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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED March 31, 2004

COMMISSION FILE NUMBER 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

(804) 435-1171

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days    x  yes    ¨  no

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    ¨  yes    x  no

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 2,331,918 shares of common stock on March 31, 2004.

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FORM 10-Q

For the interim period ending March 31, 2004.

INDEX

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PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS.

Bay Banks of Virginia, Inc.

Consolidated Balance Sheets

See Notes to Consolidated Financial Statements.

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Bay Banks of Virginia, Inc.

Consolidated Statements of Income (unaudited)

See Notes to Consolidated Financial Statements.

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Bay Banks of Virginia, Inc.

Consolidated Statements of Cash Flows (unaudited)

See Notes to Financial Statements.

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Bay Banks of Virginia, Inc.

Consolidated Statement of Changes in Shareholders’ Equity

(unaudited)

See Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

Note 1:

Bay Banks of Virginia, Inc. (the “Company”) owns 100% of the Bank of Lancaster (the “Bank”) and 100% of Bay Trust Company of Virginia, Inc. (the “Trust Company”). The Consolidated Financial Statements include the accounts of the Bank, the Trust Company, and Bay Banks of Virginia.

The accounting and reporting policies of the registrant conform to accounting principles generally accepted in the United States of America and to the general practices within the banking industry. However, in management’s opinion, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements have been reclassified to conform to current year presentations.

These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the registrant’s 2003 Annual Report to Shareholders.

As of March 31, 2004, the Company has four stock-based compensation plans. The Company accounts for the plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. No stock-based compensation cost is reflected in net income, as all options granted under these plans had an exercise price equal to market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share for the three months ended March 31, 2004 and 2003 if the Company had applied fair value recognition provisions of FASB No. 123, Accounting for Stock-Based Compensation.

Note 2: Securities

The carrying amounts of debt and other securities and their approximate fair values at March 31, 2004, and December 31, 2003, follow:

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Securities with a market value of $10.8 million were pledged as collateral for public deposits, repurchase agreements and for other purposes as required by law as of March 31, 2004. The market value of pledged securities at year-end 2003 was $12.3 million.

Note 3: Loans

The components of loans were as follows:

Loans upon which the accrual of interest has been discontinued totaled $1,377 thousand as of March 31, 2004, and $269 thousand as of December 31, 2003.

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Note 4: Allowance for Loan Losses

An analysis of the change in the allowance for loan losses follows:

Note 5: Earnings per share

The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock.

As of March 31, 2004, and March 31, 2003, options on 74,308 shares and 103,410 shares, respectively, were not included in computing diluted earnings per share, because their effects were anti-dilutive.

Note 6: Unidentifiable Intangibles

The Company has unidentifiable intangibles recorded on the consolidated financial statements relating to the purchase of five branches. The balance of the intangibles at March 31, 2004, as reflected on the consolidated balance sheet, was $2,807,842. Management has determined that these purchases qualified as acquisitions of businesses, and therefore discontinued amortization, effective January 1, 2002. Based on management’s assessment, there is no impairment in value at March 31, 2004.

Note 7: Employee Benefit Plans

Components of Net Periodic Benefit Cost

Quarter ended March 31, 2004 (unaudited)

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Employer Contributions

The Company previously disclosed in its Annual Report on Form 10-K its consolidated financial statements for the year-ended December 31, 2003, that it expected to contribute $771,589 to its pension plan and $27,843 to its post-retirement benefit plan in 2004. As of March 31, 2004, a contribution of $771,589 and $27,843, respectively, has been made. The Company presently anticipates no further contributions during the remainder of 2004.

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the results of operations and the financial condition of Bay Banks of Virginia, Inc. (the “Company”) a bank holding company. This discussion should be read in conjunction with the above consolidated financial statements and the notes thereto.

CRITICAL ACCOUNTING POLICIES

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

ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) Statement of Financial Accounting Standards (“SFAS”) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates.

The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the adequacy of the allowance is based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.

GOODWILL. In October 2003, the Financial Accounting Standards Board issued Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement amends previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the application of Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets, to branch acquisitions if such transactions meet the definition of a business combination. The provisions of the Statement do not apply to transactions between two or more mutual enterprises. In addition, the Statement amends Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and measurement provisions required for other long-lived assets held and used. The Company adopted this interpretation of Statement 147 for the intangibles associated with branch acquisitions that were executed in 1994, 1997, and 2000. The Company conducted an in-depth study of the issue and has determined that the intangibles associated with these branch acquisitions qualify as a business combination as described in Statement 141 and 142, as well as Emerging Issues Task Force Ruling 98-3.

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RECENT ACCOUNTING PRONOUNCEMENTS.

There were no new Financial Accounting Standards Board promulgations in the first quarter of 2004 that will impact Bay Banks of Virginia, Inc.

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in: interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.

Bay Banks of Virginia, Inc.

Financial Highlights (unaudited)

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EARNINGS SUMMATION

For the three months ended March 31, 2004, net income was $397 thousand as compared to $439 thousand for the comparable period in 2003, a decrease of 9.6%. Diluted earnings per average share for the first three months of 2004 were $0.17 as compared to $0.19 for the first three months of 2003. Annualized return on average assets was .5% for the first three months of 2004 as compared to .7% for the first three months of 2003, a decrease of 28.6%. Annualized return on average equity was 6.3% for the first three months of 2004, compared to 7.0% for the first three months of 2003, a decrease of 10.0%.

The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest earning assets. Changes in the volume and mix of interest earning assets and interest bearing liabilities, the associated yields and rates, and the volume of non-performing assets have a significant impact on net interest income, the net interest margin, and net income. The annualized net interest margin was 3.66% as of March 31, 2004 compared to 3.74% for the same period in 2003 for a decrease of 2.1%.

Net interest income before provision for loan losses for the first three months of 2004 was $2.3 million, compared to $2.1 million for the first three months of 2003, an increase of $195 thousand or 9.1%. Increases in net interest income were driven by loan growth (changes in volume) during the first quarter of 2004. Average interest-earning assets totaled $266.2 million for the first three months of 2004 as compared to $238.5 million for the first three months of 2003, an increase of 11.6%. Average interest-earning assets as a percent of total average assets was 91.0% for the first three months of 2004 as compared to 89.7% for the comparable period of 2003, an increase of 1.4%. The annualized yield on average interest-earning assets for the first three months of 2004 was 5.26% as compared to 5.87% for the first three months of 2003, a decrease of 10.4%.

As loan volumes continue to increase, the Company will realize increasing net interest income based upon these increases. These increases are incremental however, as the increase in yield on new loan volume which is replacing Federal Funds Sold, is partially offset by the decline in investment yields. Management expects loan growth to continue to improve throughout 2004, in which case net interest income will continue to improve. In addition, as the investment portfolio management continues, yields on this asset should also improve, thereby further improving net interest income.

Average interest-bearing liabilities totaled $227.3 million for the first three months of 2004 as compared to $212.2 million for the first three months of 2003, an increase of 7.1%. The annualized yield (cost) on interest-bearing liabilities for the first three months of 2004 was 1.88% as compared to 2.39% for the first three months of 2003, a decrease of 21.3%.

The net interest spread, which is the difference between the annualized yield on earning assets and the annualized rate on interest bearing liabilities was 3.38% at quarter end 2004 and 3.48% at quarter end 2003. This represents a reduction in net interest spread of 10 basis points or 2.9%.

Average total assets for the first three months of 2004 were $292.7 million as compared to $266.0 million for the first three months of 2003, an increase of 10.0%.

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Throughout 2003, the Company experienced significant compression in its net interest margin and consequently its net interest income. As the general rate environment reached historic lows during the fourth quarter of 2002 and throughout 2003, the Company experienced heavy volumes of loan prepayments as consumers fled adjustable rate mortgages for conventional 30 year fixed rate loans. These conventional mortgages are not held in the Company’s portfolio, but rather, are sold into the secondary market on an individual loan by loan basis. The sale of these loans creates fee income at the time of sale, but reduces the Company’s expected future cash flow from interest income and principal repayment. Fortunately, while record numbers of loans were being paid off into the secondary market, record numbers of new loans were being generated for the Company’s loan portfolio.

However, as the historically low interest rate environment continues to persist, the new loan volume that is being placed in the Company’s loan portfolio is at significantly lower rates than those that were paid off and re-financed into conventional secondary market mortgages during 2003. The first quarter of 2004 has resulted in very strong loan growth. This growth has resulted in increases in net interest income through volume rather than rate. The vast majority of loans being recorded are adjustable and variable rate loans which will re-price upwardly when the interest rate market becomes less accommodative. The balance sheet of the Company is slightly asset sensitive as of quarter end 2004 and is therefore well positioned for a rising rate environment. In contrast, a continuing accommodative interest rate policy will result in further compression in the interest income of the Company.

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Bay Banks of Virginia, Inc.

Net Interest Income Analysis (unaudited)