| CARDINAL FINANCIAL CORP Item 1A Risk Factors Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities |
| The risk factors applicable to us are the following: Our mortgage banking revenue is sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market or higher interest rates and may adversely impact our profits |
| Our mortgage banking segment is a significant portion of our consolidated business and maintaining our revenue stream in this segment is dependent upon our ability to originate loans and sell them to investors |
| Loan production levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates |
| Generally, any sustained period of decreased economic activity or higher interest rates could adversely affect our mortgage originations and, consequently, reduce our income from mortgage banking activities |
| As a result, these conditions may adversely affect our net income |
| We have goodwill and other intangibles that may become impaired, and thus result in a charge against earnings |
| At December 31, 2005, we had dlra12dtta9 million and dlra3dtta6 million of goodwill related to the George Mason and Wilson/Bennett acquisitions, respectively |
| In addition, we have identified and recorded other intangible assets, such as customer relationships and employment agreements, as of the acquisition dates of both George Mason and Wilson/Bennett |
| The carrying amounts of these intangibles at December 31, 2005 was dlra1dtta5 million at George Mason and dlra2dtta4 million at Wilson/Bennett |
| Goodwill and other intangibles are tested for impairment on an annual basis or when facts and circumstances indicate that impairment may have occurred |
| As noted above, our mortgage banking segment is sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market and higher interest rates |
| In addition to directly impacting our revenues and net income, these conditions, if sustained, may result in an impairment charge related to the goodwill and other intangibles at George Mason if we determine the carrying value of the goodwill and other intangible assets is greater than their fair value |
| When we acquired Wilson/Bennett, it had approximately dlra225dtta0 million of assets under management |
| As of December 31, 2005, assets under management were approximately dlra169dtta0 million |
| While we anticipated an initial decline in assets under management at the time of the acquisition, significant further declines of the assets managed by Wilson/Bennett may result in an impairment condition, which would require an impairment charge if we determine the carrying value of the goodwill and other intangible assets is greater than their fair value |
| We may be adversely affected by economic conditions in our market area |
| We are headquartered in Northern Virginia, and our market is the greater Washington, DC metropolitan area |
| Because our lending and deposit-gathering activities are concentrated in this market, we will be affected by the general economic conditions in the greater Washington area, which may, among other factors, be impacted by the level of federal government spending |
| Changes in the economy, and government spending in particular, may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing |
| A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors which are beyond our control would impact these local economic conditions and the demand for banking products and services generally, and could negatively affect our financial condition and performance |
| 20 ______________________________________________________________________ We have operated at a cumulative loss since our inception |
| We have operated at a cumulative loss since our organization in 1997 |
| While we reported net income in each of the three years ended December 31, 2005, we cannot assure you that we will be able to continue to operate profitably as we continue to grow |
| We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition |
| During the last five years, we have experienced significant growth, and a key aspect of our business strategy is our continued growth and expansion |
| Our ability to continue to grow depends, in part, upon our ability to: · open new branch offices or acquire existing branches or other financial institutions; · attract deposits to those locations and cross-sell new and existing depositors additional products and services; and · identify attractive loan and investment opportunities |
| We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand |
| Our ability to successfully manage our growth will also depend upon our ability to maintain capital levels sufficient to support this growth, maintain effective cost controls and adequate asset quality such that earnings are not adversely impacted to a material degree |
| As we continue to implement our growth strategy by opening new branches or acquiring branches or other banks, we expect to incur increased personnel, occupancy and other operating expenses |
| In the case of new branches, we must absorb those higher expenses while we begin to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets |
| Thus, our plans to branch aggressively could depress our earnings in the short run, even if we efficiently execute our branching strategy |
| We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel |
| We expect our future growth to be driven in a large part by the relationships maintained with our customers by our Chairman and Chief Executive Officer, Bernard H Clineburg, and our other executive and senior lending officers |
| We have entered into employment agreements with Mr |
| Clineburg and three other executive officers |
| The existence of such agreements, however, does not necessarily assure us that we will be able to continue to retain their services |
| The unexpected loss of Mr |
| Clineburg or other key employees could have a significant adverse effect on our business and possibly result in reduced revenues and earnings |
| We do not maintain key man life insurance policies on any of our corporate executives |
| The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships, as well as develop new financial products and services |
| Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment |
| These agreements make the recruitment of these professionals more difficult |
| While we have been recently successful in acquiring what we consider to be talented banking professionals, the market for talented people is competitive and we may not continue to be successful in attracting, hiring, motivating or retaining experienced banking professionals |
| 21 ______________________________________________________________________ We may incur losses if we are unable to successfully manage interest rate risk |
| Our future profitability will substantially depend upon our ability to maintain or increase the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities |
| Being asset sensitive as of December 31, 2005, the Bank’s net interest income should improve in a rising rate environment while net interest income should fall if rates decline |
| The shape of the yield curve can also impact net interest income |
| Changing rates will impact how fast our mortgage loans and mortgage-backed securities will have the principal repaid |
| Rate changes can also impact the behavior of our depositors, especially depositors in non-maturity deposits such as demand, interest checking, savings and money market accounts |
| While we attempt to minimize our exposure to interest rate risk, we are unable to eliminate it as it is an inherent part of our business |
| 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 industry-specific conditions and economic conditions generally |
| Our concentration in loans secured by real estate may increase our future 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 |
| Approximately 93prca of our loans are secured by real estate, both residential and commercial, substantially all of which are located in our market area |
| A major change in the region’s real estate market, resulting in a deterioration in real estate values, or in the local or national economy, including changes caused by raising interest rates, could adversely affect our customers’ ability to pay these loans, which in turn could adversely impact us |
| Risk of loan defaults and foreclosures is inherent in the banking industry, and we try to limit our exposure to this risk by carefully underwriting and monitoring our extensions of credit |
| We cannot fully eliminate credit risk, and as a result credit losses may occur in the future |
| 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 a periodic review and analysis of the loan portfolio, management determines the adequacy of the allowance for loan losses by considering such factors as general and industry-specific market conditions, credit quality of the loan portfolio, the collateral supporting the loans and financial performance of our loan customers relative to their financial obligations to us |
| The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and actual losses may exceed our current estimates |
| Rapidly growing loan portfolios are, by their nature, unseasoned |
| Our net loan losses since the inception of the Company are approximately dlra250cmam000 |
| As a result, estimating loan loss allowances is more difficult than with seasoned portfolios, and may be more susceptible to changes in estimates and to losses exceeding estimates |
| 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 assert that our loan loss allowance will be adequate in the future |
| Future loan losses that are greater than current estimates could have a material impact on our future financial performance |
| Banking regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize additional loan charge-offs, based on credit judgments different than those of our management |
| Any increase in the amount of our allowance or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results |
| 22 ______________________________________________________________________ Our future success is dependent on our ability to compete effectively in the highly competitive banking and financial services industry |
| We face vigorous competition from other commercial banks, savings and loan associations, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other types of financial institutions for deposits, loans and other financial services 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, as well as larger lending limits and branch systems, and offer a wider array of banking services |
| Many of our nonbank competitors are not subject to the same extensive regulations that govern us |
| As a result, these nonbank competitors have advantages over us in providing certain services |
| This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition |
| Our profitability and the value of any equity investment in us 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 and other legislation and regulations have had, and will continue to have, or may have a significant impact on the financial services industry |
| These regulations, which are generally 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 |
| Many of these regulations increase our costs and thus place other financial institutions that may not be subject to similar regulation in stronger, more favorable competitive positions |
| 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 this growth through the generation of additional deposits at existing and new branch locations, as well as expanded loan and other investment opportunities |
| However, we may need to raise additional capital in the future to support our continued growth and to maintain desired capital levels |
| Our ability to raise capital through the sale of additional equity securities or the placement of financial instruments that qualify as regulatory capital will depend primarily upon our financial condition and the condition of financial markets at that time |
| We may not be able to obtain additional capital in the amounts or on terms satisfactory to us |
| Our growth may be constrained if we are unable to raise additional capital as needed |
| We have extended off-balance sheet commitments to borrowers, which could expose us to credit and interest rate risk |
| We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers |
| These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and guarantees that would impact our liquidity and capital resources to the extent customers accept or use these commitments |
| These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet |
| Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and guarantees written is represented by the contractual or notional amount of those instruments |
| We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments |