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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 10-KSB



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ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF

THE SECURITIES EXCHANGE ACT OF
1934



For the fiscal year ended December 31, 2004



Commission File Number: 000-49787



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BOTETOURT BANKSHARES, INC.

(Exact Name of Issuer as Specified in Its Charter)



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|                         |  |                                        
|------------------------ |  | ---------------------------------------
|Virginia                 |  | 54-1867438                             
|(State of Incorporation) |  | (I.R.S. Employer Identification Number)



|                                         |  |           
|---------------------------------------- |  | ----------
|19747 Main Street                        |  |           
|Buchanan, Virginia                       |  | 24066     
|(Address of Principal Executive Offices) |  | (Zip Code)



(540) 591-5000

(Issuers telephone number, including area code)



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Securities registered pursuant to Section 12(b) of the Exchange Act: None



Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1.00



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Check whether the 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 period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90
days.    Yes  x    No ̈



Check if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is
contained in this form, and no disclosure will be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form
10-KSB. ̈



The issuers revenues for its most recent fiscal year were $13,334,493.



The aggregate market value of the voting and non-voting common equity, consisting solely of common stock, held by non-affiliates of the issuer (1,111,694 shares) computed
by reference to the closing price of such stock was $26,680,656 as of March 25, 2005.



The number of shares of outstanding common stock of the issuer as of March 25, 2005 is 1,235,668.



DOCUMENTS INCORPORATED BY REFERENCE



The issuers Proxy Statement dated April 7, 2005 is incorporated by reference into Form 10-KSB Part III, Items 9, 10, 11, 12 and 14.



TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT:    YES ̈NO  x



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PART I



Item 1. Business



General



Botetourt Bankshares,
Inc. (the Company) was incorporated as a Virginia corporation on January 17, 1997 and is the one-bank holding company for and sole shareholder of Bank of Botetourt (the Bank). The Bank was acquired by the Company on September
30, 1997. The Company has no significant operations other than owning the stock of the Bank.



The Bank operates for the primary purpose of meeting the banking needs of individuals and small to medium sized businesses in the Banks service area, while developing personal, hometown associations with these
customers. The Bank offers a wide range of banking services including checking and savings accounts; commercial, installment, mortgage and personal loans; safe deposit boxes; and other associated services. The Banks primary sources of revenue
are interest income from its lending activities, and, to a lesser extent, from its investment portfolio. The Bank also earns fees from lending and deposit activities. The major expenses of the Bank are interest on deposit accounts and general and
administrative expenses, such as salaries, occupancy and related expenses. The Bank does not provide trust services.



Bank of Botetourt was founded in 1899 and currently operates eight offices in three counties of Virginia. The main office is in Buchanan, with other
Botetourt County office locations in Daleville, Eagle Rock and Troutville. The Banks operations center for the Bank is located in Buchanan. The Roanoke County offices are located on Challenger Avenue in eastern Roanoke County and on Peters
Creek Road in north Roanoke County. The Rockbridge County offices are located at 65 East Midland Trail in Lexington, Virginia and 5905 North Lee Highway in Fairfield, Virginia. A substantial portion of the Companys market is located in the
large Roanoke Valley Metropolitan Statistical Area. This MSA varies widely with a medium-sized city, large rural base, mostly small businesses in many different manufacturing and service industries, and a relatively modest governmental employment.



The Roanoke Metropolitan Statistical Area (MSA) is the
commercial center for southwest Virginia, and is located approximately 165 miles west of Richmond, Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles southeast of Charleston, West Virginia and 222 miles southwest of Washington,
D.C. Hollins University and Roanoke College, with student enrollments of approximately 1,100 and 1,700, respectively, are located in the Roanoke MSA. Virginia Tech, with a student body of approximately 25,000, and Radford University, with a student
body of more than 8,500, are each a 45-minute drive away.



The
population in the Roanoke MSA was estimated at 291,100 at year-end 2003. The Roanoke MSAs recent growth has been slower than that in other key Virginia markets, according to the Virginia Employment Commission. The Roanoke MSA had an
unemployment rate of 3.6% in December 2004, compared with 3.4% for Virginia and 5.1% nationally.



Over 6,500 businesses operated in the Roanoke MSA recently. The business community in the Roanoke MSA is diverse. The principal components of the economy
are retail trade, services, transportation, manufacturing, finance, insurance, and real estate. The Roanoke MSAs position as a regional center creates a strong medical, legal, and business professional



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community. Carilion Health Systems, Lewis-Gale Hospital, and the Veterans Administration Hospital are among the
areas largest employers, although most do not directly affect the Companys performance, since these employers are not close to the Banks current branches. Other large employers include Norfolk Southern Corporation, Wachovia
Corporation, The Kroger Co., General Electric Co., and American Electric Power. Major employers located directly in the Banks branch market of Rockbridge County, Botetourt County and northeast Roanoke County include Mohawk Carpet, Botetourt
County Schools, Dynax America Corporation, Roanoke Cement Company, Koyo Steering Systems of USA, Inc., and Gala Industries.



Lending Activities



The Banks lending services include real estate, commercial, agricultural and consumer loans. The loan portfolio constituted 84.90% of the earning
assets of the Bank at December 31, 2004 and has historically produced the highest interest rate spread above the cost of funds. The Banks loan personnel have the authority to extend credit under guidelines established and approved by the Board
of Directors. Any aggregate credit that exceeds the authority of the loan officer is forwarded to the loan committee for approval. The loan committee is composed of the Bank President, the Vice President of credit administration, all commercial loan
officers, and three outside directors. All aggregate credits that exceed the loan committees lending authority are presented to the full Board of Directors for ultimate approval or denial. The loan committee not only acts as an approval body
to ensure consistent application of the Banks loan policy but also provides valuable insight through communication and pooling of knowledge, judgment and experience of its members.



The Bank has in the past and intends to continue to make most types of real estate loans, including but not limited to,
single and multi-family housing, farm loans, residential and commercial construction loans and loans for commercial real estate. At the end of 2004 the Bank had 25.75% of the loan portfolio in single and multi-family housing, 35.66% in non-farm,
non-residential loans, 5.11% in farm related real estate loans and 13.56% in real estate construction loans.



The Banks loan portfolio includes commercial and agricultural production loans totaling 10.82% of the portfolio at year-end 2004. Consumer loans
make up approximately 8.03% of the total loan portfolio. Consumer loans include loans for household expenditures, car loans and other loans to individuals. While this category has experienced a greater percentage of charge-offs than the other
classifications, the Bank is committed to continue to make this type of loan to fill the needs of the Banks customer base. The remaining loan portfolio consists of other loans and leases that make up 1.07% of the Banks total portfolio.



All loans in the Banks portfolio are subject to risk
from the state of the economy in the Banks area and also that of the nation. The Bank has used and continues to use conservative loan-to-value ratios and thorough credit evaluation to lessen the risk on all types of loans. The use of
conservative appraisals has also reduced exposure on real estate loans. Thorough credit checks and evaluation of past internal credit history has helped to reduce the amount of risk related to consumer loans. Government guarantees of loans are used
when appropriate, but apply to a very small percentage of the portfolio. Commercial loans are evaluated by collateral value and ability to service debt. Businesses seeking loans must have a good product line and sales, responsible management,
manageable debt load and a product that is not adversely affected by downturns in the economy.



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Investments



The Bank invests a portion of its assets in U.S. Treasury and U.S. Government corporation and agency obligations, state,
county and municipal obligations, and equity securities. The Banks investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at reduced yields and risks relative
to increases in loan demand or to offset fluctuations in deposits. The Bank does not engage in any hedging activities. For additional information relating to investments, see Financial Information.



Deposit Activities



Deposits are the major source of funds for lending and other investment
activities. The Bank considers the majority of its regular savings, demand, NOW and money market deposits and small denomination certificates of deposit, to be core deposits. These accounts comprised approximately 87.31% of the Banks total
deposits at December 31, 2004. Certificates of deposit in denominations of $100,000 or more represented the remaining 12.69% of deposits at year end.



Employees



At December 31, 2004, the Company had 82 full time equivalent employees, none of which are represented by a union or covered by a collective bargaining
agreement. Management considers employee relations to be good.



Competition



The Company
encounters strong competition both in making loans and in attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws which permit multi-bank holding companies as well as an increasing level of interstate
banking have created a highly competitive environment for commercial banking. In one or more aspects of its business, the Company competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds,
insurance companies, brokerage and investment banking companies, and other financial intermediaries. Many of these competitors have substantially greater resources and lending limits and may offer certain services that we do not currently provide.
In addition, many of the Companys competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive
environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly.



To compete, the Company relies upon specialized services, responsive handling of customer needs, and personal contacts by
its officers, directors, and staff. Large multi-branch banking competitors tend to compete primarily by rate and the number and location of branches while smaller, independent financial institutions tend to compete primarily by rate and personal
service.



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Currently, in Botetourt County, the Company competes with five other commercial banks which operate 16
branches in the county. As of June 30, 2004, the Company held 41.73% of the deposits in Botetourt County, which represents the largest market share of all financial institutions in the county. The Company held 8.66% of the market share of Rockbridge
County and 3.22% of the market share of Roanoke County.



Government Supervision and Regulation



The following discussion is a summary of the principal laws and regulations that comprise the regulatory framework applicable to the Company and the Bank. Other laws and regulations that govern various aspects of the operations of banks and
bank holding companies are not described, although violations of such laws and regulations could result in supervisory enforcement action against the Company or the Bank. The following descriptions summarize the material terms of the principal laws
and regulations and are qualified in their entirety by reference to applicable laws and regulations.



General



The Company is subject to the periodic reporting requirements of the Securities and Exchange Act of 1934, as amended (the Exchange Act)
including the filing of periodic reports with the SEC. The SEC makes such filings available on their website www.sec.gov. These filings may also be found on the Banks website www.bankofbotetourt.com.



As an Exchange Act reporting company, the Company also is subject to many
provisions of the recently enacted Sarbanes-Oxley Act of 2002 (the SOA), which is aimed at improving corporate governance and public reporting and company performance. The Company is already taking steps to ensure that it will comply
fully with the SOA and any applicable rules and regulations implemented in the future. Parts of the SOA that already are effective include provisions that (i) require that periodic reports containing financial statements that are filed with the SEC
be accompanied by Chief Executive Officer and Chief Financial Officer certifications as to their accuracy and compliance with law; (ii) prohibit public companies, with certain limited exceptions, from making personal loans to their directors or
executive officers; (iii) force company Chief Executive Officers and Chief Financial Officers to forfeit bonuses and profits if company financial statements are restated due to misconduct; (iv) require audit committees to pre-approve all audit and
non-audit services provided by an issuers outside auditors, except for deminimis non-audit services; (v) protect employees of public companies who assist in investigations relating to violations of the federal securities laws from retaliatory
action; (vi) require companies to disclose in plain English on a rapid and current basis material changes in their financial condition or operations; (vii) require a public companys Section 16 insiders to make Form 4 filings with
the SEC within two business days following the day on which purchases or sales of the companys equity securities were made; and (viii) increase penalties for existing crimes and create new criminal offenses. Compliance with other provisions
will be required after implementing rules and regulations are adopted by the SEC and the newly created Public Company Accounting Oversight Board (PCAOB) authorized by the SOA. While management expects the Company to incur additional
expenses in complying with the requirements of the SOA and the regulations adopted by the SEC and the PCAOB, it is anticipated that those expenses will not have a material effect on the Companys results of operations or financial condition.



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As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of
1956, as amended (the BHCA), and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the Federal Reserve). Under the BHCA, a bank holding company may not directly or indirectly
acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any additional bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve. The BHCA also
generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity which is determined to be so closely related to banking or to managing or controlling banks that an exception is
allowed for those activities.



As a state bank, the Bank is
subject to regulation, supervision and examination by the Virginia State Corporation Commission Bureau of Financial Institutions (Bureau). The Bank, not a member bank of the Federal Reserve System, is subject to regulation, supervision
and examination by the FDIC. Federal and Virginia laws also govern the activities in which the Bank may engage, the investments that it may make and limits the aggregate amount of loans that may be granted to one borrower to 15% of the banks
capital and surplus. Various consumer and compliance laws and regulations also affect the Banks operations.



The earnings of the Bank, and therefore the earnings of the Company, are affected by general economic conditions, management policies and the legislative
and governmental actions of various regulatory authorities, including those referred to above.



The Bureau and FDIC conduct regular examinations of the Bank and review such matters as the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other
aspects of its operations. In addition to these regular examinations, the Bank must furnish the FDIC with periodic reports containing a full and accurate statement of its affairs. Supervision, regulation and examination of banks by these agencies
are intended primarily for the protection of depositors rather than shareholders.



Insurance of Accounts, Assessments and Regulation by the FDIC



The deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law. The deposits of the Bank
are also subject to the deposit insurance assessments of the Bank Insurance Fund (BIF) of the FDIC.



The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to
regulatory capital levels of the institution and other factors (including supervisory evaluations). Under this system, depository institutions are charged anywhere from zero to $0.27 for every $100 in insured domestic deposits, based on such
institutions capital levels and supervisory subgroup assignment. These rate schedules are subject to future adjustments by the FDIC. In addition, the FDIC has authority to impose special assessments from time to time. The BIF reached its
required 1.25 reserve ratio in 1995, and in response the FDIC reduced deposit insurance assessment rates on BIF-insured deposits to historic low levels. However, due to legislation enacted in 1996 which requires that both Savings Association
Insurance Fund (SAIF)-insured deposits and BIF-insured deposits pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation, the FDIC has imposed additional assessments on BIF-insured deposits.



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The FDIC is authorized to prohibit any BIF-insured institution from engaging in any activity that the
FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against such banks. The FDIC may terminate the deposit insurance of any depository institution if it
determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed
in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the
institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination
of the Banks deposit insurance.



Capital



The FDIC and the Federal Reserve have issued risk-based and
leverage capital guidelines applicable to banking organizations that they supervise. Under the risk-based capital requirements, the Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital is to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles
(Tier 1 capital). The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance (Tier 2 capital and, together
with Tier 1 capital, total capital).



In addition,
each of the Federal banking regulatory agencies has established minimum leverage capital ratio requirements for banking organizations. These requirements provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets
equal to 3% for bank holding companies that are rated a composite 1 and 4% for all other bank holding companies. Bank holding companies are expected to maintain higher than minimum capital ratios if they have supervisory, financial,
operational or managerial weaknesses, or if they are anticipating or experiencing significant growth.



The risk-based capital standards of the FDIC and the Federal Reserve explicitly identify concentrations of credit risk and the risk arising from
non-traditional activities, including an institutions ability to manage these risks, as important factors to be taken into account by the agency in assessing an institutions overall capital adequacy. The capital guidelines also provide
that an institutions exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banks capital adequacy. The FDIC and the Federal Reserve also have
issued additional capital guidelines for bank holding companies that engage in certain trading activities. At present, these guidelines do not apply to the Company.



Other Safety and Soundness Regulations



There are a number of obligations and restrictions imposed on bank holding companies and their depository institution
subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to



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the FDIC insurance funds in the event that the depository institution becomes in danger of default or is in default. For
example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to
support such institutions in circumstances where it might not do so otherwise. In addition, the cross-guarantee provisions of Federal law require insured depository institutions under common control to reimburse the FDIC for any loss
suffered or reasonably anticipated by the BIF as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default.
The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the BIF. The FDICs claim for reimbursement is superior to claims of shareholders of the insured depository institution or
its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution.



The Federal banking agencies also have broad powers under current Federal law
to take prompt corrective action to resolve problems of insured depository institutions. The Federal Deposit Insurance Act requires that the federal banking agencies establish five capital levels for insured depository institutions - well
capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. It also requires or permits such agencies to take certain supervisory
actions should an insured institutions capital level fall. For example, an adequately capitalized institution is restricted from accepting brokered deposits. An undercapitalized or significantly
undercapitalized institution must develop a capital restoration plan and is subject to a number of mandatory and discretionary supervisory actions. These powers and authorities are in addition to the traditional powers of the Federal banking
agencies to deal with undercapitalized institutions.



Federal
regulatory authorities also have broad enforcement powers over the Company and the Bank, including the power to impose fines and other civil and criminal penalties, and to appoint a receiver in order to conserve the assets of any such institution
for the benefit of depositors and other creditors.



Reporting
Terrorist Activities: The Federal Bureau of Investigation (FBI) has sent, and will send, banking regulatory agencies lists of the names of persons suspected of involvement in the September 11, 2001 terrorist attacks and other
attacks as they may occur and are investigated. The Bank has been requested, and may be requested in the future, to search its records for any relationships or transactions with persons on those lists. In addition, on an ongoing basis, the Office of
Foreign Assets Control (OFAC), a division of the Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with enemies of the United States, as defined by
various Executive Orders and Acts of Congress. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze that account, file a suspicious activity report and notify the FBI. The Bank actively checks
high-risk OFAC areas such as new accounts, wire transfers and customer files.



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Payment of Dividends



The Company is a legal entity separate and distinct from the Bank. Virtually all of the cash revenues of the Company results
from dividends paid to the Company by the Bank. Under Virginia law a Virginia chartered bank may not declare a dividend in excess of its undivided profits. In addition, as a Virginia corporation the Bank may not declare a dividend if after the
dividend it cannot pay its debts as they become due or its assets would exceed its liabilities. A bank may not declare or pay any dividend if, after making the dividend, the bank would be undercapitalized, as defined in regulations of
the FDIC. In addition, the Company is subject to various general regulatory policies relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The Federal Reserve has indicated that banking
organizations should generally pay dividends only if, (1) the organizations net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and (2) the prospective rate of earnings retention
appears consistent with the organizations capital needs, asset quality and overall financial condition.



Community Reinvestment



The requirements of the Community Reinvestment Act (CRA) are applicable to the Bank. The CRA imposes on financial institutions an affirmative
and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institutions efforts in meeting
community credit needs currently are evaluated as part of the examination process pursuant to a number of assessment factors. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility. The
Company strives to meet the credit needs of all aspects of its market, consistent with safe and sound banking practices.



Interstate Banking and Branching



Current Federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. A bank headquartered in one
state is able to merge with a bank headquartered in another state, as long as neither of the states has opted out of such interstate merger authority prior to such date. Virginia, North Carolina, West Virginia and Maryland all permit such mergers.
Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired
branches under applicable Federal or state law.



Economic and Monetary Polices



The operations of the
Company are affected not only by general economic conditions, but also by the economic and monetary policies of various regulatory authorities. In particular, the Federal Reserve regulates money, credit and interest rates in order to influence
general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary
policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.



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Item 2. Properties



The Company and the Bank are headquartered in the Main Office at 19747 Main Street, Buchanan, Virginia. The Bank owns and operates branches at the following locations.



|                                                                              |  |             |  |                |  |                
|----------------------------------------------------------------------------- |  | ----------- |  | -------------- |  | ---------------
|Office Location &
Phone                                                       |  | Year Opened |  | Square Footage |  | Owned or Leased
|Main Office Buchanan Office 19747 Main Street Buchanan, VA 24066 540-254-1721 |  | 1923        |  | 6200           |  | Owned          
|                                                                              |  |             | 
|Daleville Office 670 Roanoke Rd Daleville, VA 24083 540-992-4777              |  | 1989        |  | 3000           |  | Owned          
|                                                                              |  |             | 
|Eagle Rock Office 58 Railroad Ave Eagle Rock, VA 24085 540-884-2265           |  | 1993        |  | 1600           |  | Owned          
|                                                                              |  |             | 
|Troutville Office 5462 Lee Highway Troutville, VA 24175 540-966-3850          |  | 1995        |  | 5000           |  | Owned          
|                                                                              |  |             | 
|Operations Center 19800 Main Street Buchanan, VA 24066 540-473-1173           |  | 1995        |  | 8500           |  | Owned          
|                                                                              |  |             | 
|Bonsack Office 3801 Challenger Ave Roanoke, VA 24012 540-777-2265             |  | 1997        |  | 1850           |  | Owned          
|                                                                              |  |             | 
|Lexington Office 65 East Midland Trail Lexington, VA 24450 540-463-7224       |  | 2003        |  | 7600           |  | Owned          
|                                                                              |  |             | 
|Peters Creek Office 3130 Peters Creek Rd Roanoke, VA 24019 540-777-2010       |  | 2001        |  | 1650           |  | Owned          
|                                                                              |  |             | 
|Fairfield Office 5905 North Lee Highway Fairfield, VA 24435 540-377-5270      |  | 2004        |  | 2000           |  | Owned          



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The Company acquired a building adjacent to its Troutville branch in 2004 which will become the Loan
Administration building. The Company is in the process of remodeling the building and expects the building to be operational in the second quarter of 2005.



Item 3. Legal Proceedings



In the ordinary course of operations, the Company and the Bank expect to be parties to various legal proceedings. At present, there are no pending or
threatened proceedings against the Company or the Bank which, if determined adversely, would have a material effect on the business, results of operations, or financial position of the Company or the Bank.



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



No matters were submitted to a vote of Companys shareholders during
the fourth quarter of 2004.



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PART II



Item 5. Market Price of and Dividends on the Registrants Common Equity and Related Stockholder Matters



Shares of the Companys Common Stock are neither listed on any stock
exchange nor quoted on the Nasdaq Stock Market and trades infrequently. Shares of Common Stock have periodically been sold in a limited number of privately negotiated transactions. Based on information available to it, the Company believes that from
January 1, 2004 to December 31, 2004, the selling price of shares of Common Stock ranged from $20.00 to $24.00. There may, however, have been other transactions at other prices not known to the Company.



Market Price and Dividends



|           |  |       |  |      
|---------- |  | ----- |  | -----
|           |  | High  |  | Low  
|2003:      |  |       |  |      
|1stQuarter |  | 23.00 |  | 21.00
|2ndQuarter |  | 23.00 |  | 23.00
|3rdQuarter |  | 23.00 |  | 22.00
|4thQuarter |  | 23.00 |  | 22.00
|           |  |      
|2004:      |  |       |  |      
|1stQuarter |  | 23.25 |  | 20.00
|2ndQuarter |  | 23.50 |  | 20.50
|3rdQuarter |  | 24.00 |  | 23.00
|4thQuarter |  | 24.00 |  | 22.50



Dividends Declared



|        |  |     
|------- |  | ----
|2003:   |  |     
|        | 
|January |  | 0.09
|April   |  | 0.09
|July    |  | 0.10
|October |  | 0.10
|        | 
|2004:   |  |     
|        | 
|January |  | 0.11
|April   |  | 0.11
|July    |  | 0.12
|October |  | 0.12



As of March 15, 2005,
there were approximately 775 record holders of Common stock.



The Company is a legal entity separate and distinct from its subsidiary, and its cash revenues depend primarily on the payment of dividends from the Bank. The Bank is subject to certain legal restrictions on the amount of dividends it is
permitted to pay to the Company. In addition, the final determination of the timing, amount and payment of dividends on shares of the Companys Common Stock is at the discretion of the Companys Board of Directors and will depend upon the
earnings of the Company and the Bank, the financial condition of the Company and other factors, including general economic conditions and applicable governmental regulations and policies.



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Item 6: Managements Discussion and Analysis



Overview



Managements Discussion and Analysis is provided to assist in the understanding and evaluation of Botetourt Bankshares, Inc.s financial condition and its
results of operations. The following discussion should be read in conjunction with the Companys consolidated financial statements.



Botetourt Bankshares, Inc., the parent company of Bank of Botetourt, currently operates eight offices in three counties of Virginia. The main office is in Buchanan, with
other Botetourt County office locations in Daleville, Eagle Rock and Troutville. The operations center for the Bank is located in Buchanan. The Roanoke County offices are located on Challenger Avenue in eastern Roanoke County and on Peters Creek
Road in north Roanoke County. The Rockbridge County offices are located at 65 East Midland Trail in Lexington and 5905 N. Lee Highway in Fairfield.



The individual market conditions of each county vary from rural to urban with Botetourt County being the most rural and Roanoke the most urban. The southern portion of
Botetourt County has enjoyed both residential and industrial growth due to the development of subdivisions and industrial parks. Bank of Botetourt and bank personnel work with local government and business leaders in an effort to continue to attract
industry to Botetourt County.



Earnings increased by 24.6% in 2004 to $2.400
million compared to $1.926 million for 2003 and $1.721 million in 2002. Return on average assets amounted to 1.17% in 2004, 1.03% in 2003, and 0.98% in 2002. During 2004, 2003 and 2002, revenues from the Bank of Botetourt represented approximately
99% of Botetourt Bankshares, Inc.s total revenues. All of these ratios compare favorably to members of the Companys peer group.



Average equity to average assets shows the Company with a strong capital position with a ratio of 8.97% at December 31, 2004. The Companys capital position
continues to be in line with its peer groups average.



The total assets
of Botetourt Bankshares, Inc. grew to $213.3 million from $196.0 million, an 8.9% increase, continuing our strategy to grow the Company.



On July 20, 2002, the Sarbanes-Oxley Act was signed to increase the reliability of financial statements issued by public companies. The Act increases the number of
independent parties responsible for the issuance of the financial statements and increases the independence of those already involved in the financial statement process. At December 31, 2004, the Company was in compliance with the Act.



Management plans to continue increasing market share by expanding to contiguous markets
using earnings from operations to fund the Companys growth. Currently, management of Botetourt Bankshares, Inc. has no plans to raise capital for its expansion through external sources.



Critical Accounting Policies



The Companys financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The notes to the audited consolidated financial statements included in the Companys Annual Report on Form 10-KSB for the year ended December 31, 2004 contain a summary of its
significant accounting policies. Management believes the Companys policies with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult
and subjective judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, the Company considers the policies related to those areas as critical.



---

The allowance for loan losses is an estimate of the losses that may be sustained in the Companys loan portfolio.
The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards (SFAS) 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and
estimable, and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable
in the secondary market, and the loan balance.



The allowance consists of
specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the
discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover uncertainties that could affect managements estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.



---

Table 1. Net Interest Income and Average Balances (thousands)



|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|--------------------------------------------- |  | -------------- | ------- | ---------------------- | ---- | ---------- |  | ---- | -------------- |  | ---------------------- | ------- | ---------- | - | ------ | -------------- | ---- | ---------------------- |  | ---------- | ------- |  | - | ------ |  | ---- | -
|                                              |  | 2004           |         |                        | 2003 |            |  | 2002 |               
|                                              |  | AverageBalance |         | InterestIncome/Expense |      | Yield/Cost |  |      | AverageBalance |  | InterestIncome/Expense |         | Yield/Cost |   |        | AverageBalance |      | InterestIncome/Expense |  | Yield/Cost |        
|Interest-earning assets:                      |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Deposit in other banks                        |  | $              | 208     |                        | $    | 2          |  | 0.96 | %              |  | $                      | 232     |            | $ | 2      |                | 0.87 | %                      |  | $          | 200     |  | $ | 3      |  | 1.50 | %
|Taxable investment securities                 |  |                | 14,663  |                        |      | 521        |  | 3.55 | %              |  |                        | 25,530  |            |   | 977    |                | 3.83 | %                      |  |            | 23,071  |  |   | 1,098  |  | 4.76 | %
|Nontaxable investment securities              |  |                | 9,412   |                        |      | 408        |  | 4.33 | %              |  |                        | 9,010   |            |   | 405    |                | 4.50 | %                      |  |            | 8,386   |  |   | 377    |  | 4.50 | %
|Federal funds sold                            |  |                | 3,639   |                        |      | 55         |  | 1.51 | %              |  |                        | 4,088   |            |   | 45     |                | 1.10 | %                      |  |            | 10,136  |  |   | 159    |  | 1.57 | %
|Loans, net1                                   |  |                | 158,934 |                        |      | 11,029     |  | 6.94 | %              |  |                        | 129,681 |            |   | 10,023 |                | 7.73 | %                      |  |            | 117,856 |  |   | 10,051 |  | 8.53 | %
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total interest-earning assets                 |  |                | 186,856 |                        |      | 12,015     |  |      |                |  |                        | 168,541 |            |   | 11,452 |                |      |                        |  |            | 159,649 |  |   | 11,688 |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Yield on average interest-earning assets      |  |                |         |                        |      |            |  | 6.43 | %              |  |                        |         |            |   |        |                | 6.80 | %                      |  |            |         |  |   |        |  | 7.32 | %
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Noninterest-earning assets:                   |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Cash and due from banks                       |  |                | 10,752  |                        |      |            |  |      |                |  |                        | 9,654   |            |   |        |                |      |                        |  |            | 7,260   |  |   |        |  |      |  
|Premises and equipment                        |  |                | 5,713   |                        |      |            |  |      |                |  |                        | 4,955   |            |   |        |                |      |                        |  |            | 4,155   |  |   |        |  |      |  
|Interest receivable and other                 |  |                | 3,311   |                        |      |            |  |      |                |  |                        | 3,259   |            |   |        |                |      |                        |  |            | 3,601   |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total noninterest-earning assets              |  |                | 19,776  |                        |      |            |  |      |                |  |                        | 17,868  |            |   |        |                |      |                        |  |            | 15,016  |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total assets                                  |  | $              | 206,632 |                        |      |            |  |      |                |  | $                      | 186,409 |            |   |        |                |      |                        |  | $          | 174,665 |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Interest-bearing liabilities:                 |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Demand deposits                               |  | $              | 20,589  |                        |      | 21         |  | 0.10 | %              |  | $                      | 18,056  |            |   | 23     |                | 0.13 | %                      |  | $          | 17,121  |  |   | 47     |  | 0.27 | %
|Savings and money markets                     |  |                | 39,405  |                        |      | 264        |  | 0.67 | %              |  |                        | 33,709  |            |   | 266    |                | 0.79 | %                      |  |            | 29,230  |  |   | 487    |  | 1.67 | %
|Time deposits                                 |  |                | 99,445  |                        |      | 3,041      |  | 3.06 | %              |  |                        | 93,737  |            |   | 3,384  |                | 3.61 | %                      |  |            | 92,152  |  |   | 4,063  |  | 4.41 | %
|Other borrowings                              |  |                | 953     |                        |      | 14         |  | 1.47 | %              |  |                        | 888     |            |   | 13     |                | 1.47 | %                      |  |            |        |  |   |       |  |     | %
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total interest-bearing liabilities            |  |                | 160,392 |                        |      | 3,340      |  |      |                |  |                        | 146,390 |            |   | 3,686  |                |      |                        |  |            | 138,503 |  |   | 4,597  |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Cost on average interest- bearing liabilities |  |                |         |                        |      |            |  | 2.08 | %              |  |                        |         |            |   |        |                | 2.52 | %                      |  |            |         |  |   |        |  | 3.32 | %
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Noninterest-bearing liabilities               |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Demand deposits                               |  |                | 26,788  |                        |      |            |  |      |                |  |                        | 22,014  |            |   |        |                |      |                        |  |            | 19,595  |  |   |        |  |      |  
|Interest payable and other                    |  |                | 913     |                        |      |            |  |      |                |  |                        | 964     |            |   |        |                |      |                        |  |            | 927     |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total noninterest-bearing liabilities         |  |                | 27,701  |                        |      |            |  |      |                |  |                        | 22,978  |            |   |        |                |      |                        |  |            | 20,522  |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total liabilities                             |  |                | 188,093 |                        |      |            |  |      |                |  |                        | 169,368 |            |   |        |                |      |                        |  |            | 159,025 |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |               
|Stockholders equity                          |  |                | 18,539  |                        |      |            |  |      |                |  |                        | 17,041  |            |   |        |                |      |                        |  |            | 15,640  |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Total liabilities and stockholders equity    |  | $              | 206,632 |                        |      |            |  |      |                |  | $                      | 186,409 |            |   |        |                |      |                        |  | $          | 174,665 |  |   |        |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Net interest income                           |  |                |         |                        | $    | 8,675      |  |      |                |  |                        |         |            | $ | 7,766  |                |      |                        |  |            |         |  | $ | 7,091  |  |      |  
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  
|Net yield on interest-earning assets          |  |                |         |                        |      |            |  | 4.64 | %              |  |                        |         |            |   |        |                | 4.61 | %                      |  |            |         |  |   |        |  | 4.44 | %
|                                              |  |                |         |                        |      |            |  |      |                |  |                        |         |            |   |        |                |      |                        |  |            |         |  |   |        |  |      |  

---

|(1) | Average loan balances include nonaccrual loans
|--- | ----------------------------------------------



---

Net Interest Income



Net interest income, the principal source of bank earnings, is the amount of income generated by earning assets (primarily loans and investment securities) less the
interest expense incurred on interest-bearing liabilities (primarily deposits used to fund earning assets). Table 1 summarizes the major components of net interest income for the past three years and also provides yields and average balances.



Net interest income increased in 2004 to $8.7 million compared to $7.8 million
in 2003 and $7.1 million in 2002. Competition for deposits and loans continue to be a major factor in net margins as does predatory pricing and competition from unregulated organizations. The net interest margin for 2004 increased by 3 basis points
to 4.64% compared to 4.61% for 2003 and 4.44% for 2002. The effects of changes in volumes and rates on net interest income in 2004 compared to 2003, and 2003 compared to 2002 are shown in Table 2.



Interest income for 2004 increased by $500,000 to $12.0 million from $11.5 million in 2003.
Interest income in 2002 totaled $11.7 million. The increase in interest income in 2004 from 2003 was the result of an increase in loan volume. The decrease in interest income in 2003 from 2002 was the result of lower interest rates.



Interest expense continued to decrease in 2004 to $3.3 million from $3.7 million in 2003 and
$4.6 million in 2002. The $400,000 decrease in 2004 from 2003 was due primarily to lower rates paid on deposits. Interest expense decreased by $900,000 in 2003 from 2002 which also was a result of lower rates paid on deposits. Interest paid on time
deposits, which make up the largest portion of interest-bearing deposits, decreased $343,000, or 10.1%, from 2003 to 2004. The average rate paid on time deposits decreased 55 basis points to 3.06% in 2004 from 3.61% in 2003 and 4.41% in 2002.



Table 2. Rate/Volume Variance Analysis (thousands)



|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|-------------------------------- |  | ------------------------------ | ----- | - | --------------------- | ------ | ---- | ------------------------------ |  | ---- | --------------------- | - | ------ | - | ---- | - |  | - | ------ | - |  | - | ----- | -
|                                 |  | 2004 Compared to 2003          |       |   | 2003 Compared to 2002 |       
|                                 |  | InterestIncome/ExpenseVariance |       |   | VarianceAttributed To |        |      | InterestIncome/ExpenseVariance |  |      | VarianceAttributed To |  
|                                 |  |                                | Rate  |   |                       | Volume |      |                                |  | Rate |                       |   | Volume |  
|Interest-earning assets:         |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Deposits in other banks          |  | $                              |      |   |                       | $      |     |                                |  | $    |                      |   |        | $ | (1   | ) |  | $ | (1     | ) |  | $ |      |  
|Taxable investment securities    |  |                                | (456  | ) |                       |        | (67  | )                              |  |      | (389                  | ) |        |   | (121 | ) |  |   | (230   | ) |  |   | 109   |  
|Nontaxable investment securities |  |                                | 3     |   |                       |        | (12  | )                              |  |      | 15                    |   |        |   | 28   |   |  |   |       |   |  |   | 28    |  
|Federal funds sold               |  |                                | 10    |   |                       |        | 1    |                                |  |      | 9                     |   |        |   | (114 | ) |  |   | (39    | ) |  |   | (75   | )
|Loans                            |  |                                | 1,006 |   |                       |        | (293 | )                              |  |      | 1,299                 |   |        |   | (28  | ) |  |   | (990   | ) |  |   | 962   |  
|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Total                            |  |                                | 563   |   |                       |        | (371 | )                              |  |      | 934                   |   |        |   | (236 | ) |  |   | (1,260 | ) |  |   | 1,024 |  
|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Interest-bearing liabilities:    |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Demand deposits                  |  |                                | (2    | ) |                       |        |     |                                |  |      | (2                    | ) |        |   | (24  | ) |  |   | (26    | ) |  |   | 2     |  
|Savings deposits                 |  |                                | (2    | ) |                       |        |     |                                |  |      | (2                    | ) |        |   | (221 | ) |  |   | (286   | ) |  |   | 65    |  
|Time deposits                    |  |                                | (343  | ) |                       |        | 22   |                                |  |      | (365                  | ) |        |   | (679 | ) |  |   | (745   | ) |  |   | 66    |  
|Other borrowings                 |  |                                | 1     |   |                       |        |     |                                |  |      | 1                     |   |        |   | 13   |   |  |   |       |   |  |   | 13    |  
|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Total                            |  |                                | (346  | ) |                       |        | 22   |                                |  |      | (368                  | ) |        |   | (911 | ) |  |   | (1,057 | ) |  |   | 146   |  
|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  
|Net interest income              |  | $                              | 909   |   |                       | $      | (393 | )                              |  | $    | 1,302                 |   |        | $ | 675  |   |  | $ | (203   | ) |  | $ | 878   |  
|                                 |  |                                |       |   |                       |        |      |                                |  |      |                       |   |        |   |      |   |  |   |        |   |  |   |       |  

---

|(1) | The variance in interest attributed to both volume and rate has been allocated to variance attributed to volume and variance attributed to rate in proportion to the
absolute value of the change in each.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Balances of nonaccrual loans have been included in average loan balances.
|--- | -------------------------------------------------------------------------



---

Provision for Loan Losses



The allowance for loan losses is established to provide for probable losses in the Companys loan portfolio. Loan losses and recoveries
are charged or credited directly to the allowance. Management determines the provision for loan losses required to maintain an allowance adequate to provide for any potential losses. The factors considered in making this decision are the
collectibility of past due loans, volume of new loans, composition of the loan portfolio, and general economic outlook.



The Bank has experienced loan growth in the past three years that exceeds its historic rate of growth. The combination of growth in new markets and experience with
specific credits and classes of credits (discussed in Table 6) has created the need for an increase in the loan loss provision in order to maintain the reserve at an adequate level. Bank management has implemented a comprehesive loan review program
which utilizes four methods in the determination of the Banks loan loss reserve. These calculation methods include an anlysis of the Banks historical loan losses, a benchmark comparision to peer group banks, an anlysis of non-performing
loans coverage and an analysis of the Banks watch list data, based upon both a formula method and a case-by-case method. While the Bank experienced above-average loan growth in 2004, asset quality remains satisfactory, increasing slightly
during the year. Nonperforming assets as year-end 2004 were 0.98% of loans outstanding as compared to 0.85% at year-end 2003. The loan growth experienced by the Bank during the past three years has resulted in above-average provisions to the loan
loss reserve during this period in order to assure the adequacy of the reserve.



Reallocation of the allowance among different segments of the portfolio, notably an increase in the allocation applicable to commercial loans, has been influenced by an increase in the growth rate for loans in this category, relative to the
other categories.



In 2004, management increased the provision for loan losses
reserve to $725,000 from $625,000 in 2003. The provision for loan losses was $975,000 in 2002. The Banks allowance for loan losses as a percentage of total loans at the end of 2004 was 1.25% as compared to 1.17% in 2003 and 1.22% in 2002.



Additional information is contained in Tables 12, 13 and 14, and is discussed
in Nonperforming and Problem Assets.



Other Income



Noninterest income consists of revenues generated from a broad range of financial services
and activities. The majority of noninterest income is a result of service charges on deposit accounts including charges for insufficient funds items and fees charged for nondeposit services such as safe deposit box rental fees, letters of credit
fees, and gains realized on the sale of fixed assets. Noninterest income totaled $1.320 million in 2004, an increase of $171,000 from the $1.149 million recorded in 2003. Noninterest income in 2002 totaled $1.281 million. The primary sources of
noninterest income for the past three years are summarized in Table 3.



Table 3. Sources of Noninterest Income (thousands)



|                                    |  |      |       |      |   |       |  |   |      
|----------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                    |  | 2004 |       | 2003 |   | 2002 
|Service charges on deposit accounts |  | $    | 760   |      | $ | 622   |  | $ | 589  
|Other service charges and fees      |  |      | 182   |      |   | 181   |  |   | 215  
|Title insurance commissions         |  |      | 175   |      |   | 176   |  |   | 171  
|Safe deposit box rent               |  |      | 19    |      |   | 20    |  |   | 18   
|Gain on the sale of securities      |  |      | 1     |      |   | 2     |  |   | 3    
|Gain on sale of foreclosed assets   |  |      |      |      |   |      |  |   | 70   
|Other income                        |  |      | 183   |      |   | 148   |  |   | 215  
|                                    |  |      |       |      |   |       |  |   |      
|Total noninterest income            |  | $    | 1,320 |      | $ | 1,149 |  | $ | 1,281
|                                    |  |      |       |      |   |       |  |   |      



---

Other Expense



Noninterest expense for 2004 increased by $265,000 or 4.8% to $5.8 million. Noninterest expense in 2003 was $5.6 million and $4.9 million in 2002 (see Table 4). The
overhead ratio of noninterest expense to adjusted total revenues (net interest income plus noninterest income excluding securities transactions) was 58.4% in 2004, 62.5% in 2003 and 59.1% in 2002.



The opening of new branches in Rockbridge and Roanoke Counties have resulted in higher
personnel, occupancy, and furniture and equipment expenses. Table 4 provides a further breakdown of noninterest expense for the past three years.



Table 4. Sources on Noninterest Expense (thousands)



|                                 |  |      |       |      |   |       |  |   |      
|-------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                 |  | 2004 |       | 2003 |   | 2002 
|Salaries & wages                 |  | $    | 2,523 |      | $ | 2,344 |  | $ | 2,197
|Employee benefits                |  |      | 856   |      |   | 774   |  |   | 608  
|                                 |  |      |       |      |   |       |  |   |      
|                                 |  |      |      
|Total personnel expense          |  |      | 3,379 |      |   | 3,118 |  |   | 2,805
|Occupancy expense                |  |      | 360   |      |   | 291   |  |   | 260  
|Furniture & equipment            |  |      | 458   |      |   | 429   |  |   | 390  
|Printing & supplies              |  |      | 115   |      |   | 111   |  |   | 103  
|FDIC deposit insurance           |  |      | 26    |      |   | 26    |  |   | 26   
|Professional services            |  |      | 100   |      |   | 95    |  |   | 132  
|Postage                          |  |      | 82    |      |   | 84    |  |   | 75   
|Telephone                        |  |      | 118   |      |   | 116   |  |   | 114  
|Courier fees                     |  |      | 44    |      |   | 36    |  |   | 37   
|Education & seminars             |  |      | 32    |      |   | 34    |  |   | 35   
|Travel expense                   |  |      | 24    |      |   | 25    |  |   | 26   
|Director fees and expense        |  |      | 71    |      |   | 62    |  |   | 54   
|Advertising and public relations |  |      | 176   |      |   | 141   |  |   | 123  
|Insurance expense                |  |      | 26    |      |   | 25    |  |   | 23   
|Capital stock tax                |  |      | 118   |      |   | 107   |  |   | 101  
|Outside services                 |  |      | 155   |      |   | 168   |  |   | 144  
|Foreclosed assets, net           |  |      | 1     |      |   | 62    |  |   |     
|Other operating expense          |  |      | 549   |      |   | 639   |  |   | 501  
|                                 |  |      |       |      |   |       |  |   |      
|Total noninterest expense        |  | $    | 5,834 |      | $ | 5,569 |  | $ | 4,949
|                                 |  |      |       |      |   |       |  |   |      



Income Taxes



Income tax expense is based on amounts reported in the statements of income (after
adjustments for non-taxable income and non-deductible expenses) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. The deferred tax
assets and liabilities represent the future Federal income tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.



Income tax expense (substantially all Federal) was $1,035,716 in 2004, $794,027 in 2003 and
$727,861 for 2002 representing 30.1%, 29.2% and 29.7% of income before income taxes, respectively. Tax expense increased $241,689 or 30.4% from 2003 to 2004.



The Banks deferred income tax benefits and liabilities result primarily from temporary differences (discussed above) in provisions for credit losses, valuation
reserves, depreciation, deferred compensation, deferred income, pension expense, and investment security discount accretion.



---

At December 31, 2004, the Company had a net deferred income tax asset of approximately $43,000, which was included in
other assets, compared to a net deferred income tax liability of $183,000 at December 31, 2003 which was included in other liabilities. The deferred income tax asset in 2004 consisted primarily of a deferred tax benefit of a $544,000 temporary
difference in provision for loan losses offset by $190,000 unrealized appreciation on investment securities available for sale and a $291,000 temporary difference in depreciation.



Earning Assets



Average earning assets increased $18.3 million in 2004 from the 2003 average of $168.5 million. Total average earning assets represented 90.4% of total average assets in
2004 and 2003. The percentage mix of average earning assets changed in 2004 with an increase in average loans and a decrease in federal funds sold and a decrease in investment securities. Average federal funds sold accounted for 1.8% of total
average assets compared to 2.2% in 2003. Average federal funds sold decreased in 2004 to provide funding for loan growth and investment securities. Average interest bearing bank balances accounted for 0.1% of total average assets in both 2004 and
2003. Average loans accounted for 76.9% of total average assets in 2004 compared to 69.6% in 2003. For 2002, average net loans represented 67.5% of average assets. A summary of average assets for the past three years is shown in Table 5.



Table 5. Average Asset Mix (thousands)





|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|----------------------- |  | -------------- | ------- | ---- | ----- | -------------- | - | ------- |  | --------------- |  | - | ------- |  | -----
|                        |  | 2004           |         | 2003 |       | 2002          
|                        |  | AverageBalance |         | %    |       | AverageBalance |   | %       |  | Average Balance |  | %
|Earning assets:         |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Loans, net              |  | $              | 158,934 |      | 76.9  |                | $ | 129,681 |  | 69.6            |  | $ | 117,856 |  | 67.5 
|Investment securities   |  |                | 24,075  |      | 11.6  |                |   | 34,540  |  | 18.5            |  |   | 31,457  |  | 18.0 
|Federal funds sold      |  |                | 3,639   |      | 1.8   |                |   | 4,088   |  | 2.2             |  |   | 10,136  |  | 5.8  
|Deposits in other banks |  |                | 208     |      | 0.1   |                |   | 232     |  | 0.1             |  |   | 200     |  | 0.1  
|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Total earning assets    |  |                | 186,856 |      | 90.4  |                |   | 168,541 |  | 90.4            |  |   | 159,649 |  | 91.4 
|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Nonearning assets:      |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Cash and due from banks |  |                | 10,752  |      | 5.2   |                |   | 9,654   |  | 5.2             |  |   | 7,260   |  | 4.1  
|Premises and equipment  |  |                | 5,713   |      | 2.8   |                |   | 4,955   |  | 2.7             |  |   | 4,155   |  | 2.4  
|Other assets            |  |                | 3,311   |      | 1.6   |                |   | 3,259   |  | 1.7             |  |   | 3,601   |  | 2.1  
|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Total nonearning assets |  |                | 19,776  |      | 9.6   |                |   | 17,868  |  | 9.6             |  |   | 15,016  |  | 8.6  
|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      
|Total assets            |  | $              | 206,632 |      | 100.0 |                | $ | 186,409 |  | 100.0           |  | $ | 174,665 |  | 100.0
|                        |  |                |         |      |       |                |   |         |  |                 |  |   |         |  |      



Loans



Average net loans totaled $158.9 million during 2004, an increase of $29.3 million or 22.6%
more than 2003. A significant portion of the loan portfolio, $137.0 million or 80.1%, is made up of loans secured by various types of real estate. Total loans secured by 1-4 family residential properties represented 25.7% of total loans at the end
of 2004 while nonfarm/nonresidential properties make up 35.7%.



The Bank makes
both consumer and commercial loans to all neighborhoods within its market area, including the low- and moderate-income areas. The market area is generally defined to be all or portions of the Botetourt, Roanoke and Rockbridge counties of Virginia
and the cities of Lexington, Buena Vista and Roanoke, Virginia. The Bank places emphasis on consumer based installment loans and commercial loans to small and medium sized businesses. Predatory pricing and competition from unregulated organizations
have also been a factor when generating new loans. The amounts of loans outstanding by type for the last five years, and the maturity distribution of variable and fixed rate loans as of year-end 2004 are presented in Table 6 and Table 7,
respectively.



---

Table 6. Loan Portfolio Summary (thousands)



|                                        |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        
|--------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                        |  | 2004 |         | 2003 |   | 2002    |  | 2001 |         | 2000
|Commercial, financial and agricultural  |  | $    | 88,404  |      |   | 74,649  |  | $    | 54,878  |      | $ | 50,122  |  | $ | 45,502 
|Real estate, construction               |  |      | 23,194  |      |   | 18,834  |  |      | 15,352  |      |   | 18,851  |  |   | 15,761 
|Real estate, mortgage                   |  |      | 43,931  |      |   | 38,560  |  |      | 31,818  |      |   | 34,410  |  |   | 33,158 
|Installment loans to individuals, other |  |      | 15,518  |      |   | 13,960  |  |      | 13,711  |      |   | 14,518  |  |   | 14,230 
|Leases                                  |  |      | 40      |      |   | 74      |  |      | 126     |      |   | 275     |  |   | 211    
|                                        |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total                                   |  | $    | 171,087 |      | $ | 146,077 |  | $    | 115,885 |      | $ | 118,176 |  | $ | 108,862
|                                        |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        



Interest rates charged on loans vary
with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulation also influence interest rates. On average, loans yielded 6.94% in 2004 compared to an average yield
of 7.73% in 2003.



Table 7. Maturity Schedule of Loans
(thousands)



|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|---------------------------------- |  | ----------------- | ------- | ------------------------------------- | - | ---------------------------- |  | ------ | ------ | ----- | - | ------ |  | - | ------- |  | ----- | -
|                                   |  | 2004              |        
|                                   |  | Other Real Estate |         | Commercial Finanical and Agricultural |   | Construction and Development |  | Others |        | Total |  
|                                   |  |                   |         |                                       |   | Amount                       |  | %      |       
|Fixed rate loans:                  |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Three months or less               |  | $                 | 622     |                                       | $ | 702                          |  | $      | 2,453  |       | $ | 2,451  |  | $ | 6,228   |  | 3.7   | %
|Over three months to twelve months |  |                   | 3,532   |                                       |   | 954                          |  |        | 2,607  |       |   | 1,648  |  |   | 8,741   |  | 5.1   | %
|Over twelve months to three years  |  |                   | 2,794   |                                       |   | 2,513                        |  |        | 784    |       |   | 4,062  |  |   | 10,153  |  | 5.9   | %
|Over three years to five years     |  |                   | 1,652   |                                       |   | 2,684                        |  |        | 344    |       |   | 4,810  |  |   | 9,490   |  | 5.6   | %
|Over five years to fifteen years   |  |                   | 10,827  |                                       |   | 428                          |  |        | 280    |       |   | 274    |  |   | 11,809  |  | 6.9   | %
|Over fifteen years                 |  |                   | 2,078   |                                       |   |                             |  |        | 23     |       |   |       |  |   | 2,101   |  | 1.2   | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Total fixed rate loans             |  |                   | 21,505  |                                       |   | 7,281                        |  |        | 6,491  |       |   | 13,245 |  |   | 48,522  |  | 28.4  | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Variable rate loans:               |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Three months or less               |  |                   | 23,659  |                                       |   | 9,935                        |  |        | 15,272 |       |   | 1,339  |  |   | 50,205  |  | 29.3  | %
|Over three months to twelve months |  |                   | 10,530  |                                       |   | 293                          |  |        | 62     |       |   | 92     |  |   | 10,977  |  | 6.4   | %
|Over twelve months to three years  |  |                   | 22,189  |                                       |   | 406                          |  |        | 708    |       |   | 44     |  |   | 23,347  |  | 13.7  | %
|Over three years to five years     |  |                   | 35,423  |                                       |   | 598                          |  |        | 661    |       |   |       |  |   | 36,682  |  | 21.4  | %
|Over five years to fifteen years   |  |                   | 516     |                                       |   |                             |  |        |       |       |   | 838    |  |   | 1,354   |  | 0.8   | %
|Over fifteen years                 |  |                   |        |                                       |   |                             |  |        |       |       |   |       |  |   |        |  |      | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Total variable rate loans          |  |                   | 92,317  |                                       |   | 11,232                       |  |        | 16,703 |       |   | 2,313  |  |   | 122,565 |  | 71.6  | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Total loans:                       |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Three months or less               |  |                   | 24,281  |                                       |   | 10,637                       |  |        | 17,725 |       |   | 3,790  |  |   | 56,433  |  | 33.0  | %
|Over three months to twelve months |  |                   | 14,062  |                                       |   | 1,247                        |  |        | 2,669  |       |   | 1,740  |  |   | 19,718  |  | 11.5  | %
|Over twelve months to three years  |  |                   | 24,983  |                                       |   | 2,919                        |  |        | 1,492  |       |   | 4,106  |  |   | 33,500  |  | 19.6  | %
|Over three years to five years     |  |                   | 37,075  |                                       |   | 3,282                        |  |        | 1,005  |       |   | 4,810  |  |   | 46,172  |  | 27.0  | %
|Over five years to fifteen years   |  |                   | 11,343  |                                       |   | 428                          |  |        | 280    |       |   | 1,112  |  |   | 13,163  |  | 7.7   | %
|Over fifteen years                 |  |                   | 2,078   |                                       |   |                             |  |        | 23     |       |   |       |  |   | 2,101   |  | 1.2   | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  
|Total loans                        |  | $                 | 113,822 |                                       | $ | 18,513                       |  | $      | 23,194 |       | $ | 15,558 |  | $ | 171,087 |  | 100.0 | %
|                                   |  |                   |         |                                       |   |                              |  |        |        |       |   |        |  |   |         |  |       |  



Investment Securities



The Bank uses its investment portfolio to provide liquidity for
unexpected deposit decreases or increased loan generation, to meet the Banks interest rate sensitivity goals, and to generate income.



---

Management of the investment portfolio has always been conservative with virtually all investments taking the form of
purchases of U.S. Treasury, U.S. Government agencies, and State and local bond issues. All securities are high quality and high grade. Management views the investment portfolio as a source of income, and purchases securities with the intent of
retaining them until maturity. However, adjustments are necessary in the portfolio to provide an adequate source of liquidity which can be used to meet funding requirements for loan demand and deposit fluctuations and to control interest rate risk.
Therefore, from time to time, management may sell certain securities prior to their maturity. Table 8 presents the investment portfolio at the end of 2004 by major types of investments and maturity ranges.



At December 31, 2004, the market value of the investment portfolio was $26.0 million,
representing a $578,000 unrealized appreciation above amortized cost. This compared to a market value of $29.9 million and a $889,000 unrealized appreciation above amortized cost a year earlier.



Table 8. Investment Securities (thousands)



December 31, 2004



|                                                        |  |                    |       |   |                           |   |        |                            |  |   |               |   |  |       |      |   |             |   |        |   |  |   |       
|------------------------------------------------------- |  | ------------------ | ----- | - | ------------------------- | - | ------ | -------------------------- |  | - | ------------- | - |  | ----- | ---- | - | ----------- | - | ------ | - |  | - | ------
|                                                        |  | Amortized Cost Due |       |   |                           |   |        |                           
|                                                        |  | In OneYear orLess  |       |   | After OneThroughFive Yrs. |   |        | After FiveThroughTen Years |  |   | AfterTenYears |   |  | Total |      |   | MarketValue
|Investment securities:                                  |  |                    |       |   |                           |   |        |                            |  |   |               |   |  |       |      |   |             |   |        |   |  |   |       
|US Government Agencies and Mortgage Backed Securities   |  | $                  | 500   |   |                           | $ | 14,036 |                            |  | $ | 1,000         |   |  | $     |     |   |             | $ | 15,536 |   |  | $ | 15,442
|State and political subs.                               |  |                    | 550   |   |                           |   | 3,312  |                            |  |   | 5,505         |   |  |       | 299  |   |             |   | 9,666  |   |  |   | 9,887 
|Other                                                   |  |                    |      |   |                           |   | 250    |                            |  |   |              |   |  |       |     |   |             |   | 250    |   |  |   | 701   
|                                                        |  |                    |       |   |                           |   |        |                            |  |   |               |   |  |       |      |   |             |   |        |   |  |   |       
|Total                                                   |  | $                  | 1,050 |   |                           | $ | 17,598 |                            |  | $ | 6,505         |   |  | $     | 299  |   |             | $ | 25,452 |   |  | $ | 26,030
|                                                        |  |                    |       |   |                           |   |        |                            |  |   |               |   |  |       |      |   |             |   |        |   |  |   |       
|Weighted average yields:                                |  |                    |       |   |                           |   |        |                            |  |   |               |   |  |       |      |   |             |   |        |   |  |   |       
|U.S. Government agencies and Mortgage Backed Securities |  |                    | 1.70  | % |                           |   | 3.35   | %                          |  |   | 3.85          | % |  |       |     | % |             |   |        |   |  |   |       
|States and political subs.                              |  |                    | 6.79  | % |                           |   | 6.30   | %                          |  |   | 5.45          | % |  |       | 5.15 | % |             |   |        |   |  |   |       
|Other                                                   |  |                    |      | % |                           |   | 6.00   | %                          |  |   |              | % |  |       |     | % |             |   |        |   |  |   |       
|                                                        |  |                    |       |   |                           |  
|Consolidated                                            |  |                    | 4.37  | % |                           |   | 3.94   | %                          |  |   | 5.20          | % |  |       | 5.15 | % |             |   | 4.30   | % |  |   |       



|                                                        |  |           |        |             |   |           |  |             |        |  |   |       
|------------------------------------------------------- |  | --------- | ------ | ----------- | - | --------- |  | ----------- | ------ |  | - | ------
|                                                        |  | 2003      |        | 2002       
|                                                        |  | BookValue |        | MarketValue |   | BookValue |  | MarketValue
|Investment securities:                                  |  |           |        |             |   |           |  |             |        |  |   |       
|U.S. Government agencies and Mortgage Backed Securities |  | $         | 19,684 |             | $ | 19,749    |  | $           | 29,575 |  | $ | 29,946
|States and political subdivisions                       |  |           | 9,081  |             |   | 9,498     |  |             | 9,167  |  |   | 9,475 
|Other                                                   |  |           | 250    |             |   | 657       |  |             | 250    |  |   | 557   
|                                                        |  |           |        |             |   |           |  |             |        |  |   |       
|Total                                                   |  | $         | 29,015 |             | $ | 29,904    |  | $           | 38,992 |  | $ | 39,978
|                                                        |  |           |        |             |   |           |  |             |        |  |   |       



Deposits



The Bank relies on deposits generated in its market area to provide the majority of funds
needed to support lending activities and for investments in liquid assets. More specifically, core deposits (total deposits less certificates of deposits in denominations of $100,000 or more) are the primary funding source. The Banks balance
sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios. Market
conditions have resulted in depositors shopping for deposit rates more than in the past. An increased customer awareness of interest rates adds to the importance of rate management. The Banks management must continuously monitor market
pricing, competitors rates, and internal interest rate spreads to maintain the Banks growth and profitability. The Bank attempts to structure rates so as to promote deposit and asset growth while at the same time increasing overall
profitability of the Bank.



---

Average total deposits for the year ended December 31, 2004 amounted to $186.2 million which was an increase of $18.7
million, or 11.2% over 2003. The percentage of the Banks average deposits that are interest-bearing decreased to 85.6% in 2004 from 86.9% in 2003. Average demand deposits which earn no interest increased to $26.8 million in 2004 from $22.0
million in 2003 and $19.6 million in 2002. Average deposits and average rates paid for the past three years are summarized in Table 9.



Table 9. Deposit Mix (thousands)



|                                |  |                |         |             |      |   |                |   |             |  |      |                |  |             |         |  |      |  
|------------------------------- |  | -------------- | ------- | ----------- | ---- | - | -------------- | - | ----------- |  | ---- | -------------- |  | ----------- | ------- |  | ---- | -
|                                |  | 2004           |         |             | 2003 |   | 2002           |  
|                                |  | AverageBalance |         | AverageRate |      |   | AverageBalance |   | AverageRate |  |      | AverageBalance |  | AverageRate |        
|Interest-bearing deposits:      |  |                |         |             |      |   |                |   |             |  |      |                |  |             |         |  |      |  
|NOW accounts                    |  | $              | 20,589  |             | 0.10 | % |                | $ | 18,056      |  | 0.13 | %              |  | $           | 17,121  |  | 0.27 | %
|Money Market                    |  |                | 14,087  |             | 0.98 | % |                |   | 9,491       |  | 0.76 | %              |  |             | 9,145   |  | 1.10 | %
|Savings                         |  |                | 25,319  |             | 0.50 | % |                |   | 24,218      |  | 0.80 | %              |  |             | 20,085  |  | 1.92 | %
|Small denomination certificates |  |                | 76,517  |             | 2.99 | % |                |   | 73,503      |  | 3.58 | %              |  |             | 73,095  |  | 4.37 | %
|Large denomination certificates |  |                | 22,928  |             | 3.30 | % |                |   | 20,234      |  | 3.70 | %              |  |             | 19,057  |  | 4.57 | %
|                                |  |                |         |             |      |   |                |   |             |  |      |                |  |             |         |  |      |  
|Total interest-bearing deposits |  |                | 159,440 |             | 2.09 | % |                |   | 145,502     |  | 2.52 | %              |  |             | 138,503 |  | 3.32 | %
|Noninteresting-bearing deposits |  |                | 26,788  |             |      |   |                |   | 22,014      |  |      |                |  |             | 19,595  |  |      |  
|                                |  |                |         |             |      |   |                |   |             |  |      |                |  |             |         |  |      |  
|Total deposits                  |  | $              | 186,228 |             |      |   |                | $ | 167,516     |  |      |                |  | $           | 158,098 |  |      |  
|                                |  |                |         |             |      |   |                |   |             |  |      |                |  |             |         |  |      |  



The average balance of certificates of
deposit issued in denominations of $100,000 or more increased by $2.7 million or 13.3%, in 2004. The strategy of management has been to support loan and investment growth with core deposits and not to aggressively solicit the more volatile, large
denomination certificates of deposit. Table 10 provides maturity information relating to Certificate of Deposits of $100,000 or more at December 31, 2004.



Table 10. Large Time Deposit Maturities (thousands)



Analysis of time deposits of $100,000 or more at December 31, 2004:



|                                                   |  |   |       
|-------------------------------------------------- |  | - | ------
|Remaining maturity of three months or less         |  | $ | 3,501 
|Remaining maturity over three through twelve month |  |   | 9,018 
|Remaining maturity over twelve months              |  |   | 11,931
|                                                   |  |   |       
|Total time deposits of $100,000 or more            |  | $ | 24,450
|                                                   |  |   |       



Capital Adequacy



Stockholders equity was $19.5 million at December 31, 2004, a 9.6% increase over the
2003 year-end total of $17.8 million. The increase was primarily a result of earnings partially offset by dividends and a decrease in the market value of available for sale securities. Average stockholders equity as a percentage of average
total assets amounted to 9.0% in 2004 and 9.1% in 2003.



Regulatory guidelines
relating to capital adequacy provide minimum risk-based ratios which assess capital adequacy while encompassing all credit risks, including those related to off-balance sheet activities. Capital ratios under these guidelines are computed by weighing
the relative risk of each asset category to derive risk-adjusted assets. The risk-based capital guidelines require minimum ratios of core (Tier 1) capital (common stockholders equity) to risk-weighted assets of 4.0% and total regulatory
capital (core capital plus allowance for loan losses up to 1.25% of risk-weighted assets) to risk-weighted assets of 8%. As of December 31, 2004 the Company and Bank had ratios of Tier 1 capital to risk-weighted assets of 11.2% and 10.4%,
respectively, and ratios of total capital to risk-weighted assets of 12.5% and 11.7%, respectively. These ratios continue to compare favorably to the Companys peer group.



---

Table 11. Year-End Risk-Based Capital (thousands)



|                                                                                |  |              |         |   |                  |   |         |              |  |   |                  |   |  |   |         |  
|------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | ------------ |  | - | ---------------- | - |  | - | ------- | -
|                                                                                |  | 2004         |         |   | 2003             |  
|                                                                                |  | Consolidated |         |   | Bank ofBotetourt |   |         | Consolidated |  |   | Bank ofBotetourt |  
|Tier I capital                                                                  |  | $            | 19,028  |   |                  | $ | 17,640  |              |  | $ | 17,140           |   |  | $ | 15,941  |  
|Qualifying allowance for loan losses (limited to 1.25% of risk-weighted assets) |  |              | 2,122   |   |                  |   | 2,119   |              |  |   | 1,689            |   |  |   | 1,689   |  
|                                                                                |  |              |         |   |                  |   |         |              |  |   |                  |   |  |   |         |  
|Total regulatory capital                                                        |  | $            | 21,150  |   |                  | $ | 19,759  |              |  | $ | 18,829           |   |  | $ | 17,630  |  
|                                                                                |  |              |         |   |                  |   |         |              |  |   |                  |   |  |   |         |  
|Total risk-weighted assets                                                      |  | $            | 169,778 |   |                  | $ | 169,490 |              |  | $ | 148,877          |   |  | $ | 148,667 |  
|                                                                                |  |              |         |   |                  |   |         |              |  |   |                  |   |  |   |         |  
|Tier I as a percent of risk-weighted assets                                     |  |              | 11.2    | % |                  |   | 10.4    | %            |  |   | 11.5             | % |  |   | 10.7    | %
|Total regulatory capital as a percent of risk- weighted assets                  |  |              | 12.5    | % |                  |   | 11.7    | %            |  |   | 12.7             | % |  |   | 11.9    | %
|Leverage ratio*                                                                 |  |              | 8.9     | % |                  |   | 8.3     | %            |  |   | 8.9              | % |  |   | 8.4     | %

---

|* | Tier I capital divided by average total assets for the quarter ended December 31.
|- | ---------------------------------------------------------------------------------



In addition, a minimum leverage ratio of Tier I capital to average total assets for the previous quarter is required by federal bank
regulators, ranging from 3.0% to 5.0%, subject to the regulators evaluation of the Banks overall safety and soundness. As of December 31, 2004, the Company and the Bank had ratios of year-end Tier I capital to average total assets for
the fourth quarter of 2004 of 8.9% and 8.3%, respectively. Table 11 sets forth summary information with respect to the Company and the Banks capital ratios at December 31, 2004 and 2003. All capital ratio levels indicate that the Company and
the Bank are well capitalized.



At December 31, 2004 the Company had 1,232,745
shares of common stock outstanding which were held by approximately 775 shareholders of record.



Nonperforming and Problem Assets



Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Bank attempts to use shorter-term loans and, although a
portion of the loans have been made based upon the value of collateral, it tries to rely primarily on the cash flow of the borrower as the source of repayment rather than the value of the collateral.



The Bank shall not accrue interest, amortize deferred net loan fees or costs, or accrete
discount on any asset (1) which is maintained on a cash basis because of deterioration in the financial condition of the borrower, (2) for which payment in full of principal or interest is not expected, or (3) upon which principal or interest has
been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection. An asset is well secured if it is secured (1) by collateral in the form of liens on or pledges of real or personal
property, including securities, that have a realizable value sufficient to discharge the debt (including accrued interest) in full, or (2) by the guarantee of a financially responsible party. An asset is in the process of collection if
collection of the asset is proceeding in due course either (1) through legal action, including judgement enforcement procedures, or (2) in appropriate circumstances, through collection efforts not involving legal actions which are reasonably
expected to result in repayment of the debt or in its restoration to a current status in the near future.



---

For purposes of applying the third test for non-accrual status listed above, the date on which an asset reaches
non-accrual status is determined by its contractual terms. If the principal or interest on an asset becomes due and unpaid for 90 days or more on a date that falls between report dates, the asset should be placed in non-accrual status as of the date
it becomes 90 days past due and it should remain in non-accrual status until it meets the criteria for restoration to accrual status.



The Bank also attempts to reduce repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer
limits, periodic loan documentation review and follow up on exceptions to credit policies.



Nonperforming assets are analyzed in Table 12 for the last five years.



Table 12. Nonperforming Assets



|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|----------------------------------- |  | ---- | ---------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | ------- | -
|                                    |  | 2004 |            |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|Non-accrual loans                   |  | $    | 488,000    |   |      | $ | 219,000   |      |  | $ | 771,000   |   |  | $    | 293,000   |   |  | $ | 88,000  |  
|Loans past due 90 days or more      |  |      | 1,127,000  |   |      |   | 876,000   |      |  |   | 1,161,000 |   |  |      | 1,080,000 |   |  |   | 664,000 |  
|Foreclosed properties               |  |      | 65,000     |   |      |   | 136,000   |      |  |   | 70,000    |   |  |      | 70,000    |   |  |   | 70,000  |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|                                    |  |      | $1,680,000 |   |      | $ | 1,231,000 |      |  | $ | 2,002,000 |   |  | $    | 1,443,000 |   |  | $ | 822,000 |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Interest income, orginal terms      |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Non-accrual loans                   |  | $    | 54,501     |   |      | $ | 25,150    |      |  | $ | 83,231    |   |  | $    | 25,234    |   |  | $ | 89,279  |  
|Loans past due 90 days or more      |  |      | 72,261     |   |      |   | 83,997    |      |  |   | 102,350   |   |  |      | 4,502     |   |  |   | 62,842  |  
|Troubled debt restructurings        |  |      |           |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|                                    |  | $    | 126,762    |   |      | $ | 109,147   |      |  | $ | 185,581   |   |  | $    | 29,736    |   |  | $ | 152,121 |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Interest income, recognized         |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Non-accrual loans                   |  | $    | 8,259      |   |      | $ | 1,112     |      |  | $ | 9,034     |   |  | $    | 6,001     |   |  | $ | 5,361   |  
|Loans past due 90 days or more      |  |      | 33,122     |   |      |   | 44,823    |      |  |   | 58,539    |   |  |      | 2,780     |   |  |   | 37,615  |  
|Troubled debt restructurings        |  |      |           |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Total                               |  | $    | 41,381     |   |      | $ | 45,935    |      |  | $ | 67,573    |   |  | $    | 8,781     |   |  | $ | 42,976  |  
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Nonperforming assets to total loans |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|                                    |  |      | 0.98       | % |      |   | 0.85      | %    |  |   | 1.73      | % |  |      | 1.22      | % |  |   | 0.76    | %
|                                    |  |      |            |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  



The allowance for loan losses is
maintained at a level management believes to be adequate to absorb potential losses. Some of the factors which management considers in determining the appropriate level of the allowance for loan losses are: past loss experience, an evaluation of the
current loan portfolio, identified loan problems, the loan volume outstanding, the present and expected economic conditions in general, and in particular, how such conditions relate to the market areas that the Bank serves. Bank regulators also
periodically review the Banks loans and other assets to assess their quality. Credits deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. The
accrual of interest on loans is discontinued on a loan when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due.



The provision for loan losses, net charge-offs and the activity in the allowance for loan losses is detailed in Table 13.



---

Table 13. Loan Losses



|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                           |  | 2004 |           |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|Allowance for loan losses, beginning       |  | $    | 1,688,812 |   |      | $ | 1,413,997 |      |  | $ | 1,303,042 |   |  | $    | 1,083,955 |   |  | $ | 893,712   |  
|Provision for loan losses, added           |  |      | 725,000   |   |      |   | 625,000   |      |  |   | 975,000   |   |  |      | 550,000   |   |  |   | 400,000   |  
|                                           |  |      |           |   |     
|Loans charged off                          |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Commercial, financial and agricultural     |  |      | (130,490  | ) |      |   | (283,628  | )    |  |   | (509,480  | ) |  |      | (128,835  | ) |  |   | (48,110   | )
|Real estate, construction                  |  |      |          |   |      |   | (50,029   | )    |  |   |          |   |  |      |          |   |  |   |          |  
|Real estate, mortgage                      |  |      | (58,275   | ) |      |   | (11,023   | )    |  |   | (63,698   | ) |  |      |          |   |  |   |          |  
|Installment loans to individuals           |  |      | (150,960  | ) |      |   | (331,700  | )    |  |   | (269,980  | ) |  |      | (223,574  | ) |  |   | (202,685  | )
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|                                           |  |      | (339,725  | ) |      |   | (626,351  | )    |  |   | (893,187  | ) |  |      | (352,409  | ) |  |   | (250,795  | )
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Recoveries of loans previously charged off |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Commercial, financial and agricultural     |  |      | 7,778     |   |      |   | 192,258   |      |  |   | 4,952     |   |  |      | 5,119     |   |  |   | 22,960    |  
|Real estate, construction                  |  |      |           |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Real estate, mortgage                      |  |      | 1,764     |   |      |   | 24,282    |      |  |   | 91        |   |  |      |          |   |  |   |          |  
|Installment loans to individuals           |  |      | 47,905    |   |      |   | 59,626    |      |  |   | 24,099    |   |  |      | 16,377    |   |  |   | 18,078    |  
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|                                           |  |      | 57,447    |   |      |   | 276,166   |      |  |   | 29,142    |   |  |      | 21,496    |   |  |   | 41,038    |  
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net charge-offs                            |  |      | (282,278  | ) |      |   | (350,185  | )    |  |   | (864,045  | ) |  |      | (330,913  | ) |  |   | (209,757  | )
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Allowance for loan losses, ending          |  | $    | 2,131,534 |   |      | $ | 1,688,812 |      |  | $ | 1,413,997 |   |  | $    | 1,303,042 |   |  | $ | 1,083,955 |  
|                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  



Net loan charge-offs as a percentage
of average loans were 0.18% in 2004. Net loan charge-offs as a percentage of average loans were 0.27% in 2003 and 0.73% in 2002. Gross charge-offs during 2004 totaled $339,725. Recoveries during 2004 totaled $57,447.



The loan portfolio also included loans to various borrowers (watch loans) at year-end for
which management had concerns about the ability of the borrowers to continue to comply with present loan repayment terms, and which could result in some of these loans being uncollectible. Management monitors these loans carefully and has provided
for these loans to the extent deemed necessary in the allowance for loan losses.



The allowance for loan losses was approximately $2.13 million, or 1.25% of gross loans outstanding at December 31, 2004, an increase of $442,722 above the reserve at December 31, 2003. Management realizes that general economic trends
greatly affect loan losses and no assurances can be made about future losses. Management does, however, consider the allowance for loan losses to be adequate at December 31, 2004.



The allocation of the reserve for loan losses is detailed in Table 14 below:



Table 14. Allocation of the Reserve for Loan Losses (thousands)



|                                        |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |        |   |          |   |       |        |       |          |  |   |       |  |       |  
|--------------------------------------- |  | ------ | ----- | -------- | ----- | - | ------ | ---- | -------- |  | ----- | ------ |  | -------- | ----- |  | ------ | - | -------- | - | ----- | ------ | ----- | -------- |  | - | ----- |  | ----- | -
|                                        |  | 2004   |       |          | 2003  |   |        | 2002 |          |  | 2001  |        |  | 2000     |      
|Balance at end of period applicable to  |  | Amount |       | Percent1 |       |   | Amount |      | Percent1 |  |       | Amount |  | Percent1 |       |  | Amount |   | Percent1 |   |       | Amount |       | Percent1 | 
|Commercial, financial and agricultural  |  | $      | 1,145 |          | 51.7  | % |        | $    | 859      |  | 51.1  | %      |  | $        | 652   |  | 47.3   | % |          | $ | 878   |        | 42.4  | %        |  | $ | 477   |  | 41.8  | %
|Real estate, construction               |  |        | 199   |          | 13.5  | % |        |      | 135      |  | 12.9  | %      |  |          | 148   |  | 13.2   | % |          |   | 165   |        | 16.0  | %        |  |   | 177   |  | 14.5  | %
|Real estate, mortgage                   |  |        | 356   |          | 25.7  | % |        |      | 458      |  | 26.4  | %      |  |          | 324   |  | 27.6   | % |          |   | 120   |        | 29.1  | %        |  |   | 210   |  | 30.5  | %
|Installment loans to individuals, other |  |        | 432   |          | 9.1   | % |        |      | 236      |  | 9.5   | %      |  |          | 290   |  | 11.8   | % |          |   | 140   |        | 12.3  | %        |  |   | 220   |  | 13.0  | %
|Leases                                  |  |        |      |          |      | % |        |      | 1        |  | 0.1   | %      |  |          |      |  | 0.1    | % |          |   |      |        | 0.2   | %        |  |   |      |  | 0.2   | %
|                                        |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |        |   |          |   |       |        |       |          |  |   |       |  |       |  
|Total                                   |  | $      | 2,132 |          | 100.0 | % |        | $    | 1,689    |  | 100.0 | %      |  | $        | 1,414 |  | 100.0  | % |          | $ | 1,303 |        | 100.0 | %        |  | $ | 1,084 |  | 100.0 | %
|                                        |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |        |   |          |   |       |        |       |          |  |   |       |  |       |  

---

|(1) | Represents the percentage of loans in each category to the total loans outstanding.
|--- | -----------------------------------------------------------------------------------



---

Liquidity and Interest Rate Sensitivity



The principal goals of the Banks asset and liability management strategy are the maintenance of adequate liquidity and the management
of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors withdrawals or borrowers loans without significant loss. Interest rate risk management balances the effects of interest rate changes on assets
that earn interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from interest rates changes.



Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance
sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability
to increase large denomination certificates, federal funds lines from correspondent banks, borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and
equity.



The liquidity ratio (the level of liquid assets divided by total
deposits plus short-term liabilities) is considered to be adequate by management.



Table 15. Interest Rate Sensitivity (thousands)



|                                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|----------------------------------------------------------- |  | -------------------------------------- | ------ | - | ---------- | - | ------ | ----------- |  | - | ------------- | -- |  | ----- | ------ | - |  | - | ------- | -
|                                                            |  | December 31, 2004 Maturities/Repricing |       
|                                                            |  | 1-3Months                              |        |   | 4-12Months |   |        | 13-60Months |  |   | Over 60Months |    |  | Total |       
|Earnings assets:                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|Loans                                                       |  | $                                      | 57,773 |   |            | $ | 29,496 |             |  | $ | 68,454        |    |  | $     | 15,364 |   |  | $ | 171,087 |  
|Investments                                                 |  |                                        | 150    |   |            |   | 900    |             |  |   | 17,641        |    |  |       | 6,877  |   |  |   | 25,568  |  
|Interest-bearing deposits with banks                        |  |                                        | 195    |   |            |   |       |             |  |   |              |    |  |       |       |   |  |   | 195     |  
|Federal funds sold                                          |  |                                        | 3,782  |   |            |   |       |             |  |   |              |    |  |       |       |   |  |   | 3,782   |  
|                                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|Total                                                       |  | $                                      | 61,900 |   |            | $ | 30,396 |             |  | $ | 86,095        |    |  | $     | 22,241 |   |  | $ | 200,632 |  
|                                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|Interest-bearing deposits:                                  |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|NOW accounts                                                |  | $                                      | 5,424  |   |            | $ |       |             |  | $ | 16,269        |    |  | $     |       |   |  | $ | 21,693  |  
|Money market                                                |  |                                        | 3,915  |   |            |   |       |             |  |   | 11,748        |    |  |       |       |   |  |   | 15,663  |  
|Savings                                                     |  |                                        | 12,697 |   |            |   |       |             |  |   | 12,758        |    |  |       |       |   |  |   | 25,455  |  
|Certificates of deposit                                     |  |                                        | 13,806 |   |            |   | 36,286 |             |  |   | 51,955        |    |  |       |       |   |  |   | 102,047 |  
|Federal funds purchased                                     |  |                                        |       |   |            |   |       |             |  |   |              |    |  |       |       |   |  |   |        |  
|                                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|Total                                                       |  | $                                      | 35,842 |   |            | $ | 36,286 |             |  | $ | 92,730        |    |  | $     |       |   |  | $ | 164,858 |  
|                                                            |  |                                        |        |   |            |   |        |             |  |   |               |    |  |       |        |   |  |   |         |  
|Interest sensitivity gap                                    |  | $                                      | 26,058 |   |            | $ | (5,890 | )           |  | $ | (6,635        | )  |  | $     | 22,241 |   |  | $ | 35,774  |  
|Cumulative interest sensitivity gap                         |  | $                                      | 26,058 |   |            | $ | 20,168 |             |  | $ | 13,533        |    |  | $     | 35,774 |   |  | $ | 35,774  |  
|Ratio of sensitivity gap to total earning assets            |  |                                        | 12.99  | % |            |   | (2.94  | )%          |  |   | (3.31         | )% |  |       | 11.09  | % |  |   | 17.83   | %
|Cumulative ratio of sensitivity gap to total earning assets |  |                                        | 12.99  | % |            |   | 10.05  | %           |  |   | 6.75          | %  |  |       | 17.83  | % |  |   | 17.83   | %



---

Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as
interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will
afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 15 shows the sensitivity of the Banks balance sheet on December 31, 2004. This table reflects the sensitivity of the balance
sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2004, the Bank appeared to be asset-sensitive with earning assets exceeding interest-bearing liabilities subject to changes in interest
rates. Included in the interest-bearing liabilities subject to interest rate changes within three months are a portion of NOW accounts, money market accounts, and savings accounts which historically have not been as interest-sensitive as other types
of interest-bearing deposits. A larger portion of these accounts are included in the thirteen to sixty month time period due to the fact that they are not considered as interest rate sensitive as other deposit liabilities. The Bank appears to be
liability-sensitive in the four to twelve month time horizon and in the thirteen to sixty month time horizon.



Matching sensitive positions alone does not ensure that the Bank has no interest rate risk. The repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net
interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.



Table 16. Key Financial Ratios



|                                 |  |       |   |  |       |   |  |       |  
|-------------------------------- |  | ----- | - |  | ----- | - |  | ----- | -
|                                 |  | 2004  |   |  | 2003  |   |  | 2002  |  
|Return on average assets         |  | 1.17  | % |  | 1.03  | % |  | 0.98  | %
|Return on average equity         |  | 12.95 | % |  | 11.30 | % |  | 11.01 | %
|Average equity to average assets |  | 8.97  | % |  | 9.14  | % |  | 8.96  | %
|Dividend payout ratio            |  | 23.63 | % |  | 24.27 | % |  | 19.28 | %



---

Item 7: Financial Statements



Independent Auditors Report



Board of Directors and Stockholders

Botetourt
Bankshares, Inc.

Buchanan, Virginia



We have audited the consolidated balance sheets of Botetourt Bankshares, Inc. and subsidiaries as of December 31, 2004 and 2003 and the related consolidated statements of
income, stockholders equity and cash flows for each of the three years in the period ended December 31, 2004. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.



We
conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Botetourt Bankshares, Inc. and subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally
accepted in the United States of America.



|                          
|--------------------------
|/s/ Larrowe & Company, PLC
|Galax, Virginia           
|January 21, 2005          



---

Consolidated Balance Sheets

December 31, 2004 and 2003



|                                                                                                                                                 |  |      |             |      |   |            
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | ----------- | ---- | - | -----------
|                                                                                                                                                 |  | 2004 |             | 2003
|Assets                                                                                                                                           |  |      |             |      |   |            
|                                                                                                                                                 |  |     
|Cash and due from banks                                                                                                                          |  | $    | 5,789,445   |      | $ | 13,002,989 
|Interest-bearing deposits with banks                                                                                                             |  |      | 194,700     |      |   | 249,475    
|Federal funds sold                                                                                                                               |  |      | 3,782,000   |      |   |           
|Investment securities available for sale                                                                                                         |  |      | 23,752,840  |      |   | 27,399,431 
|Investment securities held to maturity                                                                                                           |  |      | 2,259,662   |      |   | 2,433,891  
|Restricted equity securities                                                                                                                     |  |      | 439,700     |      |   | 370,200    
|Loans, net of allowance for loan losses of $2,131,534 in 2004 and $1,688,812 in 2003                                                             |  |      | 168,955,408 |      |   | 144,387,731
|Property and equipment, net                                                                                                                      |  |      | 5,795,172   |      |   | 5,428,561  
|Accrued income                                                                                                                                   |  |      | 981,683     |      |   | 989,642    
|Foreclosed assets                                                                                                                                |  |      | 50,000      |      |   | 135,785    
|Other assets                                                                                                                                     |  |      | 1,346,241   |      |   | 1,567,567  
|                                                                                                                                                 |  |      |             |      |   |            
|Total assets                                                                                                                                     |  | $    | 213,346,851 |      | $ | 195,965,272
|                                                                                                                                                 |  |      |             |      |   |            
|Liabilities and Stockholders Equity                                                                                                             |  |      |             |      |   |            
|                                                                                                                                                 |  |     
|Liabilities                                                                                                                                      |  |      |             |      |   |            
|Noninterest-bearing deposits                                                                                                                     |  | $    | 27,790,202  |      | $ | 24,372,998 
|Interest-bearing deposits                                                                                                                        |  |      | 164,857,274 |      |   | 149,029,870
|                                                                                                                                                 |  |      |             |      |   |            
|Total deposits                                                                                                                                   |  |      | 192,647,476 |      |   | 173,402,868
|                                                                                                                                                 |  |     
|Federal funds purchased                                                                                                                          |  |      |            |      |   | 3,971,000  
|Accrued interest payable                                                                                                                         |  |      | 394,572     |      |   | 368,819    
|Other liabilities                                                                                                                                |  |      | 848,630     |      |   | 464,725    
|                                                                                                                                                 |  |      |             |      |   |            
|Total liabilities                                                                                                                                |  |      | 193,890,678 |      |   | 178,207,412
|                                                                                                                                                 |  |      |             |      |   |            
|Commitments and contingencies                                                                                                                    |  |      |            |      |   |           
|                                                                                                                                                 |  |     
|Stockholders equity                                                                                                                             |  |      |             |      |   |            
|Common stock, $1.00 par value; 2,500,000 shares authorized; 1,232,745 and 1,230,924 shares issued and outstanding in 2004 and 2003,
respectively |  |      | 1,232,745   |      |   | 1,230,924  
|Additional paid-in capital                                                                                                                       |  |      | 1,361,970   |      |   | 1,328,190  
|Retained earnings                                                                                                                                |  |      | 16,491,678  |      |   | 14,658,543 
|Accumulated other comprehensive income (loss)                                                                                                    |  |      | 369,780     |      |   | 540,203    
|                                                                                                                                                 |  |      |             |      |   |            
|Total stockholders equity                                                                                                                       |  |      | 19,456,173  |      |   | 17,757,860 
|                                                                                                                                                 |  |      |             |      |   |            
|Total liabilities and stockholders equity                                                                                                       |  | $    | 213,346,851 |      | $ | 195,965,272
|                                                                                                                                                 |  |      |             |      |   |            



See Notes to Consolidated
Financial Statements



---

Consolidated Statements of Income

Years ended December 31, 2004, 2003 and 2002



|                                                    |  |      |            |      |   |            |  |   |           
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ----------
|                                                    |  | 2004 |            | 2003 |   | 2002      
|Interest income                                     |  |      |            |      |   |            |  |   |           
|Loans and fees on loans                             |  | $    | 11,028,391 |      | $ | 10,022,700 |  | $ | 10,050,841
|Federal funds sold                                  |  |      | 55,295     |      |   | 44,976     |  |   | 158,893   
|Investment securities:                              |  |      |            |      |   |            |  |   |           
|Taxable                                             |  |      | 520,900    |      |   | 976,549    |  |   | 1,067,590 
|Exempt from federal income tax                      |  |      | 380,673    |      |   | 379,407    |  |   | 376,577   
|Dividend income                                     |  |      | 27,249     |      |   | 25,575     |  |   | 30,540    
|Deposits with banks                                 |  |      | 2,481      |      |   | 2,406      |  |   | 3,274     
|                                                    |  |      |            |      |   |            |  |   |           
|Total interest income                               |  |      | 12,014,989 |      |   | 11,451,613 |  |   | 11,687,715
|                                                    |  |      |            |      |   |            |  |   |           
|Interest expense                                    |  |      |            |      |   |            |  |   |           
|Deposits                                            |  |      | 3,325,837  |      |   | 3,673,333  |  |   | 4,596,742 
|Federal funds purchased                             |  |      | 13,751     |      |   | 12,475     |  |   |          
|                                                    |  |      |            |      |   |            |  |   |           
|Total interest expense                              |  |      | 3,339,588  |      |   | 3,685,808  |  |   | 4,596,742 
|                                                    |  |      |            |      |   |            |  |   |           
|Net interest income                                 |  |      | 8,675,401  |      |   | 7,765,805  |  |   | 7,090,973 
|                                                    |  |      |           
|Provision for loan losses                           |  |      | 725,000    |      |   | 625,000    |  |   | 975,000   
|                                                    |  |      |            |      |   |            |  |   |           
|Net interest income after provision for loan losses |  |      | 7,950,401  |      |   | 7,140,805  |  |   | 6,115,973 
|                                                    |  |      |            |      |   |            |  |   |           
|Noninterest income                                  |  |      |            |      |   |            |  |   |           
|Service charges on deposit accounts                 |  |      | 760,277    |      |   | 622,215    |  |   | 588,647   
|Other service charges and fees                      |  |      | 181,832    |      |   | 180,746    |  |   | 215,353   
|Commissions on title services                       |  |      | 174,729    |      |   | 176,166    |  |   | 171,695   
|Net realized gains (losses) on sales of securities  |  |      | 656        |      |   | 1,750      |  |   | 2,750     
|Net gain on sale of foreclosed assets               |  |      |           |      |   |           |  |   | 69,740    
|Other income                                        |  |      | 202,010    |      |   | 167,766    |  |   | 233,068   
|                                                    |  |      |            |      |   |            |  |   |           
|Total noninterest income                            |  |      | 1,319,504  |      |   | 1,148,643  |  |   | 1,281,253 
|                                                    |  |      |            |      |   |            |  |   |           
|Noninterest expense                                 |  |      |            |      |   |            |  |   |           
|Salaries and employee benefits                      |  |      | 3,378,528  |      |   | 3,118,394  |  |   | 2,804,671 
|Occupancy                                           |  |      | 359,963    |      |   | 291,308    |  |   | 260,240   
|Equipment                                           |  |      | 458,379    |      |   | 428,727    |  |   | 390,034   
|Foreclosed assets, net                              |  |      | 1,059      |      |   | 62,317     |  |   |          
|Advertising and public relations                    |  |      | 176,090    |      |   | 141,228    |  |   | 122,607   
|Outside services                                    |  |      | 154,746    |      |   | 168,776    |  |   | 143,521   
|Other general and administrative                    |  |      | 1,305,226  |      |   | 1,358,455  |  |   | 1,227,498 
|                                                    |  |      |            |      |   |            |  |   |           
|Total noninterest expense                           |  |      | 5,833,991  |      |   | 5,569,205  |  |   | 4,948,571 
|                                                    |  |      |            |      |   |            |  |   |           
|Income before income taxes                          |  |      | 3,435,914  |      |   | 2,720,243  |  |   | 2,448,655 
|                                                    |  |      |           
|Income tax expense                                  |  |      | 1,035,716  |      |   | 794,027    |  |   | 727,861   
|                                                    |  |      |            |      |   |            |  |   |           
|Net income                                          |  | $    | 2,400,198  |      | $ | 1,926,216  |  | $ | 1,720,794 
|                                                    |  |      |            |      |   |            |  |   |           
|Basic earnings per share                            |  | $    | 1.95       |      | $ | 1.57       |  | $ | 1.40      
|                                                    |  |      |            |      |   |            |  |   |           
|Diluted earnings per share                          |  | $    | 1.95       |      | $ | 1.56       |  | $ | 1.40      
|                                                    |  |      |            |      |   |            |  |   |           
|Basic weighted average shares outstanding           |  |      | 1,232,645  |      |   | 1,230,520  |  |   | 1,228,413 
|                                                    |  |      |            |      |   |            |  |   |           
|Diluted weighted average shares outstanding         |  |      | 1,233,356  |      |   | 1,230,880  |  |   | 1,228,965 
|                                                    |  |      |            |      |   |            |  |   |           



See Notes to Consolidated
Financial Statements



---

Consolidated Statements of Changes in Stockholders Equity

Years ended December 31, 2004, 2003 and 2002



|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|------------------------------------------------------------------------------------------------------------ |  | ------------ |  | ------------------------ | --------- | ---------------- | - | --------- | ------------------------------------------- | - | ---------- | ----- |  | - | -------- | - |  | - | ---------- | -
|                                                                                                             |  | Common Stock |  | AdditionalPaid-InCapital |           | RetainedEarnings |   |           | AccumulatedOther ComprehensiveIncome (Loss) |   |            | Total | 
|                                                                                                             |  | Shares       |  | Amount                   |           |                  |   |          
|Balance, December 31, 2001                                                                                   |  | 1,225,808    |  | $                        | 1,225,808 |                  | $ | 1,232,129 |                                             | $ | 11,810,766 |       |  | $ | 223,899  |   |  | $ | 14,492,602 |  
|Net income                                                                                                   |  |             |  |                          |          |                  |   |          |                                             |   | 1,720,794  |       |  |   |         |   |  |   | 1,720,794  |  
|Net change in unrealized appreciation on investment securities available for sale, net of taxes of $184,053  |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | 357,280  |   |  |   | 357,280    |  
|Reclassified securities gains realized, net of taxes of $(935)                                               |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | (1,815   | ) |  |   | (1,815     | )
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Total comprehensive income                                                                                   |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   | 2,076,259  |  
|                                                                                                             |  |              |  |                          |           |                 
|Dividends declared ($.27 per share)                                                                          |  |             |  |                          |          |                  |   |          |                                             |   | (331,699   | )     |  |   |         |   |  |   | (331,699   | )
|Stock issued                                                                                                 |  | 2,706        |  |                          | 2,706     |                  |   | 49,037    |                                             |   |           |       |  |   |         |   |  |   | 51,743     |  
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Balance, December 31, 2002                                                                                   |  | 1,228,514    |  |                          | 1,228,514 |                  |   | 1,281,166 |                                             |   | 13,199,861 |       |  |   | 579,364  |   |  |   | 16,288,905 |  
|                                                                                                             |  |              |  |                          |           |                 
|Net income                                                                                                   |  |             |  |                          |          |                  |   |          |                                             |   | 1,926,216  |       |  |   |         |   |  |   | 1,926,216  |  
|Net change in unrealized appreciation on investment securities available for sale, net of taxes of $(19,579) |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | (38,006  | ) |  |   | (38,006    | )
|Reclassified securities gains realized, net of taxes of $(595 )                                              |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | (1,155   | ) |  |   | (1,155     | )
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Total comprehensive income                                                                                   |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   | 1,887,055  |  
|                                                                                                             |  |              |  |                          |           |                 
|Dividends declared ($.38 per share)                                                                          |  |             |  |                          |          |                  |   |          |                                             |   | (467,534   | )     |  |   |         |   |  |   | (467,534   | )
|Stock issued                                                                                                 |  | 2,410        |  |                          | 2,410     |                  |   | 47,024    |                                             |   |           |       |  |   |         |   |  |   | 49,434     |  
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Balance, December 31, 2003                                                                                   |  | 1,230,924    |  |                          | 1,230,924 |                  |   | 1,328,190 |                                             |   | 14,658,543 |       |  |   | 540,203  |   |  |   | 17,757,860 |  
|                                                                                                             |  |              |  |                          |           |                 
|Net income                                                                                                   |  |             |  |                          |          |                  |   |          |                                             |   | 2,400,198  |       |  |   |         |   |  |   | 2,400,198  |  
|Net change in unrealized appreciation on investment securities available for sale, net of taxes of $(87,570) |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | (169,990 | ) |  |   | (169,990   | )
|Reclassified securities gains realized, net of taxes of $(223)                                               |  |             |  |                          |          |                  |   |          |                                             |   |           |       |  |   | (433     | ) |  |   | (433       | )
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Total comprehensive income                                                                                   |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   | 2,229,775  |  
|                                                                                                             |  |              |  |                          |           |                 
|Dividends declared ($.46 per share)                                                                          |  |             |  |                          |          |                  |   |          |                                             |   | (567,063   | )     |  |   |         |   |  |   | (567,063   | )
|Stock issued                                                                                                 |  | 1,821        |  |                          | 1,821     |                  |   | 33,780    |                                             |   |           |       |  |   |         |   |  |   | 35,601     |  
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  
|Balance, December 31, 2004                                                                                   |  | 1,232,745    |  | $                        | 1,232,745 |                  | $ | 1,361,970 |                                             | $ | 16,491,678 |       |  | $ | 369,780  |   |  | $ | 19,456,173 |  
|                                                                                                             |  |              |  |                          |           |                  |   |           |                                             |   |            |       |  |   |          |   |  |   |            |  



See Notes to Consolidated
Financial Statements



---

Consolidated Statements of Cash Flows

Years ended December 31, 2004, 2003 and 2002



|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|----------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                        |  | 2004 |             |   | 2003 |   |             | 2002 | 
|Cash flows from operating activities                                    |  |      |             |   |      |   |             |      |  |   |             |  
|Net income                                                              |  | $    | 2,400,198   |   |      | $ | 1,926,216   |      |  | $ | 1,720,794   |  
|Adjustments to reconcile net income to net cash provided by operations: |  |      |             |   |      |   |             |      |  |   |             |  
|Depreciation and amortization                                           |  |      | 517,045     |   |      |   | 444,496     |      |  |   | 405,755     |  
|Provision for loan losses                                               |  |      | 725,000     |   |      |   | 625,000     |      |  |   | 975,000     |  
|Deferred income taxes                                                   |  |      | (139,185    | ) |      |   | (110,530    | )    |  |   | 11,250      |  
|Net realized (gains) losses on sales of assets                          |  |      | 22,323      |   |      |   | 68,931      |      |  |   | (64,230     | )
|Accretion of discount on securities, net of amortization of premiums    |  |      | (8,449      | ) |      |   | (13,074     | )    |  |   | (10,766     | )
|Changes in assets and liabilities:                                      |  |      |             |   |      |   |             |      |  |   |             |  
|Accrued income                                                          |  |      | 7,959       |   |      |   | 44,220      |      |  |   | 8,524       |  
|Other assets                                                            |  |      | 303,735     |   |      |   | (374,132    | )    |  |   | (36,102     | )
|Accrued interest payable                                                |  |      | 25,753      |   |      |   | (117,855    | )    |  |   | (75,140     | )
|Other liabilities                                                       |  |      | 472,176     |   |      |   | 265,864     |      |  |   | (363,452    | )
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided by operating activities                               |  |      | 4,326,555   |   |      |   | 2,759,136   |      |  |   | 2,571,633   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Cash flows from investing activities                                    |  |      |             |   |      |   |             |      |  |   |             |  
|Net (increase) decrease in interest-bearing deposits with banks         |  |      | 54,775      |   |      |   | (42,268     | )    |  |   | (14,769     | )
|Net (increase) decrease in federal funds sold                           |  |      | (3,782,000  | ) |      |   | 11,067,000  |      |  |   | 1,193,000   |  
|Purchases of investment securities  held to maturity                   |  |      | (675,000    | ) |      |   | (1,300,000  | )    |  |   | (749,875    | )
|Purchases of investment securities  available for sale                 |  |      | (8,323,447  | ) |      |   | (19,519,437 | )    |  |   | (32,800,594 | )
|Maturities of investment securities  held to maturity                  |  |      | 850,000     |   |      |   | 2,300,750   |      |  |   | 2,115,000   |  
|Maturities of investment securities  available for sale                |  |      | 11,150,500  |   |      |   | 28,536,800  |      |  |   | 16,610,000  |  
|Sale of investment securities  available for sale                      |  |      | 500,156     |   |      |   |            |      |  |   | 402,750     |  
|Net (increase) decrease in loans                                        |  |      | (25,292,677 | ) |      |   | (30,780,182 | )    |  |   | 1,418,233   |  
|Purchases of property and equipment, net                                |  |      | (844,552    | ) |      |   | (1,129,944  | )    |  |   | (1,198,295  | )
|Proceeds from sales of foreclosed assets                                |  |      | 80,000      |   |      |   | 152,000     |      |  |   | 11,022      |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash used in investing activities                                   |  |      | (26,282,245 | ) |      |   | (10,715,281 | )    |  |   | (13,013,528 | )
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Cash flows from financing activities                                    |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase (decrease) in noninterest-bearing deposits                 |  |      | 3,417,204   |   |      |   | 2,550,948   |      |  |   | 3,146,229   |  
|Net increase in interest-bearing deposits                               |  |      | 15,827,404  |   |      |   | 6,990,454   |      |  |   | 7,181,815   |  
|Net increase (decrease) in federal funds purchased                      |  |      | (3,971,000  | ) |      |   | 3,971,000   |      |  |   |            |  
|Common stock issued                                                     |  |      | 35,601      |   |      |   | 33,978      |      |  |   | 39,185      |  
|Dividends paid                                                          |  |      | (567,063    | ) |      |   | (467,534    | )    |  |   | (552,344    | )
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided by financing activities                               |  |      | 14,742,146  |   |      |   | 13,078,846  |      |  |   | 9,814,885   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase (decrease) in cash and cash equivalents                    |  |      | (7,213,544  | ) |      |   | 5,122,701   |      |  |   | (627,010    | )
|                                                                        |  |      |            
|Cash and due from banks, beginning                                      |  |      | 13,002,989  |   |      |   | 7,880,288   |      |  |   | 8,507,298   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Cash and due from banks, ending                                         |  | $    | 5,789,445   |   |      | $ | 13,002,989  |      |  | $ | 7,880,288   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Supplemental disclosure of cash flow information                        |  |      |             |   |      |   |             |      |  |   |             |  
|Interest paid                                                           |  | $    | 3,313,835   |   |      | $ | 3,803,663   |      |  | $ | 4,671,882   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Taxes paid                                                              |  | $    | 527,000     |   |      | $ | 908,900     |      |  | $ | 683,364     |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Supplemental disclosure of noncash activities                           |  |      |             |   |      |   |             |      |  |   |             |  
|Other real estate acquired in settlement of loans                       |  | $    |            |   |      | $ | 237,785     |      |  | $ | 1,360,270   |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Common stock issued as payment of directors fees                        |  | $    |            |   |      | $ |            |      |  | $ | 15,456      |  
|                                                                        |  |      |             |   |      |   |             |      |  |   |             |  



See Notes to Consolidated
Financial Statements



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies



Organization



Botetourt Bankshares, Inc. (the Company) is a Virginia bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, Bank
of Botetourt (the Bank). The Bank is a Virginia state chartered bank subject to regulation by the Bureau of Financial Institutions and the Federal Deposit Insurance Corporation. The Bank provides full banking services through eight branch offices in
Botetourt, Roanoke and Rockbridge counties. The Bank has a wholly-owned subsidiary, Buchanan Service Corporation, which conducts its operations through minority interests in an insurance company, two title insurance companies and as an agent for
sale of life and disability insurance.



The accounting and reporting policies
of the Company, the Bank and Buchanan Service Corporation follow generally accepted accounting principles and general practices of the financial services industry. Following is a summary of the more significant policies.



Critical Accounting Policies



The notes to the Companys audited consolidated financial statements contain a summary
of significant accounting policies. Management believes the policies with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity. Management must make difficult and subjective judgments
which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically
reviewed with the Audit Committee and Board of Directors.



Principles of
Consolidation



The consolidated financial statements include the
accounts of the Company, the Bank, and Buchanan Service Corporation. All significant intercompany transactions and balances have been eliminated in consolidation.



Business Segments



The Company reports its activities as a single business segment. In determining proper segment definition, the Company considers the materiality of a potential segment
and components of the business about which financial information is available and regularly evaluated, relative to resource allocation and performance assessment.



Use of Estimates



The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.



Material estimates that are particularly susceptible to
significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan
and foreclosed real estate losses, management obtains independent appraisals for significant properties.



Substantially all of the Companys loan portfolio consists of loans in its market area. Accordingly, the ultimate collectibility of a substantial portion of the Companys loan portfolio and the recovery of a
substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but influenced to an extent by the manufacturing and agricultural segments.



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Use of Estimates, continued



While management uses available information to recognize loan and foreclosed real estate
losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Companys allowances for loan
and foreclosed real estate losses. Such agencies may require additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the
allowances for loan and foreclosed real estate losses may change materially in the near term.



Cash and Cash Equivalents



For
the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption cash and due from banks.



Interest-bearing Deposits with Banks



Interest-bearing deposits with banks mature within one year and are carried at cost.



Trading Securities



The Company does not hold securities for short-term resale and therefore does not maintain a
trading securities portfolio.



Securities



Debt securities that management has the positive intent and ability to hold to maturity are
classified as held to maturity and recorded at amortized cost. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as available for sale
and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.



Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to
maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time
and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient
to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.



Loans Receivable



Loans receivable that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, are reported at their outstanding principal
amount adjusted for charge-offs and the allowance for loan losses. Loan origination fees and costs are not capitalized and recognized as an adjustment to the yield on the related loan as management does not consider such deferrals to be material to
the Companys financial position or results of operations.



Discounts and
premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans
are recognized over the expected lives of the loans using methods that approximate the interest method.



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Loans Receivable, continued



Interest is accrued and credited to income based on the principal amount outstanding. The
accrual of interest on impaired loans is discontinued when, in managements opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income
is subsequently recognized only to the extent cash payments are received. When facts and circumstances indicate the borrower has regained the ability to meet required payments, the loan is returned to accrual status. Past due status of loans is
determined based on contractual terms.



Allowance for Loan Losses



The allowance for loan losses is established as losses are estimated
to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.



The allowance for loan losses is evaluated on a regular basis by
management and is based upon managements periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to
repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.



The allowance consists of specific, general and unallocated components. The specific
component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained
to cover uncertainties that could affect managements estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.



A loan is considered impaired
when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally
are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length
of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans
by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent.



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.
Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.



Property and Equipment



Land is carried at cost. Buildings, furniture and equipment, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed
principally by the straight-line method over the following estimated useful lives:



|                           |  |      
|-------------------------- |  | -----
|                           |  | Years
|Buildings and improvements |  | 10-50
|Furniture and equipment    |  | 3-10 



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Foreclosed Assets



Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially
recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to
sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.



Intangible Assets



Intangible assets consist of computer software and a purchase premium which are being amortized over three and fifteen years, respectively, using the straight-line
method. At December 31, 2004 and 2003, accumulated amortization was $470,544 and $409,519, respectively. Related amortization expense was $60,981, $57,612 and $65,730 for the three-year period ended December 31, 2004. Intangible assets were
classified as other assets on the balance sheet.



Stock-based
Compensation



The Company accounts for its stock-based compensation
plans using the accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. The Company is not required to adopt the fair value based recognition provisions prescribed under SFAS No. 123,
Accounting for Stock-Based Compensation, but complies with the disclosure requirements set forth in the Statement, which include disclosing pro forma net income as if the fair value based method of accounting had been applied.



Pension and Profit Sharing/Thrift Plan



A noncontributory defined benefit pension plan is provided for all employees who meet
eligibility requirements. To be eligible, an employee must be 21 years of age and have completed one year of service. Plan benefits are based on final average compensation and years of service. The funding policy is to contribute the maximum
deductible for federal income tax purposes. The Company also provides a profit sharing/thrift plan with substantially all employees participating.



Advertising and Public Relations Expense



The Company expenses advertising and public relations costs as they are incurred.



Transfers of Financial Assets



Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered
when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not
maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.



Income Taxes



Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and consists of taxes currently due plus
deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred taxes assets and liabilities are adjusted through the provision for income taxes.



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Income Taxes, continued



Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset
in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not
included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity.



Basic Earnings per Share



Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period,
after giving retroactive effect to stock splits and stock dividends.



Diluted Earnings per Share



The computation of diluted
earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been
issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.



Comprehensive Income



Annual comprehensive income reflects the change in the Companys equity during the year arising from transactions and events other than investments by, and
distributions to, stockholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of stockholders equity rather than as income or expense.



Financial Instruments



Derivatives that are used as part of the asset/liability management process are linked to
specific assets or liabilities and have high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In addition, forwards and option contracts must reduce an exposures risk,
and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of occurring. All derivative financial instruments held or issued by the Company are
held or issued for purposes other than trading. There were no derivatives at December 31, 2004 or 2003.



In the ordinary course of business the Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial and standby letters of credit. Such financial
instruments are recorded in the financial statements when they are funded or related fees are incurred or received.



Fair Value of Financial Instruments



Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in
immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Fair Value of Financial Instruments, continued



The following methods and assumptions were used by the Company in estimating its fair value
disclosures for financial instruments:



Cash and due from banks: The
carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.



Interest-bearing deposits with banks: The carrying amounts of interestbearing deposits with banks approximate their fair values.



Available for sale and held to maturity securities: Fair values for securities, excluding restricted equity securities, are based on
quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying values of restricted equity securities approximate fair values.



Loans receivable: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying
collateral values, where applicable. The carrying amount of accrued interest receivable approximates its fair value.



Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The
fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying
amount of accrued interest payable approximates fair value.



Short-term
borrowings: The carrying amounts of federal funds purchased approximate fair value.



Other liabilities: The carrying amounts of other liabilities approximate fair value.



Reclassification



Certain
reclassifications have been made to the prior years financial statements to place them on a comparable basis with the current year. Net income and stockholders equity previously reported were not affected by these reclassifications.



Recent Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123(R), Share-Based Compensation, which
requires the recognition of cost resulting from transaction in which the Company acquires goods and services by issuing its shares, share options, or other equity instruments. This standard requires a fair value-based measurement method in
accounting for share-bases payment transactions with both employees and non-employees. This standard replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees. Accordingly, the use of the intrinsic value method as provided under APB Opinion No. 25 will be eliminated. SFAS No. 123(R) is effective for all awards of share-based payments granted, modified, or
cancelled after June 15, 2005. In addition, compensation cost for the unvested portion of awards issued prior to and outstanding as of June 15, 2005 would continue to be recognized at the grant date fair value as the remaining requisite service is
rendered. The Company is currently assessing the impact of SFAS No. 123(R) on the consolidated financial statements.



---

Notes to Consolidated Financial Statements



Note 1. Organization and Summary of Significant Accounting Policies, continued



Recent Accounting Pronouncements, continued



In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers
Disclosures about Pensions and Postretirement Benefits. This Statement requires additional disclosures about the assets, obligations and cash flows of defined benefit pension and postretirement plans, as well as the expense recorded for such
plans. As of December 31, 2004, the Company has disclosed the required elements related to its defined benefit pension plan in Note 11 to these consolidated financial statements.



Note 2. Restrictions on Cash



To comply with banking regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was approximately
$350,000 and $7,200,000 for the periods including December 31, 2004 and 2003, respectively.



Note 3. Investment Securities



Debt and
equity securities have been classified in the consolidated balance sheets according to managements intent. The carrying amount of securities and their approximate fair values at December 31 follow:



|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|--------------------------------- |  | ------------- | ----------- | --------------- | - | ---------------- |  | ---------- | ------- |  | - | ----------
|                                  |  | AmortizedCost |             | UnrealizedGains |   | UnrealizedLosses |  | Fair Value
|2004                              |  |               |             |                 |   |                  |  |            |         |  |   |           
|Available for sale:               |  |               |             |                 |   |                  |  |            |         |  |   |           
|U.S. Treasury securities          |  | $             | 4,737,818   |                 | $ | 18,904           |  | $          | 20,731  |  | $ | 4,735,991 
|U.S. Government agency securities |  |               | 9,748,002   |                 |   | 18,925           |  |            | 100,269 |  |   | 9,666,658 
|State and municipal securities    |  |               | 8,456,745   |                 |   | 244,736          |  |            | 52,220  |  |   | 8,649,261 
|Corporate securities              |  |               | 250,001     |                 |   | 450,929          |  |            |        |  |   | 700,930   
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|                                  |  |               | $23,192,566 |                 | $ | 733,494          |  | $          | 173,220 |  | $ | 23,752,840
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|Held to maturity:                 |  |               |             |                 |   |                  |  |            |         |  |   |           
|U.S. Government agency securities |  | $             | 1,050,000   |                 | $ | 346              |  | $          | 10,857  |  | $ | 1,039,489 
|State and municipal securities    |  |               | 1,209,662   |                 |   | 27,557           |  |            |        |  |   | 1,237,219 
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|                                  |  | $             | 2,259,662   |                 | $ | 27,903           |  | $          | 10,857  |  | $ | 2,276,708 
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|                                  |  |               |             |                
|                                  |  | AmortizedCost |             | UnrealizedGains |   | UnrealizedLosses |  | Fair Value
|2003                              |  |               |             |                 |   |                  |  |            |         |  |   |           
|Available for sale:               |  |               |             |                 |   |                  |  |            |         |  |   |           
|U.S. Treasury securities          |  | $             | 1,987,954   |                 | $ | 51,630           |  | $          |        |  | $ | 2,039,584 
|U.S. Government agency securities |  |               | 16,845,948  |                 |   | 87,343           |  |            | 76,562  |  |   | 16,856,729
|State and municipal securities    |  |               | 7,497,039   |                 |   | 350,059          |  |            | 1,282   |  |   | 7,845,816 
|Corporate securities              |  |               | 250,001     |                 |   | 407,301          |  |            |        |  |   | 657,302   
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|                                  |  |               | $26,580,942 |                 | $ | 896,333          |  | $          | 77,844  |  | $ | 27,399,431
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|Held to maturity:                 |  |               |             |                 |   |                  |  |            |         |  |   |           
|U.S. Government agency securities |  | $             | 850,000     |                 | $ | 3,446            |  | $          | 1,128   |  | $ | 852,318   
|State and municipal securities    |  |               | 1,583,891   |                 |   | 68,379           |  |            |        |  |   | 1,652,270 
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           
|                                  |  | $             | 2,433,891   |                 | $ | 71,825           |  | $          | 1,128   |  | $ | 2,504,588 
|                                  |  |               |             |                 |   |                  |  |            |         |  |   |           



Restricted equity securities, which
are carried at cost, consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), and The Community Bankers Bank which are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity
investments in the FHLB in order to borrow from it. The Bank is required to hold that stock so long as it borrows from the FHLB. The Banks stock in The Community Bankers Bank is restricted in the fact that the stock may only be repurchased by
that company.



---

Notes to Consolidated Financial Statements



Note 3. Investment Securities, continued



Investment securities with amortized cost of approximately $1,800,000 and $1,700,000 at December 31, 2004 and 2003, respectively, were pledged as collateral on public
deposits and for other purposes as required or permitted by law.



Gross
realized gains and losses for the years ended December 31 are as follows:



|                |  |      |      |      |   |       |  |   |      
|--------------- |  | ---- | ---- | ---- | - | ----- |  | - | -----
|                |  | 2004 |      | 2003 |   | 2002 
|Realized gains  |  | $    | 656  |      | $ | 1,750 |  | $ | 2,750
|Realized losses |  |      |     |      |   |      |  |   |     
|                |  |      |      |      |   |       |  |   |      
|                |  |      | $656 |      | $ | 1,750 |  | $ | 2,750
|                |  |      |      |      |   |       |  |   |      



The scheduled maturities of securities
available-for-sale and securities held-to-maturity at December 31, 2004, were as follows:



|                                       |  |                    |             |                  |   |               |  |            |           |  |   |          
|-------------------------------------- |  | ------------------ | ----------- | ---------------- | - | ------------- |  | ---------- | --------- |  | - | ---------
|                                       |  | Available for Sale |             | Held to Maturity
|                                       |  | AmortizedCost      |             | Fair Value       |   | AmortizedCost |  | Fair Value
|Due in one year or less                |  | $                  | 600,052     |                  |   | 600,825       |  | $          | 450,037   |  |   | 454,939  
|Due after one year through five years  |  |                    | 15,887,975  |                  |   | 15,930,638    |  |            | 1,709,625 |  |   | 1,719,742
|Due after five years through ten years |  |                    | 6,405,420   |                  |   | 6,479,531     |  |            | 100,000   |  |   | 102,027  
|Due after ten years                    |  |                    | 299,119     |                  |   | 741,846       |  |            |          |  |   |         
|                                       |  |                    |             |                  |   |               |  |            |           |  |   |          
|                                       |  |                    | $23,192,566 |                  | $ | 23,752,840    |  | $          | 2,259,662 |  | $ | 2,276,708
|                                       |  |                    |             |                  |   |               |  |            |           |  |   |          



The following table details unrealized
losses and related fair values in the Banks investment securities portfolio. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31.



|                                      |  |                     |            |                   |   |            |  |                  |           |            |   |                  |  |   |            |  |   |        
|------------------------------------- |  | ------------------- | ---------- | ----------------- | - | ---------- |  | ---------------- | --------- | ---------- | - | ---------------- |  | - | ---------- |  | - | -------
|                                      |  | Less Than 12 Months |            | 12 Months or More |   | Total     
|                                      |  | Fair Value          |            | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |           | Fair Value |   | UnrealizedLosses
|U.S. Treasury securities              |  | $                   | 3,475,603  |                   | $ | 20,731     |  | $                |          |            | $ |                 |  | $ | 3,475,603  |  | $ | 20,731 
|U.S. Government agency securities     |  |                     | 5,640,931  |                   |   | 58,074     |  |                  | 2,445,945 |            |   | 53,052           |  |   | 8,086,876  |  |   | 111,126
|State and municipal securities        |  |                     | 1,444,840  |                   |   | 52,220     |  |                  |          |            |   |                 |  |   | 1,444,840  |  |   | 52,220 
|Corporate securities                  |  |                     |           |                   |   |           |  |                  |          |            |   |                 |  |   |           |  |   |       
|                                      |  |                     |            |                   |   |            |  |                  |           |            |   |                  |  |   |            |  |   |        
|Total temporarily impaired securities |  | $                   | 10,561,374 |                   | $ | 131,025    |  | $                | 2,445,945 |            | $ | 53,052           |  | $ | 13,007,319 |  | $ | 184,077
|                                      |  |                     |            |                   |   |            |  |                  |           |            |   |                  |  |   |            |  |   |        



Management considers the nature of the
investment, the underlying causes of the decline in market value, the severity and duration of the decline in market value and other evidence, on a security by security basis, in determining if the decline in market value is other than temporary.
Management believes all unrealized losses presented in the table above to be temporary in nature.



---

Notes to Consolidated Financial Statements



Note 4. Loans Receivable



The major components of loans in the consolidated balance sheets at December 31 are as follows (in thousands):



|                                  |  |      |         |   |      |   |         |  
|--------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                  |  | 2004 |         |   | 2003 |  
|Commercial                        |  | $    | 17,721  |   |      | $ | 17,475  |  
|Real estate:                      |  |      |         |   |      |   |         |  
|Construction and land development |  |      | 23,194  |   |      |   | 18,834  |  
|Residential, 1-4 families         |  |      | 43,931  |   |      |   | 38,560  |  
|Residential, 5 or more families   |  |      | 132     |   |      |   |        |  
|Farmland                          |  |      | 8,748   |   |      |   | 7,991   |  
|Nonfarm, nonresidential           |  |      | 61,011  |   |      |   | 48,680  |  
|Agricultural                      |  |      | 792     |   |      |   | 503     |  
|Consumer                          |  |      | 13,732  |   |      |   | 12,653  |  
|Leases                            |  |      | 40      |   |      |   | 74      |  
|Other                             |  |      | 1,786   |   |      |   | 1,307   |  
|                                  |  |      |         |   |      |   |         |  
|                                  |  |      | 171,087 |   |      |   | 146,077 |  
|                                  |  |     
|Allowance for loan losses         |  |      | (2,132  | ) |      |   | (1,689  | )
|                                  |  |      |         |   |      |   |         |  
|                                  |  | $    | 168,955 |   |      | $ | 144,388 |  
|                                  |  |      |         |   |      |   |         |  



Loans receivable include $187,000 and
$69,000 in overdraft demand deposit accounts at December 31, 2004 and 2003, respectively.



Note 5. Allowance for Loan Losses



Changes in the allowance for loan losses are as follows:



|                                  |  |      |           |   |      |   |           |      |  |   |           |  
|--------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                  |  | 2004 |           |   | 2003 |   |           | 2002 | 
|Balance, beginning                |  | $    | 1,688,812 |   |      | $ | 1,413,997 |      |  | $ | 1,303,042 |  
|                                  |  |      |          
|Provision charged to expense      |  |      | 725,000   |   |      |   | 625,000   |      |  |   | 975,000   |  
|Recoveries of amounts charged off |  |      | 57,447    |   |      |   | 276,166   |      |  |   | 29,142    |  
|Amounts charged off               |  |      | (339,725  | ) |      |   | (626,351  | )    |  |   | (893,187  | )
|                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Balance, ending                   |  | $    | 2,131,534 |   |      | $ | 1,688,812 |      |  | $ | 1,413,997 |  
|                                  |  |      |           |   |      |   |           |      |  |   |           |  



---

Notes to Consolidated Financial Statements



Note 5. Allowance for Loan Losses, continued



The following is a summary of information pertaining to impaired and nonperforming loans at December 31:



|                                                        |  |      |         |      |   |           |  |   |          
|------------------------------------------------------- |  | ---- | ------- | ---- | - | --------- |  | - | ---------
|                                                        |  |      |         | 2004 |   | 2003     
|Impaired loans without a valuation allowance            |  |      |         |      | $ | 11,036    |  | $ | 64,498   
|Impaired loans with a valuation allowance               |  |      |         |      |   | 476,709   |  |   | 154,165  
|                                                        |  |      |         |      |   |           |  |   |          
|Total impaired loans                                    |  |      |         |      | $ | 487,745   |  | $ | 218,663  
|                                                        |  |      |         |      |   |           |  |   |          
|Valuation allowance related to impaired loans           |  |      |         |      | $ | 113,460   |  | $ | 75,647   
|                                                        |  |      |         |      |   |           |  |   |          
|                                                        |  |      |        
|                                                        |  |      |         | 2004 |   | 2003     
|Nonaccrual loans                                        |  |      |         |      | $ | 487,745   |  | $ | 218,663  
|Loans past due more than ninety days                    |  |      |         |      |   | 1,127,684 |  |   | 875,748  
|                                                        |  |      |         |      |   |           |  |   |          
|                                                        |  |      |         |      | $ | 1,615,429 |  | $ | 1,094,411
|                                                        |  |      |         |      |   |           |  |   |          
|                                                        |  |      |        
|                                                        |  | 2004 |         | 2003 |   | 2002     
|Average investment in impaired loans                    |  | $    | 407,982 |      | $ | 531,425   |  | $ | 571,499  
|                                                        |  |      |         |      |   |           |  |   |          
|Interest income recognized for the year                 |  | $    | 8,259   |      | $ | 1,112     |  | $ | 12,670   
|                                                        |  |      |         |      |   |           |  |   |          
|Interest income recognized on a cash basis for the year |  | $    | 259     |      | $ | 326       |  | $ | 2,360    
|                                                        |  |      |         |      |   |           |  |   |          



The Company is not committed to lend
additional funds to debtors whose loans have been modified.



Note 6.
Property and Equipment



Components of property and equipment and total
accumulated depreciation at December 31 are as follows:



|                              |  |      |           |      |   |          
|----------------------------- |  | ---- | --------- | ---- | - | ---------
|                              |  | 2004 |           | 2003
|Land                          |  | $    | 1,121,389 |      | $ | 1,090,611
|Buildings and improvements    |  |      | 4,740,083 |      |   | 3,942,216
|Furniture and equipment       |  |      | 2,355,211 |      |   | 2,104,220
|Construction in progress      |  |      |          |      |   | 359,715  
|                              |  |      |           |      |   |          
|                              |  |      | 8,216,683 |      |   | 7,496,762
|Less accumulated depreciation |  |      | 2,421,511 |      |   | 2,068,201
|                              |  |      |           |      |   |          
|                              |  | $    | 5,795,172 |      | $ | 5,428,561
|                              |  |      |           |      |   |          



The Company began leasing out a
portion of a branch facility to a third party in June, 2003. The lease expires May, 2006 and calls for annual lease payments of $22,370. Rental income received related to this facility in 2004 and 2003 was $29,587 and $19,387 respectively.



The Bank leases a parking lot adjacent to one of its branch banking facilities
under an operating lease which will expire April 4, 2006. The leases call for total annual payment of $100. The Bank also has an equipment lease contract which expires in 2008. Annual requirements for the equipment lease are $2,592.



The Bank also leases three locations for automated teller machines. These leases will expire
between January 31, 2005 and February 12, 2006. Each lease has a term of two years with three options to renew for additional two year terms. Lease payments vary by location and by the number and type of transactions processed.



---

Notes to Consolidated Financial Statements



Note 6. Property and Equipment, continued



Aggregate rental expense for 2004, 2003 and 2002 was $5,910, $22,665 and $28,757 respectively. Future minimum commitments under noncancellable leases are as follows:



|     |  |   |      
|---- |  | - | -----
|2005 |  | $ | 3,192
|2006 |  |   | 2,592
|2007 |  |   | 2,592
|2008 |  |   | 648  
|     |  |   |      
|     |  | $ | 9,024
|     |  |   |      



Note 7. Deposits



The aggregate amount of time deposits in denominations of $100,000 or more at December 31,
2004 and 2003 was $24,449,542 and $20,439,068 respectively.



At December 31,
2004, the scheduled maturities of time deposits are as follows:



|     |  |   |            
|---- |  | - | -----------
|2005 |  | $ | 50,091,050 
|2006 |  |   | 28,095,980 
|2007 |  |   | 9,951,382  
|2008 |  |   | 3,855,552  
|2009 |  |   | 10,052,486 
|     |  |   |            
|     |  | $ | 102,046,450
|     |  |   |            



Note 8. Short-Term Debt



The Company has established various credit facilities to provide
additional liquidity if and as needed. At December 31, 2004, these included unsecured lines of credit of approximately $12,000,000 and a secured line of credit of approximately $10,000,000 with correspondent banks.



Note 9. Fair Values of Financial Instruments



The estimated fair values of the Companys financial instruments are as follows
(dollars in thousands):



|                                                           |  |                   |         |                   |   |                |  |            |         |  |   |        
|---------------------------------------------------------- |  | ----------------- | ------- | ----------------- | - | -------------- |  | ---------- | ------- |  | - | -------
|                                                           |  | December 31, 2004 |         | December 31, 2003
|                                                           |  | CarryingAmount    |         | Fair Value        |   | CarryingAmount |  | Fair Value
|Financial assets                                           |  |                   |         |                   |   |                |  |            |         |  |   |        
|Cash and cash equivalents                                  |  | $                 | 5,789   |                   | $ | 5,789          |  | $          | 13,003  |  | $ | 13,003 
|Interest-bearing deposits with banks                       |  |                   | 195     |                   |   | 195            |  |            | 249     |  |   | 249    
|Federal funds sold                                         |  |                   | 3,782   |                   |   | 3,782          |  |            |        |  |   |       
|Securities, available-for-sale                             |  |                   | 23,753  |                   |   | 23,753         |  |            | 27,399  |  |   | 27,399 
|Securities, held to maturity                               |  |                   | 2,260   |                   |   | 2,277          |  |            | 2,434   |  |   | 2,505  
|Restricted equity securities                               |  |                   | 440     |                   |   | 440            |  |            | 370     |  |   | 370    
|Loans, net of allowance for credit losses                  |  |                   | 168,955 |                   |   | 161,883        |  |            | 144,388 |  |   | 138,615
|                                                           |  |                   |         |                  
|Financial liabilities                                      |  |                   |         |                   |   |                |  |            |         |  |   |        
|Deposits                                                   |  |                   | 192,647 |                   |   | 189,817        |  |            | 173,403 |  |   | 175,603
|Federal funds purchased                                    |  |                   |        |                   |   |               |  |            | 3,971   |  |   | 3,971  
|Off-balance-sheet assets (liabilities)                     |  |                   |         |                   |   |                |  |            |         |  |   |        
|Commitments to extend credit and standby letters of credit |  |                   |        |                   |   |               |  |            |        |  |   |       



---

Notes to Consolidated Financial Statements



Note 10. Earnings Per Share



The following table details the computation of basic and diluted earnings per share for each year ended December 31.



|                                                    |  |      |           |      |   |           |  |   |          
|--------------------------------------------------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                                    |  | 2004 |           | 2003 |   | 2002     
|Net income available to common shareholders         |  | $    | 2,400,198 |      | $ | 1,926,216 |  | $ | 1,720,794
|                                                    |  |      |           |      |   |           |  |   |          
|Weighted average common shares outstanding          |  |      | 1,232,645 |      |   | 1,230,520 |  |   | 1,228,413
|Effect of dilutive securities, options              |  |      | 711       |      |   | 360       |  |   | 552      
|                                                    |  |      |           |      |   |           |  |   |          
|Weighted average common shares outstanding, diluted |  |      | 1,233,356 |      |   | 1,230,880 |  |   | 1,228,965
|                                                    |  |      |           |      |   |           |  |   |          
|Basic earnings per share                            |  | $    | 1.95      |      | $ | 1.57      |  | $ | 1.40     
|                                                    |  |      |           |      |   |           |  |   |          
|Diluted earnings per share                          |  | $    | 1.95      |      | $ | 1.56      |  | $ | 1.40     
|                                                    |  |      |           |      |   |           |  |   |          



Note 11. Benefit Plans



Employee Stock Discount Plan



In 1999, the Company adopted an Employee Stock Discount Plan available to all employees who
work at least twenty hours per week, more than five months in a calendar year, and who have been employed by the Company for at least one year. The plan provides for elective payroll deductions not to exceed 5% of the employees annual
compensation to be set aside to purchase shares of common stock. Stock purchased by employees under this plan shall be at a cost of 85% of the fair market value of the common stock at the date of the purchase. Up to 15,000 shares have been reserved
for this plan. At December 31, 2004, 9,845 shares had been purchased under the provisions of this plan.



Director Stock Purchase Plan



The Company adopted a Director Stock Purchase Plan in 1999 available to all non-employee directors. The plan provides for a director to elect to receive up to 50% of director fees in shares of common stock. Stock issued under this plan
shall be at the market value of the stock on the date of issuance. Up to 5,000 shares have been reserved for this plan. At December 31, 2004, 2,600 shares had been purchased under the provisions of this plan.



Stock Option Plan



The Company adopted the 1999 Incentive Stock Option Plan (Incentive Plan) for certain
employees which reserves up to 10,000 shares. Under the terms of the plan, option exercise price shall be set by the Board of Directors at the date of grant, but shall not be less than 100% of the fair market value of the stock on the date of the
grant. Options granted under the plan expire no more than 10 years from date of grant and may not be exercised for six months after the date of grant.



|                           |  |                     |   |  |                        |  
|-------------------------- |  | ------------------- | - |  | ---------------------- | -
|                           |  | Available For Grant |   |  | Granted andOutstanding |  
|Balance, December 31, 2001 |  | 4,900               |   |  | 5,000                  |  
|Granted                    |  |                    |   |  |                       |  
|Exercised                  |  |                    |   |  | (200                   | )
|                           |  |                     |   |  |                        |  
|Balance, December 31, 2002 |  | 4,900               |   |  | 4,800                  |  
|                           |  |                    
|Granted                    |  | (4,200              | ) |  | 4,200                  |  
|Exercised                  |  |                    |   |  |                       |  
|Forfeited                  |  | 600                 |   |  | (600                   | )
|                           |  |                     |   |  |                        |  
|Balance, December 31, 2003 |  | 1,300               |   |  | 8,400                  |  
|(continued on next page)   |  |                     |   |  |                        |  



---

Notes to Consolidated Financial Statements



Note 11. Benefit Plans, continued



Stock Option Plan, continued



|                                    |  |                    |  |                       
|----------------------------------- |  | ------------------ |  | ----------------------
|                                    |  | AvailableFor Grant |  | Granted andOutstanding
|Balance, December 31, 2003, forward |  | 1,300              |  | 8,400                 
|Granted                             |  |                   |  |                      
|Exercised                           |  |                   |  |                      
|Forfeited                           |  |                   |  |                      
|                                    |  |                    |  |                       
|Balance, December 31, 2004          |  | 1,300              |  | 8,400                 
|                                    |  |                    |  |                       



Additional information relating to the
Incentive Plan is detailed below:



|                                                                               |  |      |           |      |   |           |      |  |   |          
|------------------------------------------------------------------------------ |  | ---- | --------- | ---- | - | --------- | ---- |  | - | ---------
|                                                                               |  | 2004 |           | 2003 |   |           | 2002
|Outstanding options at December 31:                                            |  |      |           |      |   |           |      |  |   |          
|Exercise price, beginning of the year(1)                                       |  | $    | 21.62     |      | $ | 20.31     |      |  | $ | 20.34    
|Exercise price, end of year(1)                                                 |  | $    | 21.62     |      | $ | 21.62     |      |  | $ | 20.31    
|Range of exercise prices                                                       |  |      |           |      |   |           |      |  |   |          
|From                                                                           |  | $    | 18.00     |      | $ | 18.00     |      |  | $ | 18.00    
|To                                                                             |  | $    | 23.00     |      | $ | 23.00     |      |  | $ | 21.00    
|Remaining contractual life in months(1)                                        |  |      | 83        |      |   | 95        |      |  |   | 93       
|                                                                               |  |      |          
|Exercisable options outstanding at December 31:                                |  |      |           |      |   |           |      |  |   |          
|Number                                                                         |  |      | 8,400     |      |   | 8,400     |      |  |   | 4,800    
|Exercise price(1)                                                              |  | $    | 21.62     |      | $ | 21.62     |      |  | $ | 20.31    
|                                                                               |  |      |          
|Weighted average exercise price of options:                                    |  |      |           |      |   |           |      |  |   |          
|Granted during the year                                                        |  | $    |          |      | $ | 23.00     |      |  | $ |         
|Exercised during the year                                                      |  | $    |          |      | $ |          |      |  | $ | 21.00    
|Forfeited during the year                                                      |  | $    |          |      | $ | 20.83     |      |  | $ |         
|Expired during the year                                                        |  | $    |          |      | $ |          |      |  | $ |         
|Significant assumptions used in determining fair value of options granted:     |  |      |           |      |   |           |      |  |   |          
|Risk-free interest rate                                                        |  |      | n/a       |      |   | 3.25      | %    |  |   | n/a      
|Expected life in years                                                         |  |      | n/a       |      |   | 10        |      |  |   | n/a      
|Expected dividends                                                             |  |      | n/a       |      |   | 1.67      | %    |  |   | n/a      
|Expected volatility                                                            |  |      | n/a       |      |   | 0.06      | %    |  |   | n/a      
|                                                                               |  |      |          
|Grant-date fair value:                                                         |  |      |           |      |   |           |      |  |   |          
|Options granted during the year                                                |  | $    |          |      | $ | 11,760    |      |  | $ |         
|                                                                               |  |      |          
|Results of operations:                                                         |  |      |           |      |   |           |      |  |   |          
|Compensation cost recognized in income for all stock-based compensation awards |  | $    |          |      | $ |          |      |  | $ |         
|                                                                               |  |      |           |      |   |           |      |  |   |          
|Pro forma net income(2)                                                        |  | $    | 2,386,338 |      | $ | 1,926,216 |      |  | $ | 1,720,794
|                                                                               |  |      |           |      |   |           |      |  |   |          
|Pro forma basic earnings per common share(2)                                   |  | $    | 1.94      |      | $ | 1.57      |      |  | $ | 1.40     
|                                                                               |  |      |           |      |   |           |      |  |   |          
|Pro forma diluted earnings per common share(2)                                 |  | $    | 1.93      |      | $ | 1.56      |      |  | $ | 1.40     
|                                                                               |  |      |           |      |   |           |      |  |   |          

---

|(1) | Weighted average
|--- | ----------------

|(2) | As if the fair value based method prescribed by SFAS No. 123 had been applied
|--- | -----------------------------------------------------------------------------



---

Notes to Consolidated Financial Statements



Note 11. Benefit Plans, continued



Defined Benefit Pension Plan



The Bank has a qualified noncontributory, Defined Benefit Pension Plan which covers substantially all of its employees. The benefits are primarily based on years of
service and earnings.



The following is a summary of the plans funded
status as of December 31:



|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|------------------------------------------------------------ |  | ---- | -------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                             |  |      |          |   | 2004 |   |           | 2003 | 
|Change in benefit obligation                                 |  |      |          |   |      |   |           |      |  |   |           |  
|Benefit obligation at beginning of year                      |  |      |          |   |      | $ | 2,250,097 |      |  | $ | 1,822,707 |  
|Service cost                                                 |  |      |          |   |      |   | 204,329   |      |  |   | 167,375   |  
|Interest cost                                                |  |      |          |   |      |   | 146,083   |      |  |   | 127,403   |  
|Actuarial (gain) loss                                        |  |      |          |   |      |   | 130,113   |      |  |   | 138,035   |  
|Benefits paid                                                |  |      |          |   |      |   | (43,978   | )    |  |   | (5,423    | )
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Benefit obligation at end of year                            |  |      |          |   |      | $ | 2,686,644 |      |  | $ | 2,250,097 |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Change in plan assets                                        |  |      |          |   |      |   |           |      |  |   |           |  
|Fair value of plan assets at beginning of year               |  |      |          |   |      | $ | 1,862,249 |      |  | $ | 1,081,144 |  
|Actual return on plan assets                                 |  |      |          |   |      |   | 204,139   |      |  |   | 254,451   |  
|Employer contribution                                        |  |      |          |   |      |   | 154,733   |      |  |   | 532,077   |  
|Benefits paid                                                |  |      |          |   |      |   | (43,978   | )    |  |   | (5,423    | )
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Fair value of plan assets at end of year                     |  |      |          |   |      | $ | 2,177,143 |      |  | $ | 1,862,249 |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Change in prepaid (accrued) benefit cost                     |  |      |          |   |      |   |           |      |  |   |           |  
|Prepaid (accrued) benefit cost, beginning                    |  |      |          |   |      | $ | 341,070   |      |  | $ | 46,849    |  
|Contributions                                                |  |      |          |   |      |   | 154,733   |      |  |   | 532,077   |  
|Pension cost                                                 |  |      |          |   |      |   | (256,037  | )    |  |   | (237,856  | )
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Prepaid (accrued) benefit cost, ending                       |  |      |          |   |      | $ | 239,766   |      |  | $ | 341,070   |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Funded status                                                |  |      |          |   |      | $ | (509,501  | )    |  | $ | (387,848  | )
|Unrecognized transitional net assets                         |  |      |          |   |      |   | (2,872    | )    |  |   | (3,829    | )
|Unrecognized prior service costs                             |  |      |          |   |      |   | 10,704    |      |  |   | 12,234    |  
|Unrecognized net actuarial loss                              |  |      |          |   |      |   | 741,435   |      |  |   | 720,513   |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Prepaid (accrued) benefit cost                               |  |      |          |   |      | $ | 239,766   |      |  | $ | 341,070   |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Weighted-average assumptions to determine benefit obligation |  |      |          |   |      |   |           |      |  |   |           |  
|Discount rate                                                |  |      |          |   |      |   | 6.0       | %    |  |   | 6.5       | %
|Expected return on plan assets                               |  |      |          |   |      |   | 8.5       | %    |  |   | 8.5       | %
|Rate of compensation increase                                |  |      |          |   |      |   | 5.0       | %    |  |   | 5.0       | %
|                                                             |  |      |         
|                                                             |  | 2004 |          |   | 2003 |   |           | 2002 | 
|Components of net periodic benefit cost                      |  |      |          |   |      |   |           |      |  |   |           |  
|Service cost                                                 |  | $    | 204,329  |   |      | $ | 167,375   |      |  | $ | 133,157   |  
|Interest cost                                                |  |      | 146,083  |   |      |   | 127,403   |      |  |   | 115,444   |  
|Expected return on plan assets                               |  |      | (121,027 | ) |      |   | (88,925   | )    |  |   | (97,475   | )
|Amortization                                                 |  |      | 573      |   |      |   | 573       |      |  |   | 573       |  
|Recognized net actuarial (gain) loss                         |  |      | 26,079   |   |      |   | 31,430    |      |  |   | 13,056    |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  
|Net periodic benefit cost                                    |  | $    | 256,037  |   |      | $ | 237,856   |      |  | $ | 164,755   |  
|                                                             |  |      |          |   |      |   |           |      |  |   |           |  



---

Notes to Consolidated Financial Statements



Note 11. Benefit Plans, continued



Weighted-average assumptions for net periodic benefit cost at September 30



|                                                 |  |      |   |  |      |  
|------------------------------------------------ |  | ---- | - |  | ---- | -
|                                                 |  | 2004 |   |  | 2003 |  
|Discount rate                                    |  | 6.5  | % |  | 7.0  | %
|Expected long-term rate of return on plan assets |  | 8.5  | % |  | 9.0  | %
|Annual salary increase                           |  | 5.0  | % |  | 5.0  | %



The accumulated benefit obligation for
the defined benefit pension plan was $1,520,169 and $1,195,780 at December 31, 2004 and 2003.



Contributions are expected to be approximately $163,333 in 2005.



Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:



|                  |  |   |        
|----------------- |  | - | -------
|10/1/04  9/30/05 |  | $ | 5,423  
|10/1/05  9/30/06 |  |   | 7,298  
|10/1/06  9/30/07 |  |   | 12,839 
|10/1/07  9/30/08 |  |   | 12,849 
|10/1/08  9/30/09 |  |   | 23,198 
|10/1/09  9/30/14 |  |   | 408,633



Long Term Rate of Return



The plan sponsor selects the expected long-term
rate-of-return-on-assets assumption in consultation with their investment advisors and actuary, and with concurrence from their auditors. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to
be invested to provide plan benefits. Historical performance is reviewed  especially with respect to real rates of return (net of inflation)  for the major asset classes held or anticipated to be held by the trust, and for the trust
itself. Undue weight is not given to recent experience  that may not continue over the measurement period  with higher significance placed on current forecasts of future long-term economic conditions.



Because assets are held in a qualified trust, anticipated returns are not reduced for taxes.
Further  solely for this purpose  the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment
policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).



Asset Allocation



The pension plans weighted-average asset allocations at September 30, 2004 and 2003, by asset category are as follows:



|                            |  |      |   |  |      |  
|--------------------------- |  | ---- | - |  | ---- | -
|                            |  | 2004 |   |  | 2003 |  
|Asset Category              |  |      |   |  |      |  
|Mutual funds  fixed income |  | 20   | % |  | 21   | %
|Mutual funds  equity       |  | 80   | % |  | 79   | %
|Other                       |  | 0    | % |  | 0    | %
|                            |  |      |   |  |      |  
|Total                       |  | 100  | % |  | 100  | %
|                            |  |      |   |  |      |  



---

Notes to Consolidated Financial Statements



Note 11. Benefit Plans, continued



The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 25% fixed
income and 75% equities. The Investment Manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the Plans investment strategy. The
Investment Manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.



It is the responsibility of the Trustee to administer the investments of the Trust within reasonable costs, being careful to avoid
sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administration costs chargeable to the Trust.



Deferred Compensation Plan



Funded deferred compensation plans have been adopted for certain members of the Board of Directors and Executive employees. The corresponding assets and liabilities
accounts at December 31, 2004 were valued at $69,498 for the Director Plan and $122,616 for the Executive Plan.



Profit Sharing/Thrift Plan



The Company provides a profit sharing/thrift plan for its employees to which contributions are made at the discretion of the Board of Directors. The plan also allows for
employee contributions of up to 12% of eligible compensation. The Company will match up to 50% of the first 6% contributed by the employee. Contributions to the plan, including the matching portion, amounted to $108,575, $94,367, and $35,639 in
2004, 2003, and 2002, respectively.



Note 12. Income Taxes



Current and Deferred Income Tax Components



The components of income tax expense (benefit) (all Federal) are as follows:



|         |  |      |            |   |      |   |         |  |   |        
|-------- |  | ---- | ---------- | - | ---- | - | ------- |  | - | -------
|         |  | 2004 |            |   | 2003 |   | 2002   
|Current  |  | $    | 1,174,901  |   |      | $ | 683,497 |  | $ | 716,611
|Deferred |  |      | (139,185   | ) |      |   | 110,530 |  |   | 11,250 
|         |  |      |            |   |      |   |         |  |   |        
|         |  |      | $1,035,716 |   |      | $ | 794,027 |  | $ | 727,861
|         |  |      |            |   |      |   |         |  |   |        



Rate Reconciliation



A reconciliation of income tax expense computed at the statutory
federal income tax rate to income tax expense included in the statements of income follows:



|                              |  |      |            |   |      |   |          |      |  |   |          |  
|----------------------------- |  | ---- | ---------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                              |  | 2004 |            |   | 2003 |   |          | 2002 | 
|Tax at statutory federal rate |  | $    | 1,168,211  |   |      | $ | 924,883  |      |  | $ | 832,543  |  
|Tax exempt interest income    |  |      | (138,693   | ) |      |   | (137,694 | )    |  |   | (128,037 | )
|Other                         |  |      | 6,198      |   |      |   | 6,838    |      |  |   | 23,355   |  
|                              |  |      |            |   |      |   |          |      |  |   |          |  
|                              |  |      | $1,035,716 |   |      | $ | 794,027  |      |  | $ | 727,861  |  
|                              |  |      |            |   |      |   |          |      |  |   |          |  



---

Notes to Consolidated Financial Statements



Note 12. Income Taxes, continued



Deferred Income Tax Analysis



The significant components of net deferred tax assets (all Federal) at December 31 are summarized as follows:



|                                                             |  |      |          |   |      |   |          |  
|------------------------------------------------------------ |  | ---- | -------- | - | ---- | - | -------- | -
|                                                             |  | 2004 |          |   | 2003 |  
|Deferred tax assets                                          |  |      |          |   |      |   |          |  
|Allowance for loan losses                                    |  | $    | 543,892  |   |      | $ | 390,560  |  
|Deferred compensation                                        |  |      | 59,040   |   |      |   | 53,982   |  
|Other                                                        |  |      | 13,620   |   |      |   |         |  
|                                                             |  |      |          |   |      |   |          |  
|Deferred tax assets                                          |  |      | 616,552  |   |      |   | 444,542  |  
|                                                             |  |      |          |   |      |   |          |  
|Deferred tax liabilities                                     |  |      |          |   |      |   |          |  
|Net unrealized appreciation on securities available for sale |  |      | (190,493 | ) |      |   | (278,286 | )
|Depreciation                                                 |  |      | (291,233 | ) |      |   | (203,333 | )
|Accretion of discount on investment securities               |  |      | (3,407   | ) |      |   | (4,875   | )
|Accrued pension costs                                        |  |      | (88,260  | ) |      |   | (122,703 | )
|Other                                                        |  |      |         |   |      |   | (19,164  | )
|                                                             |  |      |          |   |      |   |          |  
|Deferred tax liabilities                                     |  |      | (573,393 | ) |      |   | (628,361 | )
|                                                             |  |      |          |   |      |   |          |  
|Net deferred tax asset (liability)                           |  | $    | 43,159   |   |      | $ | (183,819 | )
|                                                             |  |      |          |   |      |   |          |  



Note 13. Commitments and
Contingencies



Litigation



In the normal course of business the Company is involved in various legal proceedings. After
consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the consolidated financial statements.



Financial Instruments with Off-Balance-Sheet Risk



The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets.



The Companys exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional
obligations as for on-balance-sheet instruments. A summary of commitments at December 31 is as follows:



|                             |  |      |             |      |   |           
|---------------------------- |  | ---- | ----------- | ---- | - | ----------
|                             |  | 2004 |             | 2003
|Commitments to extend credit |  | $    | 31,252,000  |      | $ | 26,953,000
|Standby letters of credit    |  |      | 1,818,000   |      |   | 1,820,000 
|                             |  |      |             |      |   |           
|                             |  |      | $33,070,000 |      | $ | 28,773,000
|                             |  |      |             |      |   |           



Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary upon extension of credit, is based on managements credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate
and income-producing commercial properties.



---

Notes to Consolidated Financial Statements



Note 13. Commitments and Contingencies, continued



Financial Instruments with Off-Balance-Sheet Risk, continued



Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held
varies as specified above and is required in instances which the Company deems necessary.



Concentrations of Credit Risk



Substantially all of the Companys loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Companys market area and such customers are generally depositors of the Bank. Investments
in state and municipal securities involve governmental entities within and outside the Companys market area. The concentrations of credit by type of loan are set forth in the Loans Receivable note. The distribution of commitments to extend
credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. The Company, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in
excess of approximately $2,000,000. Although the Company has a reasonably diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent upon economic conditions in and around Botetourt, Roanoke
and Rockbridge counties. The Company has a loan concentration relating to construction and land development. Total loans and loan commitments to this industrial group amounted to approximately $24,000,000 at December 31, 2004.



The Company from time to time has cash and cash equivalents on deposit with financial
institutions which exceed federally-insured limits.



Note 14. Regulatory
Restrictions



Dividends



The Companys dividend payments are made from dividends received from the Bank. The
Bank, as a Virginia banking corporation, may pay dividends only out of its retained earnings. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is
necessary to ensure financial soundness of the Bank.



Capital
Requirements



The Company (on a consolidated basis) and the Bank are
subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if
undertaken, could have a direct material effect on the Companys and the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors.



Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of
Tier I capital to average assets, as all those terms are defined in the regulations. Management believes, as of December 31, 2004, that the Company and the Bank met all capital adequacy requirements to which they are subject.



As of December 31, 2004, the most recent notification from the Federal Deposit Insurance
Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Banks category.



---

Notes to Consolidated Financial Statements



Note 14. Regulatory Restrictions, continued



Capital Requirements, continued



The Company and Banks actual capital amounts and ratios are also presented in the table (in thousands).



|                                         |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|---------------------------------------- |  | ------ | ------ | ----- | ------------------------------------ | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                         |  | Actual |        |       | Minimum For CapitalAdequacy Purposes |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                         |  | Amount |        | Ratio |                                      |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio |       
|December 31, 2004:                       |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 21,150 |       | 12.5                                 | % |        | $                                                                     | 13,582 |  | 8.0 | %      |  | $     | 16,978 |  | 10.0 | %
|Bank of Botetourt                        |  | $      | 19,759 |       | 11.7                                 | % |        | $                                                                     | 13,559 |  | 8.0 | %      |  | $     | 16,949 |  | 10.0 | %
|Tier I Capital (to Risk-Weighted Assets) |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 19,028 |       | 11.2                                 | % |        | $                                                                     | 6,791  |  | 4.0 | %      |  | $     | 10,187 |  | 6.0  | %
|Bank of Botetourt                        |  | $      | 17,640 |       | 10.4                                 | % |        | $                                                                     | 6,780  |  | 4.0 | %      |  | $     | 10,169 |  | 6.0  | %
|Tier I Capital (to Average Assets)       |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 19,028 |       | 9.2                                  | % |        | $                                                                     | 8,265  |  | 4.0 | %      |  | $     | 10,332 |  | 5.0  | %
|Bank of Botetourt                        |  | $      | 17,640 |       | 8.6                                  | % |        | $                                                                     | 8,211  |  | 4.0 | %      |  | $     | 10,264 |  | 5.0  | %
|                                         |  |        |        |       |                                      |  
|December 31, 2003:                       |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 18,829 |       | 12.7                                 | % |        | $                                                                     | 11,910 |  | 8.0 | %      |  | $     | 14,888 |  | 10.0 | %
|Bank of Botetourt                        |  | $      | 17,630 |       | 11.9                                 | % |        | $                                                                     | 11,893 |  | 8.0 | %      |  | $     | 14,867 |  | 10.0 | %
|Tier I Capital (to Risk-Weighted Assets) |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 17,140 |       | 11.5                                 | % |        | $                                                                     | 5,955  |  | 4.0 | %      |  | $     | 8,933  |  | 6.0  | %
|Bank of Botetourt                        |  | $      | 15,941 |       | 10.7                                 | % |        | $                                                                     | 5,947  |  | 4.0 | %      |  | $     | 8,920  |  | 6.0  | %
|Tier I Capital (to Average Assets)       |  |        |        |       |                                      |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                             |  | $      | 17,140 |       | 8.9                                  | % |        | $                                                                     | 7,677  |  | 4.0 | %      |  | $     | 9,596  |  | 5.0  | %
|Bank of Botetourt                        |  | $      | 15,941 |       | 8.4                                  | % |        | $                                                                     | 7,631  |  | 4.0 | %      |  | $     | 9,539  |  | 5.0  | %



---

Notes to Consolidated Financial Statements



Note 14. Regulatory Restrictions, continued



Intercompany Transactions



The Banks legal lending limit on loans to the Company are governed by Federal Reserve Act 23A, and differ from legal lending limits on loans to external customers.
Generally, a bank may lend up to 10% of its capital and surplus to its Parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least
20% more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United
States or agencies thereof, or by notes, drafts, bills of exchange or bankers acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of the loan amount do not apply. Under this
definition, the legal lending limit for the Bank on loans to the Company was approximately $1,924,000 at December 31, 2004. No 23A transactions were deemed to exist between the Company and the Bank at December 31, 2004.



Note 15. Transactions with Related Parties



The Company has entered into transactions with its directors, significant shareholders and
their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable
transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.



Aggregate loan transactions with related parties were as follows:



|                   |  |      |            |   |      |   |            |  
|------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                   |  | 2004 |            |   | 2003 |  
|Balance, beginning |  | $    | 1,075,959  |   |      | $ | 1,438,897  |  
|                   |  |     
|New loans          |  |      | 5,933,266  |   |      |   | 4,668,023  |  
|Repayments         |  |      | (5,969,523 | ) |      |   | (5,030,961 | )
|                   |  |      |            |   |      |   |            |  
|Balance, ending    |  | $    | 1,039,702  |   |      | $ | 1,075,959  |  
|                   |  |      |            |   |      |   |            |  



---

Notes to Consolidated Financial Statements



Note 16. Parent Company Financial Information



Condensed financial information of Botetourt Bankshares, Inc. is presented as follows:



Balance Sheets

December 31, 2004 and 2003



|                                              |  |      |            |      |   |           
|--------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                              |  | 2004 |            | 2003
|Assets                                        |  |      |            |      |   |           
|Cash and due from banks                       |  | $    | 25,400     |      | $ | 37,740    
|Securities held to maturity                   |  |      | 1,350,000  |      |   | 1,150,000 
|Investment in affiliate bank at equity        |  |      | 18,068,806 |      |   | 16,558,934
|Other assets                                  |  |      | 12,781     |      |   | 11,186    
|                                              |  |      |            |      |   |           
|Total assets                                  |  | $    | 19,456,987 |      | $ | 17,757,860
|                                              |  |      |            |      |   |           
|Liabilities                                   |  |      |            |      |   |           
|Income tax payable                            |  | $    | 814        |      | $ |          
|                                              |  |      |            |      |   |           
|Total liabilities                             |  |      | 814        |      |   |          
|                                              |  |      |            |      |   |           
|Stockholders equity                          |  |      |            |      |   |           
|Common stock                                  |  |      | 1,232,745  |      |   | 1,230,924 
|Surplus                                       |  |      | 1,361,970  |      |   | 1,328,190 
|Retained earnings                             |  |      | 16,491,678 |      |   | 14,658,543
|Accumulated other comprehensive income (loss) |  |      | 369,780    |      |   | 540,203   
|                                              |  |      |            |      |   |           
|Total stockholders equity                    |  |      | 19,456,173 |      |   | 17,757,860
|                                              |  |      |            |      |   |           
|Total liabilities and stockholders equity    |  | $    | 19,456,987 |      | $ | 17,757,860
|                                              |  |      |            |      |   |           



---

Notes to Consolidated Financial Statements



Note 16. Parent Company Financial Information, continued



Statements of Income

For the years ended December 31, 2004, 2003 and 2002



|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|--------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                  |  | 2004 |            |   | 2003 |   |            | 2002 | 
|Income                                                                            |  |      |            |   |      |   |            |      |  |   |            |  
|Dividends from affiliate bank                                                     |  | $    | 742,063    |   |      | $ | 467,534    |      |  | $ | 331,699    |  
|Interest on taxable securities                                                    |  |      | 31,718     |   |      |   | 34,488     |      |  |   | 40,956     |  
|Interest on tax exempt securities                                                 |  |      | 12,400     |   |      |   | 12,008     |      |  |   | 16,108     |  
|Gain on sale of securities                                                        |  |      |           |   |      |   |           |      |  |   |           |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|                                                                                  |  |      | 786,181    |   |      |   | 514,030    |      |  |   | 388,763    |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Expenses                                                                          |  |      |            |   |      |   |            |      |  |   |            |  
|Operating expenses                                                                |  |      | 29,807     |   |      |   | 37,231     |      |  |   | 25,069     |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Income before taxes and equity in undistributed income of affiliate               |  |      | 756,374    |   |      |   | 476,799    |      |  |   | 363,694    |  
|                                                                                  |  |      |           
|Income tax                                                                        |  |      | (870       | ) |      |   | 1,097      |      |  |   | (6,031     | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Income before equity in undistributed income of affiliate                         |  |      | 755,504    |   |      |   | 477,896    |      |  |   | 357,663    |  
|                                                                                  |  |      |           
|Equity in undistributed income of affiliate                                       |  |      | 1,644,694  |   |      |   | 1,448,320  |      |  |   | 1,363,131  |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net income                                                                        |  | $    | 2,400,198  |   |      | $ | 1,926,216  |      |  | $ | 1,720,794  |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|                                                                                 
|Statements of Cash Flows For the years ended December 31, 2004, 2003 and 2002     | 
|                                                                                  |  | 2004 |            |   | 2003 |   |            | 2002 | 
|Cash flows from operating activities                                              |  |      |            |   |      |   |            |      |  |   |            |  
|Net income                                                                        |  | $    | 2,400,198  |   |      | $ | 1,926,216  |      |  | $ | 1,720,794  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |            |   |      |   |            |      |  |   |            |  
|Equity in undistributed income of affiliate                                       |  |      | (1,644,694 | ) |      |   | (1,448,320 | )    |  |   | (1,363,131 | )
|Net increase (decrease) in other liabilities                                      |  |      | 814        |   |      |   | (4,831     | )    |  |   | 4,831      |  
|Net (increase) decrease in other assets                                           |  |      | (1,595     | ) |      |   | 3,305      |      |  |   | 221,079    |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash provided by operating activities                                         |  |      | 754,723    |   |      |   | 476,370    |      |  |   | 583,573    |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Cash flows from investing activities                                              |  |      |            |   |      |   |            |      |  |   |            |  
|Purchases of investment securities                                                |  |      | (675,000   | ) |      |   | (1,300,000 | )    |  |   | (750,000   | )
|Maturities of investment securities                                               |  |      | 475,000    |   |      |   | 1,300,000  |      |  |   | 700,000    |  
|Increase in investment in Bank                                                    |  |      | (35,601    | ) |      |   | (49,434    | )    |  |   | (51,743    | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash used in investing activities                                             |  |      | (235,601   | ) |      |   | (49,434    | )    |  |   | (101,743   | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Cash flows from financing activities                                              |  |      |            |   |      |   |            |      |  |   |            |  
|Dividends paid                                                                    |  |      | (567,063   | ) |      |   | (467,534   | )    |  |   | (552,344   | )
|Common stock issued                                                               |  |      | 35,601     |   |      |   | 49,434     |      |  |   | 51,743     |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash used by financing activities                                             |  |      | (531,462   | ) |      |   | (418,100   | )    |  |   | (500,601   | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net increase (decrease) in cash and due from banks                                |  |      | (12,340    | ) |      |   | 8,836      |      |  |   | (18,771    | )
|                                                                                  |  |      |           
|Cash and cash equivalents, beginning                                              |  |      | 37,740     |   |      |   | 28,904     |      |  |   | 47,675     |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Cash and cash equivalents, ending                                                 |  | $    | 25,400     |   |      | $ | 37,740     |      |  | $ | 28,904     |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  



---

Item 8. Changes in and Disagreements with Accountants



Not applicable.



Item 8A. Controls and Procedures



Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-14 of the Securities Exchange Act of 1934 (the Exchange Act). Based on the evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in enabling us to record, process, summarize and report in a timely manner the information required to be
disclosed in reports we file under the Exchange Act.



No change
in our internal control over financial reporting occurred during our fourth quarter of 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



PART III



Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act



The information as of December 31, 2004 regarding the names, ages, principal occupations
and business experience for the past five years for each of the Companys Directors and executive officers is provided in the Companys proxy materials for the 2005 annual meeting of shareholders, which will be filed pursuant to Schedule
14A and is incorporated herein by reference. Directors serve on the Board for one-year terms, and executive officers are all elected for terms of one year.



Report of the Audit Committee



The Audit Committee of the Board of Directors of the Company is currently comprised of three directors, Messers. Moore, Patterson, and Williamson, all of
whom satisfy all of the following criteria: (i) meet the independence requirements set forth in the NASDs definition of independent director, (ii) have not accepted directly or indirectly any consulting, advisory, or other
compensatory fee from the Company or any of its subsidiaries, (iii) are not affiliated persons of the Company or any of its subsidiaries, and (iv) are competent to read and understand financial statements. The Board of Directors has determined that
Mr. John B. Williamson, III, president of RGC Resources, Inc., a reporting company, qualifies as an audit committee financial expert within the meaning of Item 401 of Regulation SB of the Securities Exchange Act. Mr. Williamson is
independent of management based on the independence requirements set forth in the NASDs definition of independent director. For more information regarding the Audit Committee and the Audit Committee Charter, as well as information
relating to activities of the Companys outside auditor and fees paid to that auditor, please see the Companys proxy statement for its annual meeting of shareholders in 2005, which will be filed pursuant to schedule 14A, which is
incorporated by reference to this filing.



---

Code of Ethics



The Corporation has adopted a Codes of Business Conduct and Ethics that apply to its directors, executives and employees. A copy of these codes was
provided as Exhibits 99.2, 99.3, and 99.4 in the Form 10-KSB filed March, 25, 2004.



Item 10. Executive Compensation



For more
information regarding the compensation paid in 2004, 2003, and 2002 to the Company and Banks Executive Officers, please see the Companys proxy statement for its annual meeting of shareholders in 2005, which will be filed pursuant to
schedule 14A, which is incorporated by reference to this filing.



Item 11. Security Ownership of Certain Beneficial Owners and Management



Security Ownership of Management



Information as of December 31, 2004 regarding the number of shares of Common Stock beneficially owned by each director, by the executive officer and by all directors and executive officers as a group, as well as the number of shares held by
each holder of five percent or more of the outstanding common stock of the Company, is provided in the Companys proxy materials for the 2005 annual meeting of shareholders, which will be filed pursuant to Schedule 14A and is incorporated
herein by reference.



Item 12. Certain Relationships and Related
Transactions



Transactions with Management



Some of the directors and officers of the Company are at present, as in the
past, customers of the Company, and the Company has had and expects to have in the future banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their associates, on substantially the same
terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with others. These transactions do not involve more than the normal risk of collectibility or present other unfavorable
features. The aggregate outstanding balance of loans to directors, executive officers and their associates, as a group, at December 31, 2004 is provided in the Companys proxy materials for the 2005 annual meeting of shareholders, which will be
filed pursuant to Schedule 14A and is incorporated herein by reference.



There are no legal proceedings to which any director, officer, principal shareholder or associate is a party that would be material and adverse to the Company.



---

Item 13. Exhibits and Reports on Form 8-K



| | (a) | Exhibits
| | --- | --------



| | 3(i). | Restated Articles of Incorporation filed on the Form 10-SB 12G/A on June 22, 2004.
| | ----- | ----------------------------------------------------------------------------------



| | 3(ii). | Bylaws filed on the Form 10-SB 12G on April 30, 2002.
| | ------ | -----------------------------------------------------



| | 12. | Annual Report to Shareholders (Included as Item 7)
| | --- | --------------------------------------------------



| | 31.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13 a-14(a)
| | ---- | ------------------------------------------------------------------------------------------------



| | 32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
| | -- | -------------------------------------------------------------------------------------------------------



| | (b) | Reports on Form 8-K
| | --- | -------------------



No reports were filed on Form 8-K during the fourth quarter of 2004.



Item 14. Principal Accountant Fees and Services



Information regarding services provided by our independent accountants is included in the Report of the Audit Committee,
which is referenced in Item 9 and is provided in the Companys proxy materials for the 2005 annual meeting of shareholders, which will be filed pursuant to Schedule 14A and is incorporated herein by reference.



SIGNATURES



In accordance with Section 13 or 15 (d) of the Securities Exchange Act of 1934, we have caused this Report to be signed on
our behalf by the undersigned, thereunto duly authorized.



BOTETOURT BANKSHARES, INC.



|                     |  |        |  |                                                        
|-------------------- |  | ------ |  | -------------------------------------------------------
|Date: March 25, 2005 |  | By:    |  | /s/ H. Watts Steger, III                               
|                     |  | Name:  |  | H. Watts Steger, III                                   
|                     |  | Title: |  | Chief Executive Officer and and Chief Financial Officer