**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

** **

**FORM 10-Q**

** **

** **

**x Quarterly Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

 

 

**For the quarterly periodended June 30, 2006**

** **

** **

**or**

** **

** **

**o Transition Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

 

 

**For the transition periodfrom                         to                               **

** **

** **

Commission File Number:  0-24557

 

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**(703) 584-3400**

(Registrant’s telephone number, including area code)

 

 

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  x    No  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer         o         Acceleratedfiler        x        Non-acceleratedfiler        o

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

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

**24,394,361 shares of common stock, par value $1.00per share,outstanding as of July 31, 2006**

 

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**CARDINAL FINANCIAL CORPORATION**

**INDEX TO FORM 10-Q**
| **PART I — FINANCIAL  INFORMATION** | ** **                                                             |
|------------------------------------------|------------------------------------------------------------------------|
|                                     |                                                                   |   |
| Item  1.                                 | Financial  Statements:                                                 |   |
|                                     |                                                                   |   |
|                                     | Consolidated Statements of Condition                                   |   |
|                                     | At June 30, 2006 (unaudited) and December 31, 2005                     | 3 |
|                                     |                                                                   |   |
|                                     | Consolidated Statements of Income                                      |   |
|                                     | For the three and six months ended June 30, 2006 and  2005 (unaudited) | 4 |
|                                     |                                                                   |   |
|                                     | Consolidated Statements of Comprehensive Income (Loss)                 |   |
|                                     | For the three and six months ended June 30, 2006 and  2005 (unaudited) | 5 |
|                                     |                                                                   |   |
|                                     | Consolidated Statements of Changes In Shareholders’  Equity       |   |
|                                     | For the six months ended June 30, 2006 and 2005  (unaudited)           | 6 |
|                                     |                                                                   |   |
|                                     | Consolidated Statements of Cash Flows                                  |   |
|                                     | For the six months ended June 30, 2006 and 2005  (unaudited)           | 7 |
|                                     |                                                                   |   |
|                                     | Notes to Consolidated Financial Statements (unaudited)                 | 8 |
|                                     |                                                                   |   |
| Item 2.                                  | Management’s  Discussion and Analysis of Financial Condition and  |   |
|                                     | Results  of Operations                                                 | 18 |
|                                     |                                                                   |   |
| Item 3.                                  | Quantitative and Qualitative Disclosures About Market  Risk            | 40 |
|                                     |                                                                   |   |
| Item 4.                                  | Controls and Procedures                                                | 41 |
|                                     |                                                                   |   |
| **PART  II — OTHER INFORMATION**    | 42                                                                     |
| ** **                               |                                                                   |
| Item  1.                                 | Legal Proceedings                                                      | 42 |
|                                     |                                                                   |   |
| Item  1A.                                | Risk Factors                                                           | 42 |
|                                     |                                                                   |   |
| Item 2.                                  | Unregistered Sales of Equity Securities and Use of  Proceeds           | 42 |
|                                     |                                                                   |   |
| Item 3.                                  | Defaults Upon Senior Securities                                        | 42 |
|                                     |                                                                   |   |
| Item 4.                                  | Submission of Matters to a Vote of Security Holders                    | 42 |
|                                     |                                                                   |   |
| Item  5.                                 | Other Information                                                      | 43 |
|                                     |                                                                   |   |
| Item 6.                                  | Exhibits                                                               | 43 |
|                                     |                                                                   |   |
| **SIGNATURES**                           | 44                                                                     |

 

2

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**PART I. FINANCIALINFORMATION**

**Item1.  Financial Statements**

**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF CONDITIONJune 30, 2006 and December 31, 2005(In thousands, except share data)
| **Assets**                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| Cash and due  from banks                                                                                                              |       |       |       |       |       | $                       | 20,499     |                        | $          | 16,514 |   |
| Federal funds  sold                                                                                                                   |       |       |       |       |       | 3,379                   |       | 20,075                      |       |
| Total cash and cash equivalents                                                                                                       |       |       |       |       |       | 23,878                  |       | 36,589                      |       |
| Investment  securities available-for-sale                                                                                             |       |       |       |       |       | 236,417                 |       | 178,955                     |       |
| Investment securities  held-to-maturity (market value of $101,877 and $112,025 at June 30, 2006 and  December 31, 2005, respectively) |       |       |       |       |       | 106,480                 |       | 115,269                     |       |
| Total investment securities                                                                                                           |       |       |       |       |       | 342,897                 |       | 294,224                     |       |
| Other  investments                                                                                                                    |       |       |       |       |       | 7,201                   |       | 7,092                       |       |
| Loans held for  sale, net                                                                                                             |       |       |       |       |       | 376,475                 |       | 361,668                     |       |
| Loans  receivable, net of deferred fees and costs                                                                                     |       |       |       |       |       | 779,628                 |       | 705,644                     |       |
| Allowance for  loan losses                                                                                                            |       |       |       |       |       | (8,964                  | )          | (8,301                      | )          |
| Loans receivable, net                                                                                                                 |       |       |       |       |       | 770,664                 |       | 697,343                     |       |
| Premises and  equipment, net                                                                                                          |       |       |       |       |       | 20,558                  |       | 18,201                      |       |
| Deferred tax  asset                                                                                                                   |       |       |       |       |       | 6,684                   |       | 4,399                       |       |
| Goodwill and  intangibles, net                                                                                                        |       |       |       |       |       | 20,548                  |       | 20,502                      |       |
| Accrued interest  receivable and other assets                                                                                         |       |       |       |       |       | 15,683                  |       | 12,269                      |       |
| Total assets                                                                                                                          |       |       |       |       |       | $                       | 1,584,588  |                        | $          | 1,452,287 |   |
|                                                                                                                                  |       |       |       |       |       |                    |       |                        |       |
| **Liabilities  and Shareholders’ Equity**                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** **              | ** ** | ** **                  | ** ** |
| ** **                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Non-interest  bearing deposits                                                                                                        |       |       |       |       |       | $                       | 122,185    |                        | $          | 114,915 |   |
| Interest bearing  deposits                                                                                                            |       |       |       |       |       | 1,013,307               |       | 954,957                     |       |
| Other borrowed  funds                                                                                                                 |       |       |       |       |       | 224,725                 |       | 155,421                     |       |
| Mortgage funding  checks                                                                                                              |       |       |       |       |       | 51,008                  |       | 41,635                      |       |
| Escrow  liabilities                                                                                                                   |       |       |       |       |       | 2,997                   |       | 11,013                      |       |
| Accrued interest  payable and other liabilities                                                                                       |       |       |       |       |       | 20,787                  |       | 26,467                      |       |
| Total liabilities                                                                                                                     |       |       |       |       |       | 1,435,009               |       | 1,304,408                   |       |
|                                                                                                                                  |       |       |       |       |       |                    |       |                        |       |
| Common stock, $1  par value                                                                                                           |       | 2006       |       | 2005       |       |                    |       |                        |       |
| Shares authorized                                                                                                                     |       | 50,000,000 |       | 50,000,000 |       |                    |       |                        |       |
| Shares issued and outstanding                                                                                                         |       | 24,394,361 |       | 24,362,685 |       | 24,394                  |       | 24,363                      |       |
| Additional  paid-in capital                                                                                                           |       |       |       |       |       | 132,342                 |       | 132,150                     |       |
| Accumulated  deficit                                                                                                                  |       |       |       |       |       | (771                    | )          | (5,269                      | )          |
| Accumulated  other comprehensive loss                                                                                                 |       |       |       |       |       | (6,386                  | )          | (3,365                      | )          |
| Total shareholders’ equity                                                                                                       |       |       |       |       |       | 149,579                 |       | 147,879                     |       |
| Total liabilities and shareholders’ equity                                                                                       |       |       |       |       |       | $                       | 1,584,588  |                        | $          | 1,452,287 |   |

 

See accompanyingnotes to consolidated financial statements.

3

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**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF INCOME Three and six months ended June 30, 2006 and 2005  (In thousands, except share and pershare data)  (Unaudited) 

** **
| ** **                                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest income:                                               |       |                                                |       |                                              |       |   |   |   |   |
| Loans receivable                                               |       | $                                                   | 12,522     |                                              | $          | 8,334 |   | $ | 24,027 |   | $ | 15,614 |   |
| Loans held for sale                                            |       | 5,276                                               |       | 4,657                                             |       | 9,553 |   | 8,015 |   |
| Federal funds sold                                             |       | 85                                                  |       | 77                                                |       | 735 |   | 138 |   |
| Investment securities available-for-sale                       |       | 2,627                                               |       | 1,532                                             |       | 4,691 |   | 2,962 |   |
| Investment securities held-to-maturity                         |       | 1,102                                               |       | 1,253                                             |       | 2,227 |   | 2,561 |   |
| Other investments                                              |       | 88                                                  |       | 73                                                |       | 177 |   | 127 |   |
| Total interest income                                          |       | 21,700                                              |       | 15,926                                            |       | 41,410 |   | 29,417 |   |
| Interest expense:                                              |       |                                                |       |                                              |       |   |   |   |   |
| Deposits                                                       |       | 9,136                                               |       | 5,530                                             |       | 16,927 |   | 10,207 |   |
| Other borrowed funds                                           |       | 1,853                                               |       | 1,272                                             |       | 3,377 |   | 2,264 |   |
| Total interest expense                                         |       | 10,989                                              |       | 6,802                                             |       | 20,304 |   | 12,471 |   |
| Net interest income                                            |       | 10,711                                              |       | 9,124                                             |       | 21,106 |   | 16,946 |   |
| Provision for  loan losses                                     |       | 390                                                 |       | 820                                               |       | 640 |   | 1,369 |   |
| Net interest income after provision for loan losses            |       | 10,321                                              |       | 8,304                                             |       | 20,466 |   | 15,577 |   |
| Non-interest income:                                           |       |                                                |       |                                              |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 389                                                 |       | 330                                               |       | 758 |   | 610 |   |
| Loan service charges                                           |       | 558                                                 |       | 618                                               |       | 1,181 |   | 1,244 |   |
| Investment fee income                                          |       | 991                                                 |       | 291                                               |       | 1,672 |   | 450 |   |
| Net gain on sales of loans                                     |       | 2,521                                               |       | 4,035                                             |       | 5,297 |   | 7,615 |   |
| Net realized gain on investment securities  available-for-sale |       | —                                              |       | 33                                                |       | — |   | 33 |   |
| Management fee income                                          |       | 664                                                 |       | 974                                               |       | 1,082 |   | 1,498 |   |
| Other income (loss)                                            |       | 458                                                 |       | (6                                                | )          | 795 |   | 7 |   |
| Total non-interest income                                      |       | 5,581                                               |       | 6,275                                             |       | 10,785 |   | 11,457 |   |
| Non-interest expense:                                          |       |                                                |       |                                              |       |   |   |   |   |
| Salary and benefits                                            |       | 6,099                                               |       | 5,566                                             |       | 12,030 |   | 10,435 |   |
| Occupancy                                                      |       | 1,295                                               |       | 1,025                                             |       | 2,503 |   | 2,071 |   |
| Professional fees                                              |       | 714                                                 |       | 475                                               |       | 1,221 |   | 949 |   |
| Depreciation                                                   |       | 789                                                 |       | 708                                               |       | 1,538 |   | 1,389 |   |
| Data processing                                                |       | 315                                                 |       | 486                                               |       | 640 |   | 994 |   |
| Telecommunications                                             |       | 311                                                 |       | 277                                               |       | 621 |   | 610 |   |
| Amortization of intangibles                                    |       | 145                                                 |       | 72                                                |       | 293 |   | 122 |   |
| Other operating expenses                                       |       | 2,780                                               |       | 2,512                                             |       | 5,034 |   | 4,646 |   |
| Total non-interest expense                                     |       | 12,448                                              |       | 11,121                                            |       | 23,880 |   | 21,216 |   |
| Net income before income taxes                                 |       | 3,454                                               |       | 3,458                                             |       | 7,371 |   | 5,818 |   |
| Provision for  income taxes                                    |       | 1,063                                               |       | 1,166                                             |       | 2,386 |   | 1,915 |   |
| Net income                                                     |       | $                                                   | 2,391      |                                              | $          | 2,292 |   | $ | 4,985 |   | $ | 3,903 |   |
| Earnings per  common share - basic                             |       | $                                                   | 0.10       |                                              | $          | 0.11 |   | $ | 0.20 |   | $ | 0.20 |   |
| Earnings per  common share - diluted                           |       | $                                                   | 0.10       |                                              | $          | 0.11 |   | $ | 0.20 |   | $ | 0.19 |   |
| Weighted-average  common shares outstanding - basic            |       | 24,415,545                                          |       | 21,096,617                                        |       | 24,401,460 |   | 19,817,872 |   |
| Weighted-average common  shares outstanding - diluted          |       | 24,995,818                                          |       | 21,321,508                                        |       | 24,993,471 |   | 20,101,026 |   |

 

See accompanyingnotes to consolidated financial statements.

 

4

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** **

**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME  (LOSS)Three and six months ended June 30, 2006 and 2005(In thousands)(Unaudited)
| ** **                                                                                                                                                                                                                   | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                                                                                                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                                                                                                                                                                                   |       | $                                               | 2,391      |                                          | $          | 2,292 |   | $ | 4,985 |   | $ | 3,903 |   |
| Other comprehensive  income (loss):                                                                                                                                                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Unrealized gain  (loss) on available-for-sale investment securities:                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
|                                                                                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
|                                                                                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Unrealized holding gain (loss) arising during the  period, net of tax of $1.1 million and $1.5 million for the three and six  months ended June 30, 2006 and $579 and $150 for the three and six months  ended June 30, 2005 |       | (2,031                                          | )          | 1,175                                         |       | (2,754 | ) | (271 | ) |
|                                                                                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Less: reclassification adjustment for gains included  in net income, net of tax of $11 in 2005                                                                                                                               |       | —                                          |       | 22                                            |       | — |   | 22 |   |
|                                                                                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Unrealized loss on derivative instruments designated  as cash flow hedges, net of tax of $312 and $168 for the three and six months  ended June 30, 2006.                                                                    |       | (552                                            | )          | —                                        |       | (268 | ) | — |   |
|                                                                                                                                                                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Comprehensive income  (loss)                                                                                                                                                                                                 |       | $                                               | (192       | )                                             | $          | 3,445 |   | $ | 1,963 |   | $ | 3,610 |   |

 

See accompanying notesto consolidated financial statements.

5

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**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYSix months ended June 30, 2006 and 2005(In thousands)(Unaudited)
| ** **                                      | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|-----------|------------|
| Balance,  December 31, 2004                     |       | 18,463             |       | $                 | 18,463     |                             | $          | 92,868                   |       | $                                           | (15,145    | )         | $          | (1,081 | ) | $ | 95,105 |   |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Stock options  exercised                        |       | 78                 |       | 78                |       | 435                              |       | —                   |       | —                                      |       | 513       |       |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Public offering  shares issued                  |       | 5,175              |       | 5,175             |       | 34,615                           |       | —                   |       | —                                      |       | 39,790    |       |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Shares issued in  acquisition of Wilson/Bennett |       | 611                |       | 611               |       | 4,273                            |       | —                   |       | —                                      |       | 4,884     |       |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Change in  accumulated other comprehensive loss |       | —             |       | —            |       | —                           |       | —                   |       | (293                                        | )          | (293      | )          |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Net income                                      |       | —             |       | —            |       | —                           |       | 3,903                    |       | —                                      |       | 3,903     |       |
| Balance, June  30, 2005                         |       | 24,327             |       | $                 | 24,327     |                             | $          | 132,191                  |       | $                                           | (11,242    | )         | $          | (1,374 | ) | $ | 143,902 |   |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Balance,  December 31, 2005                     |       | 24,363             |       | $                 | 24,363     |                             | $          | 132,150                  |       | $                                           | (5,269     | )         | $          | (3,365 | ) | $ | 147,879 |   |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Stock options  exercised                        |       | 31                 |       | 31                |       | 196                              |       | —                   |       | —                                      |       | 227       |       |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Payment of  deferred compensation shares        |       | —             |       | —            |       | (4                               | )          | —                   |       | —                                      |       | (4        | )          |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Dividends on  common stock                      |       | —             |       | —            |       | —                           |       | (487                     | )          | —                                      |       | (487      | )          |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Change in  accumulated other comprehensive loss |       | —             |       | —            |       | —                           |       | —                   |       | (3,021                                      | )          | (3,021    | )          |
|                                            |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Net income                                      |       | —             |       | —            |       | —                           |       | 4,985                    |       | —                                      |       | 4,985     |       |
| Balance, June  30, 2006                         |       | 24,394             |       | $                 | 24,394     |                             | $          | 132,342                  |       | $                                           | (771       | )         | $          | (6,386 | ) | $ | 149,579 |   |

 

See accompanyingnotes to consolidated financial statements.

 

6

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** **

**CARDINAL FINANCIALCORPORATION AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF CASH FLOWSSix Months Ended June 30, 2006 and 2005(In thousands)(Unaudited)

** **
| ** **                                                                                                                                                                                                                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash flows from  operating activities:                                                                                                                                                                                                             |       |       |       |       |       |
| Net income                                                                                                                                                                                                                                         |       | $          | 4,985      |       | $          | 3,903 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities:                                                                                                                                                       |       |       |       |       |       |
| Depreciation                                                                                                                                                                                                                                       |       | 1,538      |       | 1,389      |       |
| Amortization of premiums, discounts and intangibles                                                                                                                                                                                                |       | 686        |       | 881        |       |
| Provision for loan losses                                                                                                                                                                                                                          |       | 640        |       | 1,369      |       |
| Loans held for sale originated and acquired                                                                                                                                                                                                        |       | (1,557,215 | )          | (2,187,040 | )          |
| Proceeds from the sale of loans held for sale                                                                                                                                                                                                      |       | 1,547,705  |       | 2,085,011  |       |
| Gain on sale of loans held for sale                                                                                                                                                                                                                |       | (5,297     | )          | (7,615     | )          |
| Gain on sale of investment securities  available-for-sale                                                                                                                                                                                          |       | —     |       | (33        | )          |
| Loss on sale of other assets                                                                                                                                                                                                                       |       | 2          |       | 13         |       |
| Increase in accrued interest receivable, other  assets, and deferred tax asset                                                                                                                                                                     |       | (4,429     | )          | (4,472     | )          |
| Increase (decrease) in accrued interest payable,  escrow liabilities and other liabilities                                                                                                                                                         |       | (5,355     | )          | 11,180     |       |
| Net cash used in operating activities                                                                                                                                                                                                              |       | (16,740    | )          | (95,414    | )          |
| Cash flows from  investing activities:                                                                                                                                                                                                             |       |       |       |       |       |
| Purchase of premises and equipment                                                                                                                                                                                                                 |       | (3,859     | )          | (3,130     | )          |
| Proceeds from sale, maturity and call of investment  securities available-for-sale                                                                                                                                                                 |       | —     |       | 1,000      |       |
| Proceeds from sale, maturity and call of  mortgage-backed securities available-for-sale                                                                                                                                                            |       | —     |       | 4,896      |       |
| Proceeds from sale of other investments                                                                                                                                                                                                            |       | 1,982      |       | 8,119      |       |
| Purchase of investment securities available-for-sale                                                                                                                                                                                               |       | (23,154    | )          | (12,964    | )          |
| Purchase of mortgage-backed securities available-for-sale                                                                                                                                                                                          |       | (58,555    | )          | (8,432     | )          |
| Purchase of other investments                                                                                                                                                                                                                      |       | (2,091     | )          | (7,607     | )          |
| Redemptions of investment securities  available-for-sale                                                                                                                                                                                           |       | 11,393     |       | 14,511     |       |
| Redemptions of investment securities  held-to-maturity                                                                                                                                                                                             |       | 8,580      |       | 10,199     |       |
| Net cash paid in acquisition                                                                                                                                                                                                                       |       | (339       | )          | (1,379     | )          |
| Net increase in loans receivable, net of deferred  fees and costs                                                                                                                                                                                  |       | (73,961    | )          | (113,063   | )          |
| Net cash used in investing activities                                                                                                                                                                                                              |       | (140,004   | )          | (107,850   | )          |
| Cash flows from  financing activities:                                                                                                                                                                                                             |       |       |       |       |       |
| Net increase in deposits                                                                                                                                                                                                                           |       | 65,620     |       | 178,276    |       |
| Net increase (decrease) in other borrowed funds                                                                                                                                                                                                    |       | 98,554     |       | (52,610    | )          |
| Net increase in mortgage funding checks                                                                                                                                                                                                            |       | 9,373      |       | 47,268     |       |
| Proceeds from FHLB advances - long term                                                                                                                                                                                                            |       | 5,000      |       | 25,000     |       |
| Repayments of FHLB advances - long term                                                                                                                                                                                                            |       | (34,250    | )          | (2,250     | )          |
| Proceeds from public offering of common stock                                                                                                                                                                                                      |       | —     |       | 39,790     |       |
| Stock options exercised                                                                                                                                                                                                                            |       | 227        |       | 513        |       |
| Deferred compensation payments                                                                                                                                                                                                                     |       | (4         | )          | —     |       |
| Dividends on common stock                                                                                                                                                                                                                          |       | (487       | )          | —     |       |
| Net cash provided by financing activities                                                                                                                                                                                                          |       | 144,033    |       | 235,987    |       |
| Net increase (decrease)  in cash and cash equivalents                                                                                                                                                                                              |       | (12,711    | )          | 32,723     |       |
| Cash and cash  equivalents at beginning of period                                                                                                                                                                                                  |       | 36,589     |       | 23,408     |       |
| Cash and cash  equivalents at end of period                                                                                                                                                                                                        |       | $          | 23,878     |       | $          | 56,131 |   |
|                                                                                                                                                                                                                                               |       |       |       |       |       |
| **Supplemental disclosure of cash  flow information:**                                                                                                                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during the period for interest                                                                                                                                                                                                           |       | $          | 20,341     |       | $          | 12,003 |   |
| Cash paid for income taxes                                                                                                                                                                                                                         |       | 4,963      |       | 150        |       |
|                                                                                                                                                                                                                                               |       |       |       |       |       |
| **Supplemental schedule of  noncash investing and financing activities:**                                                                                                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unsettled purchased investment securities  available-for-sale                                                                                                                                                                                      |       | $          | 4,200      |       | —     |   |
| ** **                                                                                                                                                                                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| On June 9, 2005, the  Company acquired all of the issued and outstanding common stock of  Wilson/Bennett Capital Management, Inc. In conjunction with the acquisition,  the following noncash changes to our financial condition occurred:         |       |       |       |       |       |
| Fair value of non-cash assets acquired, primarily  goodwill and intangibles                                                                                                                                                                        |       |       |       | $          | 6,296      |   |
| Fair value of liabilities assumed                                                                                                                                                                                                                  |       |       |       | 33         |       |
| Common shares issued in acquisition                                                                                                                                                                                                                |       |       |       | 4,884      |       |
| ** **                                                                                                                                                                                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| On February 9, 2006, the Company acquired certain  fiduciary and other assets and assumed the liabilities of FBR National Trust  Company. In conjunction with the acquisition, the following noncash changes  to our financial condition occurred: |       |       |       |       |       |
| Fair value of non-cash assets acquired                                                                                                                                                                                                             |       | $          | 507        |       |       |   |
| Fair value of liabilities assumed                                                                                                                                                                                                                  |       | 127        |       |       |       |

 

See accompanying notes toconsolidated financial statements.

7

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** **

**CARDINALFINANCIAL CORPORATION AND SUBSIDIARIES**NOTESTO CONSOLIDATED FINANCIAL STATEMENTSJune 30, 2006(Unaudited)

Note 1

*Organization*

Cardinal Financial Corporation (the ”Company”) is incorporatedunder the laws of the Commonwealth of Virginia as a financial holding companywhose activities consist of investment in its wholly-owned subsidiaries. Theprincipal operating subsidiary of the Company is Cardinal Bank (the “Bank”), astate-chartered institution. On July 7, 2004, the Bank acquired GeorgeMason Mortgage, LLC (“George Mason”), a mortgage banking company based inFairfax, Virginia. On June 9, 2005, the Company acquired Wilson/BennettCapital Management, Inc. (“Wilson/Bennett”), an asset management firm. TheCompany also owns Cardinal Wealth Services, Inc. (“CWS”), an investmentservices subsidiary. As described in Note 4, on February 9, 2006, the Bankacquired certain fiduciary and other assets and assumed certain liabilities ofFBR National Trust Company, formerly a subsidiary of Friedman, Billings, RamseyGroup, Inc.

*Basis ofPresentation*

In the opinion of management, the accompanying consolidated financialstatements have been prepared in accordance with the requirements of RegulationS-X, Article 10. Accordingly, they do not include all of the informationand footnotes required by U.S. generally accepted accounting principles forcomplete 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 and six months ended June 30, 2006 arenot necessarily indicative of the results to be expected for the full yearending December 31, 2006. The unaudited interim financial statementsshould be read in conjunction with the audited financial statements and notesto financial statements that are included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005 (the “2005Form 10-K”).

Note 2

*Summary of Significant Accounting Policies*

As a result of the acquisition of certain fiduciary and other assetsand the assumption of certain liabilities of FBR National Trust Company asdescribed in Note 4, the Company adopted an accounting policy for recognitionof trust services revenue as follows:

Trust services revenue isrecognized in the period earned in accordance with contractual percentage ofassets under management or custody and is recognized in the consolidatedstatements of income as a component of investment fee income. Revenue isgenerally determined based upon the fair value of assets under management orcustody at the end of the period.

8

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**Note 3**

***Stock-BasedCompensation***

On January 1, 2006, the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123R, *Share-BasedPayment*. This statement requires that companies recognize in theincome statement the grant-date fair value of stock options and otherequity-based compensation. The statement also requires stock awards to beclassified as either an equity award or a liability award. Equity classified awardsare valued as of the grant date using either an observable market price or avaluation methodology. Liability classified awards are valued at fair value ateach reporting date. All of the Company’s stock options are classified asequity awards.

The Company has adopted SFAS No. 123R using the modifiedprospective application method, which requires, among other things, recognitionof compensation costs for all awards outstanding at January 1, 2006 forwhich the requisite service had not been rendered. Total compensation costcharged against income as a result of the adoption of SFAS No. 123R forthe three and six months ended June 30, 2006 was $85,000 and $147,000,respectively. The total income tax benefit recognized in the income statementfor share-based compensation arrangements was $30,000 and $51,000 for the threeand six months ended June 30, 2006, respectively.

The Company estimates that this new standard will result in an increasein pretax expense of approximately $334,000 in 2006 compared to 2005 based onthe current number of unvested stock options outstanding. Additional expensewould be recorded for any future stock option grants and expense would bereduced by estimated option forfeitures.

At June 30, 2006, the Company had two stock-based employee compensationplans, the 1999 Stock Option Plan (the “Option Plan”) and the 2002 EquityCompensation Plan (the “Equity Plan”).

In 1998, the Company adopted the Option Plan pursuant to which theCompany may grant stock options for up to 625,000 shares of the Company’scommon stock to employees and members of the Company’s and its subsidiaries’boards of directors.

In 2002, the Company adopted the Equity Plan. The Equity Planauthorizes the granting of options, which may be incentive stock options, non-qualifiedstock options, stock appreciation rights, restricted stock awards, phantomstock awards or performance share awards to directors, eligible officers andkey employees of the Company. During 2006, the shareholders approved anamendment to the Equity Plan to increase the number of shares of common stockreserved for issuance under it from 1,970,000 to 2,420,000.

Stock options are granted with an exercise price equal to the commonstock’s fair market value at the date of grant. Director stock options have tenyear terms and vest and become fully exercisable at the grant date. Certainemployee stock options have ten year terms and vest and become fullyexercisable after three years. Other employee stock options have ten year termsand vest and become fully exercisable in 20% increments beginning as of thegrant date. In addition, the Company has granted stock options to employees ofthe Company that have ten year terms and vest and become fully exercisable in20% increments beginning after their first year of service. During 2005,certain stock options granted to employees had ten year terms and vested andbecame fully exercisable immediately.

9

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The following table illustrates the effect on net income and earningsper share of common stock as if the Company had applied the fair valuerecognition provisions of SFAS No. 123R to stock-based employeecompensation for the periods indicated:

(In thousands,except per share data)

|                                                                                                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                     | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| Net income                                                                                                                     |       | $                                | 2,292      |                           | $          | 3,903 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value- based  method for all awards, net of tax |       | (1,561                           | )          | (3,772                         | )          |
| Pro forma net  income                                                                                                          |       | $                                | 731        |                           | $          | 131 |   |
|                                                                                                                           |       |                             |       |                           |       |
| Earnings per  share:                                                                                                           |       |                             |       |                           |       |
| Basic - as reported                                                                                                            |       | $                                | 0.11       |                           | $          | 0.20 |   |
| Basic - pro forma                                                                                                              |       | 0.03                             |       | 0.01                           |       |
| Diluted - as reported                                                                                                          |       | 0.11                             |       | 0.19                           |       |
| Diluted - pro  forma                                                                                                           |       | 0.03                             |       | 0.01                           |       |

** **

Options to purchase 425,176 and 919,911 shares of common stock weregranted during the three and six months ended June 30, 2005, respectively.These option grants were immediately fully vested and the pro forma stock-basedemployee compensation expense during the three and six months ended June 30,2005 reflects the immediate vesting attributes of these stock option grants.

The weighted average per share fair values of stock option grants madeduring the three months ended June 30, 2006 and 2005 were $5.86 and $5.37,respectively. The weighted average per share fair values of option grants madeduring the six months ended June 30, 2006 and 2005 were $5.82 and $5.97,respectively. The fair values of the options granted for these periods wereestimated as of the grant date using the Black-Scholes option-pricing modelbased on the following weighted average assumptions:

|                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **               | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Estimated option  life   |       | 6.5 years                        |       | 10 years                       |       | 6.5 years |   | 10 years |   |
| Risk free  interest rate |       | 4.92 - 5.03%                     |       | 4.15%                          |       | 4.44 - 5.03% |   | 4.26% |   |
| Expected  volatility     |       | 43.20%                           |       | 43.11%                         |       | 43.20% |   | 43.11% |   |
| Expected dividend yield  |       | 0.50%                            |       | 0.00%                          |       | 0.50% |   | 0.00% |   |

 

Expected volatility is based upon the average annual historicalvolatility of the Company’s common stock. The estimated option life is derivedfrom the “simplified method” formula as described in Staff Accounting Bulletin107 (“SAB 107”). The risk free interest rate is based upon the five-year U.S.Treasury note rate in effect at the time of grant.  The expected dividendyield is based upon implied and historical dividend declarations.

10

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Stock option activity during the six months ended June 30, 2006 ispresented as follows:

 

|                                       | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining   Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|---------------------------------------|------------|----------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding at  December 31, 2005     |       | 2,269,221                  |       | $8.29                                  |       |                                                      |       |                                    |       |
| Granted                               |       | 203,000                    |       | 12.11                                  |       |                                                      |       |                                    |       |
| Exercised                             |       | 31,436                     |       | 7.17                                   |       |                                                      |       |                                    |       |
| Forfeited                             |       | 13,555                     |       | 9.64                                   |       |                                                      |       |                                    |       |
| Outstanding at  June 30, 2006         |       | 2,427,230                  |       | $8.61                                  |       | 8.07                                                      |       | $7,299                                  |       |
| Options  exercisable at June 30, 2006 |       | 2,089,739                  |       | $8.46                                  |       | 7.99                                                      |       | $6,596                                  |       |

 

Total intrinsic value of options exercised during the three and sixmonths ended June 30, 2006 was $128,000 and $140,000, respectively.

A summary of the status of the Company’s non-vestedstock options and changes during the six months ended June 30, 2006 is asfollows:

 

|                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|
| Balance at  December 31, 2005 |       | 241,781                    |       | $                                                       | 2.10       |   |
| Granted                       |       | 203,000                    |       | 5.82                                                    |       |
| Vested                        |       | (104,986                   | )          | 1.98                                                    |       |
| Forfeited                     |       | (2,304                     | )          | 2.42                                                    |       |
| Balance at June  30, 2006     |       | 337,491                    |       | $                                                       | 4.37       |   |

 

At June 30, 2006, there were $1.5 million of total unrecognizedcompensation cost related to non-vested share-based compensation arrangementsgranted under the plans. The cost is expected to be recognized over a weightedaverage period of 3.8 years. The total fair value of shares that vested duringthe three and six months ended June 30, 2006 was $105,000 and $335,000,respectively.

On October 19, 2005, the Company’s board of directors authorizedthat any outstanding, unvested options that were or became “underwater” (i.e.,their per share exercise price is greater than the market price) on or beforeDecember 31, 2005 be amended to become fully vested. This modificationresulted in the immediate vesting of 54,000 stock options that were held byemployees of the Company. The options that vested had exercise prices rangingfrom $9.58 to $11.15. On October 19, 2005, the market value of the Company’scommon stock was $9.81. This modification did not result in the recognition ofexpense in 2005 because the options had no intrinsic value at the grant date oron the date of modification. Vesting of these options was accelerated toeliminate the need to recognize the remaining fair value compensation expenseassociated with these options following the adoption of SFAS No. 123R. Theamount of compensation expense related to these options that would have beenrecognized in the financial 

11

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statements after the Company’s implementation of SFAS No. 123R,assuming no forfeitures, was $127,000.

#### Note 4

*Acquisitions*

On February 9, 2006, the Bank acquired certain fiduciary and otherassets and assumed certain liabilities of FBR National Trust Company, formerlya subsidiary of Friedman, Billings, Ramsey Group, Inc. The Bank acts astrustee or custodian for assets under management in excess of $5 billion as aresult of this transaction. This transaction diversifies the Bank’s sources ofnon-interest income and allows it to provide additional services to itscustomers.

This transaction was accounted for as a purchase and the acquiredassets and assumed liabilities were recorded at their fair values as of thepurchase date. This acquisition did not have a significant impact on operatingresults for the three and six months ended June 30, 2006 and is not expected tohave a material impact on the Company’s financial condition or operatingresults in 2006.

The operating results of the trust division are included in the Company’sconsolidated operating results and its Trust and Investment Services segmentinformation since the date of acquisition.

The fair value of the net assets acquired was $380,000. The acquisitionresulted in the recognition of an intangible asset for purchased customerrelationships of $161,000, which is being amortized on a straight-line basisover nine years, and in the recognition of goodwill of $178,000. The Companyused the assistance of an independent valuation consultant to determine thevalue assigned to identifiable intangible assets. Goodwill will not be amortizedbut will be reviewed for impairment when evidence of impairment exists or, at aminimum, on an annual basis.

Note 5

# *Segment Information*

The Company operates in three business segments: Commercial Banking, MortgageBanking, and Trust and Investment Services.

The Commercial Banking segment includes both commercial and consumerlending and provides customers with such products as commercial loans, realestate loans, business financing and consumer loans. In addition, this segmentalso provides customers with several choices of deposit products includingdemand deposit accounts, savings accounts and certificates of deposit. The MortgageBanking segment engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis. The Trust and Investment Services segment provides investment andfinancial advisory services to businesses and individuals, including financialplanning, retirement/estate planning, trust, estates, custody, investmentmanagement, escrows, and retirement plans.

Wilson/Bennett is included in the Trust and Investment Services segmentsince the date of acquisition, June 9, 2005. Results related to the assetsacquired, and liabilities assumed, from 

12

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FBR National Trust Company are reflected in the Trust and Investment Servicessegment since the date of their acquisition and assumption, February 9,2006.

Information about the reportable segments and reconciliation of thisinformation to the consolidated financial statements at and for the three andsix months ended June 30, 2006 and 2005, is as follows:

**(Inthousands)**

**At and for the Three Months Ended June 30, 2006:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Trust and  Investment  Services** | ** ** | **Other** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------|------------|-------------------------------|------------|------------------|------------|
| Net interest  income        |       | $                       | 9,827      |                  | $          | 1,142                                    |       | $         | —     |                          | $          | (258             | )          | $ | — |   | $ | 10,711 |   |
| Provision for  loan losses  |       | 390                     |       | —                |       | —                                   |       | —    |       | —                        |       | 390              |       |
| Non-interest  income        |       | 888                     |       | 3,690                 |       | 991                                      |       | 12        |       | —                        |       | 5,581            |       |
| Non-interest  expense       |       | 6,906                   |       | 3,912                 |       | 977                                      |       | 653       |       | —                        |       | 12,448           |       |
| Provision for  income taxes |       | 1,058                   |       | 320                   |       | 5                                        |       | (320      | )          | —                        |       | 1,063            |       |
| Net income  (loss)          |       | $                       | 2,361      |                  | $          | 600                                      |       | $         | 9          |                          | $          | (579             | )          | $ | — |   | $ | 2,391 |   |
|                        |       |                    |       |                  |       |                                     |       |      |       |                          |       |             |       |
| Total Assets                |       | $                       | 1,511,410  |                  | $          | 394,233                                  |       | $         | 6,826      |                          | $          | 157,453          |       | $ | (485,334 | ) | $ | 1,584,588 |   |

 

**At andfor the Three Months Ended June 30, 2005:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Trust and  Investment  Services** | ** ** | **Other** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------|------------|-------------------------------|------------|------------------|------------|
| Net interest  income        |       | $                       | 7,697      |                  | $          | 1,632                                    |       | $         | —     |                          | $          | (205             | )          | $ | — |   | $ | 9,124 |   |
| Provision for  loan losses  |       | 820                     |       | —                |       | —                                   |       | —    |       | —                        |       | 820              |       |
| Non-interest  income        |       | 470                     |       | 5,505                 |       | 291                                      |       | 9         |       | —                        |       | 6,275            |       |
| Non-interest  expense       |       | 5,872                   |       | 4,426                 |       | 324                                      |       | 499       |       | —                        |       | 11,121           |       |
| Provision for  income taxes |       | 453                     |       | 960                   |       | (17                                      | )          | (230      | )          | —                        |       | 1,166            |       |
| Net income  (loss)          |       | $                       | 1,022      |                  | $          | 1,751                                    |       | $         | (16        | )                             | $          | (465             | )          | $ | — |   | $ | 2,292 |   |
|                        |       |                    |       |                  |       |                                     |       |      |       |                          |       |             |       |
| Total Assets                |       | $                       | 1,310,707  |                  | $          | 495,017                                  |       | $         | 7,228      |                          | $          | 165,331          |       | $ | (511,046 | ) | $ | 1,467,237 |   |
|                        |       |                    |       |                  |       |                                     |       |      |       |                          |       |             |       |

 

**At andfor the Six Months Ended June 30, 2006:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Trust and  Investment  Services** | ** ** | **Other** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------|------------|-------------------------------|------------|------------------|------------|
| Net interest  income        |       | 19,355                  |       | $                     | 2,279      |                                     | $          | —    |       | $                             | (528       | )                | $          | — |   | $ | 21,106 |   |
| Provision for  loan losses  |       | 640                     |       | —                |       | —                                   |       | —    |       | —                        |       | 640              |       |
| Non-interest  income        |       | 1,813                   |       | 7,277                 |       | 1,672                                    |       | 23        |       | —                        |       | 10,785           |       |
| Non-interest  expense       |       | 13,105                  |       | 7,989                 |       | 1,631                                    |       | 1,155     |       | —                        |       | 23,880           |       |
| Provision for  income taxes |       | 2,414                   |       | 548                   |       | 14                                       |       | (590      | )          | —                        |       | 2,386            |       |
| Net income  (loss)          |       | 5,009                   |       | $                     | 1,019      |                                     | 27         |      | $          | (1,070                        | )          | $                | —     |   | $ | 4,985 |   |
|                        |       |                    |       |                  |       |                                     |       |      |       |                          |       |             |       |
| Total Assets                |       | $                       | 1,511,410  |                  | $          | 394,233                                  |       | $         | 6,826      |                          | $          | 157,453          |       | $ | (485,334 | ) | $ | 1,584,588 |   |
|                             |            |                         |            |                       |            |                                          |            |           |            |                               |            |                  |            |  |  |  |  |  |  |

 

**At andfor the Six Months Ended June 30, 2005:**
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Trust and  Investment  Services** | ** ** | **Other** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------|------------|-------------------------------|------------|------------------|------------|
| Net interest  income        |       | $                       | 14,437     |                  | $          | 2,943                                    |       | $         | —     |                          | $          | (434             | )          | $ | — |   | $ | 16,946 |   |
| Provision for  loan losses  |       | 1,369                   |       | —                |       | —                                   |       | —    |       | —                        |       | 1,369            |       |
| Non-interest  income        |       | 845                     |       | 10,145                |       | 450                                      |       | 17        |       | —                        |       | 11,457           |       |
| Non-interest  expense       |       | 11,465                  |       | 8,376                 |       | 545                                      |       | 830       |       | —                        |       | 21,216           |       |
| Provision for  income taxes |       | 831                     |       | 1,539                 |       | (38                                      | )          | (417      | )          | —                        |       | 1,915            |       |
| Net income  (loss)          |       | $                       | 1,617      |                  | $          | 3,173                                    |       | $         | (57        | )                             | $          | (830             | )          | $ | — |   | $ | 3,903 |   |
|                        |       |                    |       |                  |       |                                     |       |      |       |                          |       |             |       |
| Total Assets                |       | $                       | 1,310,707  |                  | $          | 495,017                                  |       | $         | 7,228      |                          | $          | 165,331          |       | $ | (511,046 | ) | $ | 1,467,237 |   |

 

At June 30, 2006, the Company did not have any operating segments otherthan those reported. Parent company financial information is included in the “Other”category and represents an 

13

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overhead function rather than an operating segment. The parent company’smost significant assets are its net investments in its subsidiaries. The parentcompany’s net interest income is comprised of interest income from short-terminvestments and interest expense on trust preferred securities. The parentcompany’s non-interest expense is primarily non-allocable executive salariesand professional services related to the Company’s regulatory requirements.

#### Note 6

##### *Earnings Per Share*

The following is the calculation of basic and diluted earnings pershare for the three and six months ended June 30, 2006 and 2005. Stock optionsoutstanding at June 30, 2006 and 2005 were 2,427,230 and 2,076,413,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 402,108 and 224,891 for the three months ended June30, 2006 and 2005, respectively. Stock options issued that were not included inthe calculation of diluted earnings per share because the exercise prices weregreater than the average market price were 414,710 and 283,154 for the sixmonths ended June 30, 2006 and 2005, respectively. 
| **(In thousands, **                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **except share and per share data)** | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  available to common shareholders                  |       | $                                               | 2,391      |                                          | $          | 2,292 |   | $ | 4,985 |   | $ | 3,903 |   |
| Weighted average  common shares - basic                       |       | 24,415,545                                      |       | 21,096,617                                    |       | 24,401,460 |   | 19,817,872 |   |
| Weighted average  common shares - diluted                     |       | 24,995,818                                      |       | 21,321,508                                    |       | 24,993,471 |   | 20,101,026 |   |
| Earnings per  common share - basic                            |       | $                                               | 0.10       |                                          | $          | 0.11 |   | $ | 0.20 |   | $ | 0.20 |   |
| Earnings per  common share - diluted                          |       | $                                               | 0.10       |                                          | $          | 0.11 |   | $ | 0.20 |   | $ | 0.19 |   |
|                                                          |       |                                            |       |                                          |       |   |   |   |   |

 

#### Note 7

##### *Derivatives and Hedging Activities*

The Company is a party to forward loan sales contracts, which areutilized to mitigate exposure to fluctuations in interest rates related to loancommitments and closed mortgage loans that are held for sale.

Beginning on October 1, 2005, the Company designated thesederivatives as cash flow hedges in accordance with SFAS No. 133, *Accounting for Derivatives Instruments and Hedging Activities*,as amended. These hedges are recorded at fair value in the statement ofcondition as an other asset or other liability with a corresponding offset toaccumulated other comprehensive income in shareholders’ equity. Amounts arereclassified from accumulated other comprehensive income to the income statementin the period or periods that the loan sale is reflected in income.

At June 30, 2006, accumulated other comprehensive income included anafter-tax unrealized loss of $556,000 related to forward loan sale contracts.Loans held for sale are generally sold within sixty days of closing and,therefore, substantially all of the amount recorded in accumulated other 

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comprehensive income at June 30, 2006 which is related to the Company’scash flow hedges will be recognized in earnings during the third quarter of2006. For the three and six months ended June 30, 2006, the hedgeineffectiveness recorded through earnings was not significant.

At June 30, 2006, the derivative asset was $3.1 million and thederivative liability was $3.6 million. The Company had $169.3 million in loancommitments and $169.3 million in associated forward loan sales. TheCompany also had $311.9 million in forward loan sales contracts hedging themajority of its loans held for sale.

#### Note 8

*Goodwilland Other Intangibles*

Information concerning total amortizable other intangible assets atJune 30, 2006 is as follows:

 
| ** **                        | ** ** | **Mortgage Banking**   | ** ** | **Trust and  Investment Services** | ** ** | **Total**                   | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|
| **(In thousands)**           | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**                | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Balance at  December 31, 2005     |       | $                           | 1,781      |                                         | $          | 247                         |       | $ | 2,602 |   | $ | 211 |   | $ | 4,383 |   | $ | 458 |   |
| 2006 activity:                    |       |                        |       |                                         |       |                        |       |   |   |   |   |   |   |
| Customer relationship intangibles |       | —                      |       | 99                                           |       | 161                         |       | 99 |   | 161 |   | 198 |   |
| Employment/non-compete agreement  |       | —                      |       | —                                       |       | —                      |       | 87 |   | — |   | 87 |   |
| Trade name                        |       | —                      |       | —                                       |       | —                      |       | 8 |   | — |   | 8 |   |
| Balance at June  30, 2006         |       | $                           | 1,781      |                                         | $          | 346                         |       | $ | 2,763 |   | $ | 405 |   | $ | 4,544 |   | $ | 751 |   |

 

The aggregate amortization expense for the three months ended June 30,2006 and 2005 was $145,000 and $72,000, respectively. The aggregateamortization expense for the six months ended June 30, 2006 and 2005 was$293,000 and $122,000, respectively.

The estimated amortization expense, as amended for the change inestimate described in Note 10, for the next five years is as follows:

|                              | ** ** | **(In thousands)** | ** ** |
|------------------------------|------------|-------------------------|------------|
| 2006 (July –  December) |       | 414                     |       |
| 2007                         |       | 725                     |       |
| 2008                         |       | 408                     |       |
| 2009                         |       | 402                     |       |
| 2010                         |       | 402                     |       |
| 2011                         |       | 402                     |       |

 

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The changes in the carrying amount of goodwill foryear to date June 30, 2006 are as follows:
| **(In thousands)**       | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Trust and  Investment  Services** | ** ** | **Total** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------|------------|
| Balance at  December 31, 2005 |       | $                       | 22         |                  | $          | 12,941                                   |       | $         | 3,614      |   | $ | 16,577 |   |
| 2006 activity:                |       |                    |       |                  |       |                                     |       |      |       |
| Trust division acquisition    |       | $                       | —     |                  | $          | —                                   |       | $         | 178        |   | $ | 178 |   |
| Balance at June  30, 2006     |       | $                       | 22         |                  | $          | 12,941                                   |       | $         | 3,792      |   | $ | 16,755 |   |

 

Note 9

*Commitmentsand Contingencies*

In the normal course of business, the Company is a party to financialinstruments with off-balance sheet risk to meet the financing needs of itscustomers. These financial instruments include commitments to extend credit andstandby letters of credit. These instruments involve, to varying degrees,elements of credit risk in excess of the amount recognized on the balancesheet.

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

At June 30, 2006, commitments to extend credit were $413 million andstandby letters of credit were $6.7 million.

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in the agreement.Commitments generally have expiration dates or other termination clauses andmay require payment of a fee. Since many of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future funding requirements. The Bank evaluates eachcustomer’s credit worthiness on a case-by-case basis. The amount of collateralobtained is based on management’s credit evaluation of the counterparty.Collateral held varies but may include accounts receivable, inventory, propertyand equipment, and income-producing commercial properties.

Unfunded commitments under lines of credit are commitments for possiblefuture extensions of credit to existing customers. Those lines of credit may ormay not be drawn upon to the total extent of funding to which the Bank hascommitted.

Standby letters of credit are conditional commitments the Bank issuesto guarantee the performance of a customer to a third party. Those guaranteesare primarily issued to support public and private borrowing arrangements,including commercial paper, bond financing, and similar transactions. Thecredit risk involved in issuing standby letters of credit is essentially thesame as that involved in extending loan facilities to customers. The Bank holdscertificates of deposit, deposit accounts, and real estate as collateralsupporting those commitments when collateral is deemed necessary.

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Note 10

*Amendmentto Employment Agreement*

On June 29, 2006, the Company entered into anAmendment to the Employment Agreement (the “Amendment”) with John W. Fisher,president and chief executive officer of Wilson/Bennett. The Amendment amendsthe Employment Agreement dated as of June 8, 2005 between the Company and Mr.Fisher.  As provided in the Amendment, Mr. Fisherwill retire from the business on September 30, 2006, work with thebusiness in a consulting and business development function throughApril 30, 2007, and honor his non-compete agreement with the Company whichwill end on September 30, 2007. As Mr. Fisher transitions out of hisinvolvement with Wilson/Bennett over the next fifteen months, we will continueto monitor the operations, customer base and assets under management and theassociated impact on the fair value of goodwill and other intangible assets.

As a result of the Amendment, the Company haschanged its estimated useful life for the intangible asset related to theemployment/non-compete agreement acquired as part of the Wilson/Bennettacquisition. The useful life was changed from an aggregate of four years fromthe acquisition date to 15 months from the date of the Amendment.  As a result of this change, amortizationexpense will increase by $118,000 during the remainder of 2006.

We completed our analysisof the fair value of the goodwill associated with our acquisition of Wilson/Bennettduring the second quarter of 2006, which indicated there was no impairment tothis asset.  

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

The following presents management’s discussion andanalysis of our consolidated financial condition at June 30, 2006 andDecember 31, 2005 and the unaudited results of our operations for thethree and six months ended June 30, 2006 and 2005. This discussion should beread in conjunction with our unaudited consolidated financial statements andthe notes thereto appearing elsewhere in this report, the audited consolidatedfinancial statements and the notes to consolidated financial statementsincluded in our Annual Report on Form 10-K for the year ended December 31,2005.

**CautionAbout Forward-Looking Statements**

Wemake forward-looking statements in this Form 10-Q that are subject to risks anduncertainties.  These forward lookingstatements include statements regarding our profitability, liquidity, allowancefor loan losses, interest rate sensitivity, market risk, growth strategy, andfinancial and other goals.  The words “believes,”“expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,”“intends,” or other similar words or terms are intended to identifyforward-looking statements.

Theseforward-looking statements are subject to significant uncertainties becausethey are based upon or are affected by factors including:

·                  theability to successfully manage our growth or implement our growth strategies ifwe are unable to identify attractive markets, locations or opportunities toexpand in the future;

·                  changesin interest rates and the successful management of interest rate risk;

·                  risksinherent in making loans such as repayment risks and fluctuating collateralvalues;

·                  maintainingcost controls and asset quality as we open or acquire new branches;

·                  maintainingcapital levels adequate to support our growth;

·                  relianceon our management team, including the ability to attract and retain keypersonnel;

·                  competitionwith other banks and financial institutions, and companies outside of thebanking industry, including those companies that have substantially greateraccess to capital and other resources;

·                  changesin general economic and business conditions in our market area;

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

·                  problemswith technology utilized by us;

·                  changingtrends in customer profiles and behavior; and

·                  changesin banking and other laws and regulations applicable to us.

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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In addition, this section should be read in conjunction withthe description of our “Risk Factors” in Item 1A of our Annual Report on Form10-K for the year ended December 31, 2005.

**Overview**

We are a locally managed financial holding companyheadquartered in Tysons Corner, Virginia, committed to providing superiorcustomer service, a diversified mix of financial products and services, andconvenient banking to our retail and business customers. We own Cardinal Bank(the “Bank”), a Virginia state-chartered community bank, Cardinal WealthServices, Inc. (“CWS”), an investment services subsidiary, andWilson/Bennett Capital Management, Inc. (“Wilson/Bennett”), an assetmanagement firm acquired in June 2005. Through these three subsidiariesand George Mason Mortgage, LLC (“George Mason”), a mortgage banking subsidiaryof the Bank, we offer a wide range of traditional banking products and servicesto both our commercial and retail customers. Our commercial relationshipmanagers focus on attracting small and medium-sized businesses as well asgovernment contractors, commercial real estate developers and builders andprofessionals, such as physicians, accountants and attorneys. We have 23 branchoffice locations and seven mortgage banking office locations and providecompetitive products and services. We complement our core banking operations byoffering a full range of investment products and services to our customersthrough our third-party brokerage relationship with Raymond James FinancialServices, Inc. and asset management services through Wilson/Bennett.

On February 9, 2006, we acquired certainfiduciary and other assets and assumed certain liabilities of FBR NationalTrust Company, formerly a subsidiary of Friedman, Billings, RamseyGroup, Inc. Our new trust division acts as trustee or custodian for assetsin excess of $5 billion. Services provided by this division include trust,estates, custody, investment management, escrows, and retirement plans. Thisacquisition did not have a significant impact on operating results for thethree and six months ended June 30, 2006 and is not expected to have a materialimpact on our financial condition or operating results in 2006. The trustdivision is included, along with CWS and Wilson/Bennett, in the Trust and InvestmentServices segment. In prior periods, this segment was called Investment Services.

On June 9, 2005, we acquired Wilson/Bennett fora total consideration of $6.5 million, which consisted of a payment of $1.6million in cash and the issuance of 611,111 shares of our common stock, whichwe valued at $4.9 million. Wilson/Bennett’s assets and liabilities wererecorded at fair value as of the purchase date. This transaction resulted inthe recognition of $3.6 million of goodwill and $2.6 million of otherintangible assets. Wilson/Bennett uses a value-oriented approach that focuseson large capitalization stocks. Wilson/Bennett’s primary source of revenue ismanagement fees earned on the assets it manages for its customers. Thesemanagement fees are generally based upon the market value of assets undermanagement and, accordingly, revenues from Wilson/Bennett will be, assuming aconsistent customer base, more when appropriate indices, such as the S&P500, are higher and lower when such indices are depressed.

When we acquired Wilson/Bennett, it hadapproximately $225.0 million of assets under management. At June 30, 2006,assets under management by Wilson/Bennett were approximately $203.8 million. AtMarch 31, 2006, assets under management were $159.7 million.  In our Quarterly Report on Form 10-Q for theperiod ended March 31, 2006, we reported that we were concerned about continuedsignificant declines in assets under management by this subsidiary.  During the second quarter of 2006,Wilson/Bennett opened a significant customer relationship 

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that increased assets under management. We completed our analysis of the fair value of the goodwill associatedwith our acquisition of Wilson/Bennett during the second quarter of 2006, whichindicated there was no impairment to this asset.  Subsequent to this evaluation, John W.Fisher, president and chief executive officer of Wilson/Bennett, announced thathe will retire from the business on September 30, 2006, work with thebusiness in a consulting and business development function throughApril 30, 2007, and honor a non-compete agreement throughSeptember 30, 2007. As Mr. Fisher transitions out of his involvementwith Wilson/Bennett over the next fifteen months, we will continue to monitorthe operations, customer base and assets under management and the associatedimpact on the fair value of goodwill and other intangible assets.

Net interest income is our primary source ofrevenue. We define revenue as net interest income plus non-interest income. Asdiscussed further in the interest rate sensitivity section, we manage our balancesheet and interest rate risk exposure to maximize, and concurrently stabilize,net interest income. We do this by monitoring our liquidity position and thespread between the interest rates earned on interest-earning assets and theinterest rates paid on interest-bearing liabilities. We attempt to minimize ourexposure to interest rate risk, but are unable to eliminate it entirely. In addition to management of interest rate risk, we also analyze our loanportfolio for exposure to credit risk. Loan defaults and foreclosures areinherent risks in the banking industry and we attempt to limit our exposure tothese risks by carefully underwriting and then monitoring our extensions ofcredit. In addition to net interest income, non-interest income is an importantsource of revenue for us and includes, among other things, service charges ondeposits and loans, investment fee income, which includes trust revenues, netgains on sales of investment securities available-for-sale, gains on sales ofmortgage loans, and management fee income

Our business strategy is to grow through geographicexpansion while maintaining strong asset quality and achieving increasingprofitability. We completed a secondary common stock offering that raised $39.8million in equity capital during the second quarter of 2005. This capital isbeing used to support the continuing expansion of our branch office network andbalance sheet growth. As a result of this increased capital and retainedearnings, our legal lending limit increased to $20.3 million as of June 30,2006.

**CriticalAccounting Policies**

*General*

U.S. generally accepted accounting principles are complex and requiremanagement to apply significant judgment to various accounting, reporting, anddisclosure matters.  Management must useassumptions, judgments and estimates when applying these principles whereprecise measurements are not possible or practical.  These policies are critical because they arehighly dependent upon subjective or complex judgments, assumptions andestimates.  Changes in such judgments,assumptions and estimates may have a significant impact on the consolidatedfinancial statements.  Actual results, infact, could differ from initial estimates.

The accounting policies we view as critical are those relating to judgments,assumptions and estimates regarding the determination of the allowance for loanlosses, accounting for economic hedging activities, accounting for businesscombinations and impairment testing of goodwill, and the valuation of deferredtax assets.

#### *Allowance for LoanLosses*

**We maintain the allowance for loan losses at a level thatrepresents management’s best estimate of known and inherent losses in our loanportfolio.  Both the amount of theprovision expense and the level of the allowance for loan losses are impactedby many factors, including**

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**generaland industry-specific economic conditions, actual and expected credit losses,historical trends and specific conditions of individual borrowers.  Unusual and infrequently occurring events,such as hurricanes and other weather-related disasters, may impact ourassessment of possible credit losses.  Asa part of our analysis, we use comparative peer group data and qualitativefactors such as levels of and trends in delinquencies and nonaccrual loans, nationaland local economic trends and conditions and concentrations of loans exhibitingsimilar risk profiles to support our estimates.**

For purposes of our analysis, we categorize loansinto one of five categories:  commercial and industrial, commercial realestate (including construction), home equity lines of credit, residentialmortgages, and consumer loans. In the absence of meaningful historical lossfactors, peer group loss factors are applied and are adjusted by thequalitative factors mentioned above. The indicated loss factors resulting fromthis analysis are applied for each of the five categories of loans. Inaddition, we individually assign loss factors to all loans that have beenidentified as having loss attributes, as indicated by deterioration in thefinancial condition of the borrower or a decline in underlying collateral valueif the loan is collateral dependent. Since we have limited historical data onwhich to base loss factors for classified loans, we apply, in accordance withregulatory guidelines, a 5% loss factor to all loans classified as specialmention, a 15% loss factor to all loans classified as substandard and a 50%loss factor to all loans classified as doubtful. Loans classified as loss loansare fully reserved or charged off.

Credit losses are an inherent part of our businessand, although we believe the methodologies for determining the allowance forloan losses and the current level of the allowance are adequate, it is possiblethat there may be unidentified losses in the portfolio at any particular timethat may become evident at a future date pursuant to additional internalanalysis or regulatory comment. Additional provisions for such losses, ifnecessary, would be recorded in the Commercial Banking or Mortgage Banking segments,as appropriate, and would negatively impact earnings.

*Derivative Instruments and Hedging Activities*

We account for our derivatives and hedgingactivities in accordance SFAS No. 133, as amended, which requires that allderivative instruments be recorded on the statement of condition at their fairvalues. We evaluate the effectivenessof these transactions at inception and on an ongoing basis. Ineffectiveness isrecorded through earnings. We do not enter into derivative transactions forspeculative purposes.

In the normal course of business, we enter intocontractual commitments, including rate lock commitments, to financeresidential mortgage loans. These commitments, which contain fixed expirationdates, offer the borrower an interest rate guarantee provided the loan meetsunderwriting guidelines and closes within the time frame established by us.Interest rate risk arises on these commitments and subsequently closed loans ifinterest rates change between the time of the interest rate lock and the deliveryof the loan to the investor. Loan commitments related to residential mortgageloans intended to be sold are considered derivatives.

To mitigate the effect of the interest rate riskinherent in providing rate lock commitments, we economically hedge ourcommitments by entering into a best efforts delivery forward loan salescontracts. During the rate lock commitment period, these forward loan salescontracts are marked to market through earnings and are not designated asaccounting hedges under SFAS No. 133, as amended. Changes in the fairvalues of loan commitments and changes in the fair values of forward loan salescontracts generally move in opposite directions, and the net impact of changesof these valuations on net income during the loan commitment period isgenerally inconsequential. At the closing of the loan, the loan commitmentderivative expires and 

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we record a loan held for sale and continue to be obligated under thesame forward loan sales contract. Loans held for sale are accounted for at thelower of cost or market in accordance with SFAS No. 65, *Accounting for Certain Mortgage Banking Activities.*Priorto October 1, 2005, the changes in value of the forward loan salescontracts from the date the loan closed to the date it was sold to an investorwere marked to market through earnings.

On October 1, 2005, we began designating ourforward loan sales contracts as hedges to mitigate the variability in cash flowto be received from the sale of mortgage loans. We contemporaneously documentthe hedging relationship, including the risk management objective and strategyfor undertaking the hedge, how effectiveness will be assessed at inception andat each reporting period and the method for measuring ineffectiveness. Wedesignate each forward loan sales agreement as a cash flow hedge of a specificloan held for sale. For derivatives designated as cash flow hedges, the fairvalue adjustments are recorded as a component of other comprehensive income,except for the ineffective portion, which is recorded through the incomestatement.

We discontinue hedge accounting prospectively whenit is determined that the derivative is no longer highly effective inoffsetting changes in anticipated cash flows of the loans held for sale.

In situations in which hedge accounting isdiscontinued, we continue to carry the derivative at its fair value on thebalance sheet and recognize any subsequent changes in fair value in earnings.When hedge accounting is discontinued because it is probable an anticipatedloan sale will not occur, we recognize immediately in earnings any gains andlosses that were accumulated in other comprehensive income.

*Accounting for Business Combinations/ImpairmentTesting of Goodwill*

We account for acquisitions of other businesses inaccordance with SFAS No. 141, *BusinessCombinations*. This statement mandates the use of purchase accountingand, accordingly, assets and liabilities, including previously unrecordedassets and liabilities, are recorded at fair values as of the acquisition date.We utilize a variety of valuation methods to estimate fair value of acquiredassets and liabilities. These methodologies are often based upon assumptionsand estimates which may change at a future date and require that the carryingamount of assets and liabilities acquired be adjusted. To support our purchaseallocations, we have utilized independent consultants to identify and valueidentifiable purchased intangibles. The difference between the fair value ofassets acquired and the liabilities assumed is recorded as goodwill. Goodwilland any other intangible assets are accounted for in accordance with SFASNo. 142, *Goodwill and Other IntangibleAssets*. In accordance with this statement, goodwill will not beamortized but will be tested on at least an annual basis for impairment.

To test goodwill for impairment, we perform ananalysis to compare the fair value of the reporting unit to which the goodwillis assigned to the carrying value of the reporting unit. We make estimates ofthe discontinued cash flows from the expected future operations of thereporting unit. If the analysis indicates that the fair value of the reportingunit is less than its carrying value, we do an analysis to compare the impliedfair value of the reporting unit’s goodwill with the carrying amount of thatgoodwill. The implied fair value of the goodwill is determined by allocatingthe fair value of the reporting unit to all its assets and liabilities. If theimplied fair value of the goodwill is less than the carrying value, animpairment loss is recognized.

 

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#### *Valuation ofDeferred Tax Assets*

We record a provision for income tax expense basedon the amounts of current taxes payable or refundable and the change in netdeferred tax assets or liabilities during the year. Deferred tax assets andliabilities are recognized for the tax effects of differing carrying values ofassets and liabilities for tax and financial statement purposes that willreverse in future periods. When substantial uncertainty exists concerning therecoverability of a deferred tax asset, the carrying value of the asset isreduced by a valuation allowance. The amount of any valuation allowanceestablished is based upon an estimate of the deferred tax asset that is morelikely than not to be recovered. Increases or decreases in the valuation allowanceresult in increases or decreases to the provision for income taxes.

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

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, *Share-Based Payment.*This statement requires that companiesrecognize in the income statement the grant-date fair value of stock optionsand other equity-based compensation. We applied this standard beginningJanuary 1, 2006. This statement requires that stock awards be classifiedas either an equity award or a liability award. Equity classified awards arevalued as of the grant date using either an observable market price or avaluation methodology. Liability classified awards are valued at fair value asof each reporting date. We adopted SFAS No. 123R using the modifiedprospective application method which requires, among other things, that werecognize compensation cost for all awards outstanding at January 1, 2006for which the requisite service has not been rendered. All of our unvestedstock options are classified as equity awards.

On July 13, 2006,the FASB issued Interpretation No. 48 (“FIN No. 48”), *Accountingfor Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109.*This interpretation clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements in accordance with SFAS No. 109,*Accounting for Income Taxes.* FIN No. 48 prescribes arecognition threshold and measurement principles for financial statementdisclosure of tax positions taken or expected to be taken on a tax return. Thisinterpretation is effective for fiscal years beginning after December 15, 2006.We are assessing the impact the adoption of FIN No. 48 will have on ourconsolidated financial position and results of operations.

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

Net income for the three months ended June 30, 2006and 2005 was $2.4 million and $2.3 million, respectively, an increase of$100,000, or 4%.  The increase in netincome for the three months ended June 30, 2006 compared to the same period of 2005is primarily a result of an increase in net interest income after provision forloan losses of $2.0 million, offset by an increase in non-interest expense of$1.3 million, and a $694,000 decrease in non-interest income.  Included in non-interest income for the threemonths ended June 30, 2006 is a $420,000 gain from the extinguishment of aborrowing.  Net income for the six monthsended June 30, 2006 and 2005 was $5.0 million and $3.9 million, respectively,an increase of $1.1 million, or 28%. The increase in net income for the sixmonths ended June 30, 2006 compared to same period of 2005 is primarily aresult of an increase in net interest income after provision for loan losses of$4.9 million, offset by an increase in non-interest expense of $2.7 million anda decrease in non-interest income of $672,000. Included in non-interest incomefor the six months ended June 30, 2006 are gains of $769,000 related tothe extinquishment of two borrowings.

Net income attributable to the Commercial Bankingsegment for the three months ended June 30, 2006 and 2005 was $2.4 million and$1.0 million, respectively.  Net incomeattributable to the Commercial Banking segment for the six months ended June30, 2006 and 2005 was $5.0 million and $1.6 million, respectively.  The increase in net income for the three andsix months 

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periods ended June 30, 2006 compared to the same periods of 2005 in theCommercial Banking segment is attributable to an increase in the volume ofaverage earning assets and the increased yields on those assets.

Net income attributable to the Mortgage Bankingsegment for the three months ended June 30, 2006 and 2005 was $600,000 and $1.8million, respectively.  Net incomeattributable to the Mortgage Banking segment for the six months ended June 30,2006 and 2005 was $1.0 million and $3.2 million, respectively. The decreases inthe Mortgage Banking segment’s net income for the three and six months periodsended June 30, 2006 compared to the same periods of 2005 were due to a slowdownin the regional housing market caused in part by rising interest rates.

The Trust and Investment Services segment, whichincludes CWS, Wilson/Bennett and the new trust division of the Bank, recordednet income of $9,000 for the three months ended June 30, 2006, as compared to anet loss of ($16,000) for the same period 2005. The trust division of the Bankis included in the results of operations since the date of acquisition,February 9, 2006. This business segment reported net income of $27,000 anda net loss of ($57,000) for the six months ended June 30, 2006 and 2005,respectively.  The increase in net incomefor this segment is due to the addition of the newly acquired trust division,which occurred during the first quarter of 2006.

Basic earnings per share were $0.10 and $0.11 forthe three months ended June 30, 2006 and 2005, respectively. For the threemonths ended June 30, 2006 and 2005, diluted earnings per share were $0.10 and$0.11, respectively. Weighted average fully diluted shares outstanding for thethree months ended June 30, 2006 and 2005 were 24,995,818 and 21,321,508,respectively.

 Basicearnings per share were $0.20 for each of the six months ended June 30, 2006and 2005, respectively. For the six months ended June 30, 2006 and 2005,diluted earnings per share were $0.20 and $0.19, respectively. Weighted averagefully diluted shares outstanding for the six months ended June 30, 2006 and2005 were 24,993,471 and 20,101,026, respectively.

Return on average assets for the three months endedJune 30, 2006 and 2005 was 0.66% and 0.70%, respectively. Return on averageequity for the three months ended June 30, 2006 and 2005 was 6.33% and 7.61%,respectively. Return on average assets for the six months ended June 30, 2006and 2005 was 0.71% and 0.64%, respectively. Return on average equity for thesix months ended June 30, 2006 and 2005 was 6.63% and 7.16%, respectively.

Net interest income represents the differencebetween interest and fees earned on interest earning assets and the interestpaid on deposits and other interest bearing liabilities. The level of netinterest income is impacted primarily by variations in the volume and mix ofthese assets and liabilities, as well as changes in interest rates. Netinterest income for the three months ended June 30, 2006 and 2005 was $10.7million and $9.1 million, respectively, a period-to-period increase of $1.6million, or 18%. The increase in net interest income is primarily the result ofan increase in the average volume of loans receivable and investment securitiescompared with the same period of 2005. These increases were funded throughincreases in total deposits and other borrowed funds. Net interest income forthe three months ended June 30, 2006 and 2005 represented 66% and 59% of ourtotal revenues, respectively.

Net interest income for the six months ended June30, 2006 and 2005 was $21.1 million and $16.9 million, respectively, aperiod-to-period increase of $4.2 million, or 25%. The increase in net interestincome is primarily the result of an increase in the average volume of loans 

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receivable and investment securities compared with the same period of2005. These increases were funded through increases in total deposits and otherborrowed funds. Net interest income for the six months ended June 30, 2006 and2005 represented 66% and 60% of our total revenues, respectively.

Our net interest margin, or net interest incomedivided by average earning assets, for the three months ended June 30, 2006 and2005 was 3.10% and 2.91%, respectively. Our net interest margin for the sixmonths ended June 30, 2006 and 2005 was 3.13% and 2.88%, respectively. Theincrease in the net interest margin for the three and six months ended June 30,2006 compared to the same periods of 2005 is a result of a higher volume ofloans receivable and investment securities and an increased rate of interestearned on those earning assets compared with the interest rate paid on theincreased volume of deposits and other borrowed funds. Tables 1 through 4present an analysis of average earning assets and interest bearing liabilitieswith related components of interest income and interest expense.

 

**Table 1.**

**Average BalanceSheets and Interest Rates on Earning Assets and Interest - Bearing Liabilities**ThreeMonths Ended June 30, 2006, 2005 and 2004(In thousands)
| ** **                                               | ** ** | **2006**             | ** ** | **2005**                       | ** ** | **2004**               | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate**               | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               | ** ** | ** **           | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-earning assets:                                 |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $                    | 83,055     |                           | $          | 1,456                  |       | 7.01% |   | $ | 66,766 |   | $ | 954 |   | 5.72% |   | $ | 57,385 |   | $ | 755 |   | 5.26% |   |
| Real estate - commercial                                 |       | 278,813              |       | 4,667                          |       | 6.70    |       | 246,548 |   | 3,891 |   | 6.31    |   | 151,236 |   | 2,340 |   | 6.19    |   |
| Real estate - construction                               |       | 138,175              |       | 2,843                          |       | 8.23    |       | 68,402 |   | 1,145 |   | 6.70    |   | 45,947 |   | 638 |   | 5.55    |   |
| Real estate - residential                                |       | 167,753              |       | 2,151                          |       | 5.13    |       | 108,400 |   | 1,451 |   | 5.35    |   | 42,028 |   | 581 |   | 5.53    |   |
| Home equity lines                                        |       | 77,150               |       | 1,320                          |       | 6.86    |       | 64,678 |   | 806 |   | 4.98    |   | 51,027 |   | 407 |   | 3.20    |   |
| Consumer                                                 |       | 4,469                |       | 85                             |       | 7.61    |       | 4,931 |   | 87 |   | 7.06    |   | 9,336 |   | 145 |   | 6.21    |   |
| Total loans                                              |       | 749,415              |       | 12,522                         |       | 6.68    |       | 559,725 |   | 8,334 |   | 5.96    |   | 356,959 |   | 4,866 |   | 5.45    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale, net                                 |       | 285,071              |       | 5,276                          |       | 7.40    |       | 387,890 |   | 4,657 |   | 4.80    |   | 468 |   | 5 |   | 4.27    |   |
| Investment securities - available-for-sale(2)            |       | 232,614              |       | 2,670                          |       | 4.59    |       | 160,006 |   | 1,532 |   | 3.83    |   | 181,147 |   | 1,553 |   | 3.43    |   |
| Investment securities held-to-maturity                   |       | 108,814              |       | 1,102                          |       | 4.05    |       | 130,982 |   | 1,253 |   | 3.83    |   | 157,827 |   | 1,478 |   | 3.75    |   |
| Other investments                                        |       | 6,319                |       | 88                             |       | 5.58    |       | 6,515 |   | 73 |   | 4.48    |   | 4,566 |   | 46 |   | 4.03    |   |
| Federal funds sold                                       |       | 6,360                |       | 85                             |       | 5.38    |       | 10,279 |   | 77 |   | 3.00    |   | 8,586 |   | 19 |   | 0.90    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets and interest income        |       | 1,388,593            |       | 21,743                         |       | 6.26%                  |       | 1,255,397 |   | 15,926 |   | 5.07% |   | 709,553 |   | 7,967 |   | 4.49% |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning  assets:                            |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                  |       | 8,079                |       |                           |       |                   |       | 10,110 |   |   |   |   |   | 10,958 |   |   |   |   |   |
| Premises and equipment, net                              |       | 19,971               |       |                           |       |                   |       | 17,333 |   |   |   |   |   | 8,065 |   |   |   |   |   |
| Goodwill and other intangibles, net                      |       | 20,647               |       |                           |       |                   |       | 17,622 |   |   |   |   |   | 22 |   |   |   |   |   |
| Accrued interest and other assets                        |       | 11,882               |       |                           |       |                   |       | 11,713 |   |   |   |   |   | 5,335 |   |   |   |   |   |
| Allowance for loan losses                                |       | (8,631               | )          |                           |       |                   |       | (6,545 | ) |   |   |   |   | (4,417 | ) |   |   |   |   |
| Total assets                                             |       | $                    | 1,440,541  |                           |       |                   |       |   | $ | 1,305,630 |   |   |   |   |   | $ | 729,516 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity**           | ** ** | ** **           | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-bearing  liabilities:                           |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                              |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 160,171              |       | 1,177                          |       | 2.95%                  |       | 121,307 |   | 362 |   | 1.19% |   | 150,689 |   | 506 |   | 1.35% |   |
| Money markets                                            |       | 125,196              |       | 777                            |       | 2.48    |       | 164,349 |   | 1,112 |   | 2.71    |   | 26,703 |   | 39 |   | 0.58    |   |
| Statement savings                                        |       | 77,590               |       | 869                            |       | 4.49    |       | 9,157 |   | 25 |   | 1.09    |   | 7,583 |   | 12 |   | 0.63    |   |
| Certificates of deposit                                  |       | 618,850              |       | 6,313                          |       | 4.08    |       | 523,279 |   | 4,031 |   | 3.08    |   | 275,287 |   | 1,941 |   | 2.82    |   |
| Total interest-bearing deposits                          |       | 981,807              |       | 9,136                          |       | 3.73    |       | 818,092 |   | 5,530 |   | 2.70    |   | 460,262 |   | 2,498 |   | 2.18    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 172,868              |       | 1,853                          |       | 4.30    |       | 202,803 |   | 1,272 |   | 2.51    |   | 94,650 |   | 471 |   | 2.00    |   |
| Total interest-bearing liabilities and interest  expense |       | 1,154,675            |       | 10,989                         |       | 3.82    |       | 1,020,895 |   | 6,802 |   | 2.67    |   | 554,912 |   | 2,969 |   | 2.15    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 114,798              |       |                           |       |                   |       | 112,239 |   |   |   |   |   | 80,991 |   |   |   |   |   |
| Other liabilities                                        |       | 19,949               |       |                           |       |                   |       | 51,955 |   |   |   |   |   | 1,574 |   |   |   |   |   |
| Common shareholders’ equity                         |       | 151,119              |       |                           |       |                   |       | 120,541 |   |   |   |   |   | 92,039 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $                    | 1,440,541  |                           |       |                   |       |   | $ | 1,305,630 |   |   |   |   |   | $ | 729,516 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin (2)     |       |                 |       | $                              | 10,754     |                   | 3.10%      |   |   |   | $ | 9,124 |   | 2.91% |   |   |   | $ | 4,998 |   | 2.82% |   |

----

(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)                Interest income for investment securitiesavailable-for-sale is reported on a fully taxable-equivalent basis at a rate of35%

25

----

** **

**Table 2.**

**Rate and VolumeAnalysis**ThreeMonths Ended June 30, 2006, 2005 and 2004(In thousands)
| ** **                                     | ** ** | **Three Months Ended  June 30, 2006   Compared to 2005** | ** ** | **Three Months Ended   June 30, 2005   Compared to 2004** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Average   Volume**                                                                   | ** ** | **Average  Rate**                                                                                 | ** ** | **Increase  (Decrease)** | ** ** | **Average   Volume** | ** ** | **Average  Rate** | ** ** | **Increase  (Decrease)** | ** ** |
| **Interest income:**                           | ** ** | ** **                                                                                  | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans (1):                                     |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                      |       | $                                                                                           | 233        |                                                                                              | $          | 269 |   | $ | 502 |   | $ | 123 |   | $ | 76 |   | $ | 199 |   |
| Real estate - commercial                       |       | 509                                                                                         |       | 267                                                                                               |       | 776 |   | 1,475 |   | 76 |   | 1,551 |   |
| Real estate - construction                     |       | 1,168                                                                                       |       | 530                                                                                               |       | 1,698 |   | 312 |   | 195 |   | 507 |   |
| Real estate - residential                      |       | 794                                                                                         |       | (94                                                                                               | )          | 700 |   | 918 |   | (48 | ) | 870 |   |
| Home equity lines                              |       | 155                                                                                         |       | 359                                                                                               |       | 514 |   | 108 |   | 291 |   | 399 |   |
| Consumer                                       |       | (8                                                                                          | )          | 6                                                                                                 |       | (2 | ) | (68 | ) | 10 |   | (58 | ) |
| Total loans                                    |       | 2,851                                                                                       |       | 1,337                                                                                             |       | 4,188 |   | 2,868 |   | 600 |   | 3,468 |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                      |       | (1,234                                                                                      | )          | 1,853                                                                                             |       | 619 |   | 4,139 |   | 513 |   | 4,652 |   |
| Investment  securities - available-for-sale(2) |       | 695                                                                                         |       | 443                                                                                               |       | 1,138 |   | (181 | ) | 160 |   | (21 | ) |
| Investment  securities held-to-maturity        |       | (212                                                                                        | )          | 61                                                                                                |       | (151 | ) | (251 | ) | 26 |   | (225 | ) |
| Other  investments                             |       | (2                                                                                          | )          | 17                                                                                                |       | 15 |   | 20 |   | 7 |   | 27 |   |
| Federal funds  sold                            |       | (30                                                                                         | )          | 38                                                                                                |       | 8 |   | 4 |   | 54 |   | 58 |   |
| Total interest income                          |       | 2,068                                                                                       |       | 3,749                                                                                             |       | 5,817 |   | 6,599 |   | 1,360 |   | 7,959 |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                          | ** ** | ** **                                                                                  | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                    |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Interest checking                              |       | 115                                                                                         |       | 700                                                                                               |       | 815 |   | (99 | ) | (45 | ) | (144 | ) |
| Money markets                                  |       | (264                                                                                        | )          | (71                                                                                               | )          | (335 | ) | 200 |   | 873 |   | 1,073 |   |
| Statement savings                              |       | 186                                                                                         |       | 658                                                                                               |       | 844 |   | 2 |   | 11 |   | 13 |   |
| Certificates of deposit                        |       | 737                                                                                         |       | 1,545                                                                                             |       | 2,282 |   | 1,744 |   | 346 |   | 2,090 |   |
| Total interest-bearing deposits                |       | 774                                                                                         |       | 2,832                                                                                             |       | 3,606 |   | 1,847 |   | 1,185 |   | 3,032 |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Other borrowed  funds                          |       | (188                                                                                        | )          | 769                                                                                               |       | 581 |   | 539 |   | 262 |   | 801 |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Total interest expense                         |       | 586                                                                                         |       | 3,601                                                                                             |       | 4,187 |   | 2,386 |   | 1,447 |   | 3,833 |   |
|                                           |       |                                                                                        |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Net interest income (2)                        |       | $                                                                                           | 1,482      |                                                                                              | $          | 148 |   | $ | 1,630 |   | $ | 4,213 |   | $ | (87 | ) | $ | 4,126 |   |

----

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

(2)             Interestincome for investment securities available-for-sale is reported on a fullytaxable-equivalent basis at a rate of 35%.

26

----

** **

**Table 3.**

**Average BalanceSheets and Interest Rates on Earning Assets and Interest - Bearing Liabilities**SixMonths Ended June 30, 2006, 2005 and 2004(In thousands)
| ** **                                               | ** ** | **2006**             | ** ** | **2005**                       | ** ** | **2004**               | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate**               | ** ** | **Average   Balance** | ** ** | **Interest   Income/  Expense** | ** ** | **Rate** | ** ** | **Average   Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               | ** ** | ** **           | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-earning  assets:                                |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and industrial                                |       | $                    | 78,104     |                           | $          | 2,761                  |       | 7.07% |   | $ | 63,836 |   | $ | 1,809 |   | 5.67% |   | $ | 58,356 |   | $ | 1,551 |   | 5.32% |   |
| Real estate - commercial                                 |       | 274,950              |       | 9,059                          |       | 6.59    |       | 235,276 |   | 7,272 |   | 6.18    |   | 144,506 |   | 4,563 |   | 6.32    |   |
| Real estate - construction                               |       | 133,626              |       | 5,382                          |       | 8.06    |       | 68,683 |   | 2,262 |   | 6.59    |   | 43,778 |   | 1,204 |   | 5.50    |   |
| Real estate - residential                                |       | 162,923              |       | 4,155                          |       | 5.10    |       | 96,746 |   | 2,594 |   | 5.36    |   | 42,382 |   | 1,196 |   | 5.64    |   |
| Home equity lines                                        |       | 76,802               |       | 2,491                          |       | 6.54    |       | 62,983 |   | 1,490 |   | 4.77    |   | 47,928 |   | 770 |   | 3.22    |   |
| Consumer                                                 |       | 4,732                |       | 179                            |       | 7.57    |       | 5,417 |   | 187 |   | 6.90    |   | 9,855 |   | 308 |   | 6.25    |   |
| Total loans                                              |       | 731,137              |       | 24,027                         |       | 6.57    |       | 532,941 |   | 15,614 |   | 5.86    |   | 346,805 |   | 9,592 |   | 5.53    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale, net                                 |       | 259,458              |       | 9,553                          |       | 7.36    |       | 338,730 |   | 8,015 |   | 4.73    |   | 301 |   | 7 |   | 4.65    |   |
| Investment securities - available-for-sale(2)            |       | 212,472              |       | 4,742                          |       | 4.46    |       | 156,974 |   | 2,962 |   | 3.77    |   | 161,637 |   | 2,824 |   | 3.50    |   |
| Investment securities held-to-maturity                   |       | 111,041              |       | 2,227                          |       | 4.01    |       | 133,450 |   | 2,561 |   | 3.84    |   | 153,922 |   | 2,828 |   | 3.67    |   |
| Other investments                                        |       | 6,440                |       | 177                            |       | 5.51    |       | 5,847 |   | 127 |   | 4.35    |   | 4,100 |   | 84 |   | 4.10    |   |
| Federal funds sold                                       |       | 32,818               |       | 735                            |       | 4.51    |       | 10,718 |   | 138 |   | 2.60    |   | 10,366 |   | 47 |   | 0.90    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets and interest income        |       | 1,353,366            |       | 41,461                         |       | 6.13%                  |       | 1,178,660 |   | 29,417 |   | 4.99% |   | 677,131 |   | 15,382 |   | 4.54% |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  earning assets:                            |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                  |       | 7,681                |       |                           |       |                   |       | 6,336 |   |   |   |   |   | 10,607 |   |   |   |   |   |
| Premises and equipment, net                              |       | 19,069               |       |                           |       |                   |       | 17,167 |   |   |   |   |   | 7,449 |   |   |   |   |   |
| Goodwill and other intangibles, net                      |       | 20,560               |       |                           |       |                   |       | 16,070 |   |   |   |   |   | 22 |   |   |   |   |   |
| Accrued interest and other assets                        |       | 11,577               |       |                           |       |                   |       | 9,769 |   |   |   |   |   | 6,274 |   |   |   |   |   |
| Allowance for loan losses                                |       | (8,529               | )          |                           |       |                   |       | (6,268 | ) |   |   |   |   | (4,413 | ) |   |   |   |   |
| Total assets                                             |       | $                    | 1,403,724  |                           |       |                   |       |   | $ | 1,221,734 |   |   |   |   |   | $ | 697,070 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**           | ** ** | ** **           | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-bearing  liabilities:                           |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                              |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 142,824              |       | 1,899                          |       | 2.68%                  |       | 130,184 |   | 790 |   | 1.22% |   | 153,106 |   | 1,034 |   | 1.35% |   |
| Money markets                                            |       | 155,368              |       | 1,963                          |       | 2.53    |       | 104,021 |   | 1,282 |   | 2.46    |   | 25,586 |   | 75 |   | 0.59    |   |
| Statement savings                                        |       | 43,721               |       | 901                            |       | 4.16    |       | 8,924 |   | 47 |   | 1.05    |   | 7,387 |   | 21 |   | 0.58    |   |
| Certificates of deposit                                  |       | 619,482              |       | 12,164                         |       | 3.93    |       | 538,096 |   | 8,088 |   | 3.01    |   | 256,425 |   | 3,650 |   | 2.85    |   |
| Total interest-bearing deposits                          |       | 961,395              |       | 16,927                         |       | 3.55    |       | 781,225 |   | 10,207 |   | 2.63    |   | 442,504 |   | 4,780 |   | 2.17    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 159,062              |       | 3,377                          |       | 4.28    |       | 178,328 |   | 2,264 |   | 2.56    |   | 84,098 |   | 771 |   | 1.84    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest  expense |       | 1,120,457            |       | 20,304                         |       | 3.65    |       | 959,553 |   | 12,471 |   | 2.62    |   | 526,602 |   | 5,551 |   | 2.11    |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                        |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 112,572              |       |                           |       |                   |       | 108,084 |   |   |   |   |   | 76,695 |   |   |   |   |   |
| Other liabilities                                        |       | 20,393               |       |                           |       |                   |       | 45,006 |   |   |   |   |   | 1,889 |   |   |   |   |   |
| Common shareholders’ equity                         |       | 150,302              |       |                           |       |                   |       | 109,091 |   |   |   |   |   | 91,884 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $                    | 1,403,724  |                           |       |                   |       |   | $ | 1,221,734 |   |   |   |   |   | $ | 697,070 |   |   |   |   |   |
|                                                     |       |                 |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)    |       |                 |       | $                              | 21,157     |                   | 3.13%      |   |   |   | $ | 16,946 |   | 2.88% |   |   |   | $ | 9,831 |   | 2.90% |   |

----

(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)                Interest income for investment securitiesavailable-for-sale is reported on a fully taxable-equivalent basis at a rate of35%.

27

----

** **

**Table 4.**

**Rate and Volume Analysis**

Six Months Ended June 30,2006, 2005 and 2004

(In thousands)

 
| ** **                                     | ** ** | **Six Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **2006 Compared to 2005**          | ** ** | **2005 Compared to 2004**          | ** ** |
| ** **                                     | ** ** | **Average**                                       | ** ** | **Average**                                       | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                     | ** ** | **Volume**                                        | ** ** | **Rate**                                          | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest income:**                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Loans (1):                                     |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                      |       | $                                                 | 404        |                                              | $          | 548 |   | $ | 952 |   | $ | 146 |   | $ | 112 |   | $ | 258 |   |
| Real estate - commercial                       |       | 1,226                                             |       | 561                                               |       | 1,787 |   | 2,866 |   | (157 | ) | 2,709 |   |
| Real estate - construction                     |       | 2,139                                             |       | 981                                               |       | 3,120 |   | 685 |   | 373 |   | 1,058 |   |
| Real estate - residential                      |       | 1,774                                             |       | (213                                              | )          | 1,561 |   | 1,534 |   | (136 | ) | 1,398 |   |
| Home equity lines                              |       | 328                                               |       | 673                                               |       | 1,001 |   | 239 |   | 481 |   | 720 |   |
| Consumer                                       |       | (24                                               | )          | 16                                                |       | (8 | ) | (138 | ) | 17 |   | (121 | ) |
| Total loans                                    |       | 5,847                                             |       | 2,566                                             |       | 8,413 |   | 5,332 |   | 690 |   | 6,022 |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Loans held for  sale, net                      |       | (1,876                                            | )          | 3,414                                             |       | 1,538 |   | 7,870 |   | 138 |   | 8,008 |   |
| Investment  securities - available-for-sale(2) |       | 1,047                                             |       | 733                                               |       | 1,780 |   | (82 | ) | 220 |   | 138 |   |
| Investment  securities held-to-maturity        |       | (430                                              | )          | 96                                                |       | (334 | ) | (376 | ) | 109 |   | (267 | ) |
| Other  investments                             |       | 13                                                |       | 37                                                |       | 50 |   | 36 |   | 7 |   | 43 |   |
| Federal funds  sold                            |       | 285                                               |       | 312                                               |       | 597 |   | 2 |   | 89 |   | 91 |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Total interest income                          |       | 4,886                                             |       | 7,158                                             |       | 12,044 |   | 12,782 |   | 1,253 |   | 14,035 |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| **Interest expense:**                          |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                    |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest checking                              |       | 78                                                |       | 1,031                                             |       | 1,109 |   | (158 | ) | (86 | ) | (244 | ) |
| Money markets                                  |       | 631                                               |       | 50                                                |       | 681 |   | 233 |   | 974 |   | 1,207 |   |
| Statement savings                              |       | 181                                               |       | 673                                               |       | 854 |   | 5 |   | 21 |   | 26 |   |
| Certificates of deposit                        |       | 1,230                                             |       | 2,846                                             |       | 4,076 |   | 3,994 |   | 444 |   | 4,438 |   |
| Total interest-bearing deposits                |       | 2,120                                             |       | 4,600                                             |       | 6,720 |   | 4,074 |   | 1,353 |   | 5,427 |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Other borrowed  funds                          |       | (244                                              | )          | 1,357                                             |       | 1,113 |   | 861 |   | 632 |   | 1,493 |   |
| Total interest expense                         |       | 1,876                                             |       | 5,957                                             |       | 7,833 |   | 4,935 |   | 1,985 |   | 6,920 |   |
|                                           |       |                                              |       |                                              |       |   |   |   |   |   |   |   |   |
| Net interest  income (2)                       |       | $                                                 | 3,010      |                                              | $          | 1,201 |   | $ | 4,211 |   | $ | 7,847 |   | $ | (732 | ) | $ | 7,115 |   |

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

(2)             Interestincome for investment securities available-for-sale is reported on a fullytaxable-equivalent basis at a rate of 35%.

The provision for loan losses for the three monthsended June 30, 2006 and 2005 was $390,000 and $820,000, respectively. For thesix months ended June 30, 2006 and 2005, the provision was $640,000 and $1.4million, respectively. The decrease in provision expense for the three and sixmonths ended June 30, 2006 compared to the same periods of 2005 is primarilythe result of our evaluation of the credit quality in our loan portfolio andthe qualitative factors we use to determine the adequacy of our loan lossreserves as described above in “Critical Accounting Policies—Allowance for LoanLosses.” The allowance for loan losses at June 30, 2006 and December 31,2005 was $9.0 million and $8.3 million, respectively.   Our allowancefor loan losses ratio to loans receivable, net was 1.15% at June 30, 2006 and1.18% at December 31, 2005. There were net recoveries of previouslycharged-off loans of $23,000 in the first six months of 2006. Non-performingloans were equal to 0.07% and 0.03% of total loans receivable at June 30, 2006and December 31, 2005, respectively.

In 1999 and 2001, the Company purchased loanparticipations of approximately $12.3 million from a bank in New Orleans,Louisiana, which represented approximately 950 loans. At June 30, 2006, theaggregate total remaining balances on these participations were approximately$1.4 million and represented approximately 200 loans secured by various typesof recreational vehicles. The borrowers are located in several southern statesincluding Louisiana. Hurricane and other weather-related problems had disruptedthe operations of the New Orleans bank, curtailed mail delivery and othercommunications in the area and caused wide-spread destruction in the gulf coastregion. We maintain an allowance of approximately $71,000 for these loans as ofJune 30, 2006. The majority of these loans continue to perform in accordancewith their terms and we anticipate removing them from our problem loan watchlist in the third quarter of 2006.

28

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Additional information on the allowance for loanlosses, its allocation to the loans receivable portfolio and information onnonperforming loans can be found in Tables 5, 6 and 7.

 

**Table 5.**

**Allowance for Loan Losses**Six Months Ended June 30, 2006 and 2005(In thousands)

 

 
| ** **                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1 |       | $        | 8,301      |     | $          | 5,878 |   |
|                          |       |     |       |     |       |
| Provision for  loan losses    |       | 640      |       | 1,369    |       |
|                          |       |     |       |     |       |
| Loans charged off:            |       |     |       |     |       |
| Commercial and industrial     |       | (42      | )          | (120     | )          |
| Consumer                      |       | (1       | )          | (1       | )          |
| Total loans charged off       |       | (43      | )          | (121     | )          |
|                          |       |     |       |     |       |
| Recoveries:                   |       |     |       |     |       |
| Commercial and industrial     |       | 66       |       | 76       |       |
| Consumer                      |       | —   |       | 8        |       |
| Total recoveries              |       | 66       |       | 84       |       |
|                          |       |     |       |     |       |
| Net (charge  offs) recoveries |       | 23       |       | (37      | )          |
|                          |       |     |       |     |       |
| Ending balance,  June 30      |       | $        | 8,964      |     | $          | 7,210 |   |
|                          |       |     |       |     |       |

 
| ** **                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------|------------|------------------|------------|
| ** **                                                  | ** ** | **2006**     | ** ** | **2005**         | ** ** |
| Loans:                                                      |       |         |       |             |       |
| Balance at period end                                       |       | $            | 779,628    |             | $          | 705,644 |   |
|                                                        |       |         |       |             |       |
| Allowance for loan losses to loans receivable, net  of fees |       | 1.15%        |       | 1.18%            |       |
|                                                        |       |         |       |             |       |
| Annualized net  charge-offs to average loans receivable     |       | 0.00%        |       | 0.01%            |       |
|                                                             |            |              |            |                  |            |  |  |

 

29

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**Table 6.**

**Allocation of the Allowance for Loan Losses**

At June 30, 2006 andDecember 31, 2005

(In thousands)

 
| ** **                       | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **Allocation**    | ** ** | **% of Total***       | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial and  industrial       |       | $1,290            |       | 10.49                 | %          | $1,153 |   | 9.83 | % |
| Real estate -  commercial        |       | 3,374             |       | 38.10                 | %          | 3,338 |   | 39.01 | % |
| Real estate -  construction      |       | 1,723             |       | 19.23                 | %          | 1,432 |   | 18.13 | % |
| Real estate -  residential       |       | 1,721             |       | 22.11                 | %          | 1,490 |   | 21.65 | % |
| Home equity  lines               |       | 721               |       | 9.52                  | %          | 721 |   | 10.63 | % |
| Consumer                         |       | 135               |       | 0.55                  | %          | 167 |   | 0.75 | % |
|                             |       |              |       |                  |       |   |   |   |   |
| Total allowance for  loan losses |       | $8,964            |       | 100.00                | %          | $8,301 |   | 100.00 | % |

----

*                    Percentageof loan type to the total loan portfolio.

 

**Table 7.**

**Nonperforming Loans Receivable**

At June 30, 2006 andDecember 31, 2005

(In thousands)

 
| ** **                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Nonaccruing  loans                            |       | $                 | 577        |                  | $          | 214 |   |
|                                          |       |              |       |                  |       |
| Loans  contractually past-due 90 days or more |       | 1                 |       | 33                    |       |
|                                          |       |              |       |                  |       |
| Total  nonperforming loans receivable         |       | $                 | 578        |                  | $          | 247 |   |

 

Non-interest income includes, among other things,service charges on deposits and loans, gains on the sale of mortgage loans,investment fee income, and management fee income, and continues to be animportant factor in our operating results. Non-interest income for the threemonths ended June 30, 2006 and 2005 was $5.6 million and $6.3 million,respectively, a decrease of $694,000, or 11%. Non-interest income for the sixmonths ended June 30, 2006 and 2005 were $10.8 million and $11.5 million,respectively, a decrease of $672,000 or 6%. Net gains on sales

30

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of mortgage loans by George Mason for the three months ended June 30,2006 and 2005 was $2.5 million and $4.0 million, respectively, a decrease of$1.5 million, or 38%.  Net gains on salesof mortgage loans by George Mason for the six months ended June 30, 2006 and2005 was $5.3 million and $7.6 million, respectively, a decrease of $2.3million, or 30%. The decrease in net gains on sales of mortgage loans for thethree and six months ended June 30, 2006 compared to the same periods of 2005was due to the slowdown in the regional housing market caused in part by risinginterest rates. Included in the net gains on sale of mortgage loans are anyorigination, underwriting, and discount points and other funding fees receivedand deferred at loan origination. Costs include direct costs associated withthe loan origination, such as commissions and salaries that are deferred at thetime of origination.   Management fee income for the three months endedJune 30, 2006 and 2005 was $664,000 and $974,000, respectively, a decrease of$310,000, or 32%. Management fee income for the six months ended June 30, 2006and 2005 was $1.1 million and $1.5 million, respectively, a decrease of$416,000, or 28%. Management fee income represents the income earned forservices provided by George Mason to other mortgage banking companies owned bylocal home builders and generally fluctuates based on the volume of loan sales.

Service charges on deposit accounts increased$59,000 to $389,000 for the three months ended June 30, 2006 compared to$330,000 for the same period of 2005. For the six months ended June 30, 2006,service charges on deposit accounts increased $148,000 to $758,000 compared to$610,000 for the same period of 2005. The increase in service charges ondeposit accounts is primarily the result of an increased number of depositaccounts in 2006 compared to 2005. Loan service charge income decreased $60,000to $558,000 for the three months ended June 30, 2006, compared to $618,000 forthe same period of 2005.  For the sixmonths ended June 30, 2006, loan service charge income decreased $63,000 to$1.18 million compared to $1.24 million for the same period of 2005.

Investment fee income increased $700,000 to $991,000for the three months ended June 30, 2006 compared to $291,000 for the sameperiod of 2005. For the six months ended June 30, 2006, investment fee incomeincreased $1.2 million to $1.7 million compared to $450,000 for the same periodof 2005. The increase in investment fee income is primarily attributable to theacquisition of Wilson/Bennett in June 2005 and the addition of the trustdivision in February 2006.

Included in other income are gains related to theextinguishment of two borrowings totaling $420,000 and $769,000 for the threeand six months ended June 30, 2006, respectively. There were no similartransactions for the same periods of 2005.

Non-interest income for the three months ended June30, 2006 and 2005 represented 34% and 41% of our total revenues,respectively.  Non-interest income forthe six months ended June 30, 2006 and 2005 represented 34% and 40% of ourtotal revenues, respectively.

Non-interest expense includes, among other things,salaries and benefits, occupancy, professional fees, depreciation, dataprocessing, telecommunications and miscellaneous expenses. Non-interest expensefor the three months ended June 30, 2006 was $12.4 million, compared to $11.1million for the same period of 2005, an increase of $1.3 million, 12%.  For the six months ended June 30, 2006,non-interest expense was $23.9 million, compared to $21.2 million for the sameperiod of 2005, an increase of $2.7 million, or 13%. The increases areprimarily attributable to our branch office expansion during the past twelvemonths and the acquisitions of Wilson/Bennett and the trust division. Expensesrelated to the branch expansion are primarily represented in the increases inour salaries and benefits expense, occupancy expense and

31

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depreciationexpense. We expect non-interest expense to continue to increase as we continueour branch expansion in 2006. We currently plan to open two branch officesduring the remainder of 2006.

The effective tax rate for the second quarter of2006 was 30.8%, compared to 33.7% for the same period of 2005. For the sixmonths ended June 30, 2006, the effective tax rate was 32.4%, compared to 32.9%for the same period of 2005. We recorded a provision for income tax expense of$1.1 million and $1.2 million for the three months ended June 30, 2006 and2005, respectively. For the six months ended June 30, 2006 and 2005, theprovision for income tax expense was $2.4 million and $1.9 million,respectively. See also “Critical Accounting Policies — Valuation of DeferredTax Assets.”

**Statementsof Condition**

Total assets were $1.58 billion at June 30, 2006,compared to $1.45 billion at December 31, 2005, an increase of $132.3million, or 9%. This growth was driven primarily by increases in loansreceivable and the investment securities portfolio, which were funded by growthin our deposits and other borrowed funds.

Investment securities were $342.9 million at June30, 2006, compared to $294.2 million at December 31, 2005, an increase of$48.7 million, or 17%. The investment portfolio consists of investmentsecurities available-for-sale and investment securities held-to-maturity.Investment securities available-for-sale are those securities that we intend tohold for an indefinite period of time, but not necessarily until maturity.These securities are carried at fair value and may be sold as part of anasset/liability strategy, liquidity management or regulatory capitalmanagement.  Investment securitiesheld-to-maturity are those securities that we have the intent and ability tohold to maturity and are carried at amortized cost. At June 30, 2006,investment securities available-for-sale were $236.4 million and investmentsecurities held-to-maturity were $106.5 million. See Table 8 for additionalinformation on our investment securities portfolio.

Investment securities with unrealized losses areinvestment grade securities. Investment securities with unrealized losses haveinterest rates that are less than current market interest rates and, therefore,the indicated temporary losses are not a result of permanent credit impairment.Mortgage-backed investment securities, which are the primary component of theunrealized losses in the investment securities portfolio, are primarilycomprised of bonds issued by the Federal National Mortgage Association (FNMA)and Federal Home Loan Mortgage Corporation (FHLMC).

**Table 8.**

**InvestmentSecurities**

At June 30, 2006 andDecember 31, 2005

(In thousands)
| ** **                                                  | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at June 30, 2006** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies                          |       |          |       |      |       |        |       |
| One to five years                                           |       | $             | 51,966     |      | $          | 50,692      |       | 4.91 | % |
| Five to ten years                                           |       | 13,050        |       | 12,944    |       | 5.92        |       |
| Total U.S.  government-sponsored agencies                   |       | 65,016        |       | 63,636    |       | 5.11        |       |
|                                                        |       |          |       |      |       |        |       |
| Mortgage-backed securities*                                 |       |          |       |      |       |        |       |
| One to five years                                           |       | 4,934         |       | 4,727     |       | 4.11        |       |
| Five to ten years                                           |       | 10,259        |       | 9,767     |       | 3.76        |       |
| After ten years                                             |       | 147,436       |       | 141,267   |       | 4.78        |       |
| Total mortgage-backed  securities                           |       | 162,629       |       | 155,761   |       | 4.70        |       |
|                                                        |       |          |       |      |       |        |       |
| Municipal securities                                        |       |          |       |      |       |        |       |
| After ten years                                             |       | 15,717        |       | 15,034    |       | 4.09        |       |
| Total municipal  securities                                 |       | 15,717        |       | 15,034    |       | 4.09        |       |
|                                                        |       |          |       |      |       |        |       |
| U.S. treasury securities                                    |       |          |       |      |       |        |       |
| One to five years                                           |       | 2,006         |       | 1,986     |       | 2.63        |       |
| Total U.S. treasury  securities                             |       | 2,006         |       | 1,986     |       | 2.63        |       |
| Total investment securities available-for-sale              |       | $             | 245,368    |      | $          | 236,417     |       | 4.75 | % |

 
| ** **                                                | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at June 30, 2006** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S. government-sponsored agencies                        |       |          |       |      |       |        |       |
| One to five years                                         |       | $             | 9,500      |      | $          | 9,066       |       | 3.52 | % |
| Five to ten years                                         |       | 13,021        |       | 12,471    |       | 4.45        |       |
| After ten years                                           |       | 3,000         |       | 2,898     |       | 4.55        |       |
| Total U.S.  government-sponsored agencies                 |       | 25,521        |       | 24,435    |       | 4.11        |       |
|                                                      |       |          |       |      |       |        |       |
| Mortgage-backed securities*                               |       |          |       |      |       |        |       |
| Five to ten years                                         |       | 7,487         |       | 7,158     |       | 4.11        |       |
| After ten years                                           |       | 65,468        |       | 62,552    |       | 4.31        |       |
| Total mortgage-backed  securities                         |       | 72,955        |       | 69,710    |       | 4.29        |       |
|                                                      |       |          |       |      |       |        |       |
| Corporate bonds                                           |       |          |       |      |       |        |       |
| After ten years                                           |       | 8,004         |       | 7,732     |       | 4.21        |       |
| Total corporate bonds                                     |       | 8,004         |       | 7,732     |       | 4.21        |       |
| Total investment  securities held-to-maturity             |       | 106,480       |       | 101,877   |       | 4.24        |       |
|                                                      |       |          |       |      |       |        |       |
| Total investment securities                               |       | $             | 351,848    |      | $          | 338,294     |       | 4.60 | % |

 

32

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| ** **                                                      | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Available-for-sale at December 31, 2005** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                             |       |          |       |      |       |        |       |
| One to five years                                               |       | $             | 43,784     |      | $          | 43,264      |       | 4.79 | % |
| Five to ten years                                               |       | 15,175        |       | 15,147    |       | 5.42        |       |
| Total U.S. government-sponsored agencies                        |       | 58,959        |       | 58,411    |       | 4.88        |       |
|                                                            |       |          |       |      |       |        |       |
| Mortgage-backed  securities*                                    |       |          |       |      |       |        |       |
| One to five years                                               |       | 5,441         |       | 5,269     |       | 4.02        |       |
| Five to ten years                                               |       | 8,980         |       | 8,678     |       | 3.88        |       |
| After ten years                                                 |       | 108,309       |       | 104,613   |       | 4.21        |       |
| Total mortgage-backed securities                                |       | 122,730       |       | 118,560   |       | 4.17        |       |
|                                                            |       |          |       |      |       |        |       |
| U.S. treasury  securities                                       |       |          |       |      |       |        |       |
| One to five years                                               |       | 2,015         |       | 1,984     |       | 2.63        |       |
| Total U.S. treasury securities                                  |       | 2,015         |       | 1,984     |       | 2.63        |       |
| Total investment  securities available-for-sale                 |       | $             | 183,704    |      | $          | 178,955     |       | 4.38 | % |

 
| ** **                                                    | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **Average** | ** ** |
|---------------------------------------------------------------|------------|---------------|------------|-----------|------------|-------------|------------|
| **Held-to-maturity at December 31, 2005** | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Yield**   | ** ** |
| U.S.  government-sponsored agencies                           |       |          |       |      |       |        |       |
| One to five years                                             |       | $             | 9,500      |      | $          | 9,172       |       | 3.52 | % |
| Five to ten years                                             |       | 13,020        |       | 12,698    |       | 4.37        |       |
| After ten years                                               |       | 3,000         |       | 2,936     |       | 4.22        |       |
| Total U.S. government-sponsored agencies                      |       | 25,520        |       | 24,806    |       | 4.03        |       |
|                                                          |       |          |       |      |       |        |       |
| Mortgage-backed  securities*                                  |       |          |       |      |       |        |       |
| Five to ten years                                             |       | 7,662         |       | 7,470     |       | 4.21        |       |
| After ten years                                               |       | 74,082        |       | 71,937    |       | 4.24        |       |
| Total mortgage-backed securities                              |       | 81,744        |       | 79,407    |       | 4.23        |       |
|                                                          |       |          |       |      |       |        |       |
| Corporate bonds                                               |       |          |       |      |       |        |       |
| After ten years                                               |       | 8,005         |       | 7,812     |       | 4.21        |       |
| Total corporate bonds                                         |       | 8,005         |       | 7,812     |       | 4.21        |       |
| Total investment securities held-to-maturity                  |       | 115,269       |       | 112,025   |       | 4.19        |       |
|                                                          |       |          |       |      |       |        |       |
| Total investment  securities                                  |       | $             | 298,973    |      | $          | 290,980     |       | 4.31 | % |

----

* Based oncontractual maturities.

 

Loans receivable, net of deferred fees and costs,increased by $74.0 million, or 10%, to $779.6 million at June 30, 2006 from$705.6 million at December 31, 2005. See Table 9 for details on the loansreceivable portfolio. We experienced growth in our commercial and industrial,real estate commercial, real estate construction and residential real estateloan portfolios. We expect continued growth within these loan categories overthe reminder of 2006 due to our increased legal lending limit of $20.3 million atJune 30, 2006 and the volume of loans we have scheduled for funding. Inaddition, we had $376.5 million in loans held for sale, net at June 30, 2006,compared to $361.7 million at December 31, 2005, an increase of $14.8million. Loans that are held for sale, net are valued at the lower of cost ormarket value.

33

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**Table 9.**

**LoansReceivable**

At June 30, 2006 andDecember 31, 2005

(In thousands)
| ** **                       | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                             |       |                        |       |                            |       |   |   |   |   |
| Commercial and  industrial       |       | $                           | 81,771     |                            | 10.49      | % | $ | 69,392 |   | 9.83 | % |
| Real estate -  commercial        |       | 297,084                     |       | 38.10                           |       | 275,381 |   | 39.01 |   |
| Real estate -  construction      |       | 149,946                     |       | 19.23                           |       | 128,009 |   | 18.13 |   |
| Real estate -  residential       |       | 172,410                     |       | 22.11                           |       | 152,818 |   | 21.65 |   |
| Home equity  lines               |       | 74,202                      |       | 9.52                            |       | 75,048 |   | 10.63 |   |
| Consumer                         |       | 4,350                       |       | 0.55                            |       | 5,255 |   | 0.75 |   |
|                             |       |                        |       |                            |       |   |   |   |   |
| Gross loans                      |       | $                           | 779,763    |                            | 100.00     | % | $ | 705,903 |   | 100.00 | % |
|                             |       |                        |       |                            |       |   |   |   |   |
| Net deferred  (fees) costs       |       | (135                        | )          |                            |       | (259 | ) |   |   |
| Less: allowance  for loan losses |       | (8,964                      | )          |                            |       | (8,301 | ) |   |   |
|                             |       |                        |       |                            |       |   |   |   |   |
| Loans  receivable, net           |       | $                           | 770,664    |                            |       |   | $ | 697,343 |   |   |   |

 

Total deposits were $1.14 billion at June 30,2006 compared to $1.07 billion at December 31, 2005. We experiencedincreases in our non-interest bearing checking, interest checking, and savingsdeposit products, which offset decreases in our interest-bearing money marketdeposits and certificates of deposit. See Table 10 for details on certificatesof deposit with balances of $100,000 or more. The increase in interest checkingdeposits is a result of new customers from our branch expansion and competitivedeposit pricing, particularly with our Chairman’s Club interest checkingrelationship product, which we introduced in the first quarter of 2006. OurChairman’s Club interest checking deposit promotion is a relationship accountthat offered initially and continues to offer an interest rate of 4.01% onbalances over $25,000. Our savings deposits increased as a result of our newSimply Savings product, which allows new customers to earn a yield of 5.01% onfunds deposited with us.  Brokered certificatesof deposit decreased $8.8 million to $981,000 at June 30, 2006 compared to $9.8million at December 31, 2005.

**Table10.**

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

At June 30, 2006

(In thousands)
| **Maturities:**                        | ** ** | **Fixed Term** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|-----------|------------|
| Three months or  less                  |       | $                   | 37,171     |            | $          | 12,631    |       | $ | 49,802 |   |
| Over three  months through six months  |       | 47,223              |       | 40,395          |       | 87,618    |       |
| Over six months  through twelve months |       | 26,247              |       | 30,116          |       | 56,363    |       |
| Over twelve  months                    |       | 49,369              |       | 12,466          |       | 61,835    |       |
|                                   |       | $                   | 160,010    |            | $          | 95,608    |       | $ | 255,618 |   |

----

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

Other borrowed funds increased $69.3 million to$224.7 million at June 30, 2006, compared to $155.4 million atDecember 31, 2005, due primarily to a $58.5 million increase in short termdealer repurchase agreement borrowings at June 30, 2006 compared to none atDecember 31, 2005. Treasury, Tax & Loan Note option borrowings decreased$3.6 million to $1.7 million at June 30, 2006 compared to $5.2 million at December 31,2005.  Long-term FHLB advances decreased$29.3 million to $59.2 million at June 30, 2006 compared to $88.5 million atDecember 31, 2005. Short-term FHLB advances increased to $20.0 million at June30, 2006 from none at December 31, 2005. Fed funds purchased increased to $25.0 million at June 30, 2006 fromnone at December 31, 2005. Table 11 provides information on our borrowings.

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**Table11.**

**Short-TermBorrowings and Other Borrowed Funds**

At June 30, 2006

(In thousands)

**Short-term FHLB advances:**
| ** **                                                    | ** ** | ** **                    | ** ** | ** **        | ** ** | ** **             | ** ** | **Amount**      |
|---------------------------------------------------------------|------------|-------------------------------|------------|-------------------|------------|------------------------|------------|-----------------|
| **Advance Date**                                         | ** ** | **Term of Advance** | ** ** | **Date Due** | ** ** | **Interest Rate** | ** ** | **Outstanding** |
| Jul-03                                                        |       | 3 years                       |       | Jul-06            |       | 2.07%                  |       | $               | 6,250 |
| Mar-03                                                        |       | 4 years                       |       | Mar-07            |       | 2.81    |       | 1,000           |
| Apr-04                                                        |       | 3 years                       |       | Apr-07            |       | 3.15    |       | 3,000           |
| Jun-05                                                        |       | 2 years                       |       | Jun-07            |       | 4.12    |       | 5,000           |
| Jun-06                                                        |       | 1 years                       |       | Jun-07            |       | 4.12    |       | 5,000           |
| Jun-06                                                        |       | 1 years                       |       | Jun-07            |       | 5.57    |       | 15,000          |
| **Total short-term FHLB advances and weighted  average rate** | ** ** | **4.25%**                     | ** ** | **$**             | **35,250** |

 
| **Other short-term borrowed  funds:**                                | ** ** | ** **             | ** ** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|------------|
| Federal Funds Purchased                                              |       | 5.08    |       | $          | 25,000 |
| TT&L Note option                                                 |       | 4.52    |       | 1,649      |
| Dealer repurchase  agreements                                        |       | 5.07    |       | 58,545     |
| Customer repurchase  agreements                                      |       | 1.98    |       | 39,703     |
| **Total other short-term borrowed  funds and weighted average rate** | ** ** | **4.08%**              | ** ** | **$**      | **124,897** |
| ** **                                                           | ** ** | ** **             | ** ** | ** ** |
| **Other borrowed funds:**                                            | ** ** | ** **             | ** ** | ** ** |
| Trust preferred                                                      |       | 7.57    |       | $          | 20,619 |
| FHLB advances - long  term                                           |       | 3.46    |       | 43,959     |
| **Other borrowed funds and  weighted average rate**                  | ** ** | **4.77%**              | ** ** | **$**      | **64,578** |
|                                                                 |       |                   |       |       |
| **Total other borrowed funds and weighted average  rate**            | ** ** | **4.31%**              | ** ** | **$**      | **224,725** |

 

At June 30, 2006, mortgage funding checks increasedby $9.4 million to $51.0 million, compared to $41.6 million atDecember 31, 2005. These liabilities are related to George Mason and areused to fund the loans in process of being sold. George Mason has creditfacilities with the Bank and also has a third party facility of $250 million.There were no borrowings outstanding under this third party facility at June30, 2006.

Shareholders’ equity at June 30, 2006 was $149.6million, an increase of $1.7 million, compared to $147.9 million atDecember 31, 2005. The increase from the year end was primarily a resultof net income of $5.0 million for the six months ended June 30, 2006, offset byan increase in unrealized losses on derivative instruments designated as cashflow hedges of $275,000 and by an unfavorable market value adjustment of $2.7million on investment securities available-for-sale as of June 30, 2006. Bookvalue per share at June 30, 2006 was $6.13, compared to $6.07 atDecember 31, 2005. Tangible book value per share at June 30, 2006 was $5.55compared to $5.12 at December 31, 2005.

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

We provide banking and non-banking financialservices and products through our subsidiaries.

*Commercial Banking*

The Commercial Banking segment includes bothcommercial and consumer lending and provides customers such products ascommercial loans, real estate loans, and other business financing and consumerloans. In addition, this segment also provides customers with various depositproducts including demand deposit accounts, savings accounts and certificatesof deposit.

For the three months ended June 30, 2006, the CommercialBanking segment recorded net income of $2.4 million compared to $1.0 millionfor the same period of 2005, an increase of $1.4 million. The increase in netincome for the second quarter 2006 is primarily related to the

35

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increased volume and interest rates in the Bank’s loan receivableportfolio. For the six months ended June 30, 2006, the Commercial Bankingsegment recorded net income of $5.0 million compared to $1.6 million for thesix months ended June 30, 2005, an increase of $3.4 million. At June 30, 2006,total assets for this segment were $1.51 billion, loans receivable, net ofdeferred fees and costs, were $779.6 million and total deposits were $1.14billion. At June 30, 2005, total assets were $1.31 billion, loans receivable,net of deferred fees and costs were $603.3 million and total deposits were$1.00 billion.

*Mortgage Banking*

The operations of the Mortgage Banking segment areconducted through George Mason. George Mason engages primarily in theorigination and acquisition of residential mortgages for sale into thesecondary market on a best efforts basis.

For the three months ended June 30, 2006 and 2005,the Mortgage Banking segment recorded net income of $600,000 and $1.8 million,respectively. The decrease in net income for 2006 is directly related to thedecreased volume of loans originated due to the slowdown in regional housingmarket caused in part by increases in interest rates. For the six months endedJune 30, 2006 and 2005, the Mortgage Banking segment recorded net income of$1.0 million and $3.2 million, respectively. At June 30, 2006, total assets forthis segment were $394.2 million, loans held for sale, net were $376.5 millionand mortgage funding checks were $51.0 million. At June 30, 2005, total assetswere $495.0 million, loans held for sale, net were $475.1 million and mortgagefunding checks were $93.7 million.

*Trust and Investment Services*

The Trust and Investment Services segment providesinvestment and financial services to business and individuals, includingfinancial planning, retirement/estate planning, trusts, estates, custody,investment management, escrows, and retirement plans. Wilson/Bennett isincluded in this operating segment since the date of its acquisition, June 9,2005. On February 9, 2006, we acquired certain fiduciary and other assetsand assumed certain liabilities of FBR National Trust Company, formerly asubsidiary of Friedman, Billings, Ramsey Group, Inc. Our new trustdivision acts as trustee or custodian for assets in excess of $5 billion.

For the three months ended June 30, 2006, the Trustand Investment Services segment recorded net income of $9,000, compared to anet loss of $16,000 for the same period of 2005, an increase in net income of$25,000. For the six months ended June 30, 2006, the Trust and Investment Servicessegment recorded net income of $27,000, compared to a net loss of $57,000 forthe same period of 2005. At June 30, 2006, total assets were $6.8 million andtotal assets under management were $5.84 billion. At June 30, 2005, totalassets for this segment were $7.2 million and total assets under managementwere $344.7 million. The increase in assets under management from 2005 to 2006is directly related to the addition of the trust division in February 2006.

As a result of an amendment to the employmentagreement with the president and chief executive officer of Wilson/Bennett, wewill accelerate the amortization of the intangible asset related to an employmentand non-compete agreement beginning July 1, 2006. As a result, pretaxamortization expense related to this asset will be $118,000 more in the lasthalf of 2006 compared to the six months ended June 30, 2006.

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Information pertaining to our business segments canbe found in Note 5 to the Notes to Consolidated Financial Statements.

## **Capital Resources**

Capital adequacy is an important measure offinancial stability and performance. Our objectives are to maintain a level ofcapitalization that is sufficient to sustain asset growth and promote depositorand investor confidence.

Regulatory agencies measure capital adequacyutilizing a formula that takes into account the individual risk profile of thefinancial institution. The guidelines define capital as both Tier 1 (whichincludes common shareholders’ equity, defined to include certain debtobligations) and Tier 2 (which includes certain other debt obligations, aportion of the allowance for loan losses, and 45% of any unrealized gains inequity securities).

At June 30, 2006, our Tier 1 and total (Tier 1 andTier 2) risk-based capital ratios were 13.87% and 14.68%, respectively. AtDecember 31, 2005, our Tier 1 and total risk-based capital ratios were14.83% and 15.65%, respectively.  Ourregulatory capital levels for the Bank and bank holding company meet thoseestablished for well-capitalized institutions. Table 12 provides additionalinformation pertaining to our capital ratios.

**Table12.**

**CapitalComponents**

At June 30, 2006 andDecember 31, 2005

(In thousands)
| ** **                                                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                                                           | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                           | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                           | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
|                                                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **At June  30, 2006**                                                | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total risk based  capital / Total capital to risk-weighted assets    |       | $          | 164,493    |                       | 14.68%     |                       | $          | 89,673                     | >  | 8.00                       | %          | $ | 112,091 | >  | 10.00% |   |
| Tier I capital /  Tier I capital to risk-weighted assets   |       | 155,417    |       | 13.87%                     |       | 44,836                     | >  | 4.00                       | %          | 67,254                     | >  | 6.00% |   |
| Tier I capital /  Total capital to average assets                    |       | 155,417    |       | 10.95%                     |       | 56,795                     | >  | 4.00                       | %          | 70,994                     | >  | 5.00% |   |
|                                                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **At  December 31, 2005**                                            | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total risk-based  capital / Total capital to risk-weighted assets    |       | $          | 159,155    |                       | 15.65%     |                       | $          | 81,334                     | >  | 8.00                       | %          | $ | 101,668 | >  | 10.00% |   |
| Tier I capital /  Tier I capital to risk-weighted assets   |       | 150,742    |       | 14.83%                     |       | 40,667                     | >  | 4.00                       | %          | 61,001                     | >  | 6.00% |   |
| Tier I capital /  Total capital to average assets                    |       | 150,742    |       | 10.71%                     |       | 56,308                     | >  | 4.00                       | %          | 70,386                     | >  | 5.00% |   |

 

**ContractualObligations**

We have entered into a number of long-termcontractual obligations to support our ongoing business activities. Thesecontractual obligations will be funded through operating revenues and liquiditysources held or available to us. The required payments under such obligationsare detailed in Table 13.

**Table13.**

**ContractualObligations**

At June 30, 2006

(In thousands)
| ** **                                           | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **Total**                                 | ** ** | **Less than  1 Year** | ** ** | **1 - 2 Years** | ** ** | **3 - 5 Years** | ** ** | **More than  5 Years** | ** ** |
| Certificates of  deposit                             |       | $                                         | 578,050    |   | $ | 424,280 |   | $ | 141,213 |   | $ | 11,905 |   | $ | 652 |   |
| Brokered  certificates of deposit                    |       | 981                                       |       | 981 |   | — |   | — |   | — |   |
| Advances from  the Federal Home Loan Bank of Atlanta |       | 79,208                                    |       | 35,250 |   | 23,750 |   | 15,208 |   | 5,000 |   |
| Trust preferred  securities                          |       | 20,619                                    |       | — |   | — |   | — |   | 20,619 |   |
| Operating lease  obligations                         |       | 20,125                                    |       | 4,629 |   | 3,336 |   | 6,018 |   | 6,142 |   |
| Total                                                |       | $                                         | 698,983    |   | $ | 465,140 |   | $ | 168,299 |   | $ | 33,131 |   | $ | 32,413 |   |

 

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**Commitmentsand Contingencies**

In the normal course of business, we are a party tofinancial instruments with off-balance sheet risk to meet the financing needsof our customers. These financial instruments include commitments to extendcredit and standby letters of credit. These instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized on thebalance sheet.

The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of those instruments. The Bank uses the same credit policiesin making commitments and conditional obligations as it does for on-balancesheet instruments.

At June 30, 2006, commitments to extend credit were$413.0 million and standby letters of credit were $6.7 million.

Commitments to extend credit are agreements to lendto a customer as long as there is no violation of any condition established in theagreement. Commitments generally have expiration dates or other terminationclauses and may require payment of a fee. Since many of the commitments areexpected to expire without being drawn upon, the total commitment amounts donot necessarily represent future funding requirements. We evaluate eachcustomer’s credit worthiness on a case-by-case basis. The amount of collateralobtained is based on management’s credit evaluation of the counterparty.Collateral held varies but may include accounts receivable, inventory, propertyand equipment, and income-producing commercial properties.

Unfunded commitments under lines of credit arecommitments for possible future extensions of credit to existing customers.Those lines of credit may or may not be drawn upon to the total extent offunding to which we have committed.

Standby letters of credit are conditionalcommitments we issued to guarantee the performance of a customer to a thirdparty. Those guarantees are primarily issued to support public and private borrowingarrangements, including commercial paper, bond financing, and similartransactions. The credit risk involved in issuing standby letters of credit isessentially the same as that involved in extending loan facilities tocustomers. We hold certificates of deposit, deposit accounts, and real estateas collateral supporting those commitments when collateral is deemed necessary.

## **Liquidity**

Liquidity in the banking industry is defined as theability to meet the demand for funds of both depositors and borrowers. We mustbe able to meet these needs with cash on hand by obtaining funding fromdepositors or other lenders or by converting non-cash items to cash. Theobjective of our liquidity management program is to ensure that we always havesufficient liquid resources to meet the demands of our depositors andborrowers. Stable core deposits and a strong capital position provide the basefor our liquidity position. We have demonstrated our ability to attract retaildeposits because of our convenient branch locations, personal service anddeposit pricing.

In addition to retail deposits, we have access tovarious wholesale funding markets. These markets include the brokered CDmarket, the repurchase agreement market and the federal funds market. We alsomaintain secured lines of credit with the Federal Reserve Bank of Richmond andthe Federal Home Loan Bank of Atlanta. Having diverse funding alternativesreduces our reliance on any one source for funding.

Cash flow from amortizing assets or maturing assetscan also provide funding to meet the needs of depositors and borrowers.

We have established a formal liquidity contingencyplan which establishes a liquidity management team and provides guidelines forliquidity management. For our liquidity management program, we first determineour current liquidity position and then forecast liquidity based on anticipatedchanges in the balance sheet. In this forecast, we expect to maintain aliquidity cushion. We also stress test our liquidity position under severaldifferent stress scenarios. Guidelines for the forecasted liquidity cushion andfor liquidity cushions for each stress scenario have been established. Inaddition, one stress test combines all other stress tests to see how liquiditywould react to several negative scenarios occurring at the same time. Webelieve that we have sufficient resources to meet our liquidity needs.

George Mason and the Bank have a one year $150million floating rate revolving credit and security agreement with a thirdparty. The purpose of this credit facility is to fund residential mortgageloans at George Mason prior to their sale into the secondary market. The creditfacility requires, among other things, that George Mason and the Bank havepositive quarterly net income and maintain specified minimum tangible andregulatory net worth levels. The Company has guaranteed repayment of this debt.The interest rate on this credit facility is LIBOR plus between 1.50% and1.875%. At June 30, 2006, this line was not utilized.

38

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In addition to this facility, this same lender hasalso provided a $100 million facility that is utilized by George Mason towarehouse residential mortgage loans held for sale to this lender. The terms ofthis facility are substantially the same as the above-referenced revolvingcredit and security agreement and the cost of this facility is netted againstinterest earned on the loans pending settlement with the lender. Loans underthis credit facility are considered sold when financed.

Liquid assets, which include cash and due frombanks, federal funds sold and investment securities available for sale, totaled$260.3 million at June 30, 2006 or 16% of total assets. We hold investmentsthat are classified as held-to-maturity in the amount of $106.5 million at June30, 2006. To maintain ready access to the Bank’s secured lines of credit, theBank has pledged the majority of its investment securities to the Federal HomeLoan Bank of Atlanta with additional investment securities pledged to theFederal Reserve Bank of Richmond. Additional borrowing capacity at the FederalHome Loan Bank of Atlanta at June 30, 2006 was approximately $244.8 million.Borrowing capacity with the Federal Reserve Bank of Richmond was approximately$16.5 million at June 30, 2006. George Mason has $650 million of lines ofcredit available, including $400 million with the Bank and $250 milliondescribed above. We anticipate maintaining liquidity at a level sufficient toprotect depositors, provide for reasonable growth and fully comply with allregulatory requirements.

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

We are exposed to various business risks includinginterest rate risk. Our goal is to maximize net interest income withoutincurring excessive interest rate risk. Management of net interest income andinterest rate risk must be consistent with the level of capital and liquiditythat we maintain. We manage interest rate risk through an asset and liabilitycommittee (“ALCO”). ALCO is responsible for managing the interest rate risk forthe Company in conjunction with liquidity and capital management.

We use a net interest income simulation model as ourprimary tool to measure interest rate sensitivity. Many assumptions aredeveloped based on expected activity in the balance sheet. For maturing assets,assumptions are created for the redeployment of these assets. For maturingliabilities, assumptions are developed for the replacement of these fundingsources. Assumptions are also developed for assets and liabilities that couldreprice during the modeled time period. These assumptions also cover how weexpect rates to change on non-maturity deposits such as NOW, Money Market,savings accounts and no-penalty certificates of deposit. Based on inputs thatinclude the current balance sheet, the current level of interest rates and thedeveloped assumptions, the model then produces an expected level of netinterest income assuming that market rates remain unchanged. This is consideredthe base case. Next, the model determines what net interest income would begiven changes in interest rates. The rate simulations are performed for a twoyear period and include ramped rate changes of down 200 basis points and up 200basis points. In the ramped down rate change, the model moves rates graduallydown 200 basis points over the first year and then rates remain flat in thesecond year. For the up 200 basis point scenario, rates are gradually moved up200 basis points in the first year and then rates remain flat in the secondyear. In both the up and down scenarios, the model assumes a parallel shift inthe yield curve. The results of these simulations are then compared to the basecase.

At June 30, 2006, given the assumptions built intoour forecasting model, we were liability sensitive. Liability sensitive meansthat we had more liabilities maturing or repricing than assets. While wecontinue to have a significant portion of our assets as floating rate assets,the average maturity of our liabilities has decreased and we have increased thelevel of non-maturity deposits which allows the bank to adjust the rates onthese liabilities quickly in a falling rate scenario. In a falling rateenvironment, net interest income should grow for a liability sensitive bank. Inthe down 200 basis point scenario for one year, net interest income improves bynot more than 2.8% compared to the base case and by not more than 4.4% over thetwo year time horizon. Being liability sensitive, net interest income generallydeclines compared to the base case in a rising rate environment. At June 30,2006, net interest income has a negative variance to the base case of not morethan 2% over the two year time horizon. These changes from the base case arewithin the guidelines we have established.

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

Our Asset/Liability Committee is responsible forreviewing our liquidity requirements and maximizing our net interest incomeconsistent with capital requirements, liquidity, interest rate and economicoutlooks, competitive factors and customer needs. Interest rate risk arisesbecause the assets of the Bank and the liabilities of the Bank have differentmaturities and repricing characteristics. In order to measure this interestrate risk, we use a simulation process that measures the impact of changinginterest rates on net interest income. This model is run for the Bank by anindependent consulting firm. The simulations incorporate assumptions related toexpected activity in the balance sheet. For maturing assets, assumptions aredeveloped for the redeployment of these assets. For maturing liabilities,assumptions are developed for the replacement of these funding sources.Assumptions are also developed for assets and liabilities that reprice duringthe modeled time period. These assumptions also cover how we expect rates tochange on non-maturity deposits such as NOW, Money Market, savings accounts andno-penalty certificates of deposit. Based on inputs that include the mostrecent period end balance sheet, the current level of interest rates and thedeveloped assumptions, the model then produces an expected level of netinterest income assuming that interest rates remain unchanged. This becomes thebase case. Next, the model determines the impact on net interest income givencertain interest rate changes. The rate simulations are performed for a twoyear period and include ramped rate changes of down 200 basis points and up 200basis points. In the ramped down rate change, the model moves rates graduallydown 200 basis points over the first year and then rates remain flat in thesecond year. For the up 200 basis point scenario, rates are gradually increasedby 200 basis points in the first year and remain flat in the second year. Inboth the up and down scenarios, the model assumes a parallel shift in the yieldcurve. The results for net interest income are then compared to the base casewith a variance to the base case determined.

At June 30, 2006, given the assumption built intoour forecasting model, we were liability sensitive. Liability sensitive meansthat we had more liabilities maturing or repricing than assets. While wecontinue to have a significant portion of our assets as floating rate assets,the average maturity of our liabilities has decreased and we have increased thelevel of non-maturity deposits which allows the bank to adjust the rates onthese liabilities quickly in a falling rate scenario. In a falling rateenvironment, net interest income should grow for a liability sensitive bank. Inthe down 200 basis point scenario for one year, net interest income improves bynot more than 2.8% compared to the base case and by not more than 4.4% over thetwo year time horizon. Being liability sensitive, net interest income generallydeclines compared to the base case in a rising rate environment. At June 30, 2006,net interest income has a negative variance to the base case of not more than2% over the two year time horizon. These changes from the base case are withinthe guidelines we have established.

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**Item 4. Controls and Procedures**

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

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

The Company also maintains a system of internalaccounting controls that is designed to provide assurance that assets aresafeguarded and that transactions are executed in accordance with management’sauthorization and are properly recorded. This system is continually reviewedand is augmented by written policies and procedures, the careful selection andtraining of qualified personnel and an internal audit program to monitor itseffectiveness. There were no changes in our internal control over financial reportingidentified in connection with our evaluation of it that occurred during ourlast fiscal quarter that materially affected, or are likely to materiallyaffect, our internal control over financial reporting.

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**PART II —OTHER INFORMATION**

**Item 1. Legal Proceedings**

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

**Item1A.  Risk Factors**

Ouroperations are subject to many risks that could adversely affect our futurefinancial condition and performance and, therefore, the market value of oursecurities.  The risk factors that areapplicable to us are outlined in our Annual Report on Form 10-K for the yearended December 31, 2005.  These riskfactors have not changed as of the date of this report.

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds**

(a)  None.

(b)  Notapplicable.

(c)  None.

**Item 3.  Defaults Upon Senior Securities**

(a)  None.

(b)  None.

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

(a)  The Company’sAnnual Meeting of Shareholders was held on April 21, 2006.

(b)  Notapplicable.

(c)  At the AnnualMeeting of Shareholders, the following persons were elected as directors forterms expiring in 2009:
| ** **            | ** ** | **Votes**  | ** ** |
|-----------------------|------------|------------|------------|
| **Director**          | ** ** | **For**    | ** ** | **Withheld** | ** ** |
| Bernard H.  Clineburg |       | 21,020,319 |       | 622,898 |   |
| James D. Russo        |       | 20,983,134 |       | 660,083 |   |
| John H. Rust,  Jr.    |       | 21,452,962 |       | 190,255 |   |
| George P. Shafran     |       | 20,754,680 |       | 888,537 |   |

 

In addition, the shareholders voted on and approved anamendment to the Company’s 2002 Equity Compensation Plan by a vote of 7,831,064for and 6,227,858 against, with 172,513 abstentions and 7,411,782 brokernon-votes.

The shareholders also voted on and approved an amendmentto the Company’s deferred income plans by a vote of 8,204,055 for and 5,804,151against, with 223,229 abstentions and 7,411,782 broker non-votes.

Finally, the shareholders voted on and ratified theappointment of KPMG LLP, as the Company’s independent auditors for 2006 by avote of 20,893,240 for and 700,508 against, with 49,469 abstentions.

(d)  None.

42

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**Item 5.  Other Information**

(a)  None.

(b)  None.

**Item 6.  Exhibits**

| 10.1 |   | Cardinal Financial Corporation 2002 Equity  Compensation Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K filed April 27,  2006)                      |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 |   | Cardinal Financial Corporation Executive Deferred  Income Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.2 to the Current Report on Form 8-K filed April 27,  2006)                     |
| 10.3 |   | Cardinal Financial Corporation Directors Deferred  Income Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.3 to the Current Report on Form 8-K filed April 27,  2006)                     |
| 10.4 |   | George Mason Mortgage, LLC Executive Deferred Income  Plan, as amended and restated April 21, 2006 (incorporated by reference to  Exhibit 10.4 to the Current Report on Form 8-K filed April 27, 2006)                          |
| 10.5 |   | Amendment to  Employment Agreement dated June 29, 2006 by and between Cardinal  Financial Corporation and John W. Fisher (incorporated by reference to Exhibit  10.1 to the Current Report on Form 8-K filed July 6, 2006) |
| 31.1 |   | Rule 13a-14(a) Certification of Chief Executive  Officer                                                                                                                                                                        |
| 31.2 |   | Rule 13a-14(a) Certification of Chief Financial  Officer                                                                                                                                                                        |
| 32.1 |   | Statement of Chief Executive Officer Pursuant to 18  U.S.C. Section 1350                                                                                                                                                        |
| 32.2 |   | Statement of Chief Financial Officer Pursuant to 18  U.S.C. Section 1350                                                                                                                                                        |

 

** **

43

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**SIGNATURES**

**Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Report to be signed on its behalf by the undersigned thereuntoduly authorized.**
|                            |   | CARDINAL FINANCIAL  CORPORATION                                  |
|----------------------------|--------|------------------------------------------------------------------|
|                       |   | (Registrant)                                                     |
|                       |   |                                                             |
|                       |   |                                                             |
| Date: August 8, 2006  |   | /s/ Bernard H. Clineburg                                         |
|                       |   | Bernard H. Clineburg                                             |
|                       |   | Chairman and Chief Executive Officer                             |
|                       |   | (Principal Executive Officer)                                    |
|                       |   |                                                             |
|                       |   |                                                             |
| Date: August 8,  2006 |   | /s/ Mark A. Wendel                                               |
|                       |   | Mark A. Wendel                                                   |
|                       |   | Executive Vice President and Director of Finance and  Accounting |
|                       |   | (Principal Financial Officer)                                    |
|                       |   |                                                             |
|                       |   |                                                             |
| Date: August 8,  2006 |   | /s/ Jennifer L. Deacon                                           |
|                       |   | Jennifer L. Deacon                                               |
|                       |   | Senior Vice President and Controller                             |
|                       |   | (Principal Accounting Officer)                                   |

 

44

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                 |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1            |       | Cardinal Financial Corporation 2002 Equity  Compensation Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K filed April 27,  2006)                      |
| 10.2            |       | Cardinal Financial Corporation Executive Deferred  Income Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.2 to the Current Report on Form 8-K filed April 27,  2006)                     |
| 10.3            |       | Cardinal Financial Corporation Directors Deferred  Income Plan, as amended and restated April 21, 2006 (incorporated by  reference to Exhibit 10.3 to the Current Report on Form 8-K filed April 27,  2006)                     |
| 10.4            |       | George Mason Mortgage, LLC Executive Deferred Income  Plan, as amended and restated April 21, 2006 (incorporated by reference to  Exhibit 10.4 to the Current Report on Form 8-K filed April 27, 2006)                          |
| 10.5            |       | Amendment to Employment Agreement dated  June 29, 2006 by and between Cardinal Financial Corporation and John W.  Fisher (incorporated by reference to Exhibit 10.1 to the Current Report on  Form 8-K filed July 6, 2006) |
| 31.1            |       | Rule 13a-14(a) Certification of Chief Executive  Officer                                                                                                                                                                        |
| 31.2            |       | Rule 13a-14(a) Certification of Chief Financial  Officer                                                                                                                                                                        |
| 32.1            |       | Statement of Chief Executive Officer Pursuant to 18  U.S.C. Section 1350                                                                                                                                                        |
| 32.2            |       | Statement of Chief Financial Officer Pursuant to 18  U.S.C. Section 1350                                                                                                                                                        |

 

45

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