Eastern Virginia Bankshares (EVBS) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File Number: 000-23565

EASTERN VIRGINIA BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1866052
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

330 Hospital Road, Tappahannock, Virginia	22560
(Address of principal executive offices)	(Zip Code)

(804) 443-8423

(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  x    No  ¨

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

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

The number of shares of the registrant’s Common Stock outstanding as of November 1, 2007 was 5,954,726.

EASTERN VIRGINIA BANKSHARES, INC.

FORM 10-Q

For the Period Ended September 30, 2007

Part I	Financial Information
Item 1.	Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
Part II	Other Information
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.	Defaults Upon Senior Securities	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	21
Item 6.	Exhibits	21
Signatures		22

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

	September 30 2007			December 31 2006
	(unaudited)
Assets:
Cash and due from banks	$	16,710		$	14,004
Federal funds sold		523			22,411
Securities available for sale, at fair value		149,879			127,167
Loans, net of unearned income		697,283			650,492
Allowance for loan losses		(7,447	)		(7,051	)
Total loans, net		689,836			643,441
Deferred income taxes		4,321			4,498
Bank premises and equipment, net		17,199			16,906
Accrued interest receivable		4,639			4,132
Other real estate		951			—
Goodwill		5,725			5,725
Other assets		13,412			13,114
Total assets	$	903,195		$	851,398
Liabilities and Shareholders’ Equity:
Liabilities
Noninterest-bearing demand accounts	$	100,751		$	99,253
Interest-bearing deposits		557,036			554,726
Total deposits		657,787			653,979
Federal funds purchased		5,805			—
Federal Home Loan Bank advances (FHLB)		127,786			90,500
Trust preferred debt		10,310			10,310
Accrued interest payable		3,936			2,278
Other liabilities		8,082			6,524
Total liabilities		813,706			763,591
Shareholders’ Equity
Common stock of $2 par value per share, authorized 50,000,000 shares, issued and outstanding 5,955,176 and 6,083,294, respectively		11,910			12,166
Surplus		19,097			21,276
Retained earnings		62,503			58,731
Accumulated other comprehensive (loss), net		(4,021	)		(4,366	)
Total shareholders’ equity		89,489			87,807
Total liabilities and shareholders’ equity	$	903,195		$	851,398

See Notes to Consolidated Financial Statements

1

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Income(Unaudited)

(Dollars in thousands except per share amounts)

	Three Months Ended September 30				Nine Months Ended September 30
	2007		2006		2007		2006
Interest and Dividend Income
Loans and fees on loans	$	12,907	$	11,450	$	37,561	$	32,422
Interest on investments:
Taxable interest income		1,361		1,073		3,625		3,313
Tax exempt interest income		374		340		1,038		1,070
Dividends		107		155		314		287
Interest on federal funds sold		73		119		573		195
Total interest and dividend income		14,822		13,137		43,111		37,287
Interest Expense
Deposits		4,797		3,959		14,189		10,716
Federal funds purchased		52		2		57		81
Interest on FHLB advances		1,374		990		3,470		2,464
Interest on trust preferred debt		216		212		631		598
Total interest expense		6,439		5,163		18,347		13,859
Net interest income		8,383		7,974		24,764		23,428
Provision for Loan Losses		325		204		628		521
Net interest income after provision for loan losses	$	8,058	$	7,770	$	24,136	$	22,907
Noninterest Income
Service charges and fees on deposit accounts		921		839		2,658		2,382
Debit and credit card fees		233		122		571		345
Investment services		171		97		348		273
Gain on sale of available for sale securities, net		14		5		14		36
Gain on sale of OREO or fixed assets		—		—		—		26
Other operating income		304		296		878		751
Total noninterest income		1,643		1,359		4,469		3,813
Noninterest Expenses
Salaries and benefits		3,712		3,634		10,892		10,958
Net occupancy and equipment expense		1,106		991		3,145		2,948
Consultant fees		130		108		426		549
Telephone		146		138		443		417
Marketing and advertising		180		249		675		741
Other operating expenses		1,157		1,273		3,502		3,716
Total noninterest expenses		6,431		6,393		19,083		19,329
Income before income taxes		3,270		2,736		9,522		7,391
Income Tax Expense		1,005		767		2,834		2,070
Net income	$	2,265	$	1,969	$	6,688	$	5,321
Earnings per share, assuming dilution	$	0.38	$	0.40	$	1.10	$	1.08
Dividends per share	$	0.16	$	0.16	$	0.48	$	0.47

See Notes to Consolidated Financial Statements

2

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statement of Cash Flows (Unaudited)

(Dollars in thousands)

	Nine Months Ended September 30
	2007			2006
Cash Flows from Operating Activities
Net income	$	6,688		$	5,321
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and investment amortization/accretion, net		1,505			1,712
Provision for loan losses		628			521
(Gain) realized on available for sale securities		(14	)		(36	)
(Gain) on sale of fully depreciated fixed assets		—			(26	)
(Increase) in other assets		(706	)		(1,878	)
Increase in other liabilities		3,216			2,036
Net cash provided by operating activities		11,317			7,650
Cash Flows from Investing Activities
Proceeds from sales of securities available for sale		4,070			4,746
Proceeds from maturities, calls, and paydowns of securities		6,555			10,622
Purchase of debt securities		(31,290	)		(6,375	)
Purchase of restricted stock		(1,635	)		(1,436	)
Net increase in loans		(47,974	)		(63,290	)
Sale of fixed assets		—			26
Purchases of bank premises and equipment		(1,746	)		(2,580	)
Net cash used in investing activities		(72,020	)		(58,287	)
Cash Flows from Financing Activities
Net change in noninterest bearing and interest bearing demand deposits and savings accounts		8,014			(28,204	)
Net change in certificates of deposit		(4,206	)		42,018
Issuance of common stock under dividend reinvestment plan		310			295
Repurchases and retirement of stock		(3,113	)		—
Stock based compensation		188			146
Stock options exercised		37			13
Director stock grant		116			191
Dividends declared		(2,916	)		(2,309	)
Net change in federal funds purchased		5,805			(6,822	)
Increase in FHLB advances		37,286			39,286
Net cash provided by financing activities		41,521			44,614
Decrease in cash and cash equivalents		(19,182	)		(6,023	)
Cash and cash equivalents
Beginning of period		36,415			21,516
End of period	$	17,233		$	15,493
Supplemental Disclosures of Cash Flow Information
Cash paid for:
Interest on deposits and other borrowings	$	16,689		$	13,139
Income taxes	$	3,304		$	2,834
Loans transferred to other real estate owned	$	951		$	—

See Notes to Consolidated Financial Statements

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EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. The accompanying unaudited consolidated financial statements, prepared in accordance with instructions for Form 10-Q, do not include all of the information and notes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. However, in the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position of Eastern Virginia Bankshares, Inc. (“we”, “us”, “our”, or “Company”) at September 30, 2007. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2006 (the “2006 Form 10-K”). Certain previously reported amounts have been reclassified to conform to current period presentation.

Eastern Virginia Bankshares, Inc., based in Tappahannock, VA, is the parent company of EVB. EVB operates 22 retail branches in the Virginia counties of Caroline, Essex, Gloucester, Hanover, King William, Lancaster, Middlesex, Northumberland, Southampton, Surry and Sussex. Subsidiaries of EVB include EVB Investments, EVB Mortgage, EVB Insurance and EVB Title. The Company’s stock trades on the NASDAQ Global Market under the symbol EVBS.

We were organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997 and commenced operations effective December 29, 1997 when Southside Bank and Bank of Northumberland, Inc. became our wholly owned subsidiaries. The transaction was accounted for using the pooling-of-interest method of accounting. We opened our third subsidiary in May 2000 when Hanover Bank began operations in Hanover County, Virginia. On April 24, 2006, we completed the conversion to a one-bank holding company by merging the three banking subsidiaries. The new bank began operating under the name “EVB” on April 24, 2006. All significant inter-company transactions and accounts have been eliminated in consolidation.

In the third quarter of 2007, we moved forward on initiatives to expand and improve our franchise. We received approvals from Virginia’s Bureau of Financial Institutions for a new branch in Quinton in New Kent County, Virginia and for the relocation of our Deltaville branch to a larger office. In addition, we are well into the remodeling of the Windmill branch in Hanover County, where our Village branch will be relocated.

The results of operations for the three and nine month periods ended September 30, 2007 are not necessarily indicative of the results to be expected for the full year.

2. Our amortized cost and estimated fair values of securities at September 30, 2007 and December 31, 2006 were as follows:

	September 30, 2007
(dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Available for Sale:
Obligations of U.S. Government agencies	$	36,782	$	116	$	402	$	36,496
Mortgage-backed securities		26,122		1		579		25,544
State and political subdivisions		36,035		263		384		35,914
Corporate, CMO and other securities		45,730		59		2,286		43,503
Restricted securities		8,422		—		—		8,422
Total	$	153,091	$	439	$	3,651	$	149,879

4

	December 31, 2006
(dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Available for Sale:
Obligations of U.S. Government agencies	$	31,596	$	32	$	496	$	31,132
Mortgage-backed securities		29,253		5		701		28,557
State and political subdivisions		32,429		352		1,844		30,937
Corporate, CMO and other securities		30,836		37		1,119		29,754
Restricted securities		6,787		—		—		6,787
Total	$	130,901	$	426	$	4,160	$	127,167

There are no securities classified as “Held to Maturity” or “Trading”.

At September 30, 2007, investments in an unrealized loss position that were temporarily impaired were as follows:

	September 30, 2007
	Less than 12 months				12 months or more				Total
(dollars in thousands) Description of Securities	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Obligations of U.S. Government agencies	$	875	$	125	$	26,860	$	277	$	27,735	$	402
Mortgage-backed securities		1,737		2		23,790		577		25,527		579
State and political subdivisions		5,973		45		8,978		339		14,951		384
Corporate, CMO and other securities		5,492		286		18,728		2,000		24,220		2,286
	$	14,077	$	458	$	78,356	$	3,193	$	92,433	$	3,651

Bonds with unrealized loss positions of less than 12 months duration at September 30, 2007 included 1 federal agency, 3 corporate bonds, 1 mortgage-backed security, 3 federal agency preferred stocks and 14 municipal bonds. Securities with losses of 12 months or greater duration included 30 federal agencies, 36 mortgage-backed securities, 14 corporate bonds, 26 municipal bonds, 7 collateralized mortgage obligations (“CMO”) and 1 federal agency preferred stock. The unrealized loss positions at September 30, 2007 were primarily related to interest rate movements. Holdings of GMAC and Ford Motor Credit Corp. contained unrealized loss positions because these securities have been downgraded by Moody’s and Standard & Poor’s rating agencies to levels below investment grade. As of September 30, 2007, we held $3.3 million in GMAC bonds and $250 thousand in Ford Motor Credit Corp. bonds. These holdings are monitored regularly by our Chief Financial Officer and reported to the EVB Board on a monthly basis. Given the attractive yield, our ability and intent to hold until maturity or principal recovery and the belief that the risk of default is remote, we have not recommended sale of the holdings and believe the unrealized loss is temporary.

5

At December 31, 2006, investments in an unrealized loss position that were temporarily impaired were as follows:

	December 31, 2006
	Less than 12 months				12 months or more				Total
(dollars in thousands) Description of Securities	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Obligations of U.S. Government agencies	$	—	$	—	$	29,123	$	496	$	29,123	$	496
Mortgage-backed securities		—		—		28,016		728		28,016		728
State and political subdivisions		3,680		22		4,718		1,822		8,398		1,844
Corporate, CMO and other securities		—		—		20,756		1,092		20,756		1,092
	$	3,680	$	22	$	82,613	$	4,138	$	86,293	$	4,160

3. Our loan portfolio was composed of the following at the dates indicated:

	(unaudited) September 30			(audited) December 31			(unaudited) September 30
(dollars in thousands)	2007			2006			2006
Commercial, industrial and agricultural loans	$	62,344		$	59,859		$	59,068
Residential real estate mortgage loans		305,194			288,114			278,791
Real estate construction loans		99,825			85,910			81,237
Commercial real estate loans		176,533			164,948			167,369
Consumer loans		52,149			51,446			50,582
All other loans		1,278			305			216
Total loans		697,323			650,582			637,263
Less unearned income		(40	)		(90	)		(130	)
Total loans net of unearned discount		697,283			650,492			637,133
Less allowance for loan losses		(7,447	)		(7,051	)		(6,880	)
Net loans	$	689,836		$	643,441		$	630,253

We had $4.0 million in non-performing assets at September 30, 2007 that included $733 thousand in loans past due 90 days or more but still accruing, $2.3 million in nonaccrual loans and $951 thousand classified as OREO.

4. Our allowance for loan losses was as follows at the dates indicated:

(dollars in thousands)	(unaudited) September 30 2007			(audited) December 31 2006			(unaudited) September 30 2006
Balance January 1	$	7,051		$	6,601		$	6,601
Provision charged against income		628			725			521
Recoveries of loans charged off		358			495			369
Loans charged off		(590	)		(770	)		(611	)
Balance at end of period	$	7,447		$	7,051		$	6,880

6

Following is a summary pertaining to impaired loans:

	September 30 2007		December 31 2006
	(in thousands)
Impaired loans for which an allowance has been provided	$	2,885	$	3,653
Allowance related to impaired loans	$	876	$	601
Average balance of impaired loans	$	3,941	$	11,927

No additional funds are committed to be advanced in connection with impaired loans. Nonaccrual loans excluded from impaired loan disclosure under Statement of Financial Accounting Standards (“SFAS”) No. 114 amounted to $806 thousand and $103 thousand at September 30, 2007 and December 31, 2006, respectively.

5. Borrowings from the Federal Home Loan Bank of Atlanta are disclosed below. We utilize FHLB borrowings for two purposes: (a) to match funds for specific loans or investments as an interest rate risk management tool and (b) for general funding of loan growth when the cost of borrowing is substantially below that of aggressive deposit funding.

	(unaudited) September 30 2007		(audited) December 31 2006		(unaudited) September 30 2006
Amortizing advances	$	4,286	$	5,000	$	5,714
LIBOR floating advances		10,000		—		—
Convertible advances		113,500		85,500		85,500
Total advances	$	127,786	$	90,500	$	91,214
						��

The table presented below shows the maturities and potential call dates of FHLB advances. All but $14.3 million of the FHLB borrowings are convertible advances that have a call provision.

	Maturities Amount		Avg Rate		Callable Amount		Avg Rate
2007	$	714	3.15	%	$	15,000	5.31	%
2008		1,429	3.15	%		40,000	4.35	%
2009		11,429	5.07	%		30,000	4.32	%
2010		5,714	5.57	%		28,500	4.20	%
2011		10,000	5.01	%		—
2015		13,500	3.87	%		—
2016		10,000	4.85	%		—
2017		75,000	4.30	%		—
Total	$	127,786	4.46	%	$	113,500	4.43	%

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6. The following table shows the weighted average number of shares used in computing per share earnings and the effect on the weighted average number of shares of diluted potential common stock. Potential dilutive common stock had no effect on earnings per share otherwise available to shareholders for the three and nine month periods ended September 30, 2007 and September 30, 2006.

	Three Months Ended
	September 30, 2007			September 30, 2006
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	6,008,935	$	0.38	4,923,556	$	0.40
Effect of dilutive securities, stock options	5,046		0.00	5,853		0.00
Diluted earnings per share	6,013,981	$	0.38	4,929,409	$	0.40
	Nine Months Ended
	September 30, 2007			September 30, 2006
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	6,062,038	$	1.10	4,914,795	$	1.08
Effect of dilutive securities, stock options	5,736		0.00	6,456		0.00
Diluted earnings per share	6,067,774	$	1.10	4,921,251	$	1.08

At September 30, 2007 and 2006, respectively, options to acquire 187,387 shares and 128,012 shares of common stock were not included in computing diluted earnings per common share because their effects were anti-dilutive.

7. On September 21, 2000, we adopted the Eastern Virginia Bankshares, Inc. 2000 Stock Option Plan to provide a means for selected key employees and directors to increase their personal financial interest in our company, thereby stimulating their efforts and strengthening their desire to remain with us. Under the Plan, up to 400,000 shares of Company common stock may be granted. No options may be granted under the Plan after September 21, 2010. On April 17, 2003, the shareholders approved the 2003 Stock Incentive Plan, amending and restating the 2000 Plan while still authorizing the issuance of up to 400,000 shares of common stock. There are 151,243 shares still available under that Plan.

On April 19, 2007, our shareholders approved the Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan to enhance our ability to recruit and retain officers, directors and employees with ability and initiative and to encourage such persons to have a greater financial interest in the company. That Plan authorizes the Company to issue up to 400,000 additional shares of common stock. No awards have been issued under this Plan.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment”. SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of grant. We had already adopted SFAS No. 123 in 2002 and began recognizing compensation expense for stock option grants in that year, as all such grants had an exercise price not less than the fair market value on the date of the grant.

8

SFAS 123R also requires that new awards to employees eligible for retirement prior to the awards becoming fully vested be recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. Our stock options granted to eligible participants prior to the adoption of SFAS 123R that had an accelerated vesting feature associated with employee retirement are being recognized, as required, as compensation cost over the vesting period except in the instance of participant’s actual retirement.

For the three and nine month periods ended September 30, 2007 and 2006, stock option compensation expense of $62 thousand and $188 thousand for 2007, and $47 thousand and $146 thousand for 2006 were included in salary and benefit expense.

Stock option compensation expense is the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for each stock grant award. Through September 30, there have been no awards issued in 2007. The weighted average estimated fair value of stock options granted in the years 2006, 2005 and 2004 was $5.40, $5.31 and $5.78, respectively. Fair value is estimated using the Black-Scholes option-pricing model with the assumptions indicated in the table below:

	2006		2005		2004
Dividend rate:	2.97	%	2.76	%	2.78	%
Price Volatility	22.94	%	23.61	%	24.99	%
Risk-free interest rate	4.65	%	4.13	%	4.95	%
Expected life:	10 Years		10 Years		10 Years

The dividend rate is calculated as the average quarterly dividend yield on our stock since our inception in December 1997 by dividing the quarterly dividend by the average closing price of the stock for the quarter. Volatility is a measure of the standard deviation of the daily closing stock price plus dividend yield for the same period. The risk-free interest rate is the 10 year Treasury strip rate on the date of the grant. The expected life is 10 years, but could be shorter in the event of a change in control of the Company or if a participant reaches his or her full retirement age of 65. Subsequent to September 30, 2007 the Company granted stock options for 49,750 shares at an exercise price of $19.25 per share with four year vesting and 10 year expiration, the option price being the closing price of EVBS shares on the grant date of October 1, 2007.

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding at beginning of year	213,832		$	21.19
Granted	—
Exercised	(2,320	)		16.10
Forfeited	(1,500	)		20.86
Outstanding at September 30 2007	210,012		$	21.25	7.40	$	77
Options exercisable at September 30, 2007	22,625			16.10	4.50	$	77

As of September 30, 2007, there was $381 thousand of unrecognized compensation expense related to stock options that will be recognized over the remaining requisite service period of approximately 1.96 years. There were no options granted in the three- or nine-month periods ended September 30, 2007 or 2006. There were no shares exercised in the three months and 2,320 shares exercised in the nine months ended September 30, 2007 at an average price of $16.10 providing cash proceeds of $37 thousand. Those shares had an intrinsic value at the time of exercise of $15 thousand. There were 825 shares exercised in the first nine months of 2006 at an average price of $16.10 providing cash proceeds of $13 thousand, with an intrinsic value of $5 thousand.

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8. Components of net periodic benefit cost were as follows for the periods indicated:

	Three Months Ended September 30						Nine Months Ended September 30
	2007			2006			2007			2006
	(in thousands)						(in thousands)
Components of Net Periodic Benefit Cost
Service cost	$	373		$	350		$	1,119		$	1,050
Interest cost		196			179			588			537
Expected return on plan assets		(189	)		(163	)		(567	)		(489	)
Amortization of prior service cost		5			5			16			15
Amortization of net obligation at transition		1			1			3			3
Recognized net actuarial loss		20			33			60			99
Net periodic benefit cost	$	406		$	405		$	1,219		$	1,215

We made our required 2006 fiscal year contribution to the pension plan in December 2006 in the amount of $1.62 million. We anticipate making our 2007 contribution of approximately $1.62 million in December 2007.

9. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but may change current practice for some entities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. We do not expect the implementation of SFAS 157 to have a material impact on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this Statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are in the process of evaluating the impact SFAS 159 may have on our consolidated financial statements.

10. The following table displays detail of comprehensive income for the three and nine month periods ended September 30, 2007 and 2006:

	Three Months Ended September 30						Nine Months Ended September 30
(dollars in thousands)	2007			2006			2007			2006
Net income	$	2,265		$	1,969		$	6,688		$	5,321
Unrealized gains (losses) on securities available for sale, net of tax expense		439			1,931			348			(47	)
Less: reclassification adjustment, net of tax		(9	)		(3	)		(9	)		(24	)
Total comprehensive income	$	2,695		$	3,897		$	7,027		$	5,250

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

We present management’s discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations. This discussion provides information about our major components of the results of operations, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented elsewhere in this report and in the 2006 Form 10-K. Operating results include those of all our operating entities combined for all periods presented.

We provide a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level so that they can provide timely lending decisions and respond promptly to customer inquiries. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.

CRITICAL ACCOUNTING POLICIES

General

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is 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. For example, 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 substantially from the historical factors that we use. 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 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 two basic principles of accounting: (i) SFAS No. 5,Accounting for Contingencies, which requires that losses be accrued when their occurrence is probable and estimable, and (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 the collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

We evaluate non-performing loans individually for impairment as required by SFAS No. 114. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of the impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5.

For loans without individual measures of impairment, we make estimates of losses for groups of loans as required by SFAS No. 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical loss rates for each loan type, the predominant collateral type for the group and the terms of the loan. The resulting estimates of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans including: borrower or industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in risk selection; level of experience, ability and depth of lending staff; and national and economic conditions.

The amounts of estimated losses for loans individually evaluated for impairment and groups of loans are added together for a total estimate of loan losses. The estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the

11

estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether a reduction to the allowance would be necessary. While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments would be made in the relevant period and may be material to the Consolidated Financial Statements.

OVERVIEW

Year-to-date net income through September 30, 2007 increased $1.4 million or 25.7% when compared to the same period in 2006. Net income for the quarter ended September 30, 2007 was $2.3 million, an increase of $296 thousand or 15.0% compared to third quarter 2006 net income of $2.0 million. Increases in net interest income of 5.1% and noninterest income of 20.9% and flat noninterest expense aided the net income growth for the quarter. Net interest income increased $409 thousand for the quarter ended September 30, 2007, compared to the same period in 2006. This increase was the result of continued loan growth that increased interest income on loans by $1.5 million, to $12.9 million for the third quarter of 2007 compared to $11.5 million in the third quarter of 2006. Income from the securities portfolio increased $274 thousand for the third quarter and $307 thousand year-to-date, which resulted from increases in both yield on the portfolio and volume for both periods. Interest expense on deposits and other borrowings increased $1.3 million for the third quarter of 2007 compared to the same quarter of 2006. Noninterest income for the third quarter 2007 compared to the 2006 third quarter increased $284 thousand largely as a result of increased deposit service charge fees of $82 thousand, an increase in debit/credit card fees of $111 thousand and a $74 thousand increase in income from our investment subsidiary. Noninterest expense was relatively flat, increasing $38 thousand in the third quarter of 2007, compared to the quarter ended September 30, 2006. Tax expense increased $238 thousand or 31.0% from the combination of an increase in our statutory tax rate in the third quarter of 2007 and higher income compared to the third quarter of 2006. Earnings per share were $0.38 for the quarter ended September 30, 2007, compared to $0.40 for the comparable period last year, a decrease of 5.0%. While net income for the quarter increased 15.0%, earnings per share decreased because of the dilutive effect of the issuance of additional shares in the December 2006 stock offering. Earnings per share were $1.10 for the first nine months of 2007, compared to $1.08 for the comparable period last year, an increase of 1.9%.

A changing yield curve which was high on short term rates, inverted on mid level rates and more normal on longer term rates continued to contribute to higher interest rates on deposits, until late in the third quarter when the Federal Reserve lowered the fed funds rate. A $28.0 million increase in Federal Home Loan Bank borrowings funded loan growth and securities growth in the third quarter of 2007. Our “Reward Checking” product introduced in the third quarter of 2006 continues to be an important tool in addressing a challenging deposit environment and the balances for this product continue to grow. While the 5.01% interest rate on that product has a detrimental impact on net interest income, it has increased debit card fee income while decreasing operational expenses. We also allowed a run off in “hot money” certificates of deposits due to the expectation of restocking these funds at lower interest rates in the future. “Hot money” represents deposits, primarily certificates of deposit, that are received from customers searching for a higher rate. These deposits leave the bank at the first opportunity the customer has to get a better rate. With the lowering of the federal funds rate and anticipation of another reduction in the future, we believe this strategy to be reasonable and prudent.

Total assets at September 30, 2007 were $903.2 million, up $87.4 million, or 10.7%, from $815.8 million at September 30, 2006 and up $51.8 million, or 6.1%, from $851.4 million at December 31, 2006. For the quarter, total assets averaged $892.6 million, 10.8% above the third quarter 2006 average of $805.5 million. At September 30, 2007, total loans, net of unearned income, amounted to $697.3 million an increase of $60.2 million, or 9.4%, from $637.1 million at September 30, 2006, and an increase of $46.8 million, or 7.2%, from $650.5 million at December 31, 2006. Net loans as a percent of total assets were 76.4% at September 30, 2007, as compared to 77.3% at September 30, 2006 and 75.6% at 2006 year-end. Loan demand was strong in the second and third quarters of 2007, compared to the cyclical slowdown in the first quarter of 2007.

At September 30, 2007, the investment portfolio totaled $149.9 million, an increase of $22.3 million from $127.5 million at September 30, 2006 and up $22.7 million, or 17.9%, from $127.2 million at December 31, 2006. In the third quarter we took advantage of some arbitrage situations to get attractive yields in adding both taxable and tax exempt investments to the portfolio. Most of the funds that are invested in the investment portfolio are part of management’s effort to balance interest rate risk and to provide liquidity. There was a net of $5.3 million of federal funds purchased at September 30, 2007, while there was $1.0 million in federal funds sold at September 30, 2006 and $22.4 million in federal funds sold at December 31, 2006.

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Total deposits of $657.8 million at September 30, 2007 represented an increase of $15.6 million, or 2.4%, from $642.2 million one year ago and an increase of $3.8 million, or 0.6%, from $654.0 million at December 31, 2006. We had a number of “hot money” certificates maturing in the third quarter, which we elected to allow to run off rather than paying higher rates than the cost of FHLB borrowings. At September 30, 2007, noninterest-bearing demand deposits of $100.8 million were down $1.7 million when compared to $102.4 million at September 30, 2006 and up $1.5 million from $99.3 million at year end 2006. Interest-bearing deposits at September 30, 2007, increased $17.3 million, or 3.2%, to $557.0 million compared to $539.7 million at September 30, 2006 and up $2.3 million, or 0.4%, compared to year end 2006. While the third quarter continued the pattern that we have seen for over a year with higher-cost certificates of deposit growing year-over-year while non-maturity interest-bearing and non interest-bearing deposits have decreased, the rate of change has slowed as interest-bearing deposits increased $17.3 million when compared with the same period in 2006.

FHLB borrowings at September 30, 2007 totaled $127.8 million, a $36.6 million, or 40.1%, increase over $91.2 million at September 30, 2006 and up $37.3 million from $90.5 million at December 31, 2006. With loan demand continuing to outpace deposit growth in the third quarter, we expanded our earning asset base using the funding source that provides the best risk/return reward characteristics. With the Federal Reserve lowering the fed funds rate, we look to the fourth quarter to be a transition period, as we expect to attract lower cost deposits to match with loans that will be repricing at lower rates and to cover loan growth.

SFAS No. 115, discussed in the 2006 Form 10-K, requires the Company to show the effect of market changes in the value of securities available for sale. The effect of the change in market value of securities, net of income taxes, is reflected in a line titled “Accumulated other comprehensive (loss), net” in the Shareholders’ Equity section of the Consolidated Balance Sheets, which includes the change in securities and a $1.9 million balance for the difference in the fair value of pension assets. The securities portion was a negative $2.1 million at September 30, 2007, a decline of $273 thousand from a negative $1.8 million at September 30, 2006 and an improvement of $345 thousand from a negative $2.5 million at December 31, 2006. The unrealized loss on securities is presented as a value at one specific point in time but fluctuates significantly over time depending on interest rate changes.

RESULTS OF OPERATIONS

Net Income

Net income increased 15.0% to $2.3 million for the three months ended September 30, 2007, compared to $2.0 million for the same period in 2006. Diluted earnings per share decreased 5.0% to $0.38 for the third quarter of 2007, compared to $0.40 for the same quarter in 2006. Net interest income increased $409 thousand for the quarter ended September 30, 2007, when compared to the same period in 2006. This increase in net interest income for the third quarter 2007 was the result of higher earnings on the loan portfolio, the result of an increase in the loan portfolio balances and rates and an increase in investment income. The $1.8 million increase in loan and investment interest was netted against a decrease of $95 thousand in dividend and fed funds sold income and a $1.3 million increase in total funding costs. Loan loss provision of $325 thousand for the quarter increased $121 thousand compared to $204 thousand in the third quarter of 2006, as management set aside extra funds to cover an impairment charge for a single credit. Noninterest income excluding securities gains was up $275 thousand, or 20.3%, for the quarter when compared to the same period in 2006. This increase comes from an $82 thousand, or 9.8%, increase in service charge income resulting from both rate and volume increases, a $111 thousand, or 91.0%, increase in debit/credit card income and a $74 thousand, or 76.3%, increase in investment services income compared to the third quarter 2006.

Noninterest expense for the three months ended September 30, 2007 increased $38 thousand or 0.6% to $6.4 million, compared to $6.4 million for the same quarter of 2006. Salaries and benefits increased $78 thousand or 2.1%, as a result of normal growth. Net occupancy expense rose $115 thousand to $1.1 million compared to $991 thousand in the third quarter of 2006. Occupancy expense was impacted by increased costs associated with the relocation of the leased Air Park branch to a new owned branch at Kings Charter and building repair costs associated with branch upgrades and various annual increases in service contracts. Marketing expense decreased $69 thousand, while other operating expenses decreased $116 thousand with a $40 thousand decrease in data processing, a $39 thousand decline in operating expense and a $14 thousand decrease in director fees.

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Net income for the nine months ended September 30, 2007 increased $1.4 million, or 25.7%, to $6.7 million from $5.3 million in the first nine months of 2006. Diluted earnings per share increased 1.9% to $1.10 for the first nine months of 2007, compared to $1.08 for the same period in 2006. Year-to-date net interest income increased $1.3 million or 5.7%. Provision for loan losses increased $107 thousand or 20.5% due to a reserve for one credit. Noninterest income excluding securities gains and losses increased $678 thousand or 18.0%. Noninterest expense decreased $246 thousand or 1.3%. The decrease in noninterest expense is a direct result of the April 2006 conversion to a one-bank holding company as salaries and benefits decreased $66 thousand and consulting fees decreased $123 thousand, both compared to the nine months ended September 30, 2006.

Return on average assets (ROA) increased to 1.01% in the third quarter of 2007, compared to 0.97% in the third quarter of 2006, and return on average equity (ROE) declined to 10.03% compared to 12.21% for the quarters ended September 30, 2007 and 2006, respectively. Year-to-date, ROA increased to 1.02%, compared to 0.90% in the nine months ended September 30, 2006 while ROE declined to 9.99% compared to 11.29% for the same nine-month periods. As anticipated, the stock offering transaction in late 2006 had a current period positive impact on ROA and a negative impact on ROE.

Net Interest Income

Net interest income on a fully tax equivalent basis totaled $8.5 million for the third quarter of 2007, a $424 thousand increase over the third quarter of 2006. When comparing the third quarter of 2007 to the same quarter in 2006, average earning assets increased 11.0% to $840.6 million compared to $757.1 million, average loans increased $67.3 million, or 10.8%, average securities increased $19.3 million, or 15.3% and average federal funds sold decreased $3.1 million, or 35.0%. The fully tax equivalent net interest margin for the three-month period ended September 30, 2007 was 4.03% compared to 4.26% for the quarter ended September 30, 2006. For the quarter, the yield on earning assets was up 11 basis points to 7.07%, compared to 6.96% for the third quarter of 2006, and the cost of interest bearing liabilities was up 47 basis points to 3.70% from 3.23% in the same period in 2006, narrowing the spread between the yield on earning assets and the cost of funds. This reflects continued intense competition in loan pricing even as the cost of funding is increasing. Our increase in funding costs is more specifically related to year-over-year increases in interest checking, large dollar certificates of deposit and other certificates of deposit of 152, 36 and 44 basis points, respectively. The cost of money market savings increased 9 basis points while the average balances declined $4.1 million. Savings deposit average balances fell $15.4 million with a 4 basis point decline in interest rate.

We believe that depositors resist committing their funds for more than one year, leaving our bank working hard to match longer term assets to the high rate short-term deposits and causing a continued decrease of the net interest margin. We are well aware of the challenge that we face and believe that wholesale funding and development/implementation of new deposit products are ways to manage the margin. We anticipate that a return to a positively sloping yield curve will enhance the margin. With the Federal Reserve’s lowering of the fed funds rate, we expect lower cost deposits to be available in the fourth quarter of 2007.

Comparing the nine months ended September 30, 2007 to the same period in 2006, net interest income on a fully tax-equivalent basis of $25.2 million increased $1.3 million, average earning assets increased $83.7 million, or 11.3% from $738.9 million to $822.6 million, average loans increased $70.0 million, or 11.6%, average securities increased $4.3 million, or 3.3%, and federal funds sold increased $9.4 million to $14.5 million. The fully tax-equivalent net interest margin for the nine-month period ended September 30, 2007 was 4.10%, compared to 4.32% for the nine months ended September 30, 2006. The continuing decrease in net interest margin is a direct result of the cost of interest-bearing funds increasing 64 basis points while the yield on earning assets was increasing only 25 basis points. We anticipate continued pressure on the net interest margin in the fourth quarter of 2007 as the impact of lower rates work through the balance sheet. Further lowering of rates should benefit us in 2008.

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Tables that disclose fully tax equivalent net interest income calculations for the three- and nine-month periods ended September 30, 2007 and 2006 follow:

Average Balances, Income and Expense, Yields and Rates (1)

	Three Months Ended September 30,
	2007							2006
	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
Assets:
Securities
Taxable	$	109,151		$	1,468	5.34	%	$	92,991		$	1,229	5.24	%
Tax exempt (1)		36,026			539	5.93	%		32,930			489	5.89	%
Total securities		145,177			2,007	5.48	%		125,921			1,718	5.41	%
Federal funds sold		5,763			73	5.03	%		8,866			119	5.33	%
Loans, net of unearned income (2)		689,645			12,907	7.43	%		622,343			11,450	7.30	%
Total earning assets		840,585			14,987	7.07	%		757,130			13,287	6.96	%
Less allowance for loan losses		(7,300	)						(6,870	)
Total non-earning assets		59,317							55,234
Total assets	$	892,602						$	805,494
Liabilities & Shareholders’ Equity:
Interest bearing deposits
Checking	$	109,677		$	526	1.90	%	$	77,532		$	74	0.38	%
Savings		81,218			244	1.19	%		96,598			300	1.23	%
Money market savings		40,562			250	2.45	%		44,699			266	2.36	%
Large dollar certificates of deposit (5)		117,164			1,426	4.83	%		105,424			1,187	4.47	%
Other certificates of deposit		207,323			2,351	4.50	%		208,372			2,132	4.06	%
Total interest-bearing deposits		555,944			4,797	3.42	%		532,625			3,959	2.95	%
Federal funds purchased		3,756			52	5.49	%		134			2	5.92	%
Other borrowings		131,357			1,590	4.80	%		100,593			1,202	4.74	%
Total interest-bearing liabilities		691,057			6,439	3.70	%		633,352			5,163	3.23	%
Noninterest-bearing liabilities
Demand deposits		99,669							100,594
Other liabilities		12,263							7,563
Total liabilities		802,989							741,509
Shareholders’ equity		89,613							63,985
Total liabilities and shareholders’ equity	$	892,602						$	805,494
Net interest income				$	8,548						$	8,124
Interest rate spread (3)						3.38	%						3.73	%
Interest expense as a percent of average earning assets						3.04	%						2.71	%
Net interest margin (4)						4.03	%						4.26	%

Notes:

(1) Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 35%. The tax equivalent adjustment for the quarter is $165 thousand, compared to $150 thousand in the prior year.

(2) Nonaccrual loans have been included in the computations of average loan balances.

(3) Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(4) Net interest margin is the net interest income, calculated on a fully taxable basis assuming a federal income tax rate of 34%, expressed as a percentage of average earning assets.

(5) Large dollar certificates of deposit are certificates issued in amounts of $100,000 or greater.

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Average Balances, Income and Expense, Yields and Rates (1)

	Nine Months Ended June 30
	2007							2006
	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
Assets:
Securities
Taxable	$	101,125		$	3,939	5.21	%	$	95,654		$	3,600	5.03	%
Tax exempt (1)		33,458			1,495	5.97	%		34,600			1,541	5.95	%
Total securities		134,583			5,434	5.40	%		130,254			5,141	5.28	%
Federal funds sold		14,503			573	5.28	%		5,146			195	5.07	%
Loans, net of unearned income (2)		673,488			37,561	7.46	%		603,467			32,422	7.18	%
Total earning assets		822,574			43,568	7.08	%		738,867			37,758	6.83	%
Less allowance for loan losses		(7,207	)						(6,759	)
Total non-earning assets		58,622							56,080
Total assets	$	873,989						$	788,188
Liabilities & Shareholders’ Equity:
Interest bearing deposits
Checking	$	101,695		$	1,268	1.67	%	$	78,683		$	218	0.37	%
Savings		83,281			748	1.20	%		103,047			966	1.25	%
Money market savings		40,798			733	2.40	%		46,252			690	1.99	%
Large dollar certificates of deposit (5)		118,879			4,288	4.82	%		100,134			3,138	4.19	%
Consumer certificates of deposit		213,976			7,152	4.47	%		200,544			5,704	3.80	%
Total interest-bearing deposits		558,629			14,189	3.40	%		528,660			10,716	2.71	%
Federal funds purchased		1,378			57	5.53	%		2,243			81	4.83	%
Other borrowings		115,906			4,101	4.73	%		89,825			3,062	4.56	%
Total interest-bearing liabilities		675,913			18,347	3.63	%		620,728			13,859	2.99	%
Noninterest-bearing liabilities
Demand deposits		97,348							98,094
Other liabilities		11,186							6,348
Total liabilities		784,447							725,170
Shareholders’ equity		89,542							63,018
Total liabilities and shareholders’ equity	$	873,989						$	788,188
Net interest income				$	25,221						$	23,899
Interest rate spread (3)						3.45	%						3.85	%
Interest expense as a percent of average earning assets						2.98	%						2.51	%
Net interest margin (4)						4.10	%						4.32	%

Notes:

(1) Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 35%. The tax equivalent adjustment for the six months is $457 thousand, compared to $471 thousand in the prior year.

(2) Nonaccrual loans have been included in the computations of average loan balances.

(3) Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(4) Net interest margin is the net interest income, calculated on a fully taxable basis assuming a federal income tax rate of 34%, expressed as a percentage of average earning assets.

(5) Large dollar certificates of deposit are certificates issued in amounts of $100,000 or greater.

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Noninterest Income

This category includes all income not related to interest on investments and interest and fees on loans. Noninterest income excluding net realized gains on securities sales was $1.6 million for the third quarter of 2007 compared to $1.4 million for the same quarter in 2006. Service charges on deposit accounts for the quarter ended September 30, 2007 were $921 thousand, compared to $839 thousand for the comparable period in 2006. Debit and credit card fees increased $111 thousand or 91.0% for the third quarter 2007 to $233 thousand compared to $122 thousand in the third quarter 2006. For the quarter ended September 30, 2007, investment subsidiary fees were $171 thousand, an increase of $74 thousand or 76.3% compared to $97 thousand for the same period in 2006. Service charge increases were from a combination of rate and volume increases. Debit and credit card increases were the result of more usage of debit cards which raised the fees related to these transactions and more fee and interchange income from credit card transactions. The increase in investment services income is the result of excellent sales in the third quarter. Other operating income without debit and credit card fees or investment services fees increased $8 thousand in the third quarter.

Noninterest income excluding net realized gains on securities sales was $4.5 million for the nine months ended September 30, 2007, compared to $3.8 million in the first nine months of 2006. This increase was primarily impacted by a $276 thousand, or 11.6%, increase in service charges on deposit accounts, a $226 thousand, or 65.5%, increase in debit/credit card fees and a $75 thousand, or 27.5%, increase in income from our investment subsidiary.

Noninterest Expense

This category includes all expenses other than interest paid on deposits and borrowings. Total noninterest expense was relatively flat with an increase of $38 thousand, or 0.6%, from $6.4 million for the third quarter of 2006 to $6.4 million for the three months ended September 30, 2007. Noninterest expense changes included increases of $78 thousand in salaries and benefits and $115 thousand in occupancy expense which were offset by decreases in marketing and advertising of $69 thousand and other operating expense of $116 thousand. Salaries and benefits increased as a result of higher brokerage commissions, higher group insurance and the addition of new personnel to support growth. Occupancy expense increased from a new branch opened in late 2006 and building repairs. Marketing and advertising are down primarily from less TV/newspaper ads which were high in 2006 when we were introducing a new product, Reward Checking. Other operating expenses are down primarily from a $70 thousand decrease in office supplies and printing/ forms expense, a $20 thousand decrease in dues and subscription expense and smaller decreases in a number of other categories. These decreases can be tied to the savings created by our becoming a one bank holding company in 2006.

For the nine-month period ended September 30, 2007, noninterest expense was down $246 thousand or 1.30% to $19.1 million from $19.3 million in the first nine months of 2006. The primary expense decreases were $66 thousand in salaries and benefits, $123 thousand in consultant fees and $173 thousand in data processing. The largest category of increase was occupancy expense, up $197 thousand, or 6.7%, primarily from the relocation discussed in the previous paragraph, building repair expenses and increases in many annually renewing service contracts.

Income Taxes

Income tax expense for the quarter ended September 30, 2007 was $1.0 million, compared to $767 thousand for the same period in 2006. The effective tax rate for the quarter was 30.7%, an increase from 28.0% in the 2006 third quarter. This increase was a result of higher income and our effort to control tax expense. On a year to date basis, tax expense has increased from $2.1 million to $2.8 million with the effective tax rate increasing from 28.0% to 29.8%. The increase in the year-to-date effective tax rate is caused by a combination of growth that has increased our statutory tax rate from 34% on the first $10 million of taxable income to 35% on taxable income that exceeds $10 million and, to a lesser degree, a decrease in the percentage of tax-exempt income compared to total income.

ASSET QUALITY

The Company’s allowance for loan losses is an estimate of the amount needed to provide for possible losses in the loan portfolio. In determining adequacy of the allowance, management considers the Company’s historical loss experience, the size and composition of the loan portfolio, specific impaired loans, the overall level of nonperforming loans, the value and adequacy of collateral and guarantors, experience and depth of lending staff, effects of credit concentrations and economic conditions. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge offs, net of recoveries. Because the risk of loan loss includes general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses can only be an estimate. (See the Allowance for Loan Losses discussion under Critical Accounting Policies earlier in this section.)

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Total nonperforming assets, which consist of nonaccrual loans, loans past due 90 days and still accruing interest and foreclosed properties, were $4.0 million at September 30, 2007, $2.9 million at December 31, 2006 and $2.6 million at September 30, 2006. Nonperforming assets are composed largely (93.1%) of loans secured by real estate in the Company’s market area. In the third quarter of 2007, we added $951 thousand to OREO as we went into a forbearance agreement with a builder. The three properties associated with this situation are expected to sell for more than we have invested in them. This reinforces management’s belief that, based on estimated fair values of the related real estate, any individual deficiency is covered by the allowance for loan losses.

Total loan charge-offs, less recoveries, amounted to $83 thousand for the third quarter of 2007 compared to $115 thousand for the same quarter in 2006, while the annualized ratio of net charge-offs to total average loans, net of unearned income, was 0.05% for the third quarter of 2007 compared to 0.07% for the same quarter in 2006. Year-to-date net charge-offs were $232 thousand, compared to $242 thousand in the first nine months of 2006 and the annualized ratio net charge-offs to total average loans, net of unearned income, was 0.05% for both periods. Full year 2006 net charge-offs were $275 thousand, or 0.04%, of average loans. The ratio of nonperforming assets to total loans and OREO at September 30, 2007 was 0.58%, up from 0.45% at December 31, 2006 and up from 0.40% at September 30, 2006. These strong numbers reflect the emphasis that management places on credit quality management, especially in an environment with increasing credit risk in the financial services industry.

The allowance for loan losses of $7.4 million at September 30, 2007 increased $567 thousand when compared to $6.9 million at September 30, 2006 and was up from $7.1 million at December 31, 2006. Recoveries have helped slow the growth of the allowance as demonstrated by the increase in allowance of $396 thousand compared to the total provision expense of $628 thousand for the same period. Management believes the balance in the allowance reflects strong asset quality, and the addition to provision expense in the third quarter demonstrates our conservative approach to loan loss reserves. The ratio of allowance for loan losses to total loans was 1.07% at September 30, 2007, 1.08% at 2006 year-end and 1.08% at September 30, 2006. The allowance for loan losses at September 30, 2007 included $876 thousand of specific impaired loan reserves.

At September 30, 2007, the Company reported $2.9 million in impaired loans, a decrease of $768 thousand from $3.7 million at December 31, 2006 and a decrease of $7.0 million from $9.9 million at September 30, 2006. The average balance of impaired loans for the three months ended September 30, 2007 was $3.9 million.

The following table summarizes the Company’s nonperforming assets at the dates indicated.

Nonperforming Assets	September 30			December 31			September 30
(Dollars in thousands)	2007			2006			2006
Nonaccrual loans	$	2,293		$	1,400		$	1,653
Restructured loans		—			—			—
Loans past due 90 days and accruing interest		733			1,504			906
Total nonperforming loans	$	3,026		$	2,904		$	2,559
Other real estate owned		951			—			—
Total nonperforming assets	$	3,977		$	2,904		$	2,559
Nonperforming assets to total loans and other real estate		0.58	%		0.45	%		0.40	%
Allowance for loan losses to nonaccrual loans		324.80	%		503.52	%		416.21	%
Net charge-offs to average loans for the year		0.04	%		0.04	%		0.05	%
Allowance for loan losses to period end loans		1.07	%		1.08	%		1.08	%

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LIQUIDITY

Liquidity represents our ability to meet present and future deposit withdrawals, to fund loans, to maintain reserve requirements and to operate the organization. To meet our liquidity needs, we maintain cash reserves and have an adequate flow of funds from maturing loans, securities and short-term investments. In addition, our subsidiary bank maintains borrowing arrangements with major regional banks and with the Federal Home Loan Bank (“FHLB”). We consider our sources of liquidity to be sufficient to meet our estimated liquidity needs.

During the third quarter of 2007, we executed net new FHLB borrowings of $28 million to take advantage of attractive rates. These new borrowings were used to fund loan growth during the quarter rather than buying “hot money” certificates when we anticipate deposit interest rates to decline in the fourth quarter. These new borrowings were laddered to have future calls in 2008, 2009 and 2010. A part of the borrowing is a $10.0 million LIBOR based instrument that is match funded against LIBOR based investments. The average rate on the new fixed-rate borrowings is 4.34%. We have made it a practice to fund growth at times with FHLB borrowings if the rates were below our interest bearing deposit costs. These borrowings have some potential long-term interest risk if rates fall significantly, but overall give us an acceptable spread and funding rate. We have relied on FHLB borrowings to support our growth at times in the past and will continue to evaluate funding opportunities as necessary to support future growth. These were the only changes to our contractual obligations that would impact liquidity since the 2006 Form 10-K disclosure. At September 30, 2007, we had immediate available credit with the FHLB of $5.5 million and with nonaffiliated banks of $14.2 million. See Note 5 to the Consolidated Financial Statements for further FHLB information.

There have been no material changes in off-balance sheet arrangements since the 2006 Form 10-K disclosure.

Management believes that we maintain overall liquidity sufficient to satisfy our depositors’ requirements and meet our customers’ credit needs.

CAPITAL RESOURCES

Our risk-based capital position at September 30, 2007 was $96.9 million, or 13.96% of risk-weighted assets, for Tier 1 capital and $102.9 million, or 14.82%, for total risk based capital. Our Tier 1 leverage ratio at September 30, 2007 was 10.96%. Our year end 2006 ratios were 15.04%, 16.15% and 11.57%, respectively. Enhancing our capital ratios to support future growth was the primary reason for the December 2006 stock offering. At September 30, 2006, these ratios were a much more modest 11.19%, 12.28% and 8.82%, respectively.

Tier 1 capital consists primarily of common shareholders’ equity, while total risk based capital adds a portion of the allowance for loan losses to Tier 1. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. Under current risk based capital standards, all banks and bank holding companies are required to have a Tier 1 capital of at least 4% and a total capital ratio of at least 8%.

INFLATION

In financial institutions, unlike most other industries, virtually all of the assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on a bank’s performance than the effects of general levels of inflation. While interest rates are significantly impacted by inflation, neither the timing nor the magnitude of the changes are directly related to price level movements. The impact of inflation on interest rates, loan demand, and deposits is reflected in the Consolidated Financial Statements.

FORWARD-LOOKING STATEMENTS

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We caution you to be aware of the speculative nature of “forward-looking statements.” These statements are not guarantees of performance or results. Statements that are not historical in nature, including statements that include the words “may,” “anticipate,” “estimate,” “could,” “should,” “would,” “will,” “plan,” “predict,” “project,” “potential,” “expect,” “believe,” “intend,” “continue,” “assume” and similar expressions, are intended to identify forward-looking statements. Although these statements reflect our good faith belief based on current expectations, estimates and projections about (among other things) the industry and the markets in which we operate, they are not guarantees of future performance. Whether actual results will conform to our expectations and predictions is subject to a number of known and unknown risks and uncertainties, including the risks and uncertainties discussed in this Form 10-Q, including the following:

• changes in the interest rates affecting our deposits and our loans;

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• the loss of any of our key employees;

• changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in our markets, or in the repayment ability of individual borrowers or issuers;

• the strength of the economy in our target market area, as well as general economic, market, or business conditions;

• changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in our banking markets;

• an insufficient allowance for loan losses as a result of inaccurate assumptions;

• our ability to manage growth;

• our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;

• our ability to assess and manage our asset quality;

• changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services;

• our ability to maintain internal control over financial reporting;

• our ability to raise capital as needed by our business;

• our reliance on secondary sources, such as Federal Home Loan Bank advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs;

• changes in laws, regulations and the policies of federal or state regulators and agencies; and

• other circumstances, many of which are beyond our control.

All of the forward-looking statements made in this filing are qualified by these factors, and there can be no assurance that the actual results anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us or our business or operations. You should also refer to risks detailed under the “Risk Factors” section included in the 2006 Form 10-K and otherwise included in our periodic and current reports filed with the Securities and Exchange Commission for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in market risk since 2006 year end as disclosed in the 2006 Form 10-K.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission. An evaluation of the effectiveness of the design and operations of our disclosure controls and procedures as of the end of the period covered by this report was carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on such evaluation, such officers concluded that our disclosure controls and procedures were effective as of the end of such period. In addition, while we have reorganized and centralized many functions over the last year, we have maintained the control points that had been previously established. There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We believe that the merger of our subsidiary banks has had a positive impact on internal controls by decreasing the number of banks, accounts and internal processes and procedures.

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PART II —OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings to which the registrant or any of its subsidiaries is a party. The only litigation in which we and our subsidiaries are involved pertains to collection suits involving delinquent loan accounts in the normal course of business.

Item 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in the 2006 Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In January 2001, the Board of Directors gave the authority to management to repurchase up to 5% of the outstanding shares of the company’s stock per calendar year based on the number of shares outstanding on December 31, of the preceding year. This authority has been reaffirmed each year and was most recently reaffirmed in June of 2007. There were no share repurchases from September 2004 through June 2007. During the third quarter of 2007, taking advantage of a depressed stock market, we repurchased 151,010 shares at an average price of $20.60 per share. As of year end 2006, there were 304,165 shares allowed to be purchased. There are 153,155 shares that can be purchased over the remainder of 2007. Repurchases may be made either in the open market or through privately negotiated transactions, as management and the board of directors deem prudent. All repurchases during 2007 have been in the open market. The impact of repurchasing shares is to lower the number of shares outstanding and thus potentially raise earnings per share and ROE.

Item 3. Defaults Upon Senior Securities(not applicable)

Item 4. Submission of Matters to a Vote of Security Holders(not applicable)

Item 5. Other Information(not applicable)

Item 6. Exhibits

Exhibit 31.1 – Rule 13a-14(a) Certification of Chief Executive Officer

Exhibit 31.2 – Rule 13a-14(a) Certification of Chief Financial Officer

Exhibit 32.1 – Section 906 Certification of Chief Executive Officer

Exhibit 32.2 – Section 906 Certification of Chief Financial Officer

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Eastern Virginia Bankshares, Inc.

/s/ Joe A. Shearin

Joe A. Shearin

President and Chief Executive Officer

/s/ Ronald L. Blevins

Ronald L. Blevins

Chief Financial Officer

Date: November 2, 2007

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Exhibit Index

Exhibit 31.1 – Rule 13a-14(a) Certification of Chief Executive Officer

Exhibit 31.2 – Rule 13a-14(a) Certification of Chief Financial Officer

Exhibit 32.1 – Section 906 Certification of Chief Executive Officer

Exhibit 32.2 – Section 906 Certification of Chief Financial Officer

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