UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

(Mark One)

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

For the quarterly period ended March 31, 2005

or

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

For the transition period from __________ to __________

Commission File No. 000-25805

Fauquier Bankshares, Inc.

(540) 347-2700

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of May 5, 2005, the latest practicable date for determination, 3,434,849 shares of common stock, par value $3.13 per share, of the registrant were outstanding.

FAUQUIER BANKSHARES, INC.

INDEX

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets

See accompanying Notes to Consolidated Financial Statements.

2

See accompanying Notes to Consolidated Financial Statements.

3

See accompanying Notes to Consolidated Financial Statements.

4

See accompanying Notes to Consolidated Financial Statements.

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FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

1.	General
	The consolidated statements include the accounts of Fauquier Bankshares, Inc. (the Corporation, Bankshares) and its wholly-owned subsidiaries, Fauquier Statutory Trust I (Trust I) and The Fauquier Bank (the Bank), of which Fauquier Services, Inc. is its sole subsidiary. In consolidation, significant intercompany financial balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial positions as of March 31, 2005 and December 31, 2004, and the results of operations and cash flows for the three months ended March 31, 2005 and 2004.
	The results of operations for the three months ended March 31, 2005 and 2004 are not necessarily indicative of the results expected for the full year.
2.	Securities
	The amortized cost of securities available for sale, with unrealized gains and losses follows:

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The amortized cost and fair value of securities available for sale, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

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	The nature of the securities which are temporarily impaired for a continuous 12 months or more can be segmented into two groups. The first group consists of two Federal Agency bonds totaling $1.8 million with a temporary loss of approximately $35,574. Both bonds within this group have Aaa/AAA ratings from Moody’s and Standard & Poors. These bonds have estimated maturity dates of five months and 47 months, and return principal on a monthly basis representing the repayment and prepayment of the underlying mortgages. The Corporation has the ability to hold these bonds to their maturity.
	The second group consists of one corporate bond, rated A2 by Moody’s, totaling $1.0 million with a temporary loss of approximately $42,500. This bond has a remaining maturity of approximately 29 years, but can be called at par on its five year anniversary. If not called, the bond reprices, every three months at a fixed index above LIBOR. The Corporation has the ability to hold this bond to its maturity.
	The carrying value of securities pledged to secure deposits and for other purposes amounted to $9,364,247 and $9,695,444 at March 31, 2005 and December 31, 2004, respectively.
3.	Loans
	A summary of the balances of loans follows:

Analysis of the allowance for loan losses follows:

Non-performing assets consist of the following:

Total loans past due 90 days or more and still accruing interest totaled $271,000 on March 31, 2005 and $162,000 on December 31, 2004, respectively.

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4.	Company-Obligated Mandatorily Redeemable Capital Securities of Subsidiary Trust
	On March 26, 2002, Bankshares’ wholly-owned Connecticut statutory business trust privately issued $4 million face amount of the trust’s Floating Rate Capital Securities (“Capital Securities”) in a pooled capital securities offering. Simultaneously, the trust used the proceeds of that sale to purchase $4 million principal amount of the Bankshares’ Floating Rate Junior Subordinated Deferrable Interest Debentures due 2032 (“Subordinated Debentures”). Both the Capital Securities and the Subordinated Debentures are callable at any time after five years from the issue date. The Subordinated Debentures are an unsecured obligation of the Bankshares and are junior in right of payment to all present and future senior indebtedness of the Bankshares. The Capital Securities are guaranteed by the Bankshares on a subordinated basis. The Capital Securities are presented in the consolidated balance sheets of the Bankshares under the caption “Company-Obligated Mandatorily Redeemable Capital Securities.” Bankshares records distributions payable on the Capital Securities as an Interest Expense in its consolidated statements of income. The cost of issuance of the Capital Securities was approximately $128,000. This cost is being amortized over a five year period from the issue date.
5.	Earnings Per Share
	The following table shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of dilutive potential common stock. Dilutive potential common stock had no effect on income available to common shareholders.

6.	Stock-Based Compensation
	At March 31, 2005, the Corporation has a stock-based compensation plan. The Corporation accounts for the plan under the recognition and measurement principles of APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share for Bankshares had the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, been applied to stock-based compensation.

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7.	Employee Benefit Plan
	The following table provides a reconciliation of the changes in the defined benefit pension plan’s obligations for the periods ended March 31, 2005 and 2004.

The Corporation previously disclosed in its financial statements for the year ended December 31, 2004, that it expected to contribute $1,186,714 to its pension plan in 2005. As of March 31, 2005, contributions totaling $1,186,714 have been made. The Corporation presently anticipates no additional contributions to fund its pension plan in 2005.

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

In addition to the historical information contained herein, this report contains forward-looking statements. Forward-looking statements are based on certain assumptions and describe future plans, strategies, and expectations of management, and are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “may,” “will” or similar expressions. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in:

	•	interest rates,
	•	general economic conditions,
	•	the legislative/regulatory climate,
	•	monetary and fiscal policies of the U.S. Government, including the policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System,
	•	the quality or composition of The Fauquier Bank’s (“TFB”) loan or investment portfolios,
	•	competition,
	•	demand for financial products and services in our market area,
	•	accounting principles, policies and guidelines.

These risks and uncertainties should be considered in evaluating forward-looking statements in this report, and you should not place undue reliance on such statements, which reflect our position as of the date of this report.

GENERAL

Fauquier Bankshares, Inc. (“Bankshares”) was incorporated under the laws of the Commonwealth of Virginia on January 13, 1984. Bankshares is a registered bank holding company and owns all of the voting shares of TFB, a Virginia state-chartered bank that commenced operations in 1902. Bankshares engages in its business through TFB, and has no significant operations other than owning the stock of TFB. Bankshares had issued and outstanding 3,433,408 shares of common stock, par value $3.13 per share, held by approximately 389 holders of record on March 31, 2005.

TFB has eight full service branch offices located in the Virginia communities of Warrenton, Catlett, The Plains, New Baltimore, Sudley Road-Manassas, Old Town-Manassas and Bealeton. The executive offices of Bankshares and the main office of TFB are located at 10 Courthouse Square, Warrenton, Virginia 20186. During the March 2005 quarter, TFB signed a lease for its ninth full service branch in Haymarket, Virginia, scheduled to open in 2006. TFB’s general market area principally includes Fauquier County, western Prince William County, and neighboring communities and is located approximately fifty (50) miles southwest of Washington, D.C.

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TFB provides a range of consumer and commercial banking services to individuals and businesses. The deposits of TFB are insured up to applicable limits by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”). The basic services offered by TFB include: demand deposit accounts, savings and money market deposit accounts, NOW accounts, time deposits, safe deposit services, credit cards, cash management, automated clearing house services (“ACH”) including direct deposits, notary services, night depository, traveler’s checks, cashier’s checks, domestic collections, savings bonds, automated teller services, drive-in tellers, internet banking, banking by telephone, and banking by mail. In addition, TFB makes secured and unsecured commercial and real estate loans, issues stand-by letters of credit and grants available credit for installment, unsecured and secured personal loans, residential mortgages and home equity loans, as well as automobile and other types of consumer financing. TFB provides automated teller machine (“ATM”) cards, as a part of the Star and Plus ATM networks, thereby permitting customers to utilize the convenience of larger ATM networks.

TFB operates a Wealth Management Services (“WMS”) division that began with the granting of trust powers to TFB in 1919. The WMS division provides personalized services that include investment management, trust, estate settlement, retirement, insurance, and brokerage services. TFB, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company, and Bankers Investments Group, LLC, a full service broker/dealer. Bankers Insurance consists of a consortium of 61 Virginia community bank owners, and Bankers Investments Group is owned by 32 Virginia community banks.

The revenues of TFB are derived primarily from interest and fees earned on real estate and other loans; interest and dividends from investment and mortgage-backed securities; and fees on deposit products and WMS services. The principal sources of funds for TFB’s lending activities are its deposits, repayment of loans, the sale and maturity of investment securities, and borrowings from the Federal Home Loan Bank (“FHLB”) of Atlanta and other banks. The principal expenses of TFB are the interest paid on deposits and borrowings, and operating and general administrative expenses. As is the case with banking institutions generally, TFB’s operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System (“Federal Reserve”). As a Virginia-chartered bank and a member of the Federal Reserve, TFB is supervised and examined by the Federal Reserve and the Virginia State Corporation Commission (“SCC”). Interest rates on competing investments and general market rates of interest influence deposit flows and costs of funds. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. TFB faces strong competition in the attraction of deposits, its primary source of lendable funds, and in the origination of loans.

CRITICAL ACCOUNTING POLICIES

GENERAL. Bankshares’ financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in our estimates. In addition, GAAP itself may change from one previously acceptable accounting method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

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ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards (SFAS) No. 5 “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has three basic components: the specific allowance, the formula allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for larger balance, non-homogeneous loans. The specific allowance uses various techniques to arrive at an estimate of loss. First, analysis of the borrower’s overall financial condition, resources and payment record, the prospects for support from financial guarantors; and the fair market value of collateral are used to estimate the probability and severity of inherent losses. Then the migration of historical default rates and loss severities, internal risk ratings, industry and market conditions and trends, and other environmental factors are considered. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The formula allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans; including 1-4 family mortgage loans, installment loans, other consumer loans, and outstanding loan commitments. Also, the formula allowance is used for the remaining pool of larger balance, non-homogeneous loans which were not allocated a specific allowance upon their review. The formula allowance begins with estimates of probable losses inherent in the homogeneous portfolio based upon various statistical analyses. These include analysis of historical and peer group delinquency and credit loss experience, together with analyses that reflect current trends and conditions. We also consider trends and changes in the volume and term of loans, changes in the credit process and/or lending policies and procedures, and an evaluation of overall credit quality. The formula allowance uses a historical loss view as an indicator of future losses. As a result, even though this history is regularly updated with the most recent loss information, it could differ from the loss incurred in the future. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowances. In addition, an unallocated reserve is maintained to recognize the imprecision in estimating and measuring inherent losses on individual loans or pools of loans.

EXECUTIVE OVERVIEW

This discussion is intended to focus on certain financial information regarding Bankshares and TFB and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of our financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.

Through the merger and consolidation of other area banks, TFB has become the primary independent community bank in its immediate geographic market. TFB continually seeks to be the principal financial service provider for its market area by providing high quality customer service, efficient technological support, value-added products, and a strong commitment to the community.

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Net income of $1.31 million for the quarter ended March 31, 2005 was a 22.5% increase from the March 2004 quarter net income of $1.07 million. The net income results were consistent with management’s internal projections. Bankshares and TFB have continued to experience growth across all of the primary operating businesses; specifically, commercial and retail lending, deposit accounts and core deposits, and assets under WMS management. During the first quarter of 2003, TFB modified its loan pricing strategies and expanded its loan product offerings in an effort to increase lending activity without sacrificing the existing credit quality standards. The result of this effort has been an 11.3% and 36.9% increase in net loan outstandings from March 31, 2004 to March 31, 2005, and March 31, 2003 to March 31, 2004, respectively. Total deposits increased 13.4% and 20.8% from March 31, 2004 to March 31, 2005, and March 31, 2003 to March 31, 2004, respectively. WMS assets under management grew to $241.6 million, or an increase of 10%, from March 31, 2004 to March 31, 2005, and 39% from March 31, 2003 to March 31, 2004.

Management continues the expansion of its branch network into western Prince William County, having signed a lease for a full service branch in Haymarket, Virginia, scheduled to open in 2006. Additionally, TFB seeks to add to its branch network in western Prince William County, as well as Fauquier County, looking toward these new retail markets for growth in deposits and WMS income. Management also seeks to increase the level of its fee income from deposits and WMS through the increase of its market share within its current marketplace. During the March 2005 quarter, the structure of the WMS division was realigned to better serve customers’ trust, asset management and investment needs.

COMPARISION OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND MARCH 31, 2004

NET INCOME. Net income for the three months ended March 31, 2005 was $1.31 million or $0.37 per diluted share compared with $1.07 million or $0.30 per diluted share for the three months ended March 31, 2004. The $240,000 or 22.5% increase in net income for the quarter was fundamentally in-line with management expectations.

NET INTEREST INCOME. Net interest income increased $470,000 or 11.5% to $4.55 million for the three months ended March 31, 2005 compared with $4.08 million for the three months ended March 31, 2004. The increase in net interest income resulted from increased interest and fee income on loans as a result of the increase in volume of loans outstanding. The net interest margin, computed on a tax equivalent basis, for the March 2005 quarter was 4.57%, compared with 4.55% for the same quarter one year earlier. Average interest-earning assets grew 11.8% to $404.9 million for the first quarter of 2005 compared with $362.2 million for the first quarter of 2004. The yield on average interest-earning assets was 5.90% for the March 2005 quarter compared with 5.67% for the March 2004 quarter. Total interest income increased $778,000 or 15.2% to $5.89 million for the three months ended March 31, 2005, compared with $5.11 million for the three months ended March 31, 2004, as a result of the growth in the volume of interest-earning assets and in the average rate of interest earned. Interest and dividends on investment securities increased $171,000 or 44.7%. Investment securities averaged $57.3 million for the first quarter of 2005 compared with $50.8 million for the same quarter one year earlier. The yield on investment securities was 3.87% on a tax equivalent basis for the first quarter of 2005, compared with 3.07% for the first quarter of 2004. Interest and fees on loans increased $605,000 or 12.8% to $5.33 million for the March 2005 quarter compared with the same quarter one year earlier. Average loans outstanding totaled $346.5 million and earned 6.22% on a tax-equivalent basis for the quarter ended March 31, 2005, compared with $304.2 million and 6.23%, respectively, for the quarter ended March 31, 2004.

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Total interest expense increased $308,000 or 30.1% to $1.33 million for the three months ended March 31, 2005 from $1.02 million for the three months ended March 31, 2004. Average interest-bearing liabilities grew 10.5% to $321.9 million for the first quarter of 2005 compared with $291.4 million for the first quarter of 2004, while the average cost on interest-bearing liabilities increased to 1.67% from 1.40% for the same respective time periods. The increase in total interest expense and the average cost of interest-bearing liabilities is primarily due to the overall increase in short-term interest rate environment, as well as the growth in the high balance, premium interest rate NOW account product first offered in March 2003. The average balance for the premium interest rate NOW account was $47.4 million with an average cost of 2.21% for the three months ending March 31, 2005, compared with $10.2 million with an average cost of 2.24% for the same three months in 2004. Average certificates of deposit balances for the first quarter of 2005 were $81.5 million at an average cost of 2.77%, compared with $77.6 million at an average cost of 2.47% for the same quarter one year earlier. Interest-bearing NOW account deposits averaged $59.6 million at an average cost of 0.13% for the March 2005 quarter, compared with $55.1 million at an average cost of 0.15% for the March 2004 quarter. Interest-bearing money market deposits averaged $64.1 million at an average cost of 1.08% for the quarter ended March 31, 2005, compared with $67.7 million at an average cost of 0.82% for the same quarter one year earlier. Savings account deposits averaged $42.5 million at an average cost of 0.34% for the March 2005 quarter, compared with $40.3 million at an average cost of 0.37% for the March 2004 quarter. Average FHLB of Atlanta advances were $18.7 million at an average cost of 4.35% for the first quarter of 2005, and $26.2 million at an average cost of 3.19% one year earlier.

Net interest income is the largest component of net income, and equals the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from nonperforming assets, the amount of prepaying loans, the mix and amount of various deposit types, and many other factors, as well as the overall volume of interest-earning assets. These factors are individually difficult to predict, and when taken together, the uncertainty of future trends compounds. Based on management’s current projections, net interest income may increase in 2005 and beyond as average interest-earning assets increase, but this may be offset in part or in whole by a possible contraction in TFB’s net interest margin resulting from competitive market conditions. Additionally, TFB’s balance sheet is positioned for a stable or rising interest rate environment. This means that net interest income is projected to increase if market interest rates rise, and decrease if market interest rates fall, all other things being equal. The specific nature of TFB’s variability in net interest income due to changes in interest rates, also known as interest rate risk, is to a large degree the result of TFB’s deposit base structure. During the first quarter of 2005, demand deposits, non-premium interest rate NOW accounts, and savings deposits averaged 22.2%, 15.7%, and 11.2% of total average deposits, respectively, while the more interest-rate sensitive time certificates of deposit and premium interest rate NOW account averaged 21.5 and 12.5% of total average deposits, respectively.

The following table sets forth information relating to Bankshares’ average balance sheet and reflects the average yield on assets and the average annualized cost of liabilities for the three month periods ended March 31, 2005 and 2004. These yields and costs are derived by annualizing the income or expense for the periods presented, and dividing the product of the annualization by the respective average daily balances of assets and liabilities for the periods presented.

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AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)

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RATE/VOLUME ANALYSIS

The following table sets forth certain information regarding changes in interest income and interest expense of Bankshares for the three month periods ended March 31, 2005 and 2004. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to changes in volume (change in volume multiplied by the prior period rate); and changes in rate (change in rate multiplied by the prior period volume). Changes which cannot be separately identified are allocated proportionately between changes in volume and changes in rate.

RATE / VOLUME VARIANCE
(In Thousands)

The monitoring and management of net interest income is the responsibility of TFB’s Asset and Liability Management Committee (“ALCO”). ALCO meets no less than once a month, and is comprised of TFB’s senior management.

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PROVISION FOR LOAN LOSSES. The provision for loan losses was $125,000 and $154,000 for the three months ended March 31, 2005 and 2004, respectively. The respective amounts of the provision for loan losses were determined based upon management’s continual evaluation of the adequacy of the allowance for loan losses, which encompasses the overall risk characteristics of the loan portfolio, trends in TFB’s delinquent and non-performing loans, estimated values of collateral, and the impact of economic conditions on borrowers. There can be no assurances, however, that future losses will not exceed estimated amounts, or that additional provisions for loan losses will not be required in future periods. Please refer to the section entitled “Critical Accounting Policies: Allowance for Loan Losses” above for an explanation of the allowance methodology.

TOTAL OTHER INCOME. Total other income increased by $4,000 or 0.3% from $1.258 million for the three months ended March 31, 2004 to $1.262 million for the three months ended March 31, 2005. Wealth management income decreased $7,000 to $318,000 for the March 2005 quarter compared with $325,000 for the same quarter one year earlier. Management seeks to increase the level of its future fee income from WMS through the increase of its market share within its marketplace. WMS fees are projected to stabilize during the remainder of 2005 and 2006, and show more moderate growth over the longer term. Service charges on deposit accounts increased $43,000, or 7.1% to $641,000 for the quarter ended March 31, 2005, compared with $599,000 for the same quarter one year earlier. Management had projected deposits on service charges to increase at approximately one-half the rate of growth in average transaction account deposits, which grew 16.6% from the March 2004 quarter to the March 2005 quarter. The impact of Check 21 legislation on deposit account service charges during the remainder of 2005 is difficult to predict. Signed by President Bush on October 28, 2003 and effective October 28, 2004, the Check Clearing for the 21st Century Act (“Check 21”) is designed to facilitate check truncation by authorizing substitute checks, to foster innovation in the check collection system without mandating receipt of checks in electronic form, and to improve the overall efficiency of the nation’s payments system. Over the long term, Check 21 may reduce service charges on transaction deposit accounts, but may also reduce related operational expenses to an equal and possibly, greater amount. Income on other service charges, commission and fees decreased $39,000 or 11.6% to $295,000 for the quarter ended March 31, 2005 compared with $334,000 one year earlier due to TFB’s sale its portfolio of merchant card customers during the first quarter of 2004. The result of this sale was the reduction of service charge income of approximately $90,000 per quarter, offset by an approximate $90,000 per quarter reduction in merchant card operating expenses.

TOTAL OTHER EXPENSES. Total other expenses increased 3.9% or $142,000 to $3.82 million for the three months ended March 31, 2005, compared with $3.68 million for the three months ended March 31, 2004. The growth in other expenses was slightly less than management’s internal projections of 5% to 6% growth. Salary and benefit expenses increased $171,000, or 9.1% from the March 2004 quarter to the March 2005 quarter. The primary cause for the growth in salary and benefit expense was the increase of full-time equivalent employees from 132 at March 31, 2004 to 137 at March 31, 2005, as well as increases in the defined-benefit pension plan and medical insurance expense, and customary annual salary increases. The growth in full-time equivalent employees primarily reflects the May 2004 opening of the Bealeton branch and the growth in lending. Net occupancy expenses increased $21,000 or 10% from the March 2004 quarter to the March 2005 quarter reflecting the occupancy expenses of the Bealeton branch that were absent in the beginning of 2004. Furniture and equipment expenses increased $18,000 or 6.0% over the same time period, reflecting the increase in computer software depreciation and related maintenance contracts. The $68,000 or 5.3% decline in other operating expenses primarily reflects the approximate $90,000 per quarter reduction in merchant card operating expenses previously discussed in “TOTAL OTHER INCOME.” In addition, TFB completed the renegotiation of its contract with its data processing service provider effective July

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2004. This renegotiated contract is projected to reduce TFB’s operating expenses by approximately $250,000 annually through 2009. These decreases in other operating expenses were partially offset by an increase in legal and accounting fees that can be primarily attributed to meeting the requirements of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”).
 
Management expects the costs associated with Sarbanes-Oxley compliance to increase during the remainder of 2005 in connection with implementing the requirements of Section 404 regarding Management’s Report on Internal Controls. Bankshares projects that the aggregate market value of its common stock held by non-affiliates will reach the $75 million as of June 30, 2005, and that it will therefore be required to comply with Section 404 for December 31, 2005. TFB expects salary and benefits to continue to be its largest other expense. As such, the most important factor with regard to potential changes in other expenses is the expansion of staff. The cost of any additional staff expansion, however, would be expected to be offset by the increased revenue generated by the additional services that the new staff would enable TFB to provide. For the remainder of 2005, TFB projects to increase staff from its current levels by approximately five full-time equivalent personnel.

COMPARISON OF MARCH 31, 2005 AND DECEMBER 31, 2004 FINANCIAL CONDITION

Assets totaled $447.4 million at March 31, 2005, an increase of 4.2% or $18.2 million from $429.2 million at December 31, 2004. Balance sheet categories reflecting significant changes include cash and due from banks, loans, federal funds sold, and deposits. Each of these categories is discussed below.

CASH AND DUE FROM BANKS. At March 31, 2005, cash and due from banks totaled $16.6 million, reflecting an increase of $7.6 million from $8.9 million at December 31, 2004. The increase in cash and due from banks was the result of temporarily increasing TFB’s deposits with the Federal Reserve Bank of Richmond in order to satisfy reserve requirements.

LOANS. Net loans were $344.0 million at March 31, 2005, which is an increase of $6.2 million or 1.8% from $337.8 million at December 31, 2004. The growth in total loans is primarily attributable to an increase of $7.9 million in commercial and industrial loans and an increase of $4.5 million in mortgage loans collateralized by 1-to-4 family residential real estate, partially offset by a $3.1 million decrease in mortgage loans collateralized by non-residential real estate. TFB’s loans are made primarily to customers located within TFB’s primary market area. During 2003, TFB modified its loan pricing strategies and expanded its loan product offerings in an effort to increase lending activity without sacrificing existing credit quality standards. This change in pricing strategy was the primary reason for the increase in loans outstanding over the last 24 months. Management will continue to utilize the same pricing strategies for the remainder of 2005, but due to competitive pricing below TFB’s rate of return targets, total loan originations may decrease when compared with 2003 and 2004, particularly in the category of 1-to-4 family first mortgage loans.

FEDERAL FUNDS SOLD. Federal funds sold were $7.3 million at March 31, 2005, compared to federal funds sold of $0.1 million at December 31, 2004.

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DEPOSITS. At March 31, 2005, total deposits were $385.6 million, reflecting an increase of $11.0 million or 2.9% from $374.7 million at December 31, 2004. The growth was attributable to growth in noninterest-bearing deposits, which increased $11.2 million, partially offset by a $0.25 million decline in interest-bearing deposits. TFB expects to increase its deposits in 2005 and beyond through the continued expansion of its branch network, as well as by offering value-added demand deposit products, and selective rate premiums on interest-bearing deposits.

ASSET QUALITY

Non-performing assets, in most cases, consist of loans that are 90 days or more past due and for which the accrual of interest has been discontinued. Management evaluates all loans that are 90 days or more past due, as well as loans that have suffered financial distress, to determine if they should be placed on non-accrual status. Factors considered by management include the estimated value of collateral, if any, and other resources of the borrower that may be available to satisfy the delinquency. Non-performing assets totaled $378,000 or 0.11% of total loans at March 31, 2005, as compared with $183,000, or 0.05% of total loans at December 31, 2004, and $1.03 million, or 0.33% of total loans at March 31, 2004. The provision for loan losses was $125,000 for the first three months of 2005 compared with $154,000 for the first three months of 2004. The 18.9% decrease in the provision for loan losses from first quarter 2004 to first quarter 2005 was largely in response to the decline in non-performing assets, partially offset by the growth in new loan originations during the last 12 months. Loans that are 90 days past due and accruing interest totaled $271,000 and $162,000 at March 31, 2005 and December 31, 2004, respectively. No loss is anticipated on these loans based on the value of the underlying collateral and other factors. There are no loans, other than those disclosed above as either non-performing or impaired, where known information about the borrower has caused management to have serious doubts about the borrower’s ability to repay the loan. There are also no other interest-bearing assets that would be subject to disclosure as either non-performing or impaired if such interest-bearing assets were loans. The largest concentrations of loans to borrowers engaged in similar activities are $25.4 million for hotel/motel/inn loans, $24.2 million for land development loans, and $11.1 million for child care facility loans. These three loan concentrations represent 7.3%, 6.9%, and 3.2% of total loans, respectively.

CONTRACTUAL OBLIGATIONS

As of March 31, 2005, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in “Management’s Discussion and Analysis” in Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2004.

OFF-BALANCE SHEET ARRANGEMENTS

As of March 31, 2005, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis” in Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2004.

CAPITAL RESOURCES

Total shareholders’ equity was $32.5 million at March 31, 2005 compared to $31.9 million at December 31, 2004, an increase of $0.6 million, or 2.0%. The increase in the accumulated other comprehensive loss component of shareholders’ equity from December 31, 2004 to March 31, 2005 reduced shareholders’ equity by $0.5 million or 1.6%.

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Bankshares’ shareholders’ equity was reduced $10,000 due to the repurchase of 397 shares of common stock at an average cost of $24.71 during the first three months of 2005. In addition, 30,926 shares of Bankshares’ common stock were newly issued at an average price of $8.64 in connection with stock option exercises under Bankshares’ stock option plans during the first three months of 2005 for a total addition to shareholders’ equity of $267,000. During July 2004, Bankshares instituted a voluntary dividend reinvestment plan (“DRIP”) through which shareholders may purchase shares of common stock through the automatic reinvestment of their dividends. Additionally through the DRIP, shareholders are also given the opportunity to purchase additional shares of common stock up to specified dollar amount limits. The DRIP may either buy existing shares in the open market, or issue newly outstanding shares in order to fulfill its reinvestment needs. Bankshares currently has registered 250,000 shares of common stock for issuance under the DRIP. For the quarter ending March 31, 2005, Bankshares issued 1,374 newly outstanding shares through the DRIP at an average price of $24.72 for a total addition to shareholders’ equity of $34,000.

Banking regulations have established minimum capital requirements for financial institutions, including risk-based capital ratios and leveraged ratios. Under these guidelines, the $4.0 million of capital securities issued by Bankshares’ subsidiary trust are treated as Tier 1 capital for purposes of the Federal Reserve’s capital guidelines for bank holding companies, as long as the capital securities and all other cumulative preferred securities of Bankshares together do not exceed 25% of Tier 1 capital. At both March 31, 2005 and December 31, 2004, Bankshares and TFB exceed their minimum regulatory capital ratios. The following table sets forth the regulatory capital ratio calculation for Bankshares:

REGULATORY CAPITAL RATIOS

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