Quarterly Report

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services.

FINANCIAL CONDITION AT MARCH 31, 2002 AND DECEMBER 31, 2001

During the three-month period ending March 31, 2002, our total assets increased by $40.2 million, or 8.4%, to $521.4 million. This asset growth was driven by funding growth, as deposits increased $15.8 million, or 4.0%, and short-term borrowings rose $7.0 million to $27.0 million. In addition, during the quarter we successfully completed a public offering of trust preferred securities, generating $17.3 million in the form of Convertible Junior Subordinated Debentures.

Consistent with prior periods, a substantial portion of our growth in funding has been deployed to satisfy strong loan demand. At March 31, 2002, loans totaled $379.5 million, an increase of $19.3 million or 5.3% during the three months. This growth was spread among our mortgage, construction and commercial loans. Our commercial mortgage loans and non-mortgage commercial loans increased by $11.0 million and $1.2 million, respectively, and collectively provided 63% of our overall loan growth. We also generated growth of $4.2 million and $2.9 million, respectively, in residential mortgage loans and construction loans.

Our total liquid assets, defined as cash and due from banks, federal funds sold and investment securities, increased by $17.4 million during the three months, to $124.4 million at March 31 versus $107.0 million at the beginning of the period. Our composition of liquid assets has shifted to take advantage of the more favorable interest rates that are being paid on investment securities as compared to overnight investments. We decreased our investment in federal funds sold from $22.9 million at December 31, 2001 to $2.1 million at March 31, 2002. We have chosen to invest more heavily in investment securities, which we increased by $45.2 million to $110.4 million at March 31, 2002 versus $65.2 million at December 31, 2001. The large majority of this increase was in the available for sale category, which we increased by $37.2 million to a total of $67.9 million at the end of the quarter.

Customer deposits continue to be our primary funding source for the institution. At March 31, 2002, deposits totaled $408.7 million, an increase of $15.8 million or 4.0% from year-end 2001. In February of 2002, we completed our trust preferred securities offering which provided $17.3 million of additional funding in the form of Convertible Junior Subordinated Debentures. We also increased our short-term borrowings from repurchase lines of credit an additional $7.0 million. We will utilize various funding sources, as necessary, to support balance sheet management and growth. However, we believe that as our branch network grows and matures, the volume of core deposits will become a relatively larger portion of our funding mix, which should contribute to a reduction in our overall funding cost.

Our capital position remains strong, with all of our regulatory capital ratios at levels that make us "well capitalized" under federal bank regulatory capital guidelines. At March 31, 2002, our stockholders' equity totaled $42.4 million, a decrease of $96,000 from the December 31, 2001 balance. Net income of $554,000 and proceeds from the issuance of common stock in the amount of $82,000 was offset by a decrease in the fair value of our available-for-sale investments, net of tax, in the amount of $732,000. Our regulatory capital was supplemented during the quarter by issuance of the Convertible Junior Subordinated Debentures discussed above.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001

Net Income. Our net income for the first three months of 2002 was $554,000, a decrease of $34,000 below that of the same three-month period in 2001. Net income per share was $.07 basic and $.06 diluted for the three months ended March 31, 2002, as compared with $.07 basic and $.07 diluted for the first three months of 2001. We have continued to

experience strong growth, with total assets averaging $500.6 million during the current three-month period as compared to $391.3 million in the prior period, an increase of 27.6%. Because of the downward trend in interest rates from period to period, resulting in dramatically lower yields during the current quarter as compared with the first quarter of 2001, our increase in net interest income did not keep pace with our overall asset growth. Our percentage growth in net interest income of 11.8%, as compared with the same period in 2001, and a decrease in our loan loss provision in the amount of $75,000 were primarily offset by a decrease in non-interest income of 8.4% and an increase in non-interest expenses of 17.6%. Our expense growth included the costs of new branches, additional branch personnel, as well as personnel costs associated with expansion of our business. While these expenses represent investments in building our franchise, they are initially a drag on earnings.

Net Interest Income. During the first three months of 2002, our net interest income increased by $379,000 or 11.8% to $3.6 million. Our total interest income benefited from strong growth in the level of average earning assets, which offset lower asset yields caused by the dramatic decline in interest rates that occurred from quarter to quarter. The rates earned on a significant portion of our loans adjust immediately when index rates such as our prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $109.8 million, or 29.7%, during the first three months of 2002 as compared to the same period in 2001. Our average yield on total interest-earning assets decreased by 243 basis points from 8.72% to 6.29%. Our average total interest-bearing liabilities increased by $105.8 million, or 32.3%, consistent with our increase in interest-earning assets. Our average cost of total interest-bearing liabilities decreased by 227 basis points from 5.92% to 3.65%. For the three months ended March 31, 2002, our net interest spread was 2.70% and our net interest margin was 3.13%. For the three months ended March 31, 2001, our net interest spread was 2.81% and our net interest margin was 3.48%.

Provision for Loan Losses. Our provision for loan losses for the three months ended March 31, 2002 was $360,000, representing a decrease of $75,000 from the $435,000 provision we made for the three months ended March 31, 2001. We have continued to increase the level of our allowance for loan losses in response to the continued growth in our loan portfolio. We have decreased our provision during the current three-month period because of the lower level of net loan charge-offs, which totaled $67,000 during the three months ended March 31, 2002, down from $208,000 during the three months ended March 31, 2001. On an annualized basis, our percentage of net loan charge-offs to average loans outstanding was .01% for the three months ended March 31, 2002 as compared with .07% for the three months ended March 31, 2001.

Non-Interest Income. For the first three months of 2002, non-interest income decreased by $70,000 or 8.4% to $762,000 from $832,000 for the same period the prior year. Although the core non-interest income components increased $120,000 or 18.7% during the first three months of 2002, the same period in 2001 included non-recurring income of $190,000 from an interest rate floor contract. Increases for the three months ended March 31, 2002 include an increase of $58,000, or 30.7%, in service charges and fees on deposit accounts as a result of deposit growth, and an increase of $73,000, or 128.1%, in other operational income.

Non-Interest Expense. We strive to maintain non-interest expenses at levels that we believe are appropriate given the nature of our operations and the investments in personnel and facilities that have been necessary to generate our growth. From 1998 forward through the current three-month period, we have consistently maintained our ratio of non-interest expenses to average total assets below 3%. Because of our growth, we have consistently seen increases in every major component of our non-interest expenses. For the three months ended March 31, 2002, our non-interest expense increased $470,000, or 17.6%. Salary and employee benefit expense increased $280,000, or 20.9%, and reflects the addition of personnel in our new branches as well as additions of personnel to expand our lines of business, and, to a lesser degree, normal salary increases. Occupancy and equipment expense increased $76,000, or 15.5%. Other expenses increased $114,000, or 13.5%, reflecting the increased volume of business activity, principally increases in lending and growth in deposit accounts. For the three months ended March 31, 2002, on an annualized basis, our ratio of non-interest expenses to average total assets improved to 2.47% as compared with 2.74% for the same three months in 2001.

Provision for Income Taxes. Our provision for income taxes, as a percentage of income before income taxes, was 35.4% and 37.7%, respectively, for the three months ended March 31, 2002 and 2001. The decline in the effective rate for the current period principally results from a higher level of investment in federally issued debt instruments that are not subject to state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources.

Liquidity is defined as our ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities; investment securities eligible for pledging to secure borrowings from dealers and customers pursuant to securities sold under repurchase agreements, investments available for sale, loan repayments, loan sales, deposits, and borrowings from the Federal Home Loan Bank and from correspondent banks under overnight federal funds credit lines. In addition to interest rate-sensitive deposits, the Company's primary demand for liquidity is anticipated fundings under credit commitments to customers.

Because of our continued growth, we have maintained a relatively high position of liquidity in the form of interest-bearing bank deposits, federal funds sold, and investment securities. These aggregated $124.4 million at March 31, 2002 compared to $107.0 million at December 31, 2001. Supplementing customer deposits as a source of funding, we have available lines of credit in the amounts of $26.0 million and $37.0 million from various correspondent banks to purchase federal funds and repurchase agreements, respectively, on a short-term basis. We also have the ability to borrow up to $85.3 million from the Federal Home Loan Bank of Atlanta, with $35.0 million outstanding at March 31, 2002 and the ability to borrow up to $102.2 million from the Federal Reserve Bank of Richmond, with no outstanding balances at March 31, 2002. During the first quarter of 2002 we successfully completed a trust preferred securities offering which provided $17.3 million of additional funding in the form of Convertible Junior Subordinated Debentures. These debt obligations also supplement our regulatory capital. At March 31, 2002, our outstanding commitments to extend credit consisted of loan commitments of $28.3 million and amounts available under home equity credit lines, other credit lines and standby letters of credit of $31.3 million, $43.4 million and $10.5 million, respectively. We believe that our combined aggregate liquidity position is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

Throughout our five-year history, our loan demand has exceeded our growth in core deposits. We have therefore relied heavily on time deposits as a source of funds. Time deposits represented 68% of our total deposits at March 31, 2002, up from 66% at December 31, 2001. Certificates of deposit of $100,000 or more represented 30% of our total deposits at March 31, 2002 and 28% at December 31, 2001. A portion of these deposits are controlled by members of our Board of Directors and Advisory Board members, or otherwise comes from customers considered to have long-standing relationships with our management. Based upon the nature of these relationships, management does not believe we are subject to significant liquidity risk related to these deposits. Large time deposits are generally considered rate sensitive. Exclusive of the brokered and other wholesale deposits, however, we believe a substantial portion of our large time deposits are relationship-oriented, and while we will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention.

At March 31, 2002, our capital to average asset ratio was 8.3%, and all of our capital ratios exceeded the minimums established for a well-capitalized bank by regulatory measures. Our Tier I risk-based capital ratio at March 31, 2002 was 12.7%.