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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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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 no: 0-22955



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BAY BANKS OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|VIRGINIA                                                       |  | 54-1838100                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



100 SOUTH MAIN
STREET, KILMARNOCK, VIRGINIA 22482

(Address of principal executive offices) (Zip Code)



Registrants telephone number, including area code: 804.435.1171



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



Securities registered under Section 12(g) of the Exchange Act:

Common Stock ($5.00 Par Value)

(Title of Class)



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO ̈



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K.  x



Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).    YES ̈NO  x



The aggregate market value of voting stock held
by non-affiliates of the registrant at June 30, 2004, based on the closing sale price of the registrants common stock on June 14, 2004, was $35,124,180.



The number of shares outstanding of the registrants common stock as of March 7, 2005 was 2,353,987.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the registrants definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 16, 2005 are incorporated by reference into Part
III of this Form 10-K.



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BAY BANKS OF VIRGINIA



INDEX



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|PART I  
|Item 1:  |  | Business                                                                                                     |  | 3   
|         |  |                                                                                                             
|Item 2:  |  | Properties                                                                                                   |  | 7   
|         |  |                                                                                                             
|Item 3   |  | Legal Proceedings                                                                                            |  | 7   
|         |  |                                                                                                             
|Item 4:  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 7   
|        
|PART II 
|         |  |                                                                                                             
|Item 5:  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 8   
|         |  |                                                                                                             
|Item 6:  |  | Selected Financial Data                                                                                      |  | 9   
|         |  |                                                                                                             
|Item 7:  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 10  
|         |  |                                                                                                             
|Item 7A: |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 20  
|         |  |                                                                                                             
|Item 8:  |  | Financial Statements and Supplementary Data                                                                  |  | 21  
|         |  |                                                                                                             
|Item 9:  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 47  
|         |  |                                                                                                             
|Item 9A: |  | Controls and Procedures                                                                                      |  | 47  
|         |  |                                                                                                             
|Item 9B: |  | Other Information                                                                                            |  | 47  
|        
|PART III
|         |  |                                                                                                             
|Item 10: |  | Directors and Executive Officers of the Registrant                                                           |  | 47  
|         |  |                                                                                                             
|Item 11: |  | Executive Compensation                                                                                       |  | 47  
|         |  |                                                                                                             
|Item 12: |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 47  
|         |  |                                                                                                             
|Item 13: |  | Certain Relationships and Related Transactions                                                               |  | 48  
|         |  |                                                                                                             
|Item 14: |  | Principal Accounting Fees and Services                                                                       |  | 48  
|        
|PART IV 
|         |  |                                                                                                             
|Item 15: |  | Exhibits, Financial Statement Schedules                                                                      |  | 48  



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PART I



ITEM 1: BUSINESS



GENERAL



Bay Banks of Virginia, Inc. the Company is a bank holding company that conducts
substantially all of its operations through its subsidiaries, Bank of Lancaster (the Bank), and Bay Trust Company (the Trust Company). Bay Banks of Virginia, Inc., was incorporated under the laws of the Commonwealth of
Virginia on June 30, 1997, in connection with the holding company reorganization of the Bank of Lancaster.



The Bank is a state-chartered bank and a member of the Federal Reserve System. The Bank services individual and commercial customers, the majority of which are in the Northern Neck of Virginia, by providing a full
range of banking and related financial services, including checking, savings, other depository services, commercial and industrial loans, residential and commercial mortgages, home equity loans, and consumer installment loans.



The Bank has two offices located in Kilmarnock, Virginia, and one office each in White Stone,
Warsaw, Montross, Heathsville, and Callao, Virginia. A substantial amount of the Banks deposits are interest bearing, and the majority of the Banks loan portfolio is secured by real estate. Deposits of the Bank are insured by the Bank
Insurance Fund of the Federal Deposit Insurance Corporation (the FDIC). The Bank opened for business in 1930 and has partnered with the community to ensure responsible growth and development since that time.



In August of 1999, Bay Banks of Virginia formed Bay Trust Company. This subsidiary of the
Company was created to purchase and manage the assets of the trust department of the Bank of Lancaster. The sale and transfer of assets from the Bank to the Trust Company was completed as of the close of business on December 31, 1999. As of January
1, 2000, the Bank of Lancaster no longer owned or managed the trust function, and thereby no longer receives an income stream from the trust department. Income generated by the Trust Company is consolidated with the Banks income and the
Companys income for the purposes of the Companys consolidated financial statements. The Trust Company opened for business on January 1, 2000, in its permanent location on Main Street in Kilmarnock, Virginia.



The Companys marketplace is situated on the Northern Neck peninsula of
Virginia, plus Middlesex County. The Northern Neck includes the counties of Lancaster, Northumberland, Richmond, and Westmoreland. The Companys primary trading area is dominated by smaller, retired households with relatively high
per capita incomes. Growth in households, employment, and retail sales is moderate but the local economic conditions are stable as growth has been positive for several years. Health care, tourism, and related services are the major employment
sectors in the Northern Neck.



The Company had total assets of
$303.5 million, deposits of $261.9 million, and shareholders equity of $25.8 million as of December 31, 2004.



Through the Bank of Lancaster and Bay Trust Company, Bay Banks of Virginia provides a wide range of services to its customers in its market area. These services are summarized as follows.



Real Estate Lending. The Banks real estate loan portfolio is the largest segment
of the loan portfolio. The Bank offers fixed and adjustable rate mortgages on one-to-four family residential properties. These mortgages are underwritten and documented within the guidelines of the regulations of the Board of Governors of the
Federal Reserve System (the Federal Reserve). The Bank underwrites mainly adjustable rate mortgages as the marketplace allows. Construction loans with a twelve-month term are also a significant component of the Banks portfolio.
Underwritten at 80% loan to value, and to qualified builders and individuals, these loans are disbursed as construction progresses and verified by Bank inspection. The Bank also offers commercial loans that are secured by real estate. These loans
are typically written at 80% loan to value and are either variable with the prime rate of interest, or adjustable in one, three, or five year terms.



The Company also offers secondary market loan origination. Through the Bank, customers may apply for a home mortgage that will be underwritten in accordance with the
guidelines of the Federal Home Loan Mortgage Corporation. These loans are then sold into the secondary market on a loan by loan basis. The Bank earns origination fees through offering this service. Customers, upon approval, receive a fixed or
adjustable rate of interest with amortization terms up to 30 years. Since these loans are sold into the secondary market, the Company earns no future interest income, nor does it incur any interest rate or re-pricing risk.



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Consumer Lending. In an effort to offer a full range of services, the Banks consumer lending includes
automobile and boat financing, home improvement loans, and unsecured personal loans. These loans historically entail greater risk than loans secured by real estate, but also offer a higher return.



Commercial Lending. Commercial lending activities include small business loans, asset
based loans, and other secured and unsecured loans and lines of credit. Commercial lending may entail greater risk than residential mortgage lending, and is therefore underwritten with strict risk management standards. Among the criteria for
determining the borrowers ability to repay is a cash flow analysis of the business and business collateral.



Business Development. The Bank offers several services to commercial customers. These services include Analysis Checking, Cash Management Deposit Accounts, Wire
Services, Direct Deposit Payroll Service, Internet Banking, Telephone Banking, and a full line of Commercial Lending options. The Bank also offers Small Business Administration loan products to include the 504 Program which provides long term
funding for commercial real estate and long lived equipment. This allows commercial customers to apply for favorable rate loans for the development of business opportunities, while providing the Bank with a partial guarantee of the outstanding loan
balance.



Bay Services Company, Inc. The Bank has one wholly owned
subsidiary, Bay Services Company, Inc., a Virginia corporation organized in 1994 (Bay Services). Bay Services owns an interest in a land title insurance agency, Bankers Title of Fredericksburg, and an investment and insurance services
company, Bankers Investment Group. Bankers Title of Fredericksburg sells title insurance to mortgage loan customers, including customers of the Bank of Lancaster and the other financial institutions that have an ownership interest in the agency.
Bankers Investment Group provides the Banks non-deposit products department with insurance and investment products for marketing within the Banks primary marketing area.



Bay Trust Company. The Trust Company offers a broad range of trust and related fiduciary services. Among these are estate settlement
and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial accounts, and rollover Individual Retirement Accounts, both self-directed and managed.



COMPETITION



The Companys marketplace is highly competitive. The Company is subject to competition from a variety of commercial banks and financial service companies, large
national and regional financial institutions, large regional credit unions, mortgage companies, consumer finance companies, mutual funds and insurance companies. Competition for loans and deposits is affected by numerous factors, but mainly by
interest rates and institutional reputation.



SUPERVISION AND REGULATION



Bank holding companies and banks are regulated under both federal and
state law. The Company is subject to regulation by the Federal Reserve. Under the Bank Holding Company Act of 1956, the Federal Reserve exercises supervisory responsibility for any non-bank acquisition, merger or consolidation. In addition, the Bank
Holding Company Act limits the activities of a bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity that is closely related to banking. In addition, the Company is registered under the
bank holding company laws of Virginia, and as such is subject to regulation and supervision by the Virginia State Corporation Commissions Bureau of Financial Institutions.



The following description summarizes the significant state and Federal laws to which the Company and the Bank are subject. To the extent
statutory or regulatory provisions or proposals are set forth the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.



The Bank is supervised and regularly examined by the Federal Reserve and the Virginia State Corporation Commissions Bureau of
Financial Institutions. These on-site examinations verify compliance with regulations governing corporate practices, capitalization, and safety and soundness. Further, the Bank is subject to the requirements of the Community Reinvestment Act (the
CRA). The CRA requires financial institutions to meet the credit needs of the local community, including low to moderate-income needs. Compliance with the CRA is monitored through regular examination by the Federal Reserve.



Federal Reserve regulations permit bank holding companies to engage in non-banking
activities closely related to banking or to managing or controlling banks. These activities include the making or servicing of loans, performing certain data processing services, and certain leasing and insurance agency activities.



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The Company owns 100% of the stock of the Bank of Lancaster. The Bank is prohibited by the Federal Reserve from holding
or purchasing its own shares except in limited circumstances. Further, the Bank is subject to certain requirements as imposed by state banking statutes and regulations. The Bank is limited by the Federal Reserve regarding what dividends it can pay
the Company. Any dividend in excess of the total of the Banks net profit for that year plus retained earnings from the prior two years must be approved by the proper regulatory agencies. Further, under the Federal Deposit Insurance Corporation
Improvement Act of 1991 (the FDICIA), insured depository institutions are prohibited from making capital distributions, if, after making such distributions, the institution would become undercapitalized as defined by
regulation. Based upon the Banks current financial position, it is not anticipated that this statute will impact the continued operation of the Bank.



As a bank holding company, Bay Banks of Virginia is required to file with the Federal Reserve an annual report and such additional information as it may require pursuant
to the Bank Holding Company Act. The Federal Reserve may also conduct examinations of the Company and any or all of its subsidiaries.



CAPITAL REQUIREMENTS



The Federal Reserve, the Office of the Comptroller of the Currency and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to banking organizations. In addition, those
regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the risk-based capital requirements of these federal
bank regulatory agencies, the Company and the Bank are required to maintain a minimum ratio of total capital to risk-weighted assets of 8%. At least half of the total capital is required to be Tier 1 capital, which consists principally
of common and certain qualifying preferred shareholders equity, less certain intangibles and other adjustments. The remainder (Tier 2 capital) consists of a limited amount of subordinated and other qualifying debt (including
certain hybrid capital instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company as of December 31, 2004 were 10.3% and 11.2%, respectively.



In addition, each of the federal regulatory agencies has established a minimum leverage
capital ratio (Tier 1 capital to average risk-weighted assets) (Tier 1 leverage ratio). These guidelines provide for a minimum Tier 1 leverage ratio of 4% for banks and bank holding companies that meet certain specified criteria,
including that they have the highest regulatory examination rating and are not contemplating significant growth or expansion. The Tier 1 leverage ratio of the Company as of December 31, 2004, was 7.4%, which is well above the minimum requirement.
The guidelines also provide that banking organizations that are experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant
reliance on intangible assets.



DEPOSIT INSURANCE



Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for insured depository
institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The risk-based system assigns an institution to one of three capital categories: (i) well-capitalized, (ii) adequately
capitalized, or (iii) undercapitalized. The FDIC also assigns an institution to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on an evaluation provided to the FDIC
by the institutions primary federal regulator and information which the FDIC determines to be relevant to the institutions financial condition and the risk posed to the deposit insurance funds (which may include, if applicable,
information provided by the institutions state supervisor). An institutions insurance assessment rate is then determined based on the capital category and supervisory category to which it is assigned.



Under the final risk-based assessment system there are nine assessment risk classifications
(i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates for deposit insurance currently range from zero basis points ($2,000 minimum) to .27%. The capital and supervisory
subgroup to which an institution is assigned by the FDIC is confidential and may not be disclosed. A banks rate of deposit insurance assessments will depend upon the category and subcategory to which the bank is assigned by the FDIC. Any
increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including the Bank.



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SAFETY AND SOUNDNESS REGULATIONS



The FDIC has adopted guidelines that establish standards for safety and soundness of banks. They are designed to identify potential safety
and soundness problems and ensure that banks address those concerns before they pose a risk to the deposit insurance fund. If the FDIC determines that an institution fails to meet any of these standards, the agency can require the institution to
prepare and submit a plan to come into compliance. If the agency determines that the plan is unacceptable or is not implemented, the agency must, by order, require the institution to correct the deficiency. The federal banking agencies have broad
powers under current federal law to make prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is considered well capitalized,
adequately capitalized, under capitalized, significantly under capitalized, or critically undercapitalized. All such terms are defined under uniform regulation defining such capital levels issued by
each of the federal banking agencies. The Bank is considered well capitalized.



The FDIC also has safety and soundness regulations and accompanying guidelines on asset quality and earnings standards. The guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent
those assets from deteriorating. The guidelines also provide standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient to maintain adequate capital and reserves. If an institution fails to comply with a safety
and soundness standard, the agency may require the institution to submit and implement an acceptable compliance plan, or face enforcement action.



THE GRAMM-LEACH BLILEY ACT OF 1999



The Gramm-Leach-Bliley Act of 1999 (GLBA) was signed into law on November 12, 1999. The main purpose of GLBA is to permit greater affiliations within the
financial services industry, primarily banking, securities and insurance. The provisions of GLBA that are believed to be of most significance to the Company are discussed below.



GLBA repealed sections 20 and 32 of the Glass-Steagall Act, which sections separated commercial banking from investment banking, and
substantially amends the Bank Holding Company Act, which prior to GLBA limited the ability of bank holding companies to engage in the securities and insurance businesses. To achieve this purpose, GLBA created a new type of company, the
financial holding company. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including



| |  |  | securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | insurance underwriting, sales and brokerage activities.
| | - |  | -------------------------------------------------------



A bank holding company may elect to become a financial holding company only if all of its depository institution subsidiaries are well-capitalized, well-managed and have
at least a satisfactory CRA rating. While the Bank meets these criteria, the Company has not elected to be treated as a financial holding company.



GLBA established a system of functional regulation under which the federal banking agencies regulate the banking activities of financial holding companies and banks
financial subsidiaries, the Securities and Exchange Commission regulates their securities activities, and state insurance regulators will regulate their insurance activities.



GLBA and certain regulations issued by federal banking agencies also provide protection against the transfer and use by financial
institutions of consumers nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institutions policies and procedures regarding
the handling of customers nonpublic personal financial information. The privacy provisions generally prohibit a financial institution from providing a customers personal financial information to unaffiliated third parties unless the
institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.



Neither the provisions of GLBA nor the Acts implementing regulations have had a material impact on the Companys or the Banks regulatory capital ratios
(as discussed above) or ability to continue to operate in a safe and sound manner.



USA PATRIOT ACT OF 2001



In October, 2001, the USA Patriot Act
of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Northern Virginia, which occurred on September 11, 2001. The Patriot Act is intended is to



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strengthen U.S. law enforcements and the intelligence communities abilities to work cohesively to combat
terrorism on a variety of fronts. The continuing and potential impact of the Patriot Act and related regulations and policies on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws, and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money laundering.



REPORTING OBLIGATIONS UNDER SECURITIES LAWS



The Company is
subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the Exchange Act), including the filing of annual, quarterly and other reports with the Securities and Exchange Commission
(SEC). As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 and regulations promulgated thereunder by the SEC, which are aimed at improving corporate governance and reporting
procedures. The Company is complying with the new rules and regulations implemented pursuant to the Sarbanes-Oxley Act and intends to comply with any applicable rules and regulations implemented in the future.



ITEM 2: PROPERTIES



The Company, through its
subsidiaries, owns or leases buildings that are used in the normal course of business. The main office is located at 100 South Main Street, Kilmarnock, Virginia, in a building owned by the Company. The Companys subsidiaries own or lease
various other offices in the counties or towns in which they operate.



Unless
otherwise noted, the properties listed below are owned by the Company and its subsidiaries as of December 31, 2004.



Corporate Headquarters



100 South Main Street, Kilmarnock, Virginia



Bank of Lancaster



100 South Main Street, Kilmarnock, Virginia

708 Rappahannock Drive, White Stone, Virginia

432 North Main Street, Kilmarnock, Virginia

4935 Richmond Road, Warsaw, Virginia

15648
Kings Highway, Montross, Virginia

6941 Northumberland Highway, Heathsville, Virginia

18 Sandy Street, Callao, Virginia

23 West
Church Street, Kilmarnock, Virginia

672 North Main Street, Kilmarnock, Virginia (leased)



Bay Trust Company



1 North Main Street, Kilmarnock, Virginia

15648 Kings Highway, Montross, Virginia



ITEM 3: LEGAL PROCEEDINGS



The Company currently
is not involved in any material legal proceeding other than the ordinary and routine litigation incidental to its business.



ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2004.



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PART II



ITEM 5: MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



Bay Banks of Virginia common stock trades on the over-the-counter (OTC) Bulletin Board under the symbol BAYK and transactions generally involve a
small number of shares. There were 2,354,187 shares of the Companys stock outstanding at the close of business on December 31, 2004, which were held by 762 shareholders of record.



The following table summarizes the high and low closing sales prices and dividends declared for the two years ended December 31, 2004.



|               |  |               |       |      |   |                    |  |     |       |      |   |       |  |   |       |  |   |     
|-------------- |  | ------------- | ----- | ---- | - | ------------------ |  | --- | ----- | ---- | - | ----- |  | - | ----- |  | - | ----
|               |  | Market Values |       |     
|               |  | 2004          |       | 2003 |   | Declared Dividends
|               |  | High          |       | Low  |   | High               |  | Low |       | 2004 |   | 2003 
|First Quarter  |  | $             | 17.00 |      | $ | 15.25              |  | $   | 15.75 |      | $ | 14.75 |  | $ | 0.15  |  | $ | 0.14
|Second Quarter |  |               | 16.00 |      |   | 14.75              |  |     | 16.25 |      |   | 14.75 |  |   | 0.15  |  |   | 0.14
|Third Quarter  |  |               | 15.50 |      |   | 14.50              |  |     | 17.00 |      |   | 15.50 |  |   | 0.15  |  |   | 0.14
|Fourth Quarter |  |               | 15.00 |      |   | 14.25              |  |     | 16.00 |      |   | 15.00 |  |   | 0.155 |  |   | 0.15



A discussion of certain restrictions
and limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends on its common stock, is set forth in Part I, Business, of this Form 10-K under the heading Supervision and
Regulation.



The dividend amount on the Companys common stock is
established by the Board of Directors on a quarterly basis with dividends paid on a quarterly basis. In making its decision on the payment of dividends on the Companys common stock, the Board considers operating results, financial condition,
capital adequacy, regulatory requirements, shareholder return, and other factors.



The Company began a share repurchase program in August of 1999 and has continued the program into 2004. The combined plans authorize the repurchase of 180,000 shares.



|               |  |                                |  |                            |       |                                                                                |     |                                                                              |       
|-------------- |  | ------------------------------ |  | -------------------------- | ----- | ------------------------------------------------------------------------------ | --- | ---------------------------------------------------------------------------- | ------
|               |  | Total Numberof SharesPurchased |  | AveragePrice Paidper Share |       | Total Number of Shares Purchasedas Part of Publicly AnnouncedPlans or Programs |     | Maximum Number of Sharesthat May Yet Be PurchasedUnder the Plans or Programs
|October, 2004  |  |                               |  | $                          |      |                                                                                |    |                                                                              | 39,852
|November, 2004 |  |                               |  | $                          |      |                                                                                |    |                                                                              | 39,852
|December, 2004 |  | 500                            |  | $                          | 14.98 |                                                                                | 500 |                                                                              | 39,352
|               |  |                                |  |                            |       |                                                                                |     |                                                                              |       
|Total          |  | 500                            |  | $                          | 14.98 |                                                                                | 500 |                                                                              |       
|               |  |                                |  |                            |       |                                                                                |     |                                                                              |       



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ITEM 6: SELECTED FINANCIAL DATA



|                                                                       |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|---------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|Years Ended December 31, (Dollars in Thousands, except per share data) |  | 2004 |           |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|FINANCIAL CONDITION                                                    |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total Assets                                                           |  | $    | 303,470   |   |      | $ | 290,711   |      |  | $ | 263,060   |   |  | $    | 245,594   |   |  | $ | 225,332   |  
|Total Loans, net of allowance                                          |  |      | 213,350   |   |      |   | 188,451   |      |  |   | 168,442   |   |  |      | 150,253   |   |  |   | 147,678   |  
|Total Deposits                                                         |  |      | 261,946   |   |      |   | 257,083   |      |  |   | 231,516   |   |  |      | 219,194   |   |  |   | 200,178   |  
|Stockholders Equity                                                   |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|before FAS 115                                                         |  |      | 25,253    |   |      |   | 24,114    |      |  |   | 23,132    |   |  |      | 22,070    |   |  |   | 21,546    |  
|after FAS 115                                                          |  |      | 25,820    |   |      |   | 25,078    |      |  |   | 24,757    |   |  |      | 22,617    |   |  |   | 21,287    |  
|Average Assets                                                         |  |      | 298,825   |   |      |   | 278,887   |      |  |   | 252,001   |   |  |      | 228,412   |   |  |   | 212,916   |  
|Average Loans, net of allowance                                        |  |      | 203,509   |   |      |   | 172,923   |      |  |   | 166,313   |   |  |      | 150,193   |   |  |   | 140,596   |  
|Average Deposits                                                       |  |      | 261,782   |   |      |   | 245,799   |      |  |   | 229,379   |   |  |      | 202,223   |   |  |   | 183,791   |  
|Average Equity, after FAS 115                                          |  |      | 25,521    |   |      |   | 25,420    |      |  |   | 23,687    |   |  |      | 22,215    |   |  |   | 20,115    |  
|Average shares outstanding                                             |  |      | 2,337,788 |   |      |   | 2,313,596 |      |  |   | 2,301,364 |   |  |      | 2,310,522 |   |  |   | 2,318,698 |  
|Average Diluted shares outstanding                                     |  |      | 2,356,598 |   |      |   | 2,338,587 |      |  |   | 2,309,959 |   |  |      | 2,344,806 |   |  |   | 2,362,404 |  
|                                                                       |  |      |           |   |     
|RESULTS OF OPERATIONS                                                  |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Interest Income                                                        |  | $    | 14,085    |   |      | $ | 13,329    |      |  | $ | 14,144    |   |  | $    | 15,442    |   |  | $ | 15,010    |  
|Interest Expense                                                       |  |      | 4,310     |   |      |   | 4,766     |      |  |   | 5,391     |   |  |      | 7,321     |   |  |   | 8,303     |  
|Net Interest Income                                                    |  |      | 9,775     |   |      |   | 8,563     |      |  |   | 8,753     |   |  |      | 8,121     |   |  |   | 6,707     |  
|Provision for Loan Losses                                              |  |      | 300       |   |      |   | 312       |      |  |   | 471       |   |  |      | 325       |   |  |   | 250       |  
|Net Interest Income after Provision                                    |  |      | 9,475     |   |      |   | 8,251     |      |  |   | 8,282     |   |  |      | 7,796     |   |  |   | 6,457     |  
|Gain/(Loss) on Sales of Investments                                    |  |      | 246       |   |      |   | 371       |      |  |   | 3         |   |  |      | 22        |   |  |   | 54        |  
|Non-interest Income net of Securities Gains                            |  |      | 2,544     |   |      |   | 2,589     |      |  |   | 2,088     |   |  |      | 2,063     |   |  |   | 1,696     |  
|Non-interest Expense                                                   |  |      | 9,323     |   |      |   | 8,536     |      |  |   | 7,203     |   |  |      | 7,043     |   |  |   | 6,020     |  
|Income before Taxes                                                    |  |      | 2,941     |   |      |   | 2,675     |      |  |   | 3,170     |   |  |      | 2,839     |   |  |   | 2,187     |  
|Income Taxes                                                           |  |      | 760       |   |      |   | 661       |      |  |   | 869       |   |  |      | 830       |   |  |   | 574       |  
|Net Income                                                             |  |      | 2,181     |   |      |   | 2,013     |      |  |   | 2,301     |   |  |      | 2,009     |   |  |   | 1,613     |  
|                                                                       |  |      |           |   |     
|PER SHARE DATA                                                         |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic Earnings per share (EPS)                                         |  | $    | 0.93      |   |      | $ | 0.87      |      |  | $ | 1.00      |   |  | $    | 0.87      |   |  | $ | 0.70      |  
|Diluted Earnings per share (EPS)                                       |  |      | 0.93      |   |      |   | 0.86      |      |  | $ | 0.99      |   |  |      | 0.86      |   |  |   | 0.69      |  
|Cash Dividends per share                                               |  |      | 0.605     |   |      |   | 0.570     |      |  |   | 0.500     |   |  |      | 0.470     |   |  |   | 0.430     |  
|Book Value per share                                                   |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|before FAS 115                                                         |  |      | 10.73     |   |      |   | 10.37     |      |  |   | 10.03     |   |  |      | 9.57      |   |  |   | 9.27      |  
|after FAS 115                                                          |  |      | 10.97     |   |      |   | 10.78     |      |  |   | 10.73     |   |  |      | 9.81      |   |  |   | 9.16      |  
|                                                                       |  |      |           |   |     
|RATIOS                                                                 |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total Capital to Risk Weighted Assets                                  |  |      | 11.2      | % |      |   | 12.1      | %    |  |   | 12.5      | % |  |      | 13.3      | % |  |   | 13.6      | %
|Tier 1 Capital to Risk Weighted Assets                                 |  |      | 10.3      | % |      |   | 11.1      | %    |  |   | 11.5      | % |  |      | 12.3      | % |  |   | 12.7      | %
|Leverage Ratio                                                         |  |      | 7.4       | % |      |   | 7.3       | %    |  |   | 7.9       | % |  |      | 8.1       | % |  |   | 8.3       | %
|Return on Average Assets                                               |  |      | 0.7       | % |      |   | 0.7       | %    |  |   | 0.9       | % |  |      | 0.9       | % |  |   | 0.8       | %
|Return on Average Equity                                               |  |      | 8.5       | % |      |   | 7.9       | %    |  |   | 9.7       | % |  |      | 9.0       | % |  |   | 8.0       | %
|Loan Loss Reserve to Loans                                             |  |      | 0.9       | % |      |   | 1.0       | %    |  |   | 1.0       | % |  |      | 1.0       | % |  |   | 0.9       | %
|Dividends paid as a percent of Net Income                              |  |      | 64.8      | % |      |   | 65.5      | %    |  |   | 50.0      | % |  |      | 53.6      | % |  |   | 61.8      | %
|Average Equity as a percent of Average Assets                          |  |      | 8.5       | % |      |   | 9.1       | %    |  |   | 9.4       | % |  |      | 9.7       | % |  |   | 9.4       | %
|                                                                       |  |      |           |   |     
|GROWTH RATES                                                           |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Year end Assets                                                        |  |      | 4.4       | % |      |   | 10.5      | %    |  |   | 7.1       | % |  |      | 9.0       | % |  |   | 12.8      | %
|Year end Loans                                                         |  |      | 13.2      | % |      |   | 11.9      | %    |  |   | 12.1      | % |  |      | 1.7       | % |  |   | 13.2      | %
|Year end Deposits                                                      |  |      | 1.9       | % |      |   | 11.0      | %    |  |   | 5.6       | % |  |      | 9.5       | % |  |   | 12.6      | %
|Year end Equity                                                        |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|before FAS 115                                                         |  |      | 4.7       | % |      |   | 4.2       | %    |  |   | 4.8       | % |  |      | 2.4       | % |  |   | 1.9       | %
|after FAS 115                                                          |  |      | 3.0       | % |      |   | 1.3       | %    |  |   | 9.5       | % |  |      | 6.2       | % |  |   | 8.0       | %
|Average Assets                                                         |  |      | 7.4       | % |      |   | 10.4      | %    |  |   | 10.3      | % |  |      | 7.3       | % |  |   | 7.2       | %
|Average Loans, net of allowance                                        |  |      | 17.7      | % |      |   | 4.0       | %    |  |   | 10.7      | % |  |      | 6.8       | % |  |   | 18.3      | %
|Average Deposits                                                       |  |      | 6.5       | % |      |   | 7.2       | %    |  |   | 13.4      | % |  |      | 10.0      | % |  |   | 4.4       | %
|Average Equity                                                         |  |      | 2.4       | % |      |   | 7.3       | %    |  |   | 6.6       | % |  |      | 10.4      | % |  |   | 0.5       | %
|Net Income                                                             |  |      | 8.4       | % |      |   | -12.5     | %    |  |   | 14.5      | % |  |      | 24.6      | % |  |   | -25.9     | %
|Cash Dividends declared                                                |  |      | 7.3       | % |      |   | 14.0      | %    |  |   | 7.4       | % |  |      | 8.3       | % |  |   | 10.2      | %
|Book Value                                                             |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|before FAS 115                                                         |  |      | 3.5       | % |      |   | 3.3       | %    |  |   | 4.8       | % |  |      | 3.2       | % |  |   | 2.2       | %
|after FAS 115                                                          |  |      | 1.8       | % |      |   | 0.5       | %    |  |   | 9.4       | % |  |      | 7.0       | % |  |   | 8.3       | %



Note: All per-share data is
adjusted to reflect a 2-for-1 split on June 7, 2002.



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ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of Bay
Banks of Virginia and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary
Data, in this Form 10-K.



CRITICAL ACCOUNTING POLICIES



GENERAL. The Companys financial statements are prepared in accordance
with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of
transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss
factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable
method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.



ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based
on two basic principles of accounting: (1) Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (2)
SFAS No. 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 use of these values is inherently subjective and our actual losses could be greater or less than the estimates.



The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Managements periodic evaluation of
the adequacy of the allowance is based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, and current
economic conditions.



OVERVIEW



2004 Compared to 2003



Bay Banks of Virginia, Inc. recorded earnings for 2004 of $2,181,360, or $.93 per share basic and $.93 per share on a
diluted basis, as compared to 2003 earnings of $2,013,185 and $.87 per share basic and $.86 per share on a diluted basis. This is an increase in net income of 8.4% as compared to year end 2003. Net interest income for 2004 increased to $9,774,657,
up 14.1% as compared to $8,562,995 for 2003. Non-interest income for 2004, before net securities gains, decreased to $2,543,569 as compared to 2003 non-interest income, before net securities gains, of $2,588,894, a decrease of 1.7%. Non-interest
expenses increased to $9,322,862, up 9.2% over 2003 non-interest expenses of $8,536,017.



Performance as measured by the Companys return on average assets (ROA) was .73% for the year ended December 31, 2004 compared to .72% for 2003. Performance as measured by return on average equity
(ROE) was 8.55% for the year ended December 31, 2004, compared to 7.92% for 2003.



2003 Compared to 2002



Earnings for the Company were $2,013,185 for 2003, down 12.5% as compared to 2002 earnings of $2,301,401. The 2003 basic earnings per share were $.87 and diluted earnings per share were $.86, as compared to 2002 basic earnings per share of
$1.00 and diluted earnings per share of $.99. Net interest income was $8,562,995 for 2003 as compared to $8,753,103 for 2002, a decrease of 2.2%. Non-interest income before net securities gains for 2003 was $2,588,894, up 23.9% over 2002
non-interest income before net securities gains of $2,088,624. Non-interest expenses for 2003 were $8,536,017, up 18.5% as compared to 2002 non-interest expenses of $7,202,587.



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Performance as measured by the Companys ROA was .72% for the year ended December 31, 2003, compared
to .91% for 2002. Performance as measured by ROE was 7.92% for the year ended December 31, 2003, compared to 9.72% for 2002.



Return on Equity and Assets



|                                   |  |      |             |   |      |   |             |      |  |   |             |  
|---------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                   |  |      |            
|Years Ended December 31,           |  | 2004 |             |   | 2003 |   |             | 2002 | 
|Net Income                         |  | $    | 2,181,360   |   |      | $ | 2,013,185   |      |  | $ | 2,301,401   |  
|Average Total Assets               |  | $    | 298,825,499 |   |      | $ | 278,887,000 |      |  | $ | 252,001,000 |  
|Return on Assets                   |  |      | 0.73        | % |      |   | 0.72        | %    |  |   | 0.90        | %
|                                   |  |      |            
|Average Equity                     |  | $    | 25,521,263  |   |      | $ | 25,420,209  |      |  | $ | 23,687,000  |  
|Return on Equity                   |  |      | 8.55        | % |      |   | 7.92        | %    |  |   | 9.70        | %
|                                   |  |      |            
|Dividends declared per share       |  | $    | 0.605       |   |      | $ | 0.570       |      |  | $ | 0.500       |  
|Average Shares Outstanding         |  |      | 2,337,788   |   |      |   | 2,313,596   |      |  |   | 2,301,364   |  
|Average Diluted Shares Outstanding |  |      | 2,356,598   |   |      |   | 2,338,587   |      |  |   | 2,309,959   |  
|Net Income per Share               |  | $    | 0.93        |   |      | $ | 0.87        |      |  | $ | 1.00        |  
|Net Income per Diluted Share       |  | $    | 0.93        |   |      | $ | 0.86        |      |  | $ | 0.99        |  
|Dividend Payout Ratio              |  |      | 64.8        | % |      |   | 65.5        | %    |  |   | 50.0        | %
|Equity to Assets Ratio             |  |      | 8.5         | % |      |   | 9.1         | %    |  |   | 9.4         | %



RESULTS OF OPERATIONS



Net Interest Income



The principal source of earnings for the Company is net interest income. Net
interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest earning assets. Changes in the volume and mix of interest earning assets and
interest bearing liabilities, the associated yields and rates, and the volume of non-performing assets have a significant impact on net interest income, the net interest margin, and net income.



Net interest income, on a fully tax equivalent basis which reflects the tax
benefits of nontaxable interest income, was $10.2 million in 2004, $9.0 million in 2003 and $9.1 million in 2002. This represents an increase in net interest income of 13.5% for 2004 as compared to 2003 and a nominal decrease of 1.3% for 2003
compared to 2002. The interest rate spread on average earning assets and liabilities was 3.37%, 3.24% and 3.56 % for 2004, 2003, and 2002 respectively.



The Companys net interest margin increased to 3.67 % for 2004 as compared to 3.53% for 2003. The net interest margin was 3.93% for 2002. The yield
on earning assets decreased to 5.22% for 2004 as compared to 5.41% and 6.27% for years 2003 and 2002, respectively. The cost of interest bearing liabilities decreased to 1.85% for 2004 as compared to 2.17% and 2.71% for years 2003 and 2002,
respectively. Average earning assets increased 9.4% to $277.5 million for 2004 as compared to $253.6 million for 2003. Average earning assets were $230.7 million for 2002. Average interest bearing liabilities increased 6.2% to $233.5 million at year
end 2004 as compared to $220.0 million at year end 2003. Average interest bearing liabilities were $199.2 million at year end 2002.



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Average Balances, Income and Expenses, Yields and Rates

Years Ended December 31,



(Fully taxable equivalent basis)



|                                   |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|---------------------------------- |  | -------------- | ------- | -------------- | ---- | ---------- |  | ---- | -------------- |  | -------------- | ------- | ---------- | - | ------ | -------------- | ---- | -------------- |  | ---------- | ------- |  | - | ------ |  | ---- | -
|                                   |  | 2004           |         |                | 2003 |            |  | 2002 |               
|                                   |  | AverageBalance |         | Income/Expense |      | Yield/Rate |  |      | AverageBalance |  | Income/Expense |         | Yield/Rate |   |        | AverageBalance |      | Income/Expense |  | Yield/Rate |        
|INTEREST EARNING ASSETS:           |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|Taxable Investments                |  | $              | 37,903  |                | $    | 1,338      |  | 3.53 | %              |  | $              | 32,269  |            | $ | 1,578  |                | 4.89 | %              |  | $          | 34,404  |  | $ | 2,023  |  | 5.88 | %
|Tax-Exempt Investments (1)         |  |                | 20,356  |                |      | 1,176      |  | 5.78 | %              |  |                | 19,335  |            |   | 1,159  |                | 6.00 | %              |  |            | 14,714  |  |   | 946    |  | 6.43 | %
|                                   |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|Total Investments                  |  |                | 58,259  |                |      | 2,514      |  | 4.31 | %              |  |                | 51,604  |            |   | 2,737  |                | 5.30 | %              |  |            | 49,118  |  |   | 2,969  |  | 6.04 | %
|                                   |  |                |         |                |      |            |  |      |               
|Gross Loans (2)                    |  |                | 205,473 |                |      | 11,787     |  | 5.74 | %              |  |                | 174,715 |            |   | 10,694 |                | 6.12 | %              |  |            | 159,951 |  |   | 11,150 |  | 6.97 | %
|Interest-bearing Deposits          |  |                | 123     |                |      | 2          |  | 1.42 | %              |  |                | 162     |            |   | 1      |                | 0.46 | %              |  |            | 200     |  |   | 1      |  | 0.55 | %
|Fed Funds Sold                     |  |                | 13,682  |                |      | 183        |  | 1.34 | %              |  |                | 27,120  |            |   | 291    |                | 1.07 | %              |  |            | 21,479  |  |   | 345    |  | 1.61 | %
|                                   |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|TOTAL INTEREST EARNING ASSETS      |  | $              | 277,537 |                | $    | 14,486     |  | 5.22 | %              |  | $              | 253,601 |            | $ | 13,723 |                | 5.41 | %              |  | $          | 230,748 |  | $ | 14,464 |  | 6.27 | %
|                                   |  |                |         |                |      |            |  |      |               
|INTEREST-BEARING LIABILITIES:      |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|Savings Deposits                   |  | $              | 66,724  |                | $    | 1,031      |  | 1.55 | %              |  | $              | 62,258  |            | $ | 1,056  |                | 1.70 | %              |  | $          | 59,506  |  | $ | 1,326  |  | 2.23 | %
|NOW Deposits                       |  |                | 46,248  |                |      | 230        |  | 0.50 | %              |  |                | 41,582  |            |   | 307    |                | 0.74 | %              |  |            | 33,069  |  |   | 420    |  | 1.27 | %
|Time Deposits => $100,000          |  |                | 31,051  |                |      | 989        |  | 3.19 | %              |  |                | 27,187  |            |   | 971    |                | 3.57 | %              |  |            | 22,721  |  |   | 890    |  | 3.91 | %
|Time Deposits < $100,000           |  |                | 62,616  |                |      | 1,922      |  | 3.07 | %              |  |                | 67,169  |            |   | 2,238  |                | 3.33 | %              |  |            | 67,730  |  |   | 2,519  |  | 3.72 | %
|Money Market Deposit Accounts      |  |                | 17,014  |                |      | 62         |  | 0.36 | %              |  |                | 16,650  |            |   | 143    |                | 0.86 | %              |  |            | 12,739  |  |   | 202    |  | 1.59 | %
|                                   |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|Total Deposits                     |  | $              | 223,653 |                | $    | 4,234      |  | 1.89 | %              |  | $              | 214,846 |            | $ | 4,715  |                | 2.19 | %              |  | $          | 195,765 |  | $ | 5,357  |  | 2.74 | %
|                                   |  |                |         |                |      |            |  |      |               
|Fed Funds Purchased                |  |                | 3       |                |      |           |  | 1.00 | %              |  |                |        |            |   |       |                | 0.00 | %              |  |            |        |  |   |       |  | 0.00 | %
|Securities Sold to Repurchase      |  |                | 5,105   |                |      | 26         |  | 0.51 | %              |  |                | 5,128   |            |   | 51     |                | 1.00 | %              |  |            | 3,406   |  |   | 34     |  | 1.00 | %
|FHLB Advance                       |  |                | 4,754   |                |      | 50         |  | 1.05 | %              |  |                |        |            |   |       |                | 0.00 | %              |  |            |        |  |   |       |  | 0.00 | %
|                                   |  |                |         |                |      |            |  |      |                |  |                |         |            |   |        |                |      |                |  |            |         |  |   |        |  |      |  
|TOTAL INTEREST-BEARING LIABILITIES |  | $              | 233,515 |                | $    | 4,310      |  | 1.85 | %              |  | $              | 219,974 |            | $ | 4,766  |                | 2.17 | %              |  | $          | 199,171 |  | $ | 5,391  |  | 2.71 | %
|                                   |  |                |         |                |      |            |  |      |               
|Net Yield on Earning Assets        |  |                |         |                | $    | 10,176     |  | 3.67 | %              |  |                |         |            | $ | 8,957  |                | 3.53 | %              |  |            |         |  | $ | 9,072  |  | 3.93 | %
|Net Interest Rate Spread           |  |                |         |                |      |            |  | 3.37 | %              |  |                |         |            |   |        |                | 3.24 | %              |  |            |         |  |   |        |  | 3.56 | %

---

Notes:



|(1) | - Income and yield is tax-equivalent assuming a federal tax rate of 34%
|--- | -----------------------------------------------------------------------

|(2) | - Includes Visa credit card program and nonaccrual loans.
|--- | ---------------------------------------------------------



The Companys balance sheet expanded at a rate of 4.4% during 2004 with year end loans increasing by 13.2% and year end deposits increasing by 1.9%
as compared to year end 2003 balances. Loan growth was primarily composed of single family residential loans with adjustment periods of one, three, or five years and variable rate commercial loans that are re-priced with adjustments in the prime
rate. Deposit growth was primarily in savings, non-interest bearing and interest bearing transaction accounts. Interest bearing transaction accounts generally re-price slowly and at the discretion of Company management. The result was that the
Company shifted its interest rate sensitivity position from liability sensitive to slightly asset sensitive. Being asset sensitive is favorable in a rising rate environment because assets will re-price faster than liabilities. The Company began to
realize the benefit of asset sensitivity as short term interest rates began to increase during the second half of 2004.



During 2003, the Company experienced significant re-pricing of its loan portfolio due to record levels of loan refinancing. The yield on total earning
assets declined to 5.41% in 2003 from 6.27% in 2002, a reduction of 13.7%. Refinancing continued through the first quarter of 2004, but to a much lesser extent than during 2003. Nevertheless, the impact of refinancing and a flattening yield curve
further compressed the yield on total interest earning assets to 5.22% in 2004 from 5.41% in 2003, a reduction of 3.5%.



Downward pressure on the earning asset yield was slowed through increases in loan offering rates and by culling low-yielding bonds within the investment
portfolio. The market place continues to experience significant sales of existing homes and new construction. The Company has remained competitive in its loan pricing, but has systematically been able to increase loan offering rates as the
marketplace allows.



During 2004, the Company was able to
reduce interest expense through increases in balances of non-interest bearing deposits and re-pricing of time and other deposits. Deposits grew by less than 2% as compared to 2003, however, the mix of deposits changed dramatically. Non-interest
bearing deposits grew by 13.4% as compared to year end 2003 and savings and interest bearing deposit accounts grew by 6.2%. This growth in



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deposits allowed the Company to reduce its total yield on deposits to 1.89% from 2.19% for the prior year. Coupled with
controlling the pressure on asset yields and increased loan volume, this provided an additional $1.2 million in net interest income.



Volume and Rate Analysis of Changes in Net Interest Income



|                                            |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  
|------------------------------------------- |  | -------------------------------------- | ----- | - | -------------------------------------- | - | ------ | ----- |  | - | ------ | - |  | ---- | ----- | - | ----- | - | ------ | - |  | - | ---- | -
|Years Ended December 31,                    |  | 2004 vs. 2003                          |       |   | 2003 vs. 2002                          |  
|                                            |  | Increase (Decrease) Due to Changes in: |       |   | Increase (Decrease) Due to Changes in: |  
|(Dollars in Thousands)                      |  | Volume                                 |       |   | Rate                                   |   |        | Total |  |   | Volume |   |  | Rate |       |   | Total |  
|Earning Assets:                             |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  
|Taxable securities                          |  | $                                      | 246   |   |                                        | $ | (486   | )     |  | $ | (240   | ) |  | $    | (120  | ) |       | $ | (325   | ) |  | $ | (445 | )
|Tax exempt securities                       |  |                                        | 60    |   |                                        |   | (43    | )     |  |   | 17     |   |  |      | 271   |   |       |   | (58    | ) |  |   | 213  |  
|Loans                                       |  |                                        | 1,796 |   |                                        |   | (703   | )     |  |   | 1,093  |   |  |      | 975   |   |       |   | (1,431 | ) |  |   | (456 | )
|Interest-bearing deposits                   |  |                                        |      |   |                                        |   | 1      |       |  |   | 1      |   |  |      |      |   |       |   |       |   |  |   |     |  
|Federal funds sold                          |  |                                        | (168  | ) |                                        |   | 60     |       |  |   | (108   | ) |  |      | 79    |   |       |   | (133   | ) |  |   | (54  | )
|                                            |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  
|Total earning assets                        |  | $                                      | 1,934 |   |                                        | $ | (1,171 | )     |  | $ | 763    |   |  | $    | 1,205 |   |       | $ | (1,947 | ) |  | $ | (742 | )
|                                            |  |                                        |       |   |                                        |  
|Interest-Bearing Liabilities:               |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  
|Interest checking                           |  |                                        | 32    |   |                                        |   | (109   | )     |  |   | (77    | ) |  | $    | 90    |   |       | $ | (203   | ) |  | $ | (113 | )
|Savings deposits                            |  |                                        | 73    |   |                                        |   | (98    | )     |  |   | (25    | ) |  |      | 58    |   |       |   | (328   | ) |  |   | (270 | )
|Money market accounts                       |  |                                        | 3     |   |                                        |   | (84    | )     |  |   | (81    | ) |  |      | 51    |   |       |   | (110   | ) |  |   | (59  | )
|Certificates of deposit < $100,000          |  |                                        | (147  | ) |                                        |   | (162   | )     |  |   | (309   | ) |  |      | (32   | ) |       |   | (249   | ) |  |   | (281 | )
|Certificates of deposit >= $100,000         |  |                                        | 129   |   |                                        |   | (111   | )     |  |   | 18     |   |  |      | 163   |   |       |   | (82    | ) |  |   | 81   |  
|Securities sold under repurchase agreements |  |                                        |      |   |                                        |   | (25    | )     |  |   | (25    | ) |  |      | 17    |   |       |   |       |   |  |   | 17   |  
|FHLB advance                                |  |                                        | 50    |   |                                        |   |       |       |  |   | 50     |   |  |      |      |   |       |   |       |   |  |   |     |  
|                                            |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  
|Total interest-bearing liabilities          |  | $                                      | 140   |   |                                        | $ | (589   | )     |  | $ | (449   | ) |  | $    | 347   |   |       | $ | (972   | ) |  | $ | (625 | )
|                                            |  |                                        |       |   |                                        |  
|Change in net interest income               |  | $                                      | 1,794 |   |                                        | $ | (582   | )     |  | $ | 1,212  |   |  | $    | 858   |   |       | $ | (975   | ) |  | $ | (117 | )
|                                            |  |                                        |       |   |                                        |   |        |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |      |  

---

Notes:

|(2) | Income and yields are reported on a tax-equivalent basis, assuming a federal tax rate of 34%.
|--- | ---------------------------------------------------------------------------------------------



Interest Sensitivity



Earnings performance and the maintenance of sufficient liquidity depend heavily on efficient management of the interest sensitivity gap. The interest
sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. The interest sensitivity gap can be managed by re-pricing assets or liabilities, which are variable rate instruments,
by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. By matching the volume of assets and liabilities that mature in the same time interval, the Company can insulate against
interest rate risk and minimize the impact of rising or falling rates.



The Company employs a variety of measurement techniques to identify and manage its exposure to changing interest rates and subsequent changes in liquidity. The Company utilizes a simulation model that estimates interest income volatility
and interest rate risk. In addition, the Company utilizes an Asset Liability Committee (the ALCO) composed of appointed members from management and the Board of Directors. Through the use of simulation, the ALCO estimates the overall
magnitude of interest rate risk and then formulates policy with which to manage asset growth and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on managements expectations regarding future
interest rate movements, economic conditions both locally and nationally, and other business and risk factors.



Earnings Simulation Analysis



The Company employs a simulation model that captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the balance sheet. The method is subject to the
accuracy of the assumptions that underlie the process, but it provides a valuable analysis of the sensitivity of earnings to changes in interest rates.



13



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##### Table of Contents

The following table reflects the interest rate sensitivity, at twenty-four months, on net interest income
for the Company using different rate scenarios.



|                     |  |                                 |  
|-------------------- |  | ------------------------------- | -
|Change in Prime Rate |  | % Change in Net Interest Income |  
|+ 200 basis points   |  | 6.37                            | %
|Flat                 |  | 0                               |  
|- 100 basis points   |  | -4.12                           | %



Unlike most industrial
companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institutions performance than do general levels of inflation.
Interest rates do not necessarily move in the same magnitude as the prices of goods and services. Another impact of inflation is on non-interest expenses, which tend to rise during periods of general inflation. The values of real estate held as
collateral by the Company for loans and foreclosed property could be affected by inflation or changing prices due to market conditions.



Management believes the most significant impact on financial results is the Companys ability to react to changes in interest rates. Management
attempts to maintain a favorable position between rate-sensitive assets and rate-sensitive liabilities in order to protect against wide interest rate fluctuations.



Economic Value of Equity Simulation



Economic value of equity simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments.
Economic values are calculated based on discounted cash flow analysis with the net economic value of equity being the fair value of all assets minus the fair value of all liabilities. The change in economic value over varying rate environments is an
indication of long term interest rate sensitivity of the balance sheet. The following chart reflects the change in the economic value of equity over varying rate environments:



|                     |  |                                                 |  |                                                         
|-------------------- |  | ----------------------------------------------- |  | --------------------------------------------------------
|Change in Prime Rate |  | Economic Value of Equity (Dollars in Thousands) |  | Change in Economic Value of Equity(Dollars in Thousands)
|+ 200 basis points   |  | 54,412                                          |  | 13,088                                                  
|+100 basis points    |  | 48,317                                          |  | 6,994                                                   
|Flat                 |  | 41,324                                          |  | 0                                                       
|- 100 basis points   |  | 33,224                                          |  | -8,100                                                  
|-200 basis points    |  | 23,868                                          |  | -17,456                                                 



Non-Interest Income



Total non-interest income decreased to $2.8 million in 2004 as compared
to $3.0 million in 2003, a reduction of 5.7%. Non-interest income in 2002 was $2.1 million. The decrease in non-interest income was due to declines in secondary market lending fees, gains on sale of other real estate, and other income. For 2004,
secondary market lending fees totaled $184 thousand as compared to $363 thousand for 2003. Gains on sale of other real estate were $14 thousand as compared to $192 thousand for the prior year, and other income was $127 thousand as compared to $151
for the prior year.



Income improved in fiduciary income,
service charges on deposit accounts, and other service charges. Fiduciary income increased to $665 thousand from $622 for 2003, service charges on deposits increased to $669 thousand from $599 thousand, and other service charges increased to $885
thousand from $663 thousand.



The two most significantly
declining non-interest income items were secondary market lending fees and gains on sale of other real estate. Secondary market lending fees declined during 2004 due to the ability of the Companys subsidiary bank to remain competitively priced
to loan rates offered in the secondary market. These loans are sold into the secondary market with servicing released. As noted above, loan growth was strong for the Company during 2004 and there was less demand for secondary market products as a
result. Gains on sale of other real estate are dependent upon the volume and nature of the properties that the Company buys back through foreclosure. During 2004, the number and value of foreclosed properties was lower than 2003 which resulted in
fewer income dollars from the sale of those foreclosed properties.



14



---

##### Table of Contents

Non-Interest Expense



During 2004, total non-interest expenses increased 9.2% to $9.3 million from $8.5 million in 2003 and $7.2 million in 2002. Non-interest expenses are
composed of salaries and benefits, occupancy expense, state bank franchise tax, Visa Program expense, telephone expense and other operating expenses.



Salary and benefit expense continues to be the major component of non-interest expenses. Salary and benefits expense increased 16.8% to $5.1 million in
2004, as compared to $4.4 million in 2003 and $3.6 million in 2002. The benefits component for 2004 increased 10.2% over 2003. If the effects of SFAS No. 91 loan origination setup credits, which reduce salary expense, are removed, salary and benefit
expense for 2004 increased only 8.4% over 2003.



Occupancy
expense increased 3.2% to $1.4 million during 2004 as compared to 2003. Occupancy expense was $884 thousand for 2002 State bank franchise tax expense declined 5.0% to $202 thousand as compared to $212 thousand for 2003. Expenses related to the Visa
Program increased by 14.2% to $422 thousand as compared to $369 thousand for 2003. Telephone expense declined 10.3% to $167 thousand as compared to $187 thousand for 2003. Other expense declined by 0.8% to $2.0 million as compared to 2003.



Management continues its program of identifying variable
expenses that can be reduced or eliminated. Net of salary and benefit expense, non-interest expenses increased by $50 thousand, or 1.2% during 2004, as compared to 2003.



Income Taxes



Income tax expense in 2004 was $760 thousand, $661 thousand in 2003 and $870 thousand in 2002. Income tax expense corresponds to an effective rate of
25.8%, 24.7% and 27.4% for the three years ended December 31, 2004, 2003, and 2002, respectively. Note 12 to the Consolidated Financial Statements provide a reconciliation between the amounts of income tax expense computed using the federal
statutory income tax rate and actual income tax expense. Also included in Note 12 to the Consolidated Financial Statements is information regarding deferred taxes for 2004, 2003, and 2002.



Loans



Loan production remained strong during 2004 as new loan volumes were only marginally impacted by loan prepayments. During
2004, as shown below, loans increased by 13.3% to $214.1 million as compared to 2003 balances of $189.0 million. Loans secured by real estate represent the largest category, comprising 84.7% of the loan portfolio at December 31, 2004. Of these
balances, 1-4 family residential, not including home equity lines, was 48.0% of total loans, down from 54.7% at year end 2003. Commercial loan balances decreased 13.3% to $21.5 million from $24.8 million at year end 2003. Commercial loan balances
were 10.1% of total loans at year end 2004 as compared to 13.1% at year end 2003. Consumer installment loans decreased 6.2% to $9.9 million from $10.6 million at year end 2003.



Types of Loans



|                                                |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        
|----------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|Years ended December 31, (Dollars
in Thousands) |  | 2004 |         | 2003 |   | 2002    |  | 2001 |         | 2000
|Commercial                                      |  | $    | 21,519  |      | $ | 24,819  |  | $    | 16,763  |      | $ | 11,399  |  | $ | 11,279 
|Real Estate  Construction                      |  | $    | 31,184  |      | $ | 24,959  |  | $    | 19,131  |      | $ | 13,914  |  | $ | 4,591  
|Real Estate  Mortgage                          |  | $    | 150,129 |      | $ | 127,577 |  | $    | 121,213 |      | $ | 115,029 |  | $ | 111,957
|Installment and Other (includes Visa program)   |  | $    | 11,266  |      | $ | 11,602  |  | $    | 11,795  |      | $ | 10,560  |  | $ | 20,590 
|                                                |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        
|Total                                           |  | $    | 214,098 |      | $ | 188,957 |  | $    | 168,902 |      | $ | 150,903 |  | $ | 148,417
|                                                |  |      |         |      |   |         |  |      |         |      |   |         |  |   |        



Notes:

Deferred loan costs and fees not included.

Allowance for loan losses not
included.



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##### Table of Contents

|                                                                 |  |                  |        |                   |   |                 |  |               |        |            |   |               |  |   |        |  |  
|---------------------------------------------------------------- |  | ---------------- | ------ | ----------------- | - | --------------- |  | ------------- | ------ | ---------- | - | ------------- |  | - | ------ |  | -
|Loan Maturity Schedule of Selected Loans as of December 31, 2004
|                                                                 |  | One Year or Less |        | One to Five Years |   | Over Five Years
|(Dollars in Thousands)                                           |  | Fixed Rate       |        | Variable Rate     |   | Fixed Rate      |  | Variable Rate |        | Fixed Rate |   | Variable Rate
|Commercial                                                       |  | $                | 1,802  |                   | $ | 13,585          |  | $             | 2,701  |            |   |              |  | $ | 3,432  |  | 
|Real Estate - Construction                                       |  | $                | 12,603 |                   | $ | 4,733           |  | $             | 12,134 |            | $ | 65            |  | $ | 1,650  |  | 
|Real Estate  Mortgage                                           |  | $                | 2,896  |                   | $ | 64,790          |  | $             | 15,392 |            | $ | 53,911        |  | $ | 13,140 |  | 
|Installment and Other                                            |  | $                | 2,522  |                   | $ | 1,602           |  | $             | 6,665  |            |   |              |  | $ | 477    |  | 
|                                                                 |  |                  |        |                   |   |                 |  |               |        |            |   |               |  |   |        |  |  
|Totals                                                           |  | $                | 19,823 |                   | $ | 84,710          |  | $             | 36,892 |            | $ | 53,976        |  | $ | 18,697 |  | 
|                                                                 |  |                  |        |                   |   |                 |  |               |        |            |   |               |  |   |        |  |  



Notes:

Loans with immediate repricing are shown in the One Year or Less category.

Variable rate loans are categorized based on their next repricing date.



Asset Quality-Provision and Allowance for Loan Losses



The provision for loan losses is a charge against earnings that is necessary to maintain the allowance for loan losses at a level consistent with managements evaluation of the loan portfolios inherent
risk. The allowance for loan losses is analyzed for adequacy on a quarterly basis to determine the required amount of provision. A loan-by-loan review is conducted on all classified loans. Inherent losses on these individual loans are determined and
these losses are compared to historical loss data for each loan type. Management then reviews the various analyses and determines the appropriate allowance. As of December 31, 2004, management considered the allowance for loan losses to be a
reasonable estimate of potential loss exposure inherent in the loan portfolio.



Allowance for Loan Losses

Years Ended December 31,



|                                                                                          |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|----------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|(Dollars in Thousands)                                                                    |  | 2004 |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|Balance, beginning of period                                                              |  | $    | 1,902   |   |      | $ | 1,697   |      |  | $ | 1,493   |   |  | $    | 1,370   |   |  | $ | 1,198   |  
|Loans charged off:                                                                        |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Commercial                                                                                |  | $    | (14     | ) |      | $ | (11     | )    |  | $ | (203    | ) |  | $    | (62     | ) |  | $ | (27     | )
|Real estate - construction                                                                |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Real estate - mortgage                                                                    |  | $    | (49     | ) |      | $ | (12     | )    |  | $ | (22     | ) |  | $    | (42     | ) |  | $ | (50     | )
|Installment and other (including Visa program)                                            |  | $    | (139    | ) |      | $ | (97     | )    |  | $ | (64     | ) |  | $    | (117    | ) |  | $ | (17     | )
|                                                                                          |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total charge - offs                                                                       |  | $    | (202    | ) |      | $ | (120    | )    |  | $ | (289    | ) |  | $    | (221    | ) |  | $ | (94     | )
|                                                                                          |  |      |         |   |     
|Recoveries of loans previously charged off:                                               |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Commercial                                                                                |  | $    | 10      |   |      |   |        |      |  | $ | 4       |   |  |      |        |   |  |   |        |  
|Real estate  construction                                                                |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Real estate  mortgage                                                                    |  | $    | 1       |   |      |   |        |      |  | $ | 1       |   |  |      |        |   |  | $ | 7       |  
|Installment and Other (including Visa program)                                            |  | $    | 21      |   |      | $ | 13      |      |  | $ | 17      |   |  | $    | 19      |   |  | $ | 9       |  
|                                                                                          |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total recoveries                                                                          |  | $    | 32      |   |      | $ | 13      |      |  | $ | 22      |   |  | $    | 19      |   |  | $ | 16      |  
|                                                                                          |  |      |         |   |     
|Net charge offs                                                                           |  | $    | (170    | ) |      | $ | (107    | )    |  | $ | (267    | ) |  | $    | (202    | ) |  | $ | (78     | )
|                                                                                          |  |      |         |   |     
|Provision for loan losses                                                                 |  | $    | 300     |   |      | $ | 312     |      |  | $ | 471     |   |  | $    | 325     |   |  | $ | 250     |  
|                                                                                          |  |      |         |   |     
|Balance, end of period                                                                    |  | $    | 2,032   |   |      | $ | 1,902   |      |  | $ | 1,697   |   |  | $    | 1,493   |   |  | $ | 1,370   |  
|                                                                                          |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Average loans outstanding during the period                                               |  | $    | 205,473 |   |      | $ | 174,715 |      |  | $ | 159,951 |   |  | $    | 151,668 |   |  | $ | 142,489 |  
|                                                                                          |  |      |         |   |     
|Ratio of net charge-offs during the period to average loans outstanding during the period |  |      | 0.08    | % |      |   | 0.06    | %    |  |   | 0.17    | % |  |      | 0.13    | % |  |   | 0.05    | %



Management maintains a
list of loans which have a potential weakness that may need special attention. This list is used to monitor such loans and is used in the determination of the sufficiency of the Companys allowance for loan losses. As of December 31, 2004, the
allowance for loan losses was $2.0 million or 0.9% of total loans as compared to $1.9 million or 1.0% for 2003.



16



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##### Table of Contents

Allocation of the Allowance for Loan Losses



|                           |  |                       |       |                    |       |   |                       |   |                    |  |       |                       |  |                    |       |  |                       |   |                    |   |       |                       |       |                    |  |   |       |  |       |  
|-------------------------- |  | --------------------- | ----- | ------------------ | ----- | - | --------------------- | - | ------------------ |  | ----- | --------------------- |  | ------------------ | ----- |  | --------------------- | - | ------------------ | - | ----- | --------------------- | ----- | ------------------ |  | - | ----- |  | ----- | -
|Years Ended December 31,   |  | 2004                  |       |                    |       |   | 2003                  |   |                    |  |       | 2002                  |  |                    |       |  | 2001                  |   |                    |   |       | 2000                  |       |                    | 
|(Dollars in Thousands)     |  | AllocationofAllowance |       | PercentofPortfolio |       |   | AllocationofAllowance |   | PercentofPortfolio |  |       | AllocationofAllowance |  | PercentofPortfolio |       |  | AllocationofAllowance |   | PercentofPortfolio |   |       | AllocationofAllowance |       | PercentofPortfolio | 
|Commercial                 |  | $                     | 1,186 |                    | 10.1  | % |                       | $ | 924                |  | 13.1  | %                     |  | $                  | 822   |  | 9.9                   | % |                    | $ | 237   |                       | 7.5   | %                  |  | $ | 70    |  | 7.6   | %
|Real estate - construction |  | $                     | 108   |                    | 14.6  | % |                       | $ | 83                 |  | 13.2  | %                     |  | $                  | 73    |  | 11.2                  | % |                    | $ | 21    |                       | 9.2   | %                  |  | $ | 22    |  | 3.1   | %
|Real estate - mortgage     |  | $                     | 563   |                    | 70.1  | % |                       | $ | 675                |  | 67.5  | %                     |  | $                  | 674   |  | 71.2                  | % |                    | $ | 1,032 |                       | 75.8  | %                  |  | $ | 1,037 |  | 72.0  | %
|Installment & Other        |  | $                     | 175   |                    | 5.2   | % |                       | $ | 220                |  | 6.2   | %                     |  | $                  | 128   |  | 7.7                   | % |                    | $ | 203   |                       | 7.5   | %                  |  | $ | 241   |  | 17.3  | %
|                           |  |                       |       |                    |       |   |                       |   |                    |  |       |                       |  |                    |       |  |                       |   |                    |   |       |                       |       |                    |  |   |       |  |       |  
|Total                      |  | $                     | 2,032 |                    | 100.0 | % |                       | $ | 1,902              |  | 100.0 | %                     |  | $                  | 1,697 |  | 100.0                 | % |                    | $ | 1,493 |                       | 100.0 | %                  |  | $ | 1,370 |  | 100.0 | %



Nonperforming Assets



As of December 31, 2004, loans upon which the accrual of
interest had been discontinued were $1.3 million. Loans upon which the accrual of interest had been discontinued at year end 2003 were $1.4 million. Potential problem loans totaled approximately $2.4 million on December 31, 2004, compared to
approximately $2.8 million on December 31, 2003. Other real estate owned including foreclosed property, at year end 2004 was $17 thousand as compared to $77 thousand for 2003. After foreclosure, management periodically performs valuations and the
real estate is carried at the lower of carrying amount or fair value less cost to sell. Management expects no losses on the sale of other real estate owned.



Non Performing Assets



|                                                                                                                                          |  |      |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | - |  | ---- | ----- | - |  | - | ----- | -
|Years Ended December 31, (Dollars
in Thousands)                                                                                           |  | 2004 |       |   | 2003 |   |       | 2002 |  |   | 2001  |   |  | 2000 |      
|Non-accrual Loans                                                                                                                         |  | $    | 1,321 |   |      | $ | 1,434 |      |  | $ | 268   |   |  | $    | 163   |   |  | $ | 25    |  
|Restructured Loans                                                                                                                        |  |      |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Foreclosed Properties                                                                                                                     |  | $    | 17    |   |      | $ | 77    |      |  | $ | 580   |   |  | $    | 614   |   |  | $ | 805   |  
|                                                                                                                                          |  |      |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total Non-performing Assets                                                                                                               |  | $    | 1,338 |   |      | $ | 1,511 |      |  | $ | 848   |   |  | $    | 777   |   |  | $ | 830   |  
|                                                                                                                                          |  |      |       |   |     
|Loans past due 90+ days as to principal or interest payments and accruing interest                                                        |  | $    | 314   |   |      | $ | 982   |      |  | $ | 673   |   |  | $    | 825   |   |  | $ | 758   |  
|Allowance for Loan Losses                                                                                                                 |  | $    | 2,032 |   |      | $ | 1,902 |      |  | $ | 1,697 |   |  | $    | 1,493 |   |  | $ | 1,370 |  
|Non-Performing Assets to Total Loans and OREO                                                                                             |  |      | 0.6   | % |      |   | 0.8   | %    |  |   | 0.5   | % |  |      | 0.5   | % |  |   | 0.6   | %
|Allowance to Total Loans and OREO                                                                                                         |  |      | 0.9   | % |      |   | 1.0   | %    |  |   | 1.0   | % |  |      | 1.0   | % |  |   | 0.9   | %
|Allowance to Non-Performing Assets                                                                                                        |  |      | 1.52  |   |      |   | 1.26  |      |  |   | 2.00  |   |  |      | 1.92  |   |  |   | 1.65  |  
|For non-accrual and restructured loans, Gross interest income which would have been recorded under original loan terms for the year
ended |  | $    | 72    |   |      | $ | 52    |      |  | $ | 10    |   |  | $    | 13    |   |  | $ | 2     |  
|                                                                                                                                          |  |      |       |   |     
|For non-accrual and restructured loans, Gross interest income recorded for the year ended                                                 |  | $    | 3     |   |      | $ | 62    |      |  | $ | 10    |   |  | $    | 13    |   |  | $ | 2     |  



Securities



As of December 31, 2004, investment securities totaled $52.3 million, a
decrease of 21.3% as compared to 2003 year end balances of $66.5 million. During 2003, the Company purchased approximately $15 million in auction rate securities as an alternative to Federal Funds Sold. The sale of most of the auction rate
securities comprised the majority of the reduction in investment volumes.



Investments by Type



|                                                    |  |      |        |      |   |        |  |   |       
|--------------------------------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------
|Years Ended December 31, (Book
Values in Thousands) |  | 2004 |        | 2003 |   | 2002  
|U.S. Government Agencies                            |  | $    | 12,179 |      | $ | 20,644 |  | $ | 7,511 
|State and Municipal Governments                     |  |      | 30,535 |      |   | 36,499 |  |   | 25,712
|Other Securities                                    |  |      | 8,773  |      |   | 7,889  |  |   | 14,466
|                                                    |  |      |        |      |   |        |  |   |       
|Total                                               |  | $    | 51,487 |      | $ | 65,032 |  | $ | 47,690



17



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Available for sale securities are carried at fair market value, with after-tax market value gains or
losses being disclosed as an unrealized component of shareholders equity entitled Accumulated other comprehensive income. Also known as unrealized gains or losses on investments, other comprehensive income is impacted
by rising or falling interest rates. As the market value of a fixed income investment will increase as interest rates fall, it will also decline as interest rates rise. The after tax unrealized gains or losses are recorded as other comprehensive
income in the equity of the Company, but have no impact on earnings until such time as the investment is sold, or realized. As of December 31, 2004, the Company had accumulated other comprehensive income of $567 thousand as compared to
$964 thousand at year end 2003.



The Company seeks to diversify
its portfolio to minimize risk and to maintain a majority of its portfolio in securities issued by states and political subdivisions due to the tax benefits such securities provide. The Company does not own any derivatives or participate in hedging
activities.



Investment Maturities and Average Yields As

of December 31, 2004



|                                             |  |                                |        |   |                  |   |        |                  |  |   |               |   |  |       |      |   |  |   |        |  
|-------------------------------------------- |  | ------------------------------ | ------ | - | ---------------- | - | ------ | ---------------- |  | - | ------------- | - |  | ----- | ---- | - |  | - | ------ | -
|(Dollars in Thousands)                       |  | One Year or Lessor No Maturity |        |   | One to FiveYears |   |        | Five to TenYears |  |   | Over TenYears |   |  | Total |     
|U.S. Treasury and Agency Securities          |  |                                |        |   |                  |   |        |                  |  |   |               |   |  |       |      |   |  |   |        |  
|Book Value                                   |  | $                              | 2,257  |   |                  | $ | 7,945  |                  |  | $ | 1,977         |   |  |       |     |   |  | $ | 12,179 |  
|Market Value                                 |  | $                              | 2,235  |   |                  | $ | 7,913  |                  |  | $ | 1,971         |   |  |       |     |   |  | $ | 12,119 |  
|Weighted average yield                       |  |                                | 2.88   | % |                  |   | 3.58   | %                |  |   | 4.41          | % |  |       |     |   |  |   | 3.58   | %
|States and Political Subdivisions Securities |  |                                |        |   |                  |   |        |                  |  |   |               |   |  |       |      |   |  |   |        |  
|Book Value                                   |  | $                              | 6,520  |   |                  | $ | 10,777 |                  |  | $ | 12,994        |   |  | $     | 244  |   |  | $ | 30,535 |  
|Market Value                                 |  | $                              | 6,522  |   |                  | $ | 11,199 |                  |  | $ | 13,295        |   |  | $     | 244  |   |  | $ | 31,260 |  
|Weighted average yield                       |  |                                | 2.20   | % |                  |   | 5.87   | %                |  |   | 5.28          | % |  |       | 5.52 | % |  |   | 4.83   | %
|Other Securities:                            |  |                                |        |   |                  |   |        |                  |  |   |               |   |  |       |      |   |  |   |        |  
|Book Value                                   |  | $                              | 5,000  |   |                  | $ | 2,540  |                  |  | $ | 916           |   |  | $     | 318  |   |  | $ | 8,774  |  
|Market Value                                 |  | $                              | 5,000  |   |                  | $ | 2,730  |                  |  | $ | 916           |   |  | $     | 318  |   |  | $ | 8,964  |  
|Weighted average yield                       |  |                                | 1.10   | % |                  |   | 6.32   | %                |  |   | 3.34          | % |  |       | 4.93 | % |  |   | 2.98   | %
|Total Securities:                            |  |                                |        |   |                  |   |        |                  |  |   |               |   |  |       |      |   |  |   |        |  
|Book Value                                   |  | $                              | 13,777 |   |                  | $ | 21,262 |                  |  | $ | 15,887        |   |  | $     | 562  |   |  | $ | 51,488 |  
|Market Value                                 |  | $                              | 13,757 |   |                  | $ | 21,842 |                  |  | $ | 16,182        |   |  | $     | 562  |   |  | $ | 52,343 |  
|Weighted average yield                       |  |                                | 1.91   | % |                  |   | 5.07   | %                |  |   | 5.06          | % |  |       | 5.19 | % |  |   | 4.22   | %



Notes:

Yields on tax-exempt securities have been computed on a tax-equivalent basis.

Average yields on securities held for sale are based on amortized cost.



Deposits



As of December 31, 2004, total
deposits increased 1.9% to $261.9 million as compared to year end 2003 deposits of $257.1 million. Non-interest bearing demand deposits increased 13.4% to $38.9 million during 2004 from $34.3 million at year end 2003. Savings and interest bearing
transaction account balances increased 6.2% to $133.9 million from $126.1 million at year end 2003. Time deposits decreased 7.7% to $89.2 million from $96.7 million at year end 2003.



18



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##### Table of Contents

Average Deposits and Rates



|                                     |  |                |         |            |      |   |                |      |            |  |      |                |  |            |         |  |      |  
|------------------------------------ |  | -------------- | ------- | ---------- | ---- | - | -------------- | ---- | ---------- |  | ---- | -------------- |  | ---------- | ------- |  | ---- | -
|Years Ended December 31,             |  | 2004           |         |            | 2003 |   |                | 2002 |           
|(Dollars in Thousands)               |  | AverageBalance |         | Yield/Rate |      |   | AverageBalance |      | Yield/Rate |  |      | AverageBalance |  | Yield/Rate |        
|Non-interest bearing Demand Deposits |  | $              | 38,129  |            | 0.00 | % |                | $    | 30,953     |  | 0.00 | %              |  | $          | 28,226  |  | 0.00 | %
|                                     |  |                |         |            |      |  
|Interest bearing Deposits:           |  |                |         |            |      |   |                |      |            |  |      |                |  |            |         |  |      |  
|NOW Accounts                         |  | $              | 46,248  |            | 0.50 | % |                | $    | 41,582     |  | 0.74 | %              |  | $          | 33,069  |  | 1.27 | %
|Regular Savings                      |  | $              | 66,724  |            | 1.55 | % |                | $    | 62,258     |  | 1.70 | %              |  | $          | 59,506  |  | 2.23 | %
|Money Market Deposit Accounts        |  | $              | 17,014  |            | 0.36 | % |                | $    | 16,650     |  | 0.86 | %              |  | $          | 12,739  |  | 1.59 | %
|Time Deposits:                       |  |                |         |            |      |   |                |      |            |  |      |                |  |            |         |  |      |  
|CDs $100,000 or more                |  | $              | 31,051  |            | 3.19 | % |                | $    | 27,187     |  | 3.57 | %              |  | $          | 22,721  |  | 3.91 | %
|CDs less than $100,000              |  | $              | 62,616  |            | 3.07 | % |                | $    | 67,169     |  | 3.33 | %              |  | $          | 67,730  |  | 3.72 | %
|                                     |  |                |         |            |      |   |                |      |            |  |      |                |  |            |         |  |      |  
|Total Interest bearing Deposits      |  | $              | 223,653 |            | 1.89 | % |                | $    | 214,846    |  | 2.19 | %              |  | $          | 195,765 |  | 2.74 | %
|                                     |  |                |         |            |      |  
|Total Average Deposits               |  | $              | 261,782 |            | 1.62 | % |                | $    | 245,799    |  | 1.92 | %              |  | $          | 223,991 |  | 2.39 | %
|                                     |  |                |         |            |      |   |                |      |            |  |      |                |  |            |         |  |      |  



Maturity Schedule of
Time Deposits of $100,000 and Over



|                                                |  |      |        |      |   |        |  |   |       
|----------------------------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------
|Years Ended Decmeber 31, (Dollars
in Thousands) |  | 2004 |        | 2003 |   | 2002  
|3 months or less                                |  | $    | 1,864  |      | $ | 3,221  |  | $ | 1,316 
|3-6 months                                      |  |      | 1,733  |      |   | 2,843  |  |   | 2,602 
|6-12 months                                     |  |      | 3,917  |      |   | 3,632  |  |   | 2,858 
|Over 12 months                                  |  |      | 22,050 |      |   | 22,019 |  |   | 17,555
|                                                |  |      |        |      |   |        |  |   |       
|Totals                                          |  | $    | 29,564 |      | $ | 31,716 |  | $ | 24,332
|                                                |  |      |        |      |   |        |  |   |       



Capital Resources



Capital resources represent funds, earned or obtained, over which a
financial institution can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Companys capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of
the Companys resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb
potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders.



The Company is required to maintain minimum amounts of capital to total risk weighted assets as defined by Federal Reserve Capital Guidelines.
According to Capital Guidelines for Bank Holding Companies, the Company is required to maintain a minimum Total Capital to Risk Weighted Asset ratio of 8.0%, a Tier 1 Capital to Risk Weighted Asset ratio of 4.0% and a Tier 1 Capital to
Adjusted Average Asset ratio (Leverage ratio) of 4.0%. As of December 31, 2004, the Company maintained these ratios at 11.2%, 10.3%, and 7.3%, respectively. At year end 2003, these ratios were 12.1%, 11.1%, and 7.3%, respectively.



Total capital, before accumulated other comprehensive income, increased 4.7%
to $25.3 million as of year end 2004 as compared to $24.1 million at year end 2003. Accumulated other comprehensive income was $567 thousand at year end 2004, down 41.2% from $964 thousand at year end 2003. The Company accounts for other
comprehensive income in the investment portfolio by adjusting capital for any after tax effect of unrealized gains and losses at the end of a given accounting period.



Liquidity



Liquidity represents an institutions ability to meet present and future financial obligations through either the sale or maturity of existing assets
or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, Federal Funds Sold, investments and loans maturing within one year. The Companys ability to obtain deposits
and purchase funds at a favorable rate determines its liability liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors requirements and to meet its customers credit needs.



19



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##### Table of Contents

At December 31, 2004, liquid assets totaled $35.8 million or 11.8% of total assets. Additional sources of
liquidity available to the Company include its capacity to borrow additional funds when necessary. The subsidiary bank maintains Federal Funds lines with regional banks totaling approximately $16.8 million. In addition, the subsidiary bank has a
line of credit with the Federal Home Loan Bank of Atlanta of approximately $19.0 million, with $11.5 million available.



Off Balance Sheet Commitments



In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These
instruments frequently involve elements of liquidity, credit and interest rate 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 instruments for commitments to extend credit and standby letters of credit written is represented by the contractual amount of these instruments. Subject to its normal credit standards and risk monitoring procedures, the Company
makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third-party. The
credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.



Off Balance Sheet Arrangements



|                                    |  |      |        |      |   |       
|----------------------------------- |  | ---- | ------ | ---- | - | ------
|December 31, (Dollars in
Thousands) |  | 2004 |        | 2003
|Total Loan Commitments Outstanding  |  | $    | 42,232 |      | $ | 35,167
|Standy-by Letters of Commitment     |  |      | 522    |      |   | 439   



The Company maintains
liquidity and credit facilities with non-affiliated banks in excess of the total loan commitments and stand-by letters of credit. As these commitments are earning assets only upon take-down of the instrument by the customer, thereby increasing loan
balances, management expects the revenue of the Company to be enhanced as these credit facilities are utilized.



STATEMENT REGARDING FORWARD-LOOKING STATEMENTS



This report contains statements concerning the Companys expectations, plans, objectives, future financial performance and other statements that are
not historical facts. These statements may constitute forward-looking statements as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and
uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not
limited to, changes in: interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or
composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Companys market area and accounting principles, policies and guidelines. These risks and uncertainties
should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.



ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



This information is incorporated herein by reference from Item 7, Managements Discussion and Analysis of Financial Condition and Results of
Operations in this Form 10-K.



20



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##### Table of Contents

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



CONSOLIDATED BALANCE SHEETS



December 31, 2004 and
2003





|                                                                                                                   |  |      |             |      |   |            
|------------------------------------------------------------------------------------------------------------------ |  | ---- | ----------- | ---- | - | -----------
|                                                                                                                   |  | 2004 |             | 2003
|ASSETS                                                                                                             |  |      |             |      |   |            
|Cash and due from banks                                                                                            |  | $    | 8,572,672   |      | $ | 7,762,030  
|Interest-bearing deposits                                                                                          |  |      | 104,949     |      |   | 102,868    
|Federal funds sold                                                                                                 |  |      | 13,989,278  |      |   | 13,907,525 
|Securities available for sale, at fair value                                                                       |  |      | 51,916,490  |      |   | 66,493,731 
|Securities held to maturity, at amortized cost(fair value, $426,320)                                               |  |      | 429,815     |      |   |           
|Loans, net of allowance for loan losses of $2,032,185and $1,901,576                                                |  |      | 213,350,454 |      |   | 188,450,953
|Premises and equipment, net                                                                                        |  |      | 9,086,442   |      |   | 8,411,776  
|Accrued interest receivable                                                                                        |  |      | 1,163,976   |      |   | 1,261,784  
|Other real estate owned                                                                                            |  |      | 16,601      |      |   | 76,514     
|Core deposit intangible                                                                                            |  |      | 2,807,842   |      |   | 2,807,842  
|Other assets                                                                                                       |  |      | 2,031,067   |      |   | 1,435,602  
|                                                                                                                   |  |      |             |      |   |            
|Total assets                                                                                                       |  | $    | 303,469,586 |      | $ | 290,710,625
|                                                                                                                   |  |      |             |      |   |            
|LIABILITIES                                                                                                        |  |      |             |      |   |            
|                                                                                                                   |  |     
|Noninterest-bearing deposits                                                                                       |  | $    | 38,877,338  |      | $ | 34,290,391 
|Savings and interest-bearing demand deposits                                                                       |  |      | 133,887,530 |      |   | 126,127,299
|Time deposits                                                                                                      |  |      | 89,181,113  |      |   | 96,665,504 
|                                                                                                                   |  |      |             |      |   |            
|Total deposits                                                                                                     |  | $    | 261,945,981 |      | $ | 257,083,194
|Securities sold under repurchase agreements                                                                        |  |      | 6,342,456   |      |   | 6,478,601  
|Federal Home Loan Bank advances                                                                                    |  |      | 7,500,000   |      |   |           
|Other liabilities                                                                                                  |  |      | 1,861,627   |      |   | 2,070,426  
|                                                                                                                   |  |      |             |      |   |            
|Total liabilities                                                                                                  |  | $    | 277,650,064 |      | $ | 265,632,221
|                                                                                                                   |  |      |             |      |   |            
|SHAREHOLDERS EQUITY                                                                                               |  |      |             |      |   |            
|                                                                                                                   |  |     
|Common stock ($5 par value; Authorized5,000,000 shares; Outstanding2,354,187 and 2,326,080 shares,
respectively) |  | $    | 11,770,937  |      | $ | 11,630,401 
|Additional paid-in capital                                                                                         |  |      | 4,621,295   |      |   | 4,336,929  
|Retained Earnings                                                                                                  |  |      | 8,860,506   |      |   | 8,146,613  
|Accumulated other comprehensive income, net                                                                        |  |      | 566,784     |      |   | 964,461    
|                                                                                                                   |  |      |             |      |   |            
|Total shareholders equity                                                                                         |  | $    | 25,819,522  |      | $ | 25,078,404 
|                                                                                                                   |  |      |             |      |   |            
|Total liabilities and shareholders equity                                                                         |  | $    | 303,469,586 |      | $ | 290,710,625
|                                                                                                                   |  |      |             |      |   |            



See Notes to
Consolidated Financial Statements.



21



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##### Table of Contents

CONSOLIDATED STATEMENTS OF INCOME



Years Ended December 31, 2004, 2003 and 2002



|                                                    |  |      |            |      |   |            |  |   |            |  
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ---------- | -
|                                                    |  | 2004 |            | 2003 |   | 2002       | 
|Interest Income                                     |  |      |            |      |   |            |  |   |            |  
|Loans including fees                                |  | $    | 11,786,878 |      | $ | 10,694,171 |  | $ | 11,150,289 |  
|Securities                                          |  |      |            |      |   |            |  |   |            |  
|Taxable                                             |  |      | 1,339,455  |      |   | 1,578,987  |  |   | 2,024,013  |  
|Tax-exempt                                          |  |      | 776,149    |      |   | 765,126    |  |   | 624,514    |  
|Federal funds sold                                  |  |      | 182,669    |      |   | 291,172    |  |   | 344,951    |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Total interest income                               |  |      | 14,085,151 |      |   | 13,329,456 |  |   | 14,143,767 |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Interest Expense                                    |  |      |            |      |   |            |  |   |            |  
|Deposits                                            |  |      | 4,234,460  |      |   | 4,715,282  |  |   | 5,356,811  |  
|Federal funds purchased                             |  |      | 162        |      |   | 0          |  |   | 0          |  
|Securities sold to repurchase                       |  |      | 25,980     |      |   | 51,179     |  |   | 33,853     |  
|FHLB advance                                        |  |      | 49,892     |      |   | 0          |  |   | 0          |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Total interest expense                              |  |      | 4,310,494  |      |   | 4,766,461  |  |   | 5,390,664  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Net interest income                                 |  |      | 9,774,657  |      |   | 8,562,995  |  |   | 8,753,103  |  
|Provision for loan losses                           |  |      | 300,000    |      |   | 312,000    |  |   | 471,000    |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Net interest income after provision for loan losses |  |      | 9,474,657  |      |   | 8,250,995  |  |   | 8,282,103  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Noninterest Income                                  |  |      |            |      |   |            |  |   |            |  
|Income from fiduciary activities                    |  |      | 664,806    |      |   | 621,546    |  |   | 635,197    |  
|Service charges & fees on deposit accounts          |  |      | 669,029    |      |   | 598,666    |  |   | 541,250    |  
|Other service charges and fees                      |  |      | 884,840    |      |   | 663,169    |  |   | 633,239    |  
|Secondary market lending fees                       |  |      | 184,048    |      |   | 362,813    |  |   | 260,913    |  
|Securities gains                                    |  |      | 246,010    |      |   | 370,728    |  |   | 2,800      |  
|Other real estate gains / (losses)                  |  |      | 13,958     |      |   | 191,959    |  |   | (22,894    | )
|Other income                                        |  |      | 126,888    |      |   | 150,741    |  |   | 40,919     |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Total noninterest income                            |  |      | 2,789,579  |      |   | 2,959,622  |  |   | 2,091,424  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Noninterest Expense                                 |  |      |            |      |   |            |  |   |            |  
|Salaries and employee benefits                      |  |      | 5,119,549  |      |   | 4,382,830  |  |   | 3,599,689  |  
|Occupancy expense                                   |  |      | 1,403,372  |      |   | 1,359,399  |  |   | 884,495    |  
|Bank franchise tax                                  |  |      | 201,910    |      |   | 212,449    |  |   | 209,015    |  
|Visa expense                                        |  |      | 421,745    |      |   | 369,384    |  |   | 321,444    |  
|Telephone expense                                   |  |      | 167,636    |      |   | 186,911    |  |   | 169,501    |  
|Other expense                                       |  |      | 2,008,650  |      |   | 2,025,044  |  |   | 2,018,443  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Total noninterest expense                           |  |      | 9,322,862  |      |   | 8,536,017  |  |   | 7,202,587  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Net income before income taxes                      |  |      | 2,941,374  |      |   | 2,674,600  |  |   | 3,170,940  |  
|Income tax expense                                  |  |      | 760,014    |      |   | 661,415    |  |   | 869,539    |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Net Income                                          |  | $    | 2,181,360  |      | $ | 2,013,185  |  | $ | 2,301,401  |  
|                                                    |  |      |            |      |   |            |  |   |            |  
|Basic Earnings Per Share                            |  |      |            |      |   |            |  |   |            |  
|Average basic shares outstanding                    |  |      | 2,337,788  |      |   | 2,313,596  |  |   | 2,301,364  |  
|Earnings per share, basic                           |  | $    | 0.93       |      | $ | 0.87       |  | $ | 1.00       |  
|Diluted Earnings Per Share                          |  |      |            |      |   |            |  |   |            |  
|Average diluted shares outstanding                  |  |      | 2,356,598  |      |   | 2,338,481  |  |   | 2,309,959  |  
|Earnings per share, diluted                         |  | $    | 0.93       |      | $ | 0.86       |  | $ | 0.99       |  



See Notes to
Consolidated Financial Statements.



22



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##### Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN

SHAREHOLDERS EQUITY



Years Ended December 31, 2004, 2003 and 2002





|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|------------------------------------------------------------------------------------------------------- |  | ----------- | ---------- | - | ------------------------ | - | --------- | ---------------- |  | - | ----------------------------------- | - |  | ------------------------ | --------- | - |  | - | ---------- | -
|                                                                                                        |  | CommonStock |            |   | AdditionalPaid-inCapital |   |           | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome |   |  | TotalShareholdersEquity |          
|Balance at December 31, 2001                                                                            |  | $           | 5,766,405  |   |                          | $ | 3,940,720 |                  |  | $ | 12,363,054                          |   |  | $                        | 546,612   |   |  | $ | 22,616,791 |  
|Comprehensive Income:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Net Income                                                                                              |  |             |            |   |                          |   |           |                  |  |   | 2,301,401                           |   |  |                          |           |   |  |   | 2,301,401  |  
|Other comprehensive income:                                                                             |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Changes in unrealized holding gains on securities arising during the period, net of taxes of $556,236   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | 1,079,752 |   |  |   |            |  
|Reclassification adjustment for securities gains included in net income, net of taxes of ($952)         |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (1,848    | ) |  |   |            |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Total other comprehensive income, net of taxes of $555,284                                              |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | 1,077,904 |   |  |   | 1,077,904  |  
|Cash dividends paid$0.50/share                                                                         |  |             |           |   |                          |   |          |                  |  |   | (1,150,503                          | ) |  |                          |          |   |  |   | (1,150,503 | )
|Stock repurchases                                                                                       |  |             | (102,895   | ) |                          |   | (142,262  | )                |  |   | (224,426                            | ) |  |                          |          |   |  |   | (469,583   | )
|2-for-1 stock split                                                                                     |  |             | 5,756,178  |   |                          |   |          |                  |  |   | (5,756,178                          | ) |  |                          |          |   |  |   |           |  
|Sale of common stock:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Dividends Reinvested                                                                                    |  |             | 92,237     |   |                          |   | 251,389   |                  |  |   |                                    |   |  |                          |          |   |  |   | 343,626    |  
|Stock Options exercised                                                                                 |  |             | 24,875     |   |                          |   | 30,846    |                  |  |   | (18,558                             | ) |  |                          |          |   |  |   | 37,163     |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Balance at December 31, 2002                                                                            |  | $           | 11,536,800 |   |                          | $ | 4,080,693 |                  |  | $ | 7,514,790                           |   |  | $                        | 1,624,516 |   |  | $ | 24,756,799 |  
|Comprehensive Income:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Net Income                                                                                              |  |             |           |   |                          |   |          |                  |  |   | 2,013,185                           |   |  |                          |          |   |  |   | 2,013,185  |  
|Other comprehensive loss:                                                                               |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Changes in unrealized holding gains on securities arising during the period, net of taxes of ($213,980) |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (415,375  | ) |  |   |            |  
|Reclassification adjustment for securities gains included in net income, net of taxes of ($126,048)     |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (244,680  | ) |  |   |            |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Total other comprehensive loss, net of taxes of ($340,028)                                              |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (660,055  | ) |  |   | (660,055   | )
|Cash dividends paid$0.57/share                                                                         |  |             |           |   |                          |   |          |                  |  |   | (1,318,104                          | ) |  |                          |          |   |  |   | (1,318,104 | )
|Stock repurchases                                                                                       |  |             | (34,750    | ) |                          |   | (11,350   | )                |  |   | (63,258                             | ) |  |                          |          |   |  |   | (109,358   | )
|Sale of common stock:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Dividends Reinvested                                                                                    |  |             | 123,351    |   |                          |   | 264,836   |                  |  |   |                                    |   |  |                          |          |   |  |   | 388,187    |  
|Stock Options exercised                                                                                 |  |             | 5,000      |   |                          |   | 2,750     |                  |  |   |                                    |   |  |                          |          |   |  |   | 7,750      |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Balance at December 31, 2003                                                                            |  | $           | 11,630,401 |   |                          | $ | 4,336,929 |                  |  | $ | 8,146,613                           |   |  | $                        | 964,461   |   |  | $ | 25,078,404 |  
|Comprehensive Income:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Net Income                                                                                              |  |             |           |   |                          |   |          |                  |  |   | 2,181,360                           |   |  |                          |          |   |  |   | 2,181,360  |  
|Other comprehensive loss:                                                                               |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Changes in unrealized holding gains on securities arising during the period, net of taxes of ($121,220) |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (235,310  | ) |  |   |            |  
|Reclassification adjustment for securities gains included in net income, net of taxes of ($83,644)      |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (162,367  | ) |  |   |            |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Total other comprehensive loss, net of taxes of ($204,864)                                              |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          | (397,677  | ) |  |   | (397,677   | )
|Cash dividends paid $0.605/share                                                                       |  |             |           |   |                          |   |          |                  |  |   | (1,414,327                          | ) |  |                          |          |   |  |   | (1,414,327 | )
|Stock repurchases                                                                                       |  |             | (17,250    | ) |                          |   | (6,432    | )                |  |   | (28,963                             | ) |  |                          |          |   |  |   | (52,645    | )
|Sale of common stock:                                                                                   |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Dividends Reinvested                                                                                    |  |             | 132,891    |   |                          |   | 267,346   |                  |  |   |                                    |   |  |                          |          |   |  |   | 400,237    |  
|Stock Options exercised                                                                                 |  |             | 24,895     |   |                          |   | 23,452    |                  |  |   | (24,177                             | ) |  |                          |          |   |  |   | 24,170     |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  
|Balance at December 31, 2004                                                                            |  | $           | 11,770,937 |   |                          | $ | 4,621,295 |                  |  | $ | 8,860,506                           |   |  | $                        | 566,784   |   |  | $ | 25,819,522 |  
|                                                                                                        |  |             |            |   |                          |   |           |                  |  |   |                                     |   |  |                          |           |   |  |   |            |  



See Notes to
Consolidated Financial Statements.



23



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##### Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS



Years Ended December 31, 2004, 2003, and 2002



|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|--------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                  |  | 2004 |             |   | 2003 |   |             | 2002 | 
|Cash Flows From Operating Activities                                              |  |      |             |   |      |   |             |      |  |   |             |  
|Net Income                                                                        |  | $    | 2,181,360   |   |      | $ | 2,013,185   |      |  | $ | 2,301,401   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |             |   |      |   |             |      |  |   |             |  
|Depreciation                                                                      |  |      | 770,720     |   |      |   | 701,317     |      |  |   | 543,472     |  
|Net amortization and accretion of securities                                      |  |      | (46,387     | ) |      |   | (38,054     | )    |  |   | 31,373      |  
|Provision for loan losses                                                         |  |      | 300,000     |   |      |   | 312,000     |      |  |   | 471,000     |  
|Net securities gains                                                              |  |      | (246,010    | ) |      |   | (370,728    | )    |  |   | (2,800      | )
|(Gain) / loss on sale of other real estate owned                                  |  |      | (13,958     | ) |      |   | (191,959    | )    |  |   | 22,894      |  
|Deferred income taxes                                                             |  |      | (21,911     | ) |      |   | 251,178     |      |  |   | 166,684     |  
|(Increase) / decrease in accrued income and other assets                          |  |      | (497,657    | ) |      |   | 398,607     |      |  |   | (534,721    | )
|Increase / (decrease) in other liabilities                                        |  |      | 17,976      |   |      |   | (146,128    | )    |  |   | 378,286     |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided by operating activities                                         |  |      | 2,444,133   |   |      |   | 2,929,418   |      |  |   | 3,377,589   |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Cash Flows From Investing Activities                                              |  |      |             |   |      |   |             |      |  |   |             |  
|Proceeds from maturities of available-for-sale securities                         |  |      | 3,612,682   |   |      |   | 6,126,479   |      |  |   | 3,245,124   |  
|Proceeds from sales of available-for-sale securities                              |  |      | 29,345,288  |   |      |   | 17,583,327  |      |  |   | 4,013,400   |  
|Purchases of available-for-sale securities                                        |  |      | (19,120,688 | ) |      |   | (40,643,573 | )    |  |   | (7,811,445  | )
|(Increase) / decrease in interest bearing deposits                                |  |      | (2,081      | ) |      |   | 56,862      |      |  |   | 16,887      |  
|(Increase) / decrease in Federal Funds Sold                                       |  |      | (81,753     | ) |      |   | 6,071,163   |      |  |   | 5,256,792   |  
|Loan originations and principal collections, net                                  |  |      | (25,199,501 | ) |      |   | (20,387,529 | )    |  |   | (18,660,600 | )
|Purchases of premises and equipment                                               |  |      | (1,445,386  | ) |      |   | (1,144,625  | )    |  |   | (1,568,446  | )
|Proceeds from sale of other real estate owned                                     |  |      | 73,871      |   |      |   | 762,344     |      |  |   | 11,012      |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash (used in) investing activities                                           |  |      | (12,817,568 | ) |      |   | (31,575,552 | )    |  |   | (15,497,276 | )
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Cash Flows From Financing Activities                                              |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase in demand, savings, and other interest-bearing deposits              |  |      | 12,347,178  |   |      |   | 20,264,297  |      |  |   | 11,923,592  |  
|Net increase / (decrease) in Time Deposits                                        |  |      | (7,484,391  | ) |      |   | 5,302,715   |      |  |   | 399,025     |  
|Net increase / (decrease) in securities sold under repurchase agreements          |  |      | (136,145    | ) |      |   | 1,996,837   |      |  |   | 1,621,490   |  
|Increase in other short term borrowings                                           |  |      | 7,500,000   |   |      |   | 0           |      |  |   | 0           |  
|Proceeds from issuance of common stock                                            |  |      | 424,407     |   |      |   | 395,937     |      |  |   | 380,789     |  
|Dividends paid                                                                    |  |      | (1,414,327  | ) |      |   | (1,318,104  | )    |  |   | (1,150,503  | )
|Repurchase of common stock                                                        |  |      | (52,645     | ) |      |   | (109,358    | )    |  |   | (469,583    | )
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net cash provided by financing activities                                         |  |      | 11,184,077  |   |      |   | 26,532,324  |      |  |   | 12,704,810  |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Net increase / (decrease) in cash & due from banks                                |  |      | 810,642     |   |      |   | (2,113,810  | )    |  |   | 585,123     |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Cash & due from banks at beginning of period                                      |  |      | 7,762,030   |   |      |   | 9,875,840   |      |  |   | 9,290,717   |  
|Cash & due from banks at end of period                                            |  | $    | 8,572,672   |   |      | $ | 7,762,030   |      |  | $ | 9,875,840   |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Supplemental Disclosures:                                                         |  |      |             |   |      |   |             |      |  |   |             |  
|Interest paid                                                                     |  | $    | 4,310,795   |   |      | $ | 4,835,012   |      |  | $ | 5,465,179   |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Income taxes paid                                                                 |  |      | 560,000     |   |      |   | 662,129     |      |  |   | 714,266     |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Unrealized gain (loss) on investment securities                                   |  |      | (602,541    | ) |      |   | (1,000,083  | )    |  |   | 1,633,188   |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  
|Loans transferred to other real estate owned                                      |  |      | 69,424      |   |      |   | 65,113      |      |  |   | 464,988     |  
|                                                                                  |  |      |             |   |      |   |             |      |  |   |             |  



See Notes to
Consolidated Financial Statements.



24



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





Note 1. Nature of Business and Significant Accounting
Policies



Principles of
consolidation.    The consolidated financial statements of the Company include the accounts of Bay Banks of Virginia, Inc. and its subsidiaries, Bank of Lancaster, and Bay Trust Company. All significant intercompany
balances and transactions have been eliminated in consolidation.



Nature of business.    Bay Banks of Virginia, Inc. is a bank holding company that conducts substantially all of its operations through its subsidiaries.



The Bank of Lancaster (the Bank) is state-chartered and a member
of the Federal Reserve System and services individual and commercial customers, the majority of which are in the Northern Neck of Virginia. The Bank has offices in the counties of Lancaster, Northumberland, Richmond, and Westmoreland, Virginia. Each
branch offers a full range of deposit and loan products to its retail and commercial customers. A substantial amount of the Banks deposits are interest bearing. The majority of the Banks loan portfolio is secured by real estate.



Bay Trust Company (the Trust Company) offers full
service trust and estate planning from its office on Main Street in Kilmarnock, Virginia. The Trust Company offers testamentary trust, revocable and irrevocable trusts, personal trusts, custodial trusts, and managed agency, as well as discount
brokerage services.



Use of
estimates.    The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. The
amounts recorded in the consolidated financial statements may be affected by those estimates and assumptions. Actual results may vary from those estimates. Estimates are used primarily in developing the allowance for loan losses.



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. 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 the following: (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 available-for-sale securities are determined using the specific identification method. Premiums and discounts are recognized in interest income using the
interest method over the terms of the securities.



Securities sold under repurchase agreements.    Securities sold under repurchase agreements, which are classified as secured borrowings, generally mature within one year from the transaction date.
Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities.



Loans.    The Company
grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of the Companys debtors to honor their contracts is dependent upon the real estate and
general economic conditions in this area.



25



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##### Table of Contents



Loans that management has
the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on
originated loans. Interest income is accrued on the unpaid principal balance. Loan originations fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.



The accrual of interest on mortgage and commercial loans is
generally discontinued at the time the loan is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90
days past due may remain on accrual status if management determines the credit is well-secured. Past due status is based on contractual terms of the loan. For those loans that are carried on nonaccrual status, interest is recognized on the cash
basis.



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 uncollectibility 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 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 payments 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.



26



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





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, unless such loans are
the subject of a restructuring agreement.



Premises and
equipment.    Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over the estimated useful lives of the
premises and equipment. Estimated useful lives range from 10-40 years for buildings, and from 3-10 years for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred, and major improvements are capitalized.



Other real estate
owned.    Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at the lower of the carrying value or fair value on the date of foreclosure to establish a new
cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of carrying amount or fair value less cost to sell.



Income taxes.    Deferred income tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities
and gives current recognition to changes in tax rates and laws.



Pension benefits.    The noncontributory defined benefit pension plan covers substantially all full-time employees. The plan provides benefits that are based on employees average compensation during
the five consecutive years of highest compensation. The funding policy is to make the minimum annual contribution that is required by applicable regulations, plus such amounts as may be determined to be appropriate from time-to-time.



Post retirement benefits. The Company provides certain health
care benefits for all retired employees that meet eligibility requirements. The Companys share of the estimated cost of benefits that will be paid after retirement is generally being accrued by charges to expense over the employees
service periods to the dates they are fully eligible for benefits, except that the Companys unfunded cost that existed at the adoption date is being accrued primarily in a straight-line manner that will result in its full accrual by the end of
the transition obligation amortization period.



Trust
assets and income.    Customer assets held by the Trust Company, other than cash on deposit, are not included in these financial statements, since such items are not assets of the Trust Company. Trust fees are recorded on
the accrual basis.



Earnings per
share.    Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional
common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options. Earnings per share calculations are presented
in Note 16.



Off-balance-sheet financial
instruments.    In the ordinary course of business the Company has entered into off-balance-sheet financial instruments such as home equity lines of credit, commitments under credit card arrangements 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.



Significant group concentration of credit risk.    Most of the Companys business activity is with customers
located in the counties of Lancaster, Northumberland, Richmond and Westmoreland, Virginia. The Company makes residential, commercial and consumer loans and a significant amount of the loan portfolio is comprised of real estate mortgage loans, which
primarily are for single-family



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residences. The adequacy of collateral on
real estate mortgage loans is highly dependent on changes to real estate values.



Advertising.    Advertising costs are expensed as incurred.



Reclassifications.    Certain reclassifications have been made to prior period balances to conform to the current year
presentation.



Stock-based compensation
plans.    SFAS No. 123, Accounting for Stock-Based Compensation,encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured
at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value
based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or
other measurement date) over the amount an employee must pay to acquire the stock. The Company has elected to continue with the accounting methodology in Opinion No. 25. Stock options issued under the Companys stock option plan have no
intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them.



Had compensation cost for the Companys stock option plans been determined based on the fair value at the grant dates for awards under the plan
consistent with the method prescribed by SFAS No. 123, the Companys net income and earnings per share would have been adjusted to the pro forma amounts as follows:



|                                                                                                                           |  |                          |           |   |      |   |           |      |  |   |           |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                                                           |  | Years Ended December 31, |          
|                                                                                                                           |  | 2004                     |           |   | 2003 |   |           | 2002 | 
|Net income, as reported                                                                                                    |  | $                        | 2,181,360 |   |      | $ | 2,013,185 |      |  | $ | 2,301,401 |  
|Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects |  |                          | (26,205   | ) |      |   | (89,199   | )    |  |   | (94,704   | )
|                                                                                                                           |  |                          |           |   |      |   |           |      |  |   |           |  
|Pro forma net income                                                                                                       |  | $                        | 2,155,155 |   |      | $ | 1,923,986 |      |  | $ | 2,206,697 |  
|                                                                                                                           |  |                          |           |   |      |   |           |      |  |   |           |  
|Earnings per share:                                                                                                        |  |                          |           |   |      |   |           |      |  |   |           |  
|Basicas reported                                                                                                          |  | $                        | 0.93      |   |      | $ | 0.87      |      |  | $ | 1.00      |  
|Basicpro forma                                                                                                            |  | $                        | 0.92      |   |      | $ | 0.83      |      |  | $ | 0.96      |  
|Dilutedas reported                                                                                                        |  | $                        | 0.93      |   |      | $ | 0.86      |      |  | $ | 0.99      |  
|Dilutedpro forma                                                                                                          |  | $                        | 0.91      |   |      | $ | 0.82      |      |  | $ | 0.96      |  



The fair value of
each option granted was estimated on the date of grant using the Black-Scholes option pricing model. The assumptions used in the 2004 grants were a risk free rate of 4.24%, volatility of 8.98%, a dividend yield of 2.75%, and an expected life of ten
years. The assumptions used for the 2003 grants were a risk free rate of 3.80%, volatility of 9.52%, a dividend yield of 2.58%, and an expected life of ten years. The assumptions used for the 2002 grants were a risk free rate of 4.20%, volatility of
7.32%, a dividend yield of 2.48%, and an expected life of ten years.



Recent Accounting Pronouncements.    In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46). This Interpretation provides guidance with respect to the identification of variable interest entities when the assets, liabilities, non-controlling interests, and results of operations of a variable
interest entity need to be included in a Companys consolidated financial statements. Due to significant implementation issues,



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





the FASB
modified the wording of FIN 46 and issued FIN 46R in December of 2003. The adoption of FIN 46 and FIN 46R did not have a material effect on the Companys consolidated financial position or consolidated results of operations.



Emerging Issues Task Force Issue No. (EITF) 03-1 The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of other-than-temporarily impaired and its
application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115) and investments
accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can
assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the
ability and intent to hold investments in instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired. On September 30, 2004, the Financial Accounting Standards Board decided
to delay the effective date for the measurement and recognition guidance contained in Issue 03-1 although this delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The
disclosure guidance in Issue 03-1 was not delayed.



EITF No.
03-16, Accounting for Investments in Limited Liability Companies was ratified by the FASB and is effective for reporting periods beginning after June 15, 2004. Limited liability companies (LLCs) have characteristics of both
corporations and partnerships, but are dissimilar from both in certain respects. Due to those similarities and differences, diversity in practice exists with respect to accounting for non-controlling investments in LLCs. The consensus reached was
that an LLC should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a non-controlling investment should be accounted for using the cost method or the equity method of accounting.



In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004), Share-Based Payment. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily employee
services, and is effective for interim or annual periods beginning after June 15, 2005. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award.



Note 2. Unidentifiable Intangibles



The Company has unidentifiable intangibles recorded on the financial statements relating to the purchase of five branches. The balance of the intangibles
at December 31, 2004, as reflected on the consolidated balance sheet was $2,807,842. Management has determined that these purchases qualified as acquisitions of businesses and therefore discontinued amortization, effective January 1, 2002, in
accordance with Statement of Financial Accounting Standard No. 142. The core deposit intangibles balance is tested for impairment at least annually. Based on the testing, there were no impairment charges in 2004.





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Note 3. Investment Securities



The aggregate amortized cost and fair values of the
available for sale securities portfolio at December 31, 2004, and 2003, was as follows:



|                                |  |               |            |                      |   |                         |  |   |            |   |  |   |           
|------------------------------- |  | ------------- | ---------- | -------------------- | - | ----------------------- |  | - | ---------- | - |  | - | ----------
|December 31, 2004               |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | Fair Value
|U.S. Government agencies        |  | $             | 12,178,591 |                      | $ | 25,767                  |  | $ | (85,636    | ) |  | $ | 12,118,722
|State and municipal obligations |  |               | 30,105,661 |                      |   | 773,164                 |  |   | (45,322    | ) |  |   | 30,833,503
|Corporate Bonds                 |  |               | 7,539,474  |                      |   | 190,791                 |  |   |           |   |  |   | 7,730,265 
|Restricted Securities           |  |               | 1,234,000  |                      |   |                        |  |   |           |   |  |   | 1,234,000 
|                                |  |               |            |                      |   |                         |  |   |            |   |  |   |           
|Total                           |  | $             | 51,057,726 |                      | $ | 989,722                 |  | $ | (130,958   | ) |  | $ | 51,916,490
|                                |  |               |            |                      |   |                         |  |   |            |   |  |   |           
|                                |  |               |            |                     
|December 31, 2003               |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | Fair Value
|U.S. Government agencies        |  | $             | 20,644,546 |                      | $ | 66,236                  |  | $ | (102,717   | ) |  | $ | 20,608,065
|State and municipal obligations |  |               | 36,498,604 |                      |   | 1,196,751               |  |   | (175,099   | ) |  |   | 37,520,256
|Corporate Bonds                 |  |               | 6,565,676  |                      |   | 476,134                 |  |   |           |   |  |   | 7,041,810 
|Restricted Securities           |  |               | 1,323,600  |                      |   |                        |  |   |           |   |  |   | 1,323,600 
|                                |  |               |            |                      |   |                         |  |   |            |   |  |   |           
|Total                           |  | $             | 65,032,426 |                      | $ | 1,739,121               |  | $ | (277,816   | ) |  | $ | 66,493,731
|                                |  |               |            |                      |   |                         |  |   |            |   |  |   |           



The aggregate
amortized cost and fair values of the held to maturity securities portfolio at December 31, 2004, was as follows:



|                                |  |               |         |                      |   |                         |  |   |           |   |  |   |        
|------------------------------- |  | ------------- | ------- | -------------------- | - | ----------------------- |  | - | --------- | - |  | - | -------
|December 31, 2004               |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealized(Losses) |  |   | FairValue
|State and municipal obligations |  | $             | 429,815 |                      | $ |                        |  | $ | (3,495    | ) |  | $ | 426,320
|                                |  |               |         |                      |   |                         |  |   |           |   |  |   |        



Gross realized gains
and gross realized losses on sales of securities were as follows:



|                         |  |      |         |      |   |         |  |   |      
|------------------------ |  | ---- | ------- | ---- | - | ------- |  | - | -----
|Years Ended December 31, |  | 2004 |         | 2003 |   | 2002   
|Gross realized gains     |  | $    | 246,345 |      | $ | 370,728 |  | $ | 2,800
|Gross realized losses    |  |      | 335     |      |   |        |  |   |     
|                         |  |      |         |      |   |         |  |   |      
|Net realized gains       |  | $    | 246,010 |      | $ | 370,728 |  | $ | 2,800
|                         |  |      |         |      |   |         |  |   |      



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





The aggregate amortized cost and market values of the investment securities portfolio by contractual maturity at December 31, 2004, are shown below:



|                                      |  |                |            |            |   |           
|------------------------------------- |  | -------------- | ---------- | ---------- | - | ----------
|                                      |  | Amortized Cost |            | Fair Value
|Due in one year or less               |  | $              | 13,777,657 |            | $ | 13,758,442
|Due after one year through five years |  |                | 21,260,523 |            |   | 21,841,051
|Due after five through ten years      |  |                | 14,971,529 |            |   | 15,265,485
|Due after ten years                   |  |                | 243,832    |            |   | 243,832   
|Restricted securities                 |  |                | 1,234,000  |            |   | 1,234,000 
|                                      |  |                |            |            |   |           
|                                      |  | $              | 51,487,541 |            | $ | 52,342,810
|                                      |  |                |            |            |   |           



Securities with a
market value of $11,877,145 and $12,319,466 at December 31, 2004 and 2003, respectively, were pledged as collateral for public deposits, repurchase agreements and for other purposes as required by law.



Securities in an unrealized loss position at December 31, 2004 and 2003, by
duration of the unrealized loss, are shown below. No impairment has been recognized on any of the securities in a loss position because of managements intent and demonstrated ability to hold securities to scheduled maturity or call dates. The
unrealized loss positions at December 31, 2004 and 2003, were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better. Bonds with unrealized loss
positions at 2004 year-end included 20 federal agencies and 17 municipal bonds, as shown below.



|                                      |            |                     |                |                   |            |         |                |   |            |  |                |        |  |   |            |  |   |        
|------------------------------------- | ---------- | ------------------- | -------------- | ----------------- | ---------- | ------- | -------------- | - | ---------- |  | -------------- | ------ |  | - | ---------- |  | - | -------
|December 31, 2004                     |            | Less than 12 months |                | 12 months or more |            | Total  
|                                      | Fair Value |                     | UnrealizedLoss |                   | Fair Value |         | UnrealizedLoss |   | Fair Value |  | UnrealizedLoss
|US Government agencies                |            | $                   | 7,907,795      |                   | $          | 53,196  |                | $ | 1,652,560  |  | $              | 32,440 |  | $ | 9,560,355  |  | $ | 85,636 
|States and municipal obligations      |            |                     | 4,715,650      |                   |            | 36,936  |                |   | 552,331    |  |                | 11,881 |  |   | 5,267,981  |  |   | 48,817 
|                                      |            |                     |                |                   |            |         |                |   |            |  |                |        |  |   |            |  |   |        
|Total temporarily impaired securities |            | $                   | 12,623,445     |                   | $          | 90,132  |                | $ | 2,204,891  |  | $              | 44,321 |  | $ | 14,828,336 |  | $ | 134,453
|                                      |            |                     |                |                   |            |         |                |   |            |  |                |        |  |   |            |  |   |        
|                                      |            |                     |               
|December 31, 2003                     |            | Less than 12 months |                | 12 months or more |            | Total  
|                                      | Fair Value |                     | UnrealizedLoss |                   | Fair Value |         | UnrealizedLoss |   | Fair Value |  | UnrealizedLoss
|US Government agencies                |            | $                   | 5,624,624      |                   | $          | 102,717 |                | $ |           |  | $              |       |  | $ | 5,623,624  |  | $ | 102,717
|States and municipal obligations      |            |                     | 5,170,948      |                   |            | 175,099 |                |   |           |  |                |       |  |   | 5,170,948  |  |   | 175,099
|                                      |            |                     |                |                   |            |         |                |   |            |  |                |        |  |   |            |  |   |        
|Total temporarily impaired securities |            | $                   | 10,794,572     |                   | $          | 277,816 |                | $ |           |  | $              |       |  | $ | 10,794,572 |  | $ | 277,816
|                                      |            |                     |                |                   |            |         |                |   |            |  |                |        |  |   |            |  |   |        



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Note 4. Loans



The
following is a summary of the balances of loans:



|                                                             |  |      |             |   |      |   |             |  
|------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | -
|December 31,                                                 |  | 2004 |             |   | 2003 |  
|Mortgage loans on real estate:                               |  |      |             |   |      |   |             |  
|Construction                                                 |  | $    | 31,184,514  |   |      | $ | 24,959,214  |  
|Secured by farmland                                          |  |      | 2,017,226   |   |      |   | 1,134,584   |  
|Secured by 1-4 family residential                            |  |      | 120,060,032 |   |      |   | 104,104,372 |  
|Other real estate loans                                      |  |      | 28,050,397  |   |      |   | 22,338,503  |  
|Loans to farmers (except those secured by real estate)       |  |      | 71,810      |   |      |   | 71,479      |  
|Commercial and industrial loans (not secured by real estate) |  |      | 21,519,358  |   |      |   | 24,819,068  |  
|Consumer installment loans                                   |  |      | 9,897,965   |   |      |   | 10,555,735  |  
|All other loans                                              |  |      | 1,296,370   |   |      |   | 974,448     |  
|Net deferred loan costs and fees                             |  |      | 1,284,967   |   |      |   | 1,395,125   |  
|                                                             |  |      |             |   |      |   |             |  
|Total loans                                                  |  | $    | 215,382,639 |   |      | $ | 190,352,529 |  
|Allowance for loan losses                                    |  |      | (2,032,185  | ) |      |   | (1,901,576  | )
|                                                             |  |      |             |   |      |   |             |  
|Loans, net                                                   |  | $    | 213,350,454 |   |      | $ | 188,450,953 |  
|                                                             |  |      |             |   |      |   |             |  



Note 5. Allowance for Loan Losses



An analysis of the change in the allowance for loan
losses follows:



|                           |  |      |           |   |      |   |           |      |  |   |           |  
|-------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                           |  | 2004 |           |   | 2003 |   |           | 2002 | 
|Balance, beginning of year |  | $    | 1,901,576 |   |      | $ | 1,696,914 |      |  | $ | 1,493,063 |  
|Provision for loan losses  |  |      | 300,000   |   |      |   | 312,000   |      |  |   | 471,000   |  
|Recoveries                 |  |      | 31,874    |   |      |   | 13,032    |      |  |   | 21,467    |  
|Loans charged off          |  |      | (201,265  | ) |      |   | (120,370  | )    |  |   | (288,616  | )
|                           |  |      |           |   |      |   |           |      |  |   |           |  
|Balance, end of year       |  | $    | 2,032,185 |   |      | $ | 1,901,576 |      |  | $ | 1,696,914 |  
|                           |  |      |           |   |      |   |           |      |  |   |           |  



Information about
impaired loans is as follows:



|                                                                                 |  |      |         |      |   |          
|-------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ---------
|                                                                                 |  | 2004 |         | 2003
|Impaired loans for which an allowance has been provided                          |  | $    | 979,701 |      | $ | 1,133,351
|Impaired loans for which no allowance has been provided                          |  |      |        |      |   |         
|                                                                                 |  |      |         |      |   |          
|Total impaired loans                                                             |  | $    | 979,701 |      | $ | 1,133,351
|                                                                                 |  |      |         |      |   |          
|Allowance provided for impaired loans, included in the allowance for loan losses |  | $    | 572,930 |      | $ | 424,647  
|                                                                                 |  |      |         |      |   |          
|Average balance in impaired loans                                                |  | $    | 983,451 |      | $ | 1,166,208
|                                                                                 |  |      |         |      |   |          
|Interest income recognized                                                       |  | $    | 3       |      | $ | 43,790   
|                                                                                 |  |      |         |      |   |          



At December 31, 2004,
and 2003, non-accrual loans excluded from impaired loan disclosure under FASB 114 totaled $341,001 and $300,250, respectively. If interest on non-accrual loans had been accrued, such income would have approximated $71,704 in 2004 and $51,836 in
2003.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





Note 6.
Premises and Equipment, net



Components of premises and
equipment included in the balance sheets at December 31, 2004, and 2003, were as follows:



|                                               |  |      |            |   |      |   |            |  
|---------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|December 31,                                   |  | 2004 |            |   | 2003 |  
|Land                                           |  | $    | 734,430    |   |      | $ | 734,430    |  
|Buildings and improvements                     |  |      | 7,086,141  |   |      |   | 6,333,549  |  
|Furniture and equipment                        |  |      | 7,477,309  |   |      |   | 6,776,854  |  
|                                               |  |      |            |   |      |   |            |  
|Total cost                                     |  | $    | 15,297,880 |   |      | $ | 13,844,833 |  
|Less accumulated amortization and depreciation |  |      | (6,211,438 | ) |      |   | (5,433,057 | )
|                                               |  |      |            |   |      |   |            |  
|Premises and equipment, net                    |  | $    | 9,086,442  |   |      | $ | 8,411,776  |  
|                                               |  |      |            |   |      |   |            |  



Amortization and
depreciation expense for the years ended December 31, 2004, 2003 and 2002 totaled $770,720, $701,317 and $543,472, respectively.



Note 7. Deposits



The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2004, and 2003, was $29,563,261 and $31,716,430, respectively.



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



|           |  |   |           
|---------- |  | - | ----------
|2005       |  | $ | 26,101,081
|2006       |  |   | 35,553,806
|2007       |  |   | 14,073,613
|2008       |  |   | 9,528,455 
|2009       |  |   | 3,918,990 
|Thereafter |  |   | 5,168     
|           |  |   |           
|           |  | $ | 89,181,113
|           |  |   |           



At December 31, 2004
and 2003, overdraft demand deposits reclassified to loans totaled $40,524 and $33,429, respectively.



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Note 8. Employee Benefit Plans



The following tables provide the reconciliation of
changes in the benefit obligations and fair value of assets and a statement of funded status for the pension plan and postretirement plan of the Company.



|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|----------------------------------------------- |  | ---------------- | --------- | - | ----------------------- | - | ---------- | ---- |  | - | --------- | - |  | ---- | -------- | - | ---- | - | -------- | - |  | - | -------- | -
|                                                |  | Pension Benefits |           |   | Postretirement Benefits |  
|                                                |  | 2004             |           |   | 2003                    |   |            | 2002 |  |   | 2004      |   |  | 2003 |          |   | 2002 |  
|Change in benefit obligation                    |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Benefit obligation, beginning of year           |  | $                | 2,557,250 |   |                         | $ | 1,940,693  |      |  | $ | 1,469,173 |   |  | $    | 515,383  |   |      | $ | 576,206  |   |  | $ | 185,986  |  
|Service cost                                    |  |                  | 237,011   |   |                         |   | 187,941    |      |  |   | 154,040   |   |  |      | 15,316   |   |      |   | 13,180   |   |  |   | 13,001   |  
|Interest cost                                   |  |                  | 166,221   |   |                         |   | 135,849    |      |  |   | 110,188   |   |  |      | 32,609   |   |      |   | 39,117   |   |  |   | 13,019   |  
|Actuarial (gain) / loss                         |  |                  | 409,503   |   |                         |   | 297,493    |      |  |   | 215,759   |   |  |      | 9,582    |   |      |   | (91,153  | ) |  |   | 372,165  |  
|Benefit payments                                |  |                  | (72,248   | ) |                         |   | (4,726     | )    |  |   | (8,467    | ) |  |      | (22,254  | ) |      |   | (21,967  | ) |  |   | (7,965   | )
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Benefit obligation, end of year                 |  |                  | 3,297,737 |   |                         |   | 2,557,250  |      |  |   | 1,940,693 |   |  |      | 550,636  |   |      |   | 515,383  |   |  |   | 576,206  |  
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Change in plan assets                           |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Fair value of plan assets, beginning of year    |  | $                | 1,472,804 |   |                         | $ | 1,098,955  |      |  | $ | 1,013,985 |   |  |      |         |   |      | $ |         |   |  |   |         |  
|Actual return on plan assets                    |  |                  | 159,928   |   |                         |   | 178,794    |      |  |   | (70,503   | ) |  |      |         |   |      |   |         |   |  |   |         |  
|Employer contributions                          |  |                  | 771,589   |   |                         |   | 199,781    |      |  |   | 163,940   |   |  |      | 22,254   |   |      |   | 21,967   |   |  |   | 7,965    |  
|Benefits payments                               |  |                  | (72,248   | ) |                         |   | (4,726     | )    |  |   | (8,467    | ) |  |      | (22,254  | ) |      |   | (21,967  | ) |  |   | (7,965   | )
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Fair value of plan assets, end of year          |  |                  | 2,332,073 |   |                         |   | 1,472,804  |      |  |   | 1,098,955 |   |  |      |         |   |      |   |         |   |  |   |         |  
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Funded Status                                   |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Funded status                                   |  |                  | (965,664  | ) |                         |   | (1,084,446 | )    |  |   | (841,738  | ) |  |      | (550,636 | ) |      |   | (515,383 | ) |  |   | (576,206 | )
|Unrecognized prior service cost                 |  |                  | 74,246    |   |                         |   | 90,618     |      |  |   | 106,990   |   |  |      |         |   |      |   |         |   |  |   |         |  
|Unrecognized transition (asset) / obligation    |  |                  |          |   |                         |   |           |      |  |   | (18,311   | ) |  |      | 26,217   |   |      |   | 29,130   |   |  |   | 32,043   |  
|Unrecognized actuarial loss                     |  |                  | 1,410,099 |   |                         |   | 1,071,063  |      |  |   | 884,819   |   |  |      | 255,925  |   |      |   | 266,343  |   |  |   | 388,033  |  
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|(Accrued) / Prepaid benefit cost                |  | $                | 518,681   |   |                         | $ | 77,235     |      |  | $ | 131,760   |   |  | $    | (268,494 | ) |      | $ | (219,910 | ) |  |   | (156,130 | )
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|                                                |  |                  |           |  
|Weighted-average assumptions as of December 31: |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |     
|Discount rate                                   |  |                  | 6.0       | % |                         |   | 6.5        | %    |  |   | 7.0       | % |  |      | 6.0      | % |      |   | 6.5      | % |  |   | 7.0      | %
|Expected return on plan assets                  |  |                  | 8.5       | % |                         |   | 8.5        | %    |  |   | 9.0       | % |  |      | 0.0      | % |      |   | 0.0      | % |  |   |         |  
|Rate of compensation increase                   |  |                  | 5.0       | % |                         |   | 5.0        | %    |  |   | 5.0       | % |  |      | 5.0      | % |      |   | 5.0      | % |  |   | 5.0      | %
|                                                |  |                  |           |  
|Components of net periodic benefit cost         |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |     
|Service cost                                    |  |                  | 237,011   |   |                         |   | 187,941    |      |  |   | 154,040   |   |  |      | 15,316   |   |      |   | 13,180   |   |  | $ | 13,001   |  
|Interest cost                                   |  |                  | 166,221   |   |                         |   | 135,849    |      |  |   | 110,188   |   |  |      | 32,609   |   |      |   | 39,117   |   |  |   | 13,019   |  
|Expected return on plan assets                  |  |                  | (134,758  | ) |                         |   | (108,177   | )    |  |   | (98,866   | ) |  |      |         |   |      |   |         |   |  |   |         |  
|Recognized net actuarial loss                   |  |                  | 45,297    |   |                         |   | 40,632     |      |  |   | 22,048    |   |  |      | 20,000   |   |      |   | 30,537   |   |  |   | 8,069    |  
|Amortization of prior service cost              |  |                  | 16,372    |   |                         |   | 16,372     |      |  |   | 16,372    |   |  |      |         |   |      |   |         |   |  |   |         |  
|Amortization of transition obligation           |  |                  |          |   |                         |   | (18,311    | )    |  |   | (18,306   | ) |  |      | 2,913    |   |      |   | 2,913    |   |  |   | 2,913    |  
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  
|Net periodic benefit cost                       |  | $                | 330,143   |   |                         | $ | 254,306    |      |  | $ | 185,476   |   |  | $    | 70,838   |   |      | $ | 85,747   |   |  | $ | 37,002   |  
|                                                |  |                  |           |   |                         |   |            |      |  |   |           |   |  |      |          |   |      |   |          |   |  |   |          |  



The accumulated
benefit obligation for the defined benefit pension plan was $1,855,516, $1,441,461, and $1,064,326 at December 31, 2004, 2003, and 2002, respectively.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





Long-term rate of return.    The plan sponsor selects the assumption for the expected long-term rate of return on assets in consultation with their investment advisors and actuary. 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:



|                          |  |      |   |  |      |  
|------------------------- |  | ---- | - |  | ---- | -
|Asset category            |  | 2004 |   |  | 2003 |  
|Mutual fundsfixed income |  | 41   | % |  | 48   | %
|Mutual fundsequity       |  | 55   | % |  | 52   | %
|Other                     |  | 4    | % |  | 0    | %
|                          |  |      |   |  |      |  
|Total                     |  | 100  | % |  | 100  | %
|                          |  |      |   |  |      |  



The trust fund is
sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 50% fixed income and 50% 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 administrative costs chargeable to the Trust.



The Company expects to contribute $324,479 to its pension plan for the Plan in 2005. Estimated future benefit payments are $2,651 for 2005, $17,285 for
2006, $28,200 for 2007, $41,134 for 2008, $52,181 for 2009 and $1,004,260 for 2010 through 2014.



Postretirement benefits plan.    The weighted average discount rates used for the post retirement benefits calculation
was 6.0% and 6.5% at the end of 2004 and 2003. The weighted average rate of compensation increase was 5.0% for 2004 and 2003. For measurement purposes, the assumed annual rate of increase in per capita health care



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costs of covered benefits was 10.0% in 2005
and 2006, 8.0% in 2007 and 2008, and 6.0% in 2009 and thereafter. If assumed health care cost trend rates were increased by 1 percentage point each year, the accumulated postretirement benefit obligation at December 31, 2004, would be increased by
$8,592, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2004, would be increased by $717. If assumed health care cost trend rates were decreased by 1
percentage point each year, the accumulated postretirement benefit obligation at December 31, 2004, would be decreased by $7,872, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year
ended December 31, 2004, would be decreased by $655.



The
Company expects to contribute $27,843 to its postretirement plan in 2005.



In addition, as of December 31, 2004, and 2003, the Company paid approximately $16,674 and $18,000, respectively, for employees who retired prior to adoption of FASB No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions.



401(k)
Retirement Plan.    The Company has a 401(k) retirement plan covering substantially all employees who have completed six months of service. Employees may contribute up to 15% of their salaries and the Company matches 100%
of the first 2% and 25% of the next 2% of employees contributions. Additional contributions can be made at the discretion of the Board of Directors. Contributions to this plan amounted to $65,914, $60,022, and $49,530, for the years ended
December 31, 2004, 2003 and 2002, respectively.



Note 9. Financial
Instruments With Off-Balance Sheet Risk



In the normal
course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments involve elements of credit and interest rate 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 instruments for commitments to extend credit and standby letters of credit written is represented by the contractual amount
of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless otherwise noted, the Company does not require collateral or other security to
support financial instruments with credit risk.



Subject to
its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of
the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At December 31, 2004 and 2003, the Company had outstanding loan commitments approximating $42,232,000
and $35,167,000, respectively.



Conditional commitments are
issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third party. At December 31, 2004 and 2003, commitments under outstanding performance stand-by letters of credit
aggregated $522,358 and $439,000, respectively. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.



The Company had unused lines of credit with nonaffiliated banks totaling $28,250,000 and $35,785,000 as of December 31,
2004, and 2003.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





Note 10.
Restrictions on Cash and Due From Banks



The Federal
Reserve requires banks to maintain cash reserves against certain categories of deposit liabilities. At December 31, 2004, and 2003, the aggregate amount of daily average required reserves for the final weekly reporting period was approximately
$3,311,000, and $2,272,000, respectively.



The Company has
approximately $2,096,292 in deposits in financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation at December 31, 2004.



Note 11. Long-Term Debt



At December 31, 2004, the Company had Federal Home Loan Bank (FHLB) debt consisting of one advance for $7.5 million. The interest rate is
variable at the three-month London Interbank Offering Rate (LIBOR) minus 50 basis points until May 15, 2005, after which it is fixed at 3.92%, maturing on May 14, 2007. At December 31, 2004, the actual rate was 1.78%. Interest is payable
quarterly. This instrument has an early conversion option which gives FHLB the option to convert, in whole only, into a three-month LIBOR-based floating rate advance, effective May 16, 2005. If the FHLB elects to convert, the Company may elect to
terminate, in whole or in part, without a prepayment fee.



Advances on the FHLB line are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit, as of December 31, 2004, was $11.5 million.



Note 12. Income Taxes



The provision for income taxes consisted of the following for the years ended December 31, 2004, 2003, and 2002.



|                  |  |      |         |   |      |   |         |  |   |        
|----------------- |  | ---- | ------- | - | ---- | - | ------- |  | - | -------
|                  |  | 2004 |         |   | 2003 |   | 2002   
|Currently payable |  | $    | 781,925 |   |      | $ | 410,237 |  | $ | 702,855
|Deferred          |  |      | (21,911 | ) |      |   | 251,178 |  |   | 166,684
|                  |  |      |         |   |      |   |         |  |   |        
|                  |  | $    | 760,014 |   |      | $ | 661,415 |  | $ | 869,539
|                  |  |      |         |   |      |   |         |  |   |        



The reasons for the
differences between the statutory Federal income tax rates and the effective tax rates are summarized as follows:



|                            |  |      |   |  |      |   |  |      |  
|--------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|                            |  | 2004 |   |  | 2003 |   |  | 2002 |  
|Statutory rates             |  | 34.0 | % |  | 34.0 | % |  | 34.0 | %
|(Decrease) resulting from:  |  |      |   |  |      |   |  |      |  
|Effect of tax-exempt income |  | (8.2 | ) |  | (9.3 | ) |  | (6.5 | )
|Other, net                  |  |     |   |  |     |   |  | (.1  | )
|                            |  |      |   |  |      |   |  |      |  
|                            |  | 25.8 | % |  | 24.7 | % |  | 27.4 | %
|                            |  |      |   |  |      |   |  |      |  



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The components of the net
deferred tax assets and liabilities included in other assets (liabilities) are as follows at December 31, 2004, 2003, and 2002.



|                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                 |  | 2004 |            |   | 2003 |   |            | 2002 | 
|Deferred tax assets                              |  |      |            |   |      |   |            |      |  |   |            |  
|Allowance for loan losses                        |  | $    | 567,866    |   |      | $ | 523,459    |      |  | $ | 453,874    |  
|Interest on non-accrual loans                    |  |      | 42,003     |   |      |   | 17,624     |      |  |   | 3,428      |  
|Post retirement benefits                         |  |      | 102,653    |   |      |   | 80,071     |      |  |   | 53,084     |  
|Deferred compensation                            |  |      | 110,108    |   |      |   | 101,844    |      |  |   | 98,333     |  
|Other                                            |  |      | 2,257      |   |      |   | 2,674      |      |  |   | 16,692     |  
|                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|                                                 |  |      | 824,887    |   |      |   | 725,672    |      |  |   | 625,411    |  
|                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|Deferred tax liabilities                         |  |      |            |   |      |   |            |      |  |   |            |  
|Unrealized gain on available-for-sale securities |  |      | (291,980   | ) |      |   | (496,844   | )    |  |   | (836,872   | )
|Pension plan                                     |  |      | (286,674   | ) |      |   | (288,600   | )    |  |   | (112,724   | )
|Depreciation                                     |  |      | (484,874   | ) |      |   | (477,337   | )    |  |   | (378,161   | )
|Amortization of intangible                       |  |      | (237,500   | ) |      |   | (158,333   | )    |  |   | (79,167    | )
|Deferred loan fees and costs                     |  |      | (436,889   | ) |      |   | (474,343   | )    |  |   | (494,783   | )
|Other                                            |  |      | (78,538    | ) |      |   | (48,558    | )    |  |   | (30,897    | )
|                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|                                                 |  |      | (1,816,455 | ) |      |   | (1,944,015 | )    |  |   | (1,932,604 | )
|                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|Net deferred tax liabilities                     |  | $    | (991,568   | ) |      | $ | (1,218,343 | )    |  | $ | (1,307,193 | )
|                                                 |  |      |            |   |      |   |            |      |  |   |            |  



Note 13. Regulatory Requirements
and Restrictions



The primary source of funds available to
the Parent Company is the payment of dividends by the subsidiary Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of the Banks regulatory agency. As of December 31, 2004, the aggregate amount of
unrestricted funds, which could be transferred from the banking subsidiary to the Parent Company, without prior regulatory approval, totaled $4,140,564 or 16.0% of consolidated net assets. The Company and Bank are subject to various regulatory
capital requirements administered by the 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 and 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 classifications are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.



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 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, that as of December 31, 2004 and
2003, the Company and the Bank meet all capital adequacy requirements to which they are subject.



As of December 31, 2004, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the framework for
prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





ratios as set
forth in the table. There are no conditions or events since that notification that management believes have changed the Banks category.



The Companys and the Banks actual capital amounts and ratios as of December 31, 2004, and 2003, are presented in the tables below:



|                                         |  |        |        |       |                            |   |        |                                                                       |        |  |      |        |  |       |        |  |       |  
|---------------------------------------- |  | ------ | ------ | ----- | -------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | ---- | ------ |  | ----- | ------ |  | ----- | -
|                                         |  | Actual |        |       | MinimumCapital Requirement |   |        | Minimum To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|(Amounts in Thousands)                   |  | Amount |        | Ratio |                            |   | Amount |                                                                       | Ratio  |  |      | Amount |  | Ratio |       
|As of December 31, 2004:                 |  |        |        |       |                            |   |        |                                                                       |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk Weighted Assets)  |  |        |        |       |                            |   |        |                                                                       |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 24,477 |       | 11.24                      | % |        | $                                                                     | 17,415 |  | 8.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 22,741 |       | 10.53                      | % |        | $                                                                     | 17,284 |  | 8.00 | %      |  | $     | 21,605 |  | 10.00 | %
|Tier 1 Capital (to Risk Weighted Assets) |  |        |        |       |                            |   |        |                                                                       |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 22,444 |       | 10.31                      | % |        | $                                                                     | 8,708  |  | 4.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 20,708 |       | 9.58                       | % |        | $                                                                     | 8,642  |  | 4.00 | %      |  | $     | 12,963 |  | 6.00  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                            |   |        |                                                                       |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 22,444 |       | 7.42                       | % |        | $                                                                     | 12,098 |  | 4.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 20,708 |       | 6.88                       | % |        | $                                                                     | 12,039 |  | 4.00 | %      |  | $     | 15,049 |  | 5.00  | %





|                                         |  |        |        |       |                             |   |        |                                                                      |        |  |      |        |  |       |        |  |       |  
|---------------------------------------- |  | ------ | ------ | ----- | --------------------------- | - | ------ | -------------------------------------------------------------------- | ------ |  | ---- | ------ |  | ----- | ------ |  | ----- | -
|                                         |  | Actual |        |       | Minimum Capital Requirement |   |        | Minimum To Be WellCapitalized UnderPromptCorrective ActionProvisions |       
|(Amounts in Thousands)                   |  | Amount |        | Ratio |                             |   | Amount |                                                                      | Ratio  |  |      | Amount |  | Ratio |       
|As of December 31, 2003:                 |  |        |        |       |                             |   |        |                                                                      |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk Weighted Assets)  |  |        |        |       |                             |   |        |                                                                      |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 23,208 |       | 12.06                       | % |        | $                                                                    | 15,397 |  | 8.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 20,812 |       | 10.91                       | % |        | $                                                                    | 15,264 |  | 8.00 | %      |  | $     | 19,080 |  | 10.00 | %
|Tier 1 Capital (to Risk Weighted Assets) |  |        |        |       |                             |   |        |                                                                      |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 21,306 |       | 11.07                       | % |        | $                                                                    | 7,698  |  | 4.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 18,910 |       | 9.91                        | % |        | $                                                                    | 7,632  |  | 4.00 | %      |  | $     | 11,448 |  | 6.00  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                             |   |        |                                                                      |        |  |      |        |  |       |        |  |       |  
|Consolidated                             |  | $      | 21,306 |       | 7.32                        | % |        | $                                                                    | 11,636 |  | 4.00 | %      |  |       | N/A    |  | N/A   |  
|Bank of Lancaster                        |  | $      | 18,910 |       | 6.59                        | % |        | $                                                                    | 11,477 |  | 4.00 | %      |  | $     | 14,346 |  | 5.00  | %



Note 14. Employee Stock Ownership
Plan



The Company has a noncontributory Employee Stock
Ownership Plan (ESOP) for the benefit of all eligible employees who have completed twelve months of service and who have attained the age of 21 years. Contributions to the plan are at the discretion of the Board of Directors.
Contributions are allocated in the ratio to which the covered compensation of each participant bears to the aggregate covered compensation of all participants for the plan year. Allocations are limited to 25% of eligible participant compensation.
Participant accounts are 30% vested after three years, 40% vested after four years with vesting increasing 20% each year thereafter, until 100% vested. The plan had 126,713



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allocated shares as of December 31, 2004.
Contributions to the plan were $50,000, $50,000 and $100,000 for 2004, 2003 and 2002, respectively. Dividends on the Companys stock held by the ESOP were $77,053, $73,794 and $65,013 in 2004, 2003 and 2002, respectively. Shares held by the
ESOP are considered outstanding for purposes of computing net earnings per share.



Note 15. Stock-Based Compensation Plans



The
Company has four stock-based compensation plans. The 1985 and 1994 Incentive Stock Option Plans are expired and no additional shares may be granted under these plans. The 2003 Incentive Stock Option Plan was approved by shareholders on May 19, 2003,
and makes 175,000 shares available for grant. The first grants from the 2003 plan occurred in 2004 for a total of 25,000 shares. Under these plans, the exercise price of each option equals the market price of the Companys common stock on the
date of grant and an options maximum term is ten years. Options granted are exercisable only after meeting certain performance targets during a specified time period. If the targets are not met, the options are forfeited.



Under the 1998 Non-Employee Directors Stock Option Plan, the Company grants
an option of 250 shares to each non-employee director annually. The plan had 17,500 shares available for grant at December 31, 2004.



A summary of the status of the incentive stock option plans as of December 31, 2004, 2003, and 2002, and changes during the years ending on those dates is
presented below:



|                                 |  |         |   |      |                              |       |        |         |   |                              |   |        |  |         |                              |  |   |      
|-------------------------------- |  | ------- | - | ---- | ---------------------------- | ----- | ------ | ------- | - | ---------------------------- | - | ------ |  | ------- | ---------------------------- |  | - | -----
|                                 |  | 2004    |   | 2003 |                              | 2002 
|                                 |  | Shares  |   |      | WeightedAverageExercisePrice |       | Shares |         |   | WeightedAverageExercisePrice |   | Shares |  |         | WeightedAverageExercisePrice
|Outstanding at beginning of year |  | 182,682 |   |      | $                            | 13.58 |        | 164,872 |   |                              | $ | 14.13  |  | 146,682 |                              |  | $ | 13.20
|Granted                          |  | 32,000  |   |      |                              | 15.91 |        | 30,500  |   |                              |   | 14.86  |  | 41,500  |                              |  |   | 16.57
|Exercised                        |  | (7,700  | ) |      |                              | 8.70  |        | (1,000  | ) |                              |   | 7.75   |  | (10,000 | )                            |  |   | 7.15 
|Forfeited                        |  | (14,861 | ) |      |                              | 14.80 |        | (11,690 | ) |                              |   | 16.58  |  | (13,310 | )                            |  |   | 16.75
|                                 |  |         |   |      |                              |       |        |         |   |                              |   |        |  |         |                              |  |   |      
|Outstanding at end of year       |  | 192,121 |   |      | $                            | 13.57 |        | 182,682 |   |                              | $ | 13.58  |  | 164,872 |                              |  | $ | 14.13
|                                 |  |         |   |      |                              |       |        |         |   |                              |   |        |  |         |                              |  |   |      
|Options exercisable at year-end  |  | 167,121 |   |      |                              |       |        | 158,682 |   |                              |   |        |  | 129,372 |                              |  |   |      
|                                 |  |         |   |      |                              |       |        |         |   |                              |   |        |  |         |                              |  |   |      



The weighted average
fair value of options granted during 2004 and 2003 was $2.26 and $2.10, respectively.



The status of the options outstanding at December 31, 2004 is as follows:



|                         |  |                     |  |                                         |  |                    |  |                              
|------------------------ |  | ------------------- |  | --------------------------------------- |  | ------------------ |  | -----------------------------
|Options Outstanding      |  | Options Exercisable
|Range of Exercise Prices |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife |  | Number Exercisable |  | WeightedAverageExercise Price
|$8.25-$13.75             |  | 49,568              |  | 1.68 yrs                                |  | 49,568             |  | $10.20                       
|$14.50-$17.50            |  | 142,553             |  | 7.00 yrs                                |  | 117,553            |  | $16.15                       
|                         |  |                     |  |                                         |  |                    |  |                              
|                         |  | 192,121             |  | 5.63 yrs                                |  | 167,121            |  | $14.38                       
|                         |  |                     |  |                                         |  |                    |  |                              



40



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





Note 16.
Earnings Per Share



The following shows the weighted
average number of shares used in computing the earnings per share and the effect on weighted average number of shares of diluted potential common stock.



|                                            |  |                          |           |      |   |           |  |   |          
|------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- |  | - | ---------
|                                            |  | Years Ended December 31,
|                                            |  | 2004                     |           | 2003 |   | 2002     
|Net Income available to common shareholders |  | $                        | 2,181,360 |      | $ | 2,013,185 |  | $ | 2,301,401
|Average number of common shares outstanding |  |                          | 2,337,788 |      |   | 2,313,596 |  |   | 2,301,364
|Effect of dilutive options                  |  |                          | 18,810    |      |   | 24,885    |  |   | 8,595    
|                                            |  |                          |           |      |   |           |  |   |          
|Average number of common shares             |  |                          | 2,356,598 |      |   | 2,338,481 |  |   | 2,309,959
|                                            |  |                          |           |      |   |           |  |   |          



As of December 31,
2004, 2003, and 2002, options on 124,414 shares, 74,308 shares, and 86,304 shares, respectively, were not included in computing earnings per common shareassuming dilution, because their effects were antidilutive.



Note 17. Related Parties



The Company has entered into transactions with its directors and principal
officers of the Company, their immediate families and affiliated companies in which they are the principal stockholders (related parties). The aggregate amount of loans to such related parties was approximately $2,694,486 and $2,963,803 at December
31, 2004, and 2003, respectively. All such loans, in the opinion of the management, were made in the normal course of business on the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions.



|                                           |  |   |           |  
|------------------------------------------ |  | - | --------- | -
|Balance, January 1, 2004                   |  | $ | 2,963,803 |  
|New loans and extensions to existing loans |  |   | 471,500   |  
|Repayments and other reductions            |  |   | (740,817  | )
|                                           |  |   |           |  
|Balance, December 31, 2004                 |  | $ | 2,694,486 |  
|                                           |  |   |           |  



Commitments to extend
credit to directors and their related interests were $1,146,368 and $778,981 in 2004 and 2003, respectively.



41



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##### Table of Contents



Note 18. Fair Value of Financial
Instruments



The estimated fair values of financial
instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.



|                                             |  |                   |             |                   |   |                |  |            |             |  |   |            
|-------------------------------------------- |  | ----------------- | ----------- | ----------------- | - | -------------- |  | ---------- | ----------- |  | - | -----------
|                                             |  | December 31, 2004 |             | December 31, 2003
|                                             |  | CarryingAmount    |             | Fair Value        |   | CarryingAmount |  | Fair Value
|Financial Assets:                            |  |                   |             |                   |   |                |  |            |             |  |   |            
|Cash and due from banks                      |  | $                 | 8,572,672   |                   | $ | 8,572,672      |  | $          | 7,762,030   |  | $ | 7,762,030  
|Interest-bearing deposits                    |  |                   | 104,949     |                   |   | 104,949        |  |            | 102,868     |  |   | 102,868    
|Federal funds sold                           |  |                   | 13,989,278  |                   |   | 13,989,278     |  |            | 13,907,525  |  |   | 13,907,525 
|Securities available-for-sale                |  |                   | 51,916,490  |                   |   | 51,916,490     |  |            | 66,493,731  |  |   | 66,493,731 
|Securities held-to-maturity                  |  |                   | 429,815     |                   |   | 426,320        |  |            |            |  |   |           
|Loans, net                                   |  |                   | 213,350,454 |                   |   | 217,070,284    |  |            | 188,450,953 |  |   | 188,947,767
|Accrued interest receivable                  |  |                   | 1,163,976   |                   |   | 1,163,976      |  |            | 1,261,784   |  |   | 1,261,784  
|Financial liabilities:                       |  |                   |             |                   |   |                |  |            |             |  |   |            
|Noninterest-bearing deposits                 |  | $                 | 38,877,338  |                   | $ | 38,877,338     |  | $          | 34,290,391  |  | $ | 34,290,391 
|Savings and other interest- bearing deposits |  |                   | 133,887,530 |                   |   | 133,892,391    |  |            | 126,127,299 |  |   | 126,122,327
|Time deposits                                |  |                   | 89,181,113  |                   |   | 90,479,859     |  |            | 96,665,504  |  |   | 99,096,992 
|Securities sold under repurchase agreements  |  |                   | 6,342,456   |                   |   | 6,342,456      |  |            | 6,478,601   |  |   | 6,478,601  
|FHLB Advance                                 |  |                   | 7,500,000   |                   |   | 7,498,740      |  |            |            |  |   |           
|Accrued interest payable                     |  |                   | 219,340     |                   |   | 219,340        |  |            | 219,641     |  |   | 219,641    



The above
presentation of fair values is required by Statement on Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments. The fair values shown do not necessarily represent the amounts which would be received on
immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.



The following methods and
assumptions were used to estimate the fair value of each class of financial instrument.



The carrying amounts of cash and due from banks, federal funds sold, non-interest-bearing deposits, and securities sold under repurchase agreements, represent items which do not present significant market risks, are
payable on demand, or are of such short duration that carrying value approximates market value.



Securities are valued at the quoted market prices for the individual securities held. Therefore carrying value equals market value.



The fair value of loans is estimated by discounting future cash flows using
the interest rates at which similar loans would be made to borrowers as of December 31, 2004.



Other time deposits are presented at estimated fair value using interest rates offered for deposits of similar remaining maturities as of December 31, 2004.



The fair value of the FHLB Advance is estimated by discounting its future
cash flows using the interest rate offered for similar advances as of December 31, 2004.



42



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.



The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or
otherwise settle the obligations with the counterparties at the reporting date.



At December 31, 2004, and 2003, the fair value of loan commitments and standby letters of credit was immaterial.



Note 19. Condensed Financial Information of Parent Company



Financial information pertaining only to Bay Banks of Virginia, Inc. is as follows:



|                                                 |  |      |            |      |   |           
|------------------------------------------------ |  | ---- | ---------- | ---- | - | ----------
|                                                 |  | 2004 |            | 2003
|Condensed Balance Sheets                         |  |      |            |      |   |           
|Assets                                           |  |      |            |      |   |           
|Cash and due from banks                          |  | $    | 438,152    |      | $ | 1,009,873 
|Investments in subsidiaries                      |  |      | 25,131,737 |      |   | 23,690,305
|Premises and equipment, net                      |  |      | 131,811    |      |   | 149,147   
|Other assets                                     |  |      | 372,507    |      |   | 416,078   
|                                                 |  |      |            |      |   |           
|Total assets                                     |  | $    | 26,074,207 |      | $ | 25,265,403
|                                                 |  |      |            |      |   |           
|Liabilities and Shareholders Equity Liabilities |  |      |            |      |   |           
|Deferred directors compensation                 |  | $    | 297,763    |      | $ | 274,438   
|Other liabilities                                |  |      | 51,963     |      |   | 7,602     
|                                                 |  |      |            |      |   |           
|Total liabilities                                |  | $    | 349,726    |      | $ | 282,040   
|Total shareholders equity                       |  |      | 25,724,481 |      |   | 24,983,363
|                                                 |  |      |            |      |   |           
|Total liabilities and shareholders equity       |  | $    | 26,074,207 |      | $ | 25,265,403
|                                                 |  |      |            |      |   |           



|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                |  | 2004 |           |   | 2003 |   |           | 2002 | 
|Condensed Statements of Income                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Dividends from subsidiaries                                                     |  | $    | 750,000   |   |      | $ | 1,275,000 |      |  | $ | 1,225,000 |  
|Other income                                                                    |  |      | 5,825     |   |      |   | 26,043    |      |  |   |          |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Total non-interest income                                                       |  |      | 755,825   |   |      |   | 1,301,043 |      |  |   | 1,225,000 |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Total non-interest expense                                                      |  |      | 338,987   |   |      |   | 364,746   |      |  |   | 186,766   |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Income before income taxes and equity in undistributed earnings of subsidiaries |  |      | 416,838   |   |      |   | 936,297   |      |  |   | 1,038,234 |  
|Income tax benefit                                                              |  |      | (85,413   | ) |      |   | (115,159  | )    |  |   | (63,500   | )
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Income before equity in undistributed earnings of subsidiaries                  |  |      | 502,251   |   |      |   | 1,051,456 |      |  |   | 1,101,734 |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Equity in undistributed earnings of subsidiaries                                |  |      | 1,679,109 |   |      |   | 961,729   |      |  |   | 1,199,667 |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  
|Net income                                                                      |  | $    | 2,181,360 |   |      | $ | 2,013,185 |      |  | $ | 2,301,401 |  
|                                                                                |  |      |           |   |      |   |           |      |  |   |           |  



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|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|--------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                  |  | 2004 |            |   | 2003 |   |            | 2002 | 
|Condensed Statement of Cash Flows                                                 |  |      |            |   |      |   |            |      |  |   |            |  
|Cash Flows from Operating Activities:                                             |  |      |            |   |      |   |            |      |  |   |            |  
|Net income                                                                        |  | $    | 2,181,360  |   |      | $ | 2,013,185  |      |  | $ | 2,301,401  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |            |   |      |   |            |      |  |   |            |  
|Depreciation and amortization                                                     |  |      | 24,625     |   |      |   | 25,826     |      |  |   | 28,758     |  
|Equity in undistributed earnings of subsidiaries                                  |  |      | (1,679,109 | ) |      |   | (961,729   | )    |  |   | (1,199,667 | )
|(Increase) in other assets                                                        |  |      | (15,905    | ) |      |   | (79,416    | )    |  |   | (16,467    | )
|Net change in deferred directors compensation                                    |  |      | 23,325     |   |      |   | 14,771     |      |  |   | (6,581     | )
|Increase / (Decrease) in other liabilities                                        |  |      | 96,548     |   |      |   | (275,132   | )    |  |   | 139,865    |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash provided by operating activities                                         |  |      | 630,844    |   |      |   | 737,505    |      |  |   | 1,247,309  |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Cash Flows from Investing Activities:                                             |  |      |            |   |      |   |            |      |  |   |            |  
|Net change in due from subsidiaries                                               |  |      |           |   |      |   |           |      |  |   | 136,745    |  
|Investment in subsidiaries                                                        |  |      | (160,000   | ) |      |   |           |      |  |   |           |  
|Purchases of premises and equipment                                               |  |      |           |   |      |   |           |      |  |   |           |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash provided by (used in) investing activities                               |  |      | (160,000   | ) |      |   |           |      |  |   | 136,745    |  
|Cash Flows from Financing Activities:                                             |  |      |            |   |      |   |            |      |  |   |            |  
|Proceeds from issuance of common stock                                            |  |      | 424,407    |   |      |   | 395,937    |      |  |   | 380,789    |  
|Dividends paid                                                                    |  |      | (1,414,327 | ) |      |   | (1,318,104 | )    |  |   | (1,150,503 | )
|Repurchase of stock                                                               |  |      | (52,645    | ) |      |   | (109,358   | )    |  |   | (469,583   | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net cash used in financing activities                                             |  |      | (1,042,565 | ) |      |   | (1,031,525 | )    |  |   | (1,239,297 | )
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Net increase (decrease) in cash and due from banks                                |  |      | (571,721   | ) |      |   | (294,020   | )    |  |   | 144,757    |  
|Cash and due from banks at January 1                                              |  |      | 1,009,873  |   |      |   | 1,303,893  |      |  |   | 1,159,136  |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  
|Cash and due from banks at December 31                                            |  | $    | 438,152    |   |      | $ | 1,009,873  |      |  | $ | 1,303,893  |  
|                                                                                  |  |      |            |   |      |   |            |      |  |   |            |  



44



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)





Note 20.
Quarterly Condensed Statements of Income (unaudited)



|                                                    |  |          |       |         |   |              |  |             |       |  |   |      
|--------------------------------------------------- |  | -------- | ----- | ------- | - | ------------ |  | ----------- | ----- |  | - | -----
|2004 Quarter ended                                  |  | March 31 |       | June 30 |   | September 30 |  | December 31
|(in thousands)                                      |  |          |       |         |   |              |  |            
|Total interest income                               |  | $        | 3,400 |         | $ | 3,435        |  | $           | 3,554 |  | $ | 3,696
|Net interest income after provision for loan losses |  |          | 2,262 |         |   | 2,306        |  |             | 2,410 |  |   | 2,497
|Other income                                        |  |          | 691   |         |   | 654          |  |             | 685   |  |   | 760  
|Other expenses                                      |  |          | 2,387 |         |   | 2,324        |  |             | 2,318 |  |   | 2,294
|Income before income taxes                          |  |          | 565   |         |   | 636          |  |             | 776   |  |   | 964  
|Net income                                          |  |          | 397   |         |   | 451          |  |             | 590   |  |   | 743  
|(in dollars)                                        |  |          |       |         |   |              |  |            
|Earnings per common shareassuming dilution         |  | $        | 0.17  |         | $ | 0.19         |  | $           | 0.25  |  | $ | 0.32 
|Dividends per common share                          |  | $        | 0.15  |         | $ | 0.15         |  | $           | 0.15  |  | $ | 0.155
|                                                    |  |          |       |        
|2003 Quarter ended                                  |  | March 31 |       | June 30 |   | September 30 |  | December 31
|(in thousands)                                      |  |          |       |         |   |              |  |            
|Total interest income                               |  | $        | 3,410 |         | $ | 3,349        |  | $           | 3,244 |  | $ | 3,325
|Net interest income after provision for loan losses |  |          | 2,064 |         |   | 2,044        |  |             | 2,021 |  |   | 2,122
|Other income                                        |  |          | 610   |         |   | 756          |  |             | 680   |  |   | 914  
|Other expenses                                      |  |          | 2,043 |         |   | 2,196        |  |             | 2,118 |  |   | 2,179
|Income before income taxes                          |  |          | 630   |         |   | 604          |  |             | 583   |  |   | 858  
|Net income                                          |  |          | 439   |         |   | 439          |  |             | 464   |  |   | 671  
|(in dollars)                                        |  |          |       |         |   |              |  |            
|Earnings per common shareassuming dilution         |  | $        | 0.19  |         | $ | 0.19         |  | $           | 0.20  |  | $ | 0.28 
|Dividends per common share                          |  | $        | 0.14  |         | $ | 0.14         |  | $           | 0.14  |  | $ | 0.15 



45



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|                                                                              |  |  |  |  |  | 
|----------------------------------------------------------------------------- |  |  |  |  |  | 
|LOGO Yount, Hyde & Barbour, P.C. Certified Public Accountants and Consultants |  |  |  |  |  | 



REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the
Shareholders and Directors

Bay Banks of Virginia, Inc.

and Subsidiaries

Kilmarnock, Virginia



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



We conducted our audits in accordance with the 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 the 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 Bay Banks of Virginia, Inc. and Subsidiaries as of 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 U.S. generally accepted accounting principles.



LOGO



Winchester, Virginia

January 21, 2005



46



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##### Table of Contents

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



None.



ITEM 9A: CONTROLS AND PROCEDURES



As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. Based upon that evaluation, the Companys Chief Executive Officer
and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included
in the Companys periodic SEC filings. There have been no significant changes in the Companys internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its
evaluation.



ITEM 9B: OTHER INFORMATION



None.



PART III



ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



All required information is detailed in the Companys 2005 definitive proxy statement for the annual meeting of shareholders (Definitive Proxy Statement), which is expected to be filed with the SEC
within the required time period, and is incorporated herein by reference.



ITEM 11: EXECUTIVE COMPENSATION



Information on executive compensation is provided in the Definitive Proxy Statement and is incorporated herein by reference.



ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS



Information on security ownership of certain beneficial owners and management is provided in the Definitive Proxy Statement, and is incorporated herein by
reference.



47



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##### Table of Contents

The following table summarizes information, as of December 31, 2004, relating to the Companys stock
incentive plans, pursuant to which grants of options to acquire shares of common stock may be granted from time to time.



|                                                       |  |                                                                                       |     |  |                                                                          |       |                                                                                      |        
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------- | --- |  | ------------------------------------------------------------------------ | ----- | ------------------------------------------------------------------------------------ | -------
|At December 31, 2004                                   |  | Number of SharesTo be IssuedUpon Exercise Of OutstandingOptions,Warrants andRights(1) |     |  | Weighted-AverageExercise Price ofOutstanding Options,Warrants and Rights |       | Number of SharesRemaining Availablefor Future Issuance UnderEquity Compensation Plan
|Equity compensation plans Approved by shareholders     |  | 192,121                                                                               | (1) |  | $                                                                        | 13.57 |                                                                                      | 167,500
|Equity compensation plans not approved by shareholders |  |                                                                                      |     |  |                                                                          |      |                                                                                      |       
|                                                       |  |                                                                                       |     |  |                                                                          |       |                                                                                      |        
|Total                                                  |  | 192,121                                                                               |     |  | $                                                                        | 13.57 |                                                                                      | 167,500

---

|(1) | Consists of options granted pursuant to the Companys incentive stock option plans.
|--- | -----------------------------------------------------------------------------------



ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



Information on certain relationships and related transactions are detailed in the Definitive Proxy Statement and incorporated herein by reference.



ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES



Information on accounting fees and services is provided in the Definitive Proxy Statement and is incorporated herein by reference.



PART IV



ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES.



|      |  |                                                                                                                                         |  |                                                                                                                                                                      
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a)1. |  | Financial Statements are included in Part II, Item 8, Financial Statements and Supplementary Data                                      
|      | 
|(a)2. |  | All required tables are included in Part I, Item 7, Managements Discussion and Analysis of Financial Condition and Resultsof Operations
|      | 
|(a)3. |  | Exhibits:                                                                                                                              
|      |  |                                                                                                                                        
|      |  | No.                                                                                                                                     |  | Description                                                                                                                                                          
|      |  |                                                                                                                                        
|      |  | 3.1                                                                                                                                     |  | Articles of Incorporation, as amended, of Bay Banks of Virginia, Inc. (Incorporated by reference to previously filed Form 10-K for the year ended December 31, 2002).
|      |  |                                                                                                                                        
|      |  | 3.2                                                                                                                                     |  | Bylaws, as amended, of Bay Banks of Virginia, Inc. (filed herewith).                                                                                                 
|      |  |                                                                                                                                        
|      |  | 10.1                                                                                                                                    |  | 1994 Incentive Stock Option Plan (Incorporated by reference to the previously filed Form S-4EF, Commission File number 333-22579, dated February 28, 1997).          
|      |  |                                                                                                                                        
|      |  | 10.2                                                                                                                                    |  | 1998 Non-Employee Directors Stock Option Plan (Incorporated by reference to the previously filed Form 10-K for the year ended December 31, 1999).                    
|      |  |                                                                                                                                        
|      |  | 10.3                                                                                                                                    |  | 2003 Incentive Stock Option Plan. (Incorporated by reference to Form S-8, Commission File Number 333-112947, previously filed on February 19, 2004).                 
|      |  |                                                                                                                                        
|      |  | 11.0                                                                                                                                    |  | Statement re: Computation of per share earnings. (Incorporated herein by reference to Note 1 of the 2004 Annual Report to Shareholders).                             
|      |  |                                                                                                                                        
|      |  | 21.0                                                                                                                                    |  | Subsidiaries of the Company (filed herewith).                                                                                                                        
|      |  |                                                                                                                                        
|      |  | 23.1                                                                                                                                    |  | Consent of Yount, Hyde & Barbour, P.C. (filed herewith)                                                                                                              
|      |  |                                                                                                                                        
|      |  | 31.1                                                                                                                                    |  | Section 302 Certification (filed herewith).                                                                                                                          
|      |  |                                                                                                                                        
|      |  | 31.2                                                                                                                                    |  | Section 302 Certification (filed herewith).                                                                                                                          
|      |  |                                                                                                                                        
|      |  | 32.0                                                                                                                                    |  | Section 906 Certification (filed herewith).                                                                                                                          



48



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##### Table of Contents

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 16th day of March, 2005.



|                                         |  |                                      
|---------------------------------------- |  | -------------------------------------
|Bay Banks of Virginia, Inc. (registrant)
|
|                                         | 
|By:                                      |  | /s/ Austin L. Roberts, III           
|                                         |  | Austin L. Roberts, III,              
|                                         |  | President and Chief Executive Officer
|                                         |  | (Principal Executive Officer)        



Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, and in the capacities indicated, on the 16th day of March 2005.



|                                                                                 
|---------------------------------------------------------------------------------
|/s/ Ammon G. Dunton, Jr.                                                         
|Ammon G. Dunton, Jr. Chairman, Board of
Directors Director                       
|                                                                                 
|/s/ Austin L. Roberts, III                                                       
|Austin L. Roberts, III President and CEO Director                                
|                                                                                 
|/s/ Robert C. Berry, Jr.                                                         
|Robert C. Berry, Jr. Vice President Director                                     
|                                                                                 
|/s/ Weston F. Conley, Jr.                                                        
|Weston F. Conley, Jr. Director                                                   
|                                                                                 
|/s/ Thomas A. Gosse                                                              
|Thomas A. Gosse Director                                                         
|                                                                                 
|/s/ Richard A. Farmar, IIIRichard A. Farmar, III Director                        
|                                                                                 
|/s/ Allen C. MarpleAllen C. Marple Director                                      
|                                                                                 
|/s/ Richard C. Abbott                                                            
|Richard C. Abbott Acting Treasurer and Principal
Financial and Accounting Officer



49