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
. . .