UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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, 2008

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		54-1288193
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
10 Courthouse Square, Warrenton, Virginia		20186
(Address of principal executive offices)		(Zip Code)

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

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 No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes o No þ

The registrant had 3,567,874 shares of common stock outstanding as of August 5, 2008.

 

 

FAUQUIER BANKSHARES, INC.

INDEX

						Page
Part I. FINANCIAL INFORMATION
		Item 1.		Financial Statements			1
				Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December 31, 2007			1
				Consolidated Statements of Income (unaudited) for the Three Months Ended June 30, 2008 and 2007			2
				Consolidated Statements of Income (unaudited) for the Six Months Ended June 30, 2008 2007			3
				Consolidated Statements of Changes in Shareholders’ Equity (unaudited) for the Six Months Ended June 30, 2008    and 2007			4
				Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2008 and 2007			5
				Notes to Consolidated Financial Statements			6
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk			33
		Item 4.		Controls and Procedures			33
Part II. OTHER INFORMATION
		Item 1.		Legal Proceedings			34
		Item 1A.		Risk Factors			34
		Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			34
		Item 3.		Defaults Upon Senior Securities			35
		Item 4.		Submission of Matters to a Vote of Security Holders			35
		Item 5.		Other Information			35
		Item 6.		Exhibits			36
SIGNATURES							37

Part I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Fauquier Bankshares, Inc. and Subsidiaries

		June 30,				December 31,
		2008				2007
Assets
Cash and due from banks		$	11,718,495			$	16,708,922
Interest-bearing deposits in other banks			752,641				823,252
Federal funds sold			—				2,020,000
Securities available for sale			39,862,904				37,376,725
Loans, net of allowance for loan losses of $4,319,306 in 2008 and $4,185,209 in 2007			425,134,460				409,107,482
Bank premises and equipment, net			8,484,975				7,180,369
Accrued interest receivable			1,594,833				1,748,546
Other assets			15,480,867				14,930,932
Total assets		$	503,029,175			$	489,896,228
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing			70,418,228				76,080,935
Interest-bearing:
NOW accounts			88,395,113				90,169,640
Savings and money market accounts			124,558,248				127,472,913
Time certificates of deposit			104,869,335				110,835,435
Total interest-bearing			317,822,696				328,477,988
Total deposits			388,240,924				404,558,923
Federal Home Loan Bank advances			65,000,000				35,000,000
Company-obligated mandatorily redeemable capital securities			4,124,000				4,124,000
Other liabilities			3,892,568				4,385,553
Commitments and Contingencies			—				—
Total liabilities			461,257,492				448,068,476
Shareholders’ Equity
Common stock, par value, $3.13; authorized 8,000,000 shares: issued and outstanding, 2008: 3,569,325 (includes nonvested shares of 38,771); 2007: 3,537,354 shares (includes nonvested shares of 31,190)			11,050,634				10,974,293
Retained earnings			32,274,031				31,626,627
Accumulated other comprehensive income (loss), net			(1,552,982	)			(773,168	)
Total shareholders’ equity			41,771,683				41,827,752
Total liabilities and shareholders’ equity		$	503,029,175			$	489,896,228

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries

		2008				2007
Interest Income
Interest and fees on loans		$	6,590,186			$	7,233,485
Interest and dividends on securities available for sale:
Taxable interest income			334,172				363,447
Interest income exempt from federal income taxes			58,187				16,291
Dividends			70,118				92,907
Interest on federal funds sold			4,452				23,951
Interest on deposits in other banks			4,488				15,872
Total interest income			7,061,603				7,745,953
Interest Expense
Interest on deposits			1,649,515				2,542,648
Interest on federal funds purchased			29,872				51,602
Interest on Federal Home Loan Bank advances			469,438				378,656
Distribution on capital securities of subsidiary trusts			45,463				71,341
Total interest expense			2,194,288				3,044,247
Net interest income			4,867,315				4,701,706
Provision for loan losses			834,000				120,000
Net interest income after provision for loan losses			4,033,315				4,581,706
Other Income
Wealth management income			331,821				354,685
Service charges on deposit accounts			751,368				717,525
Other service charges, commissions and income			664,000				440,859
(Loss) on impairment of securities			(125,000	)			—
Gain on sale of other real estate owned			28,718				—
Total other income			1,650,907				1,513,069
Other Expenses
Salaries and benefits			2,298,802				2,313,208
Net occupancy expense of premises			347,931				265,177
Furniture and equipment			285,035				296,109
Advertising expense			155,854				161,692
Consulting expense			260,707				193,948
Data processing expense			329,697				312,860
Other operating expenses			717,362				722,053
Total other expenses			4,395,388				4,265,047
Income before income taxes			1,288,834				1,829,728
Income tax expense			346,420				550,295
Net Income		$	942,414			$	1,279,433
Earnings per Share, basic		$	0.27			$	0.36
Earnings per Share, assuming dilution		$	0.26			$	0.36
Dividends per Share		$	0.20			$	0.20

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries

		2008				2007
Interest Income
Interest and fees on loans		$	13,388,785			$	14,511,990
Interest and dividends on securities available for sale:
Taxable interest income			661,678				735,452
Interest income exempt from federal income taxes			116,411				29,488
Dividends			123,120				143,404
Interest on federal funds sold			33,293				66,551
Interest on deposits in other banks			12,546				20,662
Total interest income			14,335,833				15,507,547
Interest Expense
Interest on deposits			3,723,725				4,961,275
Interest on federal funds purchased			63,359				138,445
Interest on Federal Home Loan Bank advances			881,475				903,604
Distribution on capital securities of subsidiary trusts			109,705				227,442
Total interest expense			4,778,264				6,230,766
Net interest income			9,557,569				9,276,781
Provision for loan losses			1,290,000				240,000
Net interest income after provision for loan losses			8,267,569				9,036,781
Other Income
Wealth management income			675,237				693,558
Service charges on deposit accounts			1,459,965				1,377,316
Other service charges, commissions and income			1,092,981				864,997
Gain on sale of other real estate owned			28,718				—
Realized gain (loss) on securities			(37,415	)			—
Total other income			3,219,486				2,935,871
Other Expenses
Salaries and benefits			4,627,026				4,661,441
Net occupancy expense of premises			630,326				533,283
Furniture and equipment			571,542				583,709
Advertising expense			325,596				282,093
Consulting expense			541,388				433,890
Data processing expense			662,342				612,541
Other operating expenses			1,432,762				1,347,271
Total other expenses			8,790,982				8,454,228
Income before income taxes			2,696,073				3,518,424
Income tax expense			745,153				1,066,513
Net Income		$	1,950,920			$	2,451,911
Earnings per Share, basic		$	0.55			$	0.70
Earnings per Share, assuming dilution		$	0.55			$	0.69
Dividends per Share		$	0.40			$	0.39

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries

										Accumulated
										Other
		Common				Retained				Comprehensive				Comprehensive
		Stock				Earnings				Income (Loss)				Income				Total
Balance, December 31, 2006 as restated		$	10,789,521			$	28,962,409			$	(1,217,318	)						$	38,534,612
Comprehensive income:
Net income			—				2,451,911				—			$	2,451,911				2,451,911
Other comprehensive income net of tax:
Unrealized holding gains on securities available for sale, net of deferred income taxes $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			$	(1,231,715	)						$	40,052,584
Balance, December 31, 2007		$	10,974,293			$	31,626,627			$	(773,168	)						$	41,827,752
Comprehensive income:
Net income			—				1,950,920				—				1,950,920				1,950,920
Other comprehensive income net of tax:
Unrealized holding losses on securities available for sale, net of tax benefit of $414,444															(804,508	)
Less: reclassification adjustments, net of taxes of $12,721															24,694
Other comprehensive income net of tax benefit of $401,723											(779,814	)			(779,814	)			(779,814	)
Total comprehensive income															1,171,106
Effects of changing pension plan measurement date, pursuant to FAS158, net of deferred income tax benefit of $12,437							(24,144	)											(24,144	)
Initial implementation of EITF 06-4, net of income tax benefit of $6,433							(12,487	)											(12,487	)
Cash dividends ($.40 per share)							(1,427,573	)											(1,427,573	)
Acquisition of 4,293 shares of common stock			(13,437	)			(62,725	)											(76,162	)
Amortization of unearned compensation, restricted stock awards							175,275												175,275
Restricted stock forfeiture							(49,604	)											(49,604	)
Issuance of common stock — nonvested shares (9,763 shares)			30,558				(30,558	)											—
Exercise of stock options			59,220				128,300												187,520
Balance, June 30, 2008		$	11,050,634			$	32,274,031			$	(1,552,982	)						$	41,771,683

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries

		2008				2007
Cash Flows from Operating Activities
Net income		$	1,950,920			$	2,451,911
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			466,498				518,956
Provision for loan losses			1,290,000				240,000
Loss on impairment of securities			125,000
Gain on sale of securities			(87,585	)			—
Amortization (accretion) of security premiums, net			(3,185	)			(2,798	)
Amortization of unearned compensation, net of forfeiture			125,670				127,140
Changes in assets and liabilities:
Decrease (increase) in other assets			26,593				97,126
(Decrease) increase in other liabilities			(548,485	)			(207,280	)
Net cash provided by operating activities			3,345,426				3,225,055
Cash Flows from Investing Activities
Proceeds from sale of securities available for sale			9,078,470				—
Proceeds from maturities, calls and principal payments of securities available for sale			2,472,159				1,997,343
Purchase of securities available for sale			(13,962,499	)			(1,093,743	)
Purchase of premises and equipment			(1,771,104	)			(346,311	)
(Purchase) proceeds from sale of other bank stock			(1,292,300	)			1,159,700
Net (increase) decrease in loans			(17,316,978	)			10,611,841
Net cash provided by (used in) investing activities			(22,792,252	)			12,328,830
Cash Flows from Financing Activities
Net (decrease) increase in demand deposits, NOW accounts and savings accounts			(10,351,899	)			9,571,507
Net (decrease) increase in certificates of deposit			(5,966,100	)			(15,491,931	)
Federal Home Loan Bank advances			65,000,000				25,000,000
Federal Home Loan Bank principal repayments			(35,000,000	)			(52,000,000	)
Purchase (repayment) of federal funds			—				—
Repayment (issuance) of trust preferred securities			—				(4,124,000	)
Cash dividends paid on common stock			(1,427,573	)			(1,380,939	)
Issuance of common stock			187,521				541,098
Acquisition of common stock			(76,161	)			(206,841	)
Net cash provided by financing activities			12,365,788				(38,091,106	)
Increase (decrease) in cash and cash equivalents			(7,081,038	)			(22,537,221	)
Cash and Cash Equivalents
Beginning			19,552,174				41,679,655
Ending		$	12,471,136			$	19,142,434
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest		$	5,006,550			$	5,017,141
Income taxes		$	380,000			$	720,000
Supplemental Disclosures of Noncash Investing Activities
Unrealized gain (loss) on securities available for sale, net of tax effect		$	(804,508	)		$	(14,397	)
FAS 158 Pension Liability Implementation Adjustment, net of tax effect		$	(24,144	)		$	—
Implementation of EITF 06-4, net of tax effect		$	(12,487	)		$	—

See accompanying Notes to Consolidated Financial Statements.

FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES

Note 1. General

		The consolidated statements include the accounts of Fauquier Bankshares, Inc. (“the Company”) and its wholly-owned subsidiaries: The Fauquier Bank (“the Bank”), Fauquier Statutory Trust I and Fauquier Statutory Trust II; and the Bank’s wholly-owned subsidiary, Fauquier Bank Services, Inc. In consolidation, significant intercompany financial balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial positions as of June 30, 2008 and December 31, 2007 and the results of operations for the three and six months ended June 30, 2008 and 2007. The notes included herein should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
		The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the results expected for the full year.

Note 2. Securities

The amortized cost and fair value of securities available for sale, with unrealized gains and losses follows:

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				(Losses)				Value
		June 30, 2008
Obligations of U.S. Government corporations and agencies		$	25,576,577			$	11,272			$	(238,946	)		$	25,348,903
Obligations of states and political subdivisions			5,294,315				65,930				(55,616	)			5,304,629
Corporate Bonds			6,000,000				—				(1,453,750	)			4,546,250
Mutual Funds			297,707				—				(10,205	)			287,502
FHLMC Preferred Bank Stock			316,000				—				(8,100	)			307,900
Restricted investments:
Federal Home Loan Bank Stock			3,805,800												3,805,800
Federal Reserve Bank Stock			99,000												99,000
Community Bankers’ Bank Stock			50,000				—				—				50,000
The Bankers Bank Stock			112,920				—				—				112,920
		$	41,552,319			$	77,202			$	(1,766,617	)		$	39,862,904

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				(Losses)				Value
		December 31, 2007
Obligations of U.S. Government corporations and agencies		$	23,080,415			$	30,014			$	(162,347	)		$	22,948,082
Obligations of states and political subdivisions			5,293,965				82,166				(3,948	)			5,372,183
Corporate Bonds			6,000,000				—				(348,750	)			5,651,250
Mutual Funds			291,581				—				(5,791	)			285,790
FHLMC Preferred Bank Stock			441,000				—				(97,000	)			344,000
Restricted investments:
Federal Home Loan Bank Stock			2,513,500				—				—				2,513,500
Federal Reserve Bank Stock			99,000				—				—				99,000
Community Bankers’ Bank Stock			50,000				—				—				50,000
The Bankers Bank Stock			112,920				—				—				112,920
		$	37,882,381			$	112,180			$	(617,836	)		$	37,376,725

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, 2008
		Amortized				Fair
		Cost				Value
Due in one year or less		$	14,141			$	14,162
Due after one year through five years			1,156,015				1,153,134
Due after five years through ten years			11,007,337				9,586,761
Due after ten years			24,693,399				24,445,725
Equity securities			4,681,427				4,663,122
		$	41,552,319			$	39,862,904

		For the six months ended June 30, 2008, gross realized gains from sales of securities available for sale amounted to $87,585. The proceeds from the sale of these securities, including the realized gain, amounted to $9.1 million. The tax expense applicable to this net realized gain amounted to $29,779. There were no securities sold in the quarter ended June 30, 2008 or the quarter and six month period ended June 30, 2007.
		For the quarter and the six months ended June 30, 2008, the Bank recognized a permanent impairment of $125,000 on its 10,000 shares of Freddie Mac preferred stock. There were no other impairment losses on securities in the quarter and six months ended June 30, 2008, or the quarter and six month period ended June 30, 2007.
		The following table shows the Company securities with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2008 and December 31, 2007.

June 30, 2008		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		$	19,618,367			$	(238,946	)		$	—			$	—			$	19,618,367			$	(238,946	)
Obligations of states and political subdivisions		$	2,952,945			$	(55,616	)		$	—			$	—			$	2,952,945			$	(55,616	)
Corporate Bonds			3,035,000				(965,000	)			1,511,250				(488,750	)			4,546,250				(1,453,750	)
Subtotal, debt securities			25,606,312				(1,259,562	)			1,511,250				(488,750	)			27,117,562				(1,748,312	)
Mutual Funds											287,502				(10,205	)			287,502				(10,205	)
FHLMC Preferred Bank Stock											307,900				(8,100	)			307,900				(8,100	)
Total temporary impaired securities		$	25,606,312			$	(1,259,562	)		$	2,106,652			$	(507,055	)		$	27,712,964			$	(1,766,617	)

December 31, 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		$	—			$	—			$	17,798,157			$	(162,347	)		$	17,798,157			$	(162,347	)
Obligations of states and political subdivisions		$	899,333			$	(3,948	)		$	—			$	—			$	899,333			$	(3,948	)
Corporate Bonds			3,770,000				(230,000	)			1,881,250				(118,750	)			5,651,250				(348,750	)
Subtotal, debt securities			4,669,333				(233,948	)			19,679,407				(281,097	)			24,348,740				(515,045	)
Mutual Funds			—								285,790				(5,791	)			285,790				(5,791	)
FHLMC Preferred Bank Stock			344,000				(97,000	)			—				—				344,000				(97,000	)
Total temporary impaired securities		$	5,013,333			$	(330,948	)		$	19,965,197			$	(286,888	)		$	24,978,530			$	(617,836	)

		The nature of securities which are temporarily impaired for a continuous 12 month period or more at June 30, 2008 can be segregated into three groups:
		The first group consists of two corporate bonds, rated A2 by Moody’s, have a total amortized cost of $2.0 million with a temporary loss of approximately $489,000. These bonds have an estimated maturity of 26 years, but can be called at par on the five year anniversary, which will occur in 2008 and 2009. If not called, the bonds reprice every three months at a fixed rate index above the three-month London Interbank Offered Rate (“LIBOR”). These bonds are current, and the Company has the ability to hold these bonds to maturity.
		The second group consists of a Community Reinvestment Act qualified investment bond fund with a temporary loss of approximately $10,000. The fund is a relatively small segment of the portfolio and the Company plans to hold it indefinitely.
		The third group consists of a temporary loss of approximately $8,000 on 10,000 shares of Freddie Mac preferred stock. For the quarter ended June 30, 2008, the Bank recognized a permanent impairment of $125,000 on the Freddie Mac preferred stock, and will be continually monitoring its valuation of the preferred stock as more information becomes available.
		The carrying value of securities pledged to secure deposits and for other purposes amounted to $18,909,148 and $13,565,758 at June 30, 2008 and December 31, 2007, respectively.

Note 3. Loans

             A summary of the balances of loans follows:

		June 30,				December 31,
		2008				2007
		(Thousands)
Real estate loans:
Construction		$	38,420			$	37,204
Secured by farmland			1,765				1,365
Secured by 1 - to - 4 family residential			172,951				170,983
Other real estate loans			148,368				132,918
Commercial and industrial loans (not secured by real estate)			38,286				38,203
Consumer installment loans			19,267				24,133
All other loans			10,864				8,824
Total loans		$	429,921			$	413,630
Unearned income			(468	)			(338	)
Allowance for loan losses			(4,319	)			(4,185	)
Net loans		$	425,134			$	409,107

Note 4. Allowance for Loan Losses

             Analysis of the allowance for loan losses follows:

		Six Months				Six Months				Twelve Months
		Ended June 30,				Ended June 30,				Ended December
		2008				2007				31, 2007
Balance at beginning of year		$	4,185,209			$	4,470,533			$	4,470,533
Provision for loan losses			1,290,000				240,000				717,000
Recoveries of loans previously charged-off			30,629				21,542				60,616
Loan losses charged-off			(1,186,532	)			(324,654	)			(1,062,940	)
Balance at end of year		$	4,319,306			$	4,407,421			$	4,185,209

Nonperforming assets consist of the following:

		June 30,				December 31,				June 30,
(Dollars in thousands)		2008				2007				2007
Nonaccrual loans		$	2,956			$	1,906			$	724
Restructured loans			—				—				—
Total nonperforming loans		$	2,956			$	1,906			$	724
Foreclosed property			56				222				284
Total nonperforming assets		$	3,012			$	2,128			$	1,008

		June 30, 2008				December 31, 2007
Impaired loans for which an allowance has been provided		$	1,407,864			$	2,688,501
Impaired loans for which no allowance has been provided			2,160,361				1,247,461
		$	3,568,225			$	3,935,962
Allowance provided for impaired loans, included in the allowance for loan losses		$	1,136,167			$	1,392,236

		For the Six Months				For the Year
		June 30, 2008				December 31, 2007
Average balance in impaired loans		$	3,842,355			$	4,359,817
Interest income recognized on impaired loans		$	89,152			$	261,257

		Total loans past due 90 days or more and still accruing interest totaled $9,000, $770,000, and $1,000 on June 30, 2008, December 31, 2007, and June 30, 2007, respectively. At March 31, 2008, there were two loans to one borrower totaling $2.0 million which were 90 days past due and still accruing interest. At that time the Bank had reason to believe that the loans would be sold, and the proceeds from the sale to be adequate to repay outstanding principal and interest. Due to various issues, including the filing of personal bankruptcy by the borrower, the sale was further delayed, and subsequently canceled. As of June 30, 2008, the $2.0 million has been added to nonaccrual loans with all uncollected interest and fees, totaling approximately $62,000, reversed against loan income.
		The Company has adopted Financial Accounting Standards Board (“FASB”) Statement No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by FASB Statement No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.” FASB Statement No. 114, as amended, requires that the impairment of loans that have been separately identified for evaluation is to be measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment is to be based on the net realizable value of the collateral. FASB Statement No. 114, as amended, also requires certain disclosures about investments in impaired loans and the allowance for loan losses and interest income recognized on loans.
		A loan is considered impaired when it is probable that the Bank will be unable to collect all principal and interest amounts according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and the current economic conditions. A performing loan may be considered impaired if the factors above indicate a need for impairment. A loan on non-accrual status may not be impaired if it is in the process of collection or if the shortfall in payment is insignificant. A delay of less than 30 days or a shortfall of less than 5% of the required principal and interest payments generally is considered “insignificant” and would not indicate an impairment situation, if in management’s judgment the loan will be paid in full. Loans that meet the regulatory definitions of doubtful or loss generally qualify as impaired loans under FASB Statement No. 114. As is the

case for all loans, charge-offs for impaired loans occur when the loan or portion of the loan is determined to be uncollectible.

Note 5. Company-Obligated Mandatorily Redeemable Capital Securities

		On March 26, 2002, the Company established a subsidiary trust that issued $4.0 million of capital securities as part of a pooled trust preferred security offering with other financial institutions (“Trust I”). The Company used the offering proceeds for the purposes of expansion and the repurchase of additional shares of its common stock. The interest rate on the capital security resets every three months at 3.60% above the then current three month LIBOR. Interest is paid quarterly. Under applicable regulatory guidelines, the capital securities are treated as Tier 1 capital for purposes of the Federal Reserve’s capital guidelines for bank holding companies, as long as the capital securities and all other cumulative preferred securities of the Company together do not exceed 25% of Tier 1 capital.
		On September 21, 2006, the Company’s wholly-owned Connecticut statutory business trust privately issued $4 million face amount of the trust’s Floating Rate Capital Securities in a pooled capital securities offering (“Trust II”). 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 security resets every three months at 1.70% above the then current three month LIBOR. Interest is paid quarterly.
		The purpose of the September 2006 Trust II issuance was to use the proceeds to redeem the existing capital securities of Trust I on March 26, 2007. Because of changes in the market pricing of capital securities from 2002 to 2006, the September 2006 issuance was priced 190 basis points less than that of the March 2002 issuance, and the repayment of the March 2002 issuance in March 2007 reduced the interest expense associated with the distribution on capital securities of subsidiary trust by $76,000 annually. The Company redeemed all the existing capital securities issued by Trust I on March 26, 2007.
		Total capital securities at June 30, 2008 and 2007 were $4,124,000 for both respective dates. The Trust II issuance of capital securities 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.

Note 6. 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, 2008								June 30, 2007
						Per Share								Per Share
		Shares				Amount				Shares				Amount
Basic earnings per share			3,531,310			$	0.270				3,515,669			$	0.36
Effect of dilutive securities, stock-based awards			32,516								71,979
			3,563,826			$	0.260				3,587,648			$	0.36

		Six Months								Six Months
		Ended								Ended
		June 30, 2008								June 30, 2007
						Per Share								Per Share
		Shares				Amount				Shares				Amount
Basic earnings per share			3,523,392			$	0.55				3,503,359			$	0.70
Effect of dilutive securities, stock-based awards			34,483								72,694
			3,557,875			$	0.55				3,576,053			$	0.69

Note 7. Stock-Based Compensation

		The Company has a stock-based compensation plan. Effective January 1, 2006 the Company adopted the provisions of Statement of Financial Accounting Standard (“SFAS”) 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 over the next three years. Compensation expense for nonvested shares amounted to $63,041 and $64,545 for the three months ended June 30, 2008 and 2007, respectively. Compensation expense for nonvested shares amounted to $125,671 and $127,140 for the six months ended June 30, 2008 and 2007, respectively.
		The Company did not grant options during the three months or six months ended June 30, 2008 and 2007.
		A summary of the status of the Omnibus Stock Ownership and Long-Term Incentive Plan and Non-employee Director Stock Option Plan ( collectively, the “Plans”) is presented below:

		Six Months Ended
		June 30, 2008
						Weighted
						Average				Average
		Number of				Exercise				Intrinsic
		Shares				Price				Value (1)
Outstanding at January 1			96,100			$	9.85
Granted			—
Exercised			(18,920	)			9.91
Forfeited			—
Outstanding at June 30,			77,180			$	9.84			$	514,380
Exercisable at end of quarter			77,180			$	9.84			$	514,380
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, 2008 and 2007 was $132,774 and $1,065,008, respectively.
		A summary of the status of the Company’s nonvested shares is presented below:

		Six Months Ended
		June 30, 2008
						Weighted
						Average
		Number of				Exercise
		Shares				Price
Nonvested at January 1, 2008			31,190
Granted			19,692			$	17.70
Vested			(9,763	)
Forfeited, nonvested			(2,348	)		$	21.13
Nonvested at June 30, 2008			38,771

As of June 30, 2008, there was $471,942 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized over an approximate period of three years.

Note 8. 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, 2008 and 2007.

		Three Months Ended
		June 30,
		2008				2007
Service cost		$	111,081			$	167,680
Interest cost			77,352				100,343
Expected return on plan assets			(149,050	)			(111,378	)
Amortization of transition (asset)			(4,745	)			1,942
Amortization of prior service cost			1,942				(4,745	)
Recognized net actuarial loss			—				5,258
Net periodic benefit cost		$	36,580			$	159,100

		Six Months Ended
		June 30,
		2008				2007
Service cost		$	222,162			$	335,360
Interest cost			154,704				200,686
Expected return on plan assets			(298,100	)			(222,756	)
Amortization of transition (asset)			(9,490	)			3,884
Amortization of prior service cost			3,884				(9,490	)
Recognized net actuarial loss			—				10,516
Net periodic benefit cost		$	73,160			$	318,200

The Company previously disclosed in its financial statements for the year ended December 31, 2007, that there were no contributions made to its pension plan in 2007. As of June 30, 2008, the pension plan requires no additional contributions.

On December 20, 2007, the Company’s Board of Directors approved the termination of the defined benefit pension plan effective on December 31, 2009, and effective January 1, 2010, the Company will replace the defined benefit pension plan with an enhanced 401(k) plan. Defined benefit pension plan expenses are projected to decrease from $636,000 in 2007 to approximately $150,000 in 2008 and nothing in 2009 and going forward. Expenses for the 401(k) plan are projected to increase from $134,000 in 2007 to approximately $140,000 in 2008 and 2009, and approximately $625,000 in 2010. Growth in 401(k) after 2010 is projected to increase approximately at the same rate of increase as salaries.

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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 the Bank, 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, 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 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.

For additional discussion of risk factors that may cause our actual future results to differ materially from the results indicated within forward-looking statements, please see “Risk Factors” in Item 1A of this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

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 3,569,325 shares of common stock, par value $3.13 per share, held by approximately 432 holders of record on June 30, 2008. 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 properties in Haymarket, Virginia and Bristow, Virginia, where it plans to build its ninth and tenth full-service branch offices, respectively, scheduled to open during 2009.

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, businesses and industries. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. 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, prepaid debit cards, cashier’s checks, domestic collections, savings bonds, 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” or “Wealth Management”) 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.

The Bank, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company; Infinex Investments, Inc., a full service broker/dealer; and Bankers Title Shenandoah, LLC, a title insurance company. Bankers Insurance consists of a consortium of 37 Virginia community bank owners; Infinex is owned by 55 banks in various states; and Bankers Title Shenandoah is owned by 17 Virginia community banks. On April 30, 2008, the Bank’s ownership of stock in BI Investments, LLC was exchanged for Infinex stock as part of a merger.

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 Board of Governors of the Federal Reserve System (“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. Please see “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

As of June 30, 2008, the Company had total consolidated assets of $503.0 million, total loans net of allowance for loan losses of $425.1 million, total consolidated deposits of $388.2 million, and total consolidated shareholders’ equity of $41.8 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 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 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 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) SEC 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 1-4 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, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in the specific allowances.

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 is the primary independent community bank in its immediate market area as measured by deposit market share. 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. The Company and the Bank’s primary operating businesses are in commercial and retail lending, deposit accounts and core deposits, and assets under WMS management.

Net income of $942,000 for the second quarter of 2008 was a 26.3% decrease from the net income for the second quarter of 2007 of $1.28 million. Loans, net of reserve, totaling $425.1 million at June 30, 2008, increased 3.9% when compared with December 31, 2007, and increased 4.9% when compared with June 30, 2007. Deposits decreased 4.0% compared with year-end 2007, and decreased 5.3% when compared with June 30, 2007. Assets under WMS management, totaling $288.2 million at June 30, 2008, declined 4.8% from $302.8 million at 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 in 2008 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. 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.