• Fluctuations in market rates of interest and loan and deposit pricing, which could negatively affect our net interest margin, asset valuation and income and expense projections;

• Effects of implementation of certain balance sheet strategies;

• Impacts of fair value accounting;

• Timing of expected implementation of certain balance sheet strategies;

• Anticipated growth of our insurance company;

• Assumptions used within our Asset Liability Management (ALM) process and Net Interest Income (NII) and Economic Value of Equity (EVE) models;

• Adverse changes in the overall national economy as well as adverse economic conditions in our specific market areas within Northern Virginia, Fredericksburg, and the greater Washington, D.C. Metropolitan region;

• Risks inherent in making loans such as repayment risks and fluctuating collateral values;

• Sustained weakness in the local housing market;

• Additional negative changes in the national and local home mortgage market;

• Maintaining and developing well established and valuable client relationships and referral source relationships;

• Our use of technology or the use of technology by key competitors;

• Changing trends in customer profiles and behavior;

• Competitive factors within the financial services industry;

• Impacts of implementing various accounting standards;

• Changes in regulatory requirements and/or restrictive banking legislation; and

• Other factors described from time to time in our SEC filings.

Because of these and other uncertainties, our actual results and performance may be materially different from results indicated by these forward-looking statements. In addition, our past results of operations are not necessarily indicative of future performance.
We caution you that the above list of important factors is not exclusive. These forward-looking statements are made as of the date of this report, and we may not update these forward-looking statements to reflect the impact of any circumstances or events that arise after the date the forward-looking statements are made.
Critical Accounting Policies
Bankshares' 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 estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our financial statements could change.
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) SFAS No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable, and
(2) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

Our allowance for loan losses has two basic components: the specific allowance for impaired credits and the general allowance based on relevant risk factors. 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 loans identified for impairment testing. Impairment testing includes consideration of the borrower's overall financial condition, resources and payment record, support available from financial guarantors and the fair market value of collateral. These factors are combined to estimate the probability and severity of inherent losses. When impairment is identified, a specific reserve is established based on Bankshares' calculation of the loss embedded in the individual loan. Large groups of smaller balance and homogeneous loans are collectively evaluated for impairment. Accordingly, Bankshares does not separately identify individual consumer and residential loans for impairment testing unless loans become 60 days or more past due.
The general allowance is determined by aggregating un-criticized loans (non-classified loans and loans identified for impairment testing for which no impairment was identified) by loan type based on common purpose, collateral, repayment source or other credit characteristics. We then apply allowance factors which in the judgment of management represent the expected losses over the life of the loans. In determining those factors, we consider the following:
(1) delinquencies and overall risk ratings, (2) loss history, (3) trends in volume and terms of loans, (4) effects of changes in lending policy, (5) the experience and depth of the borrowers' management, (6) national and local economic trends, (7) concentrations of credit by individual credit size and by class of loans, (8) quality of loan review system and (9) the effect of external factors (e.g., competition and regulatory requirements). This is the largest component of the overall allowance. Goodwill
Bankshares adopted SFAS No. 142, Goodwill and Other Intangible Assets, (SFAS No. 142) effective January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value based test. Based on the results of these tests, Bankshares concluded that there was no impairment, and no write-downs were recorded. Additionally, under SFAS No. 142, acquired intangible assets are separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over its useful life. The costs of other intangible assets, based on independent valuation and/or internal valuations, are being amortized over their estimated lives not to exceed fifteen years.
Share-Based Compensation
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment (SFAS No. 123R). SFAS No. 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and nonvested shares, based on the fair value of those awards at the date of grant and eliminates the choice to account for employee stock options under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). Bankshares adopted SFAS No. 123R effective January 1, 2006 using the modified prospective method and as such, results for prior periods have not been restated. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period.

Overview
Bankshares' primary financial goals are to maximize earnings and to deploy capital in profitable growth initiatives that will enhance shareholder value. Bankshares tracks the performance of our two principal business activities:
commercial and mortgage banking and our insurance agencies, in order to assess the level of success in achieving these goals.
Four key items impacted our company and the financial results in the first quarter of 2008.
• Migration of nonaccrual loans through the cycle to Other Real Estate Owned (OREO).

• Charge-offs of $1.6 million related to nonaccrual loans foreclosed upon in the first quarter of 2008. In December 2007, we reported approximately $1.5 million of specific allocations of the allowance for loan losses against the loans that migrated to OREO in the first quarter.

• We sold three pieces of OREO property for a total of $2.1 million in the first quarter of 2008. We have approximately $3.0 million under contract to settle in the second quarter of 2008.

• We took significant steps to rebalance the Fair Value Liabilities during the quarter. We prepaid $40.0 million of long-term FHLB advances; $10.0 million of long-term FHLB advances matured and approximately $21.9 million of fair value brokered certificates of deposits matured. As of March 31, 2008, fair value assets amounted to $89.4 million compared to $115.7 million of fair value liabilities. The rebalancing of the fair value liabilities is expected to provide better correlation to the fair value movements in our fair value assets.

Principal Business Activities. An overview of the financial results for each of Bankshares' principal segments is presented below. A more detailed discussion is included in "Results of Operations."
Commercial and Mortgage Banking: The Bank's pre-tax loss was $3.6 million for the three months ended March 31, 2008 compared to $1.4 million pre-tax income for the same period in the prior year. The first quarter 2008 pre-tax loss includes the effects of $2.5 million related to the rebalancing and mark-to-market of the trading securities and the reversal of $341 thousand of interest income related to nonaccrual loans.

In the first quarter of 2008, the Bank's earnings were impacted by the mismatch in fair value assets and liabilities, the cost to carry nonperforming assets and higher interest expense levels. As of March 31, 2008, the Bank had $89.4 million in fair value trading assets and $115.7 million in fair value trading liabilities, as compared to $85.0 million in fair value trading assets and $187.3 million in fair value trading liabilities as of December 31, 2007. During the quarter we prepaid $40.0 million in FHLB advances and had maturities of fair value liabilities of $31.9 million.
At December 31, 2007, Bankshares had nonaccrual loans totaling $17.1 million and OREO totaling $4.3 million. In the first quarter of 2008, the Bank's nonaccrual loans were $4.0 million and OREO was $14.2 million. The nonaccrual loans relate to nine borrowers. The largest one is $2.1 million, which is secured by residential building lots in Northern Virginia. The remainder of nonaccrual loans is made up of first and second trusts on properties in the greater Washington, D.C. Metropolitan region. The OREO balance of $14.2 million as of March 31, 2008, reflects the shift from nonaccrual loans as of December 31, 2007 to OREO during the quarter. During the first three months of 2008, Bankshares had foreclosures totaling $13.4 million, charge-offs of $1.6 million against the allowance, and sales of $2.1 million.
Total loans were $378.1 million as of March 31, 2008, compared to $398.2 million as of December 31, 2007, a decrease of $20.1 million.
Total deposits amounted to $388.1 million as of March 31, 2008, compared to $365.3 million in total deposits as of December 31, 2007. Non-interest bearing deposits were $79.0 million, or 20.4% of total deposits as of March 31, 2008, an increase of $12.8 million compared to the December 31, 2007 level of $66.2 million.
Bankshares is considered "well capitalized", as stockholders' equity amounted to $43.6 million as of March 31, 2008 and $45.7 million as of December 31, 2007.
Insurance Agencies: Pre-tax income for AIA was $430 thousand for the three months ended March 31, 2008, an increase of $32 thousand, compared to $398 thousand for the same period in the prior year. Commission revenues for the three month period ended March 31, 2008 were $1.1 million, an increase of $167 thousand or 18.6%, compared to commission revenues of $896 thousand for the three month period ended March 31, 2007. The first quarter results for 2007 do not include the addition of FIG, which was acquired in April 2007.

Financial Performance Measures. Bankshares had a net loss for the three month period ended March 31, 2008 of $2.1 million compared to net income of $1.2 million for the same period in the prior year. The net loss of $2.1 million includes the effects of the portfolio rebalancing, mark-to-market of the trading portfolio and the reversal of interest income on nonaccrual loans. These results led to ($.41) basic and diluted loss per share for the quarter ended March 31, 2008. The basic earnings per share for the quarter ended March 31, 2007 were $.22 per common share and diluted earnings per share for the same period were $.21 per common share. Weighted average diluted shares outstanding were 5,106,819 for the three months ended March 31, 2008 compared to the prior year weighted average diluted shares outstanding of 5,824,498.
Return on equity (ROE) on an annualized basis during the three months ended March 31, 2008 was (18.56)% compared to 8.82% for the same period in 2007. Return on assets (ROA) on an annualized basis for the three months ended March 31, 2008 was (1.53)% compared to .79% for the same period of 2007. Net interest margin was 2.57% for the three months ended March 31, 2008 compared to 3.31% for the three months ended March 31, 2007. The reversal of nonaccrual interest income reduced the first quarter 2008 net interest margin by 27 basis points.
Results of Operations
Net Interest Income. Net interest income (on a fully tax equivalent basis) for the three months ended March 31, 2008 was $3.2 million compared to $4.8 million for the same period in 2007. Loan interest income decreased $1.5 million to $6.2 million in the three months ended March 31, 2008 compared to $7.7 million for the same period in 2007.
The following table illustrates average balances of total interest earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and related income, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using daily average balances.

  Average Balances, Interest Income and Expense and Average Yield and Rates(1)

                                                              Three Months Ended March 31,
                                                   2008                                            2007
                                 Average        Income /         Yield /           Average       Income /        Yield /
                                 Balance        Expense            Rate            Balance        Expense         Rate
                                                                  (dollars in thousands)
Assets
Interest earning assets:
Loans (2)                       $ 389,585      $    6,241              6.44 %     $ 389,526      $   7,742           8.06 %
Trading securities                 85,763           1,109              5.20 %       162,928          1,868           4.65 %
Investment securities              25,798             377              5.88 %        31,233            432           5.61 %
Federal funds sold                  6,465              46              2.86 %         5,639             81           5.83 %

Total interest earning
assets                            507,611           7,773              6.16 %       589,326         10,123           6.97 %
Non-interest earning assets:
Cash and due from banks            17,747                                            19,207
Premises and equipment              2,086                                             2,427
Other real estate owned
(OREO)                              5,939                                                 -
Other assets                       19,804                                            16,399
Less: allowance for loan
losses                             (6,279 )                                          (4,388 )

Total non-interest earning
assets                             39,297                                            33,645

Total Assets                    $ 546,908                                         $ 622,971


Liabilities and
Stockholders' Equity
Interest-bearing
liabilities:
Interest-bearing demand
deposits                        $  31,336      $      161              2.07 %     $  35,673      $     177           2.01 %
Money market deposit
accounts                           36,755             239              2.62 %        20,517            177           3.50 %
Savings accounts                    3,781               8              0.85 %         3,658             16           1.77 %
Time deposits(3)                  232,892           2,851              4.92 %       225,066          2,693           4.85 %

Total interest-bearing
deposits                          304,764           3,259              4.30 %       284,914          3,063           4.36 %
FHLB advances(4)                   74,159             688              3.73 %        64,167            731           4.62 %
Other borrowings                   53,612             579              4.34 %       111,068          1,512           5.52 %

Total interest-bearing
liabilities                       432,535           4,526              4.21 %       460,149          5,306           4.68 %

Non-interest bearing
liabilities:
Demand deposits                    65,323                                            99,992
Other liabilities                   4,022                                             7,335

Total liabilities                 501,880                                           567,476
Stockholders' Equity               45,028                                            55,495

Total Liabilities and
Stockholders' Equity            $ 546,908                                         $ 622,971


Interest Spread (5)                                                    1.95 %                                        2.30 %


Net Interest Margin (6)                        $    3,247              2.57 %                    $   4,817           3.31 %

(1) The rates and yields are on a fully tax equivalent basis assuming a 34% federal tax rate.

(2) The Bank had average nonaccruing loans of $3.9 million in 2008 and average nonaccruing loans of $608 thousand in 2007.

The Bank had
interest income
of $341 thousand
excluded from
the above
mentioned loans
in the first
quarter of 2008.

(3) Average fair value of time deposits as of March 31, 2008 and March 31, 2007 was $102,773 and $107,356, respectively.

(4) Average fair value of FHLB advances as of March 31, 2008 and March 31, 2007 was $63,170 and $64,167, respectively.

(5) Interest spread is the average yield earned on earning assets, less the average rate incurred on interest-bearing liabilities.

(6) Net interest margin is net interest income expressed as a percentage of average earning assets.

Average loan balances (including loans held for sale) were $389.6 million for the three months ended March 31, 2008 compared to $389.5 million for the same period in 2007. The related interest income from loans was $6.2 million in 2008 compared to $7.7 million in 2007. The average yield on loans decreased from 8.06% in 2007 to 6.44% in 2008. The lower yield on loans for the first quarter of 2008 includes $341 thousand of reversed nonaccrual interest.
Trading securities interest income for the three months ended March 31, 2008 was $1.1 million compared to $1.9 million for the three months ended March 31, 2007. The average yield on trading securities was 5.20% for the first quarter of 2008 compared to 4.65% for the first quarter of 2007. Trading securities averaged $85.8 million for the three months ended March 31, 2008, compared to $162.9 million for the three months ended March 31, 2007.
Investment securities income was $377 thousand (on a fully tax equivalent basis) for the three months ended March 31, 2008 compared to $432 million for the three months ended March 31, 2007. The tax equivalent yield on investment securities for the three months ended March 31, 2008 was 5.88% compared to the March 31, 2007 yield of 5.61%. The average balance of investment securities was $25.8 million for the quarter ended March 31, 2008 compared to $31.2 million for the same quarter in 2007.
Excess liquidity results in federal funds sold for Bankshares. The short-term investments in federal funds sold contributed $46 thousand to interest income in the three month period ended March 31, 2008 compared to $81 thousand for the same period in 2007.
Total interest income (on a fully tax equivalent basis) was $7.8 million for the three months ended March 31, 2008 compared to $10.1 million for the three months ended March 31, 2007. Total average earning assets yielded 6.16% for the three months ended March 31, 2008 or 81 basis points lower than the yield of 6.97% for the same period in 2007.
Total average interest-bearing liabilities (deposits and purchased funds) were $432.5 million in the first quarter of 2008 or $27.6 million less than the first quarter of 2007 level of $460.1 million. Interest expense for all interest-bearing liabilities amounted to $4.5 million for the three months ended March 31, 2008 compared to $5.3 million for the three months ended March 31, 2007. The average cost of interest-bearing liabilities for the first quarter of 2008 was 4.21%, or 47 basis points lower than the 2007 level of 4.68%.
Non-interest bearing demand deposit balances averaged $65.3 million for the first quarter of 2008, or $34.7 million less than the 2007 level of $100.0 million. The local real estate economy remains soft and, as a result, title company and real estate closing company balances remained below the traditional levels experienced in the past.

The following table describes the impact on our interest income and expense resulting from changes in average balances and average rates for the periods indicated. The change in interest income due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Volume and Rate Analysis
(dollars in thousands)

                                                  Three Months Ended March 31,
                                                     2008 compared to 2007
                                                         Change Due To:
                                             Increase /
                                             (Decrease)        Volume        Rate
      Interest Earning Assets:
      Investment securities                  $       (55 )    $    (76 )   $     21
      Trading securities                            (759 )      (1,012 )        253
      Loans                                       (1,501 )           1       (1,502 )
      Federal funds sold                             (35 )          14          (49 )


      Total (decrease) in interest income         (2,350 )      (1,073 )     (1,277 )

      Interest-Bearing Liabilities:
      Interest-bearing deposits                      196           183           13
      Purchased funds                               (976 )        (479 )       (497 )


      Total (decrease) in interest expense          (780 )        (296 )       (484 )


      (Decrease) in net interest income      $    (1,570 )    $   (777 )   $   (793 )

Non-interest Income. The total non-interest loss amounted to $1.3 million during the three months ended March 31, 2008, a decrease of $3.2 million from the 2007 level non-interest income of $1.9 million. Our primary source of non-interest income is insurance commissions. Commission revenues added $1.1 million in operating income for the first quarter of 2008, compared to $896 thousand for the same period in 2007, an increase of $167 thousand. The first quarter results for 2007 do not include the addition of FIG, which was acquired in April 2007.
Another source of non-interest income is gains on the sale of residential mortgage loans. Bankshares earned $60 thousand on the sale of mortgage loans through ABMD in the three months ended March 31, 2008, compared to $660 thousand in the three months ended March 31, 2007. Mortgage origination levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates.
Bankshares earned $2 thousand on the sale of investment securities in the first three months of 2008, compared to $72 thousand in the first three months of 2007.

As we repositioned our balance sheet in 2007, the items accounted for under SFAS No. 159 have generated a net loss for Bankshares. The bulk of the loss is the mark-to-market adjustments on liabilities. As Bankshares has downsized the total balance sheet, there has been a mismatch between assets and liabilities. This mismatch is causing more volatility in the financial results than expected. . . .