UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2007

or

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

For the transition period from                      to                     

Fauquier Bankshares, Inc.

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)		54-1288193 (I.R.S. Employer Identification No.)

10 Courthouse Square, Warrenton, Virginia (Address of principal executive offices)		20186 (Zip Code)

(540) 347-2700
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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 þ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)
Yes o Noþ

The registrant had 3,548,258 shares of common stock outstanding as of August 10, 2007, the latest practicable date for determination.

 

 

FAUQUIER BANKSHARES, INC.

INDEX

				Page
Part I. FINANCIAL INFORMATION				3
Item 1.		Financial Statements		3
		Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December 31, 2006		3
		Consolidated Statements of Income (unaudited) for the Three Months Ended June 30, 2007 and 2006		4
		Consolidated Statements of Income (unaudited) for the Six Months Ended June 30, 2007 and 2006		5
		Consolidated Statements of Changes in Shareholders’ Equity (unaudited) for the Six Months Ended June 30, 2007 and 2006		6
		Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2007 and 2006		7
		Notes to Consolidated Financial Statements		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		29
Item 4.		Controls and Procedures		29
Part II. OTHER INFORMATION				29
Item 1.		Legal Proceedings		29
Item 1A.		Risk Factors		29
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		30
Item 3.		Defaults Upon Senior Securities		30
Item 4.		Submission of Matters to a Vote of Security Holders		30
Item 5.		Other Information		31
Item 6.		Exhibits		31
SIGNATURES				32

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets

		Unaudited				Audited
		June 30,				December 31,
		2007				2006
Assets
Cash and due from banks		$	13,359,554			$	21,019,764
Interest-bearing deposits in other banks			538,881				537,891
Federal funds sold			5,244,000				20,122,000
Securities available for sale			38,270,457				40,352,775
Loans, net of allowance for loan losses of $4,407,421 in 2007 and $4,470,533 in 2006			405,209,309				416,061,150
Bank premises and equipment, net			7,411,444				7,584,089
Accrued interest receivable			1,656,809				1,802,379
Other assets			14,337,960				14,282,097
Total assets		$	486,028,414			$	521,762,145
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing			78,031,178				85,495,160
Interest-bearing			332,119,816				330,576,258
Total deposits			410,150,994				416,071,418
Federal funds purchased			—				—
Federal Home Loan Bank advances			28,000,000				55,000,000
Company-obligated mandatorily redeemable capital securities			4,124,000				8,248,000
Other liabilities			3,523,498				3,730,778
Commitments and contingencies			—				—
Total liabilities			445,798,492				483,050,196
Shareholders’ Equity
Common stock, par value, $3.13; authorized 8,000,000 shares: issued and outstanding, 2007: 3,545,138 shares (includes nonvested shares of 31,190); 2006: 3,478,960 shares (includes nonvested shares of 31,829)			10,998,657				10,789,521
Retained earnings			30,285,643				28,962,409
Accumulated other comprehensive income (loss), net			(1,054,378	)			(1,039,981	)
Total shareholders’ equity			40,229,922				38,711,949
Total liabilities and shareholders’ equity		$	486,028,414			$	521,762,145

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended June 30, 2007 and 2006

		2007				2006
Interest Income
Interest and fees on loans		$	7,233,485			$	6,905,346
Interest and dividends on securities available for sale:
Taxable interest income			363,447				395,485
Interest income exempt from federal income taxes			16,291				13,129
Dividends			92,907				74,847
Interest on federal funds sold			23,951				2,763
Interest on deposits in other banks			15,872				6,303
Total interest income			7,745,953				7,397,873
Interest Expense
Interest on deposits			2,542,648				1,846,576
Interest on federal funds purchased			51,602				166,650
Interest on Federal Home Loan Bank advances			378,656				394,625
Distribution on capital securities of subsidiary trusts			71,341				87,018
Total interest expense			3,044,247				2,494,869
Net interest income			4,701,706				4,903,004
Provision for loan losses			120,000				180,000
Net interest income after provision for loan losses			4,581,706				4,723,004
Other Income
Wealth management income			354,685				336,334
Service charges on deposit accounts			717,525				723,513
Other service charges, commissions and income			440,859				373,063
Total other income			1,513,069				1,432,910
Other Expenses
Salaries and benefits			2,313,208				2,321,056
Net occupancy expense of premises			265,177				262,648
Furniture and equipment			296,109				347,787
Advertising expense			161,692				166,569
Consulting expense			193,948				233,265
Data processing expense			312,860				281,827
Other operating expenses			722,055				702,255
Total other expenses			4,265,049				4,315,407
Income before income taxes			1,829,726				1,840,507
Income tax expense			550,295				552,695
Net Income		$	1,279,431			$	1,287,812
Earnings per Share, basic		$	0.36			$	0.37
Earnings per Share, assuming dilution		$	0.36			$	0.36
Dividends per Share		$	0.200			$	0.190

See accompanying Notes to Consolidated Financial Statements.

Consolidated Statements of Income
(Unaudited)
For the Six Months Ended June 30, 2007 and 2006

		2007				2006
Interest Income
Interest and fees on loans		$	14,511,990			$	13,328,784
Interest and dividends on securities available for sale:
Taxable interest income			735,452				813,322
Interest income exempt from federal income taxes			29,488				26,252
Dividends			143,404				121,995
Interest on federal funds sold			66,551				17,405
Interest on deposits in other banks			20,662				11,278
Total interest income			15,507,547				14,319,036
Interest Expense
Interest on deposits			4,961,275				3,417,674
Interest on federal funds purchased			138,445				204,450
Interest on Federal Home Loan Bank advances			903,604				882,437
Distribution on capital securities of subsidiary trusts			227,442				172,723
Total interest expense			6,230,766				4,677,284
Net interest income			9,276,781				9,641,752
Provision for loan losses			240,000				300,000
Net interest income after provision for loan losses			9,036,781				9,341,752
Other Income
Wealth management income			693,558				663,881
Service charges on deposit accounts			1,377,316				1,359,452
Other service charges, commissions and income			864,997				725,405
Gain on cancellation of property rights			—				250,000
Loss on sale of securities			—				(82,564	)
Total other income			2,935,871				2,916,174
Other Expenses
Salaries and benefits			4,661,441				4,504,823
Net occupancy expense of premises			533,283				503,801
Furniture and equipment			583,709				679,506
Advertising expense			282,093				264,833
Consulting expense			433,890				527,260
Data processing expense			612,541				553,513
Other operating expenses			1,347,271				1,386,762
Total other expenses			8,454,228				8,420,498
Income before income taxes			3,518,424				3,837,428
Income tax expense			1,066,513				1,152,004
Net Income		$	2,451,911			$	2,685,424
Earnings per Share, basic		$	0.70			$	0.77
Earnings per Share, assuming dilution		$	0.69			$	0.75
Dividends per Share		$	0.390			$	0.365

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited)
For the Six Months Ended June 30, 2007 and 2006

										Accumulated
										Other
		Common				Retained				Comprehensive				Comprehensive
		Stock				Earnings				Income (Loss)				Income				Total
Balance, December 31, 2005		$	10,794,700			$	25,440,838			$	(656,393	)						$	35,579,145
Comprehensive income:
Net income							2,685,424				—			$	2,685,424				2,685,424
Other comprehensive income (loss) net of tax:
Unrealized holding losses on securities available for sale, net of deferred income taxes of $120,771			—				—				(234,437	)							—
Add: reclassification adjustment, net of tax of $28,072											54,492
Other comprehensive income (loss) net of tax:											(179,945	)			(179,945	)
Total comprehensive income															2,505,479
Cash dividends ($.365 per share)			—				(1,268,073	)			—								(1,268,073	)
SFAS No. 123(R) implementation adjustment			(67,238	)			67,238				—
Amortization of unearned compensation, restricted stock awards			—				102,879				—								102,879
Issuance of common stock			10,993				75,688				—								86,681
Exercise of stock options			38,937				26,760				—								65,697
Balance, June 30, 2006		$	10,777,392			$	27,130,754			$	(836,338	)						$	37,251,753
Balance, December 31, 2006		$	10,789,521			$	28,962,409			$	(1,039,981	)						$	38,711,949
Comprehensive income:
Net income							2,451,911				—			$	2,451,911				2,451,911
Other comprehensive income (loss) net of tax:
Unrealized holding losses on securities available for sale, net of deferred income taxes of $7,418			—				—				(14,397	)			(14,397	)			(14,397	)
Total comprehensive income															2,437,514
Cash dividends ($.39 per share)			—				(1,380,939	)			—								(1,380,939	)
Acquisition of 8,270 shares of common stock			(25,886	)			(180,955	)			—								(206,841	)
Amortization of unearned compensation, restricted stock awards			—				127,140				—								127,140
Issuance of common stock — nonvested shares (11,437 shares)			35,797				(35,797	)			—								—
Exercise of stock options			199,224				341,874				—								541,098
Balance, June 30, 2007		$	10,998,656			$	30,285,643			$	(1,054,378	)						$	40,229,922

See accompanying Notes to Consolidated Financial Statements.

-6-

     The amortized cost and fair value of securities available for sale, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

		June 30, 2007
		Amortized				Fair
		Cost				Value
Due in one year or less		$	11,752,532			$	11,572,212
Due after one year through five years			22,633,240				22,295,017
Due after five years through ten years			517,960				502,458
Due after ten years			682,129				658,650
Equity securities			3,265,651				3,242,120
		$	38,851,512			$	38,270,457

     The following table shows the Company’s investments with gross unrealized losses and their fair value, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at June 30, 2007 and December 31, 2006.

June 30, 2007		Less than 12 Months								12 Months or More								Total
						Unrealized								Unrealized								Unrealized
Description of Securities		Fair Value				(Losses)				Fair Value				(Losses)				Fair Value				(Losses)
Obligations of U.S. Government, corporations and agencies		$	4,032			$	(2	)		$	26,803,622			$	(588,534	)		$	26,807,654			$	(588,536	)
Corporate Bonds			—				—				1,978,750				(21,250	)			1,978,750				(21,250	)
Obligations of states and political subdivisions			1,058,015				(35,055	)			—				—				1,058,015				(35,055	)
Subtotal, debt securities			1,062,047				(35,057	)			28,782,372				(609,784	)			29,844,419				(644,841	)
Mutual Funds			—				—				271,900				(13,531	)			271,900				(13,531	)
FHLMC Preferred Bank Stock			441,000				(10,000	)											441,000				(10,000	)
Total temporary impaired securities		$	1,503,047			$	(45,057	)		$	29,054,272			$	(623,315	)		$	30,557,319			$	(668,372	)

December 31, 2006		Less than 12 Months								12 Months or More								Total
						Unrealized								Unrealized								Unrealized
Description of Securities		Fair Value				(Losses)				Fair Value				(Losses)				Fair Value				(Losses)
Obligations of U.S. Government, corporations and agencies		$	—			$	—			$	28,734,320			$	(599,698	)		$	28,734,320			$	(599,698	)
Corporate Bonds			—				—				3,957,500				(42,500	)			3,957,500				(42,500	)
Mutual Funds			—				—				279,445				(9,311	)			279,445				(9,311	)
Total temporary impaired securities		$	—			$	—			$	32,971,265			$	(651,509	)		$	32,971,265			$	(651,509	)

     The nature of securities which are temporarily impaired for a continuous 12 months or more can be segregated into three groups. The first group consists of Federal Agency bonds totaling $26.8 million with a temporary loss of $588,536. The bonds within this group have Aaa/AAA ratings from Moody’s and Standard & Poors, respectively. These bonds have estimated maturity dates of 18 months to 33 months. The Company has the ability to hold these bonds to maturity.

     The second group consists of corporate bonds, rated A2 by Moody’s, totaling $2.0 million with a temporary loss of $21,250. These bonds have an estimated maturity of 27 years but can be called at par on their five year anniversary. If not called, the bonds reprice every three months at a fixed rate index above LIBOR. The Company has the ability to hold these bonds to maturity.

     The third group consists of a Community Reinvestment Act qualified investment bond fund with a temporary loss of $13,531. The fund is a relatively small portion of the portfolio and the Company plans to hold it indefinitely.

     The carrying value of securities pledged to secure deposits and for other purposes amounted to $15,452,563 and $15,533,390 at June 30, 2007 and December 31, 2006, respectively.

3. Loans

     A summary of the balances of loans follows:

		June 30,				December 31,
		2007				2006
		(Thousands)
Real estate loans:
Construction		$	33,696			$	33,662
Secured by farmland			1,372				1,365
Secured by 1-to-4 family residential			171,163				168,310
Other real estate loans			127,189				134,955
Commercial and industrial loans (not secured by real estate)			39,867				41,508
Consumer installment loans			28,217				31,952
All other loans			8,495				9,273
Total loans		$	409,999			$	421,025
Unearned income			(382	)			(493	)
Allowance for loan losses			(4,407	)			(4,471	)
Net loans		$	405,210			$	416,061

     Analysis of the allowance for loan losses follows:

		Six				Six				Twelve
		Months				Months				Months
		Ended				Ended				Ended
		June 30,				June 30,				December 31,
		2007				2006				2006
Balance at beginning of period		$	4,470,533			$	4,238,143			$	4,238,143
Provision for loan losses			240,000				300,000				360,000
Recoveries of loans previously charged-off			21,542				48,347				128,463
Loan losses charged-off			(324,654	)			(128,520	)			(256,073	)
Balance at end of period		$	4,407,421			$	4,457,970			$	4,470,533

     Nonperforming assets consist of the following:

		June 30,				December 31,
		2007				2006
		(Thousands)
Nonaccrual loans		$	724			$	1,608
Restructured loans			—				—
Total nonperforming loans			724				1,608
Foreclosed property			284				140
Total nonperforming assets		$	1,008			$	1,748

     Total loans past due 90 days and still accruing interest totaled $1,000 on June 30, 2007 and December 31, 2006.

4. Company-Obligated Mandatorily Redeemable Capital Securities of Subsidiary Trusts

     On September 21, 2006, the Company’s wholly-owned Connecticut statutory business trust privately issued $4.0 million face amount of the trust’s Floating Rate Capital Securities in a pooled capital securities offering. Simultaneously, the trust used the proceeds of that sale to purchase $4.0 million principal amount of the Company’s Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. The interest rate on the capital securities resets every three months at 1.70% above the then current three month LIBOR. Interest is paid quarterly.

     Total capital securities at June 30, 2007 were $4,124,000. The capital securies and the respective subordinated debentures are callable at any time after five years from the issue date. The subordinated debentures are an unsecured obligation of the Company and are junior in right of payment to all present and future senior indebtedness of the Company. The capital securities are guaranteed by the Company on a subordinated basis.

     The purpose of the September 2006 issuance was to use the proceeds to redeem $4.0 million of capital securities previously issued on March 26, 2002. Because of changes in the market pricing of capital securities from 2002 to 2006, the September 2006 issuance is priced 190 basis points less than that of the March 2002 issuance; therefore the 2002 issuance was redeemed on March 26, 2007.

5. Earnings per Share

     The following table shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of dilutive potential common stock. Dilutive potential common stock had no effect on income available to common shareholders.

		Three Months								Three Months
		Ended								Ended
		June 30, 2007								June 30, 2006
						Per Share								Per Share
		Shares				Amount				Shares				Amount
Basic earnings per share			3,515,669			$	0.36				3,475,064			$	0.37
Effect of dilutive securities, stock-based awards			71,979								112,986
			3,587,648			$	0.36				3,588,050			$	0.36

		Six Months								Six Months
		Ended								Ended
		June 30, 2007								June 30, 2006
						Per Share								Per Share
		Shares				Amount				Shares				Amount
Basic earnings per share			3,503,359			$	0.70				3,466,540			$	0.77
Effect of dilutive securities, stock-based awards			72,694								112,686
			3,576,053			$	0.69				3,579,226			$	0.75

6. Stock-Based Compensation

     At June 30, 2007, the Company has a stock-based compensation plan. Effective January 1, 2006 the Company adopted the provisions of FASB Statement No. 123 (R), “Share-Based Payment,” which requires that the Company recognize expense related to the fair value of stock-based compensation awards in net income.

The nonvested shares are accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded. The restricted shares issued to executive officers and directors are subject to a vesting period, whereby, the restrictions on one-third of the shares lapse on the anniversary of the date the restricted shares were awarded over the next three years. Compensation expense for nonvested shares amounted to $64,545 and $58,694 for the three months ended June 30, 2007 and 2006, respectively.
Compensation expense for nonvested shares amounted to $127,140 and $102,879 for the six months ended June 30, 2007 and 2006, respectively.

     The Company did not grant options during the six months ended June 30, 2007 and 2006.

     A summary of the status of the Omnibus Stock Ownership and Long-Term Incentive Plan and Non-employee Director Stock Option Plan (the “Plans”) is presented below:

		Six Months Ended
		June 30, 2007
						Weighted
						Average				Average
		Number of				Exercise				Intrinsic
		Shares				Price				Value (1)
Outstanding at January 1,			177,466			$	9.50
Granted			—				—
Exercised			(63,650	)			8.50
Forfeited			—				—
Outstanding at June 30,			113,816			$	10.06			$	1,695,858
Exercisable at end of quarter			113,816							$	1,695,858
Weighted-average fair value per option of options granted during the year		$	—

The total intrinsic value of options exercised during the six months ended June 30, 2007 and 2006 was $1,065,008 and $240,888, respectively.

     A summary of the status of the Company’s nonvested shares is presented below:

		Six Months Ended
		June 30, 2007
						Weighted
						Average
		Number				Grant Date
		of				Fair Value
		Shares				(per Share)
Nonvested at January 1,			31,829
Granted			10,798			$	25.40
Vested			(11,437	)
Forfeited			—
Nonvested at June 30,			31,190

     As of June 30, 2007, there was $427,758 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized over a weighted average period of three years.

7. Employee Benefit Plan

     The following table provides a reconciliation of the changes in the defined benefit pension plan’s obligations for the three and six months ended June 30, 2007 and 2006.

		Three Months Ended
		June 30,
		2007				2006
Service cost		$	167,680			$	173,127
Interest cost			100,343				93,997
Expected return on plan assets			(111,378	)			(98,960	)
Amortization of transition (asset)			1,942				(4,745	)
Amortization of prior service cost			(4,745	)			1,942
Recognized net actuarial loss			5,258				15,239
Net periodic benefit cost		$	159,100			$	180,600

		Six Months Ended
		June 30,
		2007				2006
Service cost		$	335,360			$	346,254
Interest cost			200,686				187,994
Expected return on plan assets			(222,756	)			(197,920	)
Amortization of transition (asset)			3,884				(9,490	)
Amortization of prior service cost			(9,490	)			3,884
Recognized net actuarial loss			10,516				30,478
Net periodic benefit cost		$	318,200			$	361,200

     The Company previously disclosed in its financial statements for the year ended December 31, 2006, that it contributed $1,634,468 to its pension plan in 2006. As of June 30, 2007, the pension plan requires no additional contributions.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

In addition to the historical information contained herein, this report contains forward-looking statements. Forward-looking statements are based on certain assumptions and describe future plans, strategies, and expectations of the Company, and are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “may,” “will” or similar expressions. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects 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 Board of Governors of the Federal Reserve System (“Federal Reserve”), the quality or composition of the Bank’s loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area, our plans to expand our branch network and increase our market share, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements in this report, and you should not place undue reliance on such statements, which reflect our position as of the date of this report.

GENERAL

Fauquier Bankshares, Inc. (“the Company”) was incorporated under the laws of the Commonwealth of Virginia on January 13, 1984. The Company is a registered bank holding company and owns all of the voting shares of The Fauquier Bank (“the Bank”). The Company engages in its business through the Bank, a Virginia state-chartered bank that commenced operations in 1902. The Company has no significant operations other than owning the stock of the Bank. The Company had issued and outstanding 3,545,138 shares of common stock, par value $3.13 per share, held by approximately 440 holders of record on June 30, 2007. The Bank has eight full service branch offices located in the Virginia communities of Warrenton, Catlett, The Plains, Sudley Road-Manassas, Old Town-Manassas, New Baltimore, and Bealeton. The executive offices of the Company and the main office of the Bank are located at 10 Courthouse Square, Warrenton, Virginia 20186. The Bank has leased a property in Haymarket, Virginia, where it plans to build its ninth full-service branch office scheduled to open during the first quarter of 2008.

The Bank’s general market area principally includes Fauquier County, western Prince William County, and neighboring communities and is located approximately fifty (50) miles southwest of Washington, D.C.

The Bank provides a range of consumer and commercial banking services to individuals and businesses. The deposits of the Bank are insured up to applicable limits by the Bank Insurance Fund of the Federal Deposit Insurance Fund. The basic services offered by the Bank include: demand interest bearing and non-interest bearing accounts, money market deposit accounts, NOW accounts, time deposits, safe deposit services, credit cards, cash management, direct deposits, notary services, night depository, traveler’s checks, cashier’s checks, domestic collections, savings bonds, bank drafts, automated teller services, drive-in tellers, internet banking, telephone banking, and banking by mail. In addition, the Bank makes secured and unsecured commercial and real estate loans, issues stand-by letters of credit and grants available credit for installment, unsecured and secured personal loans, residential mortgages and home equity loans, as well as automobile and other types of consumer financing. The Bank provides automated teller machine (“ATM”) cards, as a part of the Star, NYCE, and Plus ATM networks, thereby permitting customers to utilize the convenience of larger ATM networks.

The Bank operates a Wealth Management Services (“WMS”) division that began with the granting of trust powers to the Bank in 1919. The WMS division provides personalized services that include investment management, trust, estate settlement, retirement, insurance, and brokerage services. Assets managed by WMS increased by $9.0 million to $303.7 million on June 30, 2007, or 3.0%, when compared with June 30, 2006, with revenue increasing from $336,000 to $355,000 or 5.5%, for the same respective second quarters of 2006 and 2007.

The Bank, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company; Bankers Investments Group, LLC, a full service broker/dealer; and Bankers Title Shenandoah, LLC, a title insurance company. Bankers Insurance consists of a consortium of 54 Virginia community bank owners; Bankers Investments Group is owned by 32 Virginia and Maryland community banks; and Bankers Title Shenandoah is owned by 11 Virginia community banks.

The revenues of the Bank are primarily derived from interest on, and fees received in connection with, real estate and other loans, and from interest and dividends from investment and mortgage-backed securities and short-term investments. The principal sources of funds for the Bank’s lending activities are its deposits, repayment of loans, the sale and maturity of investment securities, and borrowings from the Federal Home Loan Bank (“FHLB”) of Atlanta. Additional revenues are derived from fees for deposit-related and WMS-related services. The Bank’s principal expenses are the interest paid on deposits and operating and general administrative expenses.

As is the case with banking institutions generally, the Bank’s operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Federal Reserve. As a Virginia-chartered bank and a member of the Federal Reserve, the Bank is supervised and examined by the Federal Reserve and the Virginia State Corporation Commission. Interest rates on competing investments and general market rates of interest influence deposit flows and costs of funds. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans.

As of June 30, 2007, the Company had total consolidated assets of $486.0 million, total loans net of allowance for loan losses of $405.2 million, total consolidated deposits of $410.2 million, and total consolidated shareholders’ equity of $40.2 million.

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 financial statements is, to a significant extent, 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 our estimates. In addition, GAAP itself may change from one previously acceptable accounting method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact the Company’s financial statements 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 three basic principles of accounting: (i) 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, (ii) 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 and (iii) U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues,” which requires adequate documentation to support the allowance for loan losses estimate.

The Company’s allowance for loan losses has two basic components: the specific allowance and the general allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for larger balance, non-homogeneous loans. The specific allowance uses various techniques to arrive at an estimate of loss. First, analysis of the borrower’s overall financial condition, resources and payment record, the prospects for support from financial guarantors, and the fair market value of collateral are used to estimate the probability and severity of inherent losses. Then the migration of historical default rates and loss severities, internal risk ratings, industry and market conditions and trends, and other environmental factors are considered. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The general allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans; including 1-to-4 family mortgage loans, installment loans, other consumer loans, and outstanding loan commitments. Also, the general allowance is used for the remaining pool of larger balance, non-homogeneous loans which were not allocated a specific allowance upon their review. The general allowance begins with estimates of probable losses inherent in the homogeneous portfolio based upon various statistical analyses. These include analysis of historical and peer group delinquency and credit loss experience, together with analyses that reflect current trends and conditions. The Company also considers trends and changes in the volume and term of loans, changes in the credit process and/or lending policies and procedures, and an evaluation of overall credit quality. The general allowance uses a historical loss view as an indicator of future losses. As a result, even though this history is regularly updated with the most recent loss information, it could differ from the loss incurred in the future. The general allowance also captures losses that are attributable to various economic events, and industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in the specific allowance.

EXECUTIVE OVERVIEW

This discussion is intended to focus on certain financial information regarding the Company and the Bank and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of our financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.

The Bank has become the primary independent community bank in its immediate market area. It seeks to be the primary financial service provider for its market area by providing the right mix of consistently high quality customer service, efficient technological support, value-added products, and a strong commitment to the community.

Net income for the quarter ended June 30, 2007 was $1.28 million, a 0.7% decrease from the net income of $1.29 million for the quarter ended June 30, 2006. Net interest income declined $201,000 during the second quarter of 2007 compared to the same period one year earlier. This was largely offset by an $80,000 increase in other income as well as decreases of $60,000 in provision for loan losses and $50,000 in other expenses.

Net income for the six month period ended June 30, 2007 was $2.45 million, an 8.7% decrease from the net income of $2.69 million for the six month period ended June 30, 2006. The comparative decline in net income for the six month periods was primarily due to the absence in 2007 of the one-time $250,000 pre-tax gain on the cancellation of a property usage contract experienced in the first quarter of 2006. In addition, net interest income declined $365,000 during the first six months of 2007 compared to the same period one year earlier.

Net loans and total deposits were $405.2 million and $410.2 million, respectively, at June 30, 2007, a decrease of 1.8% and an increase of 1.7%, respectively, since June 30, 2006. WMS assets under management grew 3.0% from June 30, 2006 to June 30, 2007.

Net interest income is the largest component of net income, and equals the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from non-performing assets, the amount of prepaying loans, the mix and amount of various deposit types, and many other factors, as well as the overall volume of interest-earning assets. These factors are individually difficult to predict, and when taken together, the uncertainty of future trends compounds. Based on management’s current projections, net interest income may increase during the remainder of 2007 and beyond as average interest-earning assets increase, but this may be offset in part or in whole by a possible contraction in the Bank’s net interest margin resulting from competitive market conditions and a flat or inverted yield curve. Additionally, the Bank’s balance sheet is positioned for a stable or rising interest rate environment. This means that net interest income is projected to increase if market interest rates rise, and to decrease if market interest rates fall, assuming no change in the shape of the interest rate yield curve. A steeper yield curve is projected to result in an increase in net interest income, while a flatter or inverted yield curve is projected to result in a decrease in net interest income. The specific nature of the Bank’s variability in net interest income due to changes in interest rates, also known as interest rate risk, is to a large degree the result of the Bank’s deposit base structure. For the quarter ended June 30, 2007, demand deposits, NOW accounts, and savings deposits averaged 19%, 18%, and 8% of total average deposits, respectively, while the more interest-rate sensitive premium money market accounts, money market accounts, and certificates of deposit averaged 17%, 6% and 32% of total average deposits, respectively.

The Bank continues to have strong credit quality as evidenced by nonperforming assets totaling $1.01 million or 0.25% of total loans at June 30, 2007, as compared with $1.75 million, or 0.42% of total loans at December 31, 2006, and $1.76 million or 0.42% at June 30, 2006. The provision for loan losses was $120,000 for the second quarter of 2007 compared with $180,000 for the second quarter of 2006. Loan chargeoffs, net of recoveries, totaled $303,000, or 0.07% of total loans for the first six months of 2007, compared with $80,000 or 0.02% of total loans for the first six months of 2006. The decrease in the provision for loan losses for the second quarter of 2007 compared with the second quarter of 2006 was largely in response to the decrease in nonperforming loans during the second quarter of 2007, as well as the slowdown in new loan originations during the last six months, partially offset by the increase in net loan chargeoffs.

Management seeks to continue the expansion of its branch network. The Bank looks to add to its branch network in western Prince William County beyond the addition of a retail branch office in Haymarket during the first quarter of 2008. The Bank is looking toward these new retail markets for growth in deposits and WMS income. Management also seeks to increase the level of its fee income from deposits and WMS through the increase of its market share within its current marketplace.

COMPARISION OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND JUNE 30, 2006

NET INCOME. Net income for the three months ended June 30, 2007 was $1.28 million or $0.36 per diluted share compared with $1.29 million or $0.36 per diluted share for the three months ended June 30, 2006. The decline in net income of 0.7% for the second quarter of 2007 versus the second quarter of 2006 was primarily due to the $201,000 decrease in net interest income in the second quarter of 2007 versus the second quarter of 2006, largely offset by an $80,000 increase in other income, as well as decreases of $60,000 in provision for loan losses and $50,000 in other expenses.

NET INTEREST INCOME. Net interest income decreased $201,000 or 4.1% to $4.70 million for the three months ended June 30, 2007 compared with $4.90 million for the three months ended June 30, 2006. The decrease in net interest income resulted from the decrease in the net interest margin. Computed on a tax equivalent basis, the net interest margin for the June 2007 quarter was 4.12%, compared with 4.34% for the same quarter one year earlier. The primary reasons for the decrease in the net interest margin are the impact of the inversion of yield curve from July 2006 through June 2007, coupled with competitive pressures on the pricing of interest-earning assets and interest-bearing liabilities. In an inverted yield curve, the interest rates on shorter-term debt instruments exceed the interest rates on longer-term debt instruments. The impact of the declining net interest margin was partially offset by a 0.7% increase in total average earning assets from $451.3 million during the second quarter of 2006 to $454.3 million for the second quarter of 2007.

The yield on average interest-earning assets on a tax equivalent basis was 6.81% for the June 2007 quarter compared with 6.55% for the June 2006 quarter. Total interest income increased $348,000 or 4.7% to $7.75 million for the three months ended June 30, 2007, compared with $7.40 million for the three months ended June 30, 2006, as a result of the growth in the volume of interest-earning assets and in the average rate of interest earned. Interest and dividends on investment securities decreased $11,000 or 2.2%. Investment securities averaged $38.2 million for the second quarter of 2007 compared with $43.3 million for the same quarter one year earlier. The yield on investment securities was 5.03% on a tax equivalent basis for the second quarter of 2007, compared with 4.52% for the second quarter of 2006. Interest and fees on loans increased $328,000 or 4.8% to $7.23 million for the June 2007 quarter compared with $6.91 million for the same quarter one year earlier. Average loans outstanding totaled $413.1 million and earned 6.98% on a tax-equivalent basis for the quarter ended June 30, 2007, compared with $406.9 million and 6.77%, respectively, for the quarter ended June 30, 2006.

Total interest expense increased $549,000 or 22.0% to $3.04 million for the three months ended June 30, 2007 from $2.49 million for the three months ended June 30, 2006. Average interest-bearing liabilities grew 3.2% to $367.5 million for the second quarter of 2007 compared with $356.1 million for the second quarter of 2006, while the average cost on interest-bearing liabilities increased to 3.32% from 2.80% for the same respective time periods. The increase in total interest expense and the average cost of interest-bearing liabilities is primarily due to the overall increase in short-term interest rates, as well as significantly increased balances in higher cost funding sources such as the premium interest rate money market account and time deposits. The average balance for the premium interest rate money market account was $70.0 million with an average cost of 4.15% for the three months ended June 30, 2007 compared with $50.5 million with an average cost of 3.88% for the three months ended June 30, 2006. Average time deposit balances for the second quarter of 2007 were $129.6 million at an average cost of 4.53%, compared with $115.3 million at an average cost of 3.88% for the same quarter one year earlier. Interest-bearing NOW account deposits averaged $72.3 million at an average cost of 1.27% for the June 2007 quarter, compared with $66.6 million at an average cost of 0.47% for the June 2006 quarter. Other interest-bearing money market deposits averaged $26.1 million at an average cost of 1.41% for the quarter ended June 30, 2007, compared with $38.6 million at an average cost of 1.38% for the same quarter one year earlier. Savings account deposits averaged $33.3 million at an average cost of 0.41% for the June 2007 quarter, compared with $38.6 million at an average cost of 0.34% for the June 2006 quarter. Average FHLB of Atlanta advances were $28.5 million at an average cost of 5.26% for the second quarter of 2007, and $30.2 million at an average cost of 5.17% one year earlier. Capital securities of the subsidiary trust averaged $4.1 million at an average cost of 6.84% for the June 2007 quarter, compared with $4.1 million at an average cost of 8.35% for the June 2006 quarter.

The following table sets forth information relating to the Company’s average balance sheet and reflects the average yield on assets and the average annualized cost of liabilities for the three-month periods ended June 30, 2007 and 2006. These yields and costs are derived by annualizing the income or expense for the periods presented, and dividing the product of the annualization by the respective average daily balances of assets and liabilities for the periods presented.

AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)

		Three Months Ended June 30, 2007												Three Months Ended June 30, 2006
		Average				Income/				Average				Average				Income/				Average
		Balances				Expense				Rate				Balances				Expense				Rate
ASSETS:
Loans
Taxable		$	403,856			$	7,142				7.00	%		$	397,433			$	6,806				6.78	%
Tax-exempt (1)			7,711				140				7.18	%			8,390				151				7.10	%
Nonaccrual			1,569				—								1,114				—
Total Loans			413,136				7,282				6.98	%			406,937				6,957				6.77	%
Securities
Taxable			36,930				456				4.94	%			42,322				470				4.45	%
Tax-exempt (1)			1,290				25				7.65	%			1,016				20				7.75	%
Total securities			38,220				481				5.03	%			43,338				490				4.52	%
Deposits in banks			1,061				16				5.96	%			622				6				4.01	%
Federal funds sold			1,869				24				5.07	%			397				3				2.75	%
Total earning assets			454,286				7,803				6.81	%			451,294				7,456				6.55	%
Less: Reserve for loan losses			(4,512	)											(4,369	)
Cash and due from banks			15,820												16,368
Bank premises and equipment, net			7,479												8,136
Other assets			15,556												14,823
Total Assets		$	488,629											$	486,252
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Deposits
Demand deposits		$	77,103											$	90,285
Interest-bearing deposits
NOW accounts			72,261				229				1.27	%			66,620				85				0.47	%
Money market accounts			26,063				92				1.41	%			38,634				133				1.38	%
Premium money market accounts			70,049				724				4.15	%			50,522				489				3.88	%
Savings accounts			33,287				34				0.41	%			38,612				33				0.34	%
Time deposits			129,551				1,464				4.53	%			115,328				1,114				3.88	%
Total interest-bearing deposits			331,211				2,543				3.08	%			309,716				1,854				2.39	%
Federal funds purchased			3,676				52				5.63	%			12,071				167				5.46	%
Federal Home Loan Bank advances			28,473				379				5.26	%			30,176				395				5.17	%
Company-obligated mandatorily redeemable capital securities			4,124				71				6.84	%			4,124				87				8.35	%
Total interest-bearing liabilities			367,484				3,045				3.32	%			356,087				2,503				2.80	%
Other liabilities			3,489
Shareholders’ equity			40,553
Total Liabilities & Shareholders’ Equity		$	488,629											$	446,372
Net interest spread						$	4,758				3.49	%						$	4,953				3.75	%
Interest expense as a percent of average earning assets											2.68	%											2.21	%
Net interest margin											4.12	%											4.34	%