UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarter ended September 30, 2006

FIRST COMMUNITY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Nevada		55-0694814
(State or other jurisdiction of incorporation)		(IRS Employer Identification No.)
P.O. Box 989 Bluefield, Virginia		24605-0989
(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code)

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 the to such filing requirements for the past 90 days.

þ Yes                      oNo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                      Accelerated filer þ                     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes                     þ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class – Common Stock, $1.00 Par Value; 11,191,889 shares outstanding as of October 31, 2006

 

 

FIRST COMMUNITY BANCSHARES, INC.
FORM 10-Q
For the quarter ended September 30, 2006
INDEX

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2006 (Unaudited), and December 31, 2005			3
Consolidated Statements of Income for the Three- and Nine-Month Periods Ended September 30, 2006 and 2005 (Unaudited)			4
Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2006 and 2005 (Unaudited)			5
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2006 and 2005 (Unaudited)			6
Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures about Market Risk			28
Item 4. Controls and Procedures			30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 1A. Risk Factors			31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 3. Defaults Upon Senior Securities			31
Item 4. Submission of Matters to a Vote of Security Holders			31
Item 5. Other Information			31
Item 6. Exhibits			32
SIGNATURES			34
EXHIBIT INDEX			35
EX-3(II)
EX-31.1
EX-31.2
EX-32

PART I. ITEM 1. Financial Statements

FIRST COMMUNITY BANCSHARES, INC.

		September 30,				December 31,
		2006				2005
(Amounts in Thousands, Except Share Data)		(Unaudited)				(Note 1)
Assets
Cash and due from banks		$	38,961			$	46,872
Interest-bearing balances with banks			13,473				10,667
Total cash and cash equivalents			52,434				57,539
Securities available for sale (amortized cost of $475,733 at September 30, 2006; $405,667 at December 31, 2005)			475,528				404,381
Securities held to maturity (fair value of $20,659 at September 30, 2006; $24,877 at December 31, 2005)			20,250				24,173
Loans held for sale			1,046				1,274
Loans held for investment, net of unearned income			1,299,220				1,331,039
Less allowance for loan losses			14,946				14,736
Net loans held for investment			1,284,274				1,316,303
Premises and equipment			35,879				34,993
Other real estate owned			753				1,400
Interest receivable			11,435				10,232
Goodwill and other intangible assets			60,796				61,119
Other assets			65,174				41,069
Total Assets		$	2,007,569			$	1,952,483
Liabilities
Deposits:
Noninterest-bearing		$	245,097			$	230,542
Interest-bearing			1,154,358				1,175,402
Total Deposits			1,399,455				1,405,944
Interest, taxes and other liabilities			15,994				16,153
Federal funds purchased			15,500				82,500
Securities sold under agreements to repurchase			172,711				124,154
FHLB borrowings and other indebtedness			198,127				129,231
Total Liabilities			1,801,787				1,757,982
Stockholders’ Equity
Preferred stock, par value undesignated; 1,000,000 shares authorized; none issued			—				—
Common stock, $1 par value; 25,000,000 shares authorized; 11,499,018 and 11,496,312 shares issued at September 30, 2006, and December 31, 2005, including 315,350 and 244,509 shares in treasury, respectively			11,499				11,496
Additional paid-in capital			108,605				108,573
Retained earnings			95,414				82,828
Treasury stock, at cost			(9,866	)			(7,625	)
Accumulated other comprehensive income (loss)			130				(771	)
Total Stockholders’ Equity			205,782				194,501
Total Liabilities and Stockholders’ Equity		$	2,007,569			$	1,952,483

See Notes to Consolidated Financial Statements.

FIRST COMMUNITY BANCSHARES, INC.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Amounts in Thousands Except Share and Per Share Data)		2006				2005				2006				2005
Interest Income
Interest and fees on loans held for investment		$	24,578			$	23,263			$	73,009			$	66,183
Interest on securities-taxable			3,734				2,904				9,835				7,755
Interest on securities-nontaxable			1,877				1,783				5,519				5,597
Interest on deposits in banks			51				343				825				737
Total interest income			30,240				28,293				89,188				80,272
Interest Expense
Interest on deposits			8,760				6,296				24,733				16,805
Interest on borrowings			3,724				3,276				10,461				8,471
Total interest expense			12,484				9,572				35,194				25,276
Net interest income			17,756				18,721				53,994				54,996
Provision for loan losses			579				1,060				1,798				2,824
Net interest income after provision for loan losses			17,177				17,661				52,196				52,172
Noninterest Income
Wealth management income			623				757				2,038				2,239
Service charges on deposit accounts			2,611				2,660				7,683				7,431
Other service charges, commissions and fees			750				733				2,201				2,063
Gain (loss) on sale of securities			(6	)			536				60				679
Other operating income			1,120				346				3,784				912
Total noninterest income			5,098				5,032				15,766				13,324
Noninterest Expense
Salaries and employee benefits			6,151				7,260				20,834				22,030
Occupancy expense of bank premises			1,039				1,000				3,090				2,911
Furniture and equipment expense			871				855				2,579				2,452
Core deposit amortization			88				112				322				333
Other operating expense			4,064				3,891				11,309				11,189
Total noninterest expense			12,213				13,118				38,134				38,915
Income from continuing operations before income taxes			10,062				9,575				29,828				26,581
Income tax expense			2,877				2,641				8,507				7,372
Income from continuing operations			7,185				6,934				21,321				19,209
Loss from discontinued operations before income tax			—				(36	)			—				(206	)
Income tax benefit			—				(14	)			—				(80	)
Loss from discontinued operations			—				(22	)			—				(126	)
Net income		$	7,185			$	6,912			$	21,321			$	19,083
Basic earnings per common share		$	0.64			$	0.61			$	1.90			$	1.69
Diluted earnings per common share		$	0.64			$	0.61			$	1.89			$	1.68
Basic earnings per common share — continuing operations		$	0.64			$	0.61			$	1.90			$	1.70
Diluted earnings per common share — continuing operations		$	0.64			$	0.61			$	1.89			$	1.69
Dividends declared per common share		$	0.26			$	0.255			$	0.78			$	0.765
Weighted average basic shares outstanding			11,174,479				11,275,156				11,202,631				11,269,515
Weighted average diluted shares outstanding			11,245,073				11,342,912				11,273,293				11,342,233

See Notes to Consolidated Financial Statements.

FIRST COMMUNITY BANCSHARES, INC.

		Nine Months Ended
		September 30,
(Amounts in thousands)		2006				2005
Operating activities — continuing operations:
Income from continuing operations		$	21,321			$	19,209
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
Provision for loan losses			1,798				2,824
Depreciation and amortization of premises and equipment			2,564				2,474
Core deposit amortization			322				333
Net investment amortization and accretion			602				1,139
Net gain on the sale of assets			(796	)			(490	)
Mortgage loans originated for sale			(23,204	)			(28,419	)
Proceeds from sales of mortgage loans			23,551				28,351
Gain on sales of loans			(119	)			(115	)
Deferred income tax (benefit) expense			(34	)			1,098
Increase in interest receivable			(1,213	)			(1,621	)
Excess tax benefit from stock-based compensation			(139	)			—
Other operating activities, net			582				(3,560	)
Net cash provided by operating activities — continuing operations			25,235				21,223
Investing activities — continuing operations:
Proceeds from sales of securities available for sale			14,073				18,959
Proceeds from maturities and calls of securities available for sale			17,628				33,798
Proceeds from maturities and calls of securities held to maturity			3,974				9,552
Purchase of securities available for sale			(100,834	)			(90,326	)
Purchase of bank-owned life insurance			(25,000	)			—
Net decrease (increase) in loans held for investment			29,056				(87,064	)
Net cash used in branch divestiture			(13,721	)			—
Purchase of premises and equipment			(4,094	)			(2,462	)
Proceeds from sale of equipment			323				1,005
Net cash used in investing activities — continuing operations			(78,595	)			(116,538	)
Financing activities — continuing operations:
Net increase (decrease) in demand and savings deposits			(6,881	)			8,053
Net increase in time deposits			16,695				78,921
Net decrease in federal funds purchased			(67,000	)			(32,500	)
Net increase in securities sold under agreement to repurchase			48,836				15,882
Net proceeds from and repayments of FHLB and other borrowings			68,896				74,861
Proceeds from the exercise of stock options			871				333
Excess tax benefit from stock-based compensation			139				—
Acquisition of treasury stock			(4,566	)			(293	)
Dividends paid			(8,735	)			(8,618	)
Net cash provided by financing activities — continuing operations			48,255				136,639
Cash flows of discontinued operations: (Revised — See Note 2)
Net cash used in operating activities			—				(126	)
Net cash used in investing activities			—				—
Net cash used in financing activities			—				—
Net cash used in discontinued operations			—				(126	)
(Decrease) increase in cash and cash equivalents			(5,105	)			41,198
Cash and cash equivalents at beginning of period			57,539				54,746
Cash and cash equivalents at end of period		$	52,434			$	95,944
Supplemental information — Noncash items Transfer of loans to other real estate		$	883			$	1,214

See Notes to Consolidated Financial Statements.

FIRST COMMUNITY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

																		Accumulated
						Additional												Other
		Common				Paid-in				Retained				Treasury				Comprehensive
		Stock				Capital				Earnings				Stock				(Loss) Income				Total
Balance January 1, 2005		$	11,472			$	108,263			$	68,019			$	(6,881	)		$	2,360			$	183,233
Comprehensive income:
Net income			—				—				19,083				—				—				19,083
Other comprehensive income, net of tax:
Unrealized loss on securities available for sale			—				—				—				—				(307	)			(307	)
Less reclassification adjustment for gains realized in net income			—				—				—				—				(354	)			(354	)
Comprehensive income			—				—				19,083				—				(661	)			18,422
Common dividends declared			—				—				(8,618	)			—				—				(8,618	)
Acquisition of 9,917 treasury shares			—				—				—				(293	)			—				(293	)
Acquisition of Stone Capital 2,447 shares issued			2				85				—				—				—				87
Stock awards 1,500 shares issued			2				18																20
Tax benefit from exercise stock options			—				204				—				—				—				204
Option exercise 28,224 shares			20				36				—				277				—				333
Balance September 30, 2005		$	11,496			$	108,606			$	78,484			$	(6,897	)		$	1,699			$	193,388
Balance January 1, 2006		$	11,496			$	108,573			$	82,828			$	(7,625	)		$	(771	)		$	194,501
Comprehensive income:
Net income			—				—				21,321				—				—				21,321
Other comprehensive income, net of tax:
Unrealized gain on securities available for sale			—				—				—				—				663				663
Less reclassification adjustment for gains realized in net income			—				—				—				—				(14	)			(14	)
Unrealized gain on derivative securities			—				—				—				—				252				252
Comprehensive income			—				—				21,321				—				901				22,222
Common dividends declared			—				—				(8,735	)			—				—				(8,735	)
Acquisition of 145,161 treasury shares			—				—				—				(4,566	)			—				(4,566	)
Acquisition of Stone Capital 2,706 shares issued			3				85				—				—				—				88
Stock awards 5,132 shares			—				(42	)			—				160				—				118
ESOP allocation 27,733 shares							16								867								883
Equity-based compensation expense			—				223				—				—				—				223
Tax benefit from exercise stock options			—				189				—				—				—				189
Option exercises 41,455 shares			—				(439	)			—				1,298				—				859
Balance September 30, 2006		$	11,499			$	108,605			$	95,414			$	(9,866	)		$	130			$	205,782

See Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. General

Unaudited Consolidated Financial Statements

The accompanying unaudited condensed consolidated financial statements of First Community Bancshares, Inc. and subsidiaries (“First Community” or the “Company”) have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments including normal recurring accruals, necessary for a fair presentation, have been made. These results are not necessarily indicative of the results of consolidated operations that might be expected for the full calendar year.

The consolidated balance sheet as of December 31, 2005, has been derived from the audited financial statements included in the Company’s 2005 Annual Report on Form 10-K. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with standards for the preparation of interim consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the 2005 Annual Report of First Community on Form 10-K.

A more complete and detailed description of First Community’s significant accounting policies is included within Footnote 1 to the Company’s Annual Report on Form 10-K for December 31, 2005. Further discussion of the Company’s application of critical accounting policies is included within the “Application of Critical Accounting Policies” section of Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included herein.

The Company operates within one business segment, community banking.

The cash flows resulting from discontinued operations have been revised to conform to the current year’s presentation, which details cash flows from operating, investing, and financing activities.

Recent Accounting Pronouncements

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) 108, “Financial Statements – Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” This SAB provides guidance on the consideration of prior year misstatements in determining whether the current year’s financial statements are materially misstated. In providing this guidance, the SEC staff references both the “iron curtain” and “rollover” approaches to quantifying a current year misstatement for purposes of determining materiality. The iron curtain approach focuses on how the current year’s balance sheet would be affected in correcting misstatements without considering the year in which the misstatement originated. The rollover approach focuses on the amount of the misstatements that originated in the current year’s income statement. The SEC staff indicates that registrants should quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. This SAB is effective for fiscal years ending after November 15, 2006. Registrants may either restate their financials for any material misstatements arising from the application of this SAB or recognize a cumulative effect of applying SAB 108 within the current year opening balance in retained earnings. The adoption of this SAB is not expected to have a material impact on the Company’s financial condition, the results of operations, or liquidity.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of Statement No. 109 “Accounting for Income Taxes.” FIN 48 provides guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. FIN 48 also requires additional disclosures related to an entity’s accounting for uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48 on its consolidated financial statements, and is not yet in a position to determine the impact of the interpretation.

In March 2006, the FASB issued Statement No. 156, “Accounting for Servicing of Financial Assets,” which amends FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The Statement permits an entity to measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the change occurs. The Statement is effective as of an entity’s first fiscal year beginning after September 15, 2006. However, earlier adoption of the Statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements for any interim period of that fiscal year.

The adoption of this standard is not expected to have a material impact on the Company’s financial condition, the results of operations, or liquidity.

In February 2006, the FASB issued Statement No. 155, “Accounting for Certain Hybrid Financial Instruments – An Amendment of FASB Statements No. 133 and 140.” This Statement amends FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to require evaluation of all interests in securitized financial assets under Statement No. 133, eliminating a long-standing (but always intended to be temporary) exemption from Statement No. 133 for such financial instruments. As a result of the Statement, entities will have to determine if such interests may be (1) freestanding derivatives, (2) hybrid financial instruments containing embedded derivatives requiring bifurcation, or (3) hybrid financial instruments containing embedded derivatives that do not require bifurcation. In addition, the Statement permits fair value re-measurement for any hybrid instrument that contains an embedded derivative that would otherwise have to be bifurcated.

The Statement is effective for all financial instruments acquired, issued, or subject to a re-measurement event occurring after the beginning of an entity’s first fiscal year beginning after September 15, 2006. Earlier adoption of the Statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements for any interim period of that fiscal year. The adoption of this standard is not expected to have a material impact on the Company’s financial condition, the results of operations, or liquidity.

Note 2. Discontinued Operations

In August 2004, the Company sold its mortgage banking subsidiary. The transaction completed the Company’s exit from the mortgage banking business segment.

The business related to the former mortgage banking subsidiary is accounted for as discontinued operations and, therefore, the results of operations and cash flows have been removed from the Company’s results of continuing operations in accordance with SFAS 144 for all periods presented in this report. Results of the former mortgage subsidiary are presented as discontinued operations in a separate category on the income statement relating to the 2005 period following results from continuing operations. The results of discontinued operations for the three and nine months ended September 30, 2005, are presented below. The Company had no related income or loss from discontinued operations in 2006.

		Three Months Ended				Nine Months Ended
(Amounts in thousands)		September 30, 2005				September 30, 2005
Interest Income		$	—			$	—
Interest Expense			—				—
Net interest income			—				—
Other Income			—				—
Other Expense			36				206
Loss before income taxes			(36	)			(206	)
Applicable income tax benefit			(14	)			(80	)
Net Loss		$	(22	)		$	(126	)

All assets and liabilities of the mortgage banking subsidiary were disposed of in the third quarter of 2004. Accordingly, there were no assets or liabilities related to discontinued operations included in the September 30, 2006, or the December 31, 2005, consolidated balance sheets.

The cash flows resulting from discontinued operations have been revised to conform to the current year’s presentation, which details cash flows from operating, investing, and financing activities.

Note 3. Branch Divestitures

In June 2006, the Company sold its Drakes Branch, Virginia, location. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $16.4 million and loans of approximately $1.9 million. The transaction resulted in a pre-tax gain of approximately $702 thousand.

In March 2006, the Company entered into a definitive agreement to sell its branch location in Rowlesburg, West Virginia. The branch had deposits and repurchase agreements totaling approximately $10.7 million and loans of approximately $3.2 million at December 31, 2005. The transaction is expected to result in a pre-tax gain of approximately $382 thousand, and is expected to be completed by December 31, 2006.

Note 4. Investment Securities

As of September 30, 2006, and December 31, 2005, the amortized cost and estimated fair value of available for sale securities are as follows:

		September 30, 2006
		Amortized				Unrealized				Unrealized				Fair
(Amounts in thousands)		Cost				Gains				Losses				Value
U.S. Government agency securities		$	117,774			$	86			$	(1,355	)		$	116,505
States and political subdivisions			154,698				2,409				(733	)			156,374
Corporate notes			71,788				289				(363	)			71,714
Mortgage-backed securities			124,595				235				(2,282	)			122,548
Equities			6,878				1,582				(73	)			8,387
Total		$	475,733			$	4,601			$	(4,806	)		$	475,528

		December 31, 2005
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
U.S. Government agency securities		$	92,739			$	—			$	(1,315	)		$	91,424
States and political subdivisions			151,118				2,426				(1,376	)			152,168
Corporate notes			61,466				125				(317	)			61,274
Mortgage-backed securities			94,954				155				(2,115	)			92,994
Equities			5,390				1,282				(151	)			6,521
Total		$	405,667			$	3,988			$	(5,274	)		$	404,381

As of September 30, 2006, and December 31, 2005, the amortized cost and estimated fair value of held to maturity securities are as follows:

		September 30, 2006
		Amortized				Unrealized				Unrealized				Fair
(Amounts in thousands)		Cost				Gains				Losses				Value
States and political subdivisions		$	19,867			$	412			$	(2	)		$	20,277
Mortgage-backed securities			8				—				—				8
Other securities			375				—				(1	)			374
Total		$	20,250			$	412			$	(3	)		$	20,659

		December 31, 2005
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
States and political subdivisions		$	23,781			$	706			$	(1	)		$	24,486
Mortgage-backed securities			17				—				—				17
Other securities			375				—				(1	)			374
Total		$	24,173			$	706			$	(2	)		$	24,877

The following table reflects those investments in an unrealized loss position at September 30, 2006, and December 31, 2005. There were no securities in a continuous unrealized loss position for 12 or more months for which the Company does not have the ability to hold until the security matures or recovers in value.

		September 30, 2006
		Less than 12 Months								12 Months or longer								Total
(Amounts in thousands)		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Description of Securities		Value				Losses				Value				Losses				Value				Losses
U. S. Government agency securities		$	53,447			$	(537	)		$	40,539			$	(818	)		$	93,986			$	(1,355	)
States and political subdivisions			24,464				(252	)			28,534				(483	)			52,998				(735	)
Other securities			15,487				(154	)			27,295				(210	)			42,782				(364	)
Mortgage-backed securities			26,121				(384	)			73,175				(1,898	)			99,296				(2,282	)
Equity securities			1,958				(71	)			47				(2	)			2,005				(73	)
Total		$	121,477			$	(1,398	)		$	169,590			$	(3,411	)		$	291,067			$	(4,809	)

		December 31, 2005
		Less than 12 Months								12 Months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Description of Securities		Value				Losses				Value				Losses				Value				Losses
U. S. Government agency securities		$	61,469			$	(722	)		$	29,851			$	(593	)		$	91,320			$	(1,315	)
States and political subdivisions			47,706				(830	)			18,583				(547	)			66,289				(1,377	)
Other securities			41,523				(318	)			—				—				41,523				(318	)
Mortgage-backed securities			40,651				(952	)			45,607				(1,163	)			86,258				(2,115	)
Equity securities			1,786				(129	)			99				(22	)			1,885				(151	)
Total		$	193,135			$	(2,951	)		$	94,140			$	(2,325	)		$	287,275			$	(5,276	)

At September 30, 2006, the combined depreciation in value of the 200 individual security holdings in an unrealized loss position was less than 1.00% of the combined reported value of the aggregate securities portfolio. Management does not believe any individual unrealized loss as of September 30, 2006, represents other-than-temporary impairment. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature. Furthermore, the Company believes the declines in value are mostly attributable to changes in market interest rates and not the credit quality of the issuer.

Note 5. Loans

Loans, net of unearned income, consist of the following:

		September 30, 2006								December 31, 2005
(Dollars in thousands)		Amount				Percent				Amount				Percent
Loans held for investment:
Commercial and agricultural		$	105,624				8.13	%		$	110,211				8.28	%
Commercial real estate			425,622				32.76	%			464,510				34.90	%
Residential real estate			509,940				39.25	%			504,386				37.89	%
Construction			160,840				12.38	%			143,976				10.82	%
Consumer			95,000				7.31	%			106,148				7.97	%
Other			2,194				0.17	%			1,808				0.14	%
Total		$	1,299,220				100.00	%		$	1,331,039				100.00	%
Loans held for sale		$	1,046							$	1,274

The Company is a party to 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 financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized on the balance sheet. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is not a 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the counterparties. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit and written financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.

Financial instruments whose contract amounts represent credit risk at September 30, 2006, are commitments to extend credit (including availability of lines of credit) of $207.2 million and standby letters of credit and financial guarantees written of $7.1 million.

Note 6. Allowance for Loan Losses

The allowance for loan losses is maintained at a level sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provision for loan losses and recoveries of prior loan charge-offs, and decreased by loans charged off. The provision is calculated to bring the allowance to a level which, according to a systematic process of measurement, reflects the amount management estimates is needed to absorb probable losses within the portfolio.

Management performs periodic assessments to determine the appropriate level of allowance. Differences between actual loan loss experience and estimates are reflected through adjustments that are made by either increasing or decreasing the loss provision based upon current measurement criteria. Commercial, consumer and mortgage loan portfolios are evaluated separately for purposes of determining the allowance. The specific components of the allowance include allocations to individual commercial credits and allocations to the remaining non-homogeneous and homogeneous pools of loans. Management’s allocations are based on judgment of qualitative and quantitative factors about both macro and micro economic conditions reflected within the portfolio of loans and the economy as a whole. Factors considered in this evaluation include, but are not necessarily limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and non-accruals. While management has allocated the allowance for loan losses to various portfolio segments, the entire allowance is available for use against any type of loan loss deemed appropriate by management.

The following table details the Company’s allowance for loan loss activity for the three- and nine-month periods ended September 30, 2006 and 2005.

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
(Amounts in thousands)		2006				2005				2006				2005
Beginning balance		$	14,710			$	15,984			$	14,736			$	16,339
Provision for loan losses			579				1,060				1,798				2,824
Charge-offs			(832	)			(3,037	)			(2,936	)			(5,519	)
Recoveries			489				479				1,348				1,234
Reclassification of allowance for lending-related commitments			—				—				—				(392	)
Ending balance		$	14,946			$	14,486			$	14,946			$	14,486

Note 7. Deposits

The following is a summary of interest-bearing deposits by type as of September 30, 2006, and December 31, 2005.

		September 30,				December 31,
(Amounts in thousands)		2006				2005
Interest-bearing demand deposits		$	145,519			$	144,314
Savings deposits			327,120				355,184
Certificates of deposit			681,719				675,904
Total		$	1,154,358			$	1,175,402

Note 8. Borrowings

The following schedule details the Company’s Federal Home Loan Bank (“FHLB”) borrowings and other indebtedness at September 30, 2006, and December 31, 2005.

						September 30,				December 31,
(Amounts in thousands)						2006				2005
FHLB borrowings						$	182,663			$	113,767
Subordinated debt							15,464				15,464
Total						$	198,127			$	129,231

FHLB borrowings include $176.4 million in convertible and callable advances and $6.3 million of noncallable term advances from the FHLB of Atlanta at September 30, 2006. The weighted average interest rates of advances are 4.69% and 4.17% at September 30, 2006, and December 31, 2005, respectively.

In January 2006, the Company entered into a derivative swap instrument where it receives LIBOR-based variable interest payments and pays fixed interest payments. The notional amount of the derivative swap is $50 million and effectively fixes a portion of the FHLB borrowings at approximately 4.34%. After considering the effect of the interest rate swap, the effective weighted average interest rate of the FHLB borrowings is 4.26% at September 30, 2006. The fair value of the interest rate swap was $421 thousand at September 30, 2006.

At September 30, 2006, the FHLB advances have maturities between three months and 15 years. The scheduled maturities of the advances are as follows:

		Amount
		(in thousands)
2006		$	439
2007			6,250
2008			—
2009			—
2010			25,000
2011 and thereafter			150,974
Total		$	182,663

The callable advances may be redeemed at quarterly intervals after various lockout periods. These call options may substantially shorten the lives of these instruments. If these advances are called, the debt may be paid in full, converted to another FHLB credit product, or converted to a fixed or adjustable rate advance. Prepayment of the advances may result in substantial penalties based upon the differential between contractual note rates and current advance rates for similar maturities. Advances from the FHLB are secured by stock in the FHLB of Atlanta, qualifying first mortgage loans, mortgage-backed securities, and certain other securities.

Also included in borrowings is $15.5 million of junior subordinated debentures (the “Debentures”) issued by the Company in October 2003 to an unconsolidated trust subsidiary, FCBI Capital Trust (the “Trust”) with an interest rate of three-month LIBOR plus 2.95%. The Trust was able to purchase the Debentures through the issuance of trust preferred securities which had substantially identical terms as the Debentures. The Debentures mature on October 8, 2033, and are callable beginning October 8, 2008. The net proceeds from the offering were contributed as capital to the Company’s subsidiary bank to support further growth.

The Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that the Trust has not made such payments or distributions: (i) accrued and unpaid distributions, (ii) the redemption price, and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amount and all accrued and unpaid distributions and the amount of assets of the trust remaining available for distribution, in each case to the extent the Trust has funds available.

Note 9. Commitments and Contingencies

In the normal course of business, the Company is a defendant in various legal actions and asserted claims. While the Company and its legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

Note 10. Equity-Based Compensation

The Company maintains share-based compensation plans to encourage and facilitate investment in the common stock of the Company by key executives and to assist in the long-term retention of service by those executives. The Company has made stock option awards to officers and directors under a total of four stock-based compensation plans. Non-qualified and incentive stock options, as well as restricted and unrestricted stock may continue to be awarded under the 2004 Omnibus Stock Option Plan. Vesting under the 2004 plan is generally over a three-year period.

The Company adopted FASB Statement No. 123R, “Share-Based Payment” (“SFAS 123R”), on January 1, 2006, using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS 123R. Also under this method, expense is recognized for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under FASB Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Prior to the adoption of SFAS 123R, the Company accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Accordingly, the Company previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 in 2005.

		Three Months				Nine Months
		Ended				Ended
(Dollars in thousands, except per share data)		September 30, 2005				September 30, 2005
Net income as reported		$	6,912			$	19,083
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(53	)			(144	)
Pro forma net income		$	6,859			$	18,939
Income from continuing operations		$	6,934			$	19,209
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(53	)			(144	)
Pro forma income from continuing operations		$	6,881			$	19,065
Earnings per share:
Basic as reported		$	0.61			$	1.69
Basic pro forma		$	0.61			$	1.68
Diluted as reported		$	0.61			$	1.68
Diluted pro forma		$	0.60			$	1.67
Earnings per share from continuing operations:
Basic as reported		$	0.61			$	1.70
Basic pro forma		$	0.61			$	1.69
Diluted as reported		$	0.61			$	1.69
Diluted pro forma		$	0.61			$	1.68

Prior to the adoption of SFAS 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options and the vesting of restricted stock as operating cash flows in the Consolidated Statements of Cash Flows. SFAS 123R requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those options and restricted stock (“excess tax benefits”) to be classified as financing cash flows. An excess tax benefit totaling $139 thousand is classified as a financing cash inflow for the nine months ended September 30, 2006.

As a result of adopting SFAS 123R, pre-tax income and net income for the three months ended September 30, 2006, are approximately $69 thousand and $50 thousand lower, respectively, than accounting for stock options under the intrinsic value method. The increased compensation expense had no effect on basic or diluted earnings per share for the three months ended September 30, 2006. Pre-tax income and net income for the nine months ended September 30, 2006, are approximately $209 thousand and $152 thousand lower, respectively. The increased compensation expense decreased basic and diluted earnings per share approximately one cent for the nine months ended September 30, 2006.

During the three and nine months ended September 30, 2006, the Company recognized pre-tax compensation expense related to total equity-based compensation of approximately $86 thousand and $368 thousand, respectively.

As of September 30, 2006, there was approximately $515 thousand of unrecognized compensation cost related to unvested stock options. That cost is expected to be recognized over a weighted average period of 1.2 years. The actual compensation cost recognized will differ from this estimate due to a number of items, including new awards granted and changes in estimated forfeitures.

A summary of the Company’s stock option activity, and related information for the nine months ended September 30, 2006, is as follows:

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Option				Exercise				Contractual				Intrinsic
		Shares				Price				Term (Years)				Value
														(In thousands)
Outstanding at January 1, 2006			383,562			$	22.08
Granted			1,000				31.06
Exercised			(41,455	)			20.79
Forfeited			(3,432	)			27.84
Outstanding at September 30, 2006			339,675			$	22.21				12.0			$	3,792
Exercisable at September 30, 2006			227,459			$	21.15				11.0			$	2,779
Weighted-average grant-date fair value of options granted during the period		$	7.57

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and certain assumptions. The fair values of grants made in the nine-month periods ended September 30, 2006 and 2005, were estimated using the following weighted average assumptions:

		Nine Months Ended
		September 30,
		2006				2005
Volatility			28.50	%			28.57	%
Expected dividend yield			3.35	%			3.59	%
Expected term (years)			6.00				6.00
Risk-free rate			4.69	%			3.82	%

The weighted average grant-date fair value of options granted during the nine months ended September 30, 2006 and 2005, was $7.57 and $6.70, respectively. The aggregate intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005, was approximately $464 thousand and $521 thousand, respectively.

Stock Awards

The 2004 Omnibus Stock Option Plan permits the granting of restricted and unrestricted stock grants either alone, in addition to, or in tandem with other awards made by the Company. Stock grants are generally measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company’s stock. Such value is recognized as expense over the corresponding service period. Compensation costs related to these types of awards are consistently reported for all periods presented.

The following table summarizes the status of the Company’s nonvested shares as of September 30, 2006, and changes during the nine months then ended.

						Weighted
						Average
		Nonvested				Grant-Date
		Shares				Fair Value
Nonvested at January 1, 2006			4,000			$	26.24
Granted			4,532				31.39
Vested			(5,132	)			29.67
Forfeited			(100	)			32.62
Nonvested at September 30, 2006			3,300			$	27.79

PART I. ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to address information about First Community Bancshares, Inc.’s (the “Company”) financial condition and results of operations. This discussion and analysis should be read in conjunction with the Company’s 2005 Annual Report on Form 10-K and the other financial information included in this report.

The Company is a multi-state bank holding company headquartered in Bluefield, Virginia, with total assets of $2.01 billion at September 30, 2006. Through its community bank subsidiary, First Community Bank, N. A. (the “Bank”), the Company provides financial, trust and investment advisory services to individuals and commercial customers through fifty-nine locations and four wealth management offices located in the four states of Virginia, West Virginia, North Carolina and Tennessee. The Bank is the parent of Stone Capital Management, a SEC-registered investment advisory firm that offers wealth management and investment advice. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol “FCBC”.

FORWARD LOOKING STATEMENTS

The Company may from time to time make written or oral “forward-looking statements”, including statements contained in its filings with the SEC (including this Quarterly Report on Form 10-Q and the Exhibits hereto and thereto), in its reports to stockholders and in other communications which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include, among others, statements with respect to the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (many of which are beyond the Company’s control). The words “may”, “could”, “should”, “would”, “believe”, “anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from that expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of competitive new products and services of the Company and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions; the growth and profitability of the Company’s non-interest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and consolidated results of operations.

Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third party sources, when available. When third party information is not available, valuation adjustments are estimated by management primarily through the use of internal modeling techniques and appraisal estimates.

The Company’s accounting policies are fundamental to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operation. The disclosures presented in the Notes to the Consolidated Financial Statements and in Management’s Discussion and Analysis provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, accounting for acquisitions and intangible assets, and accounting for income taxes as the accounting areas that require the most subjective or complex judgments. The identified critical accounting policies are described in detail in the Company’s 2005 Annual Report on Form 10-K. There have been no material changes in the Company’s critical accounting policies since December 31, 2005.

COMPANY OVERVIEW

The Company is a full service commercial bank holding company which operates within the four-state region of Virginia, West Virginia, North Carolina, and Tennessee. The Company operates through the Bank, and offers a wide range of financial services. The Company reported total assets of $2.01 billion at September 30, 2006, and operates through fifty-nine offices and four wealth management offices.

The Company funds its lending activities primarily through the retail deposit operations of its branch banking network. Borrowings from the Federal Home Loan Bank (“FHLB”) provide additional funding as needed. The Company invests its funds primarily in loans to retail and commercial customers. In addition to loans, the Company also invests a portion of its funds in various debt securities, including those of United States agencies, state and political subdivisions, and certain corporate notes and debt instruments. The Company also maintains overnight interest-bearing balances with the FHLB and correspondent banks. The difference between interest earned on assets and interest paid on liabilities is the Company’s primary source of earnings.

BRANCHING ACTIVITY

In June 2006, the Company sold its Drakes Branch, Virginia, branch office. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $16.4 million and loans of approximately $1.9 million. The transaction resulted in a gain of approximately $702 thousand.

In March 2006, the Company entered into a definitive agreement to sell its branch office in Rowlesburg, West Virginia. The branch had deposits and repurchase agreements totaling approximately $10.7 million and loans of approximately $3.2 million at December 31, 2005. The transaction is expected to result in a gain of approximately $382 thousand, and is expected to be completed by December 31, 2006.

The two transactions are a result of the Company’s recent strategic review of its branch network. Resources from the branch divestitures will be re-deployed in markets which offer improved growth and development opportunities.

The Company currently has plans to open five new branch offices during 2007. Two locations are planned in the Winston-Salem, North Carolina, area and are scheduled to be open during the first quarter of 2007. The remaining locations are Mechanicsville, Virginia, and Daniels and Summersville, West Virginia. These locations are all in various stages of construction, and are anticipated to be open by the third quarter of 2007.

RESULTS OF OPERATIONS

Overview

Net income for the three months ended September 30, 2006, was $7.2 million or $0.64 per basic and diluted share, compared with $6.9 million or $0.61 per basic and diluted share for the three months ended September 30, 2005. Return on average equity for the three months ended September 30, 2006 was 14.05% compared to 14.23% for the three months ended September 30, 2005. Return on average assets was 1.45% for the three months ended September 30, 2006, compared to 1.40% for the three months ended September 30, 2005.

Net income for the nine months ended September 30, 2006, was $21.3 million or $1.90 per basic and $1.89 per diluted share, compared with $19.1 million or $1.69 per basic and $1.68 per diluted share for the nine months ended September 30, 2005. Return on average equity for the nine months ended September 30, 2006 was 14.29% compared to 13.49% for the nine

months ended September 30, 2005. Return on average assets was 1.45% for the nine months ended September 30, 2006, compared to 1.34% for the nine months ended September 30, 2005.

Net Interest Income – Quarterly Comparison (See Table I)

Net interest income, the largest contributor to earnings, was $17.8 million for the three months ended September 30, 2006, compared to $18.7 million for the corresponding period in 2005. Tax-equivalent net interest income totaled $18.8 million for the three months ended September 30, 2006, a decrease of $916 thousand from $19.7 million for the third quarter of 2005. The decrease was due partly to increases in rates paid on liabilities which outpaced increases in the rates earned on assets.

Compared to the third quarter of 2005, average earning assets decreased $30.2 million while interest-bearing liabilities decreased $8.3 million. Contributing to the decrease in average earning assets was the Company’s $25 million investment in bank-owned life insurance in the second quarter of 2006. The yield on average earning assets increased 56 basis points to 6.99% from 6.43%. Total cost of interest-bearing liabilities increased 78 basis points during the third quarter of 2006, which resulted in a net interest rate spread (the difference between interest income on earning assets and expense on interest bearing liabilities) that was 22 basis points lower at 3.71% compared to 3.93% for the same period last year. The Company’s tax-equivalent net interest margin of 4.20% for the three months ended September 30, 2006, decreased 13 basis points from 4.33% for the same period of 2005.

The largest contributor to the increase in the yield on average earning assets in 2006 was the increase in the rate earned on the loan portfolio. The increase in the rate to 7.47% from 6.99%, attributable to the general rise in market rates of interest, resulted in a $1.6 million increase in tax-equivalent interest income compared to the third quarter of 2005. The interest rates on variable rate loans tied to prime and other indices increased in response to the recent increases in short-term market interest rates.

During the three months ended September 30, 2006, the tax-equivalent yield on securities available for sale increased 70 basis points to 5.60%, while the average balance increased by $5.6 million. The average tax-equivalent yield increased due to the addition of higher rate securities and the reduction of lower rate securities. The average balance of the securities held-to-maturity portfolio continues to decline as securities mature and are not replaced.

Compared to the third quarter of 2005, average interest-bearing balances with banks decreased to $24.8 million during the third quarter of 2006, as the yield increased 117 basis points to 4.63%. Interest-bearing balances with banks are excess liquidity and bear market rates, which have increased with short-term benchmark interest rates.

Compared to the same period in 2005, the average balances of interest-bearing demand and savings deposits decreased $8.6 million and $30.7 million, respectively, for the three months ended September 30, 2006. The average rate paid on interest-bearing demand deposits increased by 6 basis points, while the average rate paid on savings increased 89 basis points. Average time deposits increased $10.3 million while the average rate paid increased 100 basis points from 3.02% in 2005 to 4.02% in 2006. The level of average non-interestbearing demand deposits increased $7.7 million to $240.5 million during the quarter ended September 30, 2006, compared to the corresponding period of the prior year.

The changes in average deposits between the two quarters include the effect of the previously disclosed sale of the Company’s Clifton Forge and Drakes Branch, Virginia, branch offices.

Compared to the same period in 2005, average federal funds purchased and repurchase agreements increased $27.9 million to $151.8 million during the third quarter of 2006, while the average rate increased 112 basis points. The average balance of FHLB borrowings and other long-term debt decreased by $7.1 million in 2006 to $200.1 million, while the rate paid on those borrowings decreased 10 basis points.

Net Interest Income — Year to Date Comparison (See Table II)

Net interest income was $54.0 million for the nine months ended September 30, 2006, compared to $55.0 million for the corresponding period in 2005. Tax-equivalent net interest income totaled $57.0 million for the nine months ended September 30, 2006, a decrease of $1.1 million from $58.1 million for the nine months ended September 30, 2005. The decrease reflects a $119 thousand decrease due to lower net volumes and a $944 thousand decrease due to net rate changes.

During the first nine months of 2006, average earning assets increased $36.6 million while interest-bearing liabilities increased $46.8 million over the comparable period of 2005. Included the change between periods is the part-year effect of the Company’s $25 million investment in bank-owned life insurance. The yield on average earning assets increased 54 basis points to 6.90% for the nine months ended September 30, 2006, from 6.36% for the nine months ended September 30, 2005. Total cost of interest-bearing liabilities increased 81 basis points during the same period, leaving the net interest rate spread 27 basis points lower at 3.80% compared

to 4.07% for the same period last year. The Company’s tax-equivalent net interest margin of 4.26% for the nine months ended September 30, 2006, decreased 17 basis points from 4.43% in 2005.

The largest contributor to the increase in the yield on average earning assets in 2006, on a volume-weighted basis, was the increase in the rate earned on the loan portfolio. The increase in the rate to 7.38% from 6.85%, attributable to the general rise in market rates of interest, resulted in a $5.3 million increase in tax-equivalent interest income compared to the first nine months of 2005. The increase in the loan portfolio contributed approximately $1.5 million to the change in interest income. The interest rates on variable rate loans tied to prime and other indices increased in response to the recent increases in short-term interest rates.

During the nine months ended September 30, 2006, the tax-equivalent yield on securities available for sale increased 53 basis points to 5.46% while the average balance increased by $15.2 million compared to the nine months ended September 30, 2005. The average tax-equivalent yield increased due to the addition of higher-rate securities and the reduction of lower-rate securities. The average balance of the securities held-to-maturity portfolio continues to decline as securities mature and are not replaced.

Compared to the first nine months of 2005, average interest-bearing balances with banks remained steady during 2006, while the yield increased 134 basis points to 4.49%.

The average balances of interest-bearing demand and savings deposits decreased $7.6 million and $16.8 million, respectively, for the nine months ended September 30, 2006, as compared to the same period of 2005. The average rate paid on interest-bearing demand deposits increased 5 basis points, while the average rate paid on savings increased 95 basis points. Average time deposits increased $26.7 million while the average rate paid increased 97 basis points from 2.80% in 2005 to 3.77% in 2006. The increases in rates paid are attributable to the general rise in market rates of interest. The level of average non-interest-bearing demand deposits increased $10.5 million to $237.5 million through September 30, 2006, compared to the corresponding period of the prior year.

The changes in average deposits between the two periods include the effect of the previously disclosed sale of the Company’s Clifton Forge, Virginia, branch office.

Compared to the same period in 2005, average federal funds purchased and repurchase agreements increased $13.5 million to $139.7 million for the first nine months of 2006, and the average rate paid increased 122 basis points to 3.23%. The average balance of FHLB and other borrowings increased by $30.9 million in 2006 to $201.4 million, while the rate paid on those borrowings decreased 45 basis points. The significant decrease in the rate is due to the FHLB debt restructuring near year-end 2005, where the Company paid off high interest rate obligations. The restructuring reduced the interest rate paid on $50 million of effectively fixed-rate FHLB borrowings by approximately 1.63%, and the rate paid on $25 million of floating-rate borrowings by 1.86% at the time of the transaction.

Table I

AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS

		Three Months Ended												Three Months Ended
		September 30, 2006												September 30, 2005
		Average								Yield/				Average								Yield/
		Balance				Interest (1)				Rate (1)				Balance				Interest (1)				Rate (1)
		(Dollars in thousands)
ASSETS
Earning Assets:
Loans: (2)
Taxable		$	1,304,500			$	24,562				7.47	%		$	1,318,759			$	23,241				6.99	%
Tax-exempt			1,339				24				7.11	%			1,675				33				7.84	%
Total			1,305,839				24,586				7.47	%			1,320,434				23,274				6.99	%
Securities available for sale:
Taxable			269,061				3,490				5.15	%			275,775				2,901				4.17	%
Tax-exempt			154,221				2,482				6.39	%			141,865				2,255				6.31	%
Total			423,282				5,972				5.60	%			417,640				5,156				4.90	%
Securities held to maturity:
Taxable			385				6				6.18	%			398				3				2.99	%
Tax-exempt			20,013				406				8.05	%			26,682				487				7.23	%
Total			20,398				412				8.01	%			27,080				490				7.17	%
Interest-bearing deposits			24,758				289				4.63	%			39,350				343				3.46	%
Total Earning Assets			1,774,277				31,259				6.99	%			1,804,504				29,263				6.43	%
Other assets			195,726												155,079
TOTAL ASSETS		$	1,970,003											$	1,959,583
LIABILITIES
Interest-bearing liabilities:
Demand deposits		$	144,034			$	120				0.33	%		$	152,658			$	105				0.27	%
Savings deposits			336,611				1,773				2.09	%			367,314				1,108				1.20	%
Time deposits			678,262				6,867				4.02	%			667,986				5,083				3.02	%
Total interest-bearing deposits			1,158,907				8,760				3.00	%			1,187,958				6,296				2.10	%
Federal funds purchased and repurchase agreements			151,813				1,276				3.33	%			123,936				691				2.21	%
FHLB borrowings and other long-term debt			200,096				2,448				4.85	%			207,206				2,585				4.95	%
Total interest-bearing liabilities			1,510,816				12,484				3.28	%			1,519,100				9,572				2.50	%
Non-interestbearing demand deposits			240,528												232,841
Other liabilities			15,737												14,994
Stockholders’ Equity			202,922												192,648
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	1,970,003											$	1,959,583
Net Interest Income, Tax Equivalent						$	18,775											$	19,691
Net Interest Rate Spread (3)											3.71	%											3.93	%
Net Interest Margin (4)											4.20	%											4.33	%