**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

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

**of the Securities Exchange Act of 1934**

 

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

 

**or**

 

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

**of the Securities Exchange Act of 1934**

 

**For the transition period from          to           **

 

**CommissionFile Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant asspecified 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 reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

Yes  ý   No  o

 

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

Yes  o   No  ý

 

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

 

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

outstanding as of October 31, 2004

 

 

----

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I – FINANCIAL INFORMATION**                                                             | 1                                                                            |
|-----------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------|
|                                                                                                |                                                                         |
| Item 1. Financial Statements:                                                                       | 1                                                                            |
|                                                                                                |                                                                         |
|                                                                                                | Consolidated Statements of Condition                                         |   |
|                                                                                                | At September 30, 2004 (Unaudited) and December 31,  2003           | 1 |
|                                                                                                |                                                                         |   |
|                                                                                                | Consolidated Statements of Income  (Unaudited)                               |   |
|                                                                                                | Three and nine months ended September 30,  2004 and 2003                | 2 |
|                                                                                                |                                                                         |   |
|                                                                                                | Consolidated Statements of Comprehensive  Income (Loss) (Unaudited)          |   |
|                                                                                                | Three and nine months ended September 30,  2004 and 2003                | 3 |
|                                                                                                |                                                                         |   |
|                                                                                                | Consolidated Statements of Changes In  Shareholders’ Equity (Unaudited) |   |
|                                                                                                | Nine months ended September 30, 2004  and 2003                          | 4 |
|                                                                                                |                                                                         |   |
|                                                                                                | Consolidated Statements of Cash Flows  (Unaudited)                           |   |
|                                                                                                | Nine months ended September 30, 2004  and 2003                          | 5 |
|                                                                                                |                                                                         |   |
|                                                                                                | Notes to Consolidated Financial Statements  (Unaudited)                      | 6 |
|                                                                                                |                                                                         |   |
| Item 2. Management’s Discussion and Analysis of Financial Condition  and Results of Operations | 15                                                                           |
|                                                                                                |                                                                         |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                 | 41                                                                           |
|                                                                                                |                                                                         |   |
| Item 4. Controls and Procedures                                                                     | 42                                                                           |
|                                                                                                |                                                                         |   |
| **PART II – OTHER INFORMATION**                                                                | 43                                                                           |
|                                                                                                |                                                                         |   |
| Item 1. Legal Proceedings                                                                           | 43                                                                           |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds                                | 43                                                                           |
| Item 3. Defaults Upon Senior Securities                                                             | 43                                                                           |
| Item 4. Submission of Matters to a Vote of  Security Holders                                        | 43                                                                           |
| Item 5. Other Information                                                                           | 43                                                                           |
| Item  6. Exhibits                                                                                   | 43                                                                           |
|                                                                                                |                                                                         |   |
| **SIGNATURES**                                                                                      | 44                                                                           |

 

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATEDSTATEMENTS OF CONDITION

 

At September 30, 2004 and December 31, 2003  

 

(In thousands, except share data)

 
| ** **                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **                                                                                                                                                                          | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                          |       |                   |       |                  |       |
| Cash and due  from banks                                                                                                                                                            |       | $                      | 13,726     |                  | $          | 9,555 |   |
| Federal  funds sold                                                                                                                                                                 |       | 25,580                 |       | 3,528                 |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total cash  and cash equivalents                                                                                                                                                    |       | 39,306                 |       | 13,083                |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Investment  securities available-for-sale                                                                                                                                           |       | 159,981                |       | 130,762               |       |
| Investment  securities held-to-maturity                                                                                                                                             |       | 148,034                |       | 142,852               |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total  investment securities                                                                                                                                                        |       | 308,015                |       | 273,614               |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Other  investments                                                                                                                                                                  |       | 6,797                  |       | 3,517                 |       |
| Loans held  for sale at lower of cost or market, net                                                                                                                                |       | 346,692                |       | —                |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Loans  receivable, net of deferred fees and costs                                                                                                                                   |       | 438,957                |       | 336,002               |       |
| Allowance  for loan losses                                                                                                                                                          |       | (5,291                 | )          | (4,344                | )          |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Loans  receivable, net                                                                                                                                                              |       | 433,666                |       | 331,658               |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Premises and  equipment, net                                                                                                                                                        |       | 14,917                 |       | 6,707                 |       |
| Deferred tax  asset                                                                                                                                                                 |       | 4,636                  |       | 4,473                 |       |
| Goodwill                                                                                                                                                                            |       | 16,682                 |       | 22                    |       |
| Accrued  interest receivable and other assets                                                                                                                                       |       | 7,418                  |       | 3,174                 |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total assets                                                                                                                                                                        |       | $                      | 1,178,129  |                  | $          | 636,248 |   |
|                                                                                                                                                                                |       |                   |       |                  |       |   |   |
| **Liabilities  and Shareholders’ Equity**                                                                                                                                      |       |                   |       |                  |       |
| ** **                                                                                                                                                                          |       |                   |       |                  |       |
| Deposits                                                                                                                                                                            |       | $                      | 819,934    |                  | $          | 474,129 |   |
| Other  borrowed funds                                                                                                                                                               |       | 159,353                |       | 74,457                |       |
| Warehouse  financing                                                                                                                                                                |       | 88,846                 |       | —                |       |
| Escrow  liabilities                                                                                                                                                                 |       | 3,519                  |       | —                |       |
| Accrued  interest payable and other liabilities                                                                                                                                     |       | 12,009                 |       | 2,250                 |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total  liabilities                                                                                                                                                                  |       | 1,083,661              |       | 550,836               |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Preferred  stock, $1 par value, 10,000,000 shares authorized; Series A preferred stock,  cumulative convertible, 0 and 1,364,062 shares outstanding in 2004 and 2003,  respectively |       | —                 |       | 1,364                 |       |
| Common  stock, $1 par value, 50,000,000 shares authorized; 18,441,155 and 16,377,337  shares outstanding in 2004 and 2003, respectively                                             |       | 18,441                 |       | 16,377                |       |
| Additional  paid-in capital                                                                                                                                                         |       | 92,792                 |       | 86,790                |       |
| Accumulated  deficit                                                                                                                                                                |       | (16,006                | )          | (18,614               | )          |
| Accumulated  other comprehensive loss                                                                                                                                               |       | (759                   | )          | (505                  | )          |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total  shareholders’ equity                                                                                                                                                    |       | 94,468                 |       | 85,412                |       |
|                                                                                                                                                                                |       |                   |       |                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                    |       | $                      | 1,178,129  |                  | $          | 636,248 |   |
|                                                                                                                                                                                     |            |                        |            |                       |            |  |  |  |  |  |  |

 

Seeaccompanying notes to consolidated financial statements.

 

1

----

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFINCOME

 

Three and nine months ended September 30, 2004 and 2003

(In thousands, except share and per share data)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest  income:                                              |       |                                      |       |                                     |       |   |   |   |   |
| Loans  receivable                                              |       | $                                         | 5,826      |                                     | $          | 4,166 |   | $ | 15,425 |   | $ | 12,298 |   |
| Loan held  for sale                                            |       | 3,268                                     |       | —                                   |       | 3,268 |   | — |   |
| Federal  funds sold                                            |       | 49                                        |       | 17                                       |       | 96 |   | 98 |   |
| Investment  securities available-for-sale                      |       | 1,536                                     |       | 754                                      |       | 4,360 |   | 4,047 |   |
| Investment  securities held-to-maturity                        |       | 1,432                                     |       | 1,207                                    |       | 4,260 |   | 1,207 |   |
| Other  investments                                             |       | 78                                        |       | 35                                       |       | 162 |   | 90 |   |
| Total  interest income                                         |       | 12,189                                    |       | 6,179                                    |       | 27,571 |   | 17,740 |   |
| Interest  expense:                                             |       |                                      |       |                                     |       |   |   |   |   |
| Deposits                                                       |       | 3,668                                     |       | 2,062                                    |       | 8,448 |   | 6,528 |   |
| Other  borrowed funds                                          |       | 1,116                                     |       | 279                                      |       | 1,887 |   | 470 |   |
| Warehouse  financing                                           |       | 211                                       |       | —                                   |       | 211 |   | — |   |
| Total  interest expense                                        |       | 4,995                                     |       | 2,341                                    |       | 10,546 |   | 6,998 |   |
| Net interest  income                                           |       | 7,194                                     |       | 3,838                                    |       | 17,025 |   | 10,742 |   |
| Provision  for loan losses                                     |       | 529                                       |       | 356                                      |       | 918 |   | 602 |   |
| Net interest  income after provision for loan losses           |       | 6,665                                     |       | 3,482                                    |       | 16,107 |   | 10,140 |   |
| Non-interest  income:                                          |       |                                      |       |                                     |       |   |   |   |   |
| Service  charges on deposit accounts                           |       | 296                                       |       | 238                                      |       | 798 |   | 684 |   |
| Loan service  charges                                          |       | 267                                       |       | 74                                       |       | 552 |   | 342 |   |
| Investment  fee income                                         |       | 150                                       |       | 184                                      |       | 498 |   | 473 |   |
| Net gain on  sales of loans                                    |       | 2,802                                     |       | 175                                      |       | 2,864 |   | 259 |   |
| Net realized  gain on investment securities available-for-sale |       | 3                                         |       | 291                                      |       | 245 |   | 1,201 |   |
| Management  fee income                                         |       | 674                                       |       | —                                   |       | 674 |   | — |   |
| Other  non-interest income                                     |       | 6                                         |       | 9                                        |       | 9 |   | 35 |   |
| Total  non-interest income                                     |       | 4,198                                     |       | 971                                      |       | 5,640 |   | 2,994 |   |
| Non-interest  expense:                                         |       |                                      |       |                                     |       |   |   |   |   |
| Salary and  benefits                                           |       | 4,896                                     |       | 1,678                                    |       | 8,998 |   | 4,869 |   |
| Occupancy                                                      |       | 932                                       |       | 317                                      |       | 1,893 |   | 1,093 |   |
| Professional  fees                                             |       | 578                                       |       | 221                                      |       | 922 |   | 872 |   |
| Depreciation                                                   |       | 583                                       |       | 276                                      |       | 1,215 |   | 731 |   |
| Data  processing                                               |       | 255                                       |       | 216                                      |       | 647 |   | 671 |   |
| Telecommunications                                             |       | 197                                       |       | 99                                       |       | 405 |   | 294 |   |
| Other  operating expenses                                      |       | 1,546                                     |       | 877                                      |       | 3,760 |   | 2,676 |   |
| Total  non-interest expense                                    |       | 8,987                                     |       | 3,684                                    |       | 17,840 |   | 11,206 |   |
| Net income  before income taxes                                |       | 1,876                                     |       | 769                                      |       | 3,907 |   | 1,928 |   |
| Provision  for income taxes                                    |       | 621                                       |       | —                                   |       | 1,299 |   | — |   |
| Net income                                                     |       | $                                         | 1,255      |                                     | $          | 769 |   | $ | 2,608 |   | $ | 1,928 |   |
| Dividends to  preferred shareholders                           |       | —                                    |       | 124                                      |       | — |   | 371 |   |
| Net income  to common shareholders                             |       | $                                         | 1,255      |                                     | $          | 645 |   | $ | 2,608 |   | $ | 1,557 |   |
| Earnings per  common share - basic                             |       | $                                         | 0.07       |                                     | $          | 0.06 |   | $ | 0.14 |   | $ | 0.15 |   |
| Earnings per  common share - diluted                           |       | $                                         | 0.07       |                                     | $          | 0.06 |   | $ | 0.14 |   | $ | 0.15 |   |
| Weighted-average  common shares outstanding - basic            |       | 18,439,021                                |       | 10,072,262                               |       | 18,101,639 |   | 10,058,202 |   |
| Weighted-average  common shares outstanding - diluted          |       | 18,697,179                                |       | 10,344,977                               |       | 18,361,013 |   | 10,249,184 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and nine months ended September 30, 2004 and 2003

(Dollars in thousands)

(Unaudited)

 
| ** **                                                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                            |       |                                      |       |                                     |       |   |   |   |   |
| Net income                                                                      |       | $                                         | 1,255      |                                     | $          | 769 |   | $ | 2,608 |   | $ | 1,928 |   |
| Other  comprehensive income (loss):                                             |       |                                      |       |                                     |       |   |   |   |   |
| Unrealized  gain (loss) on available-for-sale investment securities:            |       |                                      |       |                                     |       |   |   |   |   |
| Unrealized  holding gain (loss) arising                                         |       |                                      |       |                                     |       |   |   |   |   |
| during the  period, net of tax                                                  |       | 2,537                                     |       | (2,169                                   | )          | (93 | ) | (2,079 | ) |
| Less:  reclassification adjustment for gains included in net income, net of tax |       | 2                                         |       | 291                                      |       | 161 |   | 1,201 |   |
|                                                                            |       |                                      |       |                                     |       |   |   |   |   |
| Comprehensive  income (loss)                                                    |       | $                                         | 3,790      |                                     | $          | (1,691 | ) | $ | 2,354 |   | $ | (1,352 | ) |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine months ended September 30, 2004 and 2003

(In thousands)

(Unaudited)

 
| ** **                                                             | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                             | ** ** | ** **            | ** ** | ** **           | ** ** | ** **         | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Balance, December 31,  2002                                       |       | 1,365                 |       | $                    | 1,365      |               | 10,044     |              | $          | 10,044                           |       | $                        | 51,231     |                                                 | $          | (24,273    | )          | $ | 2,345 |   | $ | 40,712 |   |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Stock options exercised                                                |       | —                |       | —               |       | 32                 |       | 32                |       | 110                              |       | —                   |       | —                                               |       | 142        |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Dividends on preferred  stock                                          |       | —                |       | —               |       | —             |       | —            |       | —                           |       | (371                     | )          | —                                               |       | (371       | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Preferred stock converted  to common stock                             |       | (1                    | )          | (1                   | )          | 1                  |       | 1                 |       | —                           |       | —                   |       | —                                               |       | —     |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Change in unrealized loss  on investment securities available-for-sale |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (3,280                                               | )          | (3,280     | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Net income                                                             |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,928                    |       | —                                               |       | 1,928      |       |
| Balance, September 30,  2003                                      |       | 1,364                 |       | $                    | 1,364      |               | 10,077     |              | $          | 10,077                           |       | $                        | 51,341     |                                                 | $          | (22,716    | )          | $ | (935 | ) | $ | 39,131 |   |
| Balance, December 31,  2003                                       |       | 1,364                 |       | $                    | 1,364      |               | 16,377     |              | $          | 16,377                           |       | $                        | 86,790     |                                                 | $          | (18,614    | )          | $ | (505 | ) | $ | 85,412 |   |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Stock options exercised                                                |       | —                |       | —               |       | 93                 |       | 93                |       | 306                              |       | —                   |       | —                                               |       | 399        |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Public offering shares  issued                                         |       | —                |       | —               |       | 945                |       | 945               |       | 5,358                            |       | —                   |       | —                                               |       | 6,303      |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Preferred stock converted  to common stock                             |       | (1,364                | )          | (1,364               | )          | 1,026              |       | 1,026             |       | 338                              |       | —                   |       | —                                               |       | —     |       |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Change in unrealized loss  on investment securities available-for-sale |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (254                                                 | )          | (254       | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                                 |       |       |       |
| Net income                                                             |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 2,608                    |       | —                                               |       | 2,608      |       |
| Balance, September 30,  2004                                      |       | —                |       | $                    | —     |               | 18,441     |              | $          | 18,441                           |       | $                        | 92,792     |                                                 | $          | (16,006    | )          | $ | (759 | ) | $ | 94,468 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCASH FLOWS

 

Nine months ended September 30,2004 and 2003

 

(Inthousands)

 

(Unaudited)

 
| ** **                                                                                                                                                                                                | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|
|                                                                                                                                                                                                      |       |       |       |     |       |
| Cash flows  from operating activities:                                                                                                                                                                    |       |       |       |     |       |
| Net income                                                                                                                                                                                                |       | $          | 2,608      |     | $          | 1,928 |   |
| Adjustments  to reconcile net income to net cash used in operating activities:                                                                                                                            |       |       |       |     |       |
| Depreciation                                                                                                                                                                                              |       | 1,215      |       | 731      |       |
| Amortization  of premiums and discounts                                                                                                                                                                   |       | 1,557      |       | 1,719    |       |
| Provision  for loan losses                                                                                                                                                                                |       | 918        |       | 602      |       |
| Loans held  for sale originated and acquired                                                                                                                                                              |       | (1,244,827 | )          | (30,318  | )          |
| Proceeds  from the sale of loans held for sale                                                                                                                                                            |       | 900,999    |       | 29,792   |       |
| Gain on sale  of loans held for sale                                                                                                                                                                      |       | (2,864     | )          | (259     | )          |
| Gain on sale  of investment securities available-for-sale                                                                                                                                                 |       | (245       | )          | (1,201   | )          |
| (Increase)  decrease in accrued interest receivable, other assets, goodwill and deferred  tax asset                                                                                                       |       | (21,067    | )          | 3,235    |       |
| Decrease in  accrued interest payable, escrow liabilities and other liabilities                                                                                                                           |       | (13,278    | )          | (17,879  | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Net cash  used in operating activities                                                                                                                                                                    |       | (374,984   | )          | (11,650  | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Cash flows  from investing activities:                                                                                                                                                                    |       |       |       |     |       |
| Purchase of  premises and equipment                                                                                                                                                                       |       | (9,425     | )          | (829     | )          |
| Proceeds  from sale, maturity and call of investment securities available-for-sale                                                                                                                        |       | 23,719     |       | 88,535   |       |
| Proceeds  from maturity and call of investment securities held-to-maturity                                                                                                                                |       | 5,490      |       | —   |       |
| Proceeds  from sale of other investments                                                                                                                                                                  |       | 7,442      |       | 350      |       |
| Purchase of  investment securities available-for-sale                                                                                                                                                     |       | (78,959    | )          | (222,938 | )          |
| Purchase of  investment securities held-to-maturity                                                                                                                                                       |       | (30,514    | )          | —   |       |
| Purchase of  other investments                                                                                                                                                                            |       | (10,098    | )          | (2,483   | )          |
| Redemptions  of investment securities available-for-sale                                                                                                                                                  |       | 22,817     |       | 51,204   |       |
| Redemptions  of investment securities held-to-maturity                                                                                                                                                    |       | 21,089     |       | —   |       |
| Net cash  acquired in acquisition                                                                                                                                                                         |       | 2,028      |       | —   |       |
| Net increase  in loans receivable                                                                                                                                                                         |       | (103,592   | )          | (41,736  | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Net cash  used in investing activities                                                                                                                                                                    |       | (150,003   | )          | (127,897 | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Cash flows  from financing activities:                                                                                                                                                                    |       |       |       |     |       |
| Net increase  in deposits                                                                                                                                                                                 |       | 345,805    |       | 35,732   |       |
| Net increase  in other borrowed funds                                                                                                                                                                     |       | 27,152     |       | 27,170   |       |
| Net increase  in warehouse financing                                                                                                                                                                      |       | 88,846     |       | —   |       |
| Proceeds  from FHLB advances - long term                                                                                                                                                                  |       | 45,000     |       | 34,000   |       |
| Repayments  of FHLB advances - long term                                                                                                                                                                  |       | (7,875     | )          | (417     | )          |
| Proceeds  from public offering                                                                                                                                                                            |       | 6,303      |       | —   |       |
| Proceeds  from trust preferred issuance                                                                                                                                                                   |       | 20,000     |       | —   |       |
| Stock  options exercised                                                                                                                                                                                  |       | 399        |       | 142      |       |
| Dividends on  preferred stock                                                                                                                                                                             |       | —     |       | (371     | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Net cash  provided by financing activities                                                                                                                                                                |       | 525,630    |       | 96,256   |       |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Net increase  (decrease) in cash and cash equivalents                                                                                                                                                     |       | 643        |       | (43,291  | )          |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Cash and  cash equivalents at beginning of the period                                                                                                                                                     |       | 13,083     |       | 63,371   |       |
|                                                                                                                                                                                                      |       |       |       |     |       |
| Cash and  cash equivalents at end of the period                                                                                                                                                           |       | $          | 13,726     |     | $          | 20,080 |   |
|                                                                                                                                                                                                      |       |       |       |     |       |
| **Supplemental  disclosure of cash flow information:**                                                                                                                                                    |       |       |       |     |       |
| Cash paid  during the period for interest                                                                                                                                                                 |       | $          | 9,622      |     | $          | 6,924 |   |
| Cash paid  for income taxes                                                                                                                                                                               |       | 80         |       | —   |       |
|                                                                                                                                                                                                      |       |       |       |     |       |
| **Supplemental  schedule of noncash investing and financing activities:**                                                                                                                            |       |       |       |     |       |
| The Company  acquired all of the issued and outstanding membership interests of George  Mason Mortgage, LLC for $17.0 million. In conjunction with the acquisition,  liabilities were assumed as follows: |       |       |       |     |       |
| Fair value  of assets acquired                                                                                                                                                                            |       | $          | 372,725    |     |       |   |
| Goodwill                                                                                                                                                                                                  |       | 16,682     |       |     |       |
| Cash paid                                                                                                                                                                                                 |       | (17,000    | )          |     |       |
| Downstream  of capital to GMM                                                                                                                                                                             |       | (8,000     | )          |     |       |
| Fair value  of liabilities assumed                                                                                                                                                                        |       | $          | 364,407    |     |       |   |

 

See accompanying notes to consolidated financial statements.

 

5

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CARDINAL FINANCIAL CORPORATIONAND SUBSIDIARIES

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

(Unaudited)

 

Note 1

 

*Organization*

 

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

 

Effective July 7, 2004, the Bank completed its acquisition ofGeorge Mason Mortgage, LLC (“GMM”) from United Bank – Virginia, a wholly ownedsubsidiary of United Bankshares, Inc. GMM was acquired in a cash transaction for $17.0 million and isoperating as a subsidiary of the Bank. This transaction was accounted for as a purchase and GMM’s assets andliabilities were recorded at fair value as of the purchase date.  GMM’s operating results are included in theconsolidated results since the date of the acquisition.  This transaction resulted in the recognitionof $16.7 million of goodwill.  GMM’sprimary sources of revenue include net interest income earned on loans pendingsale, gain on the sale of loans and management fees earned relating to themanagement of other entities’ portfolios. Loans are made pursuant to purchase commitments and are sold servicingreleased.  The Bank purchased GMMprimarily to diversify its sources of income and increase non-interest incomeand to provide for increased residential loans for its portfolio.

 

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

 

6

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| ** **                                            | ** ** | **Three Months Ended**      | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **(Dollars in thousands)**                            | ** ** | **September 30, 2004** | ** ** | **September 30, 2004** | ** ** | **September 30, 2003** | ** ** |
| Net interest  income                                  |       | $                           | 7,308      |                        | $          | 21,146 |   | $ | 17,422 |   |
| Non-interest  income                                  |       | 4,605                       |       | 23,157                      |       | 31,277 |   |
| Provision  for loan losses                            |       | 529                         |       | 918                         |       | 602 |   |
| Non-interest  expense                                 |       | 9,415                       |       | 35,698                      |       | 34,935 |   |
| Net income  before income taxes                       |       | 1,969                       |       | 7,687                       |       | 13,162 |   |
| Provision  for income taxes                           |       | 652                         |       | 2,365                       |       | 5,091 |   |
| Net income                                            |       | $                           | 1,317      |                        | $          | 5,322 |   | $ | 8,071 |   |
| Earnings per  common share - basic                    |       | $                           | 0.07       |                        | $          | 0.30 |   | $ | 0.31 |   |
| Earnings per  common share - diluted                  |       | 0.07                        |       | 0.29                        |       | 0.31 |   |
| Weighted-average  common shares outstanding - basic   |       | 18,439,021                  |       | 18,101,639                  |       | 10,058,202 |   |
| Weighted-average  common shares outstanding - diluted |       | 18,697,179                  |       | 18,361,013                  |       | 10,249,184 |   |

 

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

 

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

 
| Cash paid by the Company     |   | $    | 17,000 |   |
|------------------------------|--------|------|--------|--------|
| Fair value  adjustments, net |   | (464 | )      |
| Merger  expenses             |   | 124  |   |
| Goodwill                     |   | $    | 16,660 |   |

 

Thefair value adjustments at September 30, 2004 were calculated for loansheld for sale, which were decreased by $464,000.  Loans receivable, net were not adjusted asthey were determined to be at fair value as all loans held in that portfolioare current with regard to payments of principal and interest and have variableinterest rates.

 

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

 

7

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In July 2004, the Company formed a new wholly-owned subsidiary,Cardinal Statutory Trust I (the “Trust”), for the purpose of issuing $20.0million of floating rate junior subordinated deferrable interest debentures (“trustpreferred securities”).  These trustpreferred securities are due in 2034 and have an interest rate of LIBOR (LondonInterbank Offering Rate) plus 2.40%, which adjusts quarterly.  These securities are redeemable at a premiumthrough March 2008 and at par thereafter. The Company has guaranteed payment of these securities.  The $20.6 million payable by the Company tothe Trust is included in other borrowed funds in the Consolidated Statements ofCondition as the Trust is an unconsolidated subsidiary, and, as a result, theCompany is not the primary beneficiary of this entity.  The additional $619,000 that is payable bythe Company to the Trust relates to the capital of the Trust.  The Company utilized the proceeds from theissuance of the trust preferred securities to make a capital contribution intothe Bank.

 

*Basis of Presentation*

 

In theopinion of management, the accompanying consolidated financial statements havebeen prepared in accordance with the requirements of Regulation S-X, Article 10.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  However, all adjustments that are, in theopinion of management, necessary for a fair presentation have been included.  The results of operations for the three andnine months ended September 30, 2004 are not necessarily indicative of theresults to be expected for the full year ending December 31, 2004.  The unaudited interim financial statementsshould be read in conjunction with the audited financial statements and notes tofinancial statements that are presented in the Company’s Annual Report on Form10-KSB for the year ended December 31, 2003 (the “2003 Form 10-KSB”).

 

Note 2

 

*Summary of Significant Accounting Policies*

 

Thefollowing accounting policies are listed herein as a result of the acquisitionof GMM.  For a complete list of theCompany’s significant accounting polices, see the Notes to the ConsolidatedFinancial Statements that are presented in the 2003 Form 10-KSB.

 

**(a) Loans held for sale**

 

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

 

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

 

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

 

**8**

----

 

**(c) Management fee income**

 

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

 

**(d) Derivatives and hedging activities**

 

The Company accounts for its derivatives andhedging activities in accordance with Financial Accounting Standards BoardStatement (“SFAS”) No. 133, *Accounting for DerivativeInstruments and Hedging Activity,*as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities.*  The Companyrecognizes derivatives on its Consolidated Statements of Condition at theirfair value.  In the normal course ofbusiness, the Company enters into contractual commitments to extend credit tofinance residential mortgages.  Thesecommitments, which contain fixed expiration dates, offer the borrower aninterest rate guarantee provided the loan meets underwriting guidelines andcloses within the time frame established by the Company (interest ratelock).  Interest rate risk arises onthese commitments if interest rates move between the time of the interest ratelock and the delivery of the loan to the investor.  The interest rate lock related to loans thatare intended to be sold are considered derivatives.

 

To mitigate the effect of the interest raterisk on loans intended to be sold, inherent in providing rate lock commitmentsfor loans from the lock-in date to the fund date, the Company enters into bestefforts delivery forward sale contracts. Both the interest rate lock commitments, and the forward deliverycontracts are undesignated derivatives under SFAS No. 133.  Mark-to-market adjustments on interest ratelock commitments are recorded from the inception of the interest rate lockthrough the funding date of the underlying loan.  The fair value of the hedge instruments andthe hedged items generally move in opposite directions and in equal amountsand, accordingly, the impact of changes in these valuations on net income isinconsequential.  As required by SFAS No.133, mark-to-market adjustments subsequent to funding are recorded only forthose forwards that have been designated as a qualifying hedge in accordancewith SFAS No. 133.  Although themandatory forward sales serve as an economic hedge of the loans, the loans havenot been designated as a qualifying hedge under SFAS No. 133.

 

**(e) Business combinations**

 

The acquisition of GMM was accounted for as apurchase as required by SFAS No. 141 *Business Combination.* The purchase accounting method requires thatthe cost of an acquired entity be allocated to the assets acquired andliabilities assumed based on their estimated fair values at the date ofacquisition.  The difference between thefair values and the purchase price is recorded as goodwill.  In addition, SFAS No. 141 requires thatidentified intangible assets acquired in a purchase business combination mustbe separately valued and recognized on the balance sheet if they meet certainrequirements.  As of September 30,2004, the Company has not identified or recorded any amortizable intangiblesrelated to its acquisition of GMM.

 

9

----

 

**(f) Reclassifications**

 

Certain amounts for the 2003 periods have beenreclassified to conform to the presentation for the 2004 periods.

 

**(g) Stock-Based Compensation**

 

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

 

#### **As permitted under SFAS No. 148, *Accounting for Stock-Based Compensation – Transition and Disclosure,*which amended SFAS No. 123, *Accounting forStock-Based Compensation,* the Company has elected to continue tofollow the intrinsic value method in accounting for its stock-based employeecompensation arrangements as defined by Accounting Principles Board Opinion (“APB”)No. 25, *Accounting for Stock Issued toEmployees,* and related interpretations including FinancialAccounting Standards Board Interpretation No. 44, *Accounting for Certain Transactions Involving Stock Compensation,*aninterpretation of APB No. 25.  Thefollowing table illustrates the effect on net income and earnings per commonshare as if the Company had applied the fair value recognition provisions ofSFAS No. 123 to stock-based employee compensation.**

 
| ** **                                                                                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  to common shareholders                                                                                |       | $                                         | 1,255      |                                     | $          | 645 |   | $ | 2,608 |   | $ | 1,557 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value-based  method for all awards |       | (753                                      | )          | (106                                     | )          | (1,428 | ) | (434 | ) |
| Pro forma  net income                                                                                             |       | $                                         | 502        |                                     | $          | 539 |   | $ | 1,180 |   | $ | 1,123 |   |
|                                                                                                              |       |                                      |       |                                     |       |   |   |   |   |
| Earnings per  common share:                                                                                       |       |                                      |       |                                     |       |   |   |   |   |
| Basic - as  reported                                                                                              |       | $                                         | 0.07       |                                     | $          | 0.06 |   | $ | 0.14 |   | $ | 0.15 |   |
| Basic - pro  forma                                                                                                |       | 0.03                                      |       | 0.05                                     |       | 0.07 |   | 0.11 |   |
| Diluted - as  reported                                                                                            |       | 0.07                                      |       | 0.06                                     |       | 0.14 |   | 0.15 |   |
| Diluted -  pro forma                                                                                              |       | 0.03                                      |       | 0.05                                     |       | 0.06 |   | 0.11 |   |

 

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

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

 

10

----

 

There were options to purchase 219,000 and 508,518 shares of commonstock granted during the three and nine months ended September 30, 2004,respectively.  Of those grants, 200,000and 375,204 immediately vested on the grant date for the three and nine monthsended September 30, 2004, respectively.

 

Note 3

 

*Segment Information*

 

In 2003 and for the first six months of 2004, the Company operated andreported in two business segments, commercial banking and investmentservices.  As of July 7, 2004, theCompany began operating in a third business segment, mortgage banking, with thecompletion of its acquisition of GMM. The commercial banking segment includes both commercial and consumerlending and provides customers such products as commercial loans, real estateloans, and other business financing and consumer loans.  In addition, this segment also providescustomers with several choices of deposit products including demand depositaccounts, savings accounts and certificates of deposit.  The mortgage banking segment engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis.  Theinvestment services segment provides advisory services to businesses andindividuals, including financial planning and retirement/estate planning.

 

Information about the reportable segments, and reconciliation of thisinformation to the consolidated financial statements at and for the three andnine months ended September 30, 2004 and 2003, follows:

 

11

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

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 5,716      |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (105 | ) | $ | 7,194 |   |
| Provision  for loan losses  |       | 529                     |       | —                |       | —                   |       | —                        |       | —    |       | 529              |       |
| Non-interest  income        |       | 554                     |       | 3,489                 |       | 150                      |       | —                        |       | 5         |       | 4,198            |       |
| Non-interest  expense       |       | 4,239                   |       | 4,250                 |       | 189                      |       | —                        |       | 309       |       | 8,987            |       |
| Provision  for income taxes |       | 418                     |       | 357                   |       | (15                      | )          | —                        |       | (139      | )          | 621              |       |
| Net income  (loss)          |       | $                       | 1,084      |                  | $          | 465                      |       | $                             | (24        | )         | $          | —           |       | $ | (270 | ) | $ | 1,255 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 357,252                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,178,129 |   |

 

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

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

 

12

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

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 15,493     |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (51 | ) | $ | 17,025 |   |
| Provision  for loan losses  |       | 918                     |       | —                |       | —                   |       | —                        |       | —    |       | 918              |       |
| Non-interest  income        |       | 1,659                   |       | 3,489                 |       | 487                      |       | —                        |       | 5         |       | 5,640            |       |
| Non-interest  expense       |       | 12,017                  |       | 4,250                 |       | 613                      |       | —                        |       | 960       |       | 17,840           |       |
| Provision  for income taxes |       | 1,329                   |       | 357                   |       | (45                      | )          | —                        |       | (342      | )          | 1,299            |       |
| Net income  (loss)          |       | $                       | 2,888      |                  | $          | 465                      |       | $                             | (81        | )         | $          | —           |       | $ | (664 | ) | $ | 2,608 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 357,252                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,178,129 |   |
|                             |            |                         |            |                       |            |                          |            |                               |            |           |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

**At and for the Nine Months Ended September 30,2003:**

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

 

**At September 30, 2004, the Company didnot have any operating segments other than those reported.  Parent company financial information isincluded in the “Other” category and represents an overhead function ratherthan an operating segment.  The parentcompany’s most significant assets are its net investments in itssubsidiaries.  The parent company’s netinterest income is comprised of interest income from short-term investments andinterest expense on trust preferred securities.**

 

#### **Note 4**

 

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

 

**The following is the calculation of basic anddiluted earnings per common share for the three and nine months ended September 30,2004 and 2003. Stock options outstanding at September 30, 2004 and 2003were 1,245,625 and 861,237, respectively. Stock options issued that were not included in the calculation ofdiluted earnings per share because the exercise prices were greater than theaverage market price were 29,000 and 3,545 for the three months ended September 30,2004 and 2003, respectively.  Stockoptions issued that were not included in the calculation of diluted earningsper share because the exercise prices were greater than the average marketprice were 22,000 and 15,507 for the nine months ended September 30, 2004and 2003, respectively.**

 

**13**

----

 
| **(Dollars in thousands,except**          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **share and per share data)**             | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                |       | $                                         | 1,255      |                                     | $          | 769 |   | $ | 2,608 |   | $ | 1,928 |   |
| Dividends to  preferred shareholders      |       | —                                    |       | 124                                      |       | — |   | 371 |   |
| Net income  to common shareholders        |       | $                                         | 1,255      |                                     | $          | 645 |   | $ | 2,608 |   | $ | 1,557 |   |
| Weighted  average common shares - basic   |       | 18,439,021                                |       | 10,072,262                               |       | 18,101,639 |   | 10,058,202 |   |
| Weighted  average common shares - diluted |       | 18,697,179                                |       | 10,344,977                               |       | 18,361,013 |   | 10,249,184 |   |
| Earnings per  common share - basic        |       | $                                         | 0.07       |                                     | $          | 0.06 |   | $ | 0.14 |   | $ | 0.15 |   |
| Earnings per  common share - diluted      |       | $                                         | 0.07       |                                     | $          | 0.06 |   | $ | 0.14 |   | $ | 0.15 |   |

 

Note 5

 

##### ***Warehouse Financing***

 

**In September 2004, GMM and the Bankentered into a one year $150 million floating rate revolving credit andsecurity agreement with a third party. The purpose of this credit facility is to fund residential mortgageloans at GMM pending their sale into the secondary market.  The credit facility requires, among otherthings, that GMM and the Bank have positive quarterly net income and maintainspecified minimum tangible and regulatory net worth requirements.  The Company has guaranteed repayment of thisdebt and is also required to maintain a minimum tangible net worthrequirement.  The interest rate on thiscredit facility is LIBOR plus between 1.50% and 1.875%.**

 

**In addition to this facility, the same lenderhas also provided a $100 million facility that is utilized by GMM to warehouseresidential mortgage loans pending sale to this lender.  The terms of this facility are substantiallythe same as the above-referenced revolving credit and security agreement.  Loans funded under this facility areconsidered sold to the lender when funded, and hence there is no interest rateassociated with this facility.**

 

**GMM also has a $60.0 million line of creditwith an unaffiliated party, which it uses to warehouse loans pending sale.  This line matures on December 7, 2004and has an interest rate of LIBOR plus 1.50%.**

 

 

**14**

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**Item 2****.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following presents management’s discussionand analysis of our consolidated financial condition at September 30, 2004and December 31, 2003 and the results of our operations for the three andnine months ended September 30, 2004 and 2003.  This discussion should be read in conjunctionwith our unaudited consolidated financial statements and the notes theretoappearing elsewhere in this report and the Company’s Annual Report on Form10-KSB for the year ended December 31, 2003.

 

**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, Cardinal Wealth Services, Inc., an investmentservices subsidiary, George Mason Mortgage, LLC, a mortgage banking subsidiary,and Cardinal Statutory Trust I, the issuer of $20.0 million of floating ratejunior subordinated deferrable interest debentures (“trust preferred securities”).  Through these subsidiaries, we offer a widerange of banking products and services to both our commercial and retailcustomers.  Our commercial relationshipmanagers focus on attracting small and medium-sized businesses as well ascommercial real estate developers and builders and professionals, such asphysicians, accountants and attorneys. We have a sixteen location retail branch network and provide competitiveretail products and services.  Wecomplement our core banking operations by offering investment products andservices to our customers through our third-party brokerage relationship.**

 

On July 7,2004, the Company acquired George Mason Mortgage, LLC (“GMM”), from United Bank– Virginia, a wholly owned subsidiary of United Bankshares, Inc. in an all cashtransaction for $17.0 million.  Thistransaction resulted in the recognition of $16.7 million of goodwill.  This transaction was accounted for as apurchase, and GMM’s assets and liabilities were recorded at fair value as ofthe purchase date.  GMM’s operatingresults are included in the consolidated results since the date of theacquisition.  GMM, based in Fairfax,Virginia, engages primarily in the origination and acquisition of residentialmortgages for sale into the secondary market on a best efforts basis throughnine branches located throughout the metropolitan Washington region.  GMM has approximately 200 employees and islicensed in eight states, including Virginia, Maryland and the District ofColumbia.  GMM is one of the significantresidential mortgage originators in the greater Washington metropolitan area,reporting originations of over $4 billion in 2003 and $2 billion in 2002.  GMM’s primary sources ofrevenue include net interest income earned on loans pending sale, gain on thesale of loans and management fees earned relating to the management of otherentities’ portfolios.  Loans are madepursuant to purchase commitments and are sold servicing released.

 

15

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In July 2004, the Company formed a newwholly-owned subsidiary, Cardinal Statutory Trust I, for the purpose of issuing$20.0 million of floating rate junior subordinated deferrable interestdebentures (“trust preferred securities”). These trust preferred securities are due in 2034 and have an interestrate of LIBOR (London Interbank Offering Rate) plus 2.40%, which adjustsquarterly.  These securities areredeemable at a premium through March 2008 and at par thereafter.  The Company has guaranteed payment of thesesecurities.  The $20.6 million payable bythe Company to Cardinal Statutory Trust I is included in other borrowed fundsin the Consolidated Statements of Condition since Cardinal Statutory Trust I isan unconsolidated subsidiary as the Company is not the primary beneficiary ofthis entity.  The Company utilized theproceeds from the issuance of the trust preferred securities to make a capitalcontribution into the Bank.

 

**Net interest income has been our primarysource of income.  With the addition ofGMM, our sources of non-interest income have significantly increased anddiversified our sources of income.  Asdiscussed further in the interest rate sensitivity section, we attempt tomanage our balance sheet and interest rate risk to enhance and stabilize ournet interest income over time.  We dothis by monitoring the spread between the interest rates earned on investmentsecurities and loans and the interest rates paid on deposits and otherinterest-bearing liabilities.  Changes ininterest rates may, nevertheless, affect our operating performance andfinancial condition.  We attempt tominimize our exposure to interest rate risk, but, because of marketplaceuncertainties, inherent limitations in modeling techniques and the changingnature of the financial services industry, we are unable to eliminate it.  In addition to management of interest raterisk, we analyze our loan portfolio for exposure to credit risk.  Risk of loan defaults and foreclosures are unavoidablein the banking industry and we try to limit our exposure to this risk bymonitoring our extensions of credit carefully. In addition to net interest income, non-interest income is a source ofincome for us and includes service charges on deposits and loans, investmentfee income, management fees and gains on the sale of loans held for sale and onsales of investment securities available-for-sale.**

 

**Our business strategy, which may change because ofchanges in the business environment in which we operate, is to grow throughgeographic expansion while maintaining strong asset quality and achievingsustained profitability.  We completed asecondary common stock offering that raised $41.7 million in equity capital in December 2003and an additional $6.3 million in capital following the exercise of theunderwriters’ 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 lending limitto over $12 million, which has allowed us to expand our commercial and realestate lending loan portfolios.  Weexpect to increase our loan-to-deposit ratio and shift the mix of our earningassets to higher yielding loans.  We used$17.0 million of the cash that was raised in December 2003 and January 2004to acquire GMM.  GMM adds to our plans toincrease our selection of banking products and financial services and diversifyour revenue base, increase fee income, and strengthen customer relationships.**

 

**Critical Accounting Policies**

 

U.S. generallyaccepted accounting principles are complex and require management to applysignificant judgment to various accounting measurement, reporting, anddisclosure matters.  Management must usejudgment, assumptions and estimates to apply these principles where precisemeasurements are not possible or practical. These policies are critical because they are highly dependent uponsubjective or complex judgments, assumptions and estimates.  Changes in

 

16

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such judgments,assumptions and estimates may have a significant impact on the consolidatedfinancial statements.  Actual resultscould therefore differ from those reported.

 

The accountingpolicies we view as critical are those relating to the determination of theallowance for loan losses, the valuation of deferred tax assets and hedging.

 

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

 

**We maintain the allowance for loan losses ata level that represents management’s best estimate of known and probable lossesin the loan portfolio.  Both the amountof the provision and the level of the allowance for loan losses are impacted bymany factors, including general economic conditions, actual and expected creditlosses, historical trends and the 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 ourbusiness and, although we believe the methodologies for determining theallowance for loan losses and the current level of the allowance are adequate,it is possible that there may be unidentified losses in the portfolio that maybecome evident at a future date. Additional provisions for such losses, if necessary, would be recordedin the commercial banking or mortgage banking segment, as appropriate, andwould negatively impact earnings.**

 

For purposes of our analysis, we categorizeour loans into one of five categories: commercial and industrial, commercial real estate, home equity lines ofcredit, residential mortgages and consumer. Peer group annual loss factors (in the absence of historical results)are applied to all categories and are adjusted by the projected duration of theloans in a particular category and by the qualitative factors mentionedabove.  The indicated loss factorsresulting from this analysis are applied to each of the loan categories todetermine a reserve level for each of the five categories of loans.  In addition, we individually assign lossfactors to all loans that have been identified as having loss attributes, asindicated by deterioration in the financial condition of the borrower or adecline in underlying collateral values. Since we have limited historical data on which to base loss factors forclassified loans, we apply, in accordance with regulatory guidelines, a 5% lossfactor to all special mention loans, a 15% loss factor to all substandard loansand a 50% loss factor to all loans classified as doubtful. Loans as loss loansare fully reserved and charged off.

 

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

 

We record a provision for income tax expense based on theamounts of current taxes payable (or refundable) and the change in net deferredtax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effectsof differing carrying values of assets and liabilities for tax and financialstatement purposes that will reverse in future periods.  When substantial uncertainty existsconcerning the recoverability of a deferred tax asset, the carrying value of theasset is reduced by a valuation allowance.

 

*Hedging*

 

We account for our derivatives and hedgingactivities in accordance with FASB Statement No. 133, *Accountingfor Derivative Instruments and Hedging Activity* (“SFAS No.

 

17

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133”), as amended by FASB Statement No. 138, *Accountingfor Certain Derivative Instruments and Certain Hedging Activities.*  We recognize derivatives on our consolidatedstatements of condition at their fair value. In the normal course of business, we enter into contractual commitmentsto extend credit to finance residential mortgages.  These commitments, which contain fixedexpiration dates, offer the borrower an interest rate guarantee provided theloan meets our underwriting guidelines and closes within the time frameestablished by us (interest rate lock). Interest rate risk arises for us on these commitments if interest ratesmove between the time of the interest rate lock and the delivery of the loan tothe investor.  The interest rate lockrelated to loans that are intended to be sold are considered derivatives.

 

To mitigate the effect of the interest raterisk on loans intended to be sold, inherent in providing rate lock commitmentsfor loans from the lock-in date to the fund date, we enter into best effortsdelivery forward sale contracts.  Boththe interest rate risk commitments, and the forward delivery contracts areundesignated derivatives under SFAS No. 133. Mark-to-market adjustments on interest rate lock commitments are recordedfrom the inception of the interest rate lock through the funding date of theunderlying loan.  The fair value of thehedge instruments and the hedged items generally move in opposite directionsand at the same rate and, accordingly, the impact of changes in thesevaluations on income is inconsequential. As required by SFAS No. 133, mark-to-market adjustments subsequent tofunding are recorded only for those loans that have been designated as aqualifying hedge in accordance with SFAS No. 133.  Although the mandatory forward sales serve asan economic hedge of the loans, the loans have not been designated as aqualifying hedge under SFAS No. 133.

 

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

 

On March 9, 2004, the Securities andExchange Commission issued Staff Accounting Bulletin No. 105 (“SAB No. 105”), *Application of Accounting Principles to LoanCommitments.*  SAB No. 105provides guidance regarding loan commitments to fund and sell which areaccounted for as derivative instruments, and is effective beginning April 1,2004.  The loans in our loans held forsale portfolio are accounted for as derivative instruments.  Consistent with SAB No. 105, we consider thefair value of these commitments to be zero at the commitment date, withsubsequent changes in fair value determined solely on changes in marketinterest rates.

 

In March 2004, the FASB issued EmergingIssues Task Force Issue No. 03-1 (“EITF 03-1”), *The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments. *EITF 03-1 provided guidance forevaluating whether an investment in debt and equity securities isother-than-temporarily impaired and was effective for other than-temporaryimpairment evaluations made in reporting periods beginning after June 15,2004.  According to EITF 03-1, a securityis impaired when its fair value is less than its carrying value, and animpairment is other-than-temporary if the investor does not have the “abilityand intent” to hold the investment until a forecasted recovery of its carryingamount.  EITF 03-1 requires that once aninvestment is determined to be impaired, the impairment must be assessed usingthe ability-and-intent-to-hold criterion regardless of the severity or amountof the impairment.  If the impairment isdetermined to be other-than-temporary, an impairment loss should be recognizedin earnings.  On September 30, 2004,the FASB Staff issued FSP EITF 03-1-1, which deferred the application ofmeasurement provisions of EITF 03-1.  TheFASB determined that a delay in the effective date of those provisions wasnecessary until it can issue additional guidance on the application of EITF03-1.

##### ** **

18

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

 

Net income to common shareholdersfor the three months ended September 30, 2004 and 2003 was $1.3 millionand $645,000, respectively, an improvement of $610,000, or 94.6%.  Net income to common shareholders for thenine months ended September, 30, 2004 and 2003 was $2.6 million and $1.6 million,respectively, an improvement of $1.0 million, or 67.5%.  The increase in net income to commonshareholders is primarily a result of increased net interest income andnon-interest income net of the increase in non-interest expense.  In addition, on March 29, 2004, ourpreferred stock automatically converted to common stock.  As a result of this stock conversion, netincome to common shareholders for the three and nine months periods of 2004 didnot include expenses related to preferred stock dividends.  Expenses for preferred dividends were $124,000and $371,000 for the three and nine months ended September 30, 2003,respectively.  In addition, net incomefor the three and nine months ended September 30, 2004 reflect an incometax provision of $621,000 and $1.3 million, respectively, compared to no taxprovision for the same periods of 2003. The 2003 results were not subject to an income tax provision because ofunrecognized available net operating loss carryforwards.

 

Basic and diluted earnings per common sharewere $0.07 and $0.06 for the three months ended September 30, 2004 and2003, respectively.  For the nine monthsended September 30, 2004 and 2003, basic and diluted earnings per commonshare were $0.14 and $0.15, respectively. These results are presented after the effect of dividends paid topreferred shareholders in the 2003 periods. Weighted average fully diluted common shares outstanding for the threemonths ended September 30, 2004 and 2003 were 18,697,179 and 10,344,977,respectively.  For the nine months ended September 30,2004 and 2003, weighted average fully diluted common shares outstanding were18,361,013 and 10,249,184, respectively.

 

Return on average assets for the three monthsended September 30, 2004 and 2003 was 0.43% and 0.47%, respectively.  Return on average assets for the nine monthsended September 30, 2004 and 2003 was 0.40% and 0.41%, respectively.  The decrease in the return on average assetsis a direct result of the increased average total assets due to the acquisitionof GMM and marking loans held for sale to market value as of the purchasedate.  Return on average equity for thethree months ended September 30, 2004 and 2003 was 5.23% and 6.53%,respectively.  Return on average equityfor the nine months ended September 30, 2004 and 2003 was 3.73% and 5.18%,respectively.  The decrease in the returnon average equity is a result of the increased equity from our common stockoffering.

 

Net interest income represents the differencebetween interest earned on interest earning assets and the interest paid ondeposits and other interest bearing liabilities.  The level of net interest income is impactedprimarily by variations in the volume and mix of these assets and liabilities,as well as changes in interest rates when compared to previous periods ofoperations.  Net interest income for thethree months ended September 30, 2004 and 2003 was $7.2 million and $3.8million, respectively, a period-to-period increase of $3.4 million, or87.4%.  Net interest income for the ninemonths ended September 30, 2004 and 2003 was $17.0 million and $10.7million, respectively, an increase of $6.3 million, or 58.5%.  The increase in net interest income is aresult of the increase in the average volume of investment securities and loansreceivable, net of the impact of decreased yields, during 2004, compared withthe same period of 2003, and the addition of GMM and their loans held for saleportfolio.  Net interest income recordedby GMM since its acquisition was $1.6 million.

 

Our netinterest margin for the three months ended September 30, 2004 and 2003 was2.55% and 2.88%, respectively.  For thenine months ended September 30, 2004 and 2003, our net interest margin was2.74% and 2.96%, respectively.  Thedecrease in the net interest margin

 

19

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was a result of the change in the mix of earning assets towards loweryielding earning assets and the decreased interest rate environment.  Tables 1 through 4 present an analysis ofaverage earning assets, interest bearing liabilities and demand deposits withrelated components of interest income and interest expense.

 

Table 1.

 

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

Three Months Ended September 30, 2004, 2003 and 2002

(Dollars in thousands)

 
| ** **                                               | ** ** | **2004**    | ** ** | **2003**     | ** ** | **2002**   | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $           | 60,086     |         | $          | 767        |       | 5.11 | % | $ | 45,983 |   | $ | 708 |   | 6.16 | % | $ | 49,780 |   | $ | 893 |   | 7.18 | % |
| Real estate - commercial                                 |       | 190,371     |       | 2,945        |       | 6.19       | %          | 121,606 |   | 2,100 |   | 6.91 | % | 94,614 |   | 1,887 |   | 7.98 | % |
| Real estate - construction                               |       | 58,291      |       | 848          |       | 5.82       | %          | 23,778 |   | 310 |   | 5.22 | % | 6,675 |   | 100 |   | 5.96 | % |
| Real estate - residential                                |       | 44,558      |       | 653          |       | 5.86       | %          | 38,448 |   | 602 |   | 6.27 | % | 19,103 |   | 369 |   | 7.72 | % |
| Home equity lines                                        |       | 55,039      |       | 486          |       | 3.50       | %          | 34,873 |   | 289 |   | 3.29 | % | 24,268 |   | 263 |   | 4.30 | % |
| Consumer                                                 |       | 7,858       |       | 127          |       | 6.46       | %          | 8,465 |   | 157 |   | 7.36 | % | 11,884 |   | 225 |   | 7.51 | % |
| Total loans                                              |       | 416,203     |       | 5,826        |       | 5.60       | %          | 273,153 |   | 4,166 |   | 6.10 | % | 206,324 |   | 3,737 |   | 7.24 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale, net                                 |       | 369,824     |       | 3,268        |       | 3.53       | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
| Investment securities available-for-sale                 |       | 165,721     |       | 1,536        |       | 3.71       | %          | 127,609 |   | 754 |   | 2.36 | % | 127,307 |   | 1,471 |   | 4.62 | % |
| Investment securities held-to-maturity                   |       | 154,229     |       | 1,432        |       | 3.71       | %          | 121,343 |   | 1,207 |   | 3.98 | % | — |   | — |   | 0.00 | % |
| Other investments                                        |       | 8,163       |       | 78           |       | 3.82       | %          | 3,496 |   | 35 |   | 4.00 | % | 1,199 |   | 17 |   | 5.67 | % |
| Federal funds sold                                       |       | 14,323      |       | 49           |       | 1.37       | %          | 6,915 |   | 17 |   | 0.98 | % | 62,104 |   | 260 |   | 1.66 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets and interest income        |       | 1,128,463   |       | 12,189       |       | 4.32       | %          | 532,516 |   | 6,179 |   | 4.64 | % | 396,934 |   | 5,485 |   | 5.53 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                             |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                  |       | 14,904      |       |         |       |       |       | 8,380 |   |   |   |   |   | 19,861 |   |   |   |   |   |
| Premises and equipment, net                              |       | 14,727      |       |         |       |       |       | 5,045 |   |   |   |   |   | 4,678 |   |   |   |   |   |
| Goodwill                                                 |       | 15,146      |       |         |       |       |       | 646 |   |   |   |   |   | 646 |   |   |   |   |   |
| Accrued interest and other assets                        |       | 11,084      |       |         |       |       |       | 2,583 |   |   |   |   |   | 3,500 |   |   |   |   |   |
| Allowance for loan losses                                |       | (4,864      | )          |         |       |       |       | (3,650 | ) |   |   |   |   | (3,049 | ) |   |   |   |   |
| Total assets                                             |       | $           | 1,179,460  |         |       |       |       |   | $ | 545,520 |   |   |   |   |   | $ | 422,570 |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**            |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                          |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                             |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 148,168     |       | 486          |       | 1.30       | %          | 153,681 |   | 538 |   | 1.39 | % | 130,110 |   | 904 |   | 2.76 | % |
| Money markets                                            |       | 28,065      |       | 42           |       | 0.60       | %          | 28,765 |   | 43 |   | 0.59 | % | 32,019 |   | 151 |   | 1.87 | % |
| Statement savings                                        |       | 7,827       |       | 16           |       | 0.83       | %          | 5,741 |   | 8 |   | 0.53 | % | 4,287 |   | 13 |   | 1.24 | % |
| Certificates of deposit                                  |       | 477,936     |       | 3,124        |       | 2.61       | %          | 179,540 |   | 1,473 |   | 3.25 | % | 150,658 |   | 1,535 |   | 4.04 | % |
| Total interest - bearing deposits                        |       | 661,996     |       | 3,668        |       | 2.22       | %          | 367,727 |   | 2,062 |   | 2.22 | % | 317,074 |   | 2,603 |   | 3.26 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 206,926     |       | 1,116        |       | 2.16       | %          | 63,882 |   | 279 |   | 1.74 | % | 4,065 |   | 40 |   | 3.93 | % |
| Warehouse financing                                      |       | 108,786     |       | 211          |       | 0.78       | %          | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest  expense |       | 977,708     |       | 4,995        |       | 2.04       | %          | 431,609 |   | 2,341 |   | 2.15 | % | 321,139 |   | 2,643 |   | 3.27 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                         |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 94,995      |       |         |       |       |       | 72,819 |   |   |   |   |   | 60,161 |   |   |   |   |   |
| Other liabilities                                        |       | 10,731      |       |         |       |       |       | 1,596 |   |   |   |   |   | 1,659 |   |   |   |   |   |
| Preferred shareholders’ equity                      |       | —      |       |         |       |       |       | 6,824 |   |   |   |   |   | 6,825 |   |   |   |   |   |
| Common shareholders’ equity                         |       | 96,026      |       |         |       |       |       | 32,672 |   |   |   |   |   | 32,786 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $           | 1,179,460  |         |       |       |       |   | $ | 545,520 |   |   |   |   |   | $ | 422,570 |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin (2)          |       |        |       | $            | 7,194      |       | 2.55       | % |   |   | $ | 3,838 |   | 2.88 | % |   |   | $ | 2,842 |   | 2.86 | % |

 

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(1)     Non-accrual loans 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 tax benefitattributes; therefore, there are no tax equivalent adjustments to our netinterest income.

 

20

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Table 2.

 

**Rate and Volume Analysis**

Three Months Ended September 30,2004, 2003 and 2002

(Dollarsin thousands)

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

 

----

(1)     Non-accrual loans 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.

 

21

----

 

Table 3.

 

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

Nine Months Ended September 30, 2004, 2003 and 2002

(Dollars in thousands)

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

 

----

(1)     Non-accrual loans 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.

 

22

----

 

Table 4.

 

**Rate and Volume Analysis**

Nine Months Ended September 30,2004, 2003 and 2002

(Dollarsin thousands)

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

 

----

(1)     Non-accrual loans 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 periods presented.

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

 

23

----

 

The provision for loan losses for the threemonths ended September 30, 2004 and 2003 was $529,000 and $356,000,respectively.  For the nine months ended September 30,2004 and 2003, the provision for loan losses was $918,000 and $602,000,respectively.  The increase in provisionexpense for the year to date 2004 compared to the year to date 2003 is a resultof the loan growth experienced during 2004. The allowance for loan losses at September 30, 2004 and December 31,2003 was $5.3 million and $4.3 million, respectively.  Our allowance for loan loss to loan ratio at September 30,2004 was 1.21%, compared to 1.29% at December 31, 2003.  We continued to experience good loan qualitywith annualized net charged-off loans equal to 0.04% to total loans for thenine months ended September 30, 2004, compared to 0.02% for the sameperiod of 2003.  Non-performing loanswere equal to 0.06% of total loans at September 30, 2004, compared to0.12% at December 31, 2003. Additional information on the allowance for loan losses, its allocationto the total loans receivable portfolio and information on nonperforming loanscan be found in Tables 5, 6 and 7.

 

24

----

 

Table 5.

 

**Allowancefor Loan Losses**

Nine Months Ended September 30,2004 and 2003

(Dollars in thousands)

 
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1    |       | $        | 4,344      |     | $          | 3,372 |   |
|                                  |       |     |       |     |       |
| Provision  for loan losses            |       | 918      |       | 602      |       |
|                                  |       |     |       |     |       |
| Acquired  reserve for loan loss - GMM |       | 123      |       | —   |       |
|                                  |       |     |       |     |       |
| Loans  charged off:                   |       |     |       |     |       |
| Commercial  and industrial            |       | (101     | )          | (74      | )          |
| Real estate  - commercial             |       | —   |       | —   |       |
| Real estate  - construction           |       | —   |       | —   |       |
| Real estate  - residential            |       | —   |       | —   |       |
| Home equity  lines                    |       | —   |       | —   |       |
| Consumer                              |       | (5       | )          | (6       | )          |
| Total loans  charged off              |       | (106     | )          | (80      | )          |
|                                  |       |     |       |     |       |
| Recoveries:                           |       |     |       |     |       |
| Commercial  and industrial            |       | 10       |       | 42       |       |
| Real estate  - commercial             |       | —   |       | —   |       |
| Real estate  - construction           |       | —   |       | —   |       |
| Real estate  - residential            |       | —   |       | —   |       |
| Home equity  lines                    |       | —   |       | —   |       |
| Consumer                              |       | 2        |       | 7        |       |
| Total  recoveries                     |       | 12       |       | 49       |       |
|                                  |       |     |       |     |       |
| Net (charge  offs) recoveries         |       | (94      | )          | (31      | )          |
|                                  |       |     |       |     |       |
| Ending  balance                       |       | $        | 5,291      |     | $          | 3,943 |   |

 
| ** **                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| Loans:                                                      |       |                   |       |                  |       |
| Balance at  period end                                      |       | $                      | 438,957    |                  | $          | 336,002 |   |
| Allowance  for loan losses to loans receivable, net of fees |       | 1.21                   | %          | 1.29                  | %          |
| Annualized  net charge-offs to average loans receivable     |       | 0.04                   | %          | 0.01                  | %          |
|                                                             |            |                        |            |                       |            |  |  |

 

25

----

 

Table 6.

 

**Allocationof the Allowance for Loan Losses**

At September 30, 2004and December 31, 2003

(Dollarsin thousands)

 
| ** **                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |           |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|----------------|
| ** **                       | ** ** | **2004**               | ** ** | **2003**              | ** ** |           |
| ** **                       | ** ** | **Allocation**         | ** ** | **% of Total***       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |   |
| Commercial                       |       | $                      | 771        |                  | 11.89      | %              | $ | 1,046 |   | 17.21 | % |
| Real estate  - commercial        |       | 3,030                  |       | 45.04                 | %          | 1,662          |   | 41.56 | % |   |
| Real estate  - construction      |       | 355                    |       | 14.76                 | %          | 497            |   | 12.57 | % |   |
| Real estate  - residential       |       | 452                    |       | 13.86                 | %          | 418            |   | 12.64 | % |   |
| Home equity  lines               |       | 514                    |       | 12.80                 | %          | 486            |   | 12.84 | % |   |
| Consumer                         |       | 169                    |       | 1.65                  | %          | 235            |   | 3.18 | % |   |
|                             |       |                   |       |                  |       |           |   |   |   |   |
| Total  allowance for loan losses |       | $                      | 5,291      |                  | 100.00     | %              | $ | 4,344 |   | 100.00 | % |
|                                  |            |                        |            |                       |            |                |  |  |  |  |  |  |  |  |  |

 

----

* Percentage of loan type to the total loanportfolio.

 

 

26

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Table 7.

 

**NonperformingLoans Receivable**

At September 30, 2004and December 31, 2003

(Dollars in thousands)

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

 

27

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Non-interest income for thethree months ended September 30, 2004 and 2003 was $4.2 million and$971,000, respectively, a period-to-period increase of $3.2 million, or332.3%.  Non-interest income for the ninemonths ended September 30, 2004 and 2003 was $5.6 million compared to $3.0million, an increase of $2.6 million, or 88.4%. The increase in non-interest income is primarily attributable to theincrease in net gains on sales of loans from GMM since its acquisition and a$674,000 increase in management fees attributable to GMM.  The management fees recorded by GMM representincome earned for the management and operational support provided by GMM tocertain mortgage banking companies. Non-interest income recorded by GMM for the three months ended September 30,2004 was $3.5 million.  Gains on sales ofloans include the gross gains on the sale of mortgage loans, net of originationcosts.  Included in the gross gains onsale of mortgage loans is any origination, underwriting, discount points andother funding fees received and deferred at origination.  Costs, which are originally capitalized whenthe loan closes and are deferred and recognized when the loan is sold, includedirect costs associated with origination, such as commissions, direct salariesfor funded loans, and premiums paid to investors.

 

Net realized gains oninvestment securities available-for-sale was $3,000 and $291,000 for the threemonths ended September 30, 2004 and 2003, respectively.  For the nine months ended September 30,2004 and 2003, net realized gains on investment securities available-for-salewere $245,000 and $1.2 million, respectively. The gains recorded during 2003 were recorded on sales of mortgage-backedsecurities with accelerated pre-payment speeds as a result of decreasinginterest rates.  We are currently usingthe investment securities portfolio as collateral for additional borrowings weincurred to fund GMM’s loans held for sale.

 

Service charges on depositaccounts increased $58,000 to $296,000 for the three months ended September 30,2004, compared to $238,000 for the same period of 2003.  For the nine months ended September 30,2004, service charges on deposit accounts increased $114,000 to $798,000,compared to $684,000 for the same nine-month period of 2003.  Increases in service

 

28

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charges on deposit accountsduring 2004 are a direct result of the increase in total deposits.  Loan service charge income increased $193,000to $267,000 for the three months ended September 30, 2004, compared to$74,000 for the same period of 2003. Loan service charge income for the nine months ended September 30,2004 and 2003 were $552,000 and $342,000, respectively, an increase of $210,000or 61.4%.  The increase in loan servicecharges during 2004 is a result of the increased loan volume experienced duringthe year.  Investment fee incomedecreased to $150,000 for the three months ended September 30, 2004,compared to $184,000 for the three months ended September 30, 2003.  For the nine months ended September 30,2004 and 2003, investment fee income was $498,000 and $473,000, respectively,an increase of $25,000, or 5.3%.  Theincrease in year to date investment fee income is due to the increase in assetsunder management and transaction activity in our investments services businesssegment.

 

Non-interest expense for the three and ninemonths ended September 30, 2004 was $9.0 million and $3.7 million,respectively, compared to $17.8 million and $11.2 million for the same threeand nine months periods of 2003, respectively. The results reflect period-to-period increases of $5.3 million and $6.6million for the comparable three and nine month periods of September 30,2004 and 2003, respectively.  Theseincreases are primarily a result of the addition of GMM, which recorded $4.3million in non-interest expense during the third quarter of 2004.  In addition, the branch expansion we havecompleted throughout the year has also contributed to the increase innon-interest expense.  We have openedfive branches over the first nine months of 2004, our sixteenth branch openingin Annandale, Virginia on November 1, 2004.  As of September 30, 2003, we had ninebranch locations, compared to fifteen locations at September 30,2004.  Expenses related to the branchexpansion are represented in the increases in our salaries and benefitsexpense, occupancy expense and depreciation expense.  Other operating expenses on our statements ofincome include business development, data processing and communicationsexpenses and office administration expenses.

 

The effective tax rate for thethree and nine months ended September 30, 2004 was 33.1% and 33.3%,respectively, compared to 0% for each of the comparable periods of 2003.  The increase in the effective tax rate is aresult of having recorded previously unrecognized deferred tax assets relatedto the net operating loss carryforwards during the fourth quarter of 2003.  We recorded a provision for income taxexpense of $621,000 and $1.3 million for the three and nine months ended September 30,2004, respectively, compared to $0 for each of the comparable periods of 2003,respectively.    For more information,see “Critical Accounting Policies” above in this discussion.

 

**Statements of Condition**

 

Total assets were $1.2 billion at September 30,2004, compared to $636.2 million at December 31, 2003, an increase of$541.9 million or 85.2%.  This growth wasprimarily the result of the GMM acquisition and increases in total loans, totaldeposits and the equity raised in the common stock offering during January 2004.

 

Investmentsecurities were $308.0 million at September 30, 2004, compared to $273.6million at December 31, 2003, an increase of $34.4 million or 12.6%.  The investment portfolio consists ofinvestment 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.  These securitiesare carried at fair value and may be sold

 

29

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as part of an asset/liability strategy, liquidity management, interestrate risk management, regulatory capital management or similar factors.  At September 30, 2004, investmentsecurities available-for-sale were $160.0 million and investment securitiesheld-to-maturity were $148.0 million. See Table 8 for additional information on our investment securitiesportfolio.

 

Table 8.

 

**Investment Securities**

At June 30, 2004 and December 31,2003

(Dollarsin thousands)

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

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

 

----

* Based on contractual maturities.

 

30

----

 
| ** **                                                         | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | **Average  Yield** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------|------------|
| **Available-for-sale  at December 31, 2003**                  | ** ** | ** **          | ** ** | ** **      | ** ** | ** **         | ** ** |
| 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 | % |

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

 

----

* Based on contractual maturities.

 

Loans receivable, net of deferred fees andcosts, increased by $103.0 million, or 30.6%, to $439.0 million at September 30,2004 from $336.0 million at December 31, 2003 (see Table 9 for details onthe loans receivable portfolio). We experienced increases in our commercialreal estate, construction, residential real estate and home equity loanportfolios offset by a slight decrease in our commercial and consumer loanportfolios.  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 several months due to ourincreased legal lending limit of $12.0 million and the volume of loans we havescheduled for funding.  In addition, theCompany has $346.7 million of loans held for sale at September 30, 2004 asa result of its acquisition of GMM.  Loans that are held for sale are valued at thelower of cost or market.

 

31

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Table 9.

 

**Loans Receivable**

At September 30, 2004 andDecember 31, 2003

(Dollarsin thousands)

 
| ** **                       | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                             |       |                        |       |                       |       |   |   |   |   |
| Commercial                       |       | $                           | 52,222     |                       | 11.89      | % | $ | 57,854 |   | 17.21 | % |
| Real estate  - commercial        |       | 197,792                     |       | 45.04                      | %          | 139,725 |   | 41.56 | % |
| Real estate  - construction      |       | 64,847                      |       | 14.76                      | %          | 42,243 |   | 12.57 | % |
| Real estate  - residential       |       | 60,861                      |       | 13.86                      | %          | 42,495 |   | 12.64 | % |
| Home equity  lines               |       | 56,207                      |       | 12.80                      | %          | 43,176 |   | 12.84 | % |
| Consumer                         |       | 7,259                       |       | 1.65                       | %          | 10,690 |   | 3.18 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Gross loans                      |       | $                           | 439,188    |                       | 100.00     | % | $ | 336,183 |   | 100.00 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Add: net  deferred (fees) costs  |       | (231                        | )          |                       |       | (181 | ) |   |   |
| Less:  allowance for loan losses |       | (5,291                      | )          |                       |       | (4,344 | ) |   |   |
|                             |       |                        |       |                       |       |   |   |   |   |
| Loans  receivable, net           |       | $                           | 433,666    |                       |       |   | $ | 331,658 |   |   |   |

 

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

 

32

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Table 10.

 

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

At September 30, 2004

(Dollars in thousands)

 
| **Maturities:**                        |   |    |    |
|----------------------------------------|--------|---------|---------|
| Three months  or less                  |   | $       | 15,909  |   |
| Over three  months through six months  |   | 5,852   |    |
| Over six  months through twelve months |   | 32,631  |    |
| Over twelve  months                    |   | 129,441 |    |
|                                   |   | $       | 183,833 |   |

 

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

 

33

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Table 11.

 

**Short-Term Borrowings**

AtSeptember 30, 2004

(Dollarsin thousands)

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

 

In July 2004, the Company,through a wholly-owned subsidiary, issued $20.0 million of floating rate juniorsubordinated deferrable interest debentures that are due in 2034 and pay acontractual interest rate of LIBOR (London Interbank Offering Rate) plus 2.40%,which adjusts quarterly. We can redeem these debentures at a premium within fiveyears of issuance and at par thereafter. We invested the proceeds from theissuance of these debentures in the form of a capital contribution to the Bank.For regulatory purposes, the debentures qualify as Tier I capital of the Bankand the Company. Interest expense on these debentures for the three monthsended

 

34

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September 30, 2004 was $153,000.  Additional information on these debenturescan be found in Note 1 to the Notes to Consolidated Financial Statements above.

 

At September 30, 2004, we had awarehouse financing liability of $88.8 million. This credit facility is related to GMM and is used to fund the loans inprocess of being sold.  GMM has creditfacilities with the Bank, and also has two third party facilities totaling $310million.  Additional information on thecredit facilities available to GMM are included in Note 4 to the Notes to ConsolidatedFinancial Statements above.

 

Shareholders’ equity at September 30,2004 was $94.5 million, an increase of $9.1 million, or 10.6%, compared to$85.4 million at December 31, 2003. The increase of $9.1 million from theprior year is primarily the result of the underwriters’ exercise in January 2004of their over allotment option from the secondary offering in December 2003.  The over-allotment exercise resulted in theissuance of an additional 945,000 shares of the Company’s common stock and thereceipt of $6.3 million in additional cash. Net income of $2.6 million for the year to date through September 30,2004 also added to the increase in shareholders’ equity for the period.  Book value per common share at September 30,2004 was $5.12, compared to $4.80 at December 31, 2003.

 

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

##### ** **

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

 

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

#### ** **

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

 

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

 

*Mortgage Banking*

 

The operations of the mortgage bankingsegment is conducted through George Mason Mortgage, LLC, a wholly owned subsidiary of the Bank.  GMM engages primarily in the origination andacquisition of residential mortgages for sale into the secondary market on abest efforts basis.  GMM’s operatingresults are included in our third quarter 2004 financial results from the dateof the acquisition on July 7, 2004. Since its acquisition, the mortgage banking

 

35

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segmentreported net income of $465,000.  At September 30,2004, total assets were $357.3 million, loans held for sale, which are recordedat the lower of cost or market determined on an aggregate basis, were $346.7million and warehouse financing was $88.8 million.

 

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

#### ** **

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

 

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

 

Additional information pertaining to our business segments can be foundin Note 2 to the Notes to Consolidated Financial Statements.

 

## **CapitalResources**

## ** **

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

 

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

 

At September 30, 2004, our tier 1 andtotal (tier 1 and tier 2) risk-based capital ratios were 12.6% and 13.3%,respectively.  At December 31, 2003,our tier 1 and total risk-based capital ratios were 19.7% and 20.7%,respectively.  Our regulatory capitallevels for the Bank and bank holding company meet those established forwell-capitalized institutions. The decrease in the tier 1 and total risk-basedcapital ratios is a result of the GMM acquisition. Table 12 provides additionalinformation pertaining to our capital ratios.

 

Table 12.

 

**CapitalComponents**

At September 30, 2004 and December 31,2003

(Dollars in thousands)

 
| ** **                                            | ** ** | **Actual** | ** **    | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------------------|------------|------------|---------------|------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Amount** | ** **    | **Ratio**                          | ** ** | **Amount**                                                              | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                                  |       |       |          |                               |       |                                                                    |       |   |   |   |   |   |   |
| **At September 30,  2004**                       |       |       |          |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total risk  based capital to net risk-weighted assets |       | $          |  103,933 |                               | 13.27      | %                                                                       | $          |  62,658 | > | 8.00 | % | $ |  78,322 | > | 10.00 | % |
| Tier I  capital to net risk-weighted assets           |       | 98,642     |          | 12.59                              | %          | 31,329                                                                  | >       | 4.00 | % | 46,993 | > | 6.00 | % |
| Total risk  based capital to average total assets     |       | 103,933    |          | 8.36                               | %          | 47,179                                                                  | >       | 4.00 | % | 58,973 | > | 5.00 | % |
|                                                  |       |       |          |                               |       |                                                                    |       |   |   |   |   |   |   |
| **At December 31,  2003**                        |       |       |          |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total risk  based capital to net risk-weighted assets |       | $          |  90,239  |                               | 20.66      | %                                                                       | $          |  34,951 | > | 8.00 | % | $ |  43,688 | > | 10.00 | % |
| Tier I  capital to net risk-weighted assets           |       | 85,896     |          | 19.66                              | %          | 17,475                                                                  | >       | 4.00 | % | 26,213 | > | 6.00 | % |
| Total risk  based capital to average total assets     |       | 90,239     |          | 15.45                              | %          | 23,365                                                                  | >       | 4.00 | % | 29,206 | > | 5.00 | % |

 

**Contractual Obligations**

 

We haveentered into a number of long-term contractual obligations to support ourongoing activities.  These contractualobligations will be funded through operating revenues and liquidity sourcesheld or available to us.  The requiredpayments under such obligations are detailed in Table 13.  In addition, the Company, in the normalcourse of business, is a party to

 

36

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financial instruments with off-balance sheetrisk to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, standby letters of credit and financialguarantees.  At September 30, 2004,commitments to extend credit were $161.4 million and standby letters of credit were$4.8 million.

 

Table 13.

 

**ContractualObligations**

At September 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         |       | $          | 183,833    |                       | $          | 54,392 |   | $ | 17,934 |   | $ | 111,053 |   | $ | 454 |   |
|                                                 |       |       |       |                       |       |   |   |   |   |   |   |
| Brokered  certificates of deposit                    |       | 131,636    |       | 104,766                    |       | 26,870 |   | — |   | — |   |
|                                                 |       |       |       |                       |       |   |   |   |   |   |   |
| Advances  from the Federal Home Loan Bank of Atlanta |       | 102,083    |       | 40,500                     |       | 11,750 |   | 29,833 |   | 20,000 |   |
|                                                 |       |       |       |                       |       |   |   |   |   |   |   |
| Trust  preferred securities                          |       | 20,000     |       | —                     |       | — |   | — |   | 20,000 |   |
|                                                 |       |       |       |                       |       |   |   |   |   |   |   |
| Operating  lease obligations                         |       | 16,553     |       | 3,752                      |       | 3,815 |   | 7,303 |   | 1,683 |   |
|                                                 |       |       |       |                       |       |   |   |   |   |   |   |
| Total                                                |       | $          | 454,105    |                       | $          | 203,410 |   | $ | 60,369 |   | $ | 148,189 |   | $ | 42,137 |   |

 

**Liquidity**

 

The objective of liquidity management is toensure the continuous availability of funds to meet the demands of depositors,investors and borrowers and to fund loans, investment securities, and otherassets.  Stable core deposits and astrong capital position are the primary components of a solid foundation forour liquidity position.  In addition, theavailability of regional and national wholesale funding sources includingfederal funds purchased, negotiable certificates of deposit, securities soldunder agreements to repurchase, and borrowings from the Federal Home Loan Bankenhances our liquidity.  Cash flows fromoperations, such as loan payments and payoffs, are also a significant source ofliquidity.  We have a contingency planthat provides for continued monitoring of liquidity needs and available sourcesof liquidity.  We believe we have theability to meet anticipated liquidity needs. Liquid assets, which include cash and due from banks, federal funds soldand unpledged investment securities available-for-sale totaled $157.8 million,or 13.4% of total assets, at September 30, 2004.  We had investment securities that are classifiedas held-to-maturity of $148.0 million at September 30, 2004.  We also had $118.5 million of our totalinvestment securities portfolio available as collateral for additional FederalHome Loan Bank borrowings.  Management iscommitted to maintaining liquidity at a level sufficient to protect depositors,provide for reasonable growth and fully comply with all regulatoryrequirements.

 

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

##### ** **

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

 

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

 

Table 14.

 

**InterestRate Sensitivity Gap Analysis**

At September 30, 2004

(Dollars in thousands)

 
| ** **                                                                   | ** ** | **Immediate  Repricing** | ** ** | **2-90  Days** | ** ** | **91-180  Days** | ** ** | **181-365  Days** | ** ** | **1-3  Years** | ** ** | **Over 3  Years** | ** ** | **TOTAL**  | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------|------------|----------------|------------|------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|------------|------------|
| **Assets**                                                                   |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| Total  investment securities and other investments                           | ** ** | **$**                    | **—** |           | $          | 16,895           |       | $                 | 12,115     |           | $          | 28,792            |       | $          | 112,732    |   | $ | 144,278 |   | $ | 314,812 |   |
| Federal  funds sold                                                          |       | 25,580                   |       | —         |       | —           |       | —            |       | —         |       | —            |       | 25,580     |       |
| Loans held  for sale                                                         |       | 346,692                  |       | —         |       | —           |       | —            |       | —         |       | —            |       | 346,692    |       |
| **Loans  receivable**                                                        |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| Commercial                                                                   |       | 32,342                   |       | 738            |       | 843              |       | 964               |       | 6,896          |       | 10,439            |       | 52,222     |       |
| Real estate -  commercial                                                    |       | 41,637                   |       | 265            |       | 665              |       | 506               |       | 7,536          |       | 147,183           |       | 197,792    |       |
| Real estate -  construction                                                  |       | 39,157                   |       | 6,718          |       | 7,277            |       | 7,643             |       | 2,028          |       | 2,024             |       | 64,847     |       |
| Real estate -  residential                                                   |       | 3,377                    |       | 7,770          |       | 1,482            |       | 812               |       | 5,207          |       | 42,213            |       | 60,861     |       |
| Home equity  lines                                                           |       | 50,342                   |       | 2,119          |       | 3,139            |       | 607               |       | —         |       | —            |       | 56,207     |       |
| Consumer                                                                     |       | 2,931                    |       | 7              |       | 19               |       | 132               |       | 370            |       | 3,800             |       | 7,259      |       |
| **Total  loans receivable**                                                  |       | 169,786                  |       | 17,617         |       | 13,425           |       | 10,664            |       | 22,037         |       | 205,659           |       | 439,188    |       |
| **Total  earning assets**                                                    |       | 542,058                  |       | 34,512         |       | 25,540           |       | 39,456            |       | 134,769        |       | 349,937           |       | 1,126,272  |       |
| **Cumulative  rate sensitive assets**                                        |       | $                        | 542,058    |           | $          | 576,570          |       | $                 | 602,110    |           | $          | 641,566           |       | $          | 776,335    |   | $ | 1,126,272 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| **Liabilities**                                                              |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| **Deposits**                                                                 |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| Noninterest-bearing  demand                                                  |       | $                        | 101,934    |           | $          | —           |       | $                 | —     |           | $          | —            |       | $          | —     |   | $ | — |   | $ | 101,934 |   |
| Interest-bearing  transaction accounts                                       |       | 194,608                  |       | —         |       | —           |       | —            |       | —         |       | —            |       | 194,608    |       |
| Certificates  of deposit - fixed                                             |       | —                   |       | 57,077         |       | 58,232           |       | 57,449            |       | 52,907         |       | 34,578            |       | 260,243    |       |
| Certificates  of deposit - no penalty                                        |       | —                   |       | 19,362         |       | 4,008            |       | 52,485            |       | 24,081         |       | 163,213           |       | 263,149    |       |
| **Total  deposits**                                                          |       | 296,542                  |       | 76,439         |       | 62,240           |       | 109,934           |       | 76,988         |       | 197,791           |       | 819,934    |       |
| Other  borrowed funds & warehouse financing                              |       | 125,497                  |       | 5,625          |       | 6,625            |       | 28,250            |       | 24,500         |       | 57,702            |       | 248,199    |       |
| **Total  deposits & other borrowed funds**                               |       | 422,039                  |       | 82,064         |       | 68,865           |       | 138,184           |       | 101,488        |       | 255,493           |       | 1,068,133  |       |
| **Cumulative  rate sensitive liabilities**                                   |       | $                        | 422,039    |           | $          | 504,103          |       | $                 | 572,968    |           | $          | 711,152           |       | $          | 812,640    |   | $ | 1,068,133 |   |   |   |
|                                                                         |       |                     |       |           |       |             |       |              |       |           |       |              |       |       |       |
| **Gap**                                                                      |       | $                        | 120,019    |           | $          | (47,552          | )          | $                 | (43,325    | )              | $          | (98,728           | )          | $          | 33,281     |   | $ | 94,444 |   |   |   |
| **Cumulative  gap**                                                          |       | 120,019                  |       | 72,467         |       | 29,142           |       | (69,586           | )          | (36,305        | )          | 58,139            |       |       |       |
| **Gap/  total assets**                                                       |       | 10.19                    | %          | -4.04          | %          | -3.68            | %          | -8.38             | %          | 2.82           | %          | 8.02              | %          |       |       |
| **Cumulative  gap/ total assets**                                            |       | 10.19                    | %          | 6.15           | %          | 2.47             | %          | -5.91             | %          | -3.08          | %          | 4.93              | %          |       |       |
| **Rate  sensitive assets/ rate sensitive liabilities**                       |       | 1.28                     |       | 0.42           |       | 0.37             |       | 0.29              |       | 1.33           |       | 1.37              | ** ** | ** ** | ** ** |
| **Cumulative  rate sensitive assets/ cumulative rate sensitive liabilities** |       | 1.28                     |       | 1.14           |       | 1.05             |       | 0.90              |       | 0.96           |       | 1.05              | ** ** |       | ** ** |

 

 

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**Caution About Forward-Looking Statements**

 

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

 

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

 

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

•                  changes ininterest rates and interest rate policies;

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

•                  the successfulmanagement of interest rate risk;

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

•                  maintaining capitallevels adequate to support our growth;

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

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

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

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

•                  changes ingeneral economic and business conditions in our market area;

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

•                  problems withtechnology utilized by us;

•                  changing trendsin customer profiles and behavior; and

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

 

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

 

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

 

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

 

We can reprice our interest checking, savings, andmoney market accounts at any time.  Wecarefully analyze the impact of any decrease in interest rates on our deposits,as we may experience a runoff in deposit balances as a result of such changesin interest rates.  We continue to analyzethe activity in our deposit portfolio and make changes in our gap assumptionsas the activity dictates. See Table 14 from our management’s discussion andanalysis, which reflects the repricing or expected maturities of various assetsand liabilities at September 30, 2004. This “gap” analysis represents the difference between interest sensitiveassets and liabilities in a specific time interval.

 

We also use a simulation process to measure interestrate risk and the impact of rate fluctuations on net interest income.  These simulations incorporate assumptionsregarding balance sheet growth and mix, and the re-pricing and maturitycharacteristics of existing and projected balance sheets.  One of the ways we manage our interest raterisk is through an analysis of the relationship between interest-earning assetsand interest-bearing liabilities to measure the impact that future changes ininterest rates will have on net interest income.  Using this relationship analysis, changes ininterest rates and volumes are used to test the sensitivity of our net interestincome.  While we show liabilitysensitivity in the short term indicating that an increase in interest rates maynegatively affect short-term net interest income, we would likely take actionsto minimize our exposure to negative results and within a short period of timemake adjustments so that net interest income would not be materially impacted.

 

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

 

41

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**Item 4.  Controls and Procedures**

 

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

 

**As of the end of the period covered by thisreport, an evaluation of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures was carried out under thesupervision and with the participation of the Company’s management, includingthe chief executive officer and chief financial officer.  Based on and as of the date of suchevaluation, these officers concluded that the Company’s disclosure controls andprocedures were effective.**

 

**The Company also maintains a system ofinternal accounting controls that is designed to provide assurance that assetsare safeguarded and that transactions are executed in accordance withmanagement’s authorization and properly recorded.  This system is continually reviewed and isaugmented by written policies and procedures, the careful selection andtraining of qualified personnel and an internal audit program to monitor itseffectiveness.  There were no changes inour internal control over financial reporting identified in connection with ourevaluation of it that occurred during our last fiscal quarter that materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.**

 

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**PART II – OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item 2.  UnregisteredSales of Equity Securities and Use of Proceeds**

** **

(a) None.

(b) Not applicable.

(c) None.

 

**Item 3. Defaults Upon Senior Securities**

 

(a) None.

(b) None.

 

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

 

(a) None.

(b) Not applicable.

(c) Not applicable.

(d) None.

 

**Item 5.  Other Information**

 

(a) None.

(b) None.

 

**Item 6.  Exhibits**

 

31.1                           Rule 13a-14(a) Certification of Chief ExecutiveOfficer

31.2                           Rule 13a-14(a) Certification of Chief Financial Officer

32.1                           Statement of Chief Executive Officer Pursuant to18 U.S.C. Section 1350

32.2                           Statement of Chief Financial Officer Pursuant to18 U.S.C. Section 1350

 

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**SIGNATURES**

 

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

 
| ** **                       | **CARDINAL FINANCIAL CORPORATION**                        |
|----------------------------------|-----------------------------------------------------------|
| ** **                       | **(Registrant)**                                          |
| ** **                       | ** **                                                |
| **Date: November 22, 2004** | **/s/**Bernard H. Clineburg                               | ** ** |
| ** **                       | **Bernard H. Clineburg**                                  |
| ** **                       | **Chairman, President and Chief Executive  Officer**      |
| ** **                       | **(Principal Executive Officer)**                         |
| ** **                       | ** **                                                |
| ** **                       | ** **                                                |
| **Date: November 22, 2004** | **/s/**Carl E. Dodson                                     | ** ** |
| ** **                       | **Carl E. Dodson**                                        |
| ** **                       | **Executive Vice President and Chief  Operating Officer** |
| ** **                       | **(Principal Financial Officer)**                         |
| ** **                       | ** **                                                |
| ** **                       | ** **                                                |
| **Date: November 22, 2004** | **/s/**Jennifer L. Deacon                                 | ** ** |
| ** **                       | **Jennifer L. Deacon**                                    |
| ** **                       | Senior Vice President and Controller                      |
| ** **                       | (Principal Accounting Officer)                            |

 

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