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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K

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X   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

      EXCHANGE ACT OF 1934

       For the fiscal year ended December 31, 2004

OR

    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

      EXCHANGE ACT OF 1934

        For the transition period from _______ to _______

Commission file number 0-50576

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CITIZENS BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (434) 292-7221

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Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.50 Par Value

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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 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 voting stock held by non-affiliates was $44,508,380 on June 30, 2004.

The number of outstanding shares of Common Stock as of the latest practicable date was 2,440,750 as of March 23, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement to be distributed to shareholders for the 2005 Annual Meeting of Shareholders scheduled to be held on May 18, 2005.

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TABLE OF CONTENTS

PART I

Page

ITEM 1.

BUSINESS

 4

ITEM 2.

PROPERTIES

 13

ITEM 3.

LEGAL PROCEEDINGS

 13

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE

OF SECURITY HOLDERS

 13

PART II

ITEM 5.

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED

STOCKHOLDER MATTERS AND ISSUER PURCHASES OF

EQUITY SECURITIES

 14

ITEM 6.

SELECTED FINANCIAL DATA

 15

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATION

 16

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT

MARKET RISK

 32

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 33

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS

ON ACCOUNTING AND FINANCIAL DISCLOSURE

 33

ITEM 9A.

CONTROLS AND PROCEDURES

33

ITEM 9B.

OTHER INFORMATION

34

PART III

ITEM 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 34

ITEM 11.

EXECUTIVE COMPENSATION

 34

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

34

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 34

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

34

PART IV

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

35

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PART I

ITEM 1.

 BUSINESS

General

Citizens Bancorp of Virginia, Inc. (Company) is a one-bank holding company formed on December 18, 2003 headquartered in Blackstone, Virginia.  The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (Bank).  The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System.  The Bank was incorporated in 1873 under the laws of Virginia.  Deposits are insured by the Federal Deposit Insurance Corporation.  In September 1995, the Bank became a member of the Federal Home Loan Bank of Atlanta.  

The Company’s primary activity is retail and commercial banking through its sole subsidiary - the Bank.  Financial services include commercial and consumer demand and time deposit accounts, real estate, commercial and consumer loans, online internet banking, 24-hour ATM network, brokerage services, safe deposit boxes, wire transfer services and other miscellaneous services incidental to the operation of a commercial bank.  The Bank also acts as agent for Visa and Master Card. The Bank is authorized to have a trust department, but does not offer trust services.  The Bank’s primary trade areas are served by its 9 branches located in the counties of Nottoway, Amelia, Prince Edward, and Chesterfield, Virginia. In December, 2004 the Bank received regulatory approval to open a branch in Colonial Heights, Virginia. This branch is scheduled to open in the second quarter of 2004. The location and building for the branch was acquired in December, 2004.

The Company’s primary revenue comes from retail banking in the form of interest income received on loans and investments.  This income is partially offset by the Company’s interest expense on deposits and borrowed funds, resulting in net interest income.  The Company’s earnings also come from noninterest income in the form of deposit fees, gain on the sale of investments, ATM fees, etc.  The Company’s combined noninterest income and net interest income are offset by the Company’s noninterest expense which includes employee compensation and benefits, occupancy, equipment and other operating expenses.

The Bank holds a 1.03% ownership in Bankers Investment Group, LLC which it uses as a brokerage firm for investment services.  The Bank also holds a 15.15% ownership interest in Bankers Title, LLC which it uses to sell title insurance.  The Company has an 8.06% ownership in the Davenport Community Financial Fund, LLC which seeks capital appreciation by investing substantially all of its assets in community banks located in the Midatlantic region of the United States.  The financial position and operating results of these investments are not significant to the Company as a whole and are not considered principal activities of the Company.

The Company maintains an internet website at www.greatbanksva.com which contains information relating to the business.  The Company makes available free of charge through its website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K as soon as possible after such forms have been filed with the Securities and Exchange Commission.  Copies of the Company’s Audit Committee Charter, Nominating Committee Charter and Code of Conduct are available upon written request to the Company’s Corporate Secretary.  

Employees

As of December 31, 2004, the Company employed 106 full-time equivalent employees.  The Company’s success is highly dependent on its ability to attract and retain qualified employees.  Competition in the industry is intense for employees, however the Company believes it has been successful in recruiting qualified employees and believes relations with its employees are excellent.  

Competition

The Bank competes for business with numerous other financial institutions in its various trade areas which include the counties of Nottoway, Amelia, Prince Edward, and Chesterfield, Virginia.  The Bank also serves a significant number of residents in Lunenburg County, Virginia as well as the western part of Dinwiddie County, Virginia.  The following tables reflect the Bank’s market share in its primary market places at June 30, 2004, according to information obtained from the FDIC website:

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Amelia County

Nottoway County

Prince Edward County

Credit Policies/Loan Activities

The Bank offers a full range of short to medium term commercial and consumer loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. Consumer loans may include secured and unsecured loans for financing automobiles, home improvements, education and personal investments.

Lending activities are subject to a variety of lending limits imposed by state law. While differing limits apply in certain circumstances based on the type of loan or the nature of the borrower (including the borrower’s relationship to the Bank), in general the Bank is subject to a loan-to-one borrower limit of an amount equal to 15% of its capital and surplus in the case of loans which are not fully secured by readily marketable or other permissible types of collateral. The Bank voluntarily may choose to impose a policy limit on loans to a single borrower that is less than the legal lending limit.

The Bank obtains short to medium term commercial and personal loans through direct solicitation of business owners and customers.  Completed commercial loan applications are reviewed by loan officers.  As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant.  If commercial real estate is involved, information is also obtained concerning cash flow

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after debt service.  Loan quality is analyzed based on the bank’s experience and its credit underwriting guidelines which considers appraised value, market conditions, borrower strength and collateral value.

Commercial Loans.  The Bank makes commercial loans to qualified businesses in its market area.  Commercial lending consists primarily of commercial and industrial loans to finance accounts receivable, inventory, property, plant and equipment.  Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields.  Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from his employment and other income and are secured by real estate whose value tends to be easily ascertainable.   In contrast, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself.

Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate.  To manage these risks, underwriting guidelines are required to secure commercial loans with both the assets of the borrowing business and other additional collateral and guarantees that may be available.  In addition, certain measures of the borrower are actively monitored, including advance rate, cash flow, collateral value and other appropriate credit factors.  

Residential Mortgage Loans.  The Bank’s residential mortgage loan portfolio consists of residential first and second mortgage loans, residential construction loans and home equity lines of credit and term loans secured by first and second mortgages on the residences of borrowers for home improvements, education and other personal expenditures.  Loans are made with a variety of terms, including fixed and floating or variable rates and a variety of maturities.  Maturities for construction loans generally range from 4 to 12 months for residential property and from 6 to 18 months for non-residential and multi-family properties.

Under current underwriting guidelines, residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from his/her employment and other income and are secured by real estate whose value tends to be easily ascertainable.  These loans are made consistent with the Bank's appraisal policies and real estate lending policies, which detail maximum loan-to-value ratios and maturities. Loans for owner-occupied property are generally made with a loan-to-value ratio of up to 85% for first liens.  Higher loan-to-value ratios are allowed based on the borrower’s unusually strong general liquidity, net worth and cash flow.  Loan-to-value ratios for home equity lines of credit generally do not exceed 90%.  

Construction Loans. Construction lending entails significant additional risks, compared to residential mortgage lending.  Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers.  Construction loans also involve additional risks attributable to the fact that loan funds are advanced upon the security of property under construction, which is of uncertain value prior to the completion of construction.  Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios.  To minimize the risks associated with construction lending, underwriting guidelines limit loan-to-value ratios for residential property to 85% and for non-residential property and multi-family properties to 80%, in addition to its usual credit analysis of its borrowers.  Loan-to-value ratios described above are sufficient to compensate for fluctuations in the real estate market in order to minimize the risk of loss.

Consumer Loans.  The Bank’s consumer loans consist primarily of installment loans to individuals for personal, family and household purposes.  The specific types of consumer loans that the Bank makes include home improvement loans, debt consolidation loans and general consumer lending.  Consumer loans entail greater risk than residential mortgage loans do, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  The remaining deficiency often does not warrant further substantial collection efforts against the borrower.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.  Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan such as the bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.

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The Bank’s underwriting policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful analysis of the borrower.  In evaluating consumer loans, lending officers are required to review the borrower’s level and stability of income, past credit history and the impact of these factors on the ability of the borrower to repay the loan in a timely manner.  In addition, an appropriate margin between the loan amount and collateral value is maintained.

Supervision and Regulation

General

As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended, and the examination and reporting requirements of the Board of Governors of the Federal Reserve System.  As a state-chartered commercial bank, the Bank is subject to regulation, supervision and examination by the Virginia State Corporation Commission’s Bureau of Financial Institutions.  It is also subject to regulation, supervision and examination by the Federal Reserve Board.  Other federal and state laws, including various consumer and compliance laws, govern the activities of the Bank, the investments that it makes and the aggregate amount of loans that it may grant to one borrower.

The following description summarizes the significant federal and state laws applicable to the Company and its subsidiaries.  To the extent that statutory or regulatory provisions are described, the description is qualified in its entirety by reference to that particular statutory or regulatory provision.

The Bank Holding Company Act

Under the Bank Holding Company Act, the Company is subject to periodic examination by the Federal Reserve and required to file periodic reports regarding its operations and any additional information that the Federal Reserve may require.  Activities at the bank holding company level are limited to:

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banking, managing or controlling banks;

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furnishing services to or performing services for its subsidiaries; and

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engaging in other activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities.

Some of the activities that the Federal Reserve Board has determined by regulation to be closely related to the business of a bank holding company include making or servicing loans and specific types of leases, performing specific data processing services and acting in some circumstances as a fiduciary or investment or financial adviser.

With some limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:

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acquiring substantially all the assets of any bank;

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acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or

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merging or consolidating with another bank holding company.

In addition, and subject to some exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with their regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company.  Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns a greater percentage of that class of voting securities immediately after the transaction.  The regulations provide a procedure for challenging this rebuttable control presumption.

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In November 1999, Congress enacted the Gramm-Leach-Bliley Act, which made substantial revisions to the statutory restrictions separating banking activities from other financial activities.  Under the GLBA, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become “financial holding companies.”  As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, travel agency activities, insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary to these activities.  Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLBA applies the concept of functional regulation to the activities conducted by subsidiaries.  For example, insurance activities would be subject to supervision and regulation by state insurance authorities.  Although the Company has not elected to become a financial holding company in order to exercise the broader activity powers provided by the GLBA, the Company will likely elect to do so in the future.

Payment of Dividends

The Company is a legal entity separate and distinct from its banking subsidiary.  The majority of the Company’s revenues are from dividends paid to the Company by its subsidiary.  The Bank is subject to laws and regulations that limit the amount of dividends it can pay.  In addition, both the Company and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums.  Banking regulators have indicated that banking organizations should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition.  The Company does not expect that any of these laws, regulations or policies will materially affect the ability of the Bank to pay dividends.  During the year ended December 31, 2004 the Company declared $1,736,000 in dividends payable to shareholders.  

The FDIC has the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice.  The FDIC has indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice.  

Insurance of Accounts, Assessments and Regulation by the FDIC

The deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law.  The deposits of the Bank subsidiary are subject to the deposit insurance assessments of the Bank Insurance Fund (“BIF”) of the FDIC.

The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to regulatory capital levels of the institution and other factors, including supervisory evaluations.  For example, depository institutions insured by the BIF that are “well capitalized” and that present few or no supervisory concerns are required to pay only the statutory minimum assessment of $2,000 annually for deposit insurance, while all other banks are required to pay premiums ranging from .03% to .27% of domestic deposits.  These rate schedules are subject to future adjustments by the FDIC. In addition, the FDIC has authority to impose special assessments from time to time.

The FDIC is authorized to prohibit any BIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund.  Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action.  The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital.  If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. The Company is not aware of any existing circumstances that could result in termination of any of the Bank’s deposit insurance.

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Capital Requirements

The Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises.  Under the risk-based capital requirements, the Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%.  At least half of the total capital must be composed of “Tier 1 Capital”, which is defined as common equity, retained earnings, qualifying perpetual preferred stock, and minority interest in common equity accounts of consolidated subsidiaries less certain intangibles.  The remainder may consist of “Tier 2 Capital”, which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock, a limited amount of the loan loss allowance and pretax unrealized holding gains on certain equity securities.  In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations.  Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness.  In sum, the capital measures used by the federal banking regulators are:

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the Total Capital ratio, which is the total of Tier 1 Capital and Tier 2 Capital;

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the Tier 1 Capital ratio; and

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the leverage ratio.

Under these regulations, a bank will be:

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“well capitalized” if it has a Total Capital ratio of 10% or greater, a Tier 1 Capital ratio of 6% or greater, a leverage ratio of 5% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure;

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“adequately capitalized” if it has a Total Capital ratio of 8% or greater, a Tier 1 Capital ratio of 4% or greater, and a leverage ratio of 4% or greater – or 3% in certain circumstances – and is not well capitalized;

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“undercapitalized” if it has a Total Capital ratio of less than 8% or greater, a Tier 1 Capital ratio of less than 4% - or 3% in certain circumstances, or a leverage ratio of less than 4%;

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“significantly undercapitalized” if it has a Total Capital ratio of less than 6%, a Tier 1 Capital ratio of less than 3%, or a leverage ratio of less than 3%; or

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“critically undercapitalized” if its tangible equity is equal to or less than 2% of average quarterly tangible assets.

The risk-based capital standards of the Federal Reserve Board explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy.  The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

The FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the FDIC.  These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers.  The Bank presently maintains sufficient capital to remain in compliance with these capital requirements.

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Other Safety and Soundness Regulations

There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent.  For example, under the requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise.  In addition, the “cross-guarantee” provisions of federal law required insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure.  The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds.  The FDIC’s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.

Interstate Banking and Branching

Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation.  Effective June 1, 1997, a bank headquartered in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date.  After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law.

Monetary Policy

The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve Board.  The instruments of monetary policy employed by the Federal Reserve Board include open market operations in United States government securities, changes in the discount rate on member bank borrowing and changes in reserve requirements against deposits held by all federally insured banks.  The Federal Reserve Board’s monetary policies 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 and international economy and in the money markets, as well as the effect of actions by monetary fiscal authorities, including the Federal Reserve Board, 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.

Federal Reserve System

In 1980, Congress enacted legislation that imposed reserve requirements on all depository institutions that maintain transaction accounts or nonpersonal time deposits.  NOW accounts, money market deposit accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to these reserve requirements, as are any nonpersonal time deposits at an institution.

These percentages are subject to adjustment by the Federal Reserve Board.  Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at, or on behalf of, a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets.

Transactions with Affiliates

Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act.  An affiliate of a bank is any bank or entity that controls, is controlled by or is under common control with such bank.  Generally, Sections 23A and 23B (i) limit the extent to which the Bank or its subsidiaries may engage in

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“covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the association or subsidiary as those provided to a nonaffiliate.  The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions.

Loans to Insiders

The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks.  Under Section 22(h) of the Federal Reserve Act, loans to a director, an executive officer and to a principal shareholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the bank’s loan-to-one borrower limit.  Loans in the aggregate to insiders and their related interests as a class may not exceed two times the bank’s unimpaired capital and unimpaired surplus until the bank’s total assets equal or exceed $100,000,000, at which time the aggregate is limited to the bank’s unimpaired capital and unimpaired surplus.  Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and principal shareholders of a bank or bank holding company, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting.  The FDIC has prescribed the loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000).  Section 22(h) requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.

Community Reinvestment Act

Under the Community Reinvestment Act and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice.  The Community Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs.  Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are periodically assigned ratings in this regard.  Banking regulators consider a depository institution’s Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution.  An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries.

The Gramm-Leach-Bliley Act and federal bank regulators have made various changes to the Community Reinvestment Act.  Among other changes, Community Reinvestment Act agreements with private parties must be disclosed and annual reports must be made to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a “satisfactory” rating in its latest Community Reinvestment Act examination.

Fair Lending; Consumer Laws

In addition to the Community Reinvestment Act, other federal and state laws regulate various lending and consumer aspects of the banking business.  Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers experience discrimination in their efforts to obtain loans from depository and other lending institutions.  These agencies have brought litigation against depository institutions alleging discrimination against borrowers.  Many of these suits have been settled, in some cases for material sums, short of a full trial.

Recently, these governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the

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treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity .

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations.  These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.

Gramm-Leach-Bliley Act of 1999

 The Gramm-Leach-Bliley Act of 1999 was signed into law on November 12, 1999.  The GLBA covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies.  The following description summarizes some of its significant provisions.

The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms.  It also permits bank holding companies to elect to become financial holding companies.  A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities.  In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating.

The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities.  Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in specific areas identified under the law.  Under the new law, the federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.

The GLBA adopts a system of functional regulation under which the Federal Reserve Board is designated as the umbrella regulator for financial holding companies, but financial holding company affiliates are principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates, and state insurance regulators for insurance affiliates.  It repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended.  It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker,” and a set of activities in which a bank may engage without being deemed a “dealer.”  Additionally, the GLBA makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.

The GLBA contains extensive customer privacy protection provisions.  Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information.  The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure.  An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes.  The GLBA also provides that the states may adopt customer privacy protections that are more strict than those contained in the act.

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Bank Secrecy Act

The GLBA and the Bank Secrecy Act (BSA) contain comprehensive customer privacy protection provisions.  Under these provisions, a financial institution is required to provide to its customers, at the inception of the customer relationship and annually thereafter, the Company’s policies and procedures concerning the handling of customers’ nonpublic personal financial information.  The BSA provides that, except for limited exceptions, the Company may not provide such personal information to unaffiliated third parties unless that Company discloses to its customer that such information may be so provided and the customer is given the opportunity to “opt out” of such disclosure.  The Company may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes.  The BSA also makes it a criminal offense to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means, except in limited circumstances.  

Future Regulatory Uncertainty

Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, the Company cannot forecast how federal regulation of financial institutions may change in the future and impact its operations.  Although Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, the Company fully expects that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.

ITEM 2.

     PROPERTIES

The main office of the Bank is located at 126 South Main Street, Blackstone, Virginia.  Branches are located at 101 North Main Street, Blackstone, Virginia; 1575 South Main Street, Blackstone, Virginia, 210 Carter Street, Crewe, Virginia; 102 Second Street, Northeast, Burkeville, Virginia; 9060 North Five Forks Road, Amelia, Virginia; 1517 West Third Street (Route 460 West), Farmville Virginia; 712 South Main Street, Farmville, Virginia, and 10001 Courtview Commons Lane, Chesterfield, Virginia. The future Colonial Heights branch is located at 946 Southpark Boulevard, Colonial Heights, Virginia. 

All real estate and improvements at these locations are owned by the Bank except for the real estate at the Chesterfield branch which is leased for five years renewable for five additional terms of five years each.

All of the Company’s properties are in good operating condition and are adequate for the Company’s present and anticipated future needs.

ITEM 3.

     LEGAL PROCEEDINGS

On November 19, 2004, the Company filed a lawsuit in Nottoway County Circuit Court against Mark C. Riley, its former President and Chief Executive Officer.  The Company alleges that Mr. Riley breached his contractual obligations under his employment agreement with the Company and his fiduciary obligations to the Company as its President and Chief Executive Officer.  The lawsuit seeks punitive and compensatory damages for breach of fiduciary duty by Mr. Riley, as well as a declaratory judgment that Mr. Riley breached the terms of his employment agreement with the Company, which breach would excuse the Company from its performance obligations under the agreement.  On December 14, 2004, Mr. Riley filed a separate suit against the Company in the United States District Court for the Eastern District of Virginia seeking two years’ salary and benefits under his employment agreement and punitive and compensatory damages for tortious interference with the employment agreement.  Both lawsuits are in their initial stages.

Except as set forth above, there are no other material pending legal proceedings, other that ordinary routine litigation incidental to the business, to which the Company or the Bank is a party or of which any of their property is the subject.

ITEM 4.

     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5.

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock Performance and Dividends

Shares of the Company’common stock are traded on the over-the-counter market and quoted in the OTC Bulletin Board under the symbol “CZBT.” Set forth below are the high and low sale prices of common stock as reported to management and the dividends declared during the last two years.

Market Price and Dividends

*As previously discussed, the Company changed the timing of its quarterly dividend payout in 2004 resulting in two dividend payments in the quarter ended June 30, 2004.  Prior to 2003, the Company historically paid semi-annual cash dividends.

The Company's future dividend policy is subject to the discretion of the Board of Directors and will depend on a number of factors including future earnings, liquidity, capital requirements and regulatory requirements. The Company believes its liquidity and capital resources are more than adequate to meet its cash requirements for the foreseeable future. (See Item I - Supervision and Regulation for further discussion on dividends.)

Purchases of Equity Securities

On April 21, 2004, the Company’s Board of Directors authorized a stock repurchase plan of up to 122,400 shares of the Company’s common stock.  The stock repurchase plan does not have a set expiration date.  The following table details all repurchases executed in the quarter ended December 31, 2004:

Repurchase Plan Table

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ITEM 6.

SELECTED FINANCIAL DATA

The following table sets forth selected financial data for the last five years.

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ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Management’s discussion and analysis is intended to assist the reader in evaluating and understanding the consolidated results of operations and financial condition of the Company and should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to Consolidated Financial Statements.  The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company.  

The Company conducts the general business of a commercial bank, offering traditional lending and deposit products to business and individuals.  Revenue is generated primarily from interest income received on loans, investments combined with fee income and other miscellaneous sources.  This income is primarily offset by interest paid on deposits and borrowed funds, provision for loan losses and other noninterest expenses such as salaries and employee benefits, occupancy expense and other miscellaneous expenses.

Forward Looking Statements

The Company makes forward looking statements in this annual report that are subject to risks and uncertainties.  These forward looking statements include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals.  The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward looking statements.

These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

·

the ability to successfully manage growth or to implement growth strategies if unable to identify attractive markets, locations or opportunities to expand in the future;

·

maintaining capital levels adequate to support growth;

·

maintaining cost controls and asset qualities as new branches are opened or acquired;

·

reliance on management team, including ability to attract and retain key personnel;

·

the successful management of interest rate risk;

·

changes in general economic and business conditions in market area;

·

changes in interest rates and interest rate policies;

·

risks inherent in making loans such as repayment risks and fluctuating collateral values;

·

competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·

demand, development and acceptance of new products and services;

·

problems with technology utilized by the Company;

·

changing trends in customer profiles and behavior; and

·

changes in banking and other laws and regulations.

Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements.  In addition, past results of operations do not necessarily indicate future results.

Critical Accounting Policies

The  financial  condition  and results of  operations  presented in the Consolidated Financial  Statements,  accompanying  Notes  to  the  Consolidated Financial  Statements and  management's  discussion and analysis are, to a large degree,   dependent  upon  the  accounting  policies  of the Company.  The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is a discussion of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of the Company's financial condition and results of operations.   These Critical Accounting Policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain.  In the event that different assumptions or conditions were to prevail,  and depending  upon the severity of such changes,  the  possibility of materially   different  financial  condition  or  results  

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of  operations  is  a reasonable  likelihood.  See also Note 1 of the Notes to Financial Statements for a summary of significant accounting policies.  

Allowance for Loan Losses

The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan and lease portfolio.  The Company maintains policies and procedures that address the systems of controls  over  the  following  areas  of  maintenance  of  the  allowance:  the systematic  methodology used to determine the appropriate level of the allowance to  provide  assurance they are  maintained  in  accordance  with  accounting principles  generally  accepted in the United States of America;  the accounting policies for loan charge-offs and recoveries;  the assessment and measurement of impairment in the loan and lease portfolio; and the loan grading system.

The Company evaluates various loans individually for impairment as required by Statement of Financial   Accounting Standards (SFAS) No.  114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5, Accounting for Contingencies, with a group of loans that have similar characteristics.

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

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loans and lease losses.  This estimate of losses is compared to the allowance for loan and lease losses of the Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.  The Bank recognizes the inherent imprecision in estimates of losses due to various  uncertainties and variability related to the  factors  used,  and  therefore  a  reasonable  range  around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If  different  assumptions  or  conditions  were  to  prevail  and  it is determined  that the  allowance  is not  adequate to absorb the new  estimate of probable  losses,  an additional  provision for loan losses would be made, which amount may be material to the Financial Statements.

Executive Overview

Citizens Bancorp of Virginia, Inc. reported net income of $2,474,000 in 2004, a decrease of 2.3% or $58,000 from 2003 net income of $2,532,000.  Net income on a per share basis was reported as $1.01 and $1.03 in 2004 and 2003, respectively. During 2004 the Company achieved several initiatives which included growing the loan portfolio in addition to realigning the “fixed” versus “variable” composition of loans, implementing online internet banking, continued renovations of existing branches, increasing the internal infrastructure of management to support future growth and opening its newest branch in Chesterfield, Virginia which generated $15,900,000 in loans and $2,700,000 in deposits by year end.  Despite the decline in earnings, the Company’s core earnings increased in 2004 over 2003 as discussed in the following section.

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Results of Operations

The table below lists the Company’s quarterly performance for the years ended December 31, 2004 and 2003.

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Summary

Total assets increased $11.6 million during 2004 from $269.4 million in 2003 to $281.0 million. Loans increased $22.7 million from $175.5 million at December 31, 2003 to $198.2 million at December 31, 2004.  Funding for loan growth during 2004 came primarily from a reallocation of earning assets from securities to the loan portfolio as well as from deposit growth. Total deposits were $247.0 million at December 31, 2004 , an increase of $10.6 million or 4.5% compared to $236.4 million at the end of 2003.   

Stockholders' equity increased by $378,000 during 2004, predominantly due to the retention of earnings after the declaration of $1,736,000 in cash dividends and adjustment for unrealized losses of available for sale securities.  Book value per share increased to $13.30 at December 31, 2004, from $13.10 at December 31, 2003.

The Company’s return on average assets (ROA) for 2004 was .90% compared to .94% in for 2003 while the return on average equity (ROE) was 7.59% for 2004 compared to 8.01% in 2003.  Despite the decline in key ratios and net income, the Company experienced growth in its core earnings in 2004 as  net interest income increased 6.1% and noninterest income increased 36.8% offset by an increase in noninterest expense of 10.9%.   This means that the Company realized an increase in pre-tax income of 9.1% exclusive of the loan loss provision. The Company’s improved core earnings are primarily the result of its strategies to increase the loan portfolio, controlling cost of funds on deposits and growing noninterest income.  The effects of these strategies were offset, however as a result of the following initiatives or events:

·

Increased expenses related to staffing and overhead associated with the new branch in Chesterfield, Virginia;

·

Growth in the Company’s internal infrastructure in order to provide a solid base for future growth as outlined in its strategic plan;  this growth resulted in additional investment in both the lending and operations areas;

·

Increased loan loss reserves in 2004 due to continued deterioration of two large commercial relationships;

The following table summarizes the net changes in the income statement as discussed:

Net Interest Income

Net interest income, the amount by which interest income on interest earning assets exceeds interest expense on interest bearing liabilities, is the most significant component of the Company’s earnings.  Net interest income is the function of several factors consisting of changes in the volume and composition (mix) of interest earning assets, funding sources, and market interest rates.  While management’s policies influence these factors, external forces such as customer needs and demands, competition and economic and monetary policies of the Federal Reserve Board are also contributing forces.     

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The following two tables provide information needed to understand the impact on net interest income as it relates not only to changes in average balances and mix but also as it is impacted by the combination of changes in rate and volume.  As illustrated in the tables below, net interest income increased $562,000 in 2004 which resulted in an increase in the net interest margin from 3.73% in 2003 to 3.92% in 2004.  The Company realized this increase in net interest income despite a decrease in its yield on interest earning assets by offsetting the decline in rate on interest earning assets with an increase in volume on interest earning assets resulting in a net decrease in interest income of $283,000.  The net decrease in interest income was offset by a decrease of $787,000 in interest expense due to decreased rates on interest bearing liabilities as well as a decrease of $58,000 in interest expense due to a decrease in volume, resulting in an overall increase in net interest income of $562,000 in 2004.  The following extraction from the rate and volume analysis demonstrates the net effects of the changes in net interest income from the rate and volume table:

The increase in volume on interest earning assets is primarily the result of the Company’s efforts in its strategic plan to build and realign its loan portfolio.  The decrease due to rate changes in interest bearing liabilities is primarily the result of the Company’s efforts to realign its deposit base by increasing transactional and low cost deposits while not retaining high cost time deposits.   

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21

Rate/Volume Analysis

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Noninterest Income

The Company’s noninterest income increased 36.8% to $2.0 million in 2004 compared to $1.5 million in 2003 which is an increase of $542,000.  This increase is primarily due to two factors.  In March, 2004 the Company implemented an overdraft protection program resulting in an increase of deposit fee income of 24% or $360,000 for the year.  Also, in 2004, the Company realized a decrease in the net gain on sale of OREO of $137,000.  These two events resulted in a combined increase in noninterest income in 2004 of $497,000 which represents 92% of the increase over the previous year.  The following table illustrates these changes and other changes in the main categories of noninterest income:

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The Company’s noninterest income increased $655,000 or 80% in 2003 from 2002.  This increase resulted primarily due to increases in the deposit fee structure.  As a result of competitive factors, several new service charges and fees on deposits were implemented in June 2003.  Also, in 2003, the Company realized a gain on the sale of OREO of $137,000 in addition to realizing income of $215,000 from the purchase of Bank-Owned Life Insurance.

Noninterest Expense

The Company’s noninterest expense increased 10.9% to $8.0 million in 2004 from $7.2 million in 2003.  The primary increase in noninterest expense in 2004 is due to an increase in salaries and employee benefits of $591,000 or 15.5%.  During 2004, the Company opened a new branch in Chesterfield, Virginia.  Salaries and benefits for this initiative account for more than half of this increase.  The remainder of the increase is the result of the Company’s objective to increase its internal infrastructure in order to be able to provide a solid base for future growth.

The four main components of noninterest expense and their respective increases are detailed in the table below.  

(1)  Please reference Note 10 of the Consolidated Financial Statements for the principal components of Other Expenses.

The Company’s noninterest expense increased 28.9% to $7.2 million in 2003 from $5.6 million in 2002.  Salaries and employee benefits increased 21.9% or $684,000 in 2003.  This increase in salary expense was attributed to the addition of new employees in operating and lending functions of the Company as part of the Company’s “Best Bankers” recruitment program as well as enhanced 401k and medical insurance benefits. At the beginning of 2003 the Company increased the level of flex credits available to employees to offset the rise in medical insurance premiums and to enhance employee coverage. Substantially all employees are eligible participants in the Company’s pension plan, 401K and health insurance plans.  The Company’s occupancy and equipment expense increased 39.1% or $316,000 in 2003  due to expenses related to the implementation of a new core data processing system and an updated communications system.  Other noninterest expense increased 36.9% or $617,000 in 2003 due to increases in data processing, marketing and office supplies as a result of the Company’s continued initiatives to implement new operating systems and market new products.  

The four main components of noninterest expense and their respective increases are detailed in the table below:

Provision for Income Taxes

Income before income taxes includes both taxable income and tax-exempt income, including interest on municipal securities and bank-owned life insurance.   The effective income tax rate, based on income before taxes is, therefore, lower than the statutory income tax rate of 34%.   The effective income tax rate decreased to 21.4% in 2004 from 22.9% in 2003 and 28.3% in 2002.   Income taxes for 2004 decreased to $675,000 from $751,000 in 2003 and $1.1 million in 2002 as a result of lower pre-tax net earnings and increased tax exempt income.  

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Loans

The Company uses the funds generated from deposits combined with investment sales to support its lending activities and competes aggressively for loans in its market areas.  As a result, the volume of loans increased 13.0% or $22.8 million in 2004.  (The Bank has no foreign loans.)

Loans are made predominantly to residents of the Company’s trade area.  Approximately 78% of the loan portfolio on December 31, 2004 was composed of real estate secured loans.  

The following table shows the Company’s loan distribution at the end of each of the last five years.

The Company does not engage in highly leveraged transactions.  Commitments to extend credit to customers in the normal course of business totaled $28.8 million at December 31, 2004.  (See Financial Instruments with Off-Balance Sheet Risk discussion).

The following table shows the maturities of loans outstanding as of December 31, 2004.  Also provided are the amounts due after one year classified according to the sensitivity to changes in interest rates.

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Asset Quality

The allowance for loan losses is maintained at a level that management felt was adequate after considering portfolio and economic conditions, delinquency trends, past loan loss experience, the volume of loans, as well as other factors deserving recognition.  After considering these factors, the allowance for loan losses was set at $2.7 million at year end 2004.  This compares to an allowance of $2.4 million at year end 2003.  On December 31, 2004, the allowance was 1.38% of total loans up from 1.35% one year earlier.  The provision for loan losses charged against income in 2004 was $703,000 compared to $250,000 in 2003, an increase of $453,000.  This increase in the provision for loan losses occurred primarily in the fourth quarter of 2004 as a result of the continued deterioration of two large commercial relationships.  

The following table shows the allocation of the allowance for loan losses at the dates indicated. The allocation of portions of the allowance to specific categories of loans is not intended to be indicative of future losses, and does not restrict the use of the allowance to absorb losses in any category of loans.

Allocation of Allowance for Loan Losses

Loan portfolio risks are monitored by management. A credit review of outstanding loans and loan collateral is performed by management in order to identify potential losses.   Non-accrual and impaired loans were $2,189,000 and $1,972,000 at December 31, 2004 and December 31, 2003, respectively.  It is the Company’s policy to put loans on a non-accrual basis once they are past due 90 days or more unless they are well secured and in the process of collection.

At year end 2004, management was monitoring loans considered to be impaired (under Statement 114) totaling $1,705,000, of which $829,000 are on a non-accrual status.  They are followed closely, and management at present believes the allowance for loan losses is adequate to cover anticipated losses that may be attributable to these loans.  Various forms of collateral are held as security on the loans.

A summary of non-performing assets for the past five years follows:

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Other Real Estate Owned (OREO) balances represent the lower of cost or appraised value less cost to sell of real estate acquired through foreclosure by the Company.  The Company regularly evaluates the carrying value of such assets and adjusts the balances as required.  The Company actively markets such properties to reduce potential losses and expenses related to carrying these assets.  

In 2004, charge-offs of loans, net of recoveries, were $334,000 compared to $804,000 in 2003, as illustrated in the table below.  The following table further summarizes the Company’s loan loss experience for the preceding five years:

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Investments

The Company’s purchases and sales of investments are managed in conjunction with other uses of funds, liquidity provisions, and investment market conditions. During 2004, there were realized net gains of $102,000 on investment portfolio securities due to investment sales.

The following table sets forth the carrying amount of investment in debt and equity securities at the dates indicated:

The following table sets forth the carrying amount of maturities of investment securities at December 31, 2004:

Mortgage backed securities in the amount of $8,378,000 are included in the above table based on expected weighted average maturities.

At December 31, 2004 and 2003, investment securities with a book value of $11,431,000 and $12,874,000, respectively, were pledged to collateralize public deposits and for other purposes.

All investment in debt securities are classified as available for sale and are carried at fair value adjusted for amortization of premiums and accretion of discounts.  By carrying the investment portfolio as available for sale, management has the opportunity to react to changing liquidity needs and market conditions.

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Deposits

Total deposits increased $10.6 million or 4.5% in 2004.  Higher rate Time Deposits (TDs) were allowed to flow out of the Company in order to control cost of funds and to improve the net interest income and net interest margin.  This initiative resulted in a decrease in the average balance of these higher costs deposits of $1.7 million.  As illustrated in the table below, the Company also realized increases in non-interest bearing and low cost deposit average balances of $1.6 million and $7.5 million respectively.  The combined effort of reducing high cost deposits and increasing low cost deposits resulted in decreasing interest expense in 2004 by 44 basis points or $845,000.  The Company will continue to attract new deposits based on an exceptional level of service rather than attempting to offer the highest rates in its market areas.  The average balances and rates paid on deposits for the preceding three years are shown in the table below:

Average Deposits and Rates Paid:

The Company’s time deposits with balances of $100,000 or more totaled $53.8 million at December 31, 2004, and comprised 21.8% of the Company’s total deposits.  These time deposits were maintained predominantly by long-time customers located in the Company's trade area.

Maturities of time deposit of $100,000 or more outstanding at December 31, 2004 are summarized below:

Financial Instruments with Off Balance Sheet Risk

The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments.  The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.  At December 31, 2004 and 2003, the following financial instruments were outstanding whose contract amounts represent credit risk:

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The commitments for equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines-of-credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers.  These lines-of-credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

Standby letters-of-credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Those letters-of-credit are primarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year.  The credit risk involved in issuing letters-of-credit is essentially the same as that involved in extending loan facilities to customers.  The Bank generally holds collateral supporting those commitments if deemed necessary.

Liquidity

Liquidity assesses the Company’s ability to meet financial obligations consisting of lending commitments, deposit outflows, operational expenses and contingencies that arise during the normal course of business.  Liquidity is also defined as the Company’s ability to meet the borrowing and deposit withdrawal requirements of the customers of the Company in addition to meeting current and planned expenditures.  The Company’s liquidity is derived primarily from its deposit base and equity capital and is provided through the Company’s cash, balances in correspondent banks, federal funds sold, investments maturing or repaying within one year and securities available for sale. The Company’s growth has continued to be funded primarily through these sources.  

As of December 31, 2004, approximately $68.4 million or 35% of the loan portfolio will mature or re-price within one year.   Maturities of investments in the securities portfolio are scheduled to provide a steady flow of funds to meet deposit withdrawals or loan demand.  Substantial monthly repayments on loans also provide funds for liquidity demands.   Additionally, a cash reserve is maintained, usually in the form of overnight investments in federal funds.   During 2004, the Company was a continuous seller of Federal funds in daily average amounts of $10.1 million.  

Other sources of liquidity available to the Company include its capacity to borrow additional funds when necessary.   Federal funds lines of credit are maintained with three correspondent banks however the Company did not borrow against any of these lines during 2004.  As of December 31, 2004, the Company has the following lines of credit available:

Federal Home Loan Bank of Atlanta

$41,000,000

Community Bankers Bank

  11,400,000

SunTrust

    8,000,000

Capital Resources

The Company’s principal source of capital is generated through retained earnings.  In 2004, $738,000, or 30%, of earnings were retained and added to the capital of the Company.   This percentage of retained earnings is lower than in previous years due to the Company’s transition in the timing of the quarterly payment of dividends which resulted in five quarterly dividend payouts in 2004.  Prior to 2003, the Company historically paid semi-annual cash dividends.

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Capital growth has historically benefited from a conservative dividend policy however in 2004 the dividend payout represented 70.2% of net income due to the timing of quarterly dividend payments.  The ratio of average equity to average assets was 11.86% in 2004, compared to 11.79% in 2003.   Stockholders’ equity was $32,453,129 on December 31, 2004.

The Company’s Tier I Leverage ratio was 11.6%.The Tier I risk-based capital ratio for the Company stood at 18.2% on December 31, 2004 while the Tier II or total risk-based capital ratio was 19.4%.   Both Tier I and total risk-based capital ratios at December 31, 2004 exceeded regulatory risk-based capital requirements by substantial margins and the Company continues to be well capitalized.   

Cash dividends totaling $1,736,000 were declared in 2004 which represents a payout ratio of 70.2% compared to a payout ratio of 35.8% in 2003.  It is anticipated that internally generated funds will cover any capital improvements in 2005.  The Company believes its liquidity and capital resources are more than adequate to meet its cash requirements for the foreseeable future.

Contractural Obligations as of December 31, 2004

The following table presents the Company’s contractural obligations and scheduled payments due at various intervals over the next five years and beyond:

                Payments Due by Period

Capital Expenditures

Capital expenditures were approximately $2.8 million in 2004 compared to $2.2 in 2003.  The capital expenditures in 2004 were primarily due to the expenditures associated with the opening of the Company’s new branch in 2004, the acquisition of a new branch location in Colonial Heights to be opened in the second quarter of 2005 and the Company’s continued initiative to renovate all existing branch locations.  Expenditures in 2003 were primarily due to the Company’s upgrade of its operating system including its internal network and all communications systems in addition to the Company’s initiative to renovate all branch locations.

Capital expenditures are projected to be approximately $600,000 in 2005 for the Company’s ongoing efforts to renovate all branch locations in addition to the planned opening of the new branch located in Colonial Heights, Virginia.

Inflation

In financial institutions virtually all of the assets and liabilities of the Company are monetary in nature.  As a result, interest rates have a greater impact on a bank’s performance than the effects of general levels of inflation since interest rate movement is not necessarily affected by inflation.  

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ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential risk to earnings and/or equity value due to changes in interest rates and other market conditions as they relate to the financial industry.  The Company’s market risk exposure is primarily its exposure to interest rate risk (IRR).  The measuring, monitoring and management of IRR is the responsibility of the Asset Liability Management Committee (the ALCO).  The Board of Directors of the Company has delegated responsibility for asset liability management to the ALCO whose main objectives are to manage IRR while optimizing earnings through net interest income and management of the balance sheet.  The Company uses a simulation model on a quarterly basis to measure IRR.  This model utilizes the Company’s financial data and various management assumptions and projections as they relate to growth, interest rates, noninterest income and noninterest earnings in order to forecast the interest sensitivity of the Company and its potential impact on net interest income, earnings and equity.  The model projects a “most likely” forecast which is then “shocked” with various interest rate increases and decreases in order to project the short term effects on net interest income and net income.  The model also projects the effects on the net economic value (NEV) of the Company using the same interest rate increases and decreases.  The NEV sensitivity measure is a measure of the long-term risk of the bank.  

As of December 31, 2004, the Company’s earnings sensitivity analysis indicates that the Company remains slightly asset sensitive in the near term and is exposed to declining earnings if rates fall.  This condition is common in community banks and will persist until short-term rates begin to rise in combination with shifts in the yield curve.  The Company’s NEV sensitivity analysis indicates that the Company becomes modestly liability sensitive in the long term.  Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of re-pricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net income and the effect on net income from sudden changes in interest rates.  Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.  

Summary information about the Company’s interest rate risk measures is presented below:

December 31

2004

2003

Static net prevent value change:

+200 basis point shock vs stable rate

           - 5.2%

 - 9.2%

 -200 basis point shock vs stable rate

           - 4.5%

 22.2%

1-year net income simulation projection:

+200 basis point shock vs stable rate

5.0%

  6.0%

-200 basis point shock vs stable rate

          -17.5%

-13.7%

The following static gap table illustrates the Company’s interest rate sensitivity between interest earnings assets and interest-bearing liabilities over time:

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ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are filed as a part of this report following Item 15 below:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2004 and 2003

Consolidated Statements of Income for the Years Ended December 31, 2004, 2003 and 2002

Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002

Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002

Notes to Consolidated Financial Statements

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.

CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission, including, without limitation, those controls and procedures designed to ensure that such information is accumulated and communicated to the Company’s management to allow timely decisions regarding required disclosures.

As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including the chief executive officer and chief financial officer.  Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.

The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and properly recorded.  This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel and an internal audit program to monitor its effectiveness.  There was no change in the internal control over financial reporting that occurred during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

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ITEM 9B.

OTHER INFORMATION

None.

PART III

ITEM 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.

ITEM 11.

EXECUTIVE COMPENSATION

Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.

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PART IV

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)

(1) and (2). The response to this portion of Item 15 included in Item 8 above.

(3) Exhibits.

Exhibit No.

Description

3.1

Restated Articles of Incorporation of the Company (restated in electronic format only through June 10, 2004) (filed herewith).

3.2

Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Form 8-K, filed February 6, 2004).

10.1

Employment Agreement dated as of February 14, 2005 between the Company and William E. Doyle, Jr. (filed herewith).

21.1

Subsidiary of the Company (filed herewith).

31.1

Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) (filed herewith).  

31.2

Certification of Principal Financial Officer Pursuant to Rule 13a- 14(a) (filed herewith).

32.1

Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).

32.2

Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).

(b)

Exhibits - - See Item 15(a)(3) above.

(c)

Financial Statement Schedules - - See Item 15(a)(2) above.

35

CITIZENS BANCORP OF VIRGINIA, INC.

AND SUBSIDIARY

Blackstone, Virginia

CONSOLIDATED FINANCIAL REPORT

DECEMBER 31, 2004

C O N T E N T S

Page

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

1

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated balance sheets

2

Consolidated statements of income

3

Consolidated statements of changes in stockholders’ equity

4

Consolidated statements of cash flows

5 and 6

Notes to consolidated financial statements

7-33

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Citizens Bancorp of Virginia, Inc. and Subsidiary

Blackstone, Virginia

We have audited the accompanying consolidated balance sheets of Citizens Bancorp of Virginia, Inc. and Subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 Citizens Bancorp of Virginia, Inc. and Subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

Yount, Hyde & Barbour, P.C.

Winchester, Virginia

February 2, 2005

1

2

3