| FAUQUIER BANKSHARES INC ITEM 1A RISK FACTORS Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate |
| We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels |
| Recently enacted, proposed and future banking legislation and regulations have had, will continue to have, or may have a significant impact on the financial services industry |
| These regulations, which are intended to protect depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably and can be expected to influence our earnings and growth |
| Our success depends on our continued ability to maintain compliance with these regulations |
| Failure to comply with existing or new laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have an adverse effect on our business, financial condition and results of operations |
| Regulatory changes may increase our costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products and thus place other entities that are not subject to similar regulation in stronger, more favorable competitive positions, which could adversely affect our growth |
| - 10 - _________________________________________________________________ Efforts to comply with the Sarbanes-Oxley Act will involve significant expenditures, and non-compliance with the Sarbanes-Oxley Act may adversely affect us |
| The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that apply to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices |
| We have experienced, and we expect to continue to experience, greater compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act |
| For example, by December 31, 2006 we may be required to comply with Section 404 of the Sarbanes-Oxley Act and issue a report on our internal controls |
| We expect these new rules and regulations to continue to increase our accounting, legal and other costs, and to make some activities more difficult, time consuming and costly |
| In the event that we are unable to comply with the Sarbanes-Oxley Act and related rules, we may be adversely affected |
| We depend on the services of our key personnel, and a loss of any of those personnel would disrupt our operations and result in reduced revenues |
| Our success depends upon the continued service of our senior management team and upon our ability to attract and retain qualified financial services personnel |
| Competition for qualified employees is intense |
| In our experience, it can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy |
| If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition, results of operations and cash flows could be materially adversely affected |
| We may incur losses if we are unable to successfully manage interest rate risk |
| Our profitability will depend in substantial part upon the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities |
| We may selectively pay above-market rates to attract deposits as we have done in some of our marketing promotions in the past |
| We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it |
| Our net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments |
| An increase in interest rates could adversely affect borrowers’ ability to pay the principal or interest on existing loans or reduce their desire to borrow more money |
| This may lead to an increase in our nonperforming assets or a decrease in loan originations, either of which could have a material and negative effect on our results of operations |
| Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally |
| Fluctuations in market rates are neither predictable nor controllable and may have a material and negative effect on our business, financial condition and results of operations |
| We may be adversely affected by economic conditions in our market area |
| Our marketplace is primarily in Fauquier and western Prince William Counties in northern Virginia |
| Many, if not most, of our customers live and/or work in the greater Washington, DC metropolitan area |
| Because our lending, deposit gathering, and wealth management services are concentrated in this market, we are affected by the general economic conditions in the greater Washington area |
| Changes in the economy may influence the growth rate of our loans and deposits, the quality of our loan portfolio and loan and deposit pricing and the performance of our wealth management business |
| A significant decline in economic conditions caused by inflation, recession, unemployment or other factors beyond our control could decrease the demand for banking products and services generally and/or impair the ability of existing borrowers to repay their loans, which could negatively affect our financial condition and performance |
| In recent years, there has been a proliferation of technology and communications businesses in our market area |
| Although we do not have significant credit exposure to these businesses, a downturn in these industries could have a negative impact on local economic conditions and real estate collateral values generally, which could negatively affect our profitability |
| In addition, a downturn in Washington-based federal government employment could have a negative impact on local economic conditions and real estate collateral values, and could also negatively affect our profitability |
| - 11 - _________________________________________________________________ We have a high concentration of loans secured by real estate and a downturn in the real estate market, for any reason, may increase our credit losses, which would negatively affect our financial results |
| We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans |
| At December 31, 2005, approximately 40prca and 31prca of our dlra381 million loan portfolio were secured by post-construction residential and commercial real estate, respectively, with construction loans representing an additional 7prca of our loans secured by real estate |
| Changes in the real estate market, such as deterioration in market value of collateral, or a decline in local employment, could adversely affect our customers’ ability to pay these loans, which in turn could impact our profitability |
| If the value of real estate serving as collateral for the loan portfolio were to decline materially, a significant part of the loan portfolio could become under-collateralized |
| If the loans that are secured by real estate become troubled when real estate market conditions are declining or have declined, in the event of foreclosure, we may not be able to realize the amount of collateral that we anticipated at the time of originating the loan |
| In that event, we might have to increase the provision for loan losses, which could have a material adverse effect on our operating results and financial condition |
| If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected |
| We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio |
| Through periodic review of our loan portfolio, we determine the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our customers relative to their financial obligations with us |
| The amount of future losses is susceptible to changes in economic and other market conditions, including changes in interest rates and collateral values that are beyond our control, and these future losses may exceed our current estimates |
| Rapidly growing loan portfolios are, by their nature, unseasoned |
| As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios |
| Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future |
| Excessive loan losses could have a material impact on our financial performance |
| Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management |
| Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results |
| Our future success is dependent on our ability to compete effectively in the highly competitive banking industry |
| The Northern Virginia and the greater Washington, DC metropolitan area in which we operate is considered highly attractive from an economic and demographic viewpoint, and is therefore a highly competitive banking and mortgage banking market |
| We face vigorous competition from other banks and other financial service institutions in our market area |
| A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, larger lending limits, wider branch networks, and larger marketing budgets |
| To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable financing than we can |
| Many of our non-bank competitors are not subject to the same extensive regulations and/or tax laws that govern us |
| As a result, these non-bank competitors have advantages over us in providing certain services |
| Failure to compete effectively to attract new customers and retain/or retain existing customers may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition |
| - 12 - _________________________________________________________________ If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable |
| This could negatively affect our performance and the value of our common stock |
| Our business strategy calls for continued growth |
| We anticipate that we will be able to support our growth strategy primarily through the generation of retained earnings |
| However, we may need to raise additional capital in the future to support our growth and to maintain our capital levels |
| Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time, and we may not be able to obtain additional capital when needed on terms that are satisfactory to us |
| Our growth may be constrained if we are unable to raise additional capital as needed |
| The Bank’s ability to pay dividends is subject to regulatory limitations which may affect our ability to pay its obligations and pay dividends |
| The Company is a separate legal entity from the Bank and its subsidiaries and does not have significant operations which generate cash |
| We currently depend on the Bank’s cash and liquidity, transferred to the Company as dividends from the Bank, to pay the Company’s operating expenses and dividends to shareholders |
| No assurance can be made that in the future the Bank will have the capacity to pay the necessary dividends or that the Company will not require dividends from the Bank to satisfy the Company’s obligations |
| The availability of dividends from the Bank is limited by various statutes and regulations |
| It is possible, depending upon the financial condition of the Company and other factors, that the state and/or federal bank regulators could assert that payment of dividends or other payments by the Bank are an unsafe or unsound practice |
| In the event the Bank is unable to pay sufficient dividends to the Company, the Company may not be able to service its obligations as they become due, or pay dividends on the Company’s common stock |
| Consequently, the inability to receive dividends from the Bank could adversely affect our financial condition, results of operations, cash flows and prospects |
| Our recent operating results may not be indicative of our future operating results |
| We may not be able to sustain our historical rate of growth and may not even be able to grow our business at all |
| If we continue to expand, it will be difficult for us to generate similar earnings growth |
| Consequently, our historical results of operations are not necessarily indicative of our future operations |
| Various factors, such as economic conditions, regulatory and legislative considerations and competition may also impede our ability to expand our market presence |
| If we experience a significant decrease in our rate of growth, our results of operations and financial condition may be adversely affected because a high percentage of our operating costs are fixed expenses |
| If we cannot maintain our corporate culture as we grow, our business could be harmed |
| We believe that a critical contributor to our success has been our corporate culture, which focuses on building personal relationships with our customers |
| As our organization grows, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture |
| This could negatively impact our future success |