• 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;

• The timing and value realized upon the sale of OREO property;

• 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 and 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). These accounting principles are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions or estimates may have a significant impact on our consolidated financial statements. Actual results, in fact, could differ from initial estimates. The accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments and the greatest likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are our allowance for loan losses, accounting for goodwill, and fair valuation of certain compensation expenses, which are described below.

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.
Several items impacted our company and the financial results in the second quarter of 2008:
• Total loans decreased by $26.0 million or 6.5% to $372.2 million as of June 30, 2008 compared to $398.2 million as of December 31, 2007.

• Non-interest bearing deposits increased by $23.0 million or 34.8% to $89.2 million as of June 30, 2008 compared to $66.2 million as of December 31, 2007.

• We recorded an additional provision for loan losses of $610 thousand in the quarter.

• We sold $2.7 million in several Other Real Estate Owned (OREO) properties.

• We had $566 thousand in direct OREO expenses.

• The steps we took to rebalance the fair value liabilities during the first quarter of 2008 began to show results, as we recorded a fair value gain of $166 thousand for the second quarter of 2008. As of June 30, 2008, fair value assets amounted to $98.5 million compared to $104.8 million of fair value liabilities.

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 $1.9 million for the three months ended June 30, 2008 compared to $375 thousand for the same period in the prior year. The second quarter 2008 pre-tax loss includes an increased loan loss provision of $610 thousand, $566 thousand in OREO expense and the reversal of $65 thousand of interest income related to nonaccrual loans.
The Bank's pre-tax loss was $5.5 million for the six months ended June 30, 2008 compared to $990 thousand pre-tax income for the same period in the prior year. The pre-tax loss for the six months ended June 30, 2008 includes the effects of $2.4 million related to the rebalancing and mark-to-market of the trading securities, the reversal of $406 thousand of interest income related to nonaccrual loans, a provision for loan losses of $1.2 million and $574 thousand of direct OREO expenses.
In the first quarter of 2008, the Bank's earnings were impacted by the mismatch in fair value assets and liabilities. As of June 30, 2008, the Bank had $98.5 million in fair value trading assets and $104.8 million in fair value trading liabilities, as compared to $89.4 million in fair value trading assets and $115.7 million in fair value trading liabilities as of March 31, 2008. During the first quarter we prepaid $40.0 million in FHLB advances and had maturities of fair value liabilities of $31.9 million. As a result of this rebalancing, we recorded a trading gain of $166 thousand for the second quarter.
At June 30, 2008, the Bank had nonaccrual loans totaling $2.8 million and OREO totaling $14.5 million. The nonaccrual loans relate to eight borrowers. The largest two are $1.2 million, which is a series of equipment loans and a line of credit to a single borrower involved in real estate development activities and $679 thousand which is secured by a commercial building and assets of a retail hardware and lumber company. 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 was $14.5 million as of June 30, 2008, compared to $14.2 million as of March 31, 2008 and $4.3 million as of December 31, 2007. During the first six months of 2008 there were foreclosures on nonaccrual loans of $16.1 million, charge-offs of $1.9 million against the allowance for loan losses, and sales of $4.9 million.
Total loans were $372.2 million as of June 30, 2008, compared to $398.2 million as of December 31, 2007, a decrease of $26.0 million.
Total deposits amounted to $426.3 million as of June 30, 2008, compared to $365.3 million in total deposits as of December 31, 2007. Non-interest bearing deposits were $89.2 million, or 20.9% of total deposits as of June 30, 2008, an increase of $23.0 million compared to the December 31, 2007 level of $66.2 million.
Bankshares is considered "well capitalized", as stockholders' equity amounted to $42.3 million as of June 30, 2008 and $45.7 million as of December 31, 2007.
Insurance Agencies: Pre-tax income for AIA was $164 thousand for the three months ended June 30, 2008, a decrease of $168 thousand, compared to $332 thousand for the same period in the prior year. Commission revenues for the three month period ended June 30, 2008 were $753 thousand, a decrease of $175 thousand or 18.9%, compared to commission revenues of $928 thousand for the three month period ended June 30, 2007.

Pre-tax income for AIA was $594 thousand for the six months ended June 30, 2008, a decrease of $136 thousand, compared to $730 thousand for the same period in the prior year. Commission revenues were $1.8 million for the six month periods ended June 30, 2008 and 2007.
Financial Performance Measures. Bankshares had a net loss for the three month period ended June 30, 2008 of $1.1 million compared to net income of $4 thousand for the same period in the prior year. The net loss of $1.1 million includes the effects of the additional loan loss provision, the direct OREO expenses and the reversal of interest income on nonaccrual loans. These results led to $0.21 basic and diluted loss per share for the quarter ended June 30, 2008. The basic and diluted earnings per share for the quarter ended June 30, 2007 were negligible. Weighted average diluted shares outstanding were 5,106,819 for the three months ended June 30, 2008 compared to the prior year weighted average diluted shares outstanding of 5,837,885.
For the six month period ended June 30, 2008, Bankshares had a net loss of $3.2 million compared to net income of $1.2 million for the same period in the prior year. The net loss of $3.2 million includes the effects of the portfolio rebalancing, mark-to-market of the trading portfolio, the additional loan loss provision and the reversal of interest income on nonaccrual loans. These results led to $0.62 basic and diluted loss per share for the six months ended June 30, 2008. The basic earnings per share for the six months ended June 30, 2007 were $0.22 per common share and diluted earnings per share for the same period were $0.21 per common share. Weighted average diluted shares outstanding were 5,106,819 for the six months ended June 30, 2008 compared to the prior year weighted average diluted shares outstanding of 5,881,570.
Return on equity (ROE) on an annualized basis during the three months ended June 30, 2008 was (10.03)% compared to 0.03% for the same period in 2007. Return on assets (ROA) on an annualized basis for the three months ended June 30, 2008 was (0.78)% compared to a negligible amount for the same period of 2007. Net interest margin was 2.59% for the three months ended June 30, 2008 compared to 3.34% for the three months ended June 30, 2007. The reversal of nonaccrual interest income reduced the second quarter 2008 net interest margin by 5 basis points.
ROE on an annualized basis during the six months ended June 30, 2008 was
(14.37)% compared to 4.43% for the same period in 2007. ROA on an annualized basis for the six months ended June 30, 2008 was (1.15)% compared to 0.40% for the same period of 2007. Net interest margin was 2.58% for the six months ended June 30, 2008 compared to 3.33% for the six months ended June 30, 2007. The reversal of nonaccrual interest income reduced the six month 2008 net interest margin by 16 basis points.

Results of Operations
Net Interest Income. Net interest income (on a fully tax equivalent basis) for the three months ended June 30, 2008 was $3.2 million compared to $4.9 million for the same period in 2007. Loan interest income decreased $1.9 million to $6.0 million in the three months ended June 30, 2008 compared to $7.9 million for the same period in 2007.
Net interest income (on a fully tax equivalent basis) for the six months ended June 30, 2008 was $6.5 million compared to $9.7 million for the same period in 2007. Loan interest income decreased $3.4 million to $12.2 million in the six months ended June 30, 2008 compared to $15.6 million for the same period in 2007.
The following tables illustrate 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 these tables 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 June 30,
                                                              2008                                       2007
                                              Average       Income /       Yield /       Average       Income /       Yield /
                                              Balance       Expense         Rate         Balance       Expense         Rate
                                                                          (dollars in thousands)
Assets
Interest earning assets:
Loans (2)                                    $ 375,545     $    5,972          6.40 %   $ 399,047     $    7,877          7.92 %
Trading securities                              93,845            987          4.23 %     124,484          1,525          4.91 %
Investment securities                           25,828            382          5.95 %      28,319            410          5.81 %
Federal funds sold                               7,639             40          2.11 %       4,374             21          1.93 %

Total interest earning assets                  502,857          7,381          5.90 %     556,224          9,833          7.09 %
Non-interest earning assets:
Cash and due from banks                         23,849                                     17,218
Premises and equipment                           2,098                                      2,349
Other real estate owned (OREO)                  15,037                                        362
Other assets                                    19,615                                     13,020
Less: allowance for loan losses                 (5,351 )                                   (4,531 )

Total non-interest earning assets               55,248                                     28,418

Total Assets                                 $ 558,105                                  $ 584,642


Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits             $  32,590     $      133          1.64 %   $  31,484     $      160          2.04 %
Money market deposit accounts                   32,359            223          2.77 %      21,134            190          3.61 %
Savings accounts                                 3,743              8          0.86 %       4,271             17          1.60 %
Time deposits(3)                               258,632          2,971          4.62 %     207,777          2,598          5.02 %

Total interest-bearing deposits                327,324          3,335          4.10 %     264,666          2,965          4.49 %
FHLB advances(4)                                51,055            262          2.06 %      74,939            759          4.06 %
Other borrowings                                64,700            545          3.39 %     102,479          1,477          5.78 %

Total interest-bearing liabilities             443,079          4,142          3.76 %     442,084          5,201          4.72 %

Non-interest bearing liabilities:
Demand deposits                                 69,049                                     86,408
Other liabilities                                2,365                                      1,407

Total liabilities                              514,493                                    529,899
Stockholders' Equity                            43,612                                     54,743

Total Liabilities and Stockholders' Equity   $ 558,105                                  $ 584,642


Interest Spread (5)                                                            2.14 %                                     2.37 %


Net Interest Margin (6)                                    $    3,239          2.59 %                 $    4,632          3.34 %

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

(2) The Bank had average nonaccrual loans of $4.2 million in 2008 and average nonaccrual loans of $2.2 million in 2007. The 2008 and 2007 interest income excluded in the loans above was $65 thousand and $144 thousand, respectively.

(3) Average fair value of time deposits for the second quarter of 2008 and 2007 was $83,436 and $101,476, respectively.

(4) Average fair value of FHLB advances for the second quarter of 2008 and 2007 was $26,056 and $74,939, 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 Balances, Interest Income and Expense and Average Yield and Rates(1)

                                                                           Six Months Ended June 30,
                                                                2008                                        2007
                                              Average      Income /        Yield /          Average      Income /       Yield /
                                              Balance       Expense          Rate           Balance       Expense        Rate
                                                                           (dollars in thousands)
Assets
Interest earning assets:
Loans (2)                                    $ 382,565     $  12,213             6.42 %    $ 394,313     $  15,619          7.99 %
Trading securities                              89,804         2,096             4.69 %      143,600         3,393          4.76 %
Investment securities                           25,813           759             5.91 %       29,768           842          5.70 %
Federal funds sold                               7,052            86             2.45 %        5,003           102          4.11 %

Total interest earning assets                  505,234        15,154             6.03 %      572,684        19,956          7.03 %
Non-interest earning assets:
Cash and due from banks                         20,798                                        18,207
Premises and equipment                           2,092                                         2,387
Other real estate owned (OREO)                  10,488                                           182
Other assets                                    19,729                                        14,763
Less: allowance for loan losses                 (5,815 )                                      (4,460 )

Total non-interest earning assets               47,292                                        31,079

Total Assets                                 $ 552,526                                     $ 603,763


Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits             $  31,963     $     294             1.85 %    $  33,567     $     337          2.02 %
Money market deposit accounts                   34,557           462             2.69 %       20,827           367          3.55 %
Savings accounts                                 3,762            16             0.86 %        3,966            33          1.68 %
Time deposits(3)                               245,762         5,822             4.76 %      216,374         5,291          4.93 %

Total interest-bearing deposits                316,044         6,594             4.20 %      274,734         6,028          4.42 %
FHLB advances(4)                                62,607           950             3.05 %       69,583         1,490          4.32 %
Other borrowings                                59,156         1,124             3.82 %      106,750         2,989          5.65 %

Total interest-bearing liabilities             437,807         8,668             3.98 %      451,067        10,507          4.70 %

Non-interest bearing liabilities:
Demand deposits                                 67,186                                        93,163
Other liabilities                                3,214                                         4,416

Total liabilities                              508,207                                       548,646
Stockholders' Equity                            44,319                                        55,117

Total Liabilities and Stockholders' Equity   $ 552,526                                     $ 603,763


Interest Spread (5)                                                              2.05 %                                     2.33 %


Net Interest Margin (6)                                    $   6,486             2.58 %                  $   9,449          3.33 %

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