**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-QSB**

 

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

 

**For the quarterlyperiod ended June 30, 2003**

 

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

 

**For the transitionperiod from                 to                 **

 

**Commission filenumber:  0-24557**

 

**CARDINAL FINANCIAL CORPORATION**

(Exact Name of Small Business Issuer as Specified in its Charter)

 

| **Virginia**                                                    |   | **54-1874630**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |

 

**8270 GreensboroDrive, Suite 500McLean, Virginia  22102**

(Address of Principal Executive Offices)

 

**(703) 584-3400**

(Issuer’s Telephone Number, Including Area Code)

 

**10555 Main Street, Suite 500, Fairfax, Virginia, 22030**

(Formername, former address and former fiscal year, if changed since last report)

 

Check whetherthe issuer: (1) filed all reports required to be filed by Section 13 or 15(d)of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  ý    No  o

 

State thenumber of shares outstanding of each of the issuer’s classes of common equity,as of the latest practicable date:

 

10,069,544 shares of common stock, par value $1.00 per share,outstanding as of August 8, 2003

 

 

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**CARDINAL FINANCIAL CORPORATION**

 

**INDEX TO FORM 10-QSB**

 
| **PART  I – FINANCIAL INFORMATION**                                                            |
|-----------------------------------------------------------------------------------------------------|
|                                                                                                |   |
| Item 1.   Financial Statements:                                                                |
|                                                                                                |
|                                                                                                | Consolidated Statements of Condition  June 30, 2003 and December 31, 2002 |
|                                                                                                |   |
|                                                                                                | Consolidated Statements of Operations  For the three  and six months ended  June 30, 2003 and 2002 |
|                                                                                                |   |
|                                                                                                | Consolidated Statements of Comprehensive  Income (Loss)  For the three  and six months ended  June 30, 2003 and 2002 |
|                                                                                                |   |
|                                                                                                | Consolidated Statements of Changes In  Shareholders’ Equity  For the six months ended June 30, 2003 and 2002 |
|                                                                                                |   |
|                                                                                                | Consolidated Statements of Cash Flows  For the six months ended June 30, 2003 and 2002 |
|                                                                                                |   |
|                                                                                                | Notes to Condensed Consolidated Financial  Statements |
|                                                                                                |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations |
|                                                                                                |   |
| Item 3. Controls and Procedures                                                                     |
|                                                                                                |   |
| **PART II – OTHER INFORMATION**                                                                |
|                                                                                                |   |
| Item 1.  Legal Proceedings                                                                     |
| Item 2.   Changes in Securities and Use of Proceeds                                            |
| Item 3.   Defaults Upon Senior Securities                                                      |
| Item 4.   Submission of Matters to a Vote of Security Holders                                  |
| Item 5.  Other Information                                                                     |
| Item 6.   Exhibits and Reports on Form 8-K                                                     |
|                                                                                                |   |
| **SIGNATURES**                                                                                      |

 

i

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CONDITION

June 30, 2003 and December 31, 2002

(Dollars in thousands, except share data)

 
|                                                                                                                                                                                      |   | **(Unaudited)**         |    |                        |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                      |   | **June 30,  2003** |    | **December 31,  2002** |   |
| **Assets**                                                                                                                                                                                |   |                    |    |                        |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Cash and due from banks                                                                                                                                                                   |   | $                       | 11,708  |                        | $      | 27,465 |   |
| Federal funds sold                                                                                                                                                                        |   | 5,396                   |    | 35,906                      |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Total cash and cash equivalents                                                                                                                                                           |   | 17,104                  |    | 63,371                      |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Investment securities available-for-sale                                                                                                                                                  |   | 230,004                 |    | 163,665                     |   |
| Other investments                                                                                                                                                                         |   | 2,638                   |    | 1,615                       |   |
| Loans held for sale                                                                                                                                                                       |   | 267                     |    | —                      |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Loans receivable, net of fees                                                                                                                                                             |   | 264,165                 |    | 249,106                     |   |
| Allowance for loan losses                                                                                                                                                                 |   | (3,582                  | )       | (3,372                      | )      |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Loans receivable, net                                                                                                                                                                     |   | 260,583                 |    | 245,734                     |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Premises and equipment, net                                                                                                                                                               |   | 5,089                   |    | 4,942                       |   |
| Goodwill and other intangibles, net                                                                                                                                                       |   | 646                     |    | 646                         |   |
| Accrued interest and other assets                                                                                                                                                         |   | 2,879                   |    | 6,350                       |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Total assets                                                                                                                                                                              |   | $                       | 519,210 |                        | $      | 486,323 |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| **Liabilities and Shareholders’ Equity**                                                                                                                                             |   |                    |    |                        |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Deposits                                                                                                                                                                                  |   | $                       | 438,361 |                        | $      | 423,479 |   |
| Other borrowed funds                                                                                                                                                                      |   | 38,018                  |    | 2,000                       |   |
| Accrued interest and other liabilities                                                                                                                                                    |   | 1,912                   |    | 20,132                      |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Total liabilities                                                                                                                                                                         |   | 478,291                 |    | 445,611                     |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Preferred stock, $1 par value, 10,000,000 shares authorized Series A  preferred stock, cumulative convertible, 1,364,062 and 1,364,684 shares  outstanding in 2003 and 2002, respectively |   | 1,364                   |    | 1,365                       |   |
| Common stock, $1 par value, 50,000,000 shares authorized, 10,069,544  and 10,044,345 shares outstanding in 2003 and 2002, respectively                                                    |   | 10,070                  |    | 10,044                      |   |
| Additional paid-in capital                                                                                                                                                                |   | 51,321                  |    | 51,231                      |   |
| Accumulated deficit                                                                                                                                                                       |   | (23,361                 | )       | (24,273                     | )      |
| Accumulated other comprehensive income                                                                                                                                                    |   | 1,525                   |    | 2,345                       |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Total shareholders’ equity                                                                                                                                                           |   | 40,919                  |    | 40,712                      |   |
|                                                                                                                                                                                      |   |                    |    |                        |   |
| Total liabilities and shareholders’ equity                                                                                                                                           |   | $                       | 519,210 |                        | $      | 486,323 |   |

 

See accompanying notes to consolidated financial statements.

 

1

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF OPERATIONS

For the three and six months ended June 30, 2003 and 2002

(Dollars in thousands, except per share data)

(Unaudited)

 
|                                                          |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                          |   | **2003**                              |   | **2002**                            |   | **2003** |   | **2002** |   |
| Interest income:                                              |   |                                  |   |                                |   |   |   |   |   |
| Loans receivable                                              |   | $                                     | 4,100  |                                | $      | 3,605 |   | $ | 8,133 |   | $ | 7,231 |   |
| Federal funds sold                                            |   | 42                                    |   | 200                                 |   | 80 |   | 353 |   |
| Investment securities available-for-sale                      |   | 1,614                                 |   | 1,218                               |   | 3,292 |   | 1,813 |   |
| Other investments                                             |   | 31                                    |   | 17                                  |   | 55 |   | 36 |   |
| Total interest income                                         |   | 5,787                                 |   | 5,040                               |   | 11,560 |   | 9,433 |   |
|                                                          |   |                                  |   |                                |   |   |   |   |   |
| Interest expense:                                             |   |                                  |   |                                |   |   |   |   |   |
| Deposits                                                      |   | 2,226                                 |   | 2,308                               |   | 4,466 |   | 4,232 |   |
| Other borrowed funds                                          |   | 117                                   |   | 71                                  |   | 190 |   | 168 |   |
| Total interest expense                                        |   | 2,343                                 |   | 2,379                               |   | 4,656 |   | 4,400 |   |
| Net interest income                                           |   | 3,444                                 |   | 2,661                               |   | 6,904 |   | 5,033 |   |
| Provision for loan losses                                     |   | 166                                   |   | 39                                  |   | 246 |   | 39 |   |
| Net interest income after provision for loan losses           |   | 3,278                                 |   | 2,622                               |   | 6,658 |   | 4,994 |   |
|                                                          |   |                                  |   |                                |   |   |   |   |   |
| Non-interest income:                                          |   |                                  |   |                                |   |   |   |   |   |
| Service charges on deposit accounts                           |   | 162                                   |   | 114                                 |   | 295 |   | 230 |   |
| Loan service charges                                          |   | 217                                   |   | 95                                  |   | 329 |   | 160 |   |
| Investment fee income                                         |   | 162                                   |   | 217                                 |   | 288 |   | 566 |   |
| Net gain on sales of loans                                    |   | 15                                    |   | 24                                  |   | 24 |   | 47 |   |
| Net realized gain on investment securities available-for-sale |   | 417                                   |   | —                              |   | 910 |   | — |   |
| Net gain on sales of assets                                   |   | —                                |   | —                              |   | — |   | 39 |   |
| Other income                                                  |   | 76                                    |   | 191                                 |   | 177 |   | 396 |   |
| Total non-interest income                                     |   | 1,049                                 |   | 641                                 |   | 2,023 |   | 1,438 |   |
|                                                          |   |                                  |   |                                |   |   |   |   |   |
| Non-interest expense:                                         |   |                                  |   |                                |   |   |   |   |   |
| Salary and benefits                                           |   | 1,541                                 |   | 1,345                               |   | 3,190 |   | 2,808 |   |
| Occupancy                                                     |   | 299                                   |   | 275                                 |   | 777 |   | 753 |   |
| Professional fees                                             |   | 282                                   |   | 184                                 |   | 651 |   | 492 |   |
| Depreciation                                                  |   | 259                                   |   | 185                                 |   | 455 |   | 379 |   |
| Writedown on corporate bond impairment                        |   | —                                |   | 1,660                               |   | — |   | 1,660 |   |
| Amortization and writedown of intangibles                     |   | —                                |   | 7                                   |   | — |   | 22 |   |
| Other operating expenses                                      |   | 1,277                                 |   | 836                                 |   | 2,449 |   | 1,485 |   |
| Total non-interest expense                                    |   | 3,658                                 |   | 4,492                               |   | 7,522 |   | 7,599 |   |
| Net income (loss) before income taxes                         |   | 669                                   |   | (1,229                              | )      | 1,159 |   | (1,167 | ) |
|                                                          |   |                                  |   |                                |   |   |   |   |   |
| Provision for income taxes                                    |   | —                                |   | —                              |   | — |   | — |   |
| Net income (loss)                                             |   | $                                     | 669    |                                | $      | (1,229 | ) | $ | 1,159 |   | $ | (1,167 | ) |
| Dividends to preferred shareholders                           |   | 124                                   |   | 124                                 |   | 247 |   | 247 |   |
| Net income (loss) to common shareholders                      |   | $                                     | 545    |                                | $      | (1,353 | ) | $ | 912 |   | $ | (1,414 | ) |
| Basic and diluted income (loss) per common share              |   | $                                     | 0.05   |                                | $      | (0.18 | ) | $ | 0.09 |   | $ | (0.24 | ) |
| Weighted-average common shares outstanding - basic            |   | 10,056,144                            |   | 7,327,304                           |   | 10,051,132 |   | 5,819,192 |   |
| Weighted-average common shares outstanding - diluted          |   | 10,294,425                            |   | 7,327,304                           |   | 10,208,542 |   | 5,819,192 |   |

 

See accompanying notes to consolidated financial statements.

 

2

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

For the three and six months ended June 30, 2003 and 2002

(Dollars in thousands)

(Unaudited)

 
|                                                                       |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|----------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                                       |   | **2003**                              |   | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                       |   |                                  |   |                                |   |   |   |   |   |
| Net income (loss)                                                          |   | $                                     | 669    |                                | $      | (1,229 | ) | $ | 1,159 |   | $ | (1,167 | ) |
| Other comprehensive income (loss):                                         |   |                                  |   |                                |   |   |   |   |   |
| Unrealized gain on available-for-sale investment securities:               |   |                                  |   |                                |   |   |   |   |   |
| Unrealized holding gain arising during the period                          |   | 1,303                                 |   | 1,946                               |   | 1,730 |   | 1,141 |   |
| Less: reclassification adjustment for gains included in net income  (loss) |   | 417                                   |   | —                              |   | 910 |   | — |   |
|                                                                       |   |                                  |   |                                |   |   |   |   |   |
| Comprehensive income (loss)                                                |   | $                                     | 1,555  |                                | $      | 717 |   | $ | 1,979 |   | $ | (26 | ) |

 

See accompanying notes to consolidated financial statements.

 

3

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the six months ended June 30, 2003 and 2002

(Amounts in thousands)

(Unaudited)

 
|                                                                  |   | **Preferred  Shares** |   | **Preferred  Stock** |   | **Common  Shares** |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Total** |   |
|-----------------------------------------------------------------------|--------|-----------------------|--------|----------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|------------------------------------------------------|--------|-----------|--------|
| Balance, December 31, 2001                                       |   | 1,365                 |   | $                    | 1,365  |               | 4,294  |              | $      | 4,294                            |   | $                        | 38,488 |                                                 | $      | (23,249   | )      | $ | (274 | ) | $ | 20,624 |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Dividends on preferred stock                                          |   | —                |   | —               |   | —             |   | —            |   | —                           |   | (247                     | )      | —                                               |   | (247      | )      |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Rights offering shares issued                                         |   | —                |   | —               |   | 2,437              |   | 2,437             |   | 5,484                            |   | —                   |   | —                                               |   | 7,921     |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Public offering shares issued                                         |   | —                |   | —               |   | 3,313              |   | 3,313             |   | 7,281                            |   | —                   |   | —                                               |   | 10,594    |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Change in unrealized loss on investment securities available-for-sale |   | —                |   | —               |   | —             |   | —            |   | —                           |   | —                   |   | 1,141                                                |   | 1,141     |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Net loss                                                              |   | —                |   | —               |   | —             |   | —            |   | —                           |   | (1,167                   | )      | —                                               |   | (1,167    | )      |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, June 30, 2002                                           |   | 1,365                 |   | $                    | 1,365  |               | 10,044 |              | $      | 10,044                           |   | $                        | 51,253 |                                                 | $      | (24,663   | )      | $ | 867 |   | $ | 38,866 |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, December 31, 2002                                       |   | 1,365                 |   | $                    | 1,365  |               | 10,044 |              | $      | 10,044                           |   | $                        | 51,231 |                                                 | $      | (24,273   | )      | $ | 2,345 |   | $ | 40,712 |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Stock options exercised                                               |   | —                |   | —               |   | 25                 |   | 25                |   | 90                               |   | —                   |   | —                                               |   | 115       |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Dividends on preferred stock                                          |   | —                |   | —               |   | —             |   | —            |   | —                           |   | (247                     | )      | —                                               |   | (247      | )      |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Preferred stock converted to common stock                             |   | (1                    | )      | (1                   | )      | 1                  |   | 1                 |   | —                           |   | —                   |   | —                                               |   | —    |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Change in unrealized gain on investment securities available-for-sale |   | —                |   | —               |   | —             |   | —            |   | —                           |   | —                   |   | (820                                                 | )      | (820      | )      |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Net income                                                            |   | —                |   | —               |   | —             |   | —            |   | —                           |   | 1,159                    |   | —                                               |   | 1,159     |   |
|                                                                  |   |                  |   |                 |   |               |   |              |   |                             |   |                     |   |                                                 |   |      |   |
| Balance, June 30, 2003                                           |   | 1,364                 |   | $                    | 1,364  |               | 10,070 |              | $      | 10,070                           |   | $                        | 51,321 |                                                 | $      | (23,361   | )      | $ | 1,525 |   | $ | 40,919 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

4

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**CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

For the six months ended June 30, 2003 and 2002

(Dollars in thousands)

(Unaudited)

 
|                                                                                                |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                                                |   | **2003**                            |   | **2002** |   |
| Cash flows from operating activities:                                                               |   |                                |   |   |   |
| Net income (loss)                                                                                   |   | $                                   | 1,159  |   | $ | (1,167 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |   |                                |   |   |   |
| Depreciation                                                                                        |   | 455                                 |   | 379 |   |
| Amortization of intangibles, premiums and discounts                                                 |   | 1,051                               |   | 328 |   |
| Provision for loan losses                                                                           |   | 246                                 |   | 39 |   |
| Originations of loans held for sale                                                                 |   | (9,750                              | )      | (4,369 | ) |
| Proceeds from the sale of loans held for sale                                                       |   | 9,483                               |   | 9,038 |   |
| Writedown on corporate bond impairment                                                              |   | —                              |   | 1,660 |   |
| Gain on sale of loans held for sale                                                                 |   | (24                                 | )      | (47 | ) |
| Gain on sale of investment securities available-for-sale                                            |   | (910                                | )      | — |   |
| Gain on sale of other assets                                                                        |   | —                              |   | (39 | ) |
| (Increase) decrease in accrued interest and other assets                                            |   | 3,471                               |   | (681 | ) |
| Decrease in accrued interest and other liabilities                                                  |   | (18,220                             | )      | (1,583 | ) |
|                                                                                                |   |                                |   |   |   |
| Net cash provided by (used in) operating activities                                                 |   | (13,039                             | )      | 3,558 |   |
|                                                                                                |   |                                |   |   |   |
| Cash flows from investing activities:                                                               |   |                                |   |   |   |
| Purchase of premises and equipment                                                                  |   | (602                                | )      | (30 | ) |
| Proceeds from sale, maturity and call of investment securities  available-for-sale                  |   | 61,989                              |   | 1,000 |   |
| Proceeds from sale of other investments                                                             |   | —                              |   | 190 |   |
| Purchase of investment securities available-for-sale                                                |   | (162,008                            | )      | (99,289 | ) |
| Purchase of other investments                                                                       |   | (1,023                              | )      | (184 | ) |
| Redemptions of investment securities available-for-sale                                             |   | 31,808                              |   | 4,132 |   |
| Net (increase) decrease in loans receivable                                                         |   | (14,160                             | )      | 255 |   |
|                                                                                                |   |                                |   |   |   |
| Net cash used in investing activities                                                               |   | (83,996                             | )      | (93,926 | ) |
|                                                                                                |   |                                |   |   |   |
| Cash flows from financing activities:                                                               |   |                                |   |   |   |
| Net increase in deposits                                                                            |   | 14,882                              |   | 103,988 |   |
| Net increase (decrease) in other borrowed funds                                                     |   | 36,018                              |   | (2,824 | ) |
| Proceeds from rights offering                                                                       |   | —                              |   | 7,921 |   |
| Proceeds from public offering                                                                       |   | —                              |   | 10,594 |   |
| Stock options exercised                                                                             |   | 115                                 |   | — |   |
| Dividends on preferred stock                                                                        |   | (247                                | )      | (247 | ) |
|                                                                                                |   |                                |   |   |   |
| Net cash provided by financing activities                                                           |   | 50,768                              |   | 119,432 |   |
|                                                                                                |   |                                |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                                |   | (46,267                             | )      | 29,064 |   |
|                                                                                                |   |                                |   |   |   |
| Cash and cash equivalents at beginning of period                                                    |   | 63,371                              |   | 34,459 |   |
|                                                                                                |   |                                |   |   |   |
| Cash and cash equivalents at end of period                                                          |   | $                                   | 17,104 |   | $ | 63,523 |   |
|                                                                                                |   |                                |   |   |   |
| **Supplemental disclosure of cash flow information:**                                               |   |                                |   |   |   |
| Cash paid during period for interest                                                                |   | $                                   | 4,617  |   | $ | 4,288 |   |

 

See accompanying notes to consolidated financial statements.

 

5

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CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

(Unaudited)

 

Note 1

 

*Organization*

 

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

 

*Basis of Presentation*

 

In the opinion of management,the accompanying consolidated financial statements have been prepared inaccordance with the requirements of Regulation S-X, Article 10.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  However, all adjustments that are, in theopinion of management, necessary for a fair presentation have beenincluded.  The results of operations forthe three and six months ended June 30, 2003 are not necessarilyindicative of the results to be expected for the full year ending December 31,2003.  The unaudited interim financialstatements should be read in conjunction with the audited financial statementsand notes to financial statements that are presented in the Company’s AnnualReport on Form 10-KSB for the year ended December 31, 2002 (the “2002 Form10-KSB”).

 

*Stock Based Compensation*

 

At June 30, 2003, theCompany had two stock-based employee compensation plans, the 1999 Stock OptionPlan and the 2002 Equity Compensation Plan. These plans are described more fully in Footnote 14 of the 2002 Form10-KSB.

 

As permitted under Statement ofFinancial Accounting Standards (“SFAS”) No. 148, *Accounting for Stock-Based Compensation – Transition and Disclosure,*which amended SFAS No. 123, *Accounting forStock-Based Compensation,* the Company has elected to continue tofollow the intrinsic value method in accounting for its stock-based employeecompensation arrangements as defined by Accounting Principles Board Opinion(“APB”) No. 25, *Accounting for Stock Issuedto Employees,* and related interpretations including FinancialAccounting Standards Board Interpretation No. 44, *Accounting for Certain Transactions Involving Stock Compensation,*aninterpretation of APB No. 25.  Thefollowing table illustrates the effect on net income (loss) and earnings (loss)per common

 

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share if the Company hadapplied the fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation.

 

(Dollars in thousands, except per share data)

 
|                                                                                                              |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                                                                              |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
| Net income (loss) to common shareholders                                                                          |   | $                                    | 545    |                               | $      | (1,353 | ) | $ | 912 |   | $ | (1,414 | ) |
| Deduct: Total stock based employee compensation expense determined  under fair value- based method for all awards |   | (106                                 | )      | (173                               | )      | (328 | ) | (189 | ) |
| Pro forma net income (loss)                                                                                       |   | $                                    | 439    |                               | $      | (1,526 | ) | $ | 584 |   | $ | (1,603 | ) |
|                                                                                                              |   |                                 |   |                               |   |   |   |   |   |
| Earnings (loss) per common share:                                                                                 |   |                                 |   |                               |   |   |   |   |   |
| Basic - as reported                                                                                               |   | $                                    | 0.05   |                               | $      | (0.18 | ) | $ | 0.09 |   | $ | (0.24 | ) |
| Basic - as pro forma                                                                                              |   | 0.04                                 |   | (0.21                              | )      | 0.06 |   | (0.28 | ) |
| Diluted - as reported                                                                                             |   | 0.05                                 |   | (0.18                              | )      | 0.09 |   | (0.24 | ) |
| Diluted - as pro forma                                                                                            |   | 0.04                                 |   | (0.21                              | )      | 0.06 |   | (0.28 | ) |

 

The weighted average per share fair values ofgrants made for the three and six months ended June 30, 2003 were $2.72and $2.10, respectively.  The weightedaverage per share fair values of grants made for the three and six months endedJune 30, 2002 were $2.12 and $2.12, respectively. The fair values of theoptions granted were estimated on the grant date using the Black - Scholesoption - pricing model based on the following weighted average assumptions:

 
|                    |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|-------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                    |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
| Estimated option life   |   | 10 years                             |   | 10 years                           |   | 10 years |   | 10 years |   |
| Risk free interest rate |   | 3.41                                 | %      | 4.25                               | %      | 3.96 | % | 4.25 | % |
| Expected volatility     |   | 20.40                                | %      | 20.40                              | %      | 20.40 | % | 20.40 | % |
| Expected dividend yield |   | 0.00                                 | %      | 0.00                               | %      | 0.00 | % | 0.00 | % |

 

There were13,000 options granted during the three months ended June 30, 2003 and364,500 options granted during the six months ended June 30, 2003.  Of those grants issued, 0 and 91,100,respectively, immediately vested on the grant date.

 

7

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Note 2

 

*Segment Disclosures*

 

The Company operates andreports in two business segments, banking and investment advisoryservices.  The banking segment includesboth commercial and consumer lending and provides customers such products ascommercial loans, real estate loans, and other business financing and consumerloans.  In addition, this segment alsoprovides customers with several choices of deposit products including demanddeposit accounts, savings accounts and certificates of deposit.  The investment advisory services segmentprovides advisory services to businesses and individuals including financialplanning and retirement/estate planning.

 

Information about reportablesegments, and reconciliation of such information to the consolidated financialstatements as of and for the three and six months ended June 30, 2003 and2002, follows:

 

**For the Three Months Ended June 30,2003:**

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

 

**For the Three Months Ended June 30,2002:**

 
| **(Dollars in thousands)** |   | **Banking** |    | **Investment  Advisory** |   | **Intersegment  Elimination** |   | **Other** |    | **Consolidated** |   |
|----------------------------|--------|-------------|---------|--------------------------|--------|-------------------------------|--------|-----------|---------|------------------|--------|
| Net interest income        |   | $           | 2,643   |                     | $      | —                        |   | $         | —  |             | $      | 18 |   | $ | 2,661 |   |
| Provision for loan losses  |   | 39          |    | —                   |   | —                        |   | —    |    | 39               |   |
| Non-interest income        |   | 385         |    | 217                      |   | —                        |   | 39        |    | 641              |   |
| Non-interest expense       |   | 4,244       |    | 223                      |   | —                        |   | 25        |    | 4,492            |   |
| Net income (loss)          |   | $           | (1,255  | )                        | $      | (6                            | )      | $         | —  |             | $      | 32 |   | $ | (1,229 | ) |
| Total assets               |   | $           | 394,490 |                     | $      | 340                           |   | $         | (37,510 | )                | $      | 40,087 |   | $ | 397,407 |   |

 

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**For the Six Months Ended June 30, 2003:**

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

 

**For the Six Months Ended June 30, 2002:**

** **
| **(Dollars in thousands)** |   | **Banking** |    | **Investment  Advisory** |   | **Intersegment  Elimination** |   | **Other** |    | **Consolidated** |   |
|----------------------------|--------|-------------|---------|--------------------------|--------|-------------------------------|--------|-----------|---------|------------------|--------|
| Net interest income        |   | $           | 5,014   |                     | $      | —                        |   | $         | —  |             | $      | 19 |   | $ | 5,033 |   |
| Provision for loan losses  |   | 39          |    | —                   |   | —                        |   | —    |    | 39               |   |
| Non-interest income        |   | 742         |    | 566                      |   | —                        |   | 130       |    | 1,438            |   |
| Non-interest expense       |   | 6,522       |    | 690                      |   | —                        |   | 387       |    | 7,599            |   |
| Net income (loss)          |   | $           | (805    | )                        | $      | (124                          | )      | $         | —  |             | $      | (238 | ) | $ | (1,167 | ) |
| Total assets               |   | $           | 394,490 |                     | $      | 340                           |   | $         | (37,510 | )                | $      | 40,087 |   | $ | 397,407 |   |

 

The Company does not haveoperating segments other than those reported. Parent company financial information is included in the “Other” categoryabove and represents the overhead function rather than an operating segment.  The parent company’s net interest income iscomprised of interest income from federal funds sold and other investments.

 

Note 3

 

*Earnings (Loss) Per Common Share*

 

The following table disclosesthe calculation of basic and diluted earnings (loss) per common share for thethree and six months ended June 30, 2003 and 2002. Stock optionsoutstanding as of June 30, 2003 and 2002 were 853,087 and 601,963,respectively.  Stock options issued,which were not included in the calculation of diluted earnings per sharebecause the exercise prices were greater than the average market price, were10,197 and 22,886 for the three and six months ended June 30, 2003,respectively.  Because the Companyreported a net loss to common shareholders for the three and six months endedJune 30, 2002, all stock options issued as of that date have ananti-dilutive effect and, therefore, have been excluded from the earnings(loss) per common share calculation for those respective periods.

 

9

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|                                                        |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|-------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
| **(Dollars in thousands, except share and per share data)** |   | **2003**                             |   | **2002**                           |   | **2003** |   | **2002** |   |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Net income                                                  |   | $                                    | 669    |                               | $      | (1,229 | ) | $ | 1,159 |   | $ | (1,167 | ) |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Dividends to preferred shareholders                         |   | 124                                  |   | 124                                |   | 247 |   | 247 |   |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Net income (loss) to common shareholders                    |   | 545                                  |   | (1,353                             | )      | 912 |   | (1,414 | ) |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Weighted average common shares for basic                    |   | 10,056,144                           |   | 7,327,304                          |   | 10,051,132 |   | 5,819,192 |   |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Weighted average common shares for diluted                  |   | 10,294,425                           |   | —                             |   | 10,208,542 |   | — |   |
|                                                        |   |                                 |   |                               |   |   |   |   |   |
| Basic and diluted earnings (loss) per  common share         |   | $                                    | 0.05   |                               | $      | (0.18 | ) | $ | 0.09 |   | $ | (0.24 | ) |

 

Note 4

 

*Goodwill and Other Intangible Assets*

 

At June 30, 2003, goodwillof $646,000 represented the remaining balance attributable to the purchase ofHeritage Bancorp, Inc.  In 2002, theCompany evaluated impairment of goodwill under SFAS No. 142, *Goodwill and Other Intangible Assets*.  No events have occurred that indicate animpairment of goodwill exists since our 2002 annual impairment test.

 

At June 30, 2003, theCompany had no other intangible assets.

 

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

 

The following presentsmanagement’s discussion and analysis of our consolidated financial condition asof June 30, 2003 and December 31, 2002 and the results of ouroperations for the three and six months ended June 30, 2003 and 2002.  This discussion should be read inconjunction with our unaudited consolidated financial statements and the notesthereto appearing elsewhere in this report.

 

**Company Overview**

 

Cardinal Financial Corporationis a locally owned and managed financial services organization headquartered inNorthern Virginia and is committed to providing top quality customer service, adiversified product mix and convenient avenues for banking to consumers andbusinesses.  As of June 30, 2003,total assets increased 6.8% to $519.2 million compared to $486.3 million atDecember 31, 2002.  Net loansreceivable increased 6.1% to $264.2 million compared to $249.1 million atDecember 31, 2002.  Total depositsincreased 3.5% to $438.4 million as of June 30, 2003 compared to $423.5million at December 31, 2002.  Ourinvestment advisory subsidiary, Cardinal *WealthServices, Inc.*, ended the quarter with assets under managementexceeding $92.9 million.

 

**Critical Accounting Policies**

 

*Allowance for Loan Losses*

 

We maintain the allowance forloan losses at a level that represents management’s best estimate of known andinherent losses in the loan portfolio. Both the amount of the provision expense and the level of the allowancefor loan losses are impacted by many factors, including general economicconditions, actual and expected credit losses, historical trends and specificconditions of the individual borrower. As a part of our analysis, we use comparative peer group data, durationfactors and qualitative factors such as levels of and trends in delinquenciesand nonaccrual loans, national and local economic trends and conditions andconcentrations of loans exhibiting similar risk profiles to support ourestimates.  The loan loss provision forthe three and six months ended June 30, 2003 was $166,000 and $246,000,respectively.  The loan loss provisionfor both the three and six months ended June 30, 2002 was $39,000.   The allowance for loan loss as ofJune 30, 2003 and December 31, 2002 was $3.6 million and $3.4million, respectively.  The ratio of theallowance for loan losses to total loans, net of fees, was 1.36% atJune 30, 2003 compared to 1.35% at December 31, 2002.  Additional information on the allowance forloan losses and provision expense can be found later in this discussion.

 

Credit losses are an inherentpart of our business and, although we believe the methodologies for determiningthe allowance for loan losses and the current level of the allowance areadequate, it is possible that there may be unidentified losses in the portfoliothat may become evident only at a future date. Additional provisions for such losses, if

 

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necessary, would negativelyimpact earnings and would be recorded in the banking business segment.

 

We categorize our loans intoone of five pools:  commercial and industrial,commercial real estate, home equity lines of credit, residential mortgages, andconsumer loans.  Peer group annual lossfactors (in the absence of historical results) are applied to all pools and areadjusted by the projected duration of the loan pool and by the qualitativefactors mentioned above.  The indicatedloss factors resulting from this analysis are applied to each of the loan poolsto determine a reserve level for each of the five pools of loans.  In addition, we individually assign lossfactors to all loans that have been identified as having loss attributes, asindicated by deterioration in the financial condition of the borrower or adecline in underlying collateral values. Since we have limited historical data on which to base loss factors forclassified loans, we apply a 5% loss factor to all special mention loans and a15% loss factor to all substandard loans (in accordance with regulatoryguidelines).

 

*Valuation Allowance for Deferred Tax Assets*

 

Deferred income taxes reflecttemporary differences in the recognition of revenue and expenses for taxreporting and financial statement purposes, principally because certain items,such as depreciation and amortization, are recognized in different periods forfinancial reporting and tax return purposes. A valuation allowance of $4.5 million at December 31, 2002, hasbeen established for deferred tax assets, as realization is dependent upongenerating future taxable income.

 

**Financial Condition**

 

Total assets were $519.2million at June 30, 2003 compared to $486.3 million at December 31,2002, an increase of $32.9 million or 6.8% due indirectly to the increase intotal deposits and other borrowed funds. Investment securities available-for-sale were $230.0 million atJune 30, 2003 compared to $163.7 million at December 31, 2002, anincrease of $66.3 million or 40.5% (see Table 1 for details on the investmentsecurities available-for-sale portfolio). During the first quarter of 2003, wemodified the methodology we use to calculate our reserve requirement forcertain deposit accounts, which resulted in a significant decline in thereserve balance we maintain at the Federal Reserve Bank. As a result, we wereable to decrease our cash and due from bank balances by $15.8 million, or 57.4%to $11.7 million at June 30, 2003 compared to $27.5 million atDecember 31, 2002.  These fundswere invested in the investment securities available-for-sale portfolio,allowing us to earn interest on balances that were formerly non-interestearning assets. Loans receivable, net of fees, increased by $15.1 million, or6.1% to $264.2 million at June 30, 2003 from $249.1 million atDecember 31, 2002 (see Table 2 for details on the loans receivableportfolio).

 

Total deposits increased $14.9million, or 3.5% to $438.4 million at June 30, 2003 compared to $423.5million at December 31, 2002 (see Table 3 for details on certificates ofdeposit with balances of $100,000 or more). Other borrowed funds increased $36.0

 

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million to $38.0 million atJune 30, 2003 compared to $2.0 million at December 31, 2002. Due tothe interest rates on Federal Home Loan Bank advances being at their lowestlevels in several years, we borrowed $24.0 million during the first half of 2003.  During the second quarter of 2003, weintroduced a repurchase agreement program for those commercial customers thatleave larger balances in their demand deposit accounts, allowing them to earn1.00% on the balances in this account. Repurchase agreements at June 30, 2003 were $9.0 million.  These funds were invested in investmentsecurities available-for-sale, allowing us to increase our net interest marginand tighten our interest rate sensitivity position to under 8.6% for allintervals with the exception of the immediate repricing interval. In addition,we had federal funds purchased of $5.0 million at June 30, 2003, comparedto none at December 31, 2002.

 

Shareholders’ equity atJune 30, 2003 was $40.9 million, an increase of $207,000, or 0.5%,compared to $40.7 million at December 31, 2002.  The increase was driven by year to date net income to commonshareholders of $912,000 offset partially by an unfavorable $820,000mark-to-market adjustment on our primarily mortgage-backed investmentsecurities available-for-sale portfolio. Book value per common share at June 30, 2003 was $3.39 compared to$3.37 at December 31, 2002.

 

**Resultsof Operations**

 

Net income to commonshareholders for the three and six months ended June 30, 2003 was $545,000and $912,000, respectively, an improvement of $1.9 million and $2.3 millionwhen compared to the same three and six month periods of 2002.  For the three and six months endedJune 30, 2002, we recorded a net loss to common shareholders of $1.4million and $1.4 million, respectively. The increase in net income to common shareholders is primarily a resultof increased net interest income and non-interest income.  In addition, during the second quarter of2002, we recorded an other than temporary corporate bond impairment of $1.7million, which increased non-interest expense for the three and six monthsended June 30, 2002.  Earnings percommon share increased to $0.05 and $0.09 per common share for the three andsix months ended June 30, 2003, respectively, compared to a loss percommon share of $0.18 and $0.24 for the three and six months endedJune 30, 2002, respectively. These quarterly results are presented afterthe effect of dividends paid in each three and six months period to preferredshareholders.  Dividends to preferredshareholders were $124,000 and $247,000 for each of three and six months endedJune 30, 2003 and 2002, respectively. Weighted average common shares outstanding for the three months endedJune 30, 2003 were 10,056,144 compared to 7,327,304 for the three monthsended June 30, 2002.  For the sixmonths ended June 30, 2003 and 2002, weighted average common sharesoutstanding were 10,051,132 and 5,819,192, respectively.  The increase in weighted average sharesoutstanding for both reporting periods is due to the successful rights andpublic offerings completed in May 2002.

 

Return on average assets forthe three months ended June 30, 2003 and 2002 was 0.55% and -1.33%,respectively.  For the six months endedJune 30, 2003 and 2002, return on average assets was 0.48% and -0.69%,respectively.  Return on average equityfor the

 

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three months endedJune 30, 2003 and 2002 was 6.69% and –16.23%, respectively.  For the six months ended June 30, 2003and 2002, return on average equity was 5.74% and –9.16%, respectively.

 

Net interest income is ourprimary source of revenue, representing the difference between interest andfees earned on interest earning assets and the interest paid on deposits andother interest bearing liabilities.  Thelevel of net interest income is impacted primarily by variations in the volumeand mix of these assets and liabilities, as well as changes in interest rateswhen compared to previous periods of operations.  Net interest income for the three months ended June 30, 2003and 2002 was $3.4 million and $2.7 million, respectively, a period-to-periodincrease of $783,000 or 29.4%.  Netinterest income for the six months ended June 30, 2003 and 2002 was $6.9million and $5.0 million, respectively, a period-to-period increase of $1.9million, or 37.2%.  The increase in netinterest income is a result of the increase in average volume of investmentsecurities available-for-sale and loans receivable, net of the impact ofdecreased yields, during the first half of 2003, compared with the same periodof 2002.  These increases were fundedthrough the increases in total deposits and other borrowed funds.

 

Our net interest margin for thethree months ended June 30, 2003 and 2002 was 2.90% and 3.07%, respectively.  For the six months ended June 30, 2003and 2002, net interest margin was 3.00% and 3.18%, respectively.  The decrease in the net interest margin wasa result of the change in the mix of earning assets towards lower yieldinginvestments and the decreased interest rate environment experienced during thelast two quarters of 2002.  Whencompared to the fourth quarter of 2002, our net interest margin for the secondquarter of 2003 increased 30 basis points. The changes in net interest margin are due primarily to the transfer ofcash balances and lower yielding federal funds sold into higher yieldinginvestment securities.  Our net interestmargin for the fourth quarter of 2002 was 2.60%, for the first quarter of 2003was 3.11% and for the second quarter of 2003 was 2.90%.  The decrease in the margin from the firstquarter to second quarter of 2003 was a result of the repricing activityexperienced in the investment securities portfolio during the second quarter.  Tables 4, 4a, 5, and 5a present an analysisof average earning assets, interest bearing liabilities and demand depositswith related components of interest income and interest expense.

 

Provision for loan losses forthe three months ended June 30, 2003 and 2002 was $166,000 and $39,000,respectively.  For the six months endedJune 30, 2003 and 2002, provision for loan losses was $246,000 and$39,000, respectively.  The allowancefor loan loss at June 30, 2003 was $3.6 million compared to $3.4 millionat December 31, 2002.    Ourallowance for loan loss ratio at June 30, 2003 was 1.36% compared to 1.35%at December 31, 2002.  Loan growthover the current periods presented has significantly increased from priorperiods, which has caused our increase in provision expense.  We continued to experience strong loanquality with annualized net charged-off loans equal to .03% to total loans forthe first six months of 2003 and non-performing loans equal to .24% of totalloans as of June 30, 2003. Additional information on the allowance for loan

 

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loss and its allocation to thetotal loans receivable portfolio can be found in Tables 6 and 7 to thisdiscussion.

 

Non-interest income for thethree months ended June 30, 2003 and 2002 was $1.0 million and $641,000,respectively, a period-to-period increase of $408,000, or 63.7%.  For the six months ended June 30, 2003and 2002, non-interest income was $2.0 million and $1.4 million, respectively,a period-to-period increase of $585,000, or 40.7%.   The increase in non-interest income is primarily attributable tothe realized gains on sales of a portion of our investment securitiesavailable-for-sale portfolio.  Thesegains were recorded on sales of mortgage-backed securities with rapidpre-payment qualities, which were a result of the lower interest rateenvironment experienced during the quarter and year to date.  Loan service charges for the three monthsended June 30, 2003 were $217,000 compared to $95,000 for the same threemonth period of 2002, an increase of $122,000, or 128.4%.  For the six months ended June 30, 2003,loan service charges were $329,000 compared to $160,000 for the same six monthperiod of 2002, representing an increase of $169,000 or 105.6%.   These increases were offset by decreases ininvestment fee income during the first and second quarters of 2003 compared tothe same periods of 2002.

 

Non-interest expense for thethree months ended June 30, 2003 was $3.7 million, compared to $4.5million for the same period of 2002, a decrease of $834,000, or 18.6%.  For the six months ended June 30, 2003,non-interest expense was $7.5 million, compared to $7.6 million for the samesix month period of 2002.  The decrease ispartially attributable to the other than temporary impairment writedown of $1.7million in a WorldCom bond recorded during the second quarter of 2002.Offsetting the fact that there is no bond impairment recorded in 2003,non-interest expense increased for the three and six months ended June 30,2003, as described below.  Non-interestexpense excluding the bond impairment writedown for the three and six monthsended June 30, 2002 was $2.8 million and $5.9 million, respectively.  Compared to non-interest expense less thebond impairment writedown, non-interest expense increased $826,000 and $1.6million for the three and six months ended June 30, 2003,respectively.  Both the move of ourheadquarters to Tysons Corner during the first quarter of 2003, and the openingof the Arlington branch location during the fourth quarter of 2002 have impacted2003 expenses.  In addition, weexperienced increases in salaries and benefits expense, professional fees andloan expenses, which are directly related to our strong asset growth over thepast year.

 

We have not recorded income taxexpense or benefit due to the existence of net losses in all prior years ofoperations.  We have net deferred taxassets, including net operating loss carryforwards, all of which have a fullvaluation allowance as of June 30, 2003. A valuation allowance is established against deferred tax assets when,in the judgment of management, it is more likely than not that such deferredtax assets will be realized.  Thebenefit of our deferred tax assets will only be recognized when it becomes morelikely than not that they will not be realized.  For more information, see “Critical Accounting Policies” above inthis discussion.

 

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**BusinessSegment Operations**

 

We provide banking andnon-banking financial services and products through our subsidiaries.  Management operates and reports on theresults of our operations through two business segments, banking and investmentadvisory services.

 

*Banking*

 

The banking segment providescomprehensive banking services to small businesses and individuals throughmultiple delivery channels.  Servicesoffered include commercial and consumer lending, deposit products and bankingvia the  Internet or telephone.

 

For the three months endedJune 30, 2003, the banking segment recorded net income of $922,000compared to a loss of $1.3 million for the three months ended June 30,2002, an improvement of $2.2 million. For the six months ended June 30, 2003, the banking segmentrecorded net income of $1.7 million, compared to a loss of $805,000 during thesame period of 2002, an improvement of $2.5 million.  The improvement in earnings is a result of increased net interestincome, due to increased volume of earning assets, and non-interest income, dueto realized gains on investment securities available-for-sale, for thissegment.  In addition, the writedown ofthe bond impairment was recognized in this business segment during the secondquarter of 2002.  As of June 30,2003, total assets were $516.2 million, loans receivable, net of fees, were$264.2 million and total deposits were $438.4 million.  As of June 30, 2002, total assets were$394.5 million, loans receivable, net of fees were $200.7 million and totaldeposits were $350.0 million.

 

*Investment Advisory Services*

 

The investment advisoryservices segment offers financial and estate planning services, centered on agroup of products provided through a strategic alliance with Raymond JamesFinancial Services, Inc.

 

For the three months endedJune 30, 2003, the investment advisory services segment was at breakeven,compared to a loss of $6,000 during the same period of 2002, an improvement of$6,000.  For the six months endedJune 30, 2003, this segment reported a net loss of $42,000, compared to anet loss of $124,000 for the same period of 2002.  As of June 30, 2003, total assets were $245,000 and totalassets under management were $92.9 million. As of June 30, 2002, total assets were $340,000 and total assetsunder management were $131.8 million. The decreased revenues, expenses and assets under management from thisbusiness segment during 2003 are a result of the conversion from Legg Mason,Inc. to Raymond James Financial Services, Inc., which caused a temporarydecline in transaction activity and accumulation of assets under management.

 

Information pertaining to both businesssegments can be found in Footnote 2 to the Notes to Consolidated FinancialStatements.

 

16

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**CapitalResources**

 

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

 

Regulatory agencies measurecapital adequacy utilizing a formula that takes into account the individualrisk profile of financial institutions. The guidelines define capital as both Tier 1 (primarily commonshareholders’ equity, defined to include certain debt obligations) and Tier 2(to include certain other debt obligations and a portion of the allowance forloan losses and 45% of unrealized gains in equity securities).

 

At June 30, 2003,shareholders’ equity was $40.9 million compared to $40.7 million atDecember 31, 2002.  The increase inshareholders’ equity is primarily the result of recorded net income to commonshareholders offset by the change in unrealized gains in the investmentsecurities available-for-sale portfolio. At June 30, 2003, our tier 1 and total risk-based capital ratioswere 11.3% and 12.3%, respectively.  AtDecember 31, 2002, our tier 1 and total risk-based capital ratios were12.3% and 13.4%, respectively.  Ourregulatory capital levels for the bank and bank holding company meet thoseestablished for well-capitalized institutions. Table 8 provides additionalinformation pertaining to our capital ratios.

 

**Liquidity**

 

The objective of liquiditymanagement is to ensure the continuous availability of funds to meet thedemands of depositors, investors and borrowers.  Stable core deposits and a strong capital position are thecurrent components of a solid foundation for our liquidity position.  In addition, the availability of regionaland national wholesale funding sources including federal funds purchased,negotiable certificates of deposit, securities sold under agreements torepurchase, and borrowings from the Federal Home Loan Bank enhance ourliquidity.  Cash flows from operations,such as loan payments and payoffs are also a significant source ofliquidity.  We have a contingency planthat provides for continued monitoring of liquidity needs and available sourcesof liquidity.  We believe we have theability to meet our increased liquidity needs. Liquid assets, which include cash and due from banks, federal funds soldand investment securities available-for-sale, at June 30, 2003, totaled$247.1 million, or 47.6% of total assets. Of that, $179.4 million in investment securities available-for-sale wereavailable as collateral for additional Federal Home Loan Bank borrowings.  Management is committed to maintainingliquidity at a level sufficient to protect depositors, provide for reasonablegrowth and fully comply with all regulatory requirements.

 

**InterestRate Sensitivity**

 

Asset/liability managementinvolves the monitoring of our sensitivity to interest rate movements.  In order to measure the effect of interestrates on our net interest income, management takes into consideration theexpected cash flows from the loan and securities

 

17

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portfolios and the expectedmagnitude of the repricing of specific asset and liability categories.  Management evaluates interest sensitivityrisk and then formulates guidelines to manage this risk based upon its outlookregarding the economy, forecasted interest rate movements and other businessfactors.  Management’s goal is tomaximize and stabilize the net interest margin by limiting exposure to interestrate changes.

 

The data in Table 9 reflectsthe repricing or expected maturities of various assets and liabilities as ofJune 30, 2003.  This “gap” analysisrepresents the difference between interest sensitive assets and liabilities ina specific time interval.  The interestsensitivity gap analysis presents a position that existed at one particularpoint in time, and assumes that assets and liabilities with similar repricingcharacteristics will reprice at the same time and to the same degree.

 

**Forward-Looking Statements**

 

This Quarterly Report containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements are nothistorical facts, but rather are predictions and generally can be identified byuse of statements that include phrases such as “believe,” “expect,”“anticipate,” “estimate,” “intend,” “plan, “ “foresee” or other words orphrases of similar import.  Similarly,statements that describe our future financial condition or results ofoperations, objectives, strategies, plans, goals or future performance andbusiness also are forward-looking statements. These forward-looking statements involve known and unknown risks,uncertainties and other factors, including those described in the 2002 Form10-KSB under “Forward-Looking Statements and Risk Factors,” that could causeour actual results to differ materially from those currently anticipated inthese forward-looking statements.  Inlight of these risks and uncertainties, the forward-looking events might ormight not occur.

 

18

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Table 1.

 

**Investment Securities Available-for-Sale**

Asof June 30, 2003 and December 31, 2002

(Dollarsin thousands)

 
| **As of  June 30, 2003**                  |   | **Par Value** |    | **Amortized  Cost** |   | **Fair  Value** |   | **Unrealized  Gain/(Loss)** |    | **Average  Yield** |   |
|------------------------------------------------|--------|---------------|---------|---------------------|--------|-----------------|--------|-----------------------------|---------|--------------------|--------|
| U.S. government agencies and enterprises       |   |          |    |                |   |            |   |                        |    |               |   |
| One to five years                              |   | $             | 17,000  |                | $      | 16,991          |   | $                           | 17,199  |               | $      | 208 |   | 3.58 | % |
| Five to ten years                              |   | 10,000        |    | 10,002              |   | 10,053          |   | 51                          |    | 3.84               | %      |
| After ten years                                |   | 3,000         |    | 2,999               |   | 3,024           |   | 25                          |    | 5.29               | %      |
| Total U.S. government agencies                 |   | $             | 30,000  |                | $      | 29,992          |   | $                           | 30,276  |               | $      | 284 |   | 3.84 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Mortgage-backed securities                     |   |          |    |                |   |            |   |                        |    |               |   |
| Within one year                                |   | $             | 13,245  |                | $      | 13,331          |   | $                           | 13,424  |               | $      | 93 |   | 2.44 | % |
| One to five years                              |   | 83,088        |    | 85,075              |   | 85,877          |   | 802                         |    | 3.76               | %      |
| Five to ten years                              |   | 35,124        |    | 36,005              |   | 36,271          |   | 266                         |    | 4.12               | %      |
| After ten years                                |   | 45,557        |    | 46,516              |   | 46,474          |   | (42                         | )       | 4.24               | %      |
| Total mortgage-backed securities               |   | $             | 177,014 |                | $      | 180,927         |   | $                           | 182,046 |               | $      | 1,119 |   | 3.86 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Other bonds                                    |   |          |    |                |   |            |   |                        |    |               |   |
| After ten years                                |   | $             | 13,000  |                | $      | 13,000          |   | $                           | 13,013  |               | $      | 13 |   | 3.39 | % |
| Total other bonds                              |   | $             | 13,000  |                | $      | 13,000          |   | $                           | 13,013  |               | $      | 13 |   | 3.39 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Treasury bonds                                 |   |          |    |                |   |            |   |                        |    |               |   |
| Within one year                                |   | $             | 2,500   |                | $      | 2,505           |   | $                           | 2,550   |               | $      | 45 |   | 2.67 | % |
| One to five years                              |   | 2,000         |    | 2,055               |   | 2,119           |   | 64                          |    | 2.64               | %      |
| Total treasury bonds                           |   | $             | 4,500   |                | $      | 4,560           |   | $                           | 4,669   |               | $      | 109 |   | 2.66 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Total investment securities available-for-sale |   | $             | 224,514 |                | $      | 228,479         |   | $                           | 230,004 |               | $      | 1,525 |   | 3.80 | % |

 
| **As of  December 31, 2002**              |   | **Par Value** |    | **Amortized  Cost** |   | **Fair  Value** |   | **Unrealized  Gain/(Loss)** |    | **Average  Yield** |   |
|------------------------------------------------|--------|---------------|---------|---------------------|--------|-----------------|--------|-----------------------------|---------|--------------------|--------|
| U.S. government agencies and enterprises       |   |          |    |                |   |            |   |                        |    |               |   |
| One to five years                              |   | $             | 26,750  |                | $      | 26,739          |   | $                           | 26,988  |               | $      | 249 |   | 3.47 | % |
| Five to ten years                              |   | 12,000        |    | 12,048              |   | 12,048          |   | —                      |    | 3.68               | %      |
| Total U.S. government agencies                 |   | $             | 38,750  |                | $      | 38,787          |   | $                           | 39,036  |               | $      | 249 |   | 3.53 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Mortgage-backed securities                     |   |          |    |                |   |            |   |                        |    |               |   |
| Within one year                                |   | $             | 15,325  |                | $      | 15,478          |   | $                           | 15,750  |               | $      | 272 |   | 3.61 | % |
| One to five years                              |   | 69,265        |    | 70,552              |   | 72,342          |   | 1,790                       |    | 4.82               | %      |
| Five to ten years                              |   | 13,385        |    | 13,695              |   | 13,686          |   | (9                          | )       | 4.43               | %      |
| After ten years                                |   | 13,940        |    | 15,301              |   | 15,301          |   | —                      |    | 5.20               | %      |
| Total mortgage-backed securities               |   | $             | 111,915 |                | $      | 115,026         |   | $                           | 117,079 |               | $      | 2,053 |   | 4.65 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Other bonds                                    |   |          |    |                |   |            |   |                        |    |               |   |
| After ten years                                |   | $             | 5,000   |                | $      | 5,000           |   | $                           | 5,000   |               | $      | — |   | 3.39 | % |
| Total other bonds                              |   | $             | 5,000   |                | $      | 5,000           |   | $                           | 5,000   |               | $      | — |   | 3.39 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Treasury bonds                                 |   |          |    |                |   |            |   |                        |    |               |   |
| One to five years                              |   | $             | 2,500   |                | $      | 2,507           |   | $                           | 2,550   |               | $      | 43 |   | 2.67 | % |
| Total treasury bonds                           |   | $             | 2,500   |                | $      | 2,507           |   | $                           | 2,550   |               | $      | 43 |   | 2.67 | % |
|                                           |   |          |    |                |   |            |   |                        |    |               |   |
| Total investment securities available-for-sale |   | $             | 158,165 |                | $      | 161,320         |   | $                           | 163,665 |               | $      | 2,345 |   | 4.32 | % |

 

19

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Table 2.

 

**Loans Receivable**

As of June 30, 2003 and December 31, 2002

(Dollars in thousands)

 
|                            |   | **June 30,  2003** |    | **December 31,  2002** |   |
|---------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                            |   |                    |    |                        |   |   |   |   |   |
| Commercial                      |   | $                       | 45,927  |                        | 17.38  | % | $ | 58,292 |   | 23.40 | % |
| Real estate - commercial        |   | 119,459                 |    | 45.21                       | %      | 116,135 |   | 46.63 | % |
| Real estate - construction      |   | 20,443                  |    | 7.74                        | %      | 5,781 |   | 2.32 | % |
| Real estate - residential       |   | 36,400                  |    | 13.78                       | %      | 31,808 |   | 12.77 | % |
| Home equity lines               |   | 33,064                  |    | 12.51                       | %      | 26,831 |   | 10.77 | % |
| Consumer                        |   | 8,942                   |    | 3.38                        | %      | 10,235 |   | 4.11 | % |
|                            |   |                    |    |                        |   |   |   |   |   |
| Gross loans                     |   | $                       | 264,235 |                        | 100.00 | % | $ | 249,082 |   | 100.00 | % |
|                            |   |                    |    |                        |   |   |   |   |   |
| Add: unearned income, net       |   | (70                     | )       |                        |   | 24 |   |   |   |
| Less: allowance for loan losses |   | (3,582                  | )       |                        |   | (3,372 | ) |   |   |
|                            |   |                    |    |                        |   |   |   |   |   |
| Loan receivable, net            |   | $                       | 260,583 |                        |   |   | $ | 245,734 |   |   |   |

 

20

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Table 3.

 

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

As of June 30, 2003

(Dollars in thousands)

 
|                                  |   | **June 30,  2003** |   |
|---------------------------------------|--------|-------------------------|--------|
| **Maturities:**                       |   |                    |   |
| Three months or less                  |   | $                       | 8,902  |   |
| Over three months through six months  |   | 9,215                   |   |
| Over six months through twelve months |   | 20,756                  |   |
| Over twelve months                    |   | 39,329                  |   |
|                                  |   | $                       | 78,202 |   |

 

21

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**Table 4.**

 

**Average Balance Sheets and Interest Rates on EarningAssets and Interest – Bearing Liabilities**

For the Three Months Ended June 30, 2003, 2002 and 2001

(Dollars in thousands)

 
|                                                    |   | **2003**             |    | **2002**                       |   | **2001** |   |
|---------------------------------------------------------|--------|----------------------|---------|--------------------------------|--------|----------|--------|
|                                                    |   | **Average  Balance** |    | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   |
| **Assets**                                              |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans:                                                  |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                                              |   | $                    | 50,683  |                           | $      | 817      |   | 6.45 | % | $ | 51,837 |   | $ | 933 |   | 7.20 | % | $ | 51,341 |   | $ | 1,120 |   | 8.73 | % |
| Real estate - commercial                                |   | 114,892              |    | 2,032                          |   | 7.07     | %      | 88,135 |   | 1,777 |   | 8.07 | % | 67,019 |   | 1,486 |   | 8.87 | % |
| Real estate - construction                              |   | 14,800               |    | 214                            |   | 5.78     | %      | 5,914 |   | 89 |   | 6.01 | % | 5,474 |   | 122 |   | 8.91 | % |
| Real estate - residential                               |   | 37,211               |    | 604                            |   | 6.49     | %      | 15,536 |   | 308 |   | 7.93 | % | 19,089 |   | 398 |   | 8.34 | % |
| Home equity lines                                       |   | 31,890               |    | 263                            |   | 3.31     | %      | 23,811 |   | 252 |   | 4.25 | % | 17,100 |   | 290 |   | 6.78 | % |
| Consumer                                                |   | 9,099                |    | 170                            |   | 7.49     | %      | 13,098 |   | 246 |   | 7.51 | % | 15,682 |   | 308 |   | 7.86 | % |
| Total loans                                             |   | 258,575              |    | 4,100                          |   | 6.34     | %      | 198,331 |   | 3,605 |   | 7.27 | % | 175,705 |   | 3,724 |   | 8.48 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment securities available for sale                |   | 199,129              |    | 1,614                          |   | 3.24     | %      | 99,680 |   | 1,218 |   | 4.89 | % | 4,632 |   | 85 |   | 7.34 | % |
| Other investments                                       |   | 2,576                |    | 31                             |   | 4.81     | %      | 1,196 |   | 17 |   | 5.69 | % | 1,504 |   | 22 |   | 5.85 | % |
| Federal funds sold                                      |   | 14,458               |    | 42                             |   | 1.16     | %      | 47,954 |   | 200 |   | 1.65 | % | 29,817 |   | 336 |   | 4.57 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets and interest income       |   | 474,738              |    | 5,787                          |   | 4.88     | %      | 347,161 |   | 5,040 |   | 5.81 | % | 211,658 |   | 4,167 |   | 7.88 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                            |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                 |   | 8,097                |    |                           |   |     |   | 17,652 |   |   |   |   |   | 10,518 |   |   |   |   |   |
| Premises and equipment, net                             |   | 5,219                |    |                           |   |     |   | 4,839 |   |   |   |   |   | 5,746 |   |   |   |   |   |
| Goodwill and other intangibles                          |   | 646                  |    |                           |   |     |   | 649 |   |   |   |   |   | 9,333 |   |   |   |   |   |
| Accrued interest and other assets                       |   | 4,070                |    |                           |   |     |   | 1,256 |   |   |   |   |   | 1,643 |   |   |   |   |   |
| Allowance for loan losses                               |   | (3,483               | )       |                           |   |     |   | (3,002 | ) |   |   |   |   | (2,011 | ) |   |   |   |   |
| Total assets                                            |   | $                    | 489,287 |                           |   |     |   |   | $ | 368,555 |   |   |   |   |   | $ | 236,887 |   |   |   |   |   |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**           |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                         |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                            |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                       |   | 146,086              |    | 665                            |   | 1.83     | %      | 112,517 |   | 832 |   | 2.96 | % | 13,616 |   | 66 |   | 1.94 | % |
| Money markets                                           |   | 24,838               |    | 56                             |   | 0.90     | %      | 26,655 |   | 139 |   | 2.09 | % | 23,878 |   | 197 |   | 3.31 | % |
| Statement savings                                       |   | 5,382                |    | 10                             |   | 0.73     | %      | 4,245 |   | 13 |   | 1.24 | % | 4,431 |   | 33 |   | 2.99 | % |
| Certificates of deposit                                 |   | 174,336              |    | 1,495                          |   | 3.44     | %      | 126,737 |   | 1,324 |   | 4.19 | % | 102,381 |   | 1,543 |   | 6.05 | % |
| Total interest - bearing deposits                       |   | 350,642              |    | 2,226                          |   | 2.55     | %      | 270,154 |   | 2,308 |   | 3.39 | % | 144,306 |   | 1,839 |   | 5.11 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                    |   | 28,563               |    | 117                            |   | 1.64     | %      | 7,000 |   | 71 |   | 4.04 | % | 10,951 |   | 134 |   | 4.91 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest expense |   | 379,205              |    | 2,343                          |   | 2.48     | %      | 277,154 |   | 2,379 |   | 3.44 | % | 155,257 |   | 1,973 |   | 5.10 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                        |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                         |   | 67,737               |    |                           |   |     |   | 57,554 |   |   |   |   |   | 46,112 |   |   |   |   |   |
| Other liabilities                                       |   | 2,315                |    |                           |   |     |   | 3,559 |   |   |   |   |   | 2,681 |   |   |   |   |   |
| Preferred shareholders’ equity                     |   | 6,824                |    |                           |   |     |   | 6,825 |   |   |   |   |   | 7,057 |   |   |   |   |   |
| Common shareholders’ equity                        |   | 33,206               |    |                           |   |     |   | 23,463 |   |   |   |   |   | 25,780 |   |   |   |   |   |
| Total liabilities and shareholders’ equity         |   | $                    | 489,287 |                           |   |     |   |   | $ | 368,555 |   |   |   |   |   | $ | 236,887 |   |   |   |   |   |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin             |   |                 |    | $                              | 3,444  |     | 2.90   | % |   |   | $ | 2,661 |   | 3.07 | % |   |   | $ | 2,194 |   | 4.15 | % |

 

22

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Table 4a.

 

Rate and Volume Analysis (Tax Equivalent Basis)

(Dollars in thousands)

 
|                                     |   | **Three  Months Ended June 30,  2003 Compared to 2002** |   | **Three  Months Ended June 30,  2002 Compared to 2001** |   |
|------------------------------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------|--------|
|                                     |   | **Average  Volume**                                          |   | **Average  Rate**                                            |   | **Increase  (Decrease)** |   | **Average  Volume** |   | **Average  Rate** |   | **Increase  (Decrease)** |   |
| **Interest income:**                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Loans:                                   |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Commercial                               |   | $                                                            | (21    | )                                                            | $      | (95 | ) | $ | (116 | ) | $ | 10 |   | $ | (197 | ) | $ | (187 | ) |
| Real estate - commercial                 |   | 542                                                          |   | (287                                                         | )      | 255 |   | 466 |   | (175 | ) | 291 |   |
| Real estate - construction               |   | 133                                                          |   | (8                                                           | )      | 125 |   | 10 |   | (43 | ) | (33 | ) |
| Real estate - residential                |   | 429                                                          |   | (133                                                         | )      | 296 |   | (74 | ) | (16 | ) | (90 | ) |
| Home equity lines                        |   | 86                                                           |   | (75                                                          | )      | 11 |   | 112 |   | (150 | ) | (38 | ) |
| Consumer                                 |   | (76                                                          | )      | (0                                                           | )      | (76 | ) | (51 | ) | (11 | ) | (62 | ) |
| Total loans                              |   | 1,093                                                        |   | (598                                                         | )      | 495 |   | 473 |   | (592 | ) | (119 | ) |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Investment securities available for sale |   | 1,215                                                        |   | (819                                                         | )      | 396 |   | 1,744 |   | (611 | ) | 1,133 |   |
| Other investments                        |   | 20                                                           |   | (6                                                           | )      | 14 |   | (5 | ) | (0 | ) | (5 | ) |
| Federal funds sold                       |   | (140                                                         | )      | (18                                                          | )      | (158 | ) | 213 |   | (349 | ) | (136 | ) |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Total interest income                    |   | 2,188                                                        |   | (1,441                                                       | )      | 747 |   | 2,425 |   | (1,552 | ) | 873 |   |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Interest checking                        |   | 245                                                          |   | (412                                                         | )      | (167 | ) | 481 |   | 285 |   | 766 |   |
| Money markets                            |   | (9                                                           | )      | (74                                                          | )      | (83 | ) | 23 |   | (81 | ) | (58 | ) |
| Statement savings                        |   | 4                                                            |   | (7                                                           | )      | (3 | ) | (1 | ) | (19 | ) | (20 | ) |
| Certificates of deposit                  |   | 497                                                          |   | (326                                                         | )      | 171 |   | 368 |   | (587 | ) | (219 | ) |
| Total interest - bearing deposits        |   | 737                                                          |   | (819                                                         | )      | (82 | ) | 871 |   | (402 | ) | 469 |   |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |   | 219                                                          |   | (173                                                         | )      | 46 |   | (47 | ) | (16 | ) | (63 | ) |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Total interest expense                   |   | 956                                                          |   | (992                                                         | )      | (36 | ) | 824 |   | (418 | ) | 406 |   |
|                                     |   |                                                         |   |                                                         |   |   |   |   |   |   |   |   |   |
| Net interest income                      |   | $                                                            | 1,232  |                                                         | $      | (449 | ) | $ | 783 |   | $ | 1,601 |   | $ | (1,134 | ) | $ | 467 |   |

 

23

----

 

**Table 5.**

 

**Average Balance Sheets and Interest Rates on EarningAssets and Interest - Bearing Liabilities**

For the Six Months Ended June 30, 2003, 2002 and 2001

(Dollars in thousands)

 

 
|                                                    |   | **2003**             |    | **2002**                       |   | **2001** |   |
|---------------------------------------------------------|--------|----------------------|---------|--------------------------------|--------|----------|--------|
|                                                    |   | **Average  Balance** |    | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Rate** |   |
| **Assets**                                              |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans:                                                  |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                                              |   | $                    | 51,866  |                           | $      | 1,650    |   | 6.36 | % | $ | 53,322 |   | $ | 1,896 |   | 7.11 | % | $ | 49,425 |   | $ | 2,229 |   | 9.02 | % |
| Real estate - commercial                                |   | 115,287              |    | 4,097                          |   | 7.11     | %      | 87,215 |   | 3,521 |   | 8.07 | % | 62,549 |   | 2,772 |   | 8.86 | % |
| Real estate - construction                              |   | 11,894               |    | 351                            |   | 5.90     | %      | 5,940 |   | 182 |   | 6.13 | % | 5,281 |   | 247 |   | 9.35 | % |
| Real estate - residential                               |   | 35,755               |    | 1,181                          |   | 6.61     | %      | 16,590 |   | 665 |   | 8.01 | % | 18,163 |   | 749 |   | 8.25 | % |
| Home equity lines                                       |   | 30,131               |    | 503                            |   | 3.37     | %      | 22,719 |   | 478 |   | 4.24 | % | 16,368 |   | 609 |   | 7.44 | % |
| Consumer                                                |   | 9,367                |    | 351                            |   | 7.56     | %      | 13,349 |   | 489 |   | 7.33 | % | 14,992 |   | 590 |   | 7.87 | % |
| Total loans                                             |   | 254,300              |    | 8,133                          |   | 6.40     | %      | 199,135 |   | 7,231 |   | 7.26 | % | 166,778 |   | 7,196 |   | 8.63 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment securities available for sale                |   | 189,640              |    | 3,292                          |   | 3.47     | %      | 73,821 |   | 1,813 |   | 4.91 | % | 5,090 |   | 190 |   | 7.47 | % |
| Other investments                                       |   | 2,216                |    | 55                             |   | 4.96     | %      | 1,194 |   | 36 |   | 6.03 | % | 1,482 |   | 44 |   | 5.94 | % |
| Federal funds sold                                      |   | 13,983               |    | 80                             |   | 1.14     | %      | 42,985 |   | 353 |   | 1.66 | % | 28,538 |   | 708 |   | 5.00 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets and interest income       |   | 460,139              |    | 11,560                         |   | 5.02     | %      | 317,135 |   | 9,433 |   | 5.95 | % | 201,888 |   | 8,138 |   | 8.06 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest earning assets:                            |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                 |   | 11,390               |    |                           |   |     |   | 15,706 |   |   |   |   |   | 9,681 |   |   |   |   |   |
| Premises and equipment, net                             |   | 5,114                |    |                           |   |     |   | 4,926 |   |   |   |   |   | 5,688 |   |   |   |   |   |
| Goodwill and other intangibles                          |   | 646                  |    |                           |   |     |   | 656 |   |   |   |   |   | 9,424 |   |   |   |   |   |
| Accrued interest and other assets                       |   | 4,266                |    |                           |   |     |   | 1,016 |   |   |   |   |   | 1,663 |   |   |   |   |   |
| Allowance for loan losses                               |   | (3,440               | )       |                           |   |     |   | (3,052 | ) |   |   |   |   | (1,987 | ) |   |   |   |   |
| Total assets                                            |   | $                    | 478,115 |                           |   |     |   |   | $ | 336,387 |   |   |   |   |   | $ | 226,357 |   |   |   |   |   |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**           |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing liabilities:                         |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:                            |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest checking                                       |   | 142,602              |    | 1,303                          |   | 1.84     | %      | 91,258 |   | 1,348 |   | 2.98 | % | 13,202 |   | 129 |   | 1.97 | % |
| Money markets                                           |   | 25,481               |    | 125                            |   | 0.99     | %      | 26,303 |   | 272 |   | 2.09 | % | 23,575 |   | 432 |   | 3.70 | % |
| Statement savings                                       |   | 4,940                |    | 19                             |   | 0.78     | %      | 4,269 |   | 26 |   | 1.24 | % | 4,342 |   | 64 |   | 2.97 | % |
| Certificates of deposit                                 |   | 173,796              |    | 3,019                          |   | 3.50     | %      | 121,168 |   | 2,586 |   | 4.31 | % | 97,883 |   | 3,008 |   | 6.20 | % |
| Total interest - bearing deposits                       |   | 346,819              |    | 4,466                          |   | 2.60     | %      | 242,998 |   | 4,232 |   | 3.51 | % | 139,002 |   | 3,633 |   | 5.27 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                                    |   | 21,798               |    | 190                            |   | 1.76     | %      | 8,192 |   | 168 |   | 4.08 | % | 9,260 |   | 246 |   | 5.35 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities and interest expense |   | 368,617              |    | 4,656                          |   | 2.55     | %      | 251,190 |   | 4,400 |   | 3.53 | % | 148,262 |   | 3,879 |   | 5.28 | % |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing liabilities:                        |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                         |   | 67,191               |    |                           |   |     |   | 56,774 |   |   |   |   |   | 42,142 |   |   |   |   |   |
| Other liabilities                                       |   | 1,953                |    |                           |   |     |   | 2,938 |   |   |   |   |   | 2,636 |   |   |   |   |   |
| Preferred shareholders’ equity                     |   | 6,824                |    |                           |   |     |   | 6,825 |   |   |   |   |   | 7,057 |   |   |   |   |   |
| Common shareholders’ equity                        |   | 33,530               |    |                           |   |     |   | 18,660 |   |   |   |   |   | 26,260 |   |   |   |   |   |
| Total liabilities and shareholders’ equity         |   | $                    | 478,115 |                           |   |     |   |   | $ | 336,387 |   |   |   |   |   | $ | 226,357 |   |   |   |   |   |
|                                                    |   |                 |    |                           |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income and net interest margin             |   |                 |    | $                              | 6,904  |     | 3.00   | % |   |   | $ | 5,033 |   | 3.18 | % |   |   | $ | 4,259 |   | 4.22 | % |

 

24

----

 

Table 5a.

 

Rate and Volume Analysis (Tax Equivalent Basis)

(Dollars in thousands)

 
|                                     |   | **Six Months  Ended June 30,  2003 Compared to 2002** |   | **Six Months  Ended June 30,  2002 Compared to 2001** |   |
|------------------------------------------|--------|------------------------------------------------------------|--------|------------------------------------------------------------|--------|
|                                     |   | **Average  Volume**                                        |   | **Average  Rate**                                          |   | **Increase  (Decrease)** |   | **Average  Volume** |   | **Average  Rate** |   | **Increase  (Decrease)** |   |
| **Interest income:**                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Loans:                                   |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Commercial                               |   | $                                                          | (52    | )                                                          | $      | (194 | ) | $ | (246 | ) | $ | 176 |   | $ | (509 | ) | $ | (333 | ) |
| Real estate - commercial                 |   | 1,133                                                      |   | (557                                                       | )      | 576 |   | 1,093 |   | (344 | ) | 749 |   |
| Real estate - construction               |   | 182                                                        |   | (13                                                        | )      | 169 |   | 31 |   | (96 | ) | (65 | ) |
| Real estate - residential                |   | 766                                                        |   | (250                                                       | )      | 516 |   | (64 | ) | (20 | ) | (84 | ) |
| Home equity lines                        |   | 156                                                        |   | (131                                                       | )      | 25 |   | 229 |   | (360 | ) | (131 | ) |
| Consumer                                 |   | (149                                                       | )      | 11                                                         |   | (138 | ) | (65 | ) | (36 | ) | (101 | ) |
| Total loans                              |   | 2,036                                                      |   | (1,134                                                     | )      | 902 |   | 1,400 |   | (1,365 | ) | 35 |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Investment securities available for sale |   | 2,844                                                      |   | (1,365                                                     | )      | 1,479 |   | 2,558 |   | (935 | ) | 1,623 |   |
| Other investments                        |   | 31                                                         |   | (12                                                        | )      | 19 |   | (9 | ) | 1 |   | (8 | ) |
| Federal funds sold                       |   | (238                                                       | )      | (35                                                        | )      | (273 | ) | 357 |   | (712 | ) | (355 | ) |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Total interest income                    |   | 4,673                                                      |   | (2,546                                                     | )      | 2,127 |   | 4,306 |   | (3,011 | ) | 1,295 |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| **Interest expense:**                    |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Interest - bearing deposits:             |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Interest checking                        |   | 758                                                        |   | (803                                                       | )      | (45 | ) | 764 |   | 455 |   | 1,219 |   |
| Money markets                            |   | (9                                                         | )      | (138                                                       | )      | (147 | ) | 51 |   | (211 | ) | (160 | ) |
| Statement savings                        |   | 4                                                          |   | (11                                                        | )      | (7 | ) | (1 | ) | (37 | ) | (38 | ) |
| Certificates of deposit                  |   | 1,129                                                      |   | (696                                                       | )      | 433 |   | 709 |   | (1,131 | ) | (422 | ) |
| Total interest - bearing deposits        |   | 1,882                                                      |   | (1,648                                                     | )      | 234 |   | 1,523 |   | (924 | ) | 599 |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Other borrowed funds                     |   | 274                                                        |   | (252                                                       | )      | 22 |   | (26 | ) | (52 | ) | (78 | ) |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Total interest expense                   |   | 2,156                                                      |   | (1,900                                                     | )      | 256 |   | 1,497 |   | (976 | ) | 521 |   |
|                                     |   |                                                       |   |                                                       |   |   |   |   |   |   |   |   |   |
| Net interest income                      |   | $                                                          | 2,517  |                                                       | $      | (646 | ) | $ | 1,871 |   | $ | 2,809 |   | $ | (2,035 | ) | $ | 774 |   |

 

25

----

 

Table 6.

 

**Allowance for Loan Losses**

For the Six Months Ended June 30, 2003 and 2002

(Dollars in thousands)

 
|                                                      |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------|--------|----------|--------|----------|--------|
| Beginning balance, January 1                         |   | $        | 3,372  |     | $      | 3,104 |   |
|                                                      |   |     |   |     |   |
| Provision for loan losses                                 |   | 246      |   | 39       |   |
|                                                      |   |     |   |     |   |
| Transfer to bank’s liability on unfunded commitments |   | —   |   | (74      | )      |
|                                                      |   |     |   |     |   |
| Loans charged off:                                        |   |     |   |     |   |
| Commercial                                                |   | (74      | )      | (63      | )      |
| Real estate - commercial                                  |   | —   |   | —   |   |
| Real estate - construction                                |   | —   |   | —   |   |
| Real estate - residential                                 |   | —   |   | —   |   |
| Home equity lines                                         |   | —   |   | —   |   |
| Consumer                                                  |   | (6       | )      | (14      | )      |
| Total loans charged off                                   |   | (80      | )      | (77      | )      |
|                                                      |   |     |   |     |   |
| Recoveries:                                               |   |     |   |     |   |
| Commercial                                                |   | 41       |   | 1        |   |
| Real estate - commercial                                  |   | —   |   | —   |   |
| Real estate - construction                                |   | —   |   | —   |   |
| Real estate - residential                                 |   | —   |   | —   |   |
| Home equity lines                                         |   | —   |   | —   |   |
| Consumer                                                  |   | 3        |   | 1        |   |
| Total recoveries                                          |   | 44       |   | 2        |   |
|                                                      |   |     |   |     |   |
| Net (charge-offs) recoveries                              |   | (36      | )      | (75      | )      |
|                                                      |   |     |   |     |   |
| Ending balance                                            |   | $        | 3,582  |     | $      | 2,994 |   |

 
|                                                     |   | **June 30,  2003** |    | **December 31,  2002** |   |
|----------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
| **Loans:**                                               |   |                    |    |                        |   |
| Balance at period end                                    |   | $                       | 264,165 |                        | $      | 249,106 |   |
| Allowance for loan losses to period end loans receivable |   | 1.36                    | %       | 1.35                        | %      |
|                                                          |        |                         |         |                             |        |  |  |

 

26

----

 

Table 7.

 

**Allocation of the Allowance for Loan Losses**

As of June 30, 2003 and December 31, 2002

(Dollars in thousands)

 
|                            |   | **June 30,  2003** |   | **December 31,  2002** |   |
|---------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                            |   | **Allocation**          |   | **% of  Total***            |   | **Allocation** |   | **% of  Total*** |   |
| Commercial                      |   | $                       | 1,016  |                        | 17.36  | % | $ | 1,301 |   | 23.40 | % |
| Real estate - commercial        |   | 1,727                   |   | 45.16                       | %      | 1,386 |   | 46.63 | % |
| Real estate - construction      |   | 48                      |   | 7.73                        | %      | 19 |   | 2.32 | % |
| Real estate - residential       |   | 285                     |   | 13.76                       | %      | 241 |   | 12.77 | % |
| Home equity lines               |   | 289                     |   | 12.60                       | %      | 201 |   | 10.77 | % |
| Consumer                        |   | 217                     |   | 3.39                        | %      | 224 |   | 4.11 | % |
|                            |   |                    |   |                        |   |   |   |   |   |
| Total allowance for loan losses |   | $                       | 3,582  |                        | 100.00 | % | $ | 3,372 |   | 100.00 | % |

 

----

* Percentage of loan type to the total loan portfolio.

 

27

----

 

Table 8.

 

**Capital Components**

As of June 30, 2003 andDecember 31, 2002

(Dollars in thousands)

 
|                                                             |   | **Actual** |   | **For  Capital  Adequacy Purposes** |   | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** |   |
|------------------------------------------------------------------|--------|------------|--------|-------------------------------------|--------|-------------------------------------------------------------------------|--------|
|                                                             |   | **Amount** |   | **Ratio**                           |   | **Amount**                                                              |   |   |   | **Ratio** |   | **Amount** |   |   |   | **Ratio** |   |
|                                                             |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |   |   |   |   |
| **As of June 30, 2003**                                     |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Total risk based capital/ Total capital to  risk-weighted assets |   | $          | 42,330 |                                | 12.33  | %                                                                       | $      | 27,467 |   | 3 |   | 8.00 | % | $ | 34,334 |   | 3 |   | 10.00 | % |
| Tier I capital/ Tier I capital to  risk-weighted assets          |   | 38,748     |   | 11.29                               | %      | 13,734                                                                  |   | 3 |   | 4.00 | % | 20,600 |   | 3 |   | 6.00 | % |
| Total risk based capital/ Total capital to  average assets       |   | 42,330     |   | 8.65                                | %      | 19,571                                                                  |   | 3 |   | 4.00 | % | 24,464 |   | 3 |   | 5.00 | % |
|                                                             |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |   |   |   |   |
| **As of December 31, 2002**                                 |   |       |   |                                |   |                                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Total risk based capital/ Total capital to  risk-weighted assets |   | $          | 41,093 |                                | 13.35  | %                                                                       | $      | 24,625 |   | 3 |   | 8.00 | % | $ | 30,781 |   | 3 |   | 10.00 | % |
| Tier I capital/ Tier I capital to  risk-weighted assets          |   | 37,721     |   | 12.25                               | %      | 12,313                                                                  |   | 3 |   | 4.00 | % | 18,469 |   | 3 |   | 6.00 | % |
| Total risk based capital/ Total capital to  average assets       |   | 41,093     |   | 8.97                                | %      | 18,330                                                                  |   | 3 |   | 4.00 | % | 22,913 |   | 3 |   | 5.00 | % |

 

28

----

 

Table 9.

 

**Interest Rate Sensitivity Gap Analysis**

As of June 30, 2003

(Dollars in thousands)

** **
|                                                              |   | **Immediate  Repricing** |    | **2-90  Days** |   | **91-180  Days** |   | **181-365  Days** |    | **1-3  Years** |   | **Over 3  Years** |       | **TOTAL** |       |
|-------------------------------------------------------------------|--------|--------------------------|---------|----------------|--------|------------------|--------|-------------------|---------|----------------|--------|-------------------|------------|-----------|------------|
| **Assets**                                                        |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| Investment securities available-for-sale & other investments  |   | $                        | 108,290 |           | $      | 23,973           |   | $                 | 10,045  |           | $      | 10,277            |       | $         | 34,947     |   | $ | 45,110 |   | $ | 232,642 |   |
| Federal funds sold                                                |   | 5,396                    |    | —         |   | —           |   | —            |    | —         |   | —            |       | 5,396     |       |
| **Loans Receivable, net of fees**                                 |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| Commercial & industrial                                       |   | 30,077                   |    | 5,438          |   | 5,381            |   | 9,899             |    | 46,620         |   | 67,861            |       | 165,276   |       |
| Residential                                                       |   | 680                      |    | 974            |   | 534              |   | 1,382             |    | 8,756          |   | 24,099            |       | 36,425    |       |
| Home equity lines                                                 |   | 3,478                    |    | 24,562         |   | 4,854            |   | 436               |    | —         |   | —            |       | 33,330    |       |
| Construction                                                      |   | 17,865                   |    | —         |   | 474              |   | 1,340             |    | 772            |   | —            |       | 20,451    |       |
| All other                                                         |   | 1,515                    |    | 227            |   | 334              |   | 279               |    | 786            |   | 5,809             |       | 8,950     |       |
| **Total loans receivable, net of fees**                           |   | 53,615                   |    | 31,201         |   | 11,577           |   | 13,336            |    | 56,934         |   | 97,769            |       | 264,432   |       |
| **Total earning assets**                                          |   | 167,301                  |    | 55,174         |   | 21,622           |   | 23,613            |    | 91,881         |   | 142,879           |       | 502,470   |       |
| **Cumulative rate sensitive assets**                              |   | $                        | 167,301 |           | $      | 222,475          |   | $                 | 244,097 |           | $      | 267,710           |       | $         | 359,591    |   | $ | 502,470 |   |   |   |
|                                                              |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| **Liabilities**                                                   |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| **Deposits**                                                      |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| Noninterest-bearing demand                                        |   | $                        | —  |           | $      | —           |   | $                 | —  |           | $      | —            |       | $         | —     |   | $ | 80,483 |   | $ | 80,483 |   |
| Interest-bearing transaction accounts                             |   | 36,500                   |    | 18,250         |   | 18,250           |   | 18,250            |    | 18,250         |   | 72,998            |       | 182,498   |       |
| Certificates of deposit - fixed                                   |   | 658                      |    | 13,131         |   | 8,288            |   | 20,574            |    | 57,188         |   | 14,973            |       | 114,812   |       |
| Certificates of deposit - no penalty                              |   | —                   |    | 6,856          |   | 5,767            |   | 22,725            |    | 25,220         |   | —            |       | 60,568    |       |
| **Total deposits**                                                |   | 37,158                   |    | 38,237         |   | 32,305           |   | 61,549            |    | 100,658        |   | 168,454           |       | 438,361   |       |
| Other borrowed funds                                              |   | 14,018                   |    | 4,000          |   | 4,000            |   | 7,000             |    | 8,000          |   | 1,000             |       | 38,018    |       |
| **Total deposits & other borrowed funds**                     |   | 51,176                   |    | 42,237         |   | 36,305           |   | 68,549            |    | 108,658        |   | 169,454           |       | 476,379   |       |
| **Cumulative rate sensitive liabilities**                         |   | $                        | 51,176  |           | $      | 93,413           |   | $                 | 129,718 |           | $      | 198,267           |       | $         | 306,925    |   | $ | 476,379 |   |   |   |
|                                                              |   |                     |    |           |   |             |   |              |    |           |   |              |       |      |       |
| **Gap**                                                           |   | $                        | 116,125 |           | $      | 12,937           |   | $                 | (14,683 | )              | $      | (44,936           | )          | $         | (16,777    | ) | $ | (26,575 | ) |   |   |
| **Cumulative gap**                                                |   | 116,125                  |    | 129,062        |   | 114,379          |   | 69,443            |    | 52,666         |   | 26,091            |       |      |       |
| **Gap/ total assets**                                             |   | 22.37                    | %       | 2.49           | %      | -2.83            | %      | -8.65             | %       | -3.23          | %      | -5.12             | %          |      |       |
| **Cumulative gap/ total assets**                                  |   | 22.37                    | %       | 24.86          | %      | 22.03            | %      | 13.38             | %       | 10.14          | %      | 5.03              | %          |      |       |
| **Rate sensitive assets/ rate sensitive liabilities**             |   | 3.27                     |    | 1.31           |   | 0.60             |   | 0.34              |    | 0.85           |   | 0.84              | ** ** |      | ** ** |
| **Cumulative rate sensitive assets/ rate sensitive  liabilities** |   | 3.27                     |    | 2.38           |   | 1.88             |   | 1.35              |    | 1.17           |   | 1.05              | ** ** |      | ** ** |
|                                                                   |        |                          |         |                |        |                  |        |                   |         |                |        |                   |            |           |            |  |  |  |  |  |  |  |  |

 

29

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**Item 3.  Controls and Procedures**

 

Based upon an evaluation by our ChiefExecutive Officer and Chief Financial Officer as of the end of the periodcovered by this Quarterly Report, they have concluded that our disclosurecontrols and procedures, as defined in Rule 13a-14(c) under the SecuritiesExchange Act of 1934, as amended, are effective in ensuring that all materialinformation required to be filed in this Quarterly Report has been made knownto them in a timely fashion.

 

There were no significant changes in ourinternal controls or in other factors that could materially affect, or isreasonable likely to materially affect, internal controls subsequent to thedate of the evaluation referred to above.

 

30

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**PartII - Other Information**

 

**Item 1.  Legal Proceedings**

 

From time to time, the Companyis a party to legal proceedings in the ordinary course of business.  However, the Company is not engaged in anylegal proceedings of a material nature at the present time.

 

**Item 2.  Changes in Securities and Use of Proceeds**

 

(a) None

(b) None

(c) None

(d) Not applicable

 

**Item 3.  Defaults Upon Senior Securities**

 

(a) None

(b) None

 

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

 

(a) The Company’s Annual Meeting of Shareholders was held on April 22,2003.

(b) Not applicable.

(c) The following persons were elected as directors for terms expiring inthe year indicated:

 
|                  |   |             |   | **Votes** |   |
|-----------------------|--------|------------------|--------|-----------|--------|
| **Director**          |   | **Term Expires** |   | **For**   |   | **Withheld** |   |
|                  |   |             |   |      |   |   |   |
| B. G. Beck            |   | 2004             |   | 8,535,580 |   | 31,148 |   |
| Michael A.  Garcia    |   | 2004             |   | 8,534,780 |   | 31,948 |   |
| Alice M. Starr        |   | 2004             |   | 8,535,580 |   | 31,148 |   |
| J. Hamilton  Lambert  |   | 2004             |   | 8,535,580 |   | 31,148 |   |
|                  |   |             |   |      |   |   |   |
| William E.  Peterson  |   | 2005             |   | 8,535,580 |   | 31,148 |   |
| Sidney O.  Dewberry   |   | 2005             |   | 8,534,780 |   | 31,948 |   |
|                  |   |             |   |      |   |   |   |
| Wayne W.  Broadwater  |   | 2006             |   | 8,306,161 |   | 260,567 |   |
| Bernard H.  Clineburg |   | 2006             |   | 8,425,580 |   | 141,148 |   |
| James D. Russo        |   | 2006             |   | 8,534,780 |   | 31,948 |   |
| John H. Rust,  Jr.    |   | 2006             |   | 8,463,760 |   | 102,968 |   |
| George P.  Shafran    |   | 2006             |   | 8,535,580 |   | 31,148 |   |

 

31

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The following directors have terms of office that continued after themeeting:

 
| **Director**      |   | **Term Expires** |   |
|-------------------|--------|------------------|--------|
| Harold E. Lieding |   | 2004             |   |
| William G. Buck   |   | 2005             |   |
| John W. Fisher    |   | 2005             |   |
| Emad Saadeh       |   | 2005             |   |

 

Finally, the shareholders voted on and approved the appointment of KPMGLLP as the Company’s independent auditors by a vote of 7,982,990 for, 36,179against, with 7,200 abstentions.

 

(d) None

 

**Item 5.  Other Information**

 

None

 

**Item 6.  Exhibits and Reports on Form 8-K**

 

(a)   Exhibits:

 
|   | 31.1 |   | Rule  13a-14(a) Certification of Chief Executive Officer                 |
|--------|------|--------|--------------------------------------------------------------------------|
|   | 31.2 |   | Rule  13a-14(a) Certification of Chief Financial Officer                 |
|   | 32.1 |   | Statement of  Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 |
|   | 32.2 |   | Statement of  Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 |

 

(b)   Reports on Form 8-K

 

On April 18, 2003 the Company filed aCurrent Report on Form 8-K dated April 17, 2003 to report under Item 12, apress release reporting its financial results for the quarterended March 31, 2003.

 

32

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**SIGNATURES**

 

In accordance with the requirements of theExchange Act, the registrant caused this Report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                       | **CARDINAL  FINANCIAL CORPORATION**                                                |
|----------------------------|------------------------------------------------------------------------------------|
|                       | (Registrant)                                                                       |
|                       |                                                                               |
|                       |                                                                               |
| Date: August 13, 2003 |   /s/ Bernard H. Clineburg                                               |   |
|                       | Bernard H. Clineburg                                                               |
|                       | Chairman, President and                                                            |
|                       | Chief Executive Officer                                                            |
|                       |                                                                               |
|                       |                                                                               |
| Date: August 13, 2003 |   /s/ Carl E. Dodson                                                     |   |
|                       | Carl E. Dodson                                                                     |
|                       | Executive Vice President and  Chief Financial Officer(Principal Financial Officer) |
|                       |                                                                               |
|                       |                                                                               |
| Date: August 13, 2003 |   /s/ Jennifer L. Deacon                                                 |   |
|                       | Jennifer L. Deacon                                                                 |
|                       | Vice President and  Controller(Principal Accounting Officer)                       |

 

33

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**EXHIBIT INDEX**

 
| **Exhibit  No.** |   | **Description**                                                          |
|------------------|--------|--------------------------------------------------------------------------|
|             |   |                                                                     |
| 31.1             |   | Rule  13a-14(a) Certification of Chief Executive Officer                 |
|             |   |                                                                     |
| 31.2             |   | Rule  13a-14(a) Certification of Chief Financial Officer                 |
|             |   |                                                                     |
| 32.1             |   | Statement of  Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 |
|             |   |                                                                     |
| 32.2             |   | Statement of  Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 |

 

34

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