**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

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

 

**or**

 

**For thequarterly period ended September 30, 2005**

 

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

 

**For thetransition period from              to             **

 

**CommissionFile Number:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact name of registrant asspecified in its charter)

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

 

**(703) 584-3400**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled 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) hasbeen subject to such filing requirements for the past 90 days.                                 Yes   ý   No   o

 

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

 

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

 

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

 

24,357,955 shares of common stock, par value$1.00 per share,

outstanding as of October 31, 2005

 

 

----

 

**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I – FINANCIAL INFORMATION**                                                        |   |
|-----------------------------------------------------------------------------------------------------|--------|
|                                                                                                |   |
| Item 1. Financial Statements:                                                                       | 3      |
|                                                                                                |   |
| Consolidated Statements of Condition                                                                |   |
| At September 30, 2005 (unaudited) and December 31, 2004                                   | 3      |
|                                                                                                |   |
| Consolidated Statements of Income                                                                   |   |
| For the three and nine months ended September 30, 2005 and 2004  (unaudited)                   | 4      |
|                                                                                                |   |
| Consolidated Statements of Comprehensive Income                                                     |   |
| For the three and nine months ended September 30, 2005 and 2004  (unaudited)                   | 5      |
|                                                                                                |   |
| Consolidated Statements of Changes In Shareholders’ Equity                                     |   |
| For the nine months ended September 30, 2005 and 2004  (unaudited)                             | 6      |
|                                                                                                |   |
| Consolidated Statements of Cash Flows                                                               |   |
| For the nine months ended September 30, 2005 and 2004  (unaudited)                             | 7      |
|                                                                                                |   |
| Notes to Consolidated Financial Statements (unaudited)                                              | 8      |
|                                                                                                |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations | 17     |
|                                                                                                |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                 | 41     |
|                                                                                                |   |
| Item 4. Controls and Procedures                                                                     | 42     |
|                                                                                                |   |
| **PART II – OTHER INFORMATION**                                                           |   |
|                                                                                                |   |
| Item 1. Legal Proceedings                                                                           | 43     |
| Item 2. Unregistered Sales of Equity  Securities and Use of Proceeds                                | 43     |
| Item 3. Defaults Upon Senior Securities                                                             | 43     |
| Item 4. Submission of Matters to a Vote of  Security Holders                                        | 43     |
| Item 5. Other Information                                                                           | 43     |
| Item 6. Exhibits                                                                                    | 43     |
|                                                                                                |   |
| **SIGNATURES**                                                                                      | 44     |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CONDITIONSeptember 30, 2005 and December 31, 2004(In thousands, except share data)

 
| ** **                                                                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| **Assets**                                                                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and due  from banks                                                                                                                             |       |       |       |       |       | $                            | 16,658     |                        | $          | 15,205 |   |
| Federal  funds sold                                                                                                                                  |       |       |       |       |       | 86,415                       |       | 8,203                       |       |
| Total cash and cash equivalents                                                                                                                      |       |       |       |       |       | 103,073                      |       | 23,408                      |       |
| Investment  securities available-for-sale                                                                                                            |       |       |       |       |       | 171,833                      |       | 151,554                     |       |
| Investment securities held-to-maturity  (market value of $118,875 and $136,609 at September 30, 2005 and  December 31, 2004, respectively) |       |       |       |       |       | 120,794                      |       | 137,953                     |       |
| Total investment securities                                                                                                                          |       |       |       |       |       | 292,627                      |       | 289,507                     |       |
| Other  investments                                                                                                                                   |       |       |       |       |       | 7,363                        |       | 8,110                       |       |
| Loans held  for sale, net                                                                                                                            |       |       |       |       |       | 454,660                      |       | 365,454                     |       |
| Loans  receivable, net of deferred fees and costs                                                                                                    |       |       |       |       |       | 632,148                      |       | 489,896                     |       |
| Allowance  for loan losses                                                                                                                           |       |       |       |       |       | (7,706                       | )          | (5,878                      | )          |
| Loans receivable, net                                                                                                                                |       |       |       |       |       | 624,442                      |       | 484,018                     |       |
| Premises and  equipment, net                                                                                                                         |       |       |       |       |       | 17,591                       |       | 15,531                      |       |
| Deferred tax  asset                                                                                                                                  |       |       |       |       |       | 4,762                        |       | 3,238                       |       |
| Goodwill and  intangibles, net                                                                                                                       |       |       |       |       |       | 20,644                       |       | 14,694                      |       |
| Accrued  interest receivable and other assets                                                                                                        |       |       |       |       |       | 14,464                       |       | 7,616                       |       |
| Total assets                                                                                                                                         |       |       |       |       |       | $                            | 1,539,626  |                        | $          | 1,211,576 |   |
|                                                                                                                                                 |       |       |       |       |       |                         |       |                        |       |
| **Liabilities and Shareholders’ Equity**                                                                                                        |       |       |       |       |       |                         |       |                        |       |
| ** **                                                                                                                                           |       |       |       |       |       |                         |       |                        |       |
| Non-interest  bearing deposits                                                                                                                       |       |       |       |       |       | $                            | 128,467    |                        | $          | 105,424 |   |
| Interest  bearing deposits                                                                                                                           |       |       |       |       |       | 965,924                      |       | 718,786                     |       |
| Other  borrowed funds                                                                                                                                |       |       |       |       |       | 163,892                      |       | 201,085                     |       |
| Warehouse  financing                                                                                                                                 |       |       |       |       |       | —                       |       | 30,245                      |       |
| Mortgage  funding checks                                                                                                                             |       |       |       |       |       | 104,283                      |       | 46,392                      |       |
| Escrow  liabilities                                                                                                                                  |       |       |       |       |       | 9,626                        |       | 3,020                       |       |
| Accrued  interest payable and other liabilities                                                                                                      |       |       |       |       |       | 20,696                       |       | 11,519                      |       |
| Total liabilities                                                                                                                                    |       |       |       |       |       | 1,392,888                    |       | 1,116,471                   |       |
|                                                                                                                                                 |       |       |       |       |       |                         |       |                        |       |
| **Common stock, $1 par value**                                                                                                                       | ** ** | **2005**   | ** ** | **2004**   | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Authorized                                                                                                                                           |       | 50,000,000 |       | 50,000,000 |       |                         |       |                        |       |
| Issued and outstanding                                                                                                                               |       | 24,354,505 |       | 18,462,597 |       | 24,355                       |       | 18,463                      |       |
| Additional  paid-in capital                                                                                                                          |       |       |       |       |       | 132,255                      |       | 92,868                      |       |
| Accumulated  deficit                                                                                                                                 |       |       |       |       |       | (8,256                       | )          | (15,145                     | )          |
| Accumulated  other comprehensive loss                                                                                                                |       |       |       |       |       | (1,616                       | )          | (1,081                      | )          |
| Total shareholders’ equity                                                                                                                      |       |       |       |       |       | 146,738                      |       | 95,105                      |       |
| Total liabilities and shareholders’ equity                                                                                                      |       |       |       |       |       | $                            | 1,539,626  |                        | $          | 1,211,576 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF INCOMEThree and nine months ended September 30, 2005 and 2004(In thousands, except share and per share data)(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest  income:                                              |       |                                      |       |                                     |       |   |   |   |   |
| Loans receivable                                               |       | $                                         | 9,365      |                                     | $          | 5,826 |   | $ | 24,979 |   | $ | 15,425 |   |
| Loans held for sale                                            |       | 6,101                                     |       | 3,268                                    |       | 14,117 |   | 3,268 |   |
| Federal funds sold                                             |       | 208                                       |       | 49                                       |       | 346 |   | 96 |   |
| Investment securities available-for-sale                       |       | 1,414                                     |       | 1,536                                    |       | 4,376 |   | 4,360 |   |
| Investment securities held-to-maturity                         |       | 1,197                                     |       | 1,432                                    |       | 3,757 |   | 4,260 |   |
| Other investments                                              |       | 56                                        |       | 78                                       |       | 183 |   | 162 |   |
| Total interest income                                          |       | 18,341                                    |       | 12,189                                   |       | 47,758 |   | 27,571 |   |
| Interest  expense:                                             |       |                                      |       |                                     |       |   |   |   |   |
| Deposits                                                       |       | 6,782                                     |       | 3,668                                    |       | 16,989 |   | 8,448 |   |
| Other borrowed funds                                           |       | 1,339                                     |       | 1,116                                    |       | 3,602 |   | 1,887 |   |
| Warehouse financing                                            |       | 109                                       |       | 211                                      |       | 109 |   | 211 |   |
| Total interest expense                                         |       | 8,230                                     |       | 4,995                                    |       | 20,700 |   | 10,546 |   |
| Net interest income                                            |       | 10,111                                    |       | 7,194                                    |       | 27,058 |   | 17,025 |   |
| Provision  for loan losses                                     |       | 500                                       |       | 529                                      |       | 1,869 |   | 918 |   |
| Net interest income after provision for  loan losses           |       | 9,611                                     |       | 6,665                                    |       | 25,189 |   | 16,107 |   |
| Non-interest  income:                                          |       |                                      |       |                                     |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 348                                       |       | 296                                      |       | 958 |   | 798 |   |
| Loan service charges                                           |       | 771                                       |       | 129                                      |       | 2,015 |   | 414 |   |
| Investment fee income                                          |       | 497                                       |       | 150                                      |       | 947 |   | 498 |   |
| Net gain on sales of loans                                     |       | 4,752                                     |       | 1,398                                    |       | 12,368 |   | 1,460 |   |
| Net realized gain on investment securities  available-for-sale |       | —                                    |       | 3                                        |       | 33 |   | 245 |   |
| Management fee income                                          |       | 969                                       |       | 802                                      |       | 2,467 |   | 802 |   |
| Other income                                                   |       | 12                                        |       | 6                                        |       | 19 |   | 9 |   |
| Total non-interest income                                      |       | 7,349                                     |       | 2,784                                    |       | 18,807 |   | 4,226 |   |
| Non-interest  expense:                                         |       |                                      |       |                                     |       |   |   |   |   |
| Salary and benefits                                            |       | 6,430                                     |       | 4,802                                    |       | 16,866 |   | 8,904 |   |
| Occupancy                                                      |       | 1,063                                     |       | 932                                      |       | 3,134 |   | 1,893 |   |
| Professional fees                                              |       | 875                                       |       | 578                                      |       | 1,824 |   | 922 |   |
| Depreciation                                                   |       | 711                                       |       | 583                                      |       | 2,100 |   | 1,215 |   |
| Data processing                                                |       | 233                                       |       | 255                                      |       | 1,227 |   | 647 |   |
| Telecommunications                                             |       | 303                                       |       | 197                                      |       | 913 |   | 405 |   |
| Amortization of intangibles                                    |       | 143                                       |       | —                                   |       | 265 |   | — |   |
| Other operating expenses                                       |       | 2,647                                     |       | 1,546                                    |       | 7,293 |   | 3,760 |   |
| Total non-interest expense                                     |       | 12,405                                    |       | 8,893                                    |       | 33,622 |   | 17,746 |   |
| Net income before income taxes                                 |       | 4,555                                     |       | 556                                      |       | 10,374 |   | 2,587 |   |
| Provision for  income taxes                                    |       | 1,570                                     |       | 172                                      |       | 3,485 |   | 850 |   |
| Net income                                                     |       | $                                         | 2,985      |                                     | $          | 384 |   | $ | 6,889 |   | $ | 1,737 |   |
| Earnings per  share - basic                                    |       | $                                         | 0.12       |                                     | $          | 0.02 |   | $ | 0.32 |   | $ | 0.10 |   |
| Earnings per  share - diluted                                  |       | $                                         | 0.12       |                                     | $          | 0.02 |   | $ | 0.32 |   | $ | 0.09 |   |
| Weighted-average  shares outstanding - basic                   |       | 24,346,701                                |       | 18,439,021                               |       | 21,344,071 |   | 18,101,639 |   |
| Weighted-average  shares outstanding - diluted                 |       | 24,631,402                                |       | 18,697,179                               |       | 21,606,448 |   | 18,361,013 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

4

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOMEThree and nine months ended September 30, 2005 and 2004(In thousands)(Unaudited)

 
| ** **                                                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                            |       |                                      |       |                                     |       |   |   |   |   |
| Net income                                                                      |       | $                                         | 2,985      |                                     | $          | 384 |   | $ | 6,889 |   | $ | 1,737 |   |
| Other  comprehensive income:                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Unrealized gain (loss) on  available-for-sale investment securities:            |       |                                      |       |                                     |       |   |   |   |   |
| Unrealized holding gain (loss) arising during  the period, net of tax           |       | (242                                      | )          | 2,537                                    |       | (513 | ) | (93 | ) |
| Less: reclassification adjustment for gains  included in net income, net of tax |       | —                                    |       | (2                                       | )          | (22 | ) | (161 | ) |
|                                                                            |       |                                      |       |                                     |       |   |   |   |   |
| Comprehensive  income                                                           |       | $                                         | 2,743      |                                     | $          | 2,919 |   | $ | 6,354 |   | $ | 1,483 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

5

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**CARDINAL FINANCIAL CORPORATION ANDSUBSIDIARIES**CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITYNine months ended September 30, 2005 and 2004(In thousands)(Unaudited)

 
| ** **                                      | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|-----------|------------|
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Balance, December 31, 2003                 |       | 1,364                 |       | $                    | 1,364      |               | 16,377     |              | $          | 16,377                           |       | $                        | 86,790     |                                        | $          | (18,614   | )          | $ | (505 | ) | $ | 85,412 |   |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Stock options exercised                         |       | —                |       | —               |       | 93                 |       | 93                |       | 306                              |       | —                   |       | —                                      |       | 399       |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Public offering shares issued                   |       | —                |       | —               |       | 945                |       | 945               |       | 5,358                            |       | —                   |       | —                                      |       | 6,303     |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Preferred stock  converted to common stock      |       | (1,364                | )          | (1,364               | )          | 1,026              |       | 1,026             |       | 338                              |       | —                   |       | —                                      |       | —    |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Change in  accumulated other comprehensive loss |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (254                                        | )          | (254      | )          |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Net income                                      |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 1,737                    |       | —                                      |       | 1,737     |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Balance, September 30, 2004                |       | —                |       | $                    | —     |               | 18,441     |              | $          | 18,441                           |       | $                        | 92,792     |                                        | $          | (16,877   | )          | $ | (759 | ) | $ | 93,597 |   |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Balance, December 31, 2004                 |       | —                |       | $                    | —     |               | 18,463     |              | $          | 18,463                           |       | $                        | 92,868     |                                        | $          | (15,145   | )          | $ | (1,081 | ) | $ | 95,105 |   |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Stock options exercised                         |       | —                |       | —               |       | 106                |       | 106               |       | 544                              |       | —                   |       | —                                      |       | 650       |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Public offering shares issued                   |       | —                |       | —               |       | 5,175              |       | 5,175             |       | 34,592                           |       | —                   |       | —                                      |       | 39,767    |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Shares issued in  Wilson/Bennett Acquisition    |       | —                |       | —               |       | 611                |       | 611               |       | 4,251                            |       | —                   |       | —                                      |       | 4,862     |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Change in  accumulated other comprehensive loss |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                   |       | (535                                        | )          | (535      | )          |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Net income                                      |       | —                |       | —               |       | —             |       | —            |       | —                           |       | 6,889                    |       | —                                      |       | 6,889     |       |
|                                            |       |                  |       |                 |       |               |       |              |       |                             |       |                     |       |                                        |       |      |       |
| Balance, September 30, 2005                |       | —                |       | $                    | —     |               | 24,355     |              | $          | 24,355                           |       | $                        | 132,255    |                                        | $          | (8,256    | )          | $ | (1,616 | ) | $ | 146,738 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

6

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CASH FLOWSNine months ended September 30, 2005 and 2004(In thousands)(Unaudited)

 
| ** **                                                                                                                                                                                                                                           | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash flows  from operating activities:                                                                                                                                                                                                               |       |       |       |       |       |
| Net income                                                                                                                                                                                                                                           |       | $          | 6,889      |       | $          | 1,737 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities:                                                                                                                                                         |       |       |       |       |       |
| Depreciation                                                                                                                                                                                                                                         |       | 2,100      |       | 1,215      |       |
| Amortization of premiums, discounts and  intangibles                                                                                                                                                                                                 |       | 1,357      |       | 1,557      |       |
| Provision for loan losses                                                                                                                                                                                                                            |       | 1,869      |       | 918        |       |
| Loans held for sale originated and acquired                                                                                                                                                                                                          |       | (3,902,910 | )          | (1,247,010 | )          |
| Proceeds from the sale of loans held for  sale                                                                                                                                                                                                       |       | 3,826,072  |       | 900,999    |       |
| Gain on sale of loans held for sale                                                                                                                                                                                                                  |       | (12,368    | )          | (1,460     | )          |
| Gain on sale of investment securities  available-for-sale                                                                                                                                                                                            |       | (33        | )          | (245       | )          |
| Loss on sale of other assets                                                                                                                                                                                                                         |       | 13         |       | —     |       |
| Increase in accrued interest receivable,  other assets, and deferred tax asset                                                                                                                                                                       |       | (8,372     | )          | (19,351    | )          |
| Increase (decrease) in accrued interest  payable, escrow liabilities and other liabilities                                                                                                                                                           |       | 15,778     |       | (13,335    | )          |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Net cash used in operating activities                                                                                                                                                                                                                |       | (69,605    | )          | (374,975   | )          |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Cash flows  from investing activities:                                                                                                                                                                                                               |       |       |       |       |       |
| Purchase of premises and equipment                                                                                                                                                                                                                   |       | (4,169     | )          | (9,425     | )          |
| Proceeds from sale, maturity and call of  investment securities available-for-sale                                                                                                                                                                   |       | 6,000      |       | 14,000     |       |
| Proceeds from sale, maturity and call of  mortgage-backed securities available-for-sale                                                                                                                                                              |       | 4,896      |       | 9,719      |       |
| Proceeds from maturity and call of  investment securities held-to-maturity                                                                                                                                                                           |       | —     |       | 5,490      |       |
| Proceeds from sale of other investments                                                                                                                                                                                                              |       | 8,353      |       | 7,442      |       |
| Purchase of investment securities  available-for-sale                                                                                                                                                                                                |       | (42,776    | )          | (6,000     | )          |
| Purchase of mortgage-backed securities  available-for-sale                                                                                                                                                                                           |       | (12,715    | )          | (72,959    | )          |
| Purchase of investment securities  held-to-maturity                                                                                                                                                                                                  |       | —     |       | (16,472    | )          |
| Purchase of mortgage-backed securities  held-to-maturity                                                                                                                                                                                             |       | —     |       | (14,042    | )          |
| Purchase of other investments                                                                                                                                                                                                                        |       | (7,594     | )          | (10,098    | )          |
| Redemptions of investment securities  available-for-sale                                                                                                                                                                                             |       | 22,990     |       | 22,817     |       |
| Redemptions of investment securities  held-to-maturity                                                                                                                                                                                               |       | 16,594     |       | 21,089     |       |
| Net cash (paid) acquired in acquisition                                                                                                                                                                                                              |       | (1,379     | )          | 27,599     |       |
| Net increase in loans receivable, net of  deferred fees and costs                                                                                                                                                                                    |       | (141,986   | )          | (103,592   | )          |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Net cash used in investing activities                                                                                                                                                                                                                |       | (151,786   | )          | (124,432   | )          |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Cash flows  from financing activities:                                                                                                                                                                                                               |       |       |       |       |       |
| Net increase in deposits                                                                                                                                                                                                                             |       | 270,181    |       | 345,805    |       |
| Net increase (decrease) in other borrowed  funds                                                                                                                                                                                                     |       | (54,318    | )          | 27,152     |       |
| Net increase (decrease) in warehouse  financing                                                                                                                                                                                                      |       | (30,240    | )          | 88,846     |       |
| Net increase in mortgage funding checks                                                                                                                                                                                                              |       | 57,891     |       | —     |       |
| Proceeds from FHLB advances - long term                                                                                                                                                                                                              |       | 25,000     |       | 45,000     |       |
| Repayments of FHLB advances - long term                                                                                                                                                                                                              |       | (7,875     | )          | (7,875     | )          |
| Proceeds from public offering                                                                                                                                                                                                                        |       | 39,767     |       | 6,303      |       |
| Proceeds from trust preferred issuance                                                                                                                                                                                                               |       | —     |       | 20,000     |       |
| Stock options exercised                                                                                                                                                                                                                              |       | 650        |       | 399        |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Net cash provided by financing activities                                                                                                                                                                                                            |       | 301,056    |       | 525,630    |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Net increase  in cash and cash equivalents                                                                                                                                                                                                           |       | 79,665     |       | 26,223     |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Cash and  cash equivalents at beginning of the period                                                                                                                                                                                                |       | 23,408     |       | 13,083     |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| Cash and  cash equivalents at end of the period                                                                                                                                                                                                      |       | $          | 103,073    |       | $          | 39,306 |   |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| **Supplemental  disclosure of cash flow information:**                                                                                                                                                                                               |       |       |       |       |       |
| Cash paid during the period for interest                                                                                                                                                                                                             |       | $          | 20,867     |       | $          | 9,622 |   |
| Cash paid for income taxes                                                                                                                                                                                                                           |       | 1,436      |       | 80         |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| **Supplemental  schedule of noncash investing and financing activities:**                                                                                                                                                                       |       |       |       |       |       |
| 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                                                                                                                                                                                                               |       | $          | 6,296      |       |       |   |
| Fair value of liabilities assumed                                                                                                                                                                                                                    |       | 33         |       |       |       |
| Common shares issued in acquisition                                                                                                                                                                                                                  |       | 4,862      |       |       |       |
|                                                                                                                                                                                                                                                 |       |       |       |       |       |
| On July 7, 2004, the Company acquired  all of the issued and outstanding membership interests of George Mason  Mortgage, LLC. In conjunction with the acquisition, the following noncash  changes to our financial condition occurred:          |       |       |       |       |       |
| Fair value of non-cash assets acquired                                                                                                                                                                                                               |       |       |       | $          | 14,703     |   |
| Fair value of liabilities assumed                                                                                                                                                                                                                    |       |       |       |       | 338,232    |   |

 

Seeaccompanying notes to consolidated financial statements.

 

7

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CARDINALFINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIALSTATEMENTSSeptember 30, 2005(Unaudited)

 

Note 1

 

*Organization*

 

Cardinal Financial Corporation (the “Company”) was incorporated onNovember 24, 1997 under the laws of the Commonwealth of Virginia as aholding company whose activities consist of investment in its wholly ownedsubsidiaries.  The Company openedCardinal Bank, N.A. (the “Bank”) in 1998 and Cardinal Wealth Services, Inc., an investment services subsidiary,in 1999.  In 1999, the Company opened twoadditional banking subsidiaries and, in late 2000, completed an acquisition ofHeritage Bancorp, Inc. and its banking subsidiary, The Heritage Bank.  These banking subsidiaries were consolidatedinto the Bank as of March 1, 2002. On April 15, 2004, the Company received approval from the FederalReserve Bank of Richmond to be a financial holding company.  Effective July 7, 2004, the Bankacquired George Mason Mortgage, LLC (“George Mason”), a mortgage bankingcompany based in Fairfax, Virginia.  In December 2004,the Bank converted to a state chartered institution and changed its name toCardinal Bank.  Effective June 9,2005, the Company acquired Wilson/Bennett Capital Management, Inc. (“Wilson/Bennett”),an asset management firm based in Alexandria, Virginia.

 

*Basis of Presentation*

 

In the opinionof management, the accompanying consolidated financial statements have beenprepared in accordance with the requirements of Regulation S-X, Article 10.  Accordingly, they do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. However, all adjustments that are, in the opinion of management,necessary for a fair presentation have been included.  The results of operations for the three andnine months ended September 30, 2005 are not necessarily indicative of theresults to be expected for the full year ending December 31, 2005.  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 on Form 10-Kfor the year ended December 31, 2004 (the “2004 Form 10-K”).

 

***Stock-Based Compensation***

* *

**At September 30, 2005, the Company had twostock-based employee compensation plans, the 1999 Stock Option Plan and the2002 Equity Compensation Plan.  Theseplans are described more fully in Footnote 18 of the 2004 Form 10-K.**

* *

**As permitted under Statement of FinancialAccounting Standards (“SFAS”) No. 148,*Accounting for Stock-Based Compensation –Transition and Disclosure,*which amended**SFASNo. 123,*Accounting for Stock-Based Compensation,*the Company haselected to continue to utilize the intrinsic value method in accounting for itsstock-based employee compensation arrangements as defined by AccountingPrinciples Board Opinion (“APB”) No. 25,*Accounting for Stock Issued to Employees,*and related interpretations including Financial Accounting Standards BoardInterpretation No. 44,*Accounting for Certain TransactionsInvolving Stock Compensation,*an**

 

**8**

----

 

**interpretation of APB No. 25.  The following table illustrates the effect onnet income and earnings per share of common stock if the Company had appliedthe fair value recognition provisions of SFAS No. 123, as amended, tostock-based employee compensation.**

 

(In thousands, except per share data)

 
| ** **                                                                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                                                                                     |       | $                                          | 2,985      |                                      | $          | 384 |   | $ | 6,889 |   | $ | 1,737 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value- based method for all  awards, net of tax |       | (215                                       | )          | (753                                      | )          | (3,987 | ) | (1,428 | ) |
| Pro forma  net income                                                                                                          |       | $                                          | 2,770      |                                      | $          | (369 | ) | $ | 2,902 |   | $ | 309 |   |
|                                                                                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Earnings per  share:                                                                                                           |       |                                       |       |                                      |       |   |   |   |   |
| Basic - as reported                                                                                                            |       | $                                          | 0.12       |                                      | $          | 0.02 |   | $ | 0.32 |   | $ | 0.10 |   |
| Basic - pro forma                                                                                                              |       | 0.11                                       |       | (0.02                                     | )          | 0.14 |   | 0.02 |   |
| Diluted - as reported                                                                                                          |       | 0.12                                       |       | 0.02                                      |       | 0.32 |   | 0.09 |   |
| Diluted - pro forma                                                                                                            |       | 0.11                                       |       | (0.02                                     | )          | 0.13 |   | 0.02 |   |

 

Theweighted average per share fair values of grants of stock options made duringthe three months ended September 30, 2005 and 2004 were $5.92 and $3.30,respectively.  The weighted average pershare fair values of grants made during the nine months ended September 30,2005 and 2004 were $5.97 and $3.08, respectively.  The fair values of the options granted forthese periods were estimated as of the grant date using the Black-Scholesoption-pricing model based on the following weighted average assumptions:

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Estimated  option life   |       | 10 years                                   |       | 10 years                                  |       | 10 years |   | 10 years |   |
| Risk free  interest rate |       | 4.21                                       | %          | 4.29                                      | %          | 4.25 | % | 4.12 | % |
| Expected  volatility     |       | 43.11                                      | %          | 11.80                                     | %          | 43.11 | % | 11.80 | % |
| Expected  dividend yield |       | 0.00                                       | %          | 0.00                                      | %          | 0.00 | % | 0.00 | % |

 

#### **Therewere options to purchase 44,000 and 963,911 shares of common stock grantedduring the three and nine months ended September 30, 2005,respectively.  Of those grants, 44,000and 955,911 immediately vested on the grant date for the three and nine monthsended September 30, 2005, respectively.**

#### ** **

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123R, *Share-Based Payment:  An Amendment of FASB Statements 123 and 95*(“FAS123R”)*.* This statement requires that companies recognize in the income statementthe grant-date fair value of stock options and other equity-basedcompensation.  It is required to beapplied by us beginning January 1, 2006. This statement requires that stock awards be classified as either anequity award

 

9

----

 

ora liability award.  Equity classifiedawards are valued as of the grant date using either an observable market priceor a valuation methodology.  Liabilityclassified awards are valued at fair value as of each reporting date.  The Company intends to adopt FAS 123R usingthe modified prospective application method which requires, among other things,recognition of compensation costs for all awards outstanding at January 1,2006 for which the requisite service has not been rendered.  The Company estimates that this new standardwill result in an increase in pretax expense of approximately $64,000 quarterlyand $256,000 annually in 2006 based on the current stock optionsoutstanding.  Additional expense would berecorded for any future stock option grants. On October 19, 2005, the Company’s board of directors authorizedthat any existing outstanding options that are or become “underwater” (i.e.,their per share exercise price is greater than the market price) before December 31,2005 be amended to become fully vested. This modification will not result in the recognition of additionalexpense because the intrinsic value of the awards at the grant date was zeroand the intrinsic value of these awards on the date of modification will alsobe zero.

 

#### **Note 2**

 

*Acquisitions*

 

OnJune 9, 2005, the Company acquired Wilson/Bennett for a totalconsideration of $6.5 million, which consisted of a payment of $1.6 million incash and the issuance of 611,111 shares of its common stock valued at $4.9million.  This transaction was accountedfor as a purchase and Wilson/Bennett’s assets and liabilities were recorded atfair value as of the purchase date.  Thistransaction resulted in the recognition of $3.6 million of goodwill and $2.6million of other intangible assets. Wilson/Bennett’s 2004 unaudited revenues were approximately $1.4million.  The Company anticipates thatthe acquisition of Wilson/Bennett will not have a material impact on 2005earnings.

 

Theprimary shareholder of Wilson/Bennett at the time of its acquisition by theCompany was, and continues to be, a member of the Company’s Board ofDirectors.  The Company has entered intoan employment agreement with this person which ends on April 30, 2008,with automatic one-year renewals beginning on that date and each April 30thereafter unless notice of non-renewal is provided by either party.

 

Thecommon stock utilized to complete this transaction is newly issued by theCompany, is not registered with the Securities and Exchange Commission (the “SEC”),and therefore cannot be sold until so registered or sold pursuant to anexemption from such registration. Because of this trading restriction, theCompany has valued for purchase accounting purposes the 611,111 restrictedshares at 89% of the fair market value of its unrestricted shares.

 

Theoperating results of Wilson/Bennett are included in the Company’s consolidatedoperating results and its investment services segment information since thedate of acquisition and are not separately material to consolidated operatingresults. The acquisition resulted in the recognition of the followingintangible assets which are being amortized on a straight-line basis over theperiods indicated:

 

Employment/non-competeagreement - $698,000 (4 years)

Trade nameintangible-$46,000 (3 years)

Purchased customerrelationships-$1,858,000 (10 years)

 

10

----

 

Thetransaction also resulted in the recognition of goodwill of $3.5 million. TheCompany used the assistance of an independent valuation consultant to determinethe value assigned to identifiable amortizable intangibles. Goodwill will notbe amortized but will be reviewed, along with the other identified intangibles,for impairment when evidence of impairment exists or, at a minimum, on anannual basis.

 

TheCompany has agreed to provide certain demand registration rights with respectto the 611,111 common shares issued. The owners of these shares have the rightto make one written request to the Company for the registration of one-third ofthe shares under the Securities Act of 1933, as amended, to permit the resaleof the shares.  In the event that achange of control of the Company occurs, or the Company’s employment of its currentchief executive officer terminates, both as described in a registration rightsagreement, then the registration rights would cover all the shares.  The purchase price has been increased by theestimated cost to register these shares with the SEC.  At the end of two years, the shares will nolonger be restricted.

 

#### **On July 7, 2004, the Bank completed its acquisition ofGeorge Mason. George Mason was acquired in a cash transaction for $17.0 millionand is operating as a subsidiary of the Bank. This transaction was accounted for as a purchase and George Mason’sassets and liabilities were recorded at fair value as of the purchasedate.  George Mason’s operating resultsare included in the consolidated results of operations since the date ofacquisition.  This transaction resultedin the recognition of $12.9 million of goodwill and $1.7 million of otherintangible assets.  George Mason’sprimary sources of revenue include net interest income earned on loans held forsale, gain on sale of loans and management fees earned.  Loans are made pursuant to purchasecommitments and are sold servicing released. The Bank purchased George Mason primarily to diversify its sources ofincome, increase non-interest income and be a source of residential loans forits loans receivable portfolio.**

#### ** **

Thefollowing unaudited pro forma condensed financial information presents theresults of operations of the Company for the periods indicated as if GeorgeMason had been acquired on January 1, 2004.

 

11

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| ** **                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **(In thousands, except share and  per share data)**  | ** ** | **September 30, 2004** | ** ** | **September 30, 2004** | ** ** |
| Net interest  income                                  |       | $                      | 7,308      |                   | $          | 21,146 |   |
| Non-interest  income                                  |       | 4,605                  |       | 23,157                 |       |
| Provision  for loan losses                            |       | 529                    |       | 918                    |       |
| Non-interest  expense                                 |       | 9,415                  |       | 35,698                 |       |
| Net income  before income taxes                       |       | 1,969                  |       | 7,687                  |       |
| Provision  for income taxes                           |       | 652                    |       | 2,365                  |       |
| Net income                                            |       | $                      | 1,317      |                   | $          | 5,322 |   |
|                                                  |       |                   |       |                   |       |
| Earnings per  common share - basic                    |       | $                      | 0.07       |                   | $          | 0.29 |   |
| Earnings per  common share - diluted                  |       | $                      | 0.07       |                   | $          | 0.29 |   |
| Weighted-average  common shares outstanding - basic   |       | 18,439,021             |       | 18,101,639             |       |
| Weighted-average  common shares outstanding - diluted |       | 18,697,179             |       | 18,361,013             |       |

 

Theunaudited pro forma results of operations summarized above are not necessarilyindicative of the results that would have occurred if the acquisition had beenconsummated on January 1, 2004.

 

Note 3

 

*SegmentInformation*

 

**Prior to July 7, 2004, the Companyoperated and reported in two business segments, commercial banking andinvestment services.  As of July 7,2004, the Company began operating in a third business segment, mortgagebanking, with the completion of its acquisition of George Mason.**

 

**The commercial banking segment includes bothcommercial and consumer lending and provides customers with such products ascommercial loans, real estate loans, and other business financing and consumerloans.  In addition, this segment alsoprovides customers with several choices of deposit products including demanddeposit accounts, savings accounts and certificates of deposit.  The mortgage banking segment**engagesprimarily in the origination and acquisition of residential mortgages for saleinto the secondary market on a best efforts basis.  The investment services segment provides advisoryservices to businesses and individuals, including financial planning andretirement/estate planning. Wilson/Bennett is included in the investment services segment since thedate of its acquisition, June 9, 2005.

 

**Information about the reportable segments andreconciliation of this information to the consolidated financial statements atand for the three and nine months ended September 30, 2005 and 2004, is asfollows:**

 

12

----

 

**(In thousands)**

**At and for the Three Months Ended September 30, 2005:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 8,544      |                  | $          | 1,780                    |       | $                             | —     |      | $          | —           |       | $ | (213 | ) | $ | 10,111 |   |
| Provision  for loan losses  |       | 500                     |       | —                |       | —                   |       | —                        |       | —    |       | 500              |       |
| Non-interest  income        |       | 479                     |       | 6,362                 |       | 497                      |       | —                        |       | 11        |       | 7,349            |       |
| Non-interest  expense       |       | 6,542                   |       | 4,845                 |       | 454                      |       | —                        |       | 564       |       | 12,405           |       |
| Provision  for income taxes |       | 659                     |       | 1,153                 |       | 3                        |       | —                        |       | (245      | )          | 1,570            |       |
| Net income  (loss)          |       | $                       | 1,322      |                  | $          | 2,144                    |       | $                             | 40         |      | $          | —           |       | $ | (521 | ) | $ | 2,985 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |   |   |   |   |   |   |
| Total Assets                |       | $                       | 1,409,575  |                  | $          | 467,261                  |       | $                             | 7,330      |      | $          | (511,520         | )          | $ | 166,980 |   | $ | 1,539,626 |   |

 

**At and for the Three Months EndedSeptember 30, 2004:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 5,716      |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (105 | ) | $ | 7,194 |   |
| Provision  for loan losses  |       | 529                     |       | —                |       | —                   |       | —                        |       | —    |       | 529              |       |
| Non-interest  income        |       | 325                     |       | 2,304                 |       | 150                      |       | —                        |       | 5         |       | 2,784            |       |
| Non-interest  expense       |       | 4,239                   |       | 4,156                 |       | 189                      |       | —                        |       | 309       |       | 8,893            |       |
| Provision  for income taxes |       | 402                     |       | (76                   | )          | (15                      | )          | —                        |       | (139      | )          | 172              |       |
| Net income  (loss)          |       | $                       | 871        |                  | $          | (193                     | )          | $                             | (24        | )         | $          | —           |       | $ | (270 | ) | $ | 384 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 356,438                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,177,315 |   |

 

**At and for the Nine Months EndedSeptember 30, 2005:**

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 22,980     |                  | $          | 4,723                    |       | $                             | —     |      | $          | —           |       | $ | (645 | ) | $ | 27,058 |   |
| Provision  for loan losses  |       | 1,869                   |       | —                |       | —                   |       | —                        |       | —    |       | 1,869            |       |
| Non-interest  income        |       | 1,325                   |       | 16,512                |       | 946                      |       | —                        |       | 24        |       | 18,807           |       |
| Non-interest  expense       |       | 18,008                  |       | 13,223                |       | 999                      |       | —                        |       | 1,392     |       | 33,622           |       |
| Provision  for income taxes |       | 1,490                   |       | 2,691                 |       | (35                      | )          | —                        |       | (661      | )          | 3,485            |       |
| Net income  (loss)          |       | $                       | 2,938      |                  | $          | 5,321                    |       | $                             | (18        | )         | $          | —           |       | $ | (1,352 | ) | $ | 6,889 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,409,575  |                  | $          | 467,261                  |       | $                             | 7,330      |      | $          | (511,520         | )          | $ | 166,980 |   | $ | 1,539,626 |   |

 

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

 
| ** **                  | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Intersegment  Elimination** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------------|------------|-----------|------------|------------------|------------|
| Net interest  income        |       | $                       | 15,493     |                  | $          | 1,583                    |       | $                             | —     |      | $          | —           |       | $ | (51 | ) | $ | 17,025 |   |
| Provision  for loan losses  |       | 918                     |       | —                |       | —                   |       | —                        |       | —    |       | 918              |       |
| Non-interest  income        |       | 1,430                   |       | 2,304                 |       | 487                      |       | —                        |       | 5         |       | 4,226            |       |
| Non-interest  expense       |       | 12,017                  |       | 4,156                 |       | 613                      |       | —                        |       | 960       |       | 17,746           |       |
| Provision  for income taxes |       | 1,313                   |       | (76                   | )          | (45                      | )          | —                        |       | (342      | )          | 850              |       |
| Net income  (loss)          |       | $                       | 2,675      |                  | $          | (193                     | )          | $                             | (81        | )         | $          | —           |       | $ | (664 | ) | $ | 1,737 |   |
|                        |       |                    |       |                  |       |                     |       |                          |       |      |       |             |       |
| Total Assets                |       | $                       | 1,075,460  |                  | $          | 356,438                  |       | $                             | 677        |      | $          | (370,480         | )          | $ | 115,220 |   | $ | 1,177,315 |   |

 

13

----

 

**At September 30, 2005, the Company didnot have any operating segments other than those reported.  Parent company financial information isincluded in the “Other” category and represents an overhead function ratherthan an operating segment.  The parentcompany’s most significant assets are its net investments in itssubsidiaries.  The parent company’s netinterest income is comprised of interest income from short-term investments andinterest expense on trust preferred securities. The parent company’s non-interest expense is primarily non-allocableexecutive salaries and professional services related to the Company’sregulatory requirements.**

 

#### **Note 4**

#### ** **

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

##### ** **

**The following is the calculation of basic anddiluted earnings per share for the three and nine months ended September 30,2005 and 2004. Stock options outstanding at September 30, 2005 and 2004were 2,049,817 and 1,245,625 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 27,363 and 29,000 for the three months ended September 30,2005 and 2004, respectively.  Stockoptions issued that were not included in the calculation of diluted earningsper share because the exercise prices were greater than the average marketprice were 28,357 and 22,000 for the nine months ended September 30, 2005and 2004, respectively.**

 
| **(In thousands,**                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **except share and per share  data)**        | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  available to common shareholders |       | $                                          | 2,985      |                                      | $          | 384 |   | $ | 6,889 |   | $ | 1,737 |   |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average common shares - basic      |       | 24,346,701                                 |       | 18,439,021                                |       | 21,344,071 |   | 18,101,639 |   |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average common shares - diluted    |       | 24,631,402                                 |       | 18,697,179                                |       | 21,606,448 |   | 18,361,013 |   |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Earnings per  common share - basic           |       | $                                          | 0.12       |                                      | $          | 0.02 |   | $ | 0.32 |   | $ | 0.10 |   |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Earnings per  common share - diluted         |       | $                                          | 0.12       |                                      | $          | 0.02 |   | $ | 0.32 |   | $ | 0.09 |   |

 

#### **Note 5**

 

##### ***Derivatives and Hedging Activities***

##### ** **

TheCompany accounts for derivatives and hedging activities in accordance with SFASNo. 133, *Accounting for Derivative Instruments andHedging Activities*, as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities,*and SFAS No. 149*, Amendment of Statement133 on Derivative Instruments and Hedging Activities. *All derivatives are recognized onthe consolidated statements of condition at their fair value.

 

14

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Inthe normal course of business, the Company enters into contractual commitmentsto extend credit to finance one-to-four family homes.  The commitments, which contain fixedexpiration dates, become effective when the borrowers lock-in a specifiedinterest rate within time frames established by the Company (“interest ratelocks”).  Interest rate risk arises ifinterest rates move adversely between the time of the lock-in of rates by theborrower and the sale of the loan.  Theinterest rate locks related to loans that are intended to be sold are consideredderivatives.

 

Tomitigate the effect of the interest rate risk inherent in providing rate lockcommitments, the Company economically hedges each commitment by entering into abest efforts forward loan sale contract. These forward contracts are marked to market through earnings and arenot designated as accounting hedges under SFAS No. 133.  The fair values of all loan commitments andall forward sales contracts generally move in opposite directions and,accordingly, the impact of changes in these valuations on net income during theloan commitment period is generally inconsequential.

 

Althoughthe forward loan sale contracts serve as an economic hedge of interest raterisk from holding fixed-rate loans held for sale, these forward contracts havenot been designated as accounting hedges under SFAS No. 133 and,accordingly, loans held for sale are accounted for at the lower of cost ormarket in accordance with SFAS No. 65, *Accounting for CertainMortgage Banking Activities.*

 

AtSeptember 30, 2005, the fair value of interest rate lock commitments witha notional value of $156.2 million was $(1.1 million), and the fair value offorward sale commitments with a notional value of $519.0 million was $3.0 million.  These derivatives are recorded in other assetsand other liabilities on the consolidated statements of condition at their fairvalues.  In addition to these marketvalue adjustments for interest rate lock loan commitments and forward salecommitments at September 30, 2005, a basis adjustment of $(1.9 million)has been recorded related to the loans held for sale as of that date and isincluded in loans held for sale, net in the consolidated statements ofcondition.

 

#### **Note 6**

 

*Goodwill and Other Intangibles*

 

Informationconcerning total amortizable other intangible assets at September 30, 2005is as follows:

 
| ** **                         | ** ** | **Mortgage Banking**        | ** ** | **Investment Services**       | ** ** | **Total**                   | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| **(In thousands)**                 | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Balance at  December 31, 2004 |       | $                           | 1,781      |                          | $          | 49                          |       | $ | — |   | $ | — |   | $ | 1,781 |   | $ | 49 |   |
| Customer  relationship intangibles |       | —                      |       | 148                           |       | 1,858                       |       | 58 |   | 1,858 |   | 206 |   |
| Employment/non-compete  agreement  |       | —                      |       | —                        |       | 698                         |       | 54 |   | 698 |   | 54 |   |
| Trade name                         |       | —                      |       | —                        |       | 46                          |       | 5 |   | 46 |   | 5 |   |
|                               |       | $                           | 1,781      |                          | $          | 197                         |       | $ | 2,602 |   | $ | 117 |   | $ | 4,383 |   | $ | 314 |   |

 

15

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Theaggregate amortization expense for the three and nine months ended September 30,2005 was $143,000 and $265,000, respectively. There was no amortization expense for the comparable periods of 2004.

 

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

 
| ** **                      | ** ** | **(In thousands)** | ** ** |
|---------------------------------|------------|--------------------|------------|
| 2005  (October - December) |       | $                  | 143        |   |
| 2006                            |       | 574                |       |
| 2007                            |       | 574                |       |
| 2008                            |       | 565                |       |
| 2009                            |       | 460                |       |
| 2010                            |       | 384                |       |
|                                 |            |                    |            |  |

 

Thechanges in the carrying amount of goodwill for year to date September 30,2005 are as follows:

 
| **(In thousands)**                                   | ** ** | **Commercial  Banking** | ** ** | **Mortgage  Banking** | ** ** | **Investment  Services** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------|------------|-----------|------------|
| Balance at  December 31, 2004                   |       | $                       | 22         |                  | $          | 12,941                   |       | $         | —     |   | $ | 12,963 |   |
| Goodwill attributable to Wilson/Bennett  acquisition |       | —                  |       | —                |       | 3,612                    |       | 3,612     |       |
| Balance at  September 30, 2005                  |       | $                       | 22         |                  | $          | 12,941                   |       | $         | 3,612      |   | $ | 16,575 |   |

 

Note 7

 

*Subsequent Event*

 

OnOctober 19, 2005, the Company’s Board of Directors declared a cashdividend of $0.01 per share of its outstanding common stock.  This dividend will be paid on November 15,2005 to shareholders of record as of the close of business on October 31,2005.  This represents the first dividenddeclared by the Company in its history.

 

16

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

 

The following presents management’s discussionand analysis of our consolidated financial condition at September 30, 2005and December 31, 2004 and the unaudited results of our operations for thethree and nine months periods ended September 30, 2005 and 2004.  This discussion should be read in conjunctionwith our unaudited consolidated financial statements and the notes theretoappearing elsewhere in this report, the audited consolidated financialstatements and the notes to consolidated financial statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2004.

 

**Caution About Forward-Looking Statements**

 

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

 

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

 

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

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

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

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

•                  maintainingcapital levels adequate to support our growth;

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

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

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

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

•                  problems withtechnology utilized by us;

•                  changing trendsin customer profiles and behavior; and

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

 

17

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

 

In addition, this section should be read in conjunction withthe description of our “Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

**Overview**

 

**Cardinal Financial Corporation, a locally managedfinancial holding company headquartered in Tysons Corner, Virginia, iscommitted to providing superior customer service, a diversified mix offinancial products and services, and convenient banking to our retail andbusiness consumers.  We own Cardinal Bank(the “Bank”), a Virginia state-chartered community bank, Cardinal WealthServices, Inc., an investment services subsidiary, and Wilson/BennettCapital Management, Inc. (“Wilson/Bennett”), an Alexandria, Virginia basedasset management firm acquired in June 2005.  Through these three subsidiaries and GeorgeMason Mortgage, LLC (“George Mason”), a mortgage banking subsidiary of CardinalBank, we offer a wide range of traditional banking products and services toboth our commercial and retail customers. Our commercial relationship managers focus on attracting small andmedium sized businesses as well as government contractors, commercial realestate developers and builders and professionals, such as physicians,accountants and attorneys.  We have twenty-oneretail bank office locations and provide competitive retail products andservices.  We complement our core bankingoperations by offering a full range of investment products and services to ourcustomers through our third-party brokerage relationship with Raymond JamesFinancial Services, Inc. and asset management services throughWilson/Bennett.**

** **

On June 9, 2005, we acquired Wilson/Bennett,for a 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 which wevalued at $4.9 million.  This transactionwas accounted for as a purchase and Wilson/Bennett’s assets and liabilitieswere recorded at fair value as of the purchase date.  This transaction resulted in the recognitionof $3.6 million of goodwill and $2.6 million of other intangible assets.  We believe that the Wilson/Bennettacquisition furthers our strategies of enhancing fee income, diversifying ourrevenue stream, and the services we deliver to our customers.  Wilson/Bennett uses a value-oriented approachthat focuses on large capitalization stocks. Wilson/Bennett’s 2004 unaudited revenues were approximately $1.4million.  We anticipate that theacquisition of Wilson/Bennett will not have a material impact on our 2005earnings.

 

On July 7,2004, we acquired George Mason in a cash transaction for $17.0 million.  This transaction resulted in the recognitionof $12.9 million of goodwill and $1.7 million of amortizable intangibles.  This transaction was accounted for as apurchase, and George Mason’s assets and liabilities were recorded at their fairvalues as of the purchase date.  GeorgeMason’s operating results are included in our consolidated results since theacquisition date.  George Mason, based inFairfax, Virginia, engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis through eight branches located throughout the metropolitan Washingtonregion.  George Mason has approximately200 employees and does business in eight states, including Virginia, Marylandand the District of Columbia.  GeorgeMason is one of the largest residential mortgage originators in the greaterWashington metropolitan area, with originations of over $3.5 billion in 2004and $4.5 billion in 2003.  George Mason’soriginations for the first nine months of 2005 were $3.3 billion.

 

18

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George Mason’s primary sourcesof revenue include net interest income earned on loans held for sale, gain onthe sale of loans held for sale and contractual management fees earned relatingto services provided to other mortgage companies owned by local homebuilders.  Loans are made pursuant topurchase commitments and are sold servicing released.

 

In July 2004, we formed a wholly-ownedsubsidiary, Cardinal Statutory Trust I, for the purpose of issuing $20.0million of floating rate junior subordinated deferrable interest debentures (“trustpreferred securities”).  These trust preferredsecurities are due in 2034 and pay interest at a rate equal to LIBOR (LondonInterbank Offered Rate) plus 2.40%, which adjusts quarterly.  These securities are redeemable at a premiumthrough March 2008 and at par thereafter. We have guaranteed payment of these securities.  The $20.6 million payable by us to CardinalStatutory Trust I is included in other borrowed funds in the consolidatedstatements of condition since Cardinal Statutory Trust I is an unconsolidatedsubsidiary (as we are not the primary beneficiary of this entity).  We utilized the proceeds from the issuance ofthe trust preferred securities to make a capital contribution into the Bank.

 

Net interest income is ourprimary source of revenue.  We definerevenue as net interest income plus non-interest income.  As discussed further in the interest ratesensitivity section, we manage our balance sheet and interest rate risk tomaximize, and concurrently stabilize, net interest income.  We do this by monitoring our liquidityposition and the spread between the interest rates earned on interest-earningassets and the interest rates paid on interest-bearing liabilities.  We attempt to minimize our exposure tointerest rate risk, but are unable to eliminate it entirely.  In addition to management of interest raterisk, we analyze our loan portfolio for exposure to credit risk.  Loan defaults and foreclosures areunavoidable in the banking industry and we try to limit our exposure to thisrisk by carefully underwriting and monitoring our extensions of credit.  In addition to net interest income,non-interest income is an increasingly important source of revenue for us andincludes, among other things, service charges on deposits and loans, investmentfee income and gains (losses) on sales of investment securitiesavailable-for-sale, gains on sales of loans held for sale, and management feeincome.  Our acquisition of George Masonin July 2004 has resulted in non-interest income becoming a largercomponent of our total revenues, and the acquisition of Wilson/Bennett in June 2005has further contributed to this trend.

 

**Our business strategy is to grow through geographicexpansion while maintaining strong asset quality and achieving sustainedprofitability.  We completed a secondarycommon stock offering that raised $39.8 million in capital during the secondquarter of 2005.  This capital is beingused to support the continuing expansion of our branch office network andbalance sheet growth.  As a result ofthis increased capital and retained earnings, our legal lending limit increasedto $18.7 million as of September 30, 2005, which allowed us to expand ourcommercial and real estate lending loan portfolios.  In addition, we expect to increase ourloan-to-deposit ratio and shift the mix of our earning assets to higheryielding loans.**

** **

**Critical Accounting Policies**

 

*General*

 

U. S. generallyaccepted accounting principles are complex and require management to applysignificant judgment to various accounting, reporting, and disclosurematters.  Management must use assumptionsand estimates when applying these principles where precise measurements are notpossible or practical.  These policiesare critical because they are highly dependent upon subjective or complexjudgments, assumptions and estimates. Changes in such judgments,

 

19

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assumptions and estimates may have a significant impact on theconsolidated financial statements. Actual results could differ from initial estimates.

 

The accountingpolicies we view as critical are those relating to judgments, assumptions andestimates regarding the determination of the allowance for loan losses,accounting for economic hedging activities, and the valuation of deferred taxassets.

 

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

#### ** **

**We maintain the allowance for loan losses ata level that represents management’s best estimate of known and inherent lossesin our loan portfolio.  Both the amountof the provision expense and the level of the allowance for loan losses areimpacted by many factors, including general economic conditions, actual andexpected credit losses, historical trends and specific conditions of individualborrowers.  Unusual and infrequentlyoccurring events, such as hurricanes and other weather related disasters, mayimpact our assessment of possible credit losses.  As a part of our analysis, we use comparativepeer group data and qualitative factors such as levels of and trends indelinquencies and nonaccrual loans, national and local economic trends andconditions and concentrations of loans exhibiting similar risk profiles tosupport our estimates.**

** **

**Credit losses are an inherent part of ourbusiness and, although we believe the methodologies for determining theallowance for loan losses and the current level of the allowance are adequate,it is possible that there may be unidentified losses in the portfolio at September 30,2005 that may become evident at a future date pursuant to additional internalanalysis or regulatory comment. Additional provisions for such losses, if necessary, would be recordedin the commercial banking or mortgage banking segment, as appropriate, andwould negatively impact earnings.**

** **

For purposes of our analysis, we categorizeloans into one of five categories: commercial and industrial, commercial real estate (includingconstruction), home equity lines of credit, residential mortgages, andconsumer.  In the absence of historicalloss factors, peer group loss factors are applied and are adjusted by the qualitativefactors mentioned above.  The indicatedloss factors resulting from this analysis are applied for each of the fivecategories of loans.  In addition, weindividually assign loss factors to all loans that have been identified ashaving loss attributes, as indicated by deterioration in the financialcondition of the borrower or a decline in underlying collateral value if theloan is collateral dependent.  Since wehave limited historical data on which to base loss factors for classifiedloans, we apply, in accordance with regulatory guidelines, a 5% loss factor toall loans classified as special mention, a 15% loss factor to all loansclassified as substandard and a 50% loss factor to all loans classified asdoubtful.  Loans classified as loss loansare fully reserved or charged off.

 

*Hedging*

 

We account for our derivatives and hedgingactivities in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 133, *Accounting for Derivative Instruments andHedging Activities*, as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities,*and SFAS No. 149*, Amendment of Statement133 on Derivative Instruments and Hedging Activities.*

 

In the normal course of our mortgage bankingoperations at George Mason, we enter rate lock commitments to extend credit tofinance residential properties.  Thesecommitments, which contain fixed expiration dates, offer the borrower aninterest rate guarantee provided the loan

 

20

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meets underwriting guidelines and closeswithin the time frame established by us. Interest rate risk arises on these commitments and subsequently closedloans if interest rates change between the time of the interest rate lock andthe delivery of the loan to the investor. Loan commitments related to mortgage loans that are intended to be soldare considered derivatives in accordance with the guidance of SEC StaffAccounting Bulletin No. 105, *Application of AccountingPrinciples to Loan Commitments*. Accordingly, the fair value of these derivatives as of the end of thereporting period has been determined through an analysis of changes in marketinterest rates from the interest rate lock date to the loan closing date if theloan has closed and the period end if the loan has not closed.

 

To mitigate the effect of the interest rate riskinherent in providing rate lock commitments, we economically hedge eachcommitment by entering into a best efforts forward loan sale contracts.  These forward contracts are marked to marketthrough earnings and are not designated as accounting hedges under SFAS No. 133.  The fair values of all the loan commitmentsand all forward sales contracts generally move in opposite directions and,accordingly, the impact of changes in these valuations on net income during theloan commitment period is generally inconsequential.

 

Although the forward loan sale contracts serve as aneconomic hedge of interest rate risk from holding fixed-rate loans held forsale, these forward contracts have not been designated as accounting hedgesunder SFAS No. 133 and, accordingly, loans held for sale are accounted forat the lower of cost or market in accordance with SFAS No. 65, *Accounting for Certain Mortgage Banking Activities.*

 

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

#### ** **

We record a provision for income tax expense based on theamounts of current taxes payable or refundable and the change in net deferredtax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effectsof differing carrying values of assets and liabilities for tax and financialstatement purposes that will reverse in future periods.  When substantial uncertainty existsconcerning the recoverability of a deferred tax asset, the carrying value ofthe asset is reduced by a valuation allowance. The amount of any valuation allowance established is based upon anestimate of the deferred tax asset that is probable of recovery.  Increases or decreases in the valuationallowance result in increases or decreases to the provision for income taxes.

 

###### **New FinancialAccounting Standards**

###### ** **

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, *Share-BasedPayment:  An Amendment of FASB Statements123 and 95*(“FAS 123R”)*.*  This statement requires that companies recognizein the income statement the grant-date fair value of stock options and otherequity-based compensation.  It isrequired to be applied by us beginning January 1, 2006.  This statement requires that stock awards beclassified as either an equity award or a liability award.  Equity classified awards are valued as of thegrant date using either an observable market price or a valuationmethodology.  Liability classified awardsare valued at fair value as of each reporting date.  We intend to adopt FAS 123R using themodified prospective application method which requires, among other things,that we recognize compensation cost for all awards outstanding at January 1,2006 for which the requisite service has not been rendered.  We estimate that this new standard willresult in an increase in pretax expense of approximately $64,000 quarterly and$256,000 annually in 2006 based on the current stock options outstanding.  Additional expense would be recorded for anyfuture stock option grants.  On October 19,2005, our board of directors authorized that any existing outstanding

 

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options that are or become “underwater”(i.e., their per share exercise price is greater than the market price) before December 31,2005 be amended to become fully vested. This modification will not result in the recognition of additionalexpense because the intrinsic value of the awards at the grant date was zeroand the intrinsic value of these awards on the date of modification will alsobe zero.

 

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

##### ** **

Netincome for the three months ended September 30, 2005 and 2004 was $3.0million and $384,000, respectively, an increase of $2.6 million, or 677%.  The increase in net income for the threemonths ended September 30, 2005 compared to same period of 2004 isprimarily a result of increased net interest income of $2.9 million andnon-interest income of $4.5 million, partially offset by an increase innon-interest expense of $3.5 million. Net income for the nine months ended September 30,2005 and 2004 was $6.9 million and $1.7 million, respectively, an increase of$5.2 million, or 297%.  The increase innet income for the nine months ended September 30, 2005 compared to thesame period of 2004 is primarily a result of increased net interest income of$10.0 million and non-interest income of $14.6 million, partially offset by anincrease in non-interest expense of $15.9 million.  The 2005 results include the operations ofGeorge Mason, whereas the three and nine months ended September 30, 2004include the operations of George Mason only from the date of its acquisition, July 7,2004.  Net income attributable to GeorgeMason for the three and nine months ended September 30, 2005 was $2.1million and $5.3 million, respectively. For each of the three and nine months ended September 30, 2004,George Mason had a net loss of $193,000. In addition, Wilson/Bennett is included in the results of operationssince the date of its acquisition, June 9, 2005.  Net income attributable to Wilson/Bennett forthe three and nine months ended September 30, 2005 was $34,000 and$51,000, respectively.

 

Both basic and diluted earnings per sharewere $0.12 for the three months ended September 30, 2005.  For the three months ended September 30,2004, both basic and diluted earnings per share were $0.02.  Weighted average fully diluted sharesoutstanding for the three months ended September 30, 2005 were 24,631,402compared to 18,697,179 for the three months ended September 30, 2004.  Both basic and diluted earnings per sharewere $0.32 for the nine months ended September 30, 2005.  Basic and diluted earnings per share were$0.10 and $0.09, respectively, for the nine months ended September 30,2004.  Weighted average fully dilutedshares outstanding for the nine months ended September 30, 2005 were21,606,448 compared to 18,361,013 for the nine months ended September 30,2004.

 

Return on average assets for the three monthsended September 30, 2005 and 2004 was 0.82% and 0.13%, respectively.  Return on average assets for the nine monthsended September 30, 2005 and 2004 was 0.71% and 0.27%, respectively.  Return on average equity for the three monthsended September 30, 2005 and 2004 was 8.10% and 1.60%, respectively.  Return on average equity for the nine monthsended September 30, 2005 and 2004 was 7.53% and 2.48%, 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 net interest income is impactedprimarily by variations in the volume and mix of these assets and liabilities,as well as changes in interest rates. Net interest income for the three months ended September 30, 2005and 2004 was $10.1 million and $7.2 million, respectively, a period-to-periodincrease of $2.9 million, or 40.5%.  Netinterest income for the nine months ended September 30, 2005 and 2004 was$27.0 million and $17.0 million, respectively, a period-to-

 

22

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period increase of $10.0million, or 58.9%.  The increase in netinterest income is primarily the result of an increase in the average volume ofloans receivable and loans held for sale compared with the same periods of2004.  These increases were fundedthrough the increases in total deposits and other borrowed funds.

 

Our net interest margin for the three monthsended September 30, 2005 and 2004 was 2.92% and 2.55%, respectively.  Our net interest margin for the nine monthsended September 30, 2005 and 2004 was 2.89% and 2.74%, respectively.  This compares to a net interest margin of2.72% for the year ended December 31, 2004.  The increases in the net interest margin forthe three and nine months ended September 30, 2005 compared to the sameperiods of 2004 is a result of a higher volume of loans receivable and loansheld for sale and an increased rate of interest earned compared with theinterest rate paid on the increased volume of deposits and other borrowedfunds. We remain asset sensitive and therefore anticipate that net interestmargin will improve in a rising rate environment.  Tables 1 through 4 present an analysis ofaverage earning assets, interest bearing liabilities and demand deposits withrelated components of interest income and interest expense.

 

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

ThreeMonths Ended September 30, 2005, 2004 and 2003

(Inthousands)

 
| ** **                                               | ** ** | ** **  | ** ** | **2005**     | ** ** | ** ** | ** ** | ** **  | ** ** | **2004**     | ** ** | ** ** | ** ** | ** **  | ** ** | **2003**     | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|-------------|------------|--------------|------------|------------|------------|-------------|------------|--------------|------------|------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** |
| **Assets**                                               |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Interest-earning assets:                                 |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Loans (1):                                               |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Commercial and  industrial                               |       | $           | 67,519     |         | $          | 1,089      |       | 6.45        | %          | $            | 60,086     |       | $          | 767         |       | 5.11         | %          | $          | 45,983     |   | $ | 708 |   | 6.16 | % |
| Real estate -  commercial                                |       | 277,487     |       | 4,466        |       | 6.44       | %          | 190,371     |       | 2,945        |       | 6.19       | %          | 121,606     |       | 2,100        |       | 6.91       | %          |
| Real estate -  construction                              |       | 65,414      |       | 1,189        |       | 7.27       | %          | 58,291      |       | 848          |       | 5.82       | %          | 23,778      |       | 310          |       | 5.22       | %          |
| Real estate -  residential                               |       | 130,390     |       | 1,607        |       | 4.93       | %          | 44,558      |       | 653          |       | 5.86       | %          | 38,448      |       | 602          |       | 6.27       | %          |
| Home equity lines                                        |       | 68,624      |       | 927          |       | 5.36       | %          | 55,039      |       | 486          |       | 3.50       | %          | 34,873      |       | 289          |       | 3.29       | %          |
| Consumer                                                 |       | 4,760       |       | 87           |       | 7.31       | %          | 7,858       |       | 127          |       | 6.46       | %          | 8,465       |       | 157          |       | 7.36       | %          |
| Total loans                                              |       | 614,194     |       | 9,365        |       | 6.10       | %          | 416,203     |       | 5,826        |       | 5.60       | %          | 273,153     |       | 4,166        |       | 6.10       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Loans- held for sale, net                                |       | 468,808     |       | 6,101        |       | 5.21       | %          | 369,623     |       | 3,268        |       | 3.54       | %          | —      |       | —       |       | 0.00       | %          |
| Investment  securities available-for-sale                |       | 149,207     |       | 1,414        |       | 3.79       | %          | 165,721     |       | 1,536        |       | 3.71       | %          | 127,609     |       | 754          |       | 2.36       | %          |
| Investment  securities held-to-maturity                  |       | 124,632     |       | 1,197        |       | 3.84       | %          | 154,229     |       | 1,432        |       | 3.71       | %          | 121,343     |       | 1,207        |       | 3.98       | %          |
| Other investments                                        |       | 6,718       |       | 56           |       | 3.31       | %          | 8,163       |       | 78           |       | 3.82       | %          | 3,496       |       | 35           |       | 4.00       | %          |
| Federal funds sold                                       |       | 23,863      |       | 208          |       | 3.46       | %          | 14,323      |       | 49           |       | 1.37       | %          | 6,915       |       | 17           |       | 0.98       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Total  interest-earning assets and interest income       |       | 1,387,422   |       | 18,341       |       | 5.29       | %          | 1,128,262   |       | 12,189       |       | 4.32       | %          | 532,516     |       | 6,179        |       | 4.64       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Non-interest earning assets:                             |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Cash and due from  banks                                 |       | 13,963      |       |         |       |       |       | 14,904      |       |         |       |       |       | 8,380       |       |         |       |       |       |
| Premises and  equipment, net                             |       | 17,525      |       |         |       |       |       | 14,727      |       |         |       |       |       | 5,045       |       |         |       |       |       |
| Goodwill and  intangibles, net                           |       | 20,649      |       |         |       |       |       | 15,129      |       |         |       |       |       | 646         |       |         |       |       |       |
| Accrued interest  and other assets                       |       | 21,119      |       |         |       |       |       | 11,286      |       |         |       |       |       | 2,583       |       |         |       |       |       |
| Allowance for  loan losses                               |       | (7,378      | )          |         |       |       |       | (4,864      | )          |         |       |       |       | (3,650      | )          |         |       |       |       |
| Total assets                                             |       | $           | 1,453,300  |         |       |       |       |        | $          | 1,179,444    |       |       |       |        |       | $            | 545,520    |       |       |   |   |   |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| **Liabilities  and Shareholders’ Equity**           |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Interest - bearing liabilities:                          |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Interest - bearing deposits:                             |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Interest checking                                        |       | 109,030     |       | 316          |       | 1.15       | %          | 148,168     |       | 486          |       | 1.30       | %          | 153,681     |       | 538          |       | 1.39       | %          |
| Money markets                                            |       | 223,210     |       | 1,570        |       | 2.81       | %          | 28,065      |       | 42           |       | 0.60       | %          | 28,765      |       | 43           |       | 0.59       | %          |
| Statement savings                                        |       | 9,979       |       | 29           |       | 1.14       | %          | 7,827       |       | 16           |       | 0.83       | %          | 5,741       |       | 8            |       | 0.53       | %          |
| Certificates of  deposit                                 |       | 555,193     |       | 4,867        |       | 3.51       | %          | 477,936     |       | 3,124        |       | 2.61       | %          | 179,540     |       | 1,473        |       | 3.25       | %          |
| Total interest -  bearing deposits                       |       | 897,412     |       | 6,782        |       | 3.00       | %          | 661,996     |       | 3,668        |       | 2.22       | %          | 367,727     |       | 2,062        |       | 2.22       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Other borrowed funds                                     |       | 258,735     |       | 1,448        |       | 2.22       | %          | 315,712     |       | 1,327        |       | 1.68       | %          | 63,882      |       | 279          |       | 1.74       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Total  interest-bearing liabilities and interest expense |       | 1,156,147   |       | 8,230        |       | 2.82       | %          | 977,708     |       | 4,995        |       | 2.04       | %          | 431,609     |       | 2,341        |       | 2.15       | %          |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Noninterest-bearing liabilities:                         |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Demand deposits                                          |       | 124,553     |       |         |       |       |       | 94,995      |       |         |       |       |       | 72,819      |       |         |       |       |       |
| Other liabilities                                        |       | 25,202      |       |         |       |       |       | 10,726      |       |         |       |       |       | 1,596       |       |         |       |       |       |
| Preferred  shareholders’ equity                     |       | —      |       |         |       |       |       | —      |       |         |       |       |       | 6,824       |       |         |       |       |       |
| Common  shareholders’ equity                        |       | 147,398     |       |         |       |       |       | 96,015      |       |         |       |       |       | 32,672      |       |         |       |       |       |
| Total liabilities  and shareholders’ equity         |       | $           | 1,453,300  |         |       |       |       |        | $          | 1,179,444    |       |       |       |        |       | $            | 545,520    |       |       |   |   |   |
|                                                     |       |        |       |         |       |       |       |        |       |         |       |       |       |        |       |         |       |       |       |
| Net interest  income and net interest margin (2)         |       |        |       | $            | 10,111     |       | 2.92       | %           |       |         | $          | 7,194      |       | 2.55        | %          |         |       | $          | 3,838      |   | 2.88 | % |

 

----

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

(2)          Wedo not have investments that have tax benefit attributes; therefore, there areno tax equivalent adjustments to our net interest income.

 

24

----

 

**Rate and Volume Analysis**

ThreeMonths Ended September 30, 2005 and 2004

(Inthousands)

 
| ** **                                | ** ** | **Three Months Ended September 30,  2005 Compared to 2004** | ** ** | **Three Months Ended September 30,  2004 Compared to 2003** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Average**                                                      | ** ** | **Average**                                                      | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume**                                                       | ** ** | **Rate**                                                         | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                 |       | $                                                                | 95         |                                                             | $          | 227 |   | $ | 322 |   | $ | 217 |   | $ | (158 | ) | $ | 59 |   |
| Real estate - commercial                  |       | 1,348                                                            |       | 173                                                              |       | 1,521 |   | 1,187 |   | (342 | ) | 845 |   |
| Real estate - construction                |       | 104                                                              |       | 237                                                              |       | 341 |   | 451 |   | 87 |   | 538 |   |
| Real estate - residential                 |       | 1,258                                                            |       | (304                                                             | )          | 954 |   | 97 |   | (46 | ) | 51 |   |
| Home equity lines                         |       | 119                                                              |       | 322                                                              |       | 441 |   | 167 |   | 30 |   | 197 |   |
| Consumer                                  |       | (50                                                              | )          | 10                                                               |       | (40 | ) | (11 | ) | (19 | ) | (30 | ) |
| Total loans                               |       | 2,874                                                            |       | 665                                                              |       | 3,539 |   | 2,108 |   | (448 | ) | 1,660 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Loans held  for sale, net                 |       | 877                                                              |       | 1,956                                                            |       | 2,833 |   | 3,268 |   | — |   | 3,268 |   |
| Investment  securities available-for-sale |       | (153                                                             | )          | 31                                                               |       | (122 | ) | 225 |   | 557 |   | 782 |   |
| Investment  securities held-to-maturity   |       | (275                                                             | )          | 40                                                               |       | (235 | ) | 327 |   | (102 | ) | 225 |   |
| Other  investments                        |       | (13                                                              | )          | (9                                                               | )          | (22 | ) | 47 |   | (4 | ) | 43 |   |
| Federal  funds sold                       |       | 33                                                               |       | 126                                                              |       | 159 |   | 18 |   | 14 |   | 32 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Total interest income                     |       | 3,343                                                            |       | 2,809                                                            |       | 6,152 |   | 5,993 |   | 17 |   | 6,010 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:             |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | (128                                                             | )          | (42                                                              | )          | (170 | ) | (20 | ) | (32 | ) | (52 | ) |
| Money markets                             |       | 288                                                              |       | 1,240                                                            |       | 1,528 |   | (1 | ) | 0 |   | (1 | ) |
| Statement savings                         |       | 4                                                                |       | 9                                                                |       | 13 |   | 3 |   | 5 |   | 8 |   |
| Certificates of deposit                   |       | 502                                                              |       | 1,241                                                            |       | 1,743 |   | 2,435 |   | (784 | ) | 1,651 |   |
| Total interest - bearing deposits         |       | 666                                                              |       | 2,448                                                            |       | 3,114 |   | 2,417 |   | (811 | ) | 1,606 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Other  borrowed funds                     |       | (235                                                             | )          | 356                                                              |       | 121 |   | 832 |   | 216 |   | 1,048 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Total interest expense                    |       | 431                                                              |       | 2,804                                                            |       | 3,235 |   | 3,249 |   | (595 | ) | 2,654 |   |
|                                      |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Net interest  income (2)                  |       | $                                                                | 2,912      |                                                             | $          | 5 |   | $ | 2,917 |   | $ | 2,744 |   | $ | 612 |   | $ | 3,356 |   |

 

----

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

(2)          Wedo not have investments that have tax benefit attributes; therefore, there areno tax equivalent adjustments to our net interest income.

 

25

----

 

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

NineMonths Ended September 30, 2005, 2004 and 2003

(Inthousands)

 
| ** **                                               | ** ** | **2005**    | ** ** | **2004**     | ** ** | **2003**   | ** ** |
|----------------------------------------------------------|------------|-------------|------------|--------------|------------|------------|------------|
| ** **                                               | ** ** | ** **  | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Average** | ** ** | **Income/**  | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** | **Average** | ** ** | **Income/** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **Balance** | ** ** | **Expense**  | ** ** | **Rate**   | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                 |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1):                                               |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and  industrial                               |       | $           | 65,077     |         | $          | 2,898      |       | 5.94 | % | $ | 58,937 |   | $ | 2,318 |   | 5.24 | % | $ | 49,883 |   | $ | 2,356 |   | 6.30 | % |
| Real estate -  commercial                                |       | 249,501     |       | 11,738       |       | 6.27       | %          | 159,906 |   | 7,508 |   | 6.26 | % | 117,416 |   | 6,197 |   | 7.04 | % |
| Real estate -  construction                              |       | 67,582      |       | 3,451        |       | 6.81       | %          | 48,651 |   | 2,053 |   | 5.63 | % | 15,899 |   | 662 |   | 5.55 | % |
| Real estate -  residential                               |       | 108,084     |       | 4,201        |       | 5.18       | %          | 43,312 |   | 1,856 |   | 5.71 | % | 36,663 |   | 1,783 |   | 6.49 | % |
| Home equity lines                                        |       | 64,884      |       | 2,418        |       | 4.98       | %          | 50,316 |   | 1,255 |   | 3.32 | % | 31,729 |   | 793 |   | 3.34 | % |
| Consumer                                                 |       | 5,195       |       | 273          |       | 7.03       | %          | 9,184 |   | 435 |   | 6.31 | % | 9,063 |   | 507 |   | 7.48 | % |
| Total loans                                              |       | 560,323     |       | 24,979       |       | 5.94       | %          | 370,306 |   | 15,425 |   | 5.55 | % | 260,653 |   | 12,298 |   | 6.29 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale, net                                 |       | 382,603     |       | 14,117       |       | 4.92       | %          | 124,175 |   | 3,268 |   | 3.51 | % | — |   | — |   | 0.00 | % |
| Investment securities available-for-sale                 |       | 154,356     |       | 4,376        |       | 3.78       | %          | 163,009 |   | 4,360 |   | 3.57 | % | 168,735 |   | 4,047 |   | 3.20 | % |
| Investment securities held-to-maturity                   |       | 130,479     |       | 3,757        |       | 3.84       | %          | 154,025 |   | 4,260 |   | 3.69 | % | 40,892 |   | 1,207 |   | 3.94 | % |
| Other investments                                        |       | 6,141       |       | 183          |       | 3.97       | %          | 5,464 |   | 162 |   | 3.95 | % | 2,648 |   | 90 |   | 4.53 | % |
| Federal funds sold                                       |       | 15,148      |       | 346          |       | 3.06       | %          | 11,695 |   | 96 |   | 1.09 | % | 11,601 |   | 98 |   | 1.12 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets and interest income       |       | 1,249,050   |       | 47,758       |       | 5.10       | %          | 828,674 |   | 27,571 |   | 4.44 | % | 484,529 |   | 17,740 |   | 4.88 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                             |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                 |       | 8,906       |       |         |       |       |       | 12,050 |   |   |   |   |   | 10,376 |   |   |   |   |   |
| Premises and  equipment, net                             |       | 17,288      |       |         |       |       |       | 9,893 |   |   |   |   |   | 5,091 |   |   |   |   |   |
| Goodwill and  other intangibles, net                     |       | 17,613      |       |         |       |       |       | 5,100 |   |   |   |   |   | 646 |   |   |   |   |   |
| Accrued interest  and other assets                       |       | 13,557      |       |         |       |       |       | 7,887 |   |   |   |   |   | 3,699 |   |   |   |   |   |
| Allowance for  loan losses                               |       | (6,643      | )          |         |       |       |       | (4,564 | ) |   |   |   |   | (3,511 | ) |   |   |   |   |
| Total assets                                             |       | $           | 1,299,771  |         |       |       |       |   | $ | 859,040 |   |   |   |   |   | $ | 500,830 |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**            |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                          |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                             |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                        |       | 123,055     |       | 1,106        |       | 1.20       | %          | 151,448 |   | 1,520 |   | 1.34 | % | 146,335 |   | 1,841 |   | 1.68 | % |
| Money markets                                            |       | 144,187     |       | 2,852        |       | 2.64       | %          | 26,418 |   | 116 |   | 0.58 | % | 26,588 |   | 168 |   | 0.84 | % |
| Statement savings                                        |       | 9,279       |       | 75           |       | 1.09       | %          | 7,535 |   | 38 |   | 0.67 | % | 5,210 |   | 27 |   | 0.69 | % |
| Certificates of  deposit                                 |       | 543,859     |       | 12,956       |       | 3.19       | %          | 330,802 |   | 6,774 |   | 2.73 | % | 175,732 |   | 4,492 |   | 3.42 | % |
| Total interest -  bearing deposits                       |       | 820,380     |       | 16,989       |       | 2.77       | %          | 516,203 |   | 8,448 |   | 2.18 | % | 353,865 |   | 6,528 |   | 2.47 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                     |       | 223,562     |       | 3,711        |       | 2.22       | %          | 161,866 |   | 2,098 |   | 1.73 | % | 35,980 |   | 470 |   | 1.74 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities and interest expense |       | 1,043,942   |       | 20,700       |       | 2.65       | %          | 678,069 |   | 10,546 |   | 2.07 | % | 389,845 |   | 6,998 |   | 2.40 | % |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                         |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                          |       | 113,634     |       |         |       |       |       | 82,839 |   |   |   |   |   | 69,087 |   |   |   |   |   |
| Other liabilities                                        |       | 20,195      |       |         |       |       |       | 4,857 |   |   |   |   |   | 1,833 |   |   |   |   |   |
| Preferred  shareholders’ equity                     |       | —      |       |         |       |       |       | 2,123 |   |   |   |   |   | 6,824 |   |   |   |   |   |
| Common shareholders’  equity                        |       | 122,000     |       |         |       |       |       | 91,152 |   |   |   |   |   | 33,241 |   |   |   |   |   |
| Total liabilities and shareholders’ equity          |       | $           | 1,299,771  |         |       |       |       |   | $ | 859,040 |   |   |   |   |   | $ | 500,830 |   |   |   |   |   |
|                                                     |       |        |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income and net interest margin (2)         |       |        |       | $            | 27,058     |       | 2.89       | % |   |   | $ | 17,025 |   | 2.74 | % |   |   | $ | 10,742 |   | 2.96 | % |

 

----

(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)          Wedo not have investments that have tax benefit attributes; therefore, there areno tax equivalent adjustments to our net interest income.

 

26

----

 

**Rate and Volume Analysis**Nine Months Ended September 30,2005 and 2004(In thousands)

 
| ** **                                | ** ** | **Nine Months Ended September 30,  2005 Compared to 2004** | ** ** | **Nine Months Ended September 30,  2004 Compared to 2003** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                | ** ** | **Average**                                                     | ** ** | **Average**                                                     | ** ** | **Increase** | ** ** | **Average** | ** ** | **Average** | ** ** | **Increase** | ** ** |
| ** **                                | ** ** | **Volume**                                                      | ** ** | **Rate**                                                        | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| **Interest  income:**                     |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Loans (1):                                |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Commercial and industrial                 |       | $                                                               | 241        |                                                            | $          | 339 |   | $ | 580 |   | $ | 428 |   | $ | (466 | ) | $ | (38 | ) |
| Real estate - commercial                  |       | 4,207                                                           |       | 23                                                              |       | 4,230 |   | 2,243 |   | (932 | ) | 1,311 |   |
| Real estate - construction                |       | 799                                                             |       | 599                                                             |       | 1,398 |   | 1,364 |   | 27 |   | 1,391 |   |
| Real estate - residential                 |       | 2,776                                                           |       | (431                                                            | )          | 2,345 |   | 327 |   | (254 | ) | 73 |   |
| Home equity lines                         |       | 360                                                             |       | 803                                                             |       | 1,163 |   | 469 |   | (7 | ) | 462 |   |
| Consumer                                  |       | (189                                                            | )          | 27                                                              |       | (162 | ) | 7 |   | (79 | ) | (72 | ) |
| Total loans                               |       | 8,194                                                           |       | 1,360                                                           |       | 9,554 |   | 4,838 |   | (1,711 | ) | 3,127 |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Loans held  for sale, net                 |       | 6,801                                                           |       | 4,048                                                           |       | 10,849 |   | 3,268 |   | — |   | 3,268 |   |
| Investment  securities available-for-sale |       | (231                                                            | )          | 247                                                             |       | 16 |   | (137 | ) | 450 |   | 313 |   |
| Investment  securities held-to-maturity   |       | (651                                                            | )          | 148                                                             |       | (503 | ) | 3,339 |   | (286 | ) | 3,053 |   |
| Other  investments                        |       | 20                                                              |       | 1                                                               |       | 21 |   | 96 |   | (24 | ) | 72 |   |
| Federal  funds sold                       |       | 28                                                              |       | 222                                                             |       | 250 |   | 1 |   | (3 | ) | (2 | ) |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Total interest income                     |       | 14,161                                                          |       | 6,026                                                           |       | 20,187 |   | 11,405 |   | (1,574 | ) | 9,831 |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| **Interest  expense:**                    |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest -  bearing deposits:             |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest checking                         |       | (287                                                            | )          | (127                                                            | )          | (414 | ) | 65 |   | (386 | ) | (321 | ) |
| Money markets                             |       | 515                                                             |       | 2,221                                                           |       | 2,736 |   | (1 | ) | (51 | ) | (52 | ) |
| Statement savings                         |       | 8                                                               |       | 29                                                              |       | 37 |   | 12 |   | (1 | ) | 11 |   |
| Certificates of deposit                   |       | 4,335                                                           |       | 1,847                                                           |       | 6,182 |   | 3,988 |   | (1,706 | ) | 2,282 |   |
| Total interest - bearing deposits         |       | 4,571                                                           |       | 3,970                                                           |       | 8,541 |   | 4,064 |   | (2,144 | ) | 1,920 |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Other  borrowed funds                     |       | 793                                                             |       | 820                                                             |       | 1,613 |   | 1,376 |   | 252 |   | 1,628 |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Total interest expense                    |       | 5,364                                                           |       | 4,790                                                           |       | 10,154 |   | 5,440 |   | (1,892 | ) | 3,548 |   |
|                                      |       |                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |
| Net interest  income (2)                  |       | $                                                               | 8,797      |                                                            | $          | 1,236 |   | $ | 10,033 |   | $ | 5,965 |   | $ | 318 |   | $ | 6,283 |   |

 

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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)          Wedo not have investments that have tax benefit attributes; therefore, there areno tax equivalent adjustments to our net interest income.

 

27

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The provision for loan losses for the threemonths ended September 30, 2005 and 2004 was $500,000 and $529,000,respectively.  For the nine months ended September 30,2005 and 2004, the provision for loan losses was $1.9 million and $918,000,respectively.  The increase in provisionexpense for the nine months ended September 30, 2005 compared to the ninemonths ended September 30, 2004 is primarily the result of the netincrease of $142.3 million in the loans receivable portfolio during the firstnine months of 2005.  The allowance forloan losses at September 30, 2005 and December 31, 2004 was $7.7million and $5.9 million, respectively. Our allowance for loan losses ratio to loans receivable, net was 1.22%at September 30, 2005 and 1.20% at December 31, 2004.  We continued to experience strong loanquality with annualized net charged-off loans equal to 0.01% of total loans forthe nine months ended September 30, 2005, compared to 0.04% for the sameperiod of 2004.  Non-performing loanswere equal to 0.03% and 0.11% of total loans receivable at September 30,2005 and December 31, 2004, 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 September 30,2005, the total remaining balances on these participations were approximately$2.1 million and represented approximately 270 loans secured by various typesof recreational vehicles. The borrowers are located in several southern statesincluding Louisiana. Hurricane and other weather-related problems havedisrupted the operations of the New Orleans bank, curtailed mail delivery andother communications in the area and caused wide-spread destruction in the gulfcoast region. The Company has established an approximately $100,000 allowancefor loan losses on these loans as of September 30, 2005.  This allowance amount is based upon the bestinformation that the Company was able to obtain from the New Orleans bank andincluded an analysis of the locations of the borrowers, with particularemphasis on areas known to be severely impacted by the weather, the borrowers’recent payment histories and estimate of likely insurance recoveries, whereapplicable.  Changes to the allowance forloan losses may be required as additional information becomes known.

 

Additional information on the allowance forloan losses, its allocation to the loans receivable portfolio and informationon nonperforming loans can be found in Tables 5, 6 and 7.

 

28

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**Allowancefor Loan Losses**

Nine Months Ended September 30,2005 and 2004

(In thousands)

 
| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Beginning  balance, January 1 |       | $        | 5,878      |     | $          | 4,344 |   |
|                               |       |     |       |     |       |
| Provision  for loan losses         |       | 1,869    |       | 918      |       |
|                               |       |     |       |     |       |
| Loans  charged off:                |       |     |       |     |       |
| Commercial and industrial          |       | (120     | )          | (101     | )          |
| Consumer                           |       | (8       | )          | (5       | )          |
| Total loans charged off            |       | (128     | )          | (106     | )          |
|                               |       |     |       |     |       |
| Recoveries:                        |       |     |       |     |       |
| Commercial and industrial          |       | 75       |       | 10       |       |
| Consumer                           |       | 12       |       | 2        |       |
| Total recoveries                   |       | 87       |       | 12       |       |
|                               |       |     |       |     |       |
| Net (charge  offs) recoveries      |       | (41      | )          | (94      | )          |
|                               |       |     |       |     |       |
| Ending  balance                    |       | $        | 7,706      |     | $          | 5,168 |   |

 
| ** **                                                  | ** ** | **At  September 30,  2005** | ** ** | **At  December 31,  2004** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Loans:                                                      |       |                             |       |                            |       |
| Balance at period end                                       |       | $                                | 632,148    |                            | $          | 489,896 |   |
| Allowance for loan losses to loans  receivable, net of fees |       | 1.22                             | %          | 1.20                            | %          |
| Annualized net charge-offs to average loans  receivable     |       | 0.01                             | %          | 0.02                            | %          |
|                                                             |            |                                  |            |                                 |            |  |  |

 

29

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**Allocationof the Allowance for Loan Losses**

At September 30,2005 and December 31, 2004

(In thousands)

 
| ** **                       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **Allocation**          | ** ** | **% of Total***        | ** ** | **Allocation** | ** ** | **% of Total*** | ** ** |
| Commercial                       |       | $                       | 1,169      |                   | 10.22      | % | $ | 963 |   | 11.53 | % |
| Real estate  - commercial        |       | 3,590                   |       | 46.06                  | %          | 2,732 |   | 44.88 | % |
| Real estate  - construction      |       | 757                     |       | 11.01                  | %          | 768 |   | 14.18 | % |
| Real estate  - residential       |       | 1,288                   |       | 20.90                  | %          | 692 |   | 15.69 | % |
| Home equity  lines               |       | 747                     |       | 11.12                  | %          | 612 |   | 12.32 | % |
| Consumer                         |       | 155                     |       | 0.69                   | %          | 111 |   | 1.40 | % |
|                             |       |                    |       |                   |       |   |   |   |   |
| Total  allowance for loan losses |       | $                       | 7,706      |                   | 100.00     | % | $ | 5,878 |   | 100.00 | % |

 

----

* Percentage of loan type to the total loan portfolio.

 

30

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**NonperformingLoans Receivable**

At September 30, 2005and December 31, 2004

(In thousands)

 
| ** **                                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Nonaccruing  loans                            |       | $                            | 220        |                        | $          | 547 |   |
|                                          |       |                         |       |                        |       |
| Loans  contractually past-due 90 days or more |       | —                       |       | —                      |       |
|                                          |       |                         |       |                        |       |
| Troubled  debt restructurings                 |       | —                       |       | —                      |       |
| Total  nonperforming loans receivable         |       | $                            | 220        |                        | $          | 547 |   |

 

31

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Non-interest income includes,among other things, service charges on deposits and loans, gains on the sale ofloans held for sale, investment fee income, and management fee income, and continuesto be an increasingly important factor in our operating results.  Non-interest income for the three monthsended September 30, 2005 and 2004 was $7.3 million and $2.8 million,respectively, a period-to-period increase of $4.5 million, or 164%.  Non-interest income for the nine months endedSeptember 30, 2005 and 2004 was $18.8 million and $4.2 million,respectively, a period-to-period increase of $14.6 million, or 345%.  The increase in non-interest income isprimarily attributable to increases in net gains on sales of loans by GeorgeMason of $3.4 million and $10.9 million for the three and nine months ended September 30,2005, respectively, and increases in management fee income of $167,000 and $1.7million for the three and nine months ended September 30, 2005,respectively. Management fee income represents the income earned for servicesprovided by George Mason to other mortgage banking companies owned by localhome builders.  Included in the net gainson sale of mortgage loans are any origination, underwriting, and discountpoints and other funding fees received and deferred at loan origination.  Costs include direct costs associated with theloan origination, such as commissions and salaries that are deferred at thetime of origination.

 

Service charges on depositaccounts increased $52,000 to $348,000 for the three months ended September 30,2005 compared to the same period of 2004. For the nine months ended September 30, 2005, service charges ondeposit accounts increased $160,000 to $958,000, compared to the same period of2004.  Loan service charge income increased$642,000 to $771,000 for the three months ended September 30, 2005,compared to $129,000 for the same period of 2004.  For the nine months ended September 30,2005, loan service charge income increased $1.6 million to $2.0 millioncompared to $414,000 for the same year to date period of 2004.  These increases are primarily related to the operationsof George Mason.

 

Investment fee income increasedto $497,000 for the three months ended September 30, 2005 compared to $150,000for the same three month period of 2004. For the nine months ended September 30, 2005, investment fee incomeincreased $449,000, to $947,000, compared to $498,000 for the same nine monthperiod of 2004.  The increases ininvestment fee income are primarily attributable to the acquisition ofWilson/Bennett in June 2005.

 

Non-interest expense includes, among otherthings, salaries and benefits, occupancy, professional fees, depreciation, dataprocessing, telecommunications and miscellaneous expenses.  Non-interest expense for the three monthsended September 30, 2005 was $12.4 million, compared to $8.9 million forthe same period of 2004, an increase of $3.5 million.  For the nine months ended September 30,2005, non-interest expense increased $15.9 million to $33.6 million, comparedto $17.7 million for the same nine month period of 2004.  The increases are attributable to the acquisitionof George Mason in July 2004 and our branch office expansion during thepast twelve months.  Expenses related tothe branch expansion are primarily represented in the increases in our salariesand benefits expense, occupancy expense and depreciation expense.  We expect non-interest expense to continue toincrease as we continue our branch expansion in 2005.  We currently plan to open an additional branchduring the remainder of 2005.  Theacquisition of Wilson/Bennett in June 2005 has also resulted in increasednon-interest expense.

 

The effective tax rate for the thirdquarter of 2005 was 34.5%, compared to 30.9% for the same period of 2004.  For the nine months ended September 30,2005, the effective tax rate was 33.6%, compared to 32.9% for the same periodof 2004.  We recorded a provision forincome tax expense of $1.6 million and $172,000 for the three months ended September 30,2005 and 2004, respectively.  For the ninemonths ended September 30, 2005 and 2004, the provision for income 

 

32

----

 

taxexpense was $3.5 million and $850,000, respectively.  See, also, “Critical Accounting Policies –Valuation of Deferred Tax Assets.”

 

**Statements of Condition**

 

Total assets were $1.54 billion at September 30,2005, compared to $1.21 billion at December 31, 2004, an increase of $328.1million or 27.1%.  This growth was drivenprimarily by increases in loans held for sale and loans receivable, which werefunded by growth in our deposits and the proceeds from our secondary offeringduring the second quarter of 2005.

 

Investment securities were $292.6 million at September 30,2005, compared to $289.5 million at December 31, 2004, an increase of $3.1million.  The investment portfolioconsists of investment securities available-for-sale and investment securitiesheld-to-maturity.  Investment securitiesavailable-for-sale are those securities that we intend to hold for anindefinite period of time, but not necessarily until maturity.  These securities are carried at fair valueand may be sold as part of an asset/liability strategy, liquidity management orregulatory capital management.   Investmentsecurities held-to-maturity are those securities that we have the intent andability to hold to maturity and are carried at amortized cost.  At September 30, 2005, investmentsecurities available-for-sale were $171.8 million and investment securitiesheld-to-maturity were $120.8 million. See Table 8 for additional information on our investment securitiesportfolio.

 

**InvestmentSecurities**

At September 30, 2005 and December 31,2004

(In thousands)

 
| ** **                                                         | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Average** | ** ** |
|--------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| ** **                                                         | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Available-for-sale  at September 30, 2005**                 | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** |
| Obligations  of U.S. government-sponsored agencies and enterprises |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 40,780     |       | $          | 40,741      |       | 4.74 | % |
| Five to ten years                                                  |       | 2,000         |       | 1,987      |       | 4.00        | %          |
| Total U.S. government-sponsored agencies                           |       | $             | 42,780     |       | $          | 42,728      |       | 4.71 | % |
|                                                               |       |          |       |       |       |        |       |
| Mortgage-backed  securities*                                       |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 5,819      |       | $          | 5,731       |       | 3.98 | % |
| Five to ten years                                                  |       | 9,321         |       | 9,155      |       | 3.87        | %          |
| After ten years                                                    |       | 114,445       |       | 112,228    |       | 4.14        | %          |
| Total mortgage-backed securities                                   |       | $             | 129,585    |       | $          | 127,114     |       | 4.12 | % |
|                                                               |       |          |       |       |       |        |       |
| Treasury  bonds                                                    |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 2,019      |       | $          | 1,991       |       | 2.63 | % |
| Total treasury bonds                                               |       | $             | 2,019      |       | $          | 1,991       |       | 2.63 | % |
| Total investment securities  available-for-sale                    |       | $             | 174,384    |       | $          | 171,833     |       | 4.25 | % |

 
| ** **                                                         | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Average** | ** ** |
|--------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| ** **                                                         | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Held-to-maturity  at September 30, 2005**                   | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** |
| Obligations  of U.S. government-sponsored agencies and enterprises |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 9,500      |       | $          | 9,287       |       | 3.52 | % |
| Five to ten years                                                  |       | 13,020        |       | 12,881     |       | 4.35        | %          |
| After ten years                                                    |       | 3,000         |       | 2,978      |       | 4.20        | %          |
| Total U.S. government-sponsored agencies                           |       | $             | 25,520     |       | $          | 25,146      |       | 4.03 | % |
|                                                               |       |          |       |       |       |        |       |
| Mortgage-backed  securities*                                       |       |          |       |       |       |        |       |
| Five to ten years                                                  |       | $             | 8,490      |       | $          | 8,387       |       | 4.13 | % |
| After ten years                                                    |       | 78,779        |       | 77,452     |       | 4.18        | %          |
| Total mortgage-backed securities                                   |       | $             | 87,269     |       | $          | 85,839      |       | 4.18 | % |
|                                                               |       |          |       |       |       |        |       |
| Corporate  bonds                                                   |       |          |       |       |       |        |       |
| After ten years                                                    |       | $             | 8,005      |       | $          | 7,890       |       | 4.21 | % |
| Total corporate bonds                                              |       | $             | 8,005      |       | $          | 7,890       |       | 4.21 | % |
| Total investment securities  held-to-maturity                      |       | $             | 120,794    |       | $          | 118,875     |       | 4.15 | % |
|                                                               |       |          |       |       |       |        |       |
| Total investment securities                                        |       | $             | 295,178    |       | $          | 290,708     |       | 4.21 | % |

 

----

* Based on contractual maturities.

 

33

----

 
| ** **                                                         | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Average** | ** ** |
|--------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| ** **                                                         | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Available-for-sale  at December 31, 2004**                  | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** |
| Obligations  of U.S. government-sponsored agencies and enterprises |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 3,000      |       | $          | 2,947       |       | 3.33 | % |
| Five to ten years                                                  |       | 3,000         |       | 3,009      |       | 4.46        | %          |
| Total U.S. government-sponsored agencies                           |       | $             | 6,000      |       | $          | 5,956       |       | 3.89 | % |
|                                                               |       |          |       |       |       |        |       |
| Mortgage-backed  securities*                                       |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 2,161      |       | $          | 2,131       |       | 3.59 | % |
| Five to ten years                                                  |       | 14,662        |       | 14,603     |       | 3.96        | %          |
| After ten years                                                    |       | 128,477       |       | 126,846    |       | 3.97        | %          |
| Total mortgage-backed securities                                   |       | $             | 145,300    |       | $          | 143,580     |       | 3.96 | % |
|                                                               |       |          |       |       |       |        |       |
| Treasury  bonds                                                    |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 2,031      |       | $          | 2,018       |       | 2.63 | % |
| Total treasury bonds                                               |       | $             | 2,031      |       | $          | 2,018       |       | 2.63 | % |
| Total investment securities  available-for-sale                    |       | $             | 153,331    |       | $          | 151,554     |       | 3.94 | % |

 
| ** **                                                         | ** ** | **Amortized** | ** ** | **Fair**   | ** ** | **Average** | ** ** |
|--------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|
| ** **                                                         | ** ** | **Cost**      | ** ** | **Value**  | ** ** | **Yield**   | ** ** |
| **Held-to-maturity  at December 31, 2004**                    | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** |
| Obligations  of U.S. government-sponsored agencies and enterprises |       |          |       |       |       |        |       |
| One to five years                                                  |       | $             | 6,500      |       | $          | 6,427       |       | 3.36 | % |
| Five to ten years                                                  |       | 16,018        |       | 15,901     |       | 4.28        | %          |
| After ten years                                                    |       | 2,999         |       | 2,962      |       | 4.22        | %          |
| Total U.S. government-sponsored agencies                           |       | $             | 25,517     |       | $          | 25,290      |       | 4.03 | % |
|                                                               |       |          |       |       |       |        |       |
| Mortgage-backed  securities*                                       |       |          |       |       |       |        |       |
| Five to ten years                                                  |       | $             | 10,392     |       | $          | 10,406      |       | 3.83 | % |
| After ten years                                                    |       | 94,039        |       | 92,990     |       | 4.04        | %          |
| Total mortgage-backed securities                                   |       | $             | 104,431    |       | $          | 103,396     |       | 4.02 | % |
|                                                               |       |          |       |       |       |        |       |
| Corporate  bonds                                                   |       |          |       |       |       |        |       |
| After ten years                                                    |       | $             | 8,005      |       | $          | 7,923       |       | 4.21 | % |
| Total corporate bonds                                              |       | $             | 8,005      |       | $          | 7,923       |       | 4.21 | % |
| Total investment securities  held-to-maturity                      |       | $             | 137,953    |       | $          | 136,609     |       | 4.03 | % |
|                                                               |       |          |       |       |       |        |       |
| Total investment securities                                        |       | $             | 291,284    |       | $          | 288,163     |       | 3.98 | % |

----

* Based on contractual maturities.

 

Loans receivable, net of deferred fees andcosts, increased by $142.2 million, or 29.0%, to $632.1 million at September 30,2005 from $489.9 million at December 31, 2004 (see Table 9 for details onthe loans receivable portfolio). We experienced growth in our commercial andindustrial, commercial real estate, residential real estate and home equityloan portfolios.  We expect continuedgrowth within these loan categories over the next quarter of 2005 due to ourincreased legal lending limit of $18.7 million and the volume of loans we havescheduled for funding.  Realestate-construction loans decreased slightly by $117,000 and consumer loansdecreased $2.4 million to $4.4 million from December 31, 2004 to September 30,2005.  In addition, we had $454.7 millionin loans held for sale, net at September 30, 2005, compared to $365.5million at December 31, 2004, an increase of $89.2 million.  Loans that are held for sale, net are valuedat the lower of cost or market value.

 

34

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**LoansReceivable**

At September 30, 2005 and December 31,2004

(In thousands)

 
| ** **                       | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                             |       |                        |       |                       |       |   |   |   |   |
| Commercial                       |       | $                           | 64,664     |                       | 10.22      | % | $ | 56,512 |   | 11.53 | % |
| Real estate  - commercial        |       | 291,307                     |       | 46.06                      | %          | 220,012 |   | 44.88 | % |
| Real estate -  construction      |       | 69,652                      |       | 11.01                      | %          | 69,535 |   | 14.18 | % |
| Real estate -  residential       |       | 132,159                     |       | 20.90                      | %          | 76,932 |   | 15.69 | % |
| Home equity  lines               |       | 70,320                      |       | 11.12                      | %          | 60,408 |   | 12.32 | % |
| Consumer                         |       | 4,381                       |       | 0.69                       | %          | 6,816 |   | 1.40 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Gross loans                      |       | $                           | 632,483    |                       | 100.00     | % | $ | 490,215 |   | 100.00 | % |
|                             |       |                        |       |                       |       |   |   |   |   |
| Less: net  deferred fees         |       | (335                        | )          |                       |       | (319 | ) |   |   |
| Less:  allowance for loan losses |       | (7,706                      | )          |                       |       | (5,878 | ) |   |   |
|                             |       |                        |       |                       |       |   |   |   |   |
| Loans  receivable, net           |       | $                           | 624,442    |                       |       |   | $ | 484,018 |   |   |   |

 

Total deposits increased $270.2 million, or 32.8%,to $1.09 billion at September 30, 2005, compared to $824.2 million at December 31,2004.  We experienced increases innon-interest bearing demand deposits, interest-bearing money market deposits, savingsdeposits, and certificates of deposit (see Table 10 for details on certificatesof deposit with balances of $100,000 or more). The increase in deposits is a result of new customers from our branchexpansion and competitive deposit pricing, particularly of our Monster MoneyMarket account, which we introduced in the first quarter of 2005, and increasedadvertising efforts.  Our Monster MoneyMarket promotion is a relationship account that offered and continues to offeran interest rate of 3.14% on balances over $25,000.  Deposits in our Monster Money Market product atSeptember 30, 2005 totaled $196.6 million. Brokered certificates of deposit decreased $66.5 million to $20.2million at September 30, 2005 compared to $86.7 million at December 31,2004.

 

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

At September 30, 2005

(In thousands)

 
| **Maturities:**                        | ** ** | **Fixed Rate** | ** ** | **No-Penalty*** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------|------------|-----------------|------------|-----------|------------|
| Three months  or less                  |       | $              | 37,098     |            | $          | 7,541     |       | $ | 44,639 |   |
| Over three  months through six months  |       | 14,130         |       | 1,418           |       | 15,548    |       |
| Over six  months through twelve months |       | 51,172         |       | 47,242          |       | 98,414    |       |
| Over twelve  months                    |       | 70,716         |       | 47,829          |       | 118,545   |       |
|                                   |       | $              | 173,116    |            | $          | 104,030   |       | $ | 277,146 |   |

 

----

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

 

35

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Other borrowed funds decreased $37.2million to $163.9 million at September 30, 2005, compared to $201.1million at December 31, 2004.  We hadFederal Home Loan Bank advances that matured during 2005 and were able toreplace this funding source with other short term funding and as a result of ourdeposit growth.  Table 11 providesinformation on our short-term borrowings.

 

**Short-TermBorrowings and Other Borrowed Funds**

At September 30, 2005

(In thousands)

 
| ** **                                                    | ** ** | ** **          | ** ** | **Date Amount** | ** ** | ** **        | ** ** | ** **      | ** **  |
|---------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|-------------------|------------|-----------------|-------------|
| **Advance Date**                                              | ** ** | **Term of Advance** | ** ** | **Due**         | ** ** | **Interest Rate** | ** ** | **Outstanding** | ** **  |
| Mar-03                                                        |       | 3 years             |       | Mar-06          |       | 2.33              | %          | $               | 1,000       |   |
| Apr-04                                                        |       | 2 years             |       | May-06          |       | 2.58              | %          | 2,000           |        |
| Jul-03                                                        |       | 3 years             |       | Jul-06          |       | 2.07              | %          | 6,250           |        |
| **Total short-term FHLB advances and weighted  average rate** | ** ** | **2.21**            | **%**      | **$**           | **9,250**  | ** **        |
| ** **                                                    | ** ** | ** **          | ** ** | ** **      | ** ** |
| **Other  borrowed funds:**                                    |       |                |       |            |       |              |       |            |        |
| TT&L  Note option                                         |       |                |       |            |       | 2.75              | %          | $               | 14,099      |   |
| Trust  preferred                                              |       |                |       |            |       | 5.57              | %          | 20,619          |        |
| Customer  repurchase agreements                               |       |                |       |            |       | 1.16              | %          | 35,091          |        |
| FHLB  advances - long term                                    |       |                |       |            |       | 3.44              | %          | 84,833          |        |
| **Total  other borrowed funds**                               | ** ** | ** **          | ** ** | ** **      | ** ** | **2.22**          | **%**      | **$**           | **163,892** | ** ** |

 

At September 30,2005, mortgage funding checks increased by $57.9 million to $104.3 million,compared to $46.4 million at December 31, 2004.  No warehouse financing was outstanding at September 30,2005 compared to $30.2 million at December 31, 2004.  These liabilities are related to George Masonand are used to fund the loans in process of being sold.  George Mason has credit facilities with theBank and also has a third party facility of $250 million.  There were no borrowings outstanding underthis third party facility at September 30, 2005.

 

Shareholders’ equity at September 30,2005 was $146.7 million, an increase of $51.6 million, or 54.3%, compared to $95.1million at December 31, 2004. During the second quarter of 2005, wecompleted a secondary common stock offering of 5,175,000 shares which nettedproceeds of $39.8 million.  In addition,we acquired Wilson/Bennett for $1.6 million in cash and 611,111 shares ofcommon stock, which were valued at $4.9 million.  The remaining portion of the increase fromthe prior year end was primarily net income of $6.9 million for the nine monthsended September 30, 2005, partially offset by an unfavorable market valueadjustment of $535,000 on investment securities available-for-sale as of September 30,2005.  Book value per share at September 30,2005 was $6.03, compared to $5.15 at December 31, 2004.  Tangible book value per share at September 30,2005 was $5.18 compared to $4.36 at December 31, 2004.

 

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

##### ** **

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

** **

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

#### ** **

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

 

For the three months ended September 30,2005, the commercial banking segment recorded net income of $1.3 millioncompared to $871,000 for the three months ended September 30, 2004, an increaseof $451,000.  The increase in thirdquarter net income for 2005 is primarily related to the increased volume andinterest rates in the Bank’s loan portfolios. For the nine months ended September 30, 2005, net income for thecommercial banking segment was $2.9 million compared to $2.7 million for thesame nine month period of 2004.  At September 30,2005, total assets were $1.41 billion, loans receivable, net of deferred feesand costs, were $632.1 million and total deposits were $1.09 billion.  At September 30, 2004, total assets were$1.08 billion, loans receivable, net of deferred fees and costs were $347.5million and total deposits were $819.9 million.

 

36

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*Mortgage Banking*

 

The operations of the mortgage bankingsegment are conducted through George Mason. George Mason engages primarily in the origination and acquisition ofresidential mortgages for sale into the secondary market on a best effortsbasis.  George Mason is included in thisoperating segment since the date of acquisition, July 7, 2004.

 

For the three months ended September 30,2005 and 2004, the mortgage banking segment recorded net income of $2.1 millionand a net loss of $193,000, respectively. For the nine months ended September 30, 2005 and 2004, the mortgagebanking segment recorded net income of $5.3 million and a net loss of $193,000,respectively. The loss recorded during the three and nine months periods of2004 was a result of loans held for sale and unfunded commitments beingrecorded at fair value at the time of acquisition of George Mason, whichreduced net gain on sales of loans in the post-acquisition period.  At September 30, 2005, total assets were$467.3 million, loans held for sale, net were $454.7 million and mortgage checkfundings were $104.3 million.  At September 30,2004, total assets were $356.4 million, loans held for sale, net were $347.5million and mortgage funding checks were $76.3 million.

 

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

#### ** **

The investment services segment providesinvestment and financial services through an affiliation with a third partybroker-dealer.  Wilson/Bennett isincluded in this operating segment since the date of its acquisition, June 9,2005.

 

For the three months ended September 30,2005, the investment services segment recorded a net income of $40,000,compared to a net loss of $24,000 for the same period of 2004, an increase innet income of $64,000.  For the ninemonths ended September 30, 2005, the investment services segment recordeda net loss of $18,000, compared to a net loss of $81,000 for the same period of2004.  At September 30, 2005, totalassets were $7.3 million and total assets under management were $333.4 million.  At September 30, 2004, total assets were$677,000 and total assets under management were $161.6 million.

 

Information pertaining to our business segments can be found in Note 3to the Notes to Consolidated Financial Statements.

 

## **CapitalResources**

 

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

 

Regulatory agencies measure capital adequacyutilizing a formula that takes into account the risk profile of the financialinstitution.  The guidelines definecapital as both Tier 1 (primarily common shareholders’ equity, defined toinclude certain debt obligations) and Tier 2 (to include certain other debtobligations, a portion of the allowance for loan losses, and 45% of any unrealizedgains in equity securities).

 

At September 30, 2005, our Tier 1 andtotal (Tier 1 and Tier 2) risk-based capital ratios were 14.62% and 15.40%,respectively.  At December 31, 2004,our Tier 1 and total risk-based capital ratios were 12.7% and 13.4%,respectively.  The increase in ourregulatory capital ratios is

 

37

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a result of the completion ofour common stock offering during the second quarter of 2005 and our net incomethrough September 30, 2005.  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.

**CapitalComponents**

At September 30, 2005 and December 31,2004

(In thousands)
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **To Be Well**        | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **Capitalized Under** | ** ** |
| ** **                                                       | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                                       | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                                       | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio** | ** ** |
|                                                             |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| **At  September 30, 2005**                                  |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Total risk based capital/ Total capital to  risk-weighted assets |       | $          | 155,528    |                  | 15.40      | %                     | $          | 80,799                | >  | 8.00                  | %          | $ | 100,999 | >  | 10.00 | % |
| Tier I capital/ Tier I capital to  risk-weighted assets          |       | 147,710    |       | 14.62                 | %          | 40,400                | >  | 4.00                  | %          | 60,599                | >  | 6.00 | % |
| Tier I  capital/ Total capital to average assets                 |       | 147,710    |       | 10.31                 | %          | 57,306                | >  | 4.00                  | %          | 71,633                | >  | 5.00 | % |
|                                                             |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| **At  December 31, 2004**                                   |       |       |       |                  |       |                  |       |                  |       |                  |       |   |   |
| Total risk based capital/ Total capital to  risk-weighted assets |       | $          | 107,660    |                  | 13.40      | %                     | $          | 64,294                | >  | 8.00                  | %          | $ | 80,368 | >  | 10.00 | % |
| Tier I capital/ Tier I capital to  risk-weighted assets          |       | 101,670    |       | 12.65                 | %          | 32,147                | >  | 4.00                  | %          | 48,221                | >  | 6.00 | % |
| Tier I  capital/ Total capital to average assets                 |       | 101,670    |       | 8.83                  | %          | 46,075                | >  | 4.00                  | %          | 57,594                | >  | 5.00 | % |
|                                                                  |            |            |            |                       |            |                       |            |                       |            |                       |            |  |  |  |  |  |  |

 

**Contractual Obligations**

 

We have entered into a number of long-termcontractual obligations to support our ongoing business activities.  We anticipate that these contractualobligations will be funded through operating revenues and liquidity sourcesheld or available to us.  The requiredpayments under such obligations are detailed in Table 13.

**ContractualObligations**

At September 30, 2005

(In thousands)
| ** **                                           | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** | ** **      | ** ** |
|------------------------------------------------------|------------|------------|------------|----------------------------|------------|-----------------|------------|
| ** **                                           | ** ** | **Total**  | ** ** | **Less than 1   Year**     | ** ** | **1 - 2 Years** | ** ** | **3 - 5 Years** | ** ** | **More than 5 Years** | ** ** |
| Certificates  of deposit                             |       | $          | 607,850    |                       | $          | 335,227         |       | $ | 139,831 |   | $ | 129,638 |   | $ | 3,154 |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Brokered  certificates of deposit                    |       | 20,157     |       | 20,157                     |       | —          |       | — |   | — |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Advances from the Federal Home Loan Bank of  Atlanta |       | 94,083     |       | 9,250                      |       | 15,250          |       | 49,583 |   | 20,000 |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Trust  preferred securities                          |       | 20,000     |       | —                     |       | —          |       | — |   | 20,000 |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Operating  lease obligations                         |       | 13,348     |       | 3,902                      |       | 3,477           |       | 4,878 |   | 1,091 |   |
|                                                 |       |       |       |                       |       |            |       |   |   |   |   |
| Total                                                |       | $          | 755,438    |                       | $          | 368,536         |       | $ | 158,558 |   | $ | 184,099 |   | $ | 44,245 |   |

 

**Financial Instruments with Off-Balance SheetRisk and Credit Risk**

 

In the normal course of business, we are aparty to financial instruments with off-balance sheet risk to meet thefinancing needs of our customers.  Thesefinancial instruments include commitments to extend credit and standby lettersof credit.  These instruments involve, tovarying degrees, elements of credit risk in excess of the amount recognized onthe balance sheet.

 

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

 

At September 30, 2005, commitments toextend credit were $282.0 million and standby letters of credit were $6.9million.

 

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in theagreement.  Commitments generally haveexpiration dates or other termination clauses and may require payment of afee.  Since many of the commitments areexpected to expire without being drawn upon, the total commitment amounts donot necessarily represent future funding requirements.  We evaluate each customer’s credit worthinesson a case-by-case basis.  The amount ofcollateral obtained is based on management’s credit evaluation of thecounterparty.  Collateral held varies butmay include accounts receivable, inventory, property and equipment, and income-producingcommercial properties.

 

Unfunded commitments under lines of creditare commitments for possible future extensions of credit to existingcustomers.  Those lines of credit may or maynot be drawn upon to the total extent of funding 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 primarilyissued to support public and private borrowing arrangements, includingcommercial paper, bond financing, and similar transactions.  The credit risk involved in issuing standby lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.  We hold certificates ofdeposit,**

 

38

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**deposit accounts, and real estateas collateral supporting those commitments when collateral is deemed necessary.**

 

## **Liquidity**

## ** **

Liquidity in the banking industry is defined as the abilityto meet the demand for funds of both depositors and borrowers.  We must be able to meet these needs with cashon hand by obtaining funding from depositors or other lenders or by convertingnon-cash items to cash.  The objective ofour liquidity management program is to ensure that we always have sufficientliquid resources to meet the demands of our depositors and borrowers.  Stable core deposits and a strong capitalposition provide the base for our liquidity position.  We have demonstrated our ability to attractretail deposits because of our convenient branch locations, personal serviceand deposit pricing.

 

In addition to retail deposits, we have access to variouswholesale funding markets.  These marketsinclude the brokered CD market, the repurchase agreement market and the federalfunds market.  We also maintain securedlines of credit with the Federal Reserve Bank of Richmond and the Federal HomeLoan Bank of Atlanta.  Having diversefunding alternatives reduces our reliance on any one source for funding.

 

Cash flow from amortizing assets or maturing assets can alsoprovide funding to meet the needs of depositors and borrowers.

 

We have established a formal liquidity contingency plan whichestablishes a liquidity management team and provides guidelines for liquiditymanagement.  For our liquidity managementprogram, we first determine our current liquidity position.  Liquidity is then forecasted based onforecasted changes in the balance sheet. The Bank expects to maintain a certain liquidity cushion throughout theforecast period.  In addition to theforecast, we also stress test our liquidity position under several differentstress scenarios.  Guidelines for theforecasted liquidity cushion and for liquidity cushions for each stressscenario 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.  We believe that we currently have sufficientresources to meet our anticipated liquidity needs.

 

In September 2004, George Mason and the Bank enteredinto a one year $150 million floating rate revolving credit and securityagreement with a third party.  Thepurpose of this credit facility is to fund residential mortgage loans at GeorgeMason prior to their sale into the secondary market.  The credit facility requires, among otherthings, that George Mason and the Bank have positive quarterly net income andmaintain specified minimum tangible and regulatory net worth levels.  The Company has guaranteed repayment of thisdebt.  The interest rate on this creditfacility is LIBOR plus between 1.50% and 1.875%.  We are currently in the process of renewingthis line of credit for an additional one year term.  We anticipate that this line of credit willbe renewed.  At September 30, 2005, noneof this line was utilized.

 

In addition to this facility, this same lender has alsoprovided a $100 million facility that is utilized by George Mason to warehouseresidential mortgage loans held for sale to this lender.  The terms of this facility are substantiallythe same as the above-referenced revolving credit and security agreement andthe cost of this facility is netted against interest earned on the loanspending settlement with the lender.  Weare currently in the process of renewing this line of credit for an additionalone year term.  We anticipate that thisline of credit will be renewed.  At September 30,2005, none of this line was utilized.

 

39

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Liquid assets, which include cash and due from banks, federalfunds sold and investment securities available for sale totaled $274.9 millionat September 30, 2005 or 17.9% of total assets.  We held investments that are classified asheld-to-maturity in the amount of $120.8 million at September 30, 2005.  To maintain ready access to the bank’ssecured lines of credit, the Bank has pledged the majority of its securities tothe Federal Home Loan Bank of Atlanta with additional securities pledged to theFederal Reserve Bank of Richmond. Additional borrowing capacity at the Federal Home Loan Bank of Atlantaat September 30, 2005 was approximately $213.7 million.  Borrowing capacity with the Federal ReserveBank of Richmond was approximately $20.8 million at September 30, 2005.  As noted above, George Mason has $250 millionof lines of credit available to it.  Weare committed to maintaining liquidity at a level sufficient to protectdepositors, provide for reasonable growth and fully comply with all regulatoryrequirements.

 

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

##### ** **

We are exposed to various business risks includinginterest rate risk.  Our goal is tomaximize net interest income without incurring excessive interest raterisk.  Management of net interest incomeand interest rate risk must be consistent with the level of capital andliquidity that we maintain.  We manageinterest rate risk through an asset and liability committee (“ALCO”).  ALCO is responsible for managing the interestrate risk for the 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 are developed based onexpected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment ofthese assets.  For maturing liabilities,assumptions are developed for the replacement of these funding sources.  Assumptions are also developed for assets andliabilities that could reprice during the modeled time period.  These assumptions also cover how we expectrates to change on non-maturity deposits such as NOW, Money Market and savingsaccounts.  Based on inputs that includethe 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 considered the base case.  Next, the model determines what net interestincome would be given changes in interest rates.  The rate simulations performed include aramped rate change of down 200 basis points and up 200 basis points over a twoyear time period.  In the ramped downrate change, the model moves rates gradually down 200 basis points over thefirst year and then rates remain flat in the second year.  For the up 200 basis point scenario, ratesare gradually moved up 200 basis points in the first year and then rates remainflat in the second year.  In both the upand down scenarios, the model assumes a parallel shift in the yield curve.  The results of these simulations are thencompared to the base case.

 

At September 30, 2005, we were assetsensitive.  Asset sensitive means that wehad more assets maturing and repricing than liabilities.  We have a significant portion of our assetsas floating rate assets and we have taken a significant amount of term fundingthrough fixed rate, fixed term, certificates of deposit.  In a rising rate environment, net interestincome should grow for an asset sensitive bank. In the up 200 basis point scenario for one year, net interest incomeimproves by not more than 9% compared to the base case and by not more than 11%over the two year time horizon.  Beingasset sensitive, net interest income declines compared to the base case in thedown 200 basis point scenario.  At September 30,2005, net interest income has a negative variance to the base case of less than9% for the one year period and a negative variance of less than 13% over thecumulative two year period.

 

40

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

 

Our asset and 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 arises because the assetsof the Bank and the liabilities of the Bank have different maturities andcharacteristics.  In order to measurethis interest rate risk, we use a simulation process that measures the impactof changing interest rates on net interest income.  This model is run for the Bank by anindependent consulting firm that was hired by the Bank in the fourth quarter of2004.  The simulations incorporateassumptions related to expected activity in the balance sheet.  For maturing assets, assumptions aredeveloped for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacementof these funding sources.  Assumptionsare also developed for assets and liabilities that reprice during the modeledtime period.  These assumptions alsocover how we expect rates to change on non-maturity deposits such as NOW, MoneyMarket and savings accounts.  Based oninputs that include the most recent period end balance sheet, the current levelof interest rates and the developed assumptions, the model then produces anexpected level of net interest income assuming that interest rates remainunchanged.  This becomes the base case.  Next, the model determines the impact on netinterest income given certain interest rate changes.  The rate changes include a ramped rate changeof down 200 basis points and up 200 basis points over a two year timeperiod.  In the ramped down rate change,the model moves rates gradually down 200 basis points over the first year andthen rates remain flat in the second year. For the up 200 basis point scenario, rates are gradually increased by200 basis points in the first year and remain flat in the second year.  In both the up and down scenarios, the modelassumes a parallel shift in the yield curve. The results for net interest income are then compared to the base casewith a variance to the base case determined.

 

At September 30, 2005, we were asset sensitive.  Asset sensitive means that we had more assetsmaturing or repricing than liabilities. We have a significant portion of our assets as floating rate assets andwe have also taken a significant amount of term funding through fixed rate,fixed term, certificates of deposit.  Ina rising rate environment, net interest income should grow for an assetsensitive bank.  In the up 200 basispoint scenario for one year, net interest income improves by not more than 9%compared to the base case and by not more than 11% over the two year cumulativetime horizon.

 

Being an asset sensitive bank, net interest incomedeclines compared to the base case in the down 200 basis point simulation byless than 9% for one year and by 13% over the cumulative two year period.

 

41

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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 procedures designedto ensure that such information is accumulated and communicated to the Company’smanagement 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 controls over financialreporting identified in connection with our evaluation of it that occurredduring our last fiscal quarter that materially affected, or are likely tomaterially affect, our internal controls over financial reporting.

 

42

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**PART II – OTHERINFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

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

** **

(a)  None.

(b)  Not applicable.

(c)  None.

 

**Item 3.  Defaults Upon Senior Securities**

 

(a)  None.

(b)  None.

 

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

 

(a)  None.

(b)  Not applicable.

(c)  Not applicable.

(d)  None.

 

**Item 5. Other Information**

 

(a)  None.

(b)  None.

 

**Item 6.  Exhibits**

 

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

31.2         Rule 13a-14(a) Certification of Chief FinancialOfficer

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**

** **

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

** **
| ** **                      | **CARDINAL FINANCIAL CORPORATION**                        |
|---------------------------------|-----------------------------------------------------------|
| ** **                      | **(Registrant)**                                          |
| ** **                      | ** **                                                |
| **Date: November 9, 2005** | ** /s/ Bernard  H. Clineburg**                       | ** ** |
| ** **                      | **Bernard H. Clineburg**                                  |
| ** **                      | **Chairman, President and Chief Executive  Officer**      |
| ** **                      | **(Principal Executive Officer)**                         |
| ** **                      | ** **                                                |
| ** **                      | ** **                                                |
| **Date: November 9, 2005** | ** /s/ Robert  A. Cern**                             | ** ** |
| ** **                      | **Robert A. Cern**                                        |
| ** **                      | **Executive Vice President and Chief  Financial Officer** |
| ** **                      | **(Principal Financial Officer)**                         |
| ** **                      | ** **                                                |
| ** **                      | ** **                                                |
| **Date: November 9, 2005** | ** /s/  Jennifer L. Deacon**                         | ** ** |
| ** **                      | **Jennifer L. Deacon**                                    |
| ** **                      | **Senior Vice President and Controller**                  |
| ** **                      | **(Principal Accounting Officer)**                        |

 

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