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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

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

For the transition period from ______ to _______

Commission File Number 0-12896  

OLD POINT FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Common Stock ($5.00 par value)

(Title of class)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __

        Indicate by check mark if disclosure of delinquent filers pursuant 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. [X]

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes __ No X

        The aggregate market value of the voting stock held by non-affiliates was approximately $72 million on June 30, 2003. There were 3,987,149 shares of Common Stock outstanding at March 15, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

        Certain portions of the Registrant’s Definitive Proxy Statement (“the 2004 Proxy Statement”) for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 will be incorporated by reference in Part III.

OLD POINT FINANCIAL CORPORATION

FORM 10-K

TABLE OF CONTENTS

- I -

PART I

Item 1. Business

General

Old Point Financial Corporation (the “Company”) was incorporated under the laws of Virginia on February 16, 1984, for the purpose of acquiring all the outstanding common stock of The Old Point National Bank of Phoebus (the “Bank”), in connection with the reorganization of the Bank into a one bank holding company structure. At the annual meeting of the stockholders on March 27, 1984, the proposed reorganization was approved by the requisite stockholder vote. At the effective date of the reorganization on October 1, 1984, the Bank merged into a newly formed national bank as a wholly owned subsidiary of the Company, with each outstanding share of common stock of the Bank being converted into five shares of common stock of the Company.

The Company completed a spin-off of its trust department as of April 1, 1999. The newly formed organization is chartered as Old Point Trust and Financial Services, N.A. (“Trust”). Trust is a wholly owned subsidiary of the Company. The Company does not engage in any activities other than acting as a holding company for the common stock of the Bank and Trust. The principal business of the Company is conducted through its subsidiaries which continue to conduct business in substantially the same manner and from the same offices.

The Bank is a national banking association founded in 1922. The Bank has sixteen offices in the cities of Hampton, Newport News, Norfolk and Chesapeake, as well as James City and York County, Virginia, and provides a full range of banking and related financial services, including checking, savings, certificates of deposit, and other depository services, commercial, industrial, residential real estate and consumer loan services, safekeeping services.

As of December 31, 2003, the Company had assets of $645.9 million, loans of $405.1 million, deposits of $490.4 million, and stockholders’ equity of $63.3 million. At year end, the Company and its subsidiaries had a total of 264 employees, 26 of whom were part-time.

The Company’s trade area is Hampton Roads, which includes Williamsburg, Poquoson, Newport News, Hampton, Chesapeake, Norfolk, Virginia Beach, Portsmouth and Suffolk. The area also includes the Isle of Wight, James City, Gloucester and Mathews counties. According to the 2000 Hampton Roads Statistical Digest, there are more than 1.6 million people in the area with 30% of all jobs linked to the military. The service industry, which employed approximately 194,000 in 1999, is the biggest provider of jobs in Hampton Roads.

The banking industry is highly competitive in the Hampton Roads area. There are approximately twenty commercial and savings banks conducting business in the area. Six of these are major statewide banking organizations.

The Bank encounters competition for deposits and loans from banks, saving and loan associations, and credit unions in the area in which it operates. In addition, the Bank must compete for deposits in some instances with nationally marketed money market funds, brokerage firms and on-line or internet banks.

The Company and its subsidiaries are subject to regulation and examination by the Federal Reserve Board (“the Board”), the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (“the FDIC”).

As a bank holding company within the meaning of the Bank Holding Company Act of 1956, the Company is subject to the ongoing regulation, supervision, and examination by the Federal Reserve Board (the “Board”). The Company is required to file with the Board periodic and annual reports and other information concerning its own business operations and those of its subsidiaries. In addition, prior Board approval must be obtained before the Company can acquire (i) ownership or control of any voting shares of another bank if, after such acquisition, it would control more than 5% of such shares, or (ii) all or substantially all of the assets of another bank or merge or consolidate with another bank holding company. A bank holding company is prohibited under the Bank Holding Company Act, with limited exceptions, from engaging in activities other than those of banking or of managing or controlling banks or furnishing services to its subsidiaries.

Statistical Information

The following statistical information is furnished pursuant to the requirements of Guide 3 (Statistical Disclosure by Bank Holding Companies) promulgated under the Securities Act of 1933.

I.     Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential

The following table presents the distribution of assets, liabilities, and shareholders’ equity by major categories with related average yields/rates. In these balance sheets, nonaccrual loans are included in the daily average loans outstanding. The following table sets forth a summary of changes in interest earned and paid attributable to changes in volume and changes in yields/rates.

TABLE I

AVERAGE BALANCE SHEETS, NET INTEREST INCOME* AND RATES*

* Computed on a fully taxable equivalent basis using a 34% rate

The following table sets forth a summary of changes in interest earned and paid attributable to changes in volume and changes in yields/rates.

TABLE II

ANALYSIS OF CHANGE IN NET INTEREST INCOME *

* Computed on a fully taxable equvilent basis using a 34% rate.

Interest Sensitivity

The following table reflects the earlier of the maturity or repricing data for various assets and liabilities as of December 31, 2003.

TABLE III
INTEREST SENSITIVITY ANALYSIS

The Company was liability sensitive as of December 31, 2003. There were $130 million more in liabilities than assets subject to repricing within three months. This generally indicates that net interest income should improve if interest rates fall since liabilities will reprice faster than assets.

It should be noted, however, that savings deposits; which consist of interest bearing transactions accounts, money market accounts, and savings accounts; are less interest sensitive than other market driven deposits. In a rising rate environment these deposit rates have historically lagged behind the changes in earning asset rates, thus mitigating somewhat the impact from the liability sensitivity position.

II. Investment Portfolio

Note 3 of the Notes to Financial Statements found in Item 8. Financial Statements and Supplementary Data of this Report on Form 10K presents the book and market value of investment securities on the dates indicated.

The following table shows, by type and maturity, the book value and weighted average yields of investment securities at December 31, 2003.

TABLE IV

INVESTMENT SECURITY MATURITIES AND YIELDS

Yields are calculated on a fully tax equivalent basis using a 34% rate.

At December 31, 2003, the book value of other marketable equity securities with no stated maturity totaled $3.9 million with an weighted average yield of 3.32%. These securities consisted of Federal Home Loan Bank stock of $2.5 million yielding 3.20%, Federal Reserve stock of $169 thousand yielding 6.00%, Bankers Title of Hampton Roads stock yielding 64.44%, money market fund of $897 thousand yielding 0.78% and other securities of $200 thousand. The book value of other marketable securities with no stated maturity totaled $3.1 million, yielding 3.66%; and $3.2 million, yielding 4.66%; at December 31, 2002, and 2001 respectively.

III. Loan Portfolio

The following table shows a breakdown of total loans by type at December 31 for years 1999 through 2003:

TABLE V

LOANS

Based on Standard Industry Code, there are no categories of loans which exceed 10% of total loans other than the categories disclosed in the preceding table.

The maturity distribution and rate sensitivity of certain categories of the Bank’s loan portfolio at December 31, 2003 is presented below:

TABLE VI
MATURITY SCHEDULE OF SELECTED LOANS

The following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans as of December 31 for the years 1999 through 2003.

TABLE VII
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS

Loans are placed in nonaccrual status if principal or interest has been in default for a period of 90 days or more unless the obligation is both well secured and in the process of collection. A debt is “well secured” if it is secured (i) by collateral in the form of liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full or (ii) by the guaranty of a financially responsible party. A debt is “in the process of collection” if collection of the debt is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status.

Potential problem loans consist of loans that, because of potential credit problems of the borrowers, have caused management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. At December 31, 2003 such problem loans, not included in Table VII, amounted to approximately $4.7 million. There was one relationship in excess of $500 thousand.

IV. Summary of Loan Loss Experience

The determination of the balance of the Allowance for Loan Losses is based upon a review and analysis of the loan portfolio and reflects an amount which, in management’s judgment, is adequate to provide for possible future losses. Management’s review includes monthly analysis of past due and nonaccrual loans and detailed periodic loan by loan analyses.

The principal factors considered by management in determining the adequacy of the allowance are the growth and composition of the loan portfolio, historical loss experience, the level of nonperforming loans, economic conditions, the value and adequacy of collateral, and the current level of the allowance.

The following table shows an analysis of the Allowance for Loan Losses for the years 1999 through 2003.

TABLE VIII
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

* Income before taxes plus provision for loan losses, divided by net charge-offs.

The following table shows the amount of the Allowance for Loan Losses allocated to each category at December 31 for the years 1999 through 2003.

TABLE IX
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

V. Deposits

The following table shows the average balances and average rates paid on deposits for the years ended December 31, 2003, 2002 and 2001.

TABLE X

DEPOSITS

The following table shows certificates of deposit in amounts of $100,000 or more as of December 31, 2003, 2002, and 2001 by time remaining until maturity.

TABLE XI

CERTIFICATE OF DEPOSIT $100,000 AND MORE

VI. Return on Equity and Assets

The return on average shareholders’ equity and assets, the dividend pay out ratio, and the average equity to average assets ratio for the past three years are presented below.

VII. Short Term Borrowings

The Bank periodically borrowed funds through federal funds from its correspondent banks, through the use of a demand note to the United States Treasury (Treasury Tax and Loan Deposits), and through securities sold under agreements to repurchase. The borrowings matured daily and were based on daily cash flow requirements. The borrowed amounts (in thousands) and their corresponding rates during 2003, 2002, and 2001 are presented in the following table.

TABLE XII
SHORT TERM BORROWINGS

Item 2. Properties

The Bank owns the Main Office, five office buildings, and ten branches. All of the above properties are owned directly and free of any encumbrances. The land at the Fort Monroe branch is leased by the Bank under an agreement expiring in October 2011. The remaining four branches are leased from unrelated parties under leases with renewal options which expire anywhere from 10-15 years.

For more information concerning the commitments under current leasing agreements, see Note 12. Lease Commitments of the Notes to Financial Statements found in Item 8. Financial Statements and Supplementary Data of this Report on Form 10K. Additional information on Other Real Estate Owned can be found in Note 7. Other Real Estate Owned of the Notes to Financial Statements found in Item 8. Financial Statements and Supplementary Data of this Report on Form 10K.

Item 3. Legal Proceedings

The Company is not a party to any material pending legal proceedings before any court, administrative agency, or other tribunal.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the quarter ended December 31, 2003.

Part II

Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters

Beginning in 2000 the common stock of Old Point Financial Corporation was quoted on the Nasdaq SmallCap under the symbol “OPOF”. The approximate number of shareholders of record as of December 31, 2003 was 1,342. The range of high and low prices and dividends per share of the Company’s common stock for each quarter during 2003 and 2002 is presented in Part II. Item 7. of this Annual Report on Form 10-K. Additional information related to stockholder matters can be found in Note 17. Regulatory Matters of the Notes to Financial Statements found in Item 8. Financial Statements and Supplementary Data of this Report on Form 10K.

Item 6. Selected Financial Data

The following table summarizes the Company’s performance for the past five years.

SELECTED FINANCIAL HIGHLIGHTS

Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion is intended to assist readers in understanding and evaluating the consolidated results of operations and financial condition of the Company. This discussion should be read in conjunction with the financial statements and other financial information contained elsewhere in this report. The analysis attempts to identify trends and material changes which occurred during the period presented.

EARNINGS SUMMARY

        Net income was $7.83 million, or $1.98 per share in 2003 compared to $7.05 million, or $1.80 per share in 2002 and $5.71 million, or $1.47 per share in 2001. Return on average assets was 1.30% in 2003, 1.30% in 2002 and 1.14% in 2001. Return on average equity was 12.81% in 2003, 12.80% in 2002 and 11.48% in 2001. For the past five years return on average assets has averaged 1.20% and return on average equity has averaged 12.15%. Selected Financial Highlights summarizes the Company’s performance for the past five years.

NET INTEREST INCOME

        The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. Net interest income, on a tax equivalent basis, was $24.72 million in 2003, up $1.29 million, or 6% from $23.43 million in 2002 which was up $3.09 million, or 15% from $20.34 million in 2001. Net interest income is affected by variations in interest rates and the volume and mix of earning assets and interest-bearing liabilities. The net interest yield decreased to 4.37% in 2003 from 4.57% in 2002, which was up from 4.28% in 2001.

        Tax equivalent interest income decreased $1.02 million, or 3%, in 2003. Average earning assets grew $53.63 million, or 10%. Total average loans increased $24.91 million, or 7%, while average investment securities increased $28.94 million, or 22%. The yield on earning assets decreased in 2003 by eighty-four basis points primarily due to declining interest rates.

        Interest expense decreased $2.31 million or 19%, in 2003 while interest bearing liabilities increased 8% in 2003. The cost of funding liabilities decreased seventy-six basis points. The market experienced one rate reduction by the Federal Reserve in 2003.

PROVISION/ALLOWANCE FOR LOAN LOSSES

        Provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management’s evaluation of the loan portfolio. The provision decreased to $1.00 million in 2003 and was $1.70 million in 2002 and $1.20 million in 2001. The decrease was due to a decline in the net charge offs in 2003 as detailed in the next paragraph as well as a surplus being reflected in the quarterly allowance analysis.

        Loans charged off during 2003 totaled $1.20 million compared to $1.41 million in 2002 and $1.46 million in 2001. Recoveries amounted to $462 thousand in 2003, $383 thousand in 2002 and $504 thousand in 2001.

PROVISION/ALLOWANCE FOR LOAN LOSSES (cont)

        The Company’s net loans charged off to year-end loans were 0.18% in 2003, 0.27% in 2002, and 0.28% in 2001. The allowance for loan losses, as a percentage of year-end loans, was 1.19% in 2003, 1.21% in 2002, and 1.12% in 2001.

        As of December 31, 2003, nonperforming assets were $408 thousand, down from $1.14 million at year-end 2002. Nonperforming assets consist of loans in nonaccrual status and other real estate. The 2003 total consisted of other real estate of $165 thousand and $243 thousand in nonaccrual loans. The other real estate consists of $165 thousand in commercial property originally acquired as a potential branch site and now held for sale. Nonaccrual loans consisted of $243 thousand in commercial real estate loans. Loans still accruing interest but past due 90 days or more increased to $736 thousand as of December 31, 2003 compared to $608 thousand as of December 31, 2002.

        The allowance for loan losses is analyzed for adequacy on a quarterly basis to determine the required amount of provision for loan losses. A loan-by-loan review is conducted on all significant classified commercial and mortgage loans. Inherent losses on these individual loans are determined and an allocation of the allowance is provided. Smaller nonclassified commercial and mortgage loans and all consumer loans are grouped by homogeneous pools with an allocation assigned to each pool based on an analysis of historical loss and delinquency experience, trends, economic conditions, underwriting standards, and other factors.

OTHER INCOME

        Other income increased $326 thousand, or 5% in 2003 from 2002 compared to an increase of $600 thousand, or 9% in 2002 from 2001. The growth in other income is attributed to increases in service charges on deposit accounts, merchant processing fees and Bank Owned Life Insurance (BOLI) income. Service charges on deposit accounts increased by $62 thousand in 2003. Merchant processing fees increased by $44 thousand in 2003. The Bank Owned Life Insurance (BOLI) on certain officers generated a $96 thousand increase in revenue over 2002.

OTHER EXPENSES

        Other expenses increased $1.31 million or 7% in 2003 over 2002 after increasing 9% in 2002 from 2001. Salary expense increased by $1.0 million or 9% as a result of normal yearly salary increases and the addition of new positions within the Company. The Company opened a new branch in Chesapeake in October 2003. Several new positions were added as a result of an organizational restructuring to accommodate anticipated future growth.

ASSETS

        At December 31, 2003, the Company had total assets of $645.9 million, up 12% from $576.6 million at December 31, 2002. Average assets in 2003 were $600.7 million compared to $543.2 million in 2002. The growth in assets in 2003 was due to the increase in investments, which were up 19% and loans, which were up 7% in 2003.

LOANS

        Total loans as of December 31, 2003 were $405.1 million, up 7% from $378.0 million at December 31, 2002. The Company realized significant growth in the real estate category of loans. Footnote 4 of the financial statements details the loan volume by category for the past two years.

INVESTMENT SECURITIES

        At December 31, 2003 total investment securities were $185.2 million, up 19% from $156.0 million on December 31, 2002. The goal of the Company is to provide maximum return on the investment portfolio within the framework of its asset/liability objectives. These objectives include managing interest sensitivity, liquidity and pledging requirements.

DEPOSITS

        At December 31, 2003, total deposits amounted to $490.4 million, up 8% from $454.1 million on December 31, 2002. Non-interest bearing deposits increased $23.5 million, or 26%, at year-end 2003 over 2002. Savings deposits increased $20.6 million, or 13%, in 2003 over 2002. Certificates of Deposit decreased $7.7 million or 4% in 2003 from 2002.

STOCKHOLDERS’ EQUITY

        Total stockholders’ equity as of December 31, 2003 was $63.3 million, up 9% from $58.1 million on December 31, 2002. The Company is required to maintain minimum amounts of capital under banking regulations. Under the regulations, Total Capital is composed of core capital (Tier 1) and supplemental capital (Tier 2). Tier 1 capital consists of common stockholders’ equity less goodwill. Tier 2 capital consists of certain qualifying debt and a qualifying portion of the allowance for loan losses. The following is a summary of the Company’s capital ratios for 2003, 2002 and 2001.

        Year-end book value was $15.92 in 2003 and $14.76 in 2002. Cash dividends were $2.1 million, or $.54 per share in 2003 and $1.8 million, or $.453 per share in 2002. The common stock of the Company has not been extensively traded. The table below shows the high and low closing prices for each quarter of 2003 and 2002. The stock is quoted on the Nasdaq Small Cap under the symbol “OPOF” and the prices below are based on trade information. There were 1342 stockholders of the Company as of December 31, 2003. This stockholder count does not include stockholders who hold their stock in a nominee registration.

STOCKHOLDERS’ EQUITY (cont)

The following is a summary of the dividends paid and market price on Old Point Financial Corporation common stock for 2003 and 2002.

LIQUIDITY

        Liquidity is the ability of the Company to meet present and future obligations through the acquisition of additional liabilities or sale of existing assets. Management considers the liquidity of the Company to be adequate. Sufficient assets are maintained on a short-term basis to meet the liquidity demands anticipated by Management. In addition, secondary sources are available through the use of borrowed funds if the need should arise.

        The Company’s sources of funds include a large stable deposit base and secured advances from the Federal Home Loan Bank. The Company structures its Balance Sheet such that liquid assets, such as loans are funded through customer deposits, long-term debt, other liabilities and capital.

        The Company has available short-term unsecured borrowed funds in the form of federal funds with correspondent banks. As of year-end 2003, the company had available $30 million in federal funds to handle any short-term borrowing needs.

EFFECTS OF INFLATION

        Management believes that the key to achieving satisfactory performance in an inflationary environment is its ability to maintain or improve its net interest margin and to generate additional fee income. The Company’s policy of investing in and funding with interest-sensitive assets and liabilities is intended to reduce the risks inherent in a volatile inflationary economy.

OFF-BALANCE SHEET LENDING RELATED COMMITMENTS

        The Company had $109.5 million in consumer and commercial commitments at December 31, 2003. The Company also had $1.6 million at December 31, 2003 in letters of credit that the Bank will fund if certain future events occur.

        Old Point has the liquidity and capital resources to handle these commitments in the normal course of business.

CONTRACTUAL OBLIGATIONS

        The following table provides the Company’s contractual obligations as of December 31, 2003:

Long-term debt obligations are Federal Home Loan Bank advances.

Item 7A.   Quantitative and Qualitative Disclosures About Market Risk

For information regarding Quantitative and Qualitative Disclosures About Market Risk, see Part I, “Business: Statistical Information – I. Distribution of Assets, Liabilities and Shareholder’s Equity; Interest Rates and Interest Differential”.

Item 8.   Financial Statements and Supplementary Data

The consolidated financial statements and related footnotes of the company are presented below followed by the financial statements of the parent.

The following are the summarized financial statements of the Company.

INDEPENDENT AUDITOR’S REPORT

WITT MARES EGGLESTON SMITH, PLC

To The Board of Directors
Old Point Financial Corporation
Hampton,Virginia

We have audited the accompanying consolidated balance sheets of Old Point Financial Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows and changes in stockholders’ equity for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the financial position of Old Point Financial Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 3l, 2003, in conformity with accounting principles generally accepted in the United States of America.

February 27, 2004
Norfolk, Virginia

CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF INCOME

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years ended December 31, 2003, 2002 AND 2001

See Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1, Significant Accounting Policies

PRINCIPLES OF CONSOLIDATION:

The consolidated financial statements include the accounts of Old Point Financial Corporation (“the Company”) and its wholly-owned subsidiaries The Old Point National Bank of Phoebus (“the Bank”) and Old Point Trust & Financial Services N.A. (“Trust”). All significant intercompany balances and transactions have been eliminated in consolidation.

NATURE OF OPERATIONS:

Old Point Financial Corporation is a two-bank holding company that conducts substantially all of its operations through its subsidiaries, The Old Point National Bank of Phoebus and Old Point Trust and Financial Services, N.A. The Bank services individual and commercial customers, the majority of which are in Hampton Roads. The Bank has sixteen branch offices. The Bank offers a full range of deposit and loan products to its retail and commercial customers. Substantially all of the Bank’s deposits are interest bearing. The majority of the Bank’s loan portfolio is secured by real estate. Trust offers a full range of services for individuals and businesses. Products and services include retirement planning, estate planning, financial planning, trust accounts, tax services, and investment management services.

USE OF ESTIMATES:

In preparing consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of deferred tax assets.

CASH AND CASH EQUIVALENTS:

For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash and balances due from banks and federal funds sold, all which mature within ninety days.

INVESTMENT SECURITIES:

Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (SFAS 115), addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Those investments are to be classified in three categories and accounted for as follows:

LOANS:

The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout Hampton Roads. The ability of the Corporation’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.

Accrual of interest is discontinued on a loan when management believes, after considering collection efforts and other factors that the borrower’s financial condition is such that collection of interest is doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

LOANS HELD FOR SALE:

Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by aggregate outstanding commitments from investors or current investor yield requirements. Net unrealized losses are recognized through a valuation allowance by charges to income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights.

ALLOWANCE FOR LOAN LOSSES:

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.

OFF-BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS:

In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under commercial letters of credit, and lines of credit. Such financial instruments are recorded when they are funded.

OTHER REAL ESTATE OWNED:

Other real estate owned is carried at the lower of cost or estimated fair value and consists of foreclosed real property and other property held for sale. The estimated fair value is reviewed periodically by management and any write-downs are charged against current earnings.

PREMISES AND EQUIPMENT:

Land is carried at cost. Buildings and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on both straight-line and accelerated methods and are charged to expense over the estimated useful lives of the related assets. Costs of maintenance and repairs are charged to expense as incurred.

INCOME TAXES:

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the new deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

PENSION PLAN:

The Company has a non-contributory defined benefit pension plan covering substantially all of its employees. Benefits are based on years of service and average earnings during the highest average sixty-month period during the final one hundred and twenty months of employment.

The Company’s policy is to fund the maximum amount of contributions allowed for tax purposes. The Bank accrues an amount equal to its actuarially computed obligation under the plan.

The actuarial valuation was performed using the frozen initial liability cost method. Under this method, the Bank’s contribution equals the sum of the amount necessary to amortize the frozen initial liability (past service base) over a period of years and the normal cost of the plan.

STOCK COMPENSATION PLANS:

Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Corporation’s stock option plan have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them. The Corporation has elected to continue with the accounting methodology in Opinion No. 25 and, as a result, has provided pro forma disclosures of net income and earnings per share and other disclosures, as if the fair value based method of accounting had been applied. The pro forma disclosures include the effects of all unexpired awards. (See Note 10.)

EARNINGS PER COMMON SHARE:

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method.

OTHER COMPREHENSIVE INCOME:

The accumulated other comprehensive income at December 31 2003 is comprised of unrealized security gains (loss) of $1.6 million net of taxes of $836 thousand and the minimum pension liability adjustment of $882 thousand net of a tax benefit of $459 thousand.

TRUST ASSETS AND INCOME:

Assets held by Trust are not included in the financial statements, because such items are not assets of the Company. In accordance with industry practice, trust service income is recognized primarily on the cash basis. Reporting such income on the accrual basis would not materially affect net income.

ADVERTISING EXPENSE:

Advertising expenses are expensed as incurred.

RECLASSIFICATIONS:

Certain amounts in the financial statements have been reclassified to conform with classifications adopted in the current year.

RECENT ACCOUNTING PRONOUNCEMENTS:

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. The Interpretation had no effect on the Corporation’s consolidated financial statements.

In April 2003, the FASB issued SFAS No.149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. This Statement had no effect on the Corporation’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement provides new rules on the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. Such financial instruments include mandatorily redeemable shares, instruments that require the issuer to buy back some of its shares in exchange for cash or other assets, or obligations that can be settled with shares, the monetary value of which is fixed. Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003. This Statement had no effect on the Corporation’s consolidated financial statements.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employer’s Disclosures about Pensions and Postretirement Benefits. This Statement requires additional disclosures about the assets, obligations and cash flows of defined benefit pension and postretirement plans, as well as the expense recorded for such plans. As of December 31, 2003, the Corporation has disclosed the required elements related to its defined benefit pension plan in Note 13 to these consolidated financial statements.

NOTE 2, Restrictions on Cash and Amounts due from Banks

The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2003 and 2002, these reserve balances amounted to $5,293,004 and $2,210,582, respectively.

NOTE 3, Investment Securities

At December 31, 2003, the investment securities portfolio is composed of securities classified as held-to-maturity and available-for-sale, in conjunction with SFAS 115. Investment securities held-to-maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts, and investment securities available-for-sale are carried at market value.

The amortized cost and fair value of investment securities held-to-maturity at December 31, 2003 and 2002, were:

The amortized cost and fair values of investment securities available-for-sale at December 31, 2003 were:

The amortized cost and fair values of investment securities available-for-sale at December 31, 2002 were:

NOTE 3, Investment Securities (Continued)

Investment securities carried at $93.5 million and $55.8 million at December 31, 2003 and 2002, respectively, were pledged to secure public deposits and securities sold under agreements to repurchase, Federal Home Loan Bank advances and for other purposes required or permitted by law. The Federal Home Loan Bank (FHLB) stock and the Federal Reserve Bank (FRB) stock are stated at cost as these are restricted securities without readily determinable fair values.

The amortized cost and approximate market values of investment securities at December 31, 2003 by contractual maturity are shown below.

The proceeds from the sale of available-for-sale (AFS) investment securities, and the related realized gains and losses are shown below:

NOTE 4, Loans

Loans at December 31, were reduced by deferred loan fees in excess of deferred loan cost of $60 thousand in 2003 and $19 thousand in 2002. At December 31, loans before allowance for loan losses consisted of: