| ** **                           | ** **                                                |
| **Date:  August 16, 2004** | **/s/  Bernard H. Clineburg**                             | ** ** |
| ** **                           | **Bernard  H. Clineburg**                                 |
| ** **                           | **Chairman,  President and Chief Executive Officer**      |
| ** **                           | **(Principal  Executive Officer)**                        |
| ** **                           | ** **                                                |
| **Date:  August 16, 2004** | **/s/  Carl E. Dodson**                                   | ** ** |
| ** **                           | **Carl E.  Dodson**                                       |
| ** **                           | **Executive  Vice President and Chief Financial Officer** |
| ** **                           | **(Principal  Financial Officer)**                        |
| ** **                           | ** **                                                |
| **Date:  August 16, 2004** | **/s/  Jennifer L. Deacon**                               | ** ** |
| ** **                           | **Jennifer  L. Deacon**                                   |
| ** **                           | **Senior  Vice President and Controller**                 |
| ** **                           | **(Principal  Accounting Officer)**                       |

 

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