GBTS Gateway Finl Hldgs (MM)

 

 

U. S. Securities and Exchange Commission

Washington, D.C. 20549

Form 10-K

þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2007

o		Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission file number 000-33223

Gateway Financial Holdings, Inc.

(Exact name of registrant as specified in its charter)

(757) 422-4055
(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Exchange Act:

Title of each class		Exchange on which registered
Common Stock, No Par Value		The NASDAQ Stock Market, LLC

Securities registered under Section 12(g) of the Act: None.

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act).

large accelerated filer o		accelerated filer þ		non-accelerated filer o		smaller reporting company o

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

State issuer’s revenues for its most recent fiscal year $127.3 million.

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $160.7 million.

As of March 10, 2008, (the most recent practicable date), the registrant had outstanding 12,650,985 shares of common stock, no par value per share.

Documents Incorporated By Reference

 

 

Form 10-K Table of Contents

Index		PAGE
PART I
Item 1. Description of Business			3
Item 1A. Risk Factors			11
Item 1B. Unresolved Staff Comments			17
Item 2. Properties			17
Item 3. Legal Proceedings			18
Item 4. Submission of Matters to a Vote of Security Holders			18
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			18
Item 6. Selected Financial Data			20
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			21
Item 8. Financial Statements and Supplementary Data			49
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			92
Item 9A. Controls and Procedures			92
Item 9B. Other Information			95
PART III
Item 10. Directors, Executive Officers, and Corporate Governance			95
Item 11. Executive Compensation			95
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			95
Item 13. Certain Relationships and Related Transactions, and Director Independence			96
Item 14. Principal Accounting Fees and Services			96
PART IV
Item 15. Exhibits, Financial Statement Schedules			96
Exhibit 3.1
Exhibit 3.2
Exhibit 3.3
Exhibit 10.4
Exhibit 10.5
Exhibit 10.7
Exhibit 10.8
Exhibit 10.9
Exhibit 10.10
Exhibit 21
Exhibit 23
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I

estimated by the U.S. Census Bureau, of almost 994 thousand. According to ESRI, the MSA of Raleigh has a projected population growth of 15.8% from 2005 to 2010. Richmond, Virginia is the 45 ^th largest metropolitan area in the United States with a 2006 population, estimated by the U.S. Census Bureau, of over 1.13 million.

We emphasize personalized service, access to decision makers, and a quick turn around time on lending decisions. Our slogan is “Real People . . . Real Solutions.” We have a management team with extensive experience in our local markets. We intend to leverage the core relationships we build by providing a variety of services to our customers. With that focus, we target:

	•		Small-and medium-sized businesses;
	•		Professionals and middle managers of locally based companies;
	•		Residential real estate developers; and
	•		Individual consumers.

We believe that these segments are the most under-served by local financial centers of national and super-regional financial institutions. We also intend to continue to diversify our revenue in order to continue to generate significant non-interest income. We presently offer investment brokerage and insurance services, and we originate mortgage loans for sale in the secondary market.

We believe that economic growth and bank consolidation have created a growing number of businesses and consumers in need of high quality banking and other financial services delivered with personalized attention. Consolidation in the banking market has dislocated experienced and talented management and lending personnel. As a result, we believe we have a substantial opportunity to attract experienced management, loan officers and banking customers both within our current markets and other markets in which we might expand in Virginia and North Carolina. Our business plan is to capitalize on this opportunity by developing a financial center network in growing areas within Virginia and North Carolina where we can hire experienced bankers with a loyal following of deposit and loan customers. Our plan has been to start new financial centers after we have identified either an experienced banker who will have responsibility for that market or an existing office in a location with favorable growth characteristics that is being sold by another bank. We believe that it takes a combination of an attractive location and experienced, talented people to be successful in expanding our franchise. We intend to build upon existing relationships and create new relationships and new markets by de novo expansion, further financial center acquisitions, or potential whole bank acquisitions which make strategic and economic sense.

We intend to achieve our primary goal of maximizing long-term returns to stockholders by focusing on the following objectives:

	•		Emphasize relationship banking. We have been successful in building client relationships because our regional model enables us to deliver products and services that are comparable to that of our largest competitors and high customer service levels that are most commonly associated with community banks. The Bank has divided its markets into six regions. Each region has its own Market President whose knowledge of his region, presence in his community and ability to make prompt credit decisions, strengthens our ability to develop local relationships. We typically render commercial loan decisions within 48 hours and retail loans within an hour. Localized decision making and personalized customer service form the core of our relationship banking strategy, and we plan to maintain this approach as we continue to grow in both our existing markets and new markets.
	•		Grow organically in our existing markets.   Our markets have been subject to significant bank consolidation. We believe there is a large customer base in our markets that prefers doing business with a local institution and may be dissatisfied with the service received from national and super-regional banks. By providing our customers with personalized service and a big bank product suite, we expect to continue our strong growth.
	•		Expand franchise in high growth markets.     We will actively consider both acquisitions and de novo financial center opportunities in existing and new market areas. During 2007, we have acquired The Bank of Richmond, N.A., and opened three new de novo financial centers (two in Raleigh, North Carolina, and our first financial center in Wilmington, North Carolina). We are focused on markets in central and eastern Virginia and central and eastern North Carolina that possess favorable growth characteristics and in which we have identified experienced bankers to help execute our strategy. For example, we intend to open our next financial centers in Chapel Hill and Wake Forest, North Carolina, and Charlottesville and Lynchburg, Virginia.
	•		Grow insurance agency through acquisitions.     Our independent insurance agency was created through the acquisition and integration of three independent insurance agencies. During 2007, we successfully

			integrated the acquisitions of two insurance agencies we acquired in the fourth quarter of 2006, and acquired, as a separate subsidiary, a mortgage insurance and real estate settlement agency in the Greater Hampton Roads area of Virginia. We will actively consider acquisitions in both our existing market areas and in other growing markets in eastern and central Virginia and eastern and central North Carolina that have favorable market demographics for our insurance agency subsidiary.
	•		Grow non-interest income through mortgage subsidiary.     We operate our own mortgage subsidiary. We intend to actively seek mortgage originations in both our existing market areas and in other growing markets in eastern and central Virginia and eastern and central North Carolina.
	•		Improve our core profitability. We believe as we grow our franchise that we will be able to take advantage of the economies of scale typically enjoyed by larger organizations. We believe the investments we have made in the expansion of our financial center network and technology infrastructure are sufficient to support a much larger organization, and therefore believe increases in our expense base going forward should be lower than our proportional increase in assets and revenues.
	•		Continue our disciplined execution.   We believe our success as a banking organization depends on a disciplined approach to originating loans and monitoring the performance of our loan portfolio. Despite our growth, we have consistently maintained strong asset quality. We believe our strong asset quality is the result of conservative underwriting standards, experienced loan officers and the strength of the local economies in which we operate.

Competition

Our subsidiary bank faces considerable competition in its market areas for deposits and loans from other depository institutions. Many of the bank’s depository institution competitors have substantially greater resources, broader geographic markets, and higher lending limits than the bank and are also able to provide more services and make greater use of media advertising. In recent years, intense market demands, economic pressures, and increased customer awareness of products and services, and the availability of electronic services have forced banks to diversify their services and become more cost-effective. Also, with the elimination of restrictions on interstate banking, our bank may be required to compete with out-of-state financial institutions that are not presently in its market area. Our bank presently faces strong competition in attracting and retaining deposits and loans. Based upon FDIC data as of June 30, 2007, in the Greater Hampton Roads Metropolitan Statistical Area, there were 376 financial centers operated by 32 banking institutions with approximately $18.4 billion in deposits. Our bank’s total deposits were approximately $496.3 million in the Hampton Roads market and $641.2 in the adjacent Northeastern North Carolina markets on that date. Based upon FDIC data as of June 30, 2007, in the Raleigh-Cary Metropolitan Statistical Area, there were 276 financial centers operated by 32 banking institutions with approximately $15.6 billion in deposits. The bank had almost $75.7 million in deposits in Raleigh on that date. On that date, FDIC data indicated that the Richmond area market had 374 financial centers operated by 38 banking institutions with over $34.8 billion in deposits and the bank had almost $208.4 million in deposits in the Richmond area on that date.

The bank also competes with credit unions, brokerage firms, insurance companies, money market mutual funds, consumer finance companies, mortgage companies and other financial companies, some of which are not subject to the same degree of regulation and restrictions as the bank in attracting deposits and making loans. Interest rates on deposit accounts, convenience of facilities, products and services, and marketing are all significant factors in the competition for deposits. Competition for loans comes from other commercial banks, savings institutions, insurance companies, consumer finance companies, credit unions, mortgage banking firms and other institutional lenders. We primarily compete for loan originations through our handling of loans and the overall quality of service. Competition is affected by the availability of lendable funds, general and local economic conditions, interest rates, and other factors that are not readily predictable.

We expect competition will continue in the future due to statewide financial center laws and the entry of additional bank and nonbank competitors in our markets.

Other Products and Services

Other Banking Products and Services.

To enable our bank to offer more personalized service to its customers, we offer a range of products and services, including 24-hour internet banking, direct deposit, travelers’ checks, safe deposit boxes, United States savings bonds and automatic account transfers. We earn fees for most of these services. We also receive ATM transaction fees

from transactions performed by our customers participating in a shared network of automated teller machines and a debit card system that our customers can use throughout our market areas and in other states.

Other Financial Services.

Through its subsidiary, Gateway Investment Services, Inc., our bank uses a networking arrangement to make available securities brokerage products to its customers. We also offer property, casualty, life and health insurance products to businesses and individuals through our bank’s insurance subsidiary, Gateway Insurance Services, Inc. Gateway Insurance Services is an independent insurance agency that does not engage in insurance underwriting. It has offices in Edenton, Hertford, Elizabeth City, Moyock, Plymouth and Kitty Hawk, North Carolina, and Chesapeake and Newport News, Virginia. The bank’s subsidiary, Gateway Title Agency, Inc., engages in title insurance and settlement services for real estate transactions and its mortgage banking subsidiary, Gateway Bank Mortgage, Inc., offers our customers a range of mortgage products that are sold on the secondary market.

Employees

The Company had 420 full-time equivalent employees at December 31, 2007. None of the Company’s employees are covered by a collective bargaining agreement. The Company considers its relations with its employees to be good.

SUPERVISION AND REGULATION

Banking is a complex, highly regulated industry. The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. The descriptions of and references to the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

Gateway Financial Holdings, Inc.

We are a bank holding company that has elected to be treated as a financial holding company. As a bank holding company under the Bank Holding Company Act of 1956, as amended, we are registered with and subject to regulation by the Federal Reserve. We are required to file annual and other reports with, and furnish information to, the Federal Reserve. The Federal Reserve conducts periodic examinations of us and may examine any of our subsidiaries, including the bank.

The Bank Holding Company Act provides that a bank holding company must obtain the prior approval of the Federal Reserve for the acquisition of more than five percent of the voting stock or substantially all the assets of any bank or bank holding company. In addition, the Bank Holding Company Act restricts the extension of credit to any bank holding company by its subsidiary bank. The Bank Holding Company Act also provides that, with certain exceptions, a bank holding company may not engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries or own or control more than five percent of the voting shares of any company that is not a bank. The Federal Reserve has deemed limited activities to be closely related to banking and therefore permissible for a bank holding company.

Subject to various limitations, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 permits a bank holding company to elect to become a “financial holding company.” A financial holding company greatly expands the scope of activities in which a bank holding company may engage by allowing it to affiliate with securities firms and insurance companies and engage in other activities that are “financial in nature.” Among the activities that are deemed “financial in nature” are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, certain merchant banking activities, as well as activities that the Federal Reserve considers to be closely related to banking.

A bank holding company may become a financial holding company under the Modernization Act if each of its subsidiary banks is “well-capitalized” under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community

Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities.

Under the Modernization Act, the Federal Reserve serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Modernization Act also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial institutions.

Enforcement Authority . We will be required to obtain the approval of the Federal Reserve prior to engaging in or, with certain exceptions, acquiring control of more than 5% of the voting shares of a company engaged in, any new activity. Prior to granting such approval, the Federal Reserve must weigh the expected benefits of any such new activity to the public (such as greater convenience, increased competition, or gains in efficiency) against the risk of
possible adverse effects of such activity (such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices). The Federal Reserve has cease-and-desist powers over bank holding companies and their nonbanking subsidiaries where their actions would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. The Federal Reserve also has authority to regulate debt obligations (other than commercial paper) issued by bank holding companies. This authority includes the power to impose interest ceilings and reserve requirements on such debt obligations. A bank holding company and its subsidiaries are also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

Interstate Acquisitions . Federal banking law generally provides that a bank holding company may acquire or establish banks in any state of the United States, subject to certain aging and deposit concentration limits. In addition, North Carolina banking laws permit a bank holding company which owns stock of a bank located outside North Carolina to acquire a bank or bank holding company located in North Carolina. Federal banking law will not permit a bank holding company to own or control banks in North Carolina if the acquisition would exceed 20% of the total deposits of all federally-insured deposits in North Carolina.

Capital Adequacy . The Federal Reserve has promulgated capital adequacy regulations for all bank holding companies with assets in excess of $150 million. The Federal Reserve’s capital adequacy regulations are based upon a risk-based capital determination, whereby a bank holding company’s capital adequacy is determined in light of the risk, both on- and off-balance sheet, contained in the company’s assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value.

The regulations divide capital between Tier 1 capital (core capital) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, noncumulative perpetual preferred stock, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt. Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1 component must comprise at least 50% of qualifying total capital.

Every bank holding company has to achieve and maintain a minimum Tier 1 capital ratio of at least 4.0% and a minimum total capital ratio of at least 8.0%. In addition, banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital to average total consolidated assets (leverage capital ratio) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies and a minimum leverage ratio of at least 4.0% for all other banks. The Federal Deposit Insurance Corporation and the Federal Reserve define Tier 1 capital for banks in the same manner for both the leverage ratio and the risk-based capital ratio. However, the Federal Reserve defines Tier 1 capital for bank holding companies in a slightly different manner. As of December 31, 2007, our Tier 1 leverage capital ratio and total capital were 9.76% and 11.40%, respectively.

The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory level, without significant reliance on intangible assets. The guidelines also indicate that the Federal Reserve will continue to consider a “Tangible Tier 1 Leverage Ratio” in evaluating proposals for expansion or new activities. The Tangible Tier 1

Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total assets. As of December 31, 2007, the Federal Reserve had not advised us of any specific minimum Tangible Tier 1 Leverage Ratio applicable to us.

Source of Strength for Subsidiary. Bank holding companies are required to serve as a source of financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required to guarantee the subsidiaries’ compliance with capital restoration plans filed with their bank regulators, subject to certain limits.

Dividends. As a holding company that does not, as an entity, currently engage in separate business activities of a material nature, our ability to pay cash dividends depends upon the cash dividends received from our subsidiary bank and management fees paid by the bank. We must pay our operating expenses from funds we receive from the bank. Therefore, shareholders may receive cash dividends from us only to the extent that funds are available after payment of operating expenses. In addition, the Federal Reserve generally prohibits bank holding companies from paying cash dividends except out of operating earnings, provided that the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. As a North Carolina corporation, our payment of cash dividends is subject to the restrictions under North Carolina law on the declaration of cash dividends. Under such provisions, cash dividends may not be paid if a corporation will not be able to pay its debts as they become due in the usual course of business after paying such a cash dividend or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed to satisfy certain liquidation preferential rights.

Change of Control. State and federal banking law restricts the amount of voting stock of a bank that a person may acquire without the prior approval of banking regulators. The Bank Holding Company Act requires that a bank holding company obtain the approval of the Federal Reserve before it may merge with a bank holding company, acquire a subsidiary bank, acquire substantially all of the assets of any bank, or before it may acquire ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of that bank or bank holding company. The overall effect of such laws is to make it more difficult to acquire our company by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, our shareholders may be less likely to benefit from rapid increases in stock prices that often result from tender offers or similar efforts to acquire control of other types of companies.

Gateway Bank & Trust Co.

The bank is subject to various requirements and restrictions under the laws of the United States and the State of North Carolina. As a North Carolina bank, the bank is subject to regulation, supervision and regular examination by the North Carolina Banking Commission. As a member of the Federal Reserve, the bank is subject to regulation, supervision and regular examination by the Federal Reserve. The North Carolina Banking Commission and the Federal Reserve have the power to enforce compliance with applicable banking statutes and regulations. These requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the bank.

Transactions with Affiliates . The bank may not engage in specified transactions (including, for example, loans) with its affiliates unless the terms and conditions of those transactions are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions with or involving other nonaffiliated entities. In the absence of comparable transactions, any transaction between the bank and its affiliates must be on terms and under circumstances, including credit standards, which in good faith would be offered or would apply to nonaffiliated companies. In addition, transactions referred to as “covered transactions” between the Bank and its affiliates may not exceed 10% of the bank’s capital and surplus per affiliate and an aggregate of 20% of its capital and surplus for covered transactions with all affiliates. Certain transactions with affiliates, such as loans, also must be secured by collateral of specific types and amounts. The bank also is prohibited from purchasing low-quality assets from an affiliate. Every company under common control with the bank, including our company, is deemed to be an affiliate of the bank.

Loans to Insiders . Federal law also constrains the types and amounts of loans that the bank may make to its executive officers, directors and principal shareholders. Among other things, these loans are limited in amount, must be approved by the bank’s board of directors in advance, and must be on terms and conditions as favorable to the bank as those available to an unrelated person.

Regulation of Lending Activities . Loans made by the bank are also subject to numerous federal and state laws and regulations, including the Truth-In-Lending Act, Federal Consumer Credit Protection Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate mortgage disclosure requirements. Remedies to the borrower or consumer and penalties to the bank are provided if the bank fails to comply with these laws and regulations. The scope and requirements of these laws and regulations have expanded significantly in recent years.

Financial Centers . All banks located in North Carolina are authorized to financial center statewide. Accordingly, a bank located anywhere in North Carolina has the ability, subject to regulatory approval, to establish financial center facilities near any of our facilities and within our market area. If other banks were to establish financial center facilities near our facilities, it is uncertain whether these financial center facilities would have a material adverse effect on our business.

Federal law provides for nationwide interstate banking, and subject to certain aging and deposit concentration limits that may be imposed under applicable state laws. Applicable North Carolina statutes permit regulatory authorities to approve de novo financial center in North Carolina by institutions located in states that would permit North Carolina institutions to financial center on a de novo basis into those states. Federal regulations prohibit an out-of-state bank from using interstate financial center authority primarily for the purpose of deposit production. These regulations include guidelines to insure that interstate financial centers operated by an out-of-state bank in a host state are reasonably helping to meet the credit needs of the host state communities served by the out-of-state bank.

Pursuant to a regulatory agreement between the state banking regulatory authorities in North Carolina and Virginia, we are permitted to open and operate financial centers in Virginia. The Virginia banking regulator has the opportunity to comment on our operations in Virginia, but the bank’s Virginia operations are subject to regulation, supervision and regular examination by the North Carolina Commissioner of Banks.

Reserve Requirements. Pursuant to regulations of the Federal Reserve, the bank must maintain average daily reserves against its transaction accounts. During 2007, no reserves were required to be maintained on the first $8.5 million of transaction accounts, but reserves equal to 3.0% were required on the aggregate balances of those accounts between $8.5 million and $45.8 million, and additional reserves were required on aggregate balances in excess of $45.8 million in an amount equal to 10.0% of the excess. These percentages are subject to annual adjustment by the Federal Reserve, which has advised that for 2008, no reserves will be required to be maintained on the first $9.3 million of transaction accounts, but reserves equal to 3.0% will be required on the aggregate balances of those accounts between $9.3 million and $43.9 million, and additional reserves are required on aggregate balances in excess of $43.9 million in an amount equal to 10.0% of the excess. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets. As of December 31, 2007, the bank met its reserve requirements.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the federal bank regulatory agencies, in connection with their examination of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. The bank received a “satisfactory” rating in its most recent CRA examination.

Governmental Monetary Policies . The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowings, control of borrowings, open market transactions in United States government securities, the imposition of and changes in reserve requirements against member banks and deposits and assets of foreign financial centers, and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the monetary policies available to the Federal Reserve. Those monetary policies influence to a significant extent the overall growth of all bank loans, investments and deposits and the interest rates charged on loans or paid on time and savings deposits in order to mitigate recessionary and inflationary pressures. These

techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid for deposits.

The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the bank.

Dividends . All dividends paid by the bank are paid to our company, the sole shareholder of the bank. The general dividend policy of the bank is to pay dividends at levels consistent with maintaining liquidity and preserving applicable capital ratios and servicing obligations. The payment of dividends is subject to the discretion of the board of directors of the bank and will depend upon such factors as future earnings, financial condition, cash needs, capital adequacy, compliance with applicable statutory and regulatory requirements and general business conditions.

The ability of the bank to pay dividends is restricted under applicable law and regulations. Under North Carolina banking law, dividends must be paid out of retained earnings and no cash dividends may be paid if payment of the dividend would cause the bank’s surplus to be less than 50% of its paid-in capital. Also, under federal banking law, no cash dividend may be paid if the bank is undercapitalized or insolvent or if payment of the cash dividend would render the bank undercapitalized or insolvent, and no cash dividend may be paid by the bank if it is in default of any deposit insurance assessment due to the Federal Deposit Insurance Corporation.

The exact amount of future dividends on the stock of the bank will be a function of the profitability of the bank in general and applicable tax rates in effect from year to year. The bank’s ability to pay dividends in the future will directly depend on its future profitability, which cannot be accurately estimated or assured.

Capital Adequacy . The capital adequacy regulations which apply to state banks, such as the bank, are similar to the Federal Reserve requirements promulgated with respect to bank holding companies discussed above.

Changes in Management . Any depository institution that has been chartered less than two years, is not in compliance with the minimum capital requirements of its primary federal banking regulator, or is otherwise in a troubled condition must notify its primary federal banking regulator of the proposed addition of any person to the board of directors or the employment of any person as a senior executive officer of the institution at least 30 days before such addition or employment becomes effective. During this 30-day period, the applicable federal banking regulatory agency may disapprove of the addition of such director or employment of such officer. The bank is not subject to any such requirements.

Enforcement Authority . The federal banking laws also contain civil and criminal penalties available for use by the appropriate regulatory agency against certain “institution-affiliated parties” primarily including management, employees and agents of a financial institution, as well as independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs and who caused or are likely to cause more than minimum financial loss to or a significant adverse affect on the institution, who knowingly or recklessly violate a law or regulation, breach a fiduciary duty or engage in unsafe or unsound practices. These practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. These laws authorize the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets or take other action as determined by the primary federal banking agency to be appropriate.

Prompt Corrective Action . Banks are subject to restrictions on their activities depending on their level of capital. Federal “prompt corrective action” regulations divide banks into five different categories, depending on their level of capital. Under these regulations, a bank is deemed to be “well-capitalized” if it has a total risk-based capital ratio of 10% or more, a core capital ratio of six percent or more and a leverage ratio of five percent or more, and if the bank is not subject to an order or capital directive to meet and maintain a certain capital level. Under these regulations, a bank is deemed to be “adequately capitalized” if it has a total risk-based capital ratio of eight percent or more, a core capital ratio of four percent or more and a leverage ratio of four percent or more (unless it receives the highest composite rating at its most recent examination and is not experiencing or anticipating significant growth, in which instance it must maintain a leverage ratio of three percent or more). Under these regulations, a bank is deemed to be “undercapitalized” if it has a total risk-based capital ratio of less than eight percent, a core capital ratio of less than four percent or a leverage ratio of less than three percent. Under these regulations, a bank is

deemed to be “significantly undercapitalized” if it has a risk-based capital ratio of less than six percent, a core capital ratio of less than three percent and a leverage ratio of less than three percent. Under such regulations, a bank is deemed to be “critically undercapitalized” if it has a leverage ratio of less than or equal to two percent. In addition, the applicable federal banking agency has the ability to downgrade a bank’s classification (but not to “critically undercapitalized”) based on other considerations even if the bank meets the capital guidelines. If a state member bank, such as the Bank, is classified as undercapitalized, the bank is required to submit a capital restoration plan to the Federal Reserve. An undercapitalized bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new financial center office, except under certain circumstances, including the acceptance by the Federal Reserve of a capital restoration plan for that bank.

If a state member bank is classified as undercapitalized, the Federal Reserve may take certain actions to correct the capital position of the bank. If a state member bank is classified as significantly undercapitalized, the Federal Reserve would be required to take one or more prompt corrective actions. These actions would include, among other things, requiring sales of new securities to bolster capital, changes in management, limits on interest rates paid, prohibitions on transactions with affiliates, termination of certain risky activities and restrictions on compensation paid to executive officers. If a bank is classified as critically undercapitalized, the bank must be placed into conservatorship or receivership within 90 days, unless the Federal Deposit Insurance Corporation determines otherwise.

The capital classification of a bank affects the frequency of examinations of the bank and impacts the ability of the bank to engage in certain activities and affects the deposit insurance premiums paid by the bank. The Federal Reserve is required to conduct a full-scope, on-site examination of every member bank at least once every twelve months.

Banks also may be restricted in their ability to accept brokered deposits, depending on their capital classification. “Well-capitalized” banks are permitted to accept brokered deposits, but all banks that are not well-capitalized are not permitted to accept such deposits. The Federal Reserve may, on a case-by-case basis, permit member banks that are adequately capitalized to accept brokered deposits if the Federal Reserve determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank.

Deposit Insurance. The bank’s deposits are insured up to $100,000 per insured non-IRA account and up to $250,000 per IRA account by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. The bank is required to pay deposit insurance assessments set by the FDIC. The FDIC determines the Bank’s deposit insurance assessment rates on the basis of four risk categories. The bank’s assessment will range from 0.02 to 0.04% at the lowest assessment category up to a maximum assessment of 0.40% of the bank’s average deposit base, with the exact assessment determined by the bank’s assets, its capital and the FDIC’s supervisory opinion of its operations. The insurance assessment rate may change periodically and was significantly increased for all depository institutions during 2007. Increases in the assessment rate may have an adverse effect on the bank’s operating results. The FDIC has the authority to terminate deposit insurance.

Future legislation and regulations.

Our management and the bank’s management cannot predict what other legislation might be enacted or what other regulations might be adopted or the effects thereof. Any change in applicable law or regulation, state or federal, may have a material adverse effect on their business.

Our business strategy includes the continuation of significant growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

     We intend to continue pursuing a significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. We cannot assure you we will be able to expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.

Our business is subject to the success of the local economies where we operate.

     Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our primary and secondary markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Adverse economic conditions in our specific market area could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

     Any adverse market or economic conditions in Virginia and North Carolina may disproportionately increase the risk that our borrowers will be unable to make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in Virginia and North Carolina could adversely affect the value of our assets, our revenues, results of operations and financial condition.

We may face risks with respect to future expansion.

     As a strategy, we have sought to increase the size of our franchise by aggressively pursuing business development opportunities, and we have grown rapidly since our incorporation. We have purchased a number of banking offices of other financial institutions as a part of that strategy and have acquired a number of insurance agencies. We may acquire other financial institutions and insurance agencies or parts of those entities in the future. Acquisitions and mergers involve a number of risks, including:

	•		the time and costs associated with identifying and evaluating potential acquisitions and merger partners;
	•		the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target entity may not be accurate;
	•		the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
	•		our ability to finance an acquisition and possible ownership and economic dilution to our current shareholders and to investors purchasing common stock in this offering;
	•		the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses;
	•		entry into new markets where we lack experience;
	•		the introduction of new products and services into our business;
	•		the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; and
	•		the risk of loss of key employees and customers.

     We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There can be no assurance integration efforts for any future mergers or acquisitions will be successful. Also, we may issue equity securities, including common stock, and securities convertible into shares of our common stock in connection with future acquisitions, which could cause ownership and economic dilution to our current shareholders. There is no assurance that, following any future mergers or acquisition, our integration efforts will be successful or our company, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.

If the value of real estate in our core market areas were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.

     With most of our loans concentrated in the Richmond and Greater Metropolitan Hampton Roads areas of Virginia and the coastal and eastern Piedmont region of North Carolina, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

     In addition to the financial strength and cash flow characteristics of the borrower in each case, the bank often secures loans with real estate collateral. At December 31, 2007, approximately 80% of the bank’s loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

An inadequate allowance for loan losses would reduce our earnings and capital.

     Our loan losses could exceed the allowance for loan losses we have set aside. Our average loan size continues to increase. Reliance on historic loan loss experience may not be indicative of future loan losses. Approximately 78.0% of our loan portfolio is composed of construction, acquisition and development, commercial mortgage and commercial and industrial loans. Repayment of such loans is generally considered more subject to market risk than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless of the underwriting criteria we utilize, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of our loan collateral and problems affecting the credit of our borrowers.

     Management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require the bank to increase the allowance for loan losses as a part of their examination process, the bank’s earnings and capital could be significantly and adversely affected.

A significant part of our loan portfolio is unseasoned.

     Since the beginning of 2006, our loan portfolio has more than doubled in size, growing by approximately $856 million. It is difficult to assess the future performance of this part of our loan portfolio due to the recent origination of these loans. Industry experience shows that it takes several years for loan difficulties to become apparent. We can give no assurance that these loans will not become non-performing or delinquent, which could adversely affect our future performance.

Our reliance on time deposits, including out-of-market certificates of deposit, as a source of funds for loans and our other liquidity needs could have an adverse effect on our operating results.

     Among other sources of funds, we rely heavily on deposits for funds to make loans and provide for our other liquidity needs.  However, our loan demand has exceeded the rate at which we have been able to build core deposits so we have relied heavily on time deposits, including out-of-market certificates of deposit, as a source of funds.  Those deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those time deposits when they mature, or we may have to pay a higher rate of interest to attract or keep them or to replace them with other deposits or with funds from other sources.  Not being able to attract those deposits or to keep or replace them as they mature would adversely affect our liquidity.  Paying higher deposit rates to attract, keep or replace those deposits could have a negative effect on our interest margin and operating results.

The building of market share through our de novo financial center strategy could cause our expenses to increase faster than our revenues.

     We intend to continue to build market share through our de novo financial center strategy. During 2007, we opened two new financial centers in Raleigh, North Carolina and our first financial center in Wilmington, North Carolina. We currently intend to open five additional new financial centers in 2008. There are considerable costs involved in opening financial centers. New financial centers generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, our new financial centers can be expected to negatively impact our earnings for some period of time until the financial centers reach certain economies of scale. Our expenses could be further increased if we encounter delays in the opening of any of our new financial centers. Finally, we have no assurance our new financial centers will be successful even after they have been established.

Our recent results may not be indicative of our future results.

     We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent and rapid growth may distort some of our historical financial ratios and statistics. In the future, we may not have the benefit of several recently favorable factors, such as a generally stable interest rate environment, a strong residential mortgage market, or the ability to find suitable expansion opportunities. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our operating costs being fixed expenses.

We may be adversely affected by interest rate changes.

     Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. Net interest income is the difference between income from interest-earning assets, such as loans, and the expense of interest-bearing liabilities, such as deposits and our borrowings, including our outstanding junior subordinated debentures. We may not be able to effectively manage changes in what we charge as interest on our earning assets and the expense we must pay on interest-bearing liabilities, which may significantly reduce our earnings. The Federal Reserve has made significant reductions in interest rates during the first quarter of 2008. Since rates charged on loans often tend to react to market conditions faster than do rates paid on deposit accounts, these rate changes are expected to have a negative impact on our earnings until we can make appropriate adjustments in our deposit rates. In addition, there are costs associated with our risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of our ability to continue to maintain a consistent positive spread between the interest earned on our earning assets and the interest paid on our interest-bearing liabilities.

Our operations and customers might be affected by the occurrence of a natural disaster or other catastrophic event in our market area.

     Because substantially all of our loans are with customers and businesses located in the central and coastal portions of Virginia and North Carolina, catastrophic events, including natural disasters, such as hurricanes which historically have struck the east coast of the United States with some regularity, or terrorist attacks, could disrupt our operations. Any of these natural disasters or other catastrophic events could have a negative impact on most or all of our offices and customer base, as well as the strength of our loan portfolio. Even though we carry business interruption insurance policies, make contingency plans and typically have provisions in our contracts that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies or for which we do not have coverage. Any natural disaster or catastrophic event affecting us could have a significant negative impact on our operations.

Competition from financial institutions and other financial service providers may adversely affect our profitability.

     The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.

     We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will be successful.

We are subject to extensive regulation that could limit or restrict our activities.

     We are a public company that operates in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal and state agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

     The laws and regulations applicable to public companies and the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank and financial holding companies, our cost of compliance could adversely affect our ability to operate profitably.

Our directors and executive officers own a significant portion of our common stock

     Our directors and executive officers, as a group, beneficially owned approximately 15% of our outstanding common stock as of December 31, 2007 (approximately 21% upon the exercise of outstanding vested options). As a result of their ownership, the directors and executive officers will have the ability, by voting their shares in concert, to significantly influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.

Our continued success is dependent upon the services of our management team.

     Our future success and profitability is substantially dependent upon the management and banking abilities of our senior executives. We believe that our continued growth and future results will depend in part upon our attracting and retaining highly skilled and qualified management and sales and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting or retaining such personnel. We also cannot guarantee that members of our executive management team will remain with us. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.

Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.

     We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. During 2007 we issued $26.2 million of common stock and $25 million in trust preferred securities to acquire The Bank of Richmond, N.A. Additionally, we conducted a private placement of $23.3 million in preferred stock to support our continued growth. We may at some point need to again raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of

our ability to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.

Our future capital needs could result in dilution of your investment.

     Our board of directors may determine from time to time there is a need to obtain additional capital through the issuance of additional shares of our common stock or other securities. These issuances would likely dilute the ownership interests of the investors in this offering and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders.

The trading volume in our common stock is low and the sale of substantial amounts of our common stock in the public market could depress the price of our common stock.

     The average daily trading volume of our shares on The Nasdaq Global Select Market for the three months ended March 10, 2008 was approximately 32,000 shares. Lightly traded stock can be more volatile than stock trading in an active public market. We cannot predict the extent to which an active public market for our common stock will develop or be sustained. During the last half of 2007, the market prices for the securities of many banks and bank holding companies have experienced wide price fluctuations that have not necessarily been related to their operating performance. Therefore, our shareholders may not be able to sell their shares at the volumes, prices, or times that they desire.

     We cannot predict the effect, if any, that future sales of our common stock in the market, or availability of shares of our common stock for sale in the market, will have on the market price of our common stock. We therefore can give no assurance that sales of substantial amounts of our common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our ability to raise capital through sales of our common stock.

Our ability to pay dividends is limited and we may be unable to pay future dividends.

     Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of our bank subsidiary to pay dividends to us is limited by their obligations to maintain sufficient capital and by other general restrictions on their dividends under federal and state bank regulatory requirements. If we do not satisfy these regulatory requirements, we will be unable to pay dividends on our common stock.

Holders of our junior subordinated debentures have rights that are senior to those of our common shareholders.

     We have supported our continued growth through the issuance of trust preferred securities from special purpose trusts and accompanying junior subordinated debentures. At December 31, 2007, we had outstanding trust preferred securities and accompanying junior subordinated debentures totaling $56.1 million. Payments of the principal and interest on the trust preferred securities of this special purpose trust are conditionally guaranteed by us. Further, the accompanying junior subordinated debentures we issued to the special purpose trust are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on our common stock.

Certain provisions under our Articles of Incorporation and applicable law may make it difficult for others to obtain control of our corporation even if such a change in control may be favored by some shareholders.

     Certain provisions in our Articles of Incorporation and applicable North Carolina corporate and banking law may have the effect of discouraging a change of control of GFH even if such a transaction is favored by some of our shareholders and could result in shareholders receiving a substantial premium over the current market price of our shares. The primary purpose of these provisions is to encourage negotiations with our management by persons interested in acquiring control of our corporation. These provisions may also tend to perpetuate present

management and make it difficult for shareholders owning less than a majority of the shares to be able to elect even a single director.

Our securities are not FDIC insured.

     Our common stock is not a savings or deposit account or other obligation of the bank, and is not insured by the Bank Insurance Fund of Federal Deposit Insurance Corporation or any other governmental agency and is subject to investment risk, including the possible loss of principal.

		Approximate Square				Year Established/
Office Location		Footage				Acquired
Virginia Beach - 2098 Princess Anne Rd (3)			2,500				2005
Virginia Beach - 3001 Shore Dr (3)			2,000				2003

The properties we own, including land, buildings and improvements, furniture, equipment and vehicles, had a net book value at December 31, 2007 of $73.6 million. In the opinion of the Company’s management, such properties are adequately covered by insurance, are in good operating condition, ordinary wear and tear excepted, and are adequate and suitable for the ordinary and regular conduct and operation of our business.

Gateway Bank is undercapitalized or insolvent or if payment of the cash dividend would render Gateway Bank undercapitalized or insolvent, and no cash dividend may be paid by Gateway Bank if it is in default of any deposit insurance assessment due to the FDIC. Subject to these restrictions, our Board of Directors will consider the payment of dividends when it is deemed prudent to do so.

The Company’s stock repurchase program, as approved by the Board of Directors on April 30, 2007, provides for the purchase of up to 500,000 shares. There have been 400,637 shares purchased under the 2007 plan during the year ended December 31, 2007.

The following table presents information with respect to shares of common stock repurchased by the Company during the forth quarter of 2007

ITEM 6 – SELECTED FINANCIAL DATA

The information presented below is derived in part from the audited consolidated financial statements and notes thereto of the Company. This information presented below does not purport to be complete and should be read in conjunction with the Company’s consolidated financial statements appearing elsewhere in this annual report.

		For the Years Ended December 31,
		2007				2006				2005				2004				2003
		(Dollars in thousands, except per share data)
Asset Quality Ratios:
Nonperforming loans to period-end loans			0.22	%			0.33	%			0.03	%			0.13	%			0.52	%
Allowance for loan losses to period-end loans			1.01	%			0.95	%			0.94	%			1.09	%			1.19	%
Allowance for loan losses to nonperforming loans			450.22	%			287.70	%			3079.90	%			849.59	%			228.02	%
Nonperforming assets to total assets (5)			0.21	%			0.27	%			0.02	%			0.09	%			0.38	%
Net loan charge-offs to average loans outstanding			0.09	%			0.04	%			0.02	%			0.01	%			0.11	%
Capital Ratios: (6)
Total risk-based capital			11.40	%			12.99	%			15.17	%			17.40	%			12.68	%
Tier 1 risk-based capital			10.43	%			12.11	%			14.31	%			16.41	%			11.59	%
Leverage ratio			9.76	%			11.38	%			13.73	%			13.89	%			9.33	%
Equity to assets ratio			8.80	%			9.08	%			10.19	%			12.01	%			7.93	%
Other Data:
Number of banking offices			33				24				18				16				10
Number of full time equivalent employees			420				327				247				191				123

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 regulations; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services.

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of Gateway Financial Holdings, Inc. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this annual report and the supplemental financial data appearing throughout this discussion and analysis. On April 25, 2006 the Company’s Board of Directors declared an 11– for-10 stock split effected in the form of a 10% stock dividend, which was distributed May 15, 2006 to stockholders of record on April 28, 2006. On May 16, 2005 the Company’s Board of Directors declared an 11– for-10 stock split effected in the form of a 10% stock dividend, which was distributed June 20, 2005 to stockholders of record on May 30, 2005. All references in this discussion and analysis to per share results and weighted average shares outstanding have been adjusted to reflect the effects of these stock splits.

OVERVIEW

Gateway Financial Holdings, Inc. is a financial holding company incorporated under the laws of North Carolina to serve as the holding company for Gateway Bank & Trust Co., a North Carolina chartered commercial bank. The bank began operations on December 1, 1998 and, effective October 1, 2001, became our wholly owned subsidiary.

Since inception, we have aggressively pursued the primary objective of building a full-service commercial banking operation, while effectively supplementing our banking activities with other financial services intended to generate significant non-interest income. Accordingly, a key component of our growth strategy has been expanding our franchise through the opening of newly constructed financial centers and strategic financial center acquisitions. We have grown into a regional community bank with a total of thirty-three full-service financial centers — nineteen in Virginia: Virginia Beach (7), Richmond (6), Chesapeake (3), Suffolk, Norfolk and Emporia; and fourteen in North Carolina: Elizabeth City (3), Edenton, Kitty Hawk (2), Raleigh (3), Moyock, Nags Head, Plymouth, Roper, and Wilmington. We acquired The Bank of Richmond, N.A., effective June 1, 2007, and operate the six financial centers in the Richmond metropolitan area and one loan production office in Charlottesville, Virginia, under the assumed name “The Bank of Richmond.” Consistent with our long-range strategic objectives, we will continue to consider acquisition opportunities including whole bank or financial center locations. We will also continue to explore de novo financial center opportunities in markets that we consider attractive. We currently intend to open five additional new financial centers in 2008, including our first financial centers in Chapel Hill and Wake Forest, North Carolina, and Charlottesville and Lynchburg, Virginia, as well as our second office in Emporia, Virginia

The bank has four wholly-owned operating subsidiaries, which have contributed to our market presence. Gateway Insurance Services, Inc., an insurance agency with offices in Edenton, Hertford, Elizabeth City, Plymouth, Moyock and Kitty Hawk, North Carolina, and the Hampton Roads area of Virginia, sells insurance products to businesses and individuals. Gateway Investment Services, Inc., assists Bank customers in their securities brokerage activities through an arrangement with an unaffiliated broker-dealer. As prescribed by this arrangement, Gateway Investment Services earns revenue through a commission sharing arrangement with the unaffiliated broker-dealer. Gateway Bank Mortgage, Inc., provides mortgage banking services with products that are sold on the secondary market. Gateway Title Agency, Inc., engages in title insurance and settlement services for real estate transactions. In an ongoing effort to create significant sources of non-interest income, we will continue to look for ways to expand non-traditional banking activities in our insurance and investment services subsidiaries.

Since inception, we have concentrated our efforts on building a franchise and infrastructure that can deliver and sustain long-term profitability. We have been profitable for twenty-four consecutive quarters, producing net income of $3.9 million in 2005, $5.3 million in 2006, and $11.0 million during the year ended December 31, 2007. While we anticipate continued profitability, future expansion activity can be expected to generate significant additional costs that can negatively impact earnings as we pursue our growth strategies.

In addition to our banking activities, the Bank has focused on insurance, mortgage and brokerage services to develop sustainable and growth-oriented sources of non-interest income. In the fourth quarter of 2006 Gateway Insurance Services acquired two agencies in Virginia (The Insurance Center and C D West & Company) opening the door for further expansion in the Hampton Roads area of Virginia. In February 2007, The Bank acquired Gateway Title Agency, Inc., which engages in title insurance and settlement services for real estate transactions. In addition, the Bank organized Gateway Investment Services in September 1999 to assist customers in their securities brokerage activities through a networking arrangement with an unaffiliated broker-dealer. Through this arrangement, Gateway

Investment Services earns revenues through commission sharing from the unaffiliated broker-dealer. In June 2006 we opened our wholly owned mortgage origination company in Raleigh, North Carolina with offices also in Elizabeth City, and Kitty Hawk, North Carolina and offices in Norfolk and Virginia Beach, Virginia. The Bank will continue to look for ways to expand non-traditional banking activities in its insurance subsidiary and securities networking arrangement, which create significant sources of non-interest income.

FINANCIAL CONDITION
December 31, 2007 and 2006

The Company continued its pattern of steady growth during 2007, with total assets increasing by $660.7 million, or 54.7%, to $1.87 billion at December 31, 2007 from $1.2 billion at December 31, 2006. This growth was principally driven by increased loans from our franchise expansion, the completion of our acquisition of The Bank of Richmond on June 1, 2007, the purchase of investment securities used primarily for balance sheet management and liquidity purposes, and the purchase of premises and equipment associated with the opening of three de novo financial centers during the second half of 2007, including a regional headquarters building in Raleigh, North Carolina. Assets acquired through the acquisition of The Bank of Richmond aggregated $235.7 million, including $36.7 million of goodwill. Total loans increased by $527.8 million, or 53.1%, from $994.6 million at December 31, 2006 to $1.5 billion at December 31, 2007. Of this increase, $168.0 million was related to loans from the acquisition of The Bank of Richmond. Therefore, organic loan growth for 2007 aggregated $359.8 million or 36.2%. This increase was attributed to the seasoning of our financial centers and our private banking center during the year and the steady economies of the markets in which we operate. The increases in loans were comprised principally of increases of $222.5 million, $124.4 million, and $92.1 million of construction, acquisition and development, commercial and industrial, and commercial real estate loans, respectively – areas of lending that the Company targets. This growth was concentrated mainly in the Raleigh and Wilmington North Carolina and Richmond and greater Hampton Roads areas of Virginia. As of December 31, 2007, 78.0% of our loan portfolio was represented by commercial, industrial, real estate, and construction and acquisition and development loans. The Company has maintained liquidity at what it believes to be an appropriate level. Liquid assets, consisting of cash and due from banks, interest-earning deposits in other banks and trading and investment securities available for sale, were $170.4 million, or 9.1% of total assets, at December 31, 2007 as compared to $120.3 million, or 10.0% of total assets at December 31, 2006.

Funding for the growth in assets and loans was provided by an increase in deposits of $485.2 million to $1.4 billion, and an increase in total borrowings of $115.2 million. Of the increase in deposits, $177.6 million was related to deposits from the acquisition of The Bank of Richmond. Therefore, non-acquisition related deposits grew $307.6 million or 33.3%, from $923.7 million at December 31, 2006. Non-interest-bearing demand deposits increased by 14.7% or $15.9 million to $123.9 million from the $108.0 million balance at December 31, 2006. Savings, money market and NOW accounts increased by 49.8% or $133.9 million to $402.5 million, from the $268.7 million balance at December 31, 2006. These increases resulted from the maturing of our branch network, especially those financial centers opened during the last half of the year in Wilmington and Raleigh, North Carolina. Additionally, we introduced a new “Platinum” money market account during the second quarter of 2007, and an U-sweep and Clear Advantage NOW account during the fourth quarter of 2007 that has been very successful, as well as, our low cost business checking and sweep account programs. Time deposits totaled $882.5 million at December 31, 2007 as compared to $547.1 million at December 31, 2006. This increase of $335.5 million was driven primarily by retail CDs special offerings that are very competitive in our market place, an increase in brokered CDs of $130.7 million, and CD’s related to the acquisition of The Bank of Richmond of $125.8 million. Time deposits of more than $100,000 were $271.3 million, or 19.3% of total deposits at December 31, 2007 as compared with $205.5 million, or 22.2% of total deposits at December 31, 2006. The Company continued using brokered deposits to fund growth. The total brokered time deposits increased to $225.9 million as of December 31, 2007 compared to $95.2 million at December 31, 2006. As a percentage of total deposits, our brokered deposits increased to 16.0% of total deposits as compared to 10.3% at December 31, 2006. Brokered deposits were used primarily to fund loan growth in our loan production offices in Wilmington, Greenville and Chapel Hill, North Carolina, and Charlottesville, Virginia; and our private banking center in Raleigh. Loans for these offices aggregated $429.3 million as of December 31, 2007, an increase of $248.4 million during 2007. As of December 31, 2007 we had $282.1 million in total borrowings outstanding, as compared with $166.9 million outstanding at December 31, 2006. The Company issued an additional $25.7 million of junior subordinated debentures (commonly referred to as trust preferred securities) during the second quarter of 2007 which was used to fund the cash portion of the consideration for The Bank of Richmond acquisition. Additionally, the Company borrowed an additional $58 million from the Federal Home Loan Bank of Atlanta during 2007 that supported our loan and franchise growth not covered by deposit growth. These advances were primarily five year convertible advances with call provisions that provided a lower cost of funding.

Total stockholders’ equity increased by $54.8 million to $164.4 million from December 31, 2006, primarily as a result of issuing approximately 1.85 million shares of Company stock to fund the stock portion of the consideration to acquire The Bank of Richmond, the issuance of $23.2 million of non-cumulative perpetual preferred stock in a private placement in December 2007, and net income of $11.0 million; offset by cash dividends of $3.5 million during the year, and the repurchase and retirement of $5.6 million of its common stock. The capital ratios of the Company and the Bank continue to be in excess of the minimums required to be deemed well-capitalized by regulatory authorities.

NET INTEREST INCOME

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2007, 2006 and 2005, average interest-earning assets were $1.4 billion, $956.8 million and $611.1 million, respectively. During these same years, the Company’s net interest margins were 3.49%, 3.87% and 3.81%, respectively.

Average Balances and Average Rates Earned and Paid. The following table sets forth, for the periods indicated, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or costs, net interest income, net interest spread, net interest margin, and ratio of average interest-earning assets to average interest-bearing liabilities. In preparing the table, nonaccrual loans are included in the average loan balance.

RATE/VOLUME ANALYSIS

     The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.

faced during the last half of the year, which saw credit spreads on these types of securities widen significantly. It would not be anticipated that the Company would experience a fair value gain of this magnitude in the future, and in all likelihood would show a fair value loss if credit market conditions become more normalized.

The Company’s primary focus (banking, mortgage loan origination, insurance, and investment services) continues to grow with de novo development of its branch network and subsidiary operations, and the completed acquisition of The Bank of Richmond on June 1, 2007. The acquisition and the opening of three de novo financial centers during the last half of the year (two in Raleigh, North Carolina and our first full financial center in Wilmington, North Carolina) increased our total financial centers to 33, along with a private banking center in Raleigh and four loan production offices. Our franchise has generated consistently high levels of net interest income and non-interest income since inception. During the year ended December 31, 2007, total revenue (defined as net interest income and non-interest income) increased $20.6 million or 44.5% to $66.9 million over the prior year. The significant increase in revenues was the primary reason for the increase in net income, partially offset by increases in non-interest expenses, loan loss provision, and income taxes. The Company has incurred additional non-interest expenses as a result of the franchise growth from period to period, increased FDIC insurance costs, higher franchise tax costs, and the acquisition of The Bank of Richmond (which increased non-interest expenses by approximately $2.4 million for the year ended December 31, 2007).

Net Interest Income. Total interest income increased to $109.6 million for the year ended December 31, 2007, a $36.5 million or 49.9% increase from the $73.1 million earned in 2006. Total interest income benefited from a 46.9% increase in average earning assets, driven primarily from a $427 million or 51.1% growth in average loans as compared with the prior year. The average yield on interest-earning assets increased 15 basis points from 7.64% to 7.79% due to restructuring the investment portfolio during the second quarter of this year, which increased the investment yield from 4.59% for the prior year to 5.22% for the year ended December 31, 2007. The yield on loans was flat year over year at 8.08%. However, loan yields in the fourth quarter of 2007 decreased to 7.93% from 8.20% for the fourth quarter of last year as a result of the 100 basis points cut in interest rate during the last four months of 2007. The current trend with interest rates is for them to continue to fall during the first part of 2008 with uncertainty as to which direction interest rates will take later in the year.

Average total interest-bearing liabilities increased by $452.5 million, or 53.8%, for the year ended December 31, 2007 as compared with the prior year, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities increased by 38 basis points over the same time period from 4.29% to 4.67% primarily as a result of several factors including: (1) funding $130.7 million of the growth over the last 12 months (primarily from loan production offices and our private banking center) with wholesale brokered CD’s (which typically have a higher all-in interest rate than bank core deposits); (2) our portfolio of CDs re-pricing upwards during the first half of the year as a result of interest rates continuing to increase due to competition for deposits, and (3) the introduction of a higher cost money market account and CD special during the second quarter of this year. Our costs for CD’s increased from 4.56% in 2006 to 5.07% in 2007, and our interest bearing transaction accounts increased from 3.23% to 3.49%. The rise in the cost of interest-bearing liabilities mitigated somewhat during the fourth quarter, as costs for the fourth quarter only increased 9 basis points as compared with the fourth quarter of last year, primarily as a result of the drop in interest rates — which had an immediate effect or our short-term borrowings, and allowed us to immediately start re-pricing our interest bearing transaction deposit accounts. The cost of our transaction accounts decreased to 3.42% for the fourth quarter of this year as compared with 3.47% for the entire year and 3.43% for the fourth quarter of last year.

As a result of the leveling of loan yields, and the increase in funding costs as discussed above, the interest rate spread decreased 23 basis points from 3.35% for the year ended December 31, 2006 to 3.12% for the current year; and the net interest margin decreased 38 basis points from 3.87% for the year ended December 31, 2006 to 3.49% for 2007. Despite this drop in interest margin during 2007, net interest income increased $12.1 million or 32.7% in the current year over 2006, driven primarily by the increased volume of $427 million higher average loans in 2007 as compared with the prior year.

Provision for Loan Losses. The Company recorded a $4.9 million provision for loan losses for the year ended December 31, 2007, an increase of $1.5 million over the $3.4 million provision for loan losses recorded for the prior year. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. In evaluating the allowance for loan losses, Management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant qualitative factors. In both 2007 and 2006, the provision for loan losses was made principally in response to growth in loans, as well as changes in conditions

related to the above factors. Net charge-offs as a percentage of average loans increased to 0.09% for the year ended December 31, 2007 from 0.04% in the prior year; and the Company’s level of nonperforming assets has increased slightly to $3.4 million at December 31, 2007, however, as a percentage to total loans outstanding, decreased from 0.33% at December 31, 2006 to 0.22% at December 31, 2007. Loan growth for the year ended December 31, 2007 (excluding the loans acquired through the acquisition of The Bank of Richmond) was $359.8 million as compared with $327.9 million for the year ended December 31, 2006. Impaired loans increased from $4.1 million at December 31, 2006 to $15.2 million at December 31, 2007, resulting in an approximate $682,500 increase in the allowance. At December 31, 2007 and December 31, 2006, respectively, the allowance for loan losses was $15.3 million and $9.4 million, representing 1.01% and 0.95%, respectively, of loans outstanding at the end of each period. Other than the nonaccrual loans listed under the caption “Asset Quality,” the Company’s loan portfolio continues to perform very well.

Non-Interest Income. Non-interest income aggregated $17.8 million for the year ended December 31, 2007 as compared with $9.3 million for the year ended December 31, 2007, an increase of $8.5 million or 91.6%. Both years were affected by the fluctuations in the fair value and net cash settlements of the economic hedge. Non-interest income included a gain and net cash settlements of the economic hedge of $584,000 for the year ended December 31, 2007; and a loss and net cash settlements of the economic hedge of $1.9 million for the year ended December 31, 2006. The change in fair value was primarily as a result of fluctuations (both favorable and unfavorable) in LIBOR swap interest rate and market conditions during both years. The Company terminated its position in the economic hedge during the third quarter of 2007, and received a termination fee of $115,000 that was included in the above gain for 2007. Revenues from the Company’s non-banking activities over the past 12 months have continued to increase. Since inception, the Company has actively pursued additional non-interest income sources outside of traditional banking operations, including income from insurance, mortgage, brokerage operations and title insurance. Revenue from Gateway’s insurance operations increased $2.4 million or 81.9% to $5.2 million for the year ended December 31, 2007 as compared with the prior year. The increase in insurance revenues was due primarily to the acquisition of two agencies in Virginia in the fourth quarter of 2006 and a title insurance company during the first quarter of 2007, as well as, internal growth from cross-selling bank customers and building our customer base as our bank franchise has grown. Revenue from the mortgage subsidiary increased $1.4 million or 91.2% in 2007 to $3.0 million over the prior year. The increase in mortgage revenue is attributable to having a full year of operations in 2007 as compared with 2006 in which Gateway Bank Mortgage, Inc. only commenced operations in June. Mortgage revenues in the fourth quarter of the current year decreased 15.4% from the fourth quarter of the prior year attributed primarily to the nationwide issues that affected the mortgage industry during the last half of 2007. Although Gateway Bank Mortgage, Inc. essentially does no sub-prime lending, the limited access to the secondary markets had a negative effect on selling mortgages into the secondary markets, thus slowing revenues during the latter part of the year.

Service charges on deposit accounts increased $644,000 or 19.6% for the year ended December 31, 2007, as compared with the prior year as a result of the Company’s growth in transaction deposit accounts from period to period from its expanding financial center network.

Other income increased $945,000 million for the year ended December 31, 2007 as compared with the prior year primarily as a result of the gain in the fair value of its trust preferred debt securities of $960,000 during 2007. The Company elected the fair value option for certain of its trust preferred securities effective January 1 of this year, to hedge its short-term trading investment portfolio. As a result of the unusual credit conditions the financial industry faced during the last half of the year, the credit spreads on these debt securities widened significantly resulting in the gain. It would not be anticipated that the Company would experience a market value gain of this magnitude in the future, and in all likelihood would show a market value loss if credit market conditions become more normalized.

As a result of Gateway’s continuous efforts to introduce new products and services in order to better service its customers as well as enhance the overall diversification of its revenue base, non-interest income as a percent of total revenue was 26.6% for the year ended December 31, 2007 as compared with 20.0% for the prior year. Proforma non-interest income (non-interest income excluding the effects of the economic hedge on both periods discussed above) as a percent of total revenue was 25.9% for 2007 as compared with 23.7% for the prior year. Due to the volatility and lack of comparability caused by the economic hedge management believes presentation of an unadjusted non-GAAP pro-forma non-interest income and related percent to the revenues provides useful information to investors.

Non-Interest Expenses. Non-interest expenses aggregated $44.9 million for the year ended December 31, 2007, an increase of $10.0 million or 28.5% over the $34.9 million reported for the prior year. Substantially all of this increase resulted from the Bank’s growth and franchise development throughout all of 2006 in which the Bank opened six de novo financial centers, built a state of the art operations center, opened a private banking center, launched a new mortgage subsidiary and made two insurance agency acquisitions; and the opening of three de novo financial centers during the last half of 2007. Additionally, the acquisition of The Bank of Richmond added $2.4

million of non-interest expense during the last seven months of 2007. The acquisition and the significant expansion over the past two years resulted in personnel costs increasing by $7.7 million, or 44.5% to $25.0 million for the year ended December 31, 2007 from $17.3 million for prior year. During the past year the Company had 93 new hires (of which 40 were related to The Bank of Richmond), while the costs of occupancy and equipment costs increased by $1.4 million, or 20.2% to $8.3 million from $6.9 million for the prior year. Other expenses increased $549,000 or 6.0% for the year ended December 31, 2007 as compared with the prior year. The increase was related to approximately $690,000 in higher FDIC premiums that resulted from the FDIC increasing insurance premiums effective January 1 of this year, $204,000 higher franchise taxes that has resulted from the increase in our financial centers in Virginia, and $160,000 higher intangibles amortization that has resulted from acquisitions since the third quarter of last year; offset by lower promotion and consultant expenses.

Provision for Income Taxes. The Company’s effective tax rate was approximately 35.2% and 33.3% for the years ended December 31, 2007 and 2006, respectively. The reason that the effective rate was lower for the year ended December 31, 2006 was due to the effect tax-exempt income from municipal securities and BOLI had on lower pre-tax income for that year. As a result of the Company’s sustained pattern of profitability we expect our tax rate to remain near the level incurred for the current year. Deferred tax assets have increased primarily due to increases in our loan loss provision.

RESULTS OF OPERATIONS
Years Ended December 31, 2006 and 2005

Overview. The Company reported net income of $5.3 million or $.47 per diluted share for the year ended December 31, 2006, as compared with net income of $3.9 million or $.46 per diluted share for 2005, an increase of $1.3 million or 33.8% in net income, and an increase of $.01 or 2.1% in net income per diluted share. The results from operations were negatively affected during the year by the change in fair value of its interest rate swap that was entered into in December 2005 to hedge the interest rate of its variable loan portfolio. The change in the fair value of this economic hedge reduced non-interest income by $1.2 million, and in total the loss and net cash settlement on the economic hedge was $1.9 million for the year. This loss (net of taxes using a 37.5 % blended rate) reduced net income by $1.2 million or $0.11 per diluted share. The market value of the interest rate swap can be volatile from quarter to quarter, and thus can affect net income positively or negatively depending on interest rate conditions and other factors.

The Company’s primary focus continues to be on growth and development of its financial center network and subsidiary operations, sacrificing some profitability in the near term. The Bank opened our first financial center in Raleigh, North Carolina in January 2006 and Norfolk, Virginia in February 2006. In March 2006 the Bank opened another financial center in Virginia Beach, Virginia and opened a newly constructed financial center in Kitty Hawk, North Carolina in April 2006. In addition, we opened two financial centers in August, one in Chesapeake and Virginia Beach adding to our presence in those markets. These new locations increased the number of full-service financial centers to twenty four. The Company has incurred additional non-interest expenses both as a result of growth from period to period, and also as a result of staff additions and other costs incurred as a result of the financial center expansion during 2006. In 2004 interest rates obtained at or near forty year historical lows and steadily rose until June 2006. During 2006, Wall Street Journal Prime increased from 7.25% at December 31, 2005 to 8.25% at the end of June and has remained at 8.25% through December 31, 2006. The Company’s interest rate spread has increased primarily due to the Bank’s management of the interest rates on its loan and deposit portfolios while maintaining an upward growth trend.

Net Interest Income. Net interest income increased to $37.0 million for the year ended December 31, 2006, a $13.7 million or 58.8% increase from the $23.3 million earned during 2005. Total interest income benefited from growth in the level of average earning assets during the year. Asset growth combined with higher asset yields caused by the increase in market interest rates during periods reported contributed to this rise in income. Average total interest-earning assets increased $345.7 million, or 56.6%, for 2006 as compared to 2005, while the average yield increased by 115 basis points from 6.49% to 7.64%. Average total interest-bearing liabilities increased by $304.5 million, or 56.7% for 2006 as compared to 2005, while the average cost of interest-bearing liabilities increased by 124 basis points from 3.05% to 4.29%. Our cost of funds increased at a higher pace than our yield on interest-earning assets as a result of deposits steadily repricing at higher rates throughout the entire year, while the yield on our loan and investment portfolio has remained relatively flat for the last half of 2006 since the last increase in interest rates occurred in June 2006. This resulted in a 9 basis point decrease in interest rate spread. However, despite the decrease in interest rate spread, because we were able increase our interest earning assets by $41.2 million more than our interest bearing liabilities (primarily as a result of $21.0 million increase in average demand deposit accounts), our interest rate margin improved during 2006 by 6 basis points. For the year ended December 31, 2006, the net interest rate spread was 3.35%

and the net interest margin was 3.87%. For the year ended December 31, 2005, the net interest spread was 3.44% and the net interest margin was 3.81%.

Provision for Loan Losses. The Company recorded a $3.4 million provision for loan losses in 2006, representing an increase of $1.2 million from the $2.2 million provision made in 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. In evaluating the allowance for loan losses, Management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and other relevant factors. In both 2006 and 2005 the provision for loan losses was made principally in response to growth in loans, as total loans outstanding increased by $327.9 million in 2006 and by $284.7 million in 2005. Additionally, the 2006 provision was also increased as a result of the increase in impaired loans. At December 31, the allowance for loan losses was $9.4 million for 2006 and $6.3 million for 2005, representing .95% and .94%, respectively, of loans outstanding.

Non-Interest Income. Non-interest income totaled $9.3 million for the year ended December 31, 2006 as compared with $8.1 million for 2006, an increase of $1.2 million, or 14.9%. Since inception, the Company has actively pursued additional non-interest income sources outside of traditional banking operations, including income from insurance, mortgage banking, and brokerage networking operations. Non-interest income was negatively affected in 2006 by the loss and net cash settlement on economic hedge of $1.9 million. Of this loss, $1.2 million was related to the drop in fair value of the economic hedge that resulted from the rise in rates primarily during the first half of 2006. The fair value of the economic hedge can be volatile from quarter to quarter and thus effect non-interest income either positively or negatively depending on interest rate conditions and other factors. Excluding the effect of the economic hedge, non-interest income was $11.2 million which represented a $3.1 million or 38.7% increase during 2005.

The 2006 increases were broad based and include $986,000 in service charges on deposit accounts, $495,000 in income from insurance operations, $88,000 in income from brokerage operations, $185,000 from bank owned life insurance, $748,000 from mortgage operations, $560,000 from gain on the sale of securities and $396,000 from other service fee income. The increase in service charges was a direct result of the increase in the number of deposit accounts opened during 2006 that came from the financial center expansion and Haberfeld High Performance Checking program. The increase in insurance operations resulted also from the franchise expansion, growth in lines of business, and the two insurance company acquisitions made in the fourth quarter of 2006. The increase in brokerage revenues resulted from expanding our brokerage services into Virginia during the first quarter with the hiring of an experienced broker in Virginia Beach. The increase in income from bank owned life insurance was the result of purchasing an additional $7.0 million of bank owned life insurance during the third quarter of 2006. During mid 2006 the bank dissolved its 49% ownership of Gateway First Mortgage, LLC (“Gateway First”) which provided mortgage banking services to the Bank and to other lenders and replaced it with our wholly owned mortgage subsidiary, Gateway Bank Mortgage, Inc., which accounted for the increase in mortgage revenues in 2006 as compared with the prior year.

Non-Interest Expenses. Non-interest expenses totaled $35.0 million for the year ended December 31, 2006, an increase of $11.7 million or 50.3% over the $23.3 million reported for 2005. In comparison, total assets averaged $1.0 billion for 2006, an increase of 53.7% over average total assets of $679.0 million for the year ended December 31, 2005. Substantially all of the increase in non-interest expenses resulted from the Company’s growth and franchise expansion, and reflects the additional expenses in the current year associated with the opening of six new financial centers, increasing the number of full-service banking locations to twenty four; a private banking center, launching a new mortgage subsidiary, opening a new state of the art operations center, starting two new loan production offices, and making two insurance agency acquisitions. Eighteen of the twenty four financial centers were fully operational throughout 2006 and sixteen of the eighteen financial centers were fully operational throughout all of 2005. As a result of such expansion, personnel costs increased by $5.7 million, or 49.2%, the costs of occupancy, data processing and equipment costs increased by $3.0 million or 53.9%, and other non-interest expenses increased by $3.0 million or 49.1%. The increase in other expense included $1.03 million of expenses related to the Haberfeld High Performance Checking account program in 2006 (there were none of these expenses in 2005), and an increase of $237,000 related to other promotional and advertising costs, increased franchise taxes related to Virginia financial center expansion of $500,000, increased consulting and professional costs of $318,000, and increased travel and business development expenses of $340,000. Despite these higher expenses as a percentage of average total assets, total non-interest expenses decreased to 3.35% for 2006 from 3.43% for 2005.

Income Taxes. Income tax expense was $2.6 million for 2006 as compared with $2.0 million for 2005. The Company’s effective tax rate for both tax years was approximately 33.3%. As a result of the Company’s sustained pattern of profitability we expect our tax rate to remain near this level in 2007. Deferred taxes increased primarily due to increases in our allowance for loan losses and the unrealized loss related to our economic hedge.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s sources of funds are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and trading and investment securities available for sale. These funds, together with loan repayments, are used to make loans and to fund continuing operations. In addition, at December 31, 2007, the Bank had credit availability with the Federal Home Loan Bank of Atlanta (“FHLB”) of approximately $195.0 million, with $174.0 million outstanding secured by commercial loans and investment securities; federal funds lines of credit with six other financial institutions in the aggregate amount of $106.5 million from which $28 million was borrowed at December 31, 2007; and a line of credit with a bank of $20.0 million from which $4.0 million was borrowed at December 31, 2007. The Company also utilizes the wholesale brokered CD market to fund liquidity on an as needed basis.

Total deposits were $1.4 billion and $923.7 million at December 31, 2007 and 2006, respectively. As a result of the Company’s loan demand exceeding the rate at which core deposits have been built, the Company has relied significantly on time deposits as a source of funds. Certificates of deposit are the only deposit accounts that have stated maturity dates. Such deposits are generally considered to be rate sensitive. At December 31, 2007, time deposits represented 62.6% of the Company’s total deposits, up from 59.2% of total deposits at December 31, 2006. Certificates of deposit of $100,000 or more represented 19.3% and 22.2%, respectively, of the Bank’s total deposits at December 31, 2007 and 2006. At December 31, 2007, the Company had $225.9 million in brokered time deposits, representing 16.0% of total deposits at that date, up from 10.3% of total deposits at December 31, 2006. The bank has primarily used brokered deposits to fund its loan production offices and private banking center. While the Company will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, the Company anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity.

Management anticipates that the Company will rely primarily upon customer deposits, loan repayments, current earnings, brokered deposits, and as necessary, additional borrowings, to provide liquidity, and will use funds thus generated to make loans and to purchase securities, primarily securities issued by the federal government and its agencies, corporate securities, and mortgage-backed securities.

At December 31, 2007 and 2006, the Company’s tangible equity to asset ratio was 6.07% and 8.04%, respectively. All capital ratios place the Bank in excess of the minimum required to be deemed a well-capitalized bank by regulatory measures. The regulatory capital position of both the Company and the Bank was enhanced during December 2007 with the issuance of $23.2 million in perpetual non-cumulative preferred stock and $25.7 million of trust preferred securities in May 2007 that qualify, subject to certain limitations, as Tier 1 capital. The Company’s Tier 1 capital ratio at December 31, 2007 and 2006 was 10.43% and 12.11%, respectively.

Management expects that the Bank will remain “well-capitalized” for regulatory purposes, although there can be no assurance that additional capital will not be required in the near future due to greater-than-expected growth, or otherwise.

     The following table reflects other commitments of the company outstanding as of December 31, 2007.

In the normal course of business, the Company may enter into purchase agreements for goods or services. In management’s opinion, the dollar amount of such agreements at December 31, 2007 is not material and has not been included in the above table.

ASSET/LIABILITY MANAGEMENT

The Company’s results of operations depend substantially on its net interest income. Like most financial institutions, the Bank’s interest income and cost of funds are affected by general economic conditions and by competition in the market place. The purpose of asset/liability management is to provide stable net interest income growth by protecting the Company’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. The Company maintains, and has complied with, a Board approved asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Company’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, the Company has generally invested such funds in securities, primarily U.S. Treasury securities, securities issued by governmental agencies, mortgage-backed securities and corporate obligations. The securities portfolio contributes to the Company’s profits and plays an important part in the overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the securities portfolio are safety, liquidity, yield, asset/liability management (interest rate risk), and investing in securities that can be pledged for public deposits.

In reviewing the needs of the Company with regard to proper management of its asset/liability program, the Company’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing), and forecasted interest rate changes. A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayment speeds on mortgage-related assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model as of November 30, 2007, the Company would expect an increase in net interest income of $1.6 million if interest rates increase from rates as of December 31, 2007 by 200 basis points and a decrease in net interest income of $6.0 million if interest rates decrease from rates as of December 31, 2007 by 200 basis points.

The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure to interest rate risk. The Company believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2007 which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor availability and have been placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments which will be received throughout the lives of the loans. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

		Terms to Repricing at December 31, 2007
						Over 3				Total
		3 Months				Months to				Within				Over 12
		or Less				12 Months				12 Months				Months				Total
		(Dollars in thousands)
Interest-earning assets:
Loans		$	911,465			$	93,632			$	1,005,097			$	517,304			$	1,522,401
Interest-earning deposits			1,092				—				1,092				—				1,092
Investment securities available for sale			5,720				492				6,212				120,538				126,750
Trading securities			23,011				—				23,011				—				23,011
FHLB/FRB stock			15,660				—				15,660				—				15,660
Total interest-earning assets		$	956,948			$	94,124			$	1,051,072			$	637,842			$	1,688,914
Percentage of total interest-earning assets			56.66	%			5.57	%			62.23	%			37.77	%			100.00	%
Cumulative percentage to total interest- earning assets			56.66	%			62.23	%			62.23	%			100.00	%			100.00	%
Interest-bearing liabilities:
Deposits:
Savings, NOW and money market		$	402,523			$	—			$	402,523			$	—			$	402,523
Time			274,389				548,907				823,296				59,215				882,511
Borrowings			88,102				5,000				93,102				189,000				282,102
Total interest-bearing liabilities		$	765,014			$	553,907			$	1,318,921			$	248,215			$	1,567,136
Percentage of total interest-bearing liabilities			48.82	%			35.34	%			84.16	%			15.84	%			100.00	%
Cumulative percentage of total interest- bearing liabilities			48.82	%			84.16	%			84.16	%			100.00	%			100.00	%
Interest sensitivity gap		$	191,934			$	(459,783	)		$	(267,849	)		$	389,627			$	121,778
Cumulative interest sensitivity gap		$	191,934			$	(267,849	)		$	(267,849	)		$	121,778			$	121,778
Cumulative interest sensitivity gap as a percentage of total interest-earning assets			11.36	%			(15.86	)%			(15.86	)%			7.21	%			7.21	%
Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities			125.09	%			79.69	%			79.69	%			107.77	%			107.77	%

The table illustrates that if assets and liabilities reprice in the time intervals indicated in the table, the Company is asset sensitive in the very short-term (three months or less), becomes liability sensitive between three and twelve months, and then becomes asset sensitive again over twelve months. As stated above, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. For instance, while the table is based on the assumption that interest-bearing demand accounts, money market accounts and savings accounts are immediately sensitive to movements in rates, the Company expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets which are considered to be immediately sensitive. Additionally, certain assets have features which restrict changes in the interest rates of such assets both on a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Company places primary emphasis on its income simulation model when managing its exposure to changes in interest rates.

CRITICAL ACCOUNTING POLICIES

The preparation of the Company’s audited consolidated financial statements and the information included in management’s discussion and analysis is governed by policies that are based on accounting principles generally accepted in the United States of America and general practices within the banking industry. Among the more

significant policies are those that govern accounting for loans and allowance for loan losses, stock based compensation, derivatives and goodwill. These policies are discussed in Note B of the “Notes To Consolidated Financial Statements” included in this Annual Report.

A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results, and requires a difficult, subjective or complex judgment by management. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. Estimates and judgments are integral to our accounting for certain items, and those estimates and judgments affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. The Company periodically evaluates its estimates, including those related to the allowance for loan losses, goodwill, intangible assets, and stock based compensation. While we base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. Further information regarding the accounting policies that we consider to be critical is provided below.

Allowance for loan losses . The Company’s most significant critical accounting policy is the determination of its allowance for loan losses. The allowance for loan losses reflects the estimated losses that will result from the inability of our customers to make required payments. The allowance for loan losses results from management’s evaluation of the risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrower, fair market value of collateral and other items that, in our opinion, deserve current recognition in estimating possible credit losses. Our evaluation process is based on historical evidence and current trends among delinquencies, defaults and nonperforming assets. Our estimate of the allowance for loan losses does not include the impact of events that might occur in the future.

Management considers the established allowance adequate to absorb losses that relate to loans outstanding at December 31, 2007, although future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examination. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated, and additional provisions may be required. For further information on the allowance for loan losses, see “Financial Condition” in Management’s Discussion and Analysis and Note D of the “Notes to Consolidated Financial Statements” included in this Annual Report.

Goodwill and Other Intangible Assets. Intangible assets include goodwill and other identifiable assets, such as core deposit premiums, resulting from acquisitions. Core deposit premiums are amortized primarily on a straight-line basis over a ten-year life based upon historical studies of core deposits. Intangible assets related to insurance agency acquisitions are amortized over the expected life of the book of business acquired. Goodwill is not amortized but is tested annually for impairment or at any time an event occurs or circumstances change that may trigger a decline in the value of the reporting unit. Examples of such events or circumstances include adverse changes in legal factors, business climate, unanticipated competition, change in regulatory environment or loss of key personnel.

The Company tests for impairment in accordance with SFAS No. 142. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. The fair value of a reporting unit is computed using one or a combination of the following three methods: income, market value or cost method. The income method uses a discounted cash flow analysis to determine fair value by considering a reporting unit’s capital structure and applying a risk-adjusted discount rate to forecast earnings based on a capital asset pricing model. The market value method uses recent transaction analysis or publicly traded comparable analysis for similar assets and liabilities to determine fair value. The cost method assumes the net assets of a recent business combination accounted for under the purchase method of accounting will be recorded at fair value if no event or circumstance has occurred triggering a decline in the value. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired, and a second step of impairment test will be performed. In the second step, the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.

Stock Compensation Plans . Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-

Based Payment,” (“SFAS No. 123R”) which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 “Accounting for Stock Based Compensation,” and supersedes APB No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows flows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of the grant.

OFF-BALANCE SHEET ARRANGEMENTS

Information about the Company’s off-balance sheet risk exposure is presented in Note K to the accompanying consolidated financial statements. As part of its ongoing business, the Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2007, except as otherwise disclosed in Note G to the accompanying consolidated financial statements, the Company is not involved in any unconsolidated SPE transactions.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note B to the consolidated financial statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

LENDING ACTIVITIES

General . The Company provides to its customers a full range of short- to medium-term commercial and industrial, real estate, agricultural, Small Business Administration guaranteed, Farmers Home Administration guaranteed, mortgage, construction and consumer loans, both secured and unsecured.

The Company’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that the Company seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Company, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Company. The Company supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work. The Company has focused its portfolio lending activities on typically higher yielding commercial, construction and consumer loans rather than lower yielding 1-4 family mortgages which the Company typically sells in the secondary market. The following table sets forth at the dates indicated the Company’s loan portfolio composition by type of loan:

		At December 31,
		2007								2006
						Percent								Percent
		Amount				of Total				Amount				of Total
		(Dollars in thousands)
Commercial & industrial		$	263,283				17.3	%		$	137,658				13.8	%
Real estate – construction			604,335				39.7	%			381,788				38.4	%
Real estate – commercial mortgage			321,806				21.1	%			229,752				23.1	%
Real estate – 1-4 family mortgage			193,549				12.7	%			128,920				13.0	%
Consumer			22,133				1.4	%			15,347				1.5	%
Mortgage loans held for sale			5,624				.4	%			15,576				1.6	%
Home equity lines of credit			113,191				7.4	%			85,882				8.6	%
Subtotal			1,523,921				100.0	%			994,923				100.0	%
Less: Allowance for loan losses			(15,339	)							(9,405	)
Unamortized net deferred (fees) costs			(1,520	)							(331	)
Net loans		$	1,507,062							$	985,187