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 March 31, 2009

or

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

For the transition period from                      to                     

Commission File No.: 000-25805

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)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o 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):

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 3,596,537 shares of common stock outstanding as of May 5, 2009.

 

 

FAUQUIER BANKSHARES, INC.

INDEX

				Page
Part I. FINANCIAL INFORMATION					3
Item 1.		Financial Statements			3
		Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008			3
		Consolidated Statements of Income (unaudited) for the Three Months Ended March 31, 2009 and 2008			4
		Consolidated Statements of Changes in Shareholders’ Equity (unaudited) for the Three Months Ended March 31, 2009 and 2008			5
		Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2009 and 2008			6
		Notes to Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			30
Item 4.		Controls and Procedures			30
Part II. OTHER INFORMATION					31
Item 1.		Legal Proceedings			31
Item 1A.		Risk Factors			31
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 3.		Defaults Upon Senior Securities			31
Item 4.		Submission of Matters to a Vote of Security Holders			31
Item 5.		Other Information			31
Item 6.		Exhibits			32
SIGNATURES					32

Part I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets

		March 31,				December 31,
		2009				2008
		(Unaudited)				(Audited)
Assets
Cash and due from banks		$	6,631,246			$	7,698,661
Interest-bearing deposits in other banks			8,065,476				3,324,501
Federal funds sold			3,004,000				—
Securities available for sale			35,225,310				37,839,375
Loans, net of allowance for loan losses of $4,872,571 in 2009 and $4,779,662 in 2008			443,349,278				434,678,433
Bank premises and equipment, net			9,010,139				8,621,217
Accrued interest receivable			1,534,335				1,549,597
Other real estate owned			2,029,085				3,034,470
Other assets			17,964,020				17,768,978
Total assets		$	526,812,889			$	514,515,232
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing		$	65,287,928			$	69,065,944
Interest-bearing:
NOW accounts			77,205,178				74,555,901
Savings and money market accounts			102,870,470				102,810,758
Time certificates of deposit			170,917,300				153,861,028
Total interest-bearing			350,992,948				331,227,687
Total deposits			416,280,876				400,293,631
Federal funds purchased			—				18,275,000
Federal Home Loan Bank advances			60,000,000				45,000,000
Company-obligated mandatorily redeemable capital securities			4,124,000				4,124,000
Other liabilities			5,589,476				5,334,664
Commitments and contingencies			—				—
Total liabilities			485,994,352				473,027,295
Shareholders’ Equity
Common stock, par value, $3.13; authorized 8,000,000 shares: issued and outstanding, 2009: 3,596,537 shares (includes nonvested shares of 51,134); 2008: 3,564,317 shares (includes nonvested shares of 38,219)			11,097,111				11,036,687
Retained earnings			32,978,774				32,668,530
Accumulated other comprehensive income (loss), net			(3,257,348	)			(2,217,280	)
Total shareholders’ equity			40,818,537				41,487,937
Total liabilities and shareholders’ equity		$	526,812,889			$	514,515,232

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended March 31, 2009 and 2008

		2009				2008
Interest Income
Interest and fees on loans		$	6,360,231			$	6,798,599
Interest and dividends on securities available for sale:
Taxable interest income			356,163				327,506
Interest income exempt from federal income taxes			61,461				58,224
Dividends			4,463				53,002
Interest on federal funds sold			107				28,841
Interest on deposits in other banks			3,669				8,058
Total interest income			6,786,094				7,274,230
Interest Expense
Interest on deposits			1,558,776				2,074,210
Interest on federal funds purchased			10,446				33,487
Interest on Federal Home Loan Bank advances			266,667				412,037
Distribution on capital securities of subsidiary trusts			35,835				64,242
Total interest expense			1,871,724				2,583,976
Net interest income			4,914,370				4,690,254
Provision for loan losses			200,000				456,000
Net interest income after provision for loan losses			4,714,370				4,234,254
Other Income
Wealth management income			251,456				343,416
Service charges on deposit accounts			607,176				708,597
Other service charges, commissions and income			422,188				428,981
Gain on sale of securities			—				87,585
(Loss) on sale of other real estate owned			(135,759	)			—
Total other income			1,145,061				1,568,579
Other Expenses
Salaries and benefits			2,354,939				2,328,224
Net occupancy expense of premises			307,067				282,395
Furniture and equipment			280,450				286,507
Advertising expense			120,978				169,742
Consulting expense			335,943				280,681
Data processing expense			348,494				332,645
Other operating expenses			847,096				715,400
Total other expenses			4,594,967				4,395,594
Income before income taxes			1,264,464				1,407,239
Income tax expense			341,555				398,733
Net Income		$	922,909			$	1,008,506
Earnings per Share, basic		$	0.26			$	0.29
Earnings per Share, assuming dilution		$	0.26			$	0.28
Dividends per Share		$	0.20			$	0.20

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the Three Months Ended March 31, 2009 and 2008

										Accumulated
										Other
		Common				Retained				Comprehensive				Comprehensive
		Stock				Earnings				Income (Loss)				Income				Total
Balance, December 31, 2007		$	10,974,293			$	31,626,627			$	(773,168	)						$	41,827,752
Comprehensive income:
Net income							1,008,506							$	1,008,506				1,008,506
Other comprehensive income net of tax:
Unrealized holding gains on securities available for sale, net of deferred income taxes of $113,989											221,272				221,272
Less: reclassification adjustments, net of tax benefit of $29,779											(57,806	)			(57,806	)
Other comprehensive income net of tax of $84,210															163,466				163,466
Total comprehensive income														$	1,171,972
Effects of changing pension plan measurement date, pursuant to FAS 158, 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 $6,433							(12,487	)											(12,487	)
Cash dividends ($.20 per share)							(713,662	)											(713,662	)
Acquisition of 2,680 shares of common stock			(8,388	)			(37,515	)											(45,903	)
Amortization of unearned compensation, restricted stock awards							77,012												77,012
Restricted Stock forfeiture							(13,971	)											(13,971	)
Issuance of common stock — nonvested shares (9,763 shares)			30,558				(30,558	)											—
Exercise of stock options			59,239				128,277												187,516
Balance, March 31, 2008		$	11,055,702			$	32,008,085			$	(609,702	)						$	42,454,085
Balance, December 31, 2008		$	11,036,687			$	32,668,530			$	(2,217,280	)						$	41,487,937
Comprehensive income:
Net income							922,909								922,909				922,909
Other comprehensive income net of tax:
Unrealized holding losses on securities available for sale, net of tax benefit of $535,793											(1,040,068	)			(1,040,068	)			(1,040,068	)
Total comprehensive income															(117,159	)
Cash dividends ($.20 per share)							(719,307	)											(719,307	)
Amortization of unearned compensation, restricted stock awards							85,289												85,289
Issuance of common stock — nonvested shares (10,585 shares)			33,131				(33,131	)											—
Exercise of stock options			27,293				54,484												81,777
Balance, March 31, 2009		$	11,097,111			$	32,978,774			$	(3,257,348	)						$	40,818,537

See accompanying Notes to Consolidated Financial Statements.

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2009 and 2008
(Unaudited)

		2009				2008
Cash Flows from Operating Activities
Net income		$	922,909			$	1,008,506
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			203,179				234,083
Provision for loan losses			200,000				456,000
Loss on sale of other real estate			135,759				—
(Gain) on sale of securities			—				(87,585	)
Amortization (accretion) of security premiums, net			(12,714	)			32,498
Amortization of unearned compensation, net of forfeiture			85,289				63,041
Changes in assets and liabilities:
Decrease in other assets			356,014				468,532
(Decrease) increase in other liabilities			254,812				(633,176	)
Net cash provided by operating activities			2,145,248				1,541,899
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			1,773,795				1,057,190
Purchase of securities available for sale			(2,978	)			(10,996,072	)
Purchase of premises and equipment			(592,101	)			(1,672,601	)
(Purchase) proceeds from sale of other bank stock			(719,900	)			(392,300	)
Net (increase) decrease in loans			(8,870,845	)			(3,320,994	)
Proceeds from sale of other real estate owned			869,626				—
Net cash provided by (used in) investing activities			(7,542,403	)			(6,246,307	)
Cash Flows from Financing Activities
Net (decrease) increase in demand deposits, NOW accounts and savings accounts			(1,069,027	)			(12,977,334	)
Net (decrease) increase in certificates of deposit			17,056,272				(1,474,780	)
Federal Home Loan Bank advances			80,000,000				20,000,000
Federal Home Loan Bank principal repayments			(65,000,000	)			(10,000,000	)
Purchase of federal funds			(18,275,000	)			5,000,000
Cash dividends paid on common stock			(719,307	)			(713,662	)
Issuance of common stock			81,777				187,516
Acquisition of common stock			—				(45,903	)
Net cash provided by financing activities			12,074,715				(24,163	)
Increase (decrease) in cash and cash equivalents			6,677,560				(4,728,571	)
Cash and Cash Equivalents
Beginning			11,023,162				19,552,174
Ending		$	17,700,722			$	14,823,603
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest		$	1,967,496			$	2,723,453
Income taxes		$	—			$	—
Supplemental Disclosures of Noncash Investing Activities
Unrealized gain (loss) on securities available for sale, net of tax effect		$	(1,040,068	)		$	163,466
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
Notes to Consolidated Financial Statements

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”) 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 March 31, 2009 and December 31, 2008 and the results of operations for the three months ended March 31, 2009 and 2008. The notes included herein should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

The results of operations for the three months ended March 31, 2009 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
		March 31, 2009
Obligations of U.S. Government corporations and agencies		$	23,451,199			$	750,530			$	—			$	24,201,729
Obligations of states and political subdivisions			5,574,990				60,253				(53,076	)			5,582,167
Corporate Bonds			6,000,000				—				(4,758,940	)			1,241,060
Mutual Funds			306,867				—				(2,833	)			304,034
FHLMC Preferred Bank Stock			18,500				—				(9,800	)			8,700
Restricted investments:
Federal Home Loan Bank Stock			3,625,700				—				—				3,625,700
Federal Reserve Bank Stock			99,000				—				—				99,000
Community Bankers’ Bank Stock			50,000				—				—				50,000
Silverton Bank Stock			112,920				—				—				112,920
		$	39,239,176			$	810,783			$	(4,824,649	)		$	35,225,310

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				(Losses)				Value
		December 31, 2008
Obligations of U.S. Government corporations and agencies		$	25,212,561			$	561,884			$	(2,030	)		$	25,772,415
Obligations of states and political subdivisions			5,574,709				29,033				(146,019	)			5,457,723
Corporate Bonds			6,000,000				—				(2,861,903	)			3,138,097
Mutual Funds			303,889				—				(5,969	)			297,920
FHLMC Preferred Bank Stock			18,500				—				(13,000	)			5,500
Restricted investments:
Federal Home Loan Bank Stock			2,905,800				—				—				2,905,800
Federal Reserve Bank Stock			99,000				—				—				99,000
Community Bankers’ Bank Stock			50,000				—				—				50,000
Silverton Bank Stock			112,920				—				—				112,920
		$	40,277,379			$	590,917			$	(3,028,921	)		$	37,839,375

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.

		March 31, 2009
		Amortized				Fair
		Cost				Value
Due in one year or less		$	—
Due after one year through five years			921,958				932,512
Due after five years through ten years			9,715,436				9,976,579
Due after ten years			24,388,815				20,115,885
Equity securities			4,212,967				4,200,334
		$	39,239,176			$	35,225,310

There were no impairment losses on securities in the quarters ended March 31, 2009 or March 31, 2008. Subsequent to March 31, 2009, the Company determined that its investment in Silverton Bank stock was impaired. An impairment loss of $112,920 will be recognized in the June 30, 2009 quarter.

For the quarter ended March 31, 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 March 31, 2009.

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 March 31, 2009 and December 31, 2008, respectively.

March 31, 2009		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		$	—			$	—			$	—			$	—			$	—			$	—
Obligations of states and political subdivisions			1,990,531				(46,582	)			402,768				(6,494	)			2,393,299				(53,076	)
Corporate Bonds											1,241,060				(4,758,940	)			1,241,060				(4,758,940	)
Subtotal, debt securities			1,990,531				(46,582	)			1,643,828				(4,765,434	)			3,634,359				(4,812,016	)
Mutual Funds			—				—				304,034				(2,833	)			304,034				(2,833	)
FHLMC Preferred Bank Stock			8,700				(9,800	)			—				—				8,700				(9,800	)
Total temporary impaired securities		$	1,999,231			$	(56,382	)		$	1,947,862			$	(4,768,267	)		$	3,947,093			$	(4,824,649	)

December 31, 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		$	785,744			$	(2,030	)		$	—			$	—				785,744			$	(2,030	)
Obligations of states and political subdivisions			4,181,657				(146,019	)											4,181,657				(146,019	)
Corporate Bonds											3,138,097				(2,861,903	)			3,138,097				(2,861,903	)
Subtotal, debt securities			4,967,401				(148,049	)			3,138,097				(2,861,903	)			8,105,498				(3,009,952	)
Mutual Funds			—				—				297,920				(5,969	)			297,920				(5,969	)
FHLMC Preferred Bank Stock			5,500				(13,000	)			—				—				5,500				(13,000	)
Total temporary impaired securities		$	4,972,901			$	(161,049	)		$	3,436,017			$	(2,867,872	)		$	8,408,918			$	(3,028,921	)

The nature of securities which are temporarily impaired for a continuous 12 month period or more at March 31, 2009 can be segregated into three groups:

The first group consists of four corporate bonds with a cost basis totaling $6.0 million and a temporary loss of approximately $4.8 million. The method for valuing these four corporate bonds came from Moody’s Analytics. Moody’s Analytics employs a two step discounted cashflow valuation process. The first step is to use Monte Carlo simulations to evaluate the credit quality of the collateral pool and the structural supports. Step two is to apply a discount rate to the cash flows to calculate a value. These four corporate bonds are the “Class B” or subordinated “mezzanine” tranche of pooled trust preferred securities. The trust preferred securities are collateralized by the interest and principal payments made on trust preferred capital offerings by a geographically diversified pool of approximately 50 different financial institutions. They have an estimated maturity of 26 years, but can be called at par on the five year anniversary, which already passed in 2008 for two bonds, and will occur in June and September 2009 for the other two bonds. 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, they have sufficient collateralization and cash flow projections to satisfy the cash flow portion of the Other Than Temporary Impairment test under Emerging Issues Task Force No. 99-20-1 as of March 31, 2009, and the Company has the ability to hold these bonds to maturity. Additional information regarding each of the pooled trust preferred securities as of March 31, 2009 follows:

																								Estimate in amount
																								of additional
																								deferrals/defaults
								Percent of				Percent of				Percent of								before temporary
								Underlying				Underlying				Underlying				Current				or permanent
								Collateral				Collateral in				Collateral in				Moody’s				shortfall in
Cost				Fair Value				Performing				Deferral				Default				Rating				cashflow
$	1,000,000				205,129				82.1	%			15.0	%			2.9	%		Ca					7	%
	2,000,000				400,849				89.7	%			9.7	%			0.6	%		Ca					14	%
	2,000,000				517,962				91.0	%			9.0	%			0.0	%		Ca					8	%
	1,000,000				117,120				85.5	%			9.4	%			5.1	%		Ca					2	%

The second group consists of one municipal bond with a temporary loss of $6,494. This bond is current and has an A2 rating from Moody’s. The Company plans to hold it until maturity in 2021.

The third group consists of a Community Reinvestment Act qualified investment bond fund with a temporary loss of approximately $2,833. The fund is a relatively small balance 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 $24.7 million and $25.9 million at March 31, 2009 and December 31, 2008, respectively.

Note 3. Loans

A summary of the balances of loans follows:

		March 31,				December 31,
		2009				2008
		(Thousands)
Real estate loans:
Construction		$	41,313			$	38,037
Secured by farmland			1,281				1,293
Secured by 1 - to - 4 family residential			180,921				175,791
Other real estate loans			165,942				160,443
Commercial and industrial loans (not secured by real estate)			35,128				39,985
Consumer installment loans			14,255				15,695
All other loans			10,016				8,934
Total loans		$	448,856			$	440,178
Unearned income			(634	)			(720	)
Allowance for loan losses			(4,873	)			(4,780	)
Net loans		$	443,349			$	434,678

Of the $165.9 million in other real estate loans at March 31, 2009, $101.6 million were owner occupied. Of the $160.4 million in other real estate loans at December 31, 2008, $96.2 million were owner occupied.

Note 4. Allowance for Loan Losses

Analysis of the allowance for loan losses follows:

										Twelve Months
		Three Months				Three Months				Ended
		Ended March				Ended March				December 31,
		31, 2009				31, 2008				2008
Balance at beginning of year		$	4,779,662			$	4,185,209			$	4,185,209
Provision for loan losses			200,000				456,000				3,227,269
Recoveries of loans previously charged-off			13,462				23,382				72,298
Loan losses charged-off			(120,553	)			(468,627	)			(2,705,114	)
Balance at end of year		$	4,872,571			$	4,195,964			$	4,779,662

Nonperforming assets consist of the following:

		March 31,				December 31,				March 31,
(Dollars in thousands)		2009				2008				2008
Nonaccrual loans		$	1,573			$	1,208			$	1,961
Restructured loans			—				—				—
Total nonperforming loans		$	1,573			$	1,208			$	1,961
Other real estate owned		$	2,029				3,034
Foreclosed property			36				33				64
Total nonperforming assets		$	3,638			$	4,275			$	2,025
Allowance for loan losses to period end loans and other repossessed assets owned			1.08	%			1.08	%			1.01	%
Non-performing assets to period end loans and other repossessed assets owned			0.81	%			0.97	%			0.49	%

		March 31, 2009				December 31, 2008				March 31, 2008
Impaired loans for which an allowance has been provided		$	1,629,725			$	809,221			$	2,966,225
Impaired loans for which no allowance has been provided			228,496				81,604				1,103,215
		$	1,858,221			$	890,825			$	4,069,440
Allowance provided for impaired loans, included in the allowance for loan losses		$	776,777			$	720,395			$	1,351,098
		Three Months				Twelve Months				Three Months
		Ended March 31,				Ended				Ended March 31,
		2009				December 31, 2008				2008
Average balance in impaired loans		$	1,871,016			$	1,308,909			$	3,962,818
Interest income recognized on impaired loans		$	14,757			$	35,940			$	34,119

Total loans past due 90 days or more and still accruing interest were $4,000 at March 31, 2009 and, $102,000, and $2.0 million on December 31, 2008, and March 31, 2008, respectively.

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 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.

Total capital securities at March 31, 2009 and 2008 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
		March 31, 2009								March 31, 2008
						Per Share								Per Share
		Shares				Amount				Shares				Amount
Basic earnings per share			3,535,817			$	0.26				3,515,475			$	0.29
Effect of dilutive securities, stock-based awards			18,950								36,451
			3,554,767			$	0.26				3,551,926			$	0.28

Shares not included in the calculation above because their effects were not dilutive totaled 23,732 at March 31, 2009.

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 $85,289 and $63,041, net of forfeiture, for the three months ended March 31, 2009 and 2008, respectively.

The Company did not grant stock options during the three months ended March 31, 2009 or March 31, 2008.

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:

		Three Months Ended
		March 31, 2009
						Weighted
						Average				Average
		Number of				Exercise				Intrinsic
		Shares				Price				Value (1)
Outstanding at January 1, 2009			77,180			$	9.84
Granted			—
Exercised			(8,720	)			9.38
Forfeited			—
Outstanding at March 31, 2009			68,460			$	9.89
Exercisable at end of quarter			68,460			$	9.89			$	75,991
Weighted-average fair value per option of options granted during the year			—								`

The total intrinsic value of options exercised during the three months ended March 31, 2009 and 2008 was $22,478 and $132,774, respectively.

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

		Three Months Ended
		March 31, 2009
						Weighted
		Number of				Average
		Shares				Price
Nonvested at January 1, 2009			38,219
Granted			23,500			$	10.05
Vested			(10,585	)
Nonvested at March 31, 2009			51,134

As of March 31, 2009, there was $485,000 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 35 months.

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 months ended March 31, 2009 and 2008.

		Three Months Ended
		March 31,
		2009				2008
Service cost		$	62,707			$	111,081
Interest cost			73,827				77,352
Expected return on plan assets			(65,029	)			(149,050	)
Amortization of transition (asset)			—				(4,745	)
Amortization of prior service cost			—				1,942
Recognized net actuarial loss			—				—
Net periodic benefit cost		$	71,505			$	36,580

The Company previously disclosed in its financial statements for the year ended December 31, 2008, that there were no contributions made to its pension plan in 2008. As of March 31, 2009, the pension plan required 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. On January 18, 2008, the assets within the defined benefit pension plan were redeployed from ownership in various equity and debt mutual fund investments, and into a short-term money market fund in order to preserve asset value until the plan is terminated.

Defined benefit pension plan expenses are projected to be approximately $286,000 in 2009 and nothing due to curtailment going forward. Expenses for the 401(k) plan are projected to increase from $141,576 in 2008 to approximately $154,000 in 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.

Note 9. Fair Value Measurement

The Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. SFAS 157 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

In October of 2008, the FASB issued Staff Position No. 157-3 (“FSP 157-3”) to clarify the application of SFAS 157 in a market that is not active and to provide key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 was effective upon issuance, including prior periods for which financial statements were not issued.

SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under SFAS 157 based on these two types of inputs are as follows:

	Level 1	—	Valuation is based on quoted prices in active markets for identical assets and liabilities.
	Level 2	—	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
	Level 3	—	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2009:

Fair Value Measurements at March 31, 2009 Using Quoted Prices

in Active

Significant

Markets for

Other

Significant

Balance at

Identical

Observable

Unobservable

(In Thousands)

March 31,

Assets

Inputs

Inputs

Description

2009

(Level 1)

(Level 2)

(Level 3)

Assets

Available-for-sale securities

$

35,225

$

33,984

$

1,241

$

—

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with accounting principles generally accepted in the United States (“GAAP’). Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. The Company had no loans held for sale as of March 31, 2009.

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Certain assets such as other real estate owned are measured the lower of cost or at fair value less the cost to sell. Management believes that the fair value component in its valuation follows the provisions of SFAS 157.

The following table summarizes the Company’s financial and non-financial assets that were measured at fair value on a nonrecurring basis during the period.

Carrying value at March 31, 2009

Quoted Prices

in Active

Significant

Markets for

Other

Significant

Balance as of

Identical

Observable

Unobservable

(In Thousands)

March 31,

Assets

Inputs

Inputs

Description

2009

(Level 1)

(Level 2)

(Level 3)

Assets:

Impaired loans, net of reserve for losses

$

853

—

$

776

$

77

Other real estate owned

$

2,029

—

$

2,029

—

The fair value is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the assets.

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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

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 3,596,537 shares of common stock, par value $3.13 per share, held by approximately 434 holders of record on March 31, 2009. 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 Bristow, Virginia and Haymarket, Virginia, where it plans to build its ninth and tenth full-service branch offices, respectively, scheduled to open during 2009 and 2010.

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 (“FDIC”). 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 also is a member of the Certificate of Deposit Account Registry Service (“CDARS”). CDARs can provide a customer multi-million dollar FDIC insurance on CD investments through the transfer and/or exchange with other FDIC insured institutions. CDARS is a registered service mark of Promontory Interfinancial Network, LLC.

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 36 Virginia community bank owners; Infinex is owned by 54 banks and banking associations 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, 2008.

As of March 31, 2009, the Company had total consolidated assets of $526.8 million, total loans net of allowance for loan losses of $443.3 million, total consolidated deposits of $416.3 million, and total consolidated shareholders’ equity of $40.8 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 $923,000 for the first quarter of 2009, was an 8.5% decrease from the net income for the first quarter of 2008 of $1.01 million. Loans, net of reserve, totaling $443.3 million at March 31, 2009, increased 2.0% when compared with December 31, 2008, and increased 7.6% when compared with March 31, 2008. Deposits, totaling $416.3 million at March 31, 2009, increased 4.0% compared with year-end 2008, and increased 6.7% when compared with March 31, 2008. Assets under WMS management, totaling $237.2 million in market value at March 31, 2009, declined 18.5% from $291.2 million in market value at March 31, 2008, primarily due to the decline in valuations of common stock under management. For example, from March 31, 2008 to March 31, 2009, stocks measured in the Standard & Poors’ 500 index declined by approximately 39.7%.

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, competition for loans and deposits, 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 2009 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/or 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.

Since the third quarter of 2008, the Bank has seen its competition for deposits increase significantly. The pricing of retail deposits, which traditionally has been at an interest rate less than the interest rate on a FHLB of Atlanta advance of similar term, has exceeded the corresponding FHLB rate by 50 to 100 basis points or more. The increased cost of deposits has resulted in less net interest income and a narrower net interest margin. The intensified competition for deposits is, for the most part, the result of liquidity and capitalization pressures faced by many of the large multi-state financial institutions who compete in the Bank’s market area.

The Bank’s non-performing assets totaled $3.6 million or 0.81% of total loans and real estate owned at March 31, 2009, as compared with $4.3 million or 0.97% of total loans and real estate owned at December 31, 2008, and $2.0 million or 0.49% of total loans at March 31, 2008. The provision for loan losses was $200,000 for the first quarter of 2009 compared with $456,000 for the first quarter of 2008. Loan chargeoffs, net of recoveries, totaled $107,000 or 0.02% of total average loans for the first three months of 2009, compared with $445,000 or 0.11% of total average loans for the first three months of 2008. The $256,000 decrease in the provision for loan losses from first quarter 2008 to first quarter 2009 was largely in response to the decline in non-performing assets since September 30, 2008. Total allowance for loan losses was $4.9 million or 1.08% of total loans and real estate-owned at March 31, 2009 compared with $4.8 million or 1.08% of loans at December 31, 2008.

Management seeks to continue the expansion of its branch network. The Bank has leased properties in Bristow, Virginia and Haymarket, Virginia, where it plans to build its ninth and tenth full-service branch offices, respectively, scheduled to open in 2009 and 2010. The Bank is looking toward these new retail markets for growth in deposits and WMS income. Management seeks to increase the level of its fee income from deposits and WMS through the increase of its market share within its marketplace.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND MARCH 31, 2008

NET INCOME

Net income was $923,000 for the first quarter of 2009, an 8.5% decrease from the first quarter of 2008 net income of $1.01 million. Earnings per share on a fully diluted basis were $0.26 in 2009 compared to $0.28 in 2008. Profitability as measured by return on average assets decreased from 0.83% in the first quarter of 2008 to 0.72% for the same period in 2009. Profitability as measured by return on average equity decreased from 9.48% to 8.89% over the same respective quarters in 2008 and 2009. The decline in net income and the corresponding profitability measures was primarily due to the loss on the sale of other real estate owned and the increase in FDIC insurance, partially offset by a $224,000 increase in net interest income in the first quarter of 2009 compared with the first quarter of 2008.

NET INTEREST INCOME AND EXPENSE

Net interest income increased $224,000 or 4.8% to $4.91 million for the quarter ended March 31, 2009 from $4.69 million for the quarter ended March 31, 2008. The increase in net interest income was due to the impact of total average earning assets increasing 7.1% from $453.3 million during the first quarter of 2008 to $485.6 million during the first quarter of 2009. This was partially offset by the Company’s net interest margin decreasing from 4.15% in the first quarter of 2008 to 4.11% in the first quarter of 2009.

Total interest income decreased $488,000 or 6.7% to $6.79 million for the first quarter of 2009 from $7.27 million for the first quarter of 2008. This decrease was primarily due to the 76 basis point decrease in the yield on average assets from first quarter 2008 to first quarter 2009. This was partially offset by the increase in total average earning assets of $32.3 million.

The average yield on loans decreased to 5.79% for the first quarter of 2009 compared with 6.61% for the first quarter of 2008. Average loan balances increased $32.6 million or 7.9% from $410.6 million during the first quarter of 2008 to $443.2 million during the first quarter of 2009. The decline in rate, partially offset by the increase in loans outstanding, resulted in a $438,000 or 6.4% decrease in interest and fee income from loans for the first quarter of 2009 compared with the same period in 2008.

Average investment security balances increased $244,000 from $37.4 million in the first quarter of 2008 to $37.6 million in the first quarter of 2009. The tax-equivalent average yield on investments decreased from 5.02% for the first quarter of 2008 to 4.82% for the first quarter of 2009. Together, there was a decrease in interest and dividend income on security investments of $17,000 or 3.8%, from $439,000 for the first quarter of 2008 to $422,000 for the first quarter of 2009. This decrease was primarily due to the suspension of dividend income on FHLB of Atlanta stock during the first quarter of 2009. Interest income on deposits in other banks decreased $4,000 from first quarter 2008 to first quarter 2009. Interest income on federal funds sold decreased $29,000 from the first quarter of 2008 to the first quarter of 2009, reflecting a decline in the average balances from $4.4 million to $170,000.

Total interest expense decreased $712,000 or 27.6% from $2.58 million for the first quarter of 2008 to $1.87 million for the first quarter of 2009 primarily due to the overall decline in shorter-term market interest rates. Interest paid on deposits decreased $515,000 or 24.8% from $2.07 million for the first quarter of 2008 to $1.56 million for the first quarter of 2009. Average Premium money market account balances decreased $22.7 million from first quarter 2008 to first quarter 2009, while their average rate decreased from 2.93% to 1.07% over the same period resulting in a decrease of $405,000 of interest expense for the first quarter of 2009. Average time deposit balances increased $48.8 million from first quarter of 2008 to the first quarter of 2009 while the average rate on time deposits decreased from 4.13% to 3.26% resulting in an increase of $143,000 in interest expense for the first quarter of 2009. Average NOW deposit balances decreased $10.1 million from the first quarter of 2008 to the first quarter of 2009, while the average rate on NOW accounts decreased from 1.27% to 0.43% resulting in a reduction of $189,000 in NOW interest expense for the first quarter of 2009.

Interest expense on federal funds purchased decreased $23,000 for the first quarter of 2009 when compared to the first quarter of 2008 due to the decline in the average fed funds rate from 4.36% to 0.86%, partially offset by the $1.8 million increase in average federal funds purchased. Interest expense on FHLB of Atlanta advances decreased $145,000 from the first quarter of 2008 to the first quarter of 2009 due to the decrease in the average rate paid on FHLB advances from 3.88% to 1.79%, partially offset by the increase in average FHLB advance balances of $17.5 million, The average rate on total interest-bearing liabilities decreased from 2.76% for the first quarter of 2008 to 1.86% for the first quarter of 2009.

The following table sets forth information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balances of assets and liabilities, respectively, for the periods presented.

AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(Dollars in Thousands)

		Three Months Ended March 31, 2009												Three Months Ended March 31, 2008
		Average				Income/				Average				Average				Income/				Average
		Balances				Expense				Rate				Balances				Expense				Rate
ASSETS:
Loans
Taxable		$	433,103			$	6,264				5.80	%		$	401,352			$	6,711				6.63	%
Tax-exempt (1)			8,534				145				6.80	%			7,347				133				7.17	%
Nonaccrual (2)			1,530				—								1,877				—
Total Loans			443,167				6,409				5.79	%			410,576				6,844				6.61	%
Securities
Taxable			31,946				361				4.52	%			31,927				381				4.77	%
Tax-exempt (1)			5,672				93				6.57	%			5,447				88				6.48	%
Total securities			37,618				454				4.82	%			37,374				469				5.02	%
Deposits in banks			4,594				4				0.32	%			982				8				3.25	%
Federal funds sold			170				0.1				0.26	%			4,389				29				2.60	%
Total earning assets			485,550				6,867				5.67	%			453,321				7,350				6.43	%
Less: Reserve for loan losses			(4,883	)											(4,165	)
Cash and due from banks			7,529												15,542
Bank premises and equipment, net			8,857												7,465
Other assets			22,265												16,436
Total Assets		$	519,318											$	488,599
LIABILITIES & SHAREHOLDERS’ EQUITY:
Deposits
Demand deposits		$	64,226											$	66,716
Interest-bearing deposits
NOW accounts			75,465				81				0.43	%			85,597				270				1.27	%
Money market accounts			19,938				35				0.71	%			24,581				89				1.45	%
Premium money market accounts			51,940				138				1.07	%			74,592				543				2.93	%
Savings accounts			32,234				25				0.31	%			30,442				34				0.45	%
Time deposits			159,486				1,281				3.26	%			110,797				1,138				4.13	%
Total interest-bearing deposits			339,063				1,559				1.86	%			326,009				2,074				2.56	%
Federal funds purchased			4,914				10				0.86	%			3,088				33				4.36	%
Federal Home Loan Bank advances			59,556				267				1.79	%			42,018				412				3.88	%
Capital securities of subsidiary trust			4,124				36				3.48	%			4,124				64				6.16	%
Total interest-bearing liabilities			407,656				1,872				1.86	%			375,239				2,583				2.76	%
Other liabilities			5,346												3,863
Shareholders’ equity			42,090												42,781
Total Liabilities & Shareholders’ Equity		$	519,318											$	488,599
Net interest spread						$	4,995				3.81	%						$	4,767				3.67	%
Interest expense as a percent of average earning assets											1.56	%											2.28	%
Net interest margin											4.11	%											4.15	%