Table of Contents

UNITED STATESSECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549

_______________________

FORM 10-Q

TQUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF
THE SECURITIES
                                    EXCHANGE  ACTOF 1934

For the quarterly period ended June 30, 2003

 ̈TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF
THE SECURITIES
                                   EXCHANGE ACTOF 1934

For the transition period from
__________ to ___________

__________________________________

Commission File Number: 000-25081

VAIL BANKS, INC. (Exact name of registrant as
specified in its charter)

Colorado
84-1250561(State or other jurisdiction of
(I.R.S. Employerincorporation or organization)
Identification No.)


0015 Benchmark Road, Suite 300, P.O. Box 6580, Avon, Colorado
81620(Address of principal executive offices)

(970) 476-2002(Registrant’s telephone number, including area
code)

108 South Frontage Road West, Vail,
Colorado 81657(Former name, former address and former fiscal
year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YesSNo ̈.

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)          Yes ̈NoS.

Indicate the number of shares outstanding of each of the
issuer’s classes of common stock, as of the latest practicable
date:As of July 31, 2003, there were 5,342,050 shares of common stock
($1.00 par value per share) outstanding.



VAIL BANKS, INC.

FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2003

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATIONITEM 1.
FINANCIAL STATEMENTSConsolidated Balance Sheets
3Consolidated Statements of Income and Comprehensive Income
4Consolidated Statements of Cash Flows
5Notes to Unaudited Consolidated Financial Statements
7ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONSForward Looking Statements
14Basis of Presentation
14Overview
14Results of Operations
15Financial Condition
16Asset Quality
16Liquidity
18Capital Resources
19Recent Accounting Pronouncements
20ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
21ITEM 4.
CONTROLS AND PROCEDURES
22PART II
OTHER INFORMATIONITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
23ITEM 6.





EXHIBITS AND REPORTS ON FORM 8-K





23SIGNATURES




2

Table of Contents

PART
I       FINANCIAL INFORMATION

Item
1.     FINANCIAL STATEMENTS

VAIL BANKS, INC.Consolidated Balance
SheetsJune 30,

December 31,(in thousands, except share data)

2003

2002ASSETS




(unaudited)Cash and due from banks
$
16,806

24,940Federal funds sold

64,660

50,040Investment securities, available for sale

102,010

57,634Investment securities, held to maturity (fair value of$530(unaudited) and $731 as of June 30, 2003 and December 31, 2002,
respectively)

497

684Investments in bank stocks, at cost

4,338

3,703Loans held for sale

7,146

9,879Gross loans (includes related party loans of $6,588 (unaudited) and
$4,733as of June 30, 2003 and December 31, 2002, respectively)

320,505

331,162Allowance for loan losses

(3,138)

(3,747)Net deferred loan fees

(537)

(159)Premises and equipment, net

38,664

39,005Interest receivable

2,606

1,914Goodwill, net

35,970

35,970Other intangible assets, net

779

816Other assets



4,057

2,422$
594,363

554,263LIABILITIES AND SHAREHOLDERS’ EQUITYLiabilitiesDeposits (includes related party deposits of $2,487 (unaudited) and
$3,425 atJune 30, 2003 and December 31, 2002, respectively)Non-interest bearing
$
92,375

97,383Interest bearing

365,066

331,315Total deposits

457,441

428,698Federal Home Loan Bank advances

45,701

30,000Guaranteed preferred beneficial interest in Company’s subordinated
debt

24,000

24,000Interest payable and other liabilities

3,561

4,080Total liabilities

530,703

486,778Minority interest

714

713Shareholders’ equityPreferred stock - $1 par value; 2,250,000 shares authorized, no sharesissued and outstanding at June 30, 2003 (unaudited) and December 31,
2002,
respectively

-

-Common stock - $1 par value; 20,000,000 shares authorized,5,441,639(unaudited) and 5,734,303 issued and outstanding atJune 30, 2003 and December 31, 2002, respectively

5,442

5,734Additional paid-in capital

36,212

41,123Retained earnings

20,923

19,492Accumulated other comprehensive income, net of tax expense of
       $218
(unaudited) and $243 at June 30, 2003 and December 31, 2002,
       respectively

369

423Total shareholders’ equity

62,946

66,772$
594,363

554,263The accompanying notes are an integral part of these unaudited consolidated
financial statements


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Vail Banks, Inc.Consolidated
Statements of Incomeand
Comprehensive Income(in thousands, except share data)

Three months endedJune 30,

Six months endedJune 30,2003

2002

2003

2002(unaudited)

(unaudited)

(unaudited)

(unaudited)Interest and dividend incomeLoans, including fees
$
6,793

7,561

13,542

15,449Investment securities

1,128

935

1,997

1,663Federal funds sold and other short-term
        investments

157

161

289

243Total interest and
dividend income

8,078

8,657

15,828

17,355Interest expenseDeposits

1,232

1,322

2,404

2,659Short-term borrowings

93

67

168

127Long-term borrowings

331

197

565

320Trust preferred securities

611

611

1,223

1,223Total interest expense

2,267

2,197

4,360

4,329Net interest income

5,811

6,460

11,468

13,026Provision for loan losses

125

170

250

382Net interest income after
provision                                for loan losses

5,686

6,290

11,218

12,644Non-interest incomeDeposit related

824

898

1,576

1,780Mortgage broker fees

1,334

1,075

2,784

2,209Other

687

827

1,368

1,7312,845

2,800

5,728

5,720Non-interest expenseSalaries and employee benefits

4,287

4,117

8,612

8,190Occupancy

808

815

1,628

1,606Furniture and equipment

691

745

1,399

1,452Amortization of intangible assets

18

37

37

37Other

1,091

1,438

2,243

2,7856,895

7,152

13,919

14,070Income before income tax
expense

1,636

1,938

3,027

4,294Income tax expense

499

629

915

1,465Net income

1,137

1,309

2,112

2,829Unrealized gain (loss) on available for sale         securities, net of
taxes

245

762

(54)

302Comprehensive income
$
1,382

2,071

2,058

3,131Earnings per shareBasic
$
0.21

0.23

0.39

0.50Diluted
$
0.20

0.22

0.37

0.48Weighted average common sharesBasic

5,327,503

5,677,359

5,416,998

5,678,810Diluted

5,706,629

5,957,842

5,769,878

5,950,804


The accompanying notes are an integral part of these unaudited consolidated
financial statements


4

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VAIL BANKS,
INC.Consolidated
Statements of Cash Flows(in thousands)

Six months endedJune 30,2003

2002(unaudited)

(unaudited)Cash flows from operating activitiesNet income
$
2,112

2,829Adjustments to reconcile net income to net cash provided by
     operating activitiesNet amortization of premiums on investment securities

195

153Provision for loan losses

250

382Gain on sale of loans

(95)

-Depreciation and amortization

1,162

1,213Recognition of stock compensation on restricted common stock and
     stock options

179

123Deferred income tax expense

(177)

-Other

(37)

(128)Changes in operating assets and liabilitiesLoans held for sale

2,733

2,399Interest receivable

(692)

44Other assets

(915)

(738)Interest payable and other
liabilities

(519)

(830)Other, net

1

7Net cash provided by operating
activities

4,197

5,454Cash flows from investing activitiesPurchases of investment securities, available for sale

(66,289)

(36,677)Purchases of bank stocks

(635)

(1,275)Proceeds from redemption of bank stocks

-

598Proceeds from maturities of investment securities, held to
maturity

187

107Proceeds from maturities/calls of investment securities, available
for sale

21,639

6,503Net decrease in loans

8,033

43,208Purchases of premises and equipment

(1,067)

(1,724)Proceeds from sales of premises and equipment

50

1,724Proceeds from sales of foreclosed properties

1,990

594Net cash (used) provided by investing activities

(36,092)

13,058Cash flows from financing activitiesNet increase (decrease) in deposits

28,743

(4,257)Net increase in Federal Home Loan Bank advances

15,701

8,900Proceeds from issuance of common stock

81

146Repurchase of common stock

(5,463)

(1,086)Payment of cash dividends on common stock

(681)

(582)Net cash provided by financing
activities

38,381

3,121Net increase in cash and cash
equivalents

6,486

21,633Cash and cash equivalents at beginning of period

74,980

35,526Cash and cash equivalents at end of period
$
81,466

57,159


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VAIL BANKS,
INC.Consolidated Statements of Cash Flows
(Continued)(in thousands)

Six months endedJune 30,2003

2002(unaudited)

(unaudited)Supplemental disclosures of cash flow informationCash paid during the period for:Interest
expense
$
4,326

4,379Income
taxes
$
1,323

1,430Non-cash investing and financing transactions    Foreclosure
of collateralized loans, net of reserve
$
2,238

355Net change in unrealized gain/loss on investment securities
available         for sale, net of taxes
$
(54)

302Reclassification of idle premises and equipment to other
assets
$
(274)

-Reclassification of other assets to premises and equipment
$
57

-Issuance of restricted common stock
$
130

117




The accompanying notes are an integral part of these unaudited consolidated
financial statements

6

Table of Contents

VAIL BANKS, INC.

Notes to Unaudited
Consolidated Financial Statements

1.     ORGANIZATION AND BASIS OF PRESENTATION

The
accompanying unaudited consolidated financial statements include the accounts of
Vail Banks, Inc. (Vail Banks) and its wholly owned subsidiaries, WestStar Bank
(WestStar), Vail Banks Statutory Trust I, and Vail Banks Statutory Trust II.
WestStar and Vail Banks own a combined 54.04% interest in Avon 56 Limited and
WestStar owns a 100% interest in First Western Mortgage Services which are also
included in the accompanying consolidated financial statements.  All entities
are collectively referred to as “the Company.”  All significant
intercompany accounts and transactions have been eliminated in consolidation.

The
accompanying unaudited consolidated financial statements, which are for interim
periods, do not include all disclosures provided in the consolidated financial
statements as of December 31, 2002.  These interim unaudited consolidated
financial statements and the notes thereto should be read in conjunction with
the Company’s Annual Report on Form 10-K as of and for the year ended
December 31, 2002.

In
the opinion of the Company, all adjustments necessary, consisting of only normal
recurring items, have been included for a fair presentation of the accompanying
consolidated financial statements.  Operating results for the three and six
months ended June 30, 2003, are not necessarily indicative of the results that
may be expected for the full year.

Certain
reclassifications have been made to the 2002 financial statements to conform to
the 2003 presentation.

2.     INVESTMENT SECURITIES

Investment
securities consist of the following:

June 30, 2003

December 31, 2002Amortized

Fair

Amortized

Fair


(in thousands)

Cost

Value

Cost

Value


(unaudited)

(unaudited)Securities available for saleGovernment agencies
$
27,470

27,425

13,299

13,323State and municipal

20,857

21,071

3,851

3,880Mortgage-backed securities

44,087

44,484

35,318

35,931FHLMC preferred stock

9,009

9,030

4,500

4,500Total securities available for sale
$
101,423

102,010

56,968

57,634Securities held to maturityMortgage-backed securities
$
497

530

684

731Total securities held to maturity
$
497

530

684

731Investments in bank stocksFederal Home Loan Bank stock
$
2,285

2,285

1,650

1,650Federal Reserve Bank stock

1,869

1,869

1,869

1,869Bankers’ Bank of the West stock

184

184

184

184$
4,338

4,338

3,703

3,703


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The following table presents the components of investment income for the three
and six months ended June 30, 2003 and 2002.

|                           |   | Three months ended
June 30, |  | Six months ended
June 30,
|-------------------------- | - | --------------------------- |  | -------------------------
|(in thousands)             |   | 2003                        |  | 2002                     
|                           |   | (unaudited)                 |  | (unaudited)              
|Taxable interest income    | $ | 753                         |  | 813                      
|Nontaxable interest income |   | 328                         |  | 75                       
|Dividends                  |   | 47                          |  | 47                       
|                           | $ | 1,128                       |  | 935                      

3.     LOANS

Gross loans consist of the following:

(in thousands)

June 30, 2003

December 31,
2002(unaudited)Commercial, industrial and land
$
187,820

203,932Real estate - construction

63,136

55,275Real estate - mortgage

62,095

62,188Consumer and other

7,454

9,767$
320,505

331,162


As
of June 30, 2003 and December 31, 2002, $129,000 and $172,000, respectively, of
deposit account overdrafts have been reclassified to loans.

In
the ordinary course of business, the Company had loans receivable from
directors, executive officers and principal shareholders (holders of more than
five percent of the outstanding shares of common stock) of the Company and their
affiliates as follows:

(in thousands)

2003


Balance at January 1, 2003
$
4,733New loans, including renewals **

2,468Payments, including renewals

(613)Balance at June 30, 2003 (unaudited)
$
6,588** Comprised of $1,518,000 of new loans and $950,000 relating to the repurchase
of a loan participation.


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4.      PROVISION AND ALLOWANCE FOR
LOAN LOSSES

Transactions
in the allowance are summarized as follows:

|(in thousands)                             |   | 2003 
|------------------------------------------ | - | -----
|                                           |   |      
|Allowance at January 1, 2003               | $ | 3,747
|Loans charged off                          |   | (950)
|Recoveries on loans previously charged off |   | 91   
|Provision for loan losses                  |   | 250  
|Allowance at June 30, 2003 (unaudited)     | $ | 3,138

5.  PREMISES AND EQUIPMENT

During
May 2003, the Company entered into an agreement to sell one of its bank
buildings and lease back a minor portion of the space.  The sale is subject
to numerous contingencies that have not yet been met.  Assuming the
contingencies are met, the transaction is expected to close before the end of
2003 and would result in a gain to the Company.

6.    
BORROWINGS

WestStar
is a member of the Federal Home Loan Bank of Topeka (FHLB) and, as a regular
part of its business, obtains both short and long-term advances from this FHLB.
Advances are collateralized primarily by FHLB stock owned by WestStar and loans
secured by certain mortgages or deeds of trust. As of June 30, 2003, the
Company’s total borrowing capacity was $117.8 million of which $45.7
million of borrowings were outstanding ($12.3 million was short-term and $33.4
million was long-term) and $24.0 million in the form of stand-by irrevocable
letters of credit issued by the FHLB were pledged as collateral for uninsured
public fund deposits.

WestStar
has established an unsecured, overnight federal funds line with Bankers’
Bank of the West that expires on August 31, 2003.  As of June 30, 2003, this
authorized borrowing line totaled $41.5 million with $0 outstanding.

WestStar has also established overnight federal funds lines with First Tennessee
Bank, N.A. (First Tennessee) totaling $20.0 million.  If drawn upon, $10.0
million will be a secured line and $10.0 million will be an unsecured line.
These lines are subject to cancellation by First Tennessee at any time upon the
occurrence of certain conditions.  As of June 30, 2003, no amounts were
outstanding under the lines.

7.    
SHAREHOLDERS' EQUITY

Stock Repurchase Plan

On October 15, 2002, the Company’s Board of Directors reauthorized the
Company’s stock repurchase program, allowing additional

repurchases of
up to $10 million through October 2003.  Since inception of the program in March
2001, the Company has repurchased 1,326,580 shares at an average cost of $11.77
per share.  During the first half of 2003, the Company repurchased 442,290
common shares at an average cost of $12.35.

Restricted Stock

The
Company accounts for its restricted stock grants in accordance with Accounting
Principles Board (APB) Opinion No. 25.  Accordingly, compensation expense is
recorded over the vesting period of the restricted stock equal to the value of
the restricted shares using the market price of the stock on the grant date.  On
February 18, 2003, the Board granted 112,005 shares of restricted stock to
several officers of the Company.  The Company is recognizing compensation
expense of $1.3 million ratably over the vesting period of 10 years.
Additionally, on April 25, 2003, the Board granted 18,272 shares of restricted
stock to an officer of the Company.  The Company is recognizing compensation
expense of $226,000 related to this grant ratably over the vesting period of 10
years.

Earnings Per Share

Basic
earnings per share represents net income available to common shareholders
divided by the weighted-average number of common shares outstanding during the
period.  Diluted earnings per share is computed similar to basic earnings per
share, except that the weighted average common shares outstanding is increased
to include the number of additional common shares that would have been
outstanding if dilutive potential common shares had been issued.  Common
equivalent shares are not included where inclusion would be anti-dilutive.

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The following table presents the net income and weighted average common shares
outstanding used to calculate earnings per share for the six months ended June
30, 2003 and 2002:

|                                            |   | June 30,   
|------------------------------------------- | - | -----------
|(in thousands, except share data)           |   | 2003       
|                                            |   |            
|                                            |   | (unaudited)
|Basic earnings per share computation        |   |            
|                                            |   |            
|Net income available to common shareholders | $ | 2,112      
|                                            |   |            
|Weighted average shares outstanding - basic |   | 5,416,998  
|                                            |   |            
|Basic earnings per share                    | $ | 0.39       



|                                              |   | June 30,   
|--------------------------------------------- | - | -----------
|(in thousands, except share data)             |   | 2003       
|                                              |   | (unaudited)
|                                              |   |            
|Diluted earnings per share computation        |   |            
|                                              |   |            
|Net income available to common shareholders   | $ | 2,112      
|                                              |   |            
|Weighted average shares outstanding - basic   |   | 5,416,998  
|Shares assumed issued:                        |   |            
|Stock
options                                 |   | 128,559    
|Restricted
stock                              |   | 224,321    
|                                              |   |            
|Weighted average shares outstanding - diluted |   | 5,769,878  
|                                              |   |            
|Diluted earnings per share                    | $ | 0.37       

During
the six months ended June 30, 2003 and 2002, options to purchase an average of
44,000 and 48,000 shares of common stock at an average exercise price of $12.25
per share were outstanding, but were not included in the computation of diluted
earnings per share because the exercise prices of these options were greater
than the average market prices of the common stock during such periods.

Stock Options

On
February 10, 2003, the Board approved the grant of 26,000 stock options to
employees and directors of the Company.

The
Company accounts for its stock options in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation, which permits entities to expense over
the vesting period the fair value of stock-based awards as measured on the date
of grant.  Alternatively, SFAS 123 allows entities to apply the provisions of
APB Opinion No. 25 while disclosing pro forma net income and pro forma earnings
per share for employee stock option grants made in 1995 and future years as if
the fair-value-based method defined in SFAS 123 had been applied.  The Company
has elected to apply the accounting provisions of APB Opinion No. 25 to employee
stock option grants and provide the pro forma disclosure provisions of SFAS 123.
Accordingly, stock-based compensation expense for employee option grants is not
recognized in the consolidated financial statements, as options granted under
the Plan generally have an exercise price equal to the market value of the
underlying common stock on the date of grant.  However, during May 2002,
approximately 20,000 stock options were granted at a strike price below market
value.  The Company recognized $3,000 and $4,000, respectively, of compensation
expense during the six months ended June 30, 2003 and 2002 related to these
options.  Any non-employee stock option grants are accounted for under SFAS 123.

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The
fair value of each employee stock option grant was estimated on the date of
grant using the Black-Scholes option-pricing model.  The following
weighted-average assumptions were used:

2003

2002(unaudited)

(unaudited)Dividend yield

2.0%

2.0%Expected life

7 years

6 yearsExpected volatility

26.0%

27.0%Risk-free interest rate

3.6%

4.8%


Had
the Company determined compensation cost based on the fair value accounting
provisions prescribed by SFAS 123 and using the assumptions listed above, the
Company’s net income and earnings per share would have been adjusted to
the pro forma amounts indicated below:

Three months ended June 30,

Six months endedJune 30,(in thousands, except share data)

2003

2002

2003

2002(unaudited)

(unaudited)

(unaudited)

(unaudited)Net incomeAs reported
$
1,137

1,309

2,112

2,829Deduct:  Total stock-based employee
     compensation determined under the                 fair value method, net of tax

(53)

(233)

(106)

(319)Pro forma
$
1,084

1,076

2,006

2,510Earnings per share - basicAs reported
$
0.21

0.23

0.39

0.50Pro forma
$
0.20

0.19

0.37

0.44Earnings per share - dilutedAs reported
$
0.20

0.22

0.37

0.48Pro forma
$
0.19

0.18

0.35

0.42


8.     REGULATORY
MATTERS

As
of June 30, 2003, the Company met all capital adequacy requirements to which it
was subject.  As of that date, the Company had Tier 1 and Total Risk-Based
Capital ratios of 12.95% and 14.60%, respectively, and a Leverage ratio of
8.47%.  Regulatory guidelines permit the Company’s trust preferred
securities to be included in the calculation of Tier 1 and Total Risk-Based
capital, subject to certain limitations.

As
of June 30, 2003, WestStar met all capital adequacy requirements to which it was
subject and exceeded the minimum ratios to be designated as
“well-capitalized.”  As of June 30, 2003, WestStar had Tier 1 and
Total Risk-Based Capital ratios of 13.39% and 14.25%, respectively, and a
Leverage ratio of 8.74%.

11

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9.    
SEGMENT INFORMATION

Information about reportable segments and reconciliation of such information to
the consolidated financial statements as of and for the six months ended June 30
is as follows:

Six Months Ended June 30, 2003 (unaudited)Mortgage(in thousands)

Banking

Brokerage

Other

TotalCondensed income statementTotal income
$
18,773

2,781

2

21,556Total expense

14,197

2,220

2,112

18,529Income before income
taxes

4,576

561

(2,110)

3,027Income taxes

1,486

204

(775)

915Net income
$
3,090

357

(1,335)

2,112




Six Months Ended June 30, 2002 (unaudited)Mortgage(in thousands)

Banking

Brokerage

Other

TotalCondensed income statementTotal income
$
20,864

2,208

3

23,075Total expense

14,915

1,802

2,064

18,781Income before income
taxes

5,949

406

(2,061)

4,294Income taxes

2,094

139

(768)

1,465Net income
$
3,855

267

(1,293)

2,829


10.     RECENT
ACCOUNTING PRONOUNCEMENTS.

During
June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities.  This statement is effective for exit or
disposal activities initiated after December 31, 2002.  These activities may
include sale or termination of a line of business, the closure of business
activities in a particular location, the relocation of business activities from
one location to another, changes in management structure, and a fundamental
reorganization that affects the nature and focus of operations.  The Statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires companies to recognize liabilities associated
with exit or disposal activities at the time that they are incurred rather than
at the date of a commitment to the exit or disposal plan.  The Company adopted
this standard on January 1, 2003.  Adoption of this standard did not have an
effect on the Company’s consolidated financial condition or results of
operations.

During
April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.  This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities.
This statement is effective for contracts entered into or modified after June
30, 2003, except for certain circumstances, and for hedging relationships
designated after June 30, 2003.  The Company does not utilize derivative
instruments or engage in hedging activities.  Accordingly, adoption of this
standard is not anticipated to have an effect on the Company’s
consolidated financial condition or results of operations.

12

Table of Contents

During
May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.  This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity.  It requires that an issuer classify a financial instrument that is
within its scope as a liability when previously it was classified as equity.
This statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003.  It is to be implemented by
reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance of the statement and still
existing at the beginning of the interim period of adoption.  Restatement is not
permitted.  The Company will adopt this statement on July 1, 2003.  Adoption of
this statement is not anticipated to have an effect on the Company’s

consolidated financial condition or results of operations.

11.     SUBSEQUENT EVENTS

On
July 21, 2003, the Board of Directors declared a regular quarterly dividend of
$0.07 per share payable on August 15, 2003 to shareholders of record on August
1, 2003.

Between
July 1, 2003 and July 31, 2003, the Company repurchased 100,700 shares of common
stock at a total cost of $1.4 million, or $14.08 per share.  These transactions
would have materially changed the number of shares outstanding at June 30, 2003,
had these transactions occurred prior to quarter-end.

















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Item
2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward
Looking Statements

This
Quarterly Report on Form 10-Q contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995.  These
forward-looking statements include, but are not limited to, statements about our
plans, objectives, expectations and intentions and other statements contained in
this report that are not historical facts.  When used in this report, the words
“expects,” “anticipates,” “intends,”
“plans,” “believes,” “seeks,”
“estimates” and similar expressions are generally intended to
identify forward-looking statements.  These forward-looking statements are
inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond our control.  In
addition, these forward-looking statements are subject to assumptions with
respect to future business strategies and decisions that are subject to change.
Actual results may differ materially from the results discussed in these
forward-looking statements as a result of the impact of economic conditions and
interest rates, loan losses, risks related to the execution of the
Company’s growth strategy, the possible loss of key personnel, factors
that could affect the Company’s ability to compete in its trade areas,
changes in regulations and government policies and other factors discussed in
the Company’s filings with the Securities and Exchange Commission.  Vail
Banks does not intend to update any forward-looking statements whether written
or oral, relating to matters discussed in this Quarterly Report on Form 10-Q.

Basis of Presentation

The
following discussion and analysis provides information regarding the
Company’s financial condition as of June 30, 2003, and its results of
operations for the six and three months ended June 30, 2003, in comparison to
the six and three months ended June 30, 2002. The following discussion should be
read in conjunction with the unaudited consolidated financial statements and
related notes included elsewhere in this Quarterly Report on Form 10-Q, and in
conjunction with the Company’s Annual Report on Form 10-K for the year
ended December 31, 2002.

Overview

Net
income was $2.1 million for the six months ended June 30, 2003, down from $2.8
million for the six months ended June 30, 2002, a decrease of 25%.  Net income
was $1.1 million for the three months ended June 30, 2003, down from $1.3
million for the three months ended June 30, 2002, a decrease of 13%.

Diluted
earnings per share for the six months ended June 30, 2003, was $0.37 compared to
$0.48 for the six months ended June 30, 2002, a decrease of 23%.  Diluted
earnings per share for the three months ended June 30, 2003, was $0.20 compared
to $0.22 for the three months ended June 30, 2002, a decrease of 9%.

The
annualized return on average assets was 0.73% for the six months ended June 30,
2003 compared to 1.01% for the six months ended June 30, 2002, and 0.76% for the
quarter ended June 30, 2003, compared to 0.92% for the quarter ended June 30,
2002.

The
annualized return on average equity was 6.54% for the six months ended June 30,
2003 compared to 8.87% for the six months ended June 30, 2002, and 7.08% for the
quarter ended June 30, 2003, compared to 8.13% for the quarter ended June 30,
2002.

During
May 2003, the Company announced plans to expand its presence in the Denver Front
Range market, a key market of Colorado.  The Company intends to open additional
banking offices over a period of years as market opportunities and availability
of executive talent dictates.  The first new Denver office was opened during
July 2003.

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Table of Contents

Results of Operations

Net
Interest Income.Net interest income, on a fully tax-equivalent basis
(FTE), decreased by $1.4 million, or 11% to $11.7 million for the six months
ended June 30, 2003 from $13.1 million for the six months ended June 30, 2002.
Net interest income, on a fully tax-equivalent basis (FTE), decreased by
$525,000, or 8% to $6.0 million for the three months ended June 30, 2003 from
$6.5 million for the three months ended June 30, 2002.   The net interest margin
on an FTE basis was 4.83% and 4.77% for the six and three months ended June 30,
2003 as compared to 5.63% and 5.51% for the comparable periods in 2002.  Net
interest margin is influenced by the level and relative mix of earning assets,
interest bearing liabilities, non-interest bearing liabilities and
shareholders’ equity as well as the cost of interest bearing liabilities
as compared to the yield on earnings assets.   The decrease in net interest
margin during the first half of 2003 was primarily due to (1) the 50 basis point
interest rate cut implemented by the Federal Reserve in November 2002, (2) a
shift in the mix of earning assets from higher yielding loans to lower yielding
investments and federal funds sold, (3) an increase in higher cost borrowings
relative to lower cost deposits as a result of the Company’s wholesale
funding of loans, described below, and its leverage strategy, and (4) an
increase in the deferral of loan fees in the first half of 2003 when compared
with the first half of 2002.  During the first half of  2003, the Company
deferred $481,000 in loan fees, reflecting a more conservative approach that
more closely recognizes loan fee income over the lives of the related loans.  A
portion of the deferral also included fees on long-term loans now being funded
with long-term borrowings.  A substantial portion of such deferred fees will be
recognized as income in subsequent quarters of calendar year 2003.  Vail Banks
has experienced increased liquidity as the result of a decrease in loan demand
attributable to the soft economy and more conservative underwriting policies and
an increase in deposits.  In response, the Company capitalized on the low
interest rate environment and its wholesale funding source to extend fixed rate
financing to several customers, thereby locking in a spread.  Between June 30,
2002 and June 30, 2003 the Company’s borrowings increased $15.7 million
and investments increased $34.2 million, while at the same time deposits
increased $19.3 million and loans dropped $27.4 million.

Interest
income FTE decreased to $16.1 million and $8.2 million for the six and three
months ended June 30, 2003, as compared to $17.5 million and $8.7 million for
the six and three months ended June 30, 2002 despite the fact that average
earning assets increased during this period.  Average earning assets increased
4%, from $469.9 million for the six months ended June 30, 2002 to $489.7 million
for the six months ended June 30, 2003.  Subsequent to June 30, 2002, the mix of
earning assets shifted away from higher yielding loans toward lower yielding
investment securities and federal funds sold.  During the first half of 2003,
average loans declined to 68% of earning assets as compared to 79% during the
first half of 2002.  During this time, loans had a yield of 8.15% as compared to
the 4.64% yield on investment securities and 1.18% yield on federal funds sold.
As a result of this shift, the total yield on average earnings assets decreased
87 basis points to 6.62% for the first half of 2003, as compared to 7.49% for
the first half of 2002.

Interest
expense increased to $4.4 million and $2.3 million for the six and three months
ended June 30, 2003, as compared to $4.3 million and $2.2 million for the
corresponding periods in 2002.  This increase was primarily due to a $12.6
million increase in average borrowings and a $10.3 million, or 3%, increase in
average interest bearing deposits during the first half of 2003 as compared to
the first half of 2002.  These increases were offset by the impact of the 50
basis point decline in interest rates during November 2002 as well as the effect
of maturing certificates of deposit renewing at significantly lower interest
rates.  As a result, the total cost of interest-bearing liabilities decreased 10
basis points to 2.08% for the first half of 2003, as compared to 2.18% for the
first half of 2002.   This decrease in cost of interest bearing liabilities,
however, was not in proportion to the decrease in yield on average interest
earning assets, resulting in an overall decrease in net interest income for the
first half of 2003.

Non-Interest
Income. During the six months ended June 30, 2003, non-interest income
increased by $8,000, or less than 1%, to $5.728 million for the six months ended
June 30, 2003, from $5.720 million for the six months ended June 30, 2002.
During the three months ended June 30, 2003, non-interest income increased by
$45,000, or 2%, to $2.845 million for the three months ended June 30, 2003, from
$2.800 million for the three months ended June 30, 2002.  These increases were
primarily attributable to an increase in mortgage broker fees partially offset
by a decrease in deposit related service charges and other non-interest income.
Mortgage broker fees increased $575,000 and $259,000 from the six and three
months ended June 30, 2002, respectively, due to continued refinancing activity
as a result of low interest rates. Deposit related income decreased $204,000 and
$74,000, or 11% and 8%, respectively, from the six and three months ended June
30, 2002 primarily due to a $174,000 and $63,000 decrease, respectively, in
insufficient funds charges.   Other non-interest income decreased $363,000 and
$140,000, or 21% and 17%, respectively, from the six and three months ended June
30, 2002 primarily due to the outsourcing of the Company’s merchant card
program.  This outsourcing accounted for a $241,000 and $119,000 reduction in
other non-interest income and a $265,000 and $117,000 decrease in other
non-interest expense for the six and three months ended June 30, 2003 over the
comparable periods in 2002.

Non-Interest
Expense.   Non-interest expense decreased by $151,000, or 1%, to $13.9
million for the six months ended June 30, 2003, from $14.1 million for the six
months ended June 30, 2002.  Non-interest expense decreased by $257,000, or 4%,
to $6.9 million for the three months ended June 30, 2003, from $7.2 million for
the three months ended June 30, 2002.  These decreases are largely attributable
to the outsourcing of the merchant card program during first quarter 2003 which
resulted in decreased expenses of $265,000 and $117,000 during the six and three
months ended June 30, 2003, respectively, as well as decreases in fees paid to
outside professionals and decreased loan related expenses.  These decreases were
partially offset by increasing costs of employee related expenses.  Although
staffing levels have been reduced, mortgage broker commissions increased
$349,000, or 33%, from the first six months of 2002 due to increased refinancing
activity.

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Table of Contents

The
efficiency ratio increased to 80% for the quarter ended June 30, 2003 and 81%
for the six months ended June 30, 2003, from 77% for the quarter ended June 30,
2002 and 75% for the six months ended June 30, 2002.  This increase in the
efficiency ratio was due to the decline in revenue (net interest income plus
non-interest income) of $604,000 during second quarter 2003 and $1.6 million
during the first half of 2003, while non-interest expenses only declined by
$257,000 and $151,000, respectively, during the same periods.

Income Taxes. The Companys effective income tax rate
(income tax expense as a percentage of pre-tax income) was 30.2% and 30.5% for
the six and three months ended June 30, 2003 as compared to 34.1% and 32.5% for
the six and three months ended June 30, 2002. This decrease in the effective
income tax rate was primarily due to an increase in tax-exempt interest income
generated from municipal securities purchased during 2003, as well as a decrease
in the deferred tax expense of $45,000 for the six and three months ending June
30, 2003.

Financial Condition

The
Company’s assets increased by $40.1 million or 7%, to $594.4 million as of
June 30, 2003, from $554.3 million as of December 31, 2002.

Federal
funds sold balances increased by $14.6 million, or 29%, to $64.7 million as of
June 30, 2003 from $50.0 million at December 31, 2002.  Investment securities
increased to $106.8 million as of June 30, 2003, compared to $62.0 million as of
December 31, 2002, a 72% increase.  During this period, quality loan demand
remained flat while deposits continued to grow, resulting in additional funds to
invest.   In response, the Company capitalized on the low interest rate
environment and its wholesale funding source to extend fixed rate financing to
several customers, thereby locking in a spread.  Between December 31, 2002 and
June 30, 2003, FHLB borrowings increased $15.7 million, or 52%.

As
of June 30, 2003, loans held for sale decreased $2.7 million, or 28%, from
December 31, 2002.  The ending balance of loans held for sale at any particular
date is dependent on the timing of the closing and ultimate funding of these
loans by the outside investor.  Thus, an increase or decrease in the ending
balance is primarily a function of this timing and not indicative of trends in
mortgage loan demand.

Gross
loans decreased $10.7 million, or 3%, from December 31, 2002.   This decrease
was primarily due to the soft economy and more conservative underwriting
policies.

Premises
and equipment decreased by $341,000, or less than 1%, from $39.0 million as of
December 31, 2002, to $38.7 million as of June 30, 2003.  This decrease was
mainly attributable to $1.1 million of depreciation and amortization expense and
the transfer of $274,000 of idle assets to other assets, offset by the purchase
of $1.1 million of premises and equipment primarily related to equipment
upgrades and the remodeling of branches.  During May 2003, the Company entered into an
agreement to sell one of its bank buildings and lease back a minor portion of
the space.  The sale is subject to numerous contingencies that have not yet
been met.  Assuming the contingencies are met, the transaction is expected
to close before the end of 2003 and would result in a gain to the Company.

Deposits
increased by $28.7 million, or 7%, from $428.7 million as of December 31, 2002,
to $457.4 million as of June 30, 2003.  The increase in deposits was largely
attributable to an increase in public funds between December 31, 2002 and June
30, 2003 as well as a focused effort to attract new CD deposits at lower rates.
Public funds deposits increased during this time frame due, to some degree, to
the collection of property taxes by counties.

Asset Quality

Provision
and Allowance for Loan Losses.Provision expense for the six and three
months ended June 30, 2003, was $250,000 and $125,000, respectively, compared to
$382,000 and $170,000, respectively, for the six and three months ended June 30,
2002.  The allowance for loan losses of $3.1 million as of June 30, 2003,
decreased 16% from the $3.7 million level as of December 31, 2002 and represents
0.98% of total loans and 182% of non-performing loans as of June 30, 2003 as
compared to 1.13% and 100%, respectively at December 31, 2002.   During this
same time period, average loans decreased $8.4 million, or 2%, and
non-performing loans decreased $2.0 million, or 54%.  The majority of this
reduction was achieved by completing foreclosures and subsequent sales of real
estate on several large loans that were on non-accrual, resulting in no further
loss to the Company.  The $2.1 million increase from June 2002 in loans past due
90 days or more and still accruing is primarily due to a single credit for which
the Company is well secured, in the process of foreclosure and on which the
Company anticipates no loss.  Accordingly, the $609,000 decrease in the
allowance for loan losses from December 31, 2002 reflects the Company’s
revised estimate of probable losses in the loan portfolio.

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Table of Contents

The
amount of the provision for loan losses is based on regular evaluations of the
loan portfolio, with particular attention directed toward non-performing,
delinquent, and other potential problem loans.  During these evaluations,
consideration is also given to such factors as management’s evaluation of
specific loans, the level and composition of delinquent and non-performing
loans, historical loan loss experience, results of examinations by regulatory
agencies, external and internal asset review processes, the market value of
collateral, the strength and availability of guarantees, concentrations of
credit and other judgmental factors.

The
following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data.

> Allowance for Loan Losses Analysis (in thousands)
> 
> Six months endedJune 30,2003
> 
> 2002(unaudited)
> 
> (unaudited)Average total loans
> $
> 335,051
> 
> 370,459Total loans at end of period
> $
> 319,968
> 
> 347,392Allowance at beginning of period
> $
> 3,747
> 
> 4,375Loans charged off
> 
> (950)
> 
> (838)Recoveries on loans previously charged off
> 
> 91
> 
> 68Provision for loan losses
> 
> 250
> 
> 382Allowance at end of period
> $
> 3,138
> 
> 3,987Annualized net charge-offs to average loans
> 
> 0.52%
> 
> 0.42%Allowance to total loans at end of period
> 
> 0.98%
> 
> 1.15%

Non-Performing Assets. The following table presents information regarding
non-performing assets as of the dates indicated:

> Non-Performing Assets  (in thousands)
> 
> June 30,2003
> 
> 2002(unaudited)
> 
> (unaudited)Nonaccrual loans
> $
> 1,722
> 
> 3,701Restructured loans
> 
> -
> 
> -Total non-performing
> loans
> 
> 1,722
> 
> 3,701Foreclosed properties
> 
> 542
> 
> 130Total non-performing
> assets
> 
> 2,264
> 
> 3,831Loans 90 days or more past due and accruing
> 
> 2,323
> 
> 219Total risk assets
> $
> 
> 4,587
> 
> 4,050Non-performing loans to total loans
> 
> 0.54%
> 
> 1.07%Non-performing assets to loan related assets
> 
> 0.71%
> 
> 1.10%Non-performing assets to total assets
> 
> 0.38%
> 
> 0.68%Risk assets to loan related assets
> 
> 1.43%
> 
> 1.17%

The
Company believes that it has adequate collateral to recover the majority of the
balance of the nonaccrual loans.  Foreclosed properties are recorded at the
lower of cost or fair value less estimated costs to sell.  All anticipated
losses are recorded at the time of transfer from loans.  Management is not aware
of any significant adverse trends relating to its loan portfolio.

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Liquidity

Liquidity
is a measure of the Company’s ability to meet its commitments and
obligations with available funds. These commitments may include paying dividends
to shareholders, funding new loans for borrowers, funding withdrawals by
depositors, paying general and administrative expenses, and funding capital
expenditures. Historically, the Company’s primary source of funds has been
customer deposits.  Scheduled loan repayments are a relatively stable source of
funds.  Deposit inflows and unscheduled loan repayments, which are influenced by
fluctuations in the general level of interest rates, returns available on other
investments, competition, economic conditions and other factors, are relatively
unstable.  Other sources of liquidity include sale or maturity of investment
securities and the ability to borrow funds.  Company borrowing may be used on a
short-term basis to compensate for reductions in other sources of funds (such as
deposit inflows at less than projected levels).  Company borrowing may also be
used on a longer-term basis to support expanded lending and investing activities
and to match the maturity or repricing intervals of assets.

As
of June 30, 2003, the Company had cash and cash equivalents (including federal
funds sold) of $81.5 million and investment securities of $106.8 million.
Approximately $102.0 million, or 95%, of the Company’s investment
portfolio is classified as available-for-sale and can be readily sold, however
$64.5 million of this amount has been pledged to secure public fund deposits and
may not be available to meet general liquidity needs.  Based on current plans
and business conditions, the Company expects that its cash, cash equivalents,
investment securities and available borrowing capacity under its credit
facilities, together with any amounts generated from operations, will be
sufficient to meet the Company’s liquidity requirements for the next 12
months. However, there can be no assurance that the Company will not be required
to seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company.

Cash Flows

Net Cash from Operating Activities

During
the six-month period ended June 30, 2003, cash of $4.2 million was provided by
operating activities consisting primarily of net income of $2.1 million plus
non-cash expenses of $1.5 million and net decreases in operating assets and
liabilities of $608,000. Non-cash expenses consisted primarily of $1.1 million
of depreciation and amortization expense on premises and equipment, a $250,000
loan loss provision, $195,000 of net amortization of premiums on investment
securities, $179,000 of stock compensation, and $177,000 of deferred income tax
expense.  The net decrease in operating assets and liabilities was primarily due
to a $2.7 million decrease in loans held for sale offset by a $915,000 increase
in other assets, a $692,000 increase in interest receivable, and a $519,000
decrease in interest payable and other liabilities.

During
the six-month period ended June 30, 2002, cash of $5.5 million was provided by
operating activities consisting primarily of net income of $2.8 million plus
non-cash expenses of $1.7 million and net decreases in operating assets and
liabilities of $882,000. Non-cash expenses consisted primarily of $1.2 million
of depreciation and amortization expense on premises and equipment and a
$382,000 loan loss provision.  The net decrease in operating assets and
liabilities was primarily due to a $2.4 million decrease in loans held for sale,
offset by a $738,000 increase in other assets and an $830,000 decrease in
interest payable and other liabilities.  The decrease in loans held for sale was
primarily due to a change in the types of mortgage loans originated during that
period.

Net Cash from Investing Activities

During
the six-month period ended June 30, 2003, cash of $36.1 million was used for
investing activities.  These outflows consisted primarily of the purchase of
$66.9 million of investment securities and $1.1 million in purchases of premises
and equipment, offset by the maturity and/or calls of $21.8 million of
investment securities, a decrease in loans of $8.0 million, and $2.0 million of
proceeds from sales of foreclosed properties.

During
the six-month period ended June 30, 2002, investing activities provided cash of
$13.1 million.  These inflows consisted primarily of a $43.2 million decrease in
loans, the maturity and/or calls of $7.2 million of investment securities, $1.7
million of proceeds from sales of premises and equipment and $594,000 of
proceeds from sales of foreclosed properties.  The proceeds from sales of
premises and equipment were primarily related to the sale of the previous office
building in Dillon. These inflows were offset by the purchase of $38.0 million
of investment securities and the purchase of $1.7 million of premises and
equipment.

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Table of Contents

Net Cash from Financing Activities

During
the six-month period ended June 30, 2003, cash of $38.4 million was provided by
financing activities consisting primarily of an increase in deposits of $28.7
million and the receipt of $15.7 million of proceeds from FHLB advances, offset
by the repurchase of $5.5 million of common stock and the payment of dividends
on common stock of $681,000.

During
the six-month period ended June 30, 2002, cash of $3.1 million was provided by
financing activities consisting primarily of the receipt of $8.9 million of
proceeds from FHLB advances, offset by a decrease in deposits of $4.3 million,
the repurchase of $1.1 million of common stock, and payment of dividends on
common stock of $582,000.

Borrowings

WestStar
is a member of the Federal Home Loan Bank of Topeka (FHLB) and, as a regular
part of its business, obtains both short and long-term advances from this FHLB.
Advances are collateralized primarily by FHLB stock owned by WestStar and loans
secured by certain mortgages or deeds of trust. As of June 30, 2003, the
Company’s total borrowing capacity was $117.8 million of which $45.7
million of borrowings were outstanding ($12.3 million was short-term and $33.4
million was long-term) and $24.0 million in the form of stand-by irrevocable
letters of credit issued by the FHLB were pledged as collateral for uninsured
public fund deposits.

WestStar
has established an unsecured, overnight federal funds line with Bankers’
Bank of the West that expires on August 31, 2003.  As of June 30, 2003, this
authorized borrowing line totaled $41.5 million with $0 outstanding.

WestStar
has also established overnight federal funds lines with First Tennessee Bank,
N.A. (First Tennessee) totaling $20.0 million.  If drawn upon, $10.0 million
will be a secured line and $10.0 million will be an unsecured line.  These lines
are subject to cancellation by First Tennessee at any time upon the occurrence
of certain conditions.  As of June 30, 2003, no amounts were outstanding under
the lines.

Dividends

Payment
of dividends is at the discretion of the Board and is determined by taking into
account the earnings, capital levels, cash requirements, and the financial
condition of Vail Banks and WestStar, as well as applicable government
regulations and other relevant factors.  On July 21, 2003, the Board declared a
regular quarterly dividend of $0.07 per share payable on August 15, 2003 to
shareholders of record on August 1, 2003.  This represents a 17% increase over
the previous quarterly dividend payment of $0.06 per share.

Stock Repurchase Plan

On


October 15, 2002, the Company’s Board of Directors reauthorized the
Company’s stock repurchase program, allowing additional repurchases of up
to $10 million through October 2003.  Since inception of the program in March
2001, the Company has repurchased 1,326,580 shares at an average cost of $11.77
per share.  During the first half of 2003, the Company repurchased 442,290
common shares at an average cost of $12.35.

Capital Resources

As
of June 30, 2003, shareholders’ equity had decreased $3.8 million, or 6%,
to $62.9 million from $66.8 million as of December 31, 2002.  This decrease is
primarily related to the repurchase of 442,290 shares of common stock at a cost
of $5.5 million, and the payment of common stock dividends of $681,000, offset
by the retention of $2.1 million of earnings.

As
of June 30, 2003 and 2002, the Company met all capital adequacy requirements to
which it was subject.  As of June 30, 2003, the Company had Tier 1 and Total
Risk-Based Capital ratios of 12.95% and 14.60%, respectively, and a Leverage
ratio of 8.47%.  Regulatory guidelines permit the Company’s trust
preferred securities to be included in the calculation of Tier 1 and Total
Risk-Based capital, subject to certain limitations.  As of June 30, 2002, the
Company had Tier 1 and Total Risk-Based Capital ratios of 12.91% and 14.48%,
respectively, and a Leverage ratio of 9.46%.

As
of June 30, 2003 and 2002, WestStar met all capital adequacy requirements to
which it was subject and exceeded the minimum ratios to be designated as
“well-capitalized.”  As of June 30, 2003, WestStar had Tier 1 and
Total Risk-Based Capital ratios of 13.39% and 14.25%, respectively, and a
Leverage ratio of 8.74%.  As of June 30, 2002, WestStar had Tier 1 and Total
Risk-Based Capital ratios of 11.89% and 12.91%, respectively, and a Leverage
ratio of 8.70%.

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Table of Contents

Recent Accounting
Pronouncements

During
June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities.  This statement is effective for exit or disposal
activities initiated after December 31, 2002.  These activities may include sale
or termination of a line of business, the closure of business activities in a
particular location, the relocation of business activities from one location to
another, changes in management structure, and a fundamental reorganization that
affects the nature and focus of operations.  The Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and requires companies to recognize liabilities associated with exit or disposal
activities at the time that they are incurred rather than at the date of a
commitment to the exit or disposal plan.  The Company adopted this standard on
January 1, 2003.  Adoption of this standard did not have an effect on the
Company’s consolidated financial condition or results of
operations.

During
April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.  This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities.
This statement is effective for contracts entered into or modified after June
30, 2003, except for certain circumstances, and for hedging relationships
designated after June 30, 2003.  The Company does not utilize derivative
instruments or engage in hedging activities.  Accordingly, adoption of this
standard is not anticipated to have an effect on the Company’s
consolidated financial condition or results of operations.

During
May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.  This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity.  It requires that an issuer classify a financial instrument that is
within its scope as a liability when previously it was classified as equity.
This statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003.  It is to be implemented by
reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance of the statement and still
existing at the beginning of the interim period of adoption.  Restatement is not
permitted.  The Company will adopt this statement on July 1, 2003.  Adoption of
this statement is not anticipated to have an effect on the Company’s
consolidated financial condition or results of operations.











20

Table of Contents

Item 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative Disclosures About Market Risk

The table below provides information about the Company’s financial
instruments as of December 31, 2002 that are sensitive to changes in interest
rates.

Principal Amount Maturing (b)
in:(in thousands)

2003
2004
2005
2006
2007
Thereafter or Non-Maturing
Total
Fair Value
December 31, 2002INTEREST RATE SENSITIVE ASSETS


Federal funds sold and interest earning deposits

$50,072
$              -
$         -
$             -
$             -
$             -
$50,072
$50,072Weighted average interest rate

1.09%
0.00%
0.00%
0.00%
0.00%
0.00%
1.09%Adjustable-rate securities

-
-
-
-
2,001
26,451
28,452
28,565Weighted average interest rate (a)

0.00%
0.00%
0.00%
0.00%
3.25%
5.08%
4.95%Fixed-rate securities

851
458
5
1,119
116
26,651
29,200
29,800Weighted average interest rate (a)

5.97%
5.26%
7.00%
5.36%
6.48%
5.79%
5.77%Investments in bank stocks

-
-
-
-
-
3,703
3,703
3,703Weighted average interest rate

0.00%
0.00%
0.00%
0.00%
0.00%
4.90%
4.90%Loans held for sale

9,879
-
-
-
-
-
9,879
9,879Weighted average interest rate

5.20%
0.00%
0.00%
0.00%
0.00%
0.00%
5.20%Adjustable-rate loans

113,373
49,486
21,546
17,880
24,941
25,804
253,030
253,177Weighted average interest rate

7.19%
6.39%
6.51%
6.13%
6.79%
7.35%
6.88%Fixed-rate loans

23,911
19,501
11,212
7,472
2,875
13,002
77,973
81,246Weighted average interest rate

8.50%
8.73%
8.36%
8.23%
7.38%
7.32%
8.27%Total interest rate sensitive assets

$198,086
$69,445
$32,763
$26,471
$29,933
$95,611
$452,309
$456,442Weighted average
interest rate

5.71%
7.04%
7.15%
6.69%
6.61%
6.19%
6.24%


INTEREST RATE SENSITIVE LIABILITIES

Interest-bearing checking, savings and money market
accounts

$             -
$         -
$            -
$         -
$         -
$209,964
$209,964
$209,964Weighted average interest rate

0.00%
0.00%
0.00%
0.00%
0.00%
0.63%
0.63%Fixed-rate time deposits

106,668
12,026
1,639
381
637
-
121,351
122,215Weighted average interest rate
2.55%
3.19%
3.75%
4.04%
3.42%
0.00%
2.64%Fixed-rate borrowings

9,490
8,940
5,715
5,615
240
-
30,000
31,039Weighted average interest rate
2.91%
3.77%
3.99%
4.46%
4.80%
0.00%
3.68%Trust preferred

-
-
-
-
-
24,000
24,000
25,208Weighted average interest rate

0.00%
0.00%
0.00%
0.00%
0.00%
10.19%
10.19%Total interest rate sensitive liabilities

$116,158
$20,966
$7,354
$5,996
$877
$233,964
$385,315
$388,426Weighted average
interest rate

2.58%
3.44%
3.94%
4.43%
3.80%
1.61%
2.10%


(a)     These interest rates are not adjusted to
reflect tax equivalent yields. 
(b)     The above amounts represent scheduled
maturities and do not include prepayments that may occur.

Qualitative Disclosures About Market Risk

Market
risk is the exposure to loss resulting from changes in interest rates, foreign
currency exchange rates, commodity prices and equity prices. The primary market
risk to which the Company is exposed is interest rate risk arising from the
instruments and transactions entered into by the Company.  They include loans,
securities available for sale, deposit liabilities, and borrowings.  Interest
rate risk occurs when interest-sensitive assets and liabilities reprice at
different times as market interest rates change. Interest-sensitive assets and
liabilities are those that are subject to repricing in the near term, including
both variable rate instruments and those fixed rate instruments that are
approaching maturity.  For example, if fixed-rate assets are funded with
floating-rate debt, the spread between asset and liability rates will decline or
turn negative if rates increase. Additionally, interest rate risk results from
changing spreads between asset and liability rates.

21

Table of Contents

The
Company’s Asset/Liability Management Committee manages interest rate risk.
The principal objective of asset/liability management is to manage the levels of
interest-sensitive assets and liabilities to minimize net interest income
fluctuations in times of fluctuating market interest rates. To effectively
measure and manage interest rate risk, the Company uses computer simulations
that determine the impact on net interest income of numerous interest rate
scenarios, balance sheet trends and strategies. These simulations cover the
following financial instruments: short-term financial instruments, investment
securities, loans, deposits, and borrowings. These simulations incorporate
assumptions about balance sheet dynamics, such as loan and deposit growth and
pricing, changes in funding mix, and asset and liability repricing and maturity
characteristics. Simulations are run under various interest rate scenarios to
determine the impact on net income and capital. From these computer simulations,
interest rate risk is quantified and appropriate strategies are developed and
implemented.  During 2002 and the first six months of 2003, the Company did not
use interest rate derivative financial instruments as an asset/liability
management tool to hedge mismatches in interest rate exposures.

During
the first six months of 2003, Vail Banks experienced increased liquidity, which
was used in part to purchase longer-term investment securities.  While the
liquidity position increased, the overall balance sheet restructuring increased
the asset sensitive nature of the balance sheet.  Therefore, Vail Banks was more
sensitive to changes in interest rates at June 30, 2003 than at December 31,
2002.

During
the remainder of 2003, the Company will face risk primarily from the possibility
of lower interest rates. Although the Company’s gap position is slightly
positive at June 30, 2003, due to the low level of deposit rates, the bank is
more sensitive to downward changes in rates.  If rates fall, asset yields will
decline faster than the cost of interest bearing liabilities, leading to a
decline in the margin. The extent of this decline will depend on the degree to
which retail deposit rates change relative to market rates. The 550 basis point
reduction in short-term rates by the Federal Reserve Bank since December 2000
effectively repriced a significant portion of the Company’s loan
portfolio.  While it also produced an opportunity to reduce funding costs, at
the current level of interest rates, further reductions in funding costs may be
limited.

Item 4.       CONTROLS AND PROCEDURES

Company
management, including the president and chief financial officer, supervised and
participated in an evaluation of the Company’s disclosure controls and
procedures (as defined in rules of the Securities and Exchange Commission) as of
June 30, 2003.  Based on, and as of the date of, that evaluation, the
Company’s president and chief financial officer have concluded that the
Company’s disclosure controls and procedures were effective in
accumulating and communicating information to management, including the
president and chief financial officer, as appropriate to allow timely decisions
regarding required disclosures of that information under the Securities and
Exchange Commission’s rules and forms and that the disclosure controls and
procedures are designed to ensure that the information required to be disclosed
in reports that are filed or submitted under the Securities and Exchange Act of
1934, as amended, are recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission’s rules
and forms.

There
were no significant changes in the Company’s internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.





22

Table of Contents

PART II
 OTHER INFORMATION

Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.

On May 19, 2003, the Company held its annual meeting of shareholders. At that
meeting, the security holders voted on the following items:

1.   Election of directors-Directors were elected with the
following results:

Name
Term
Votes CastFor Election
Votes CastAgainst Election
VotesWithheld
Abstentions
Broker Non-VotesDennis Devor
3 years
4,831,946
0
6,649
0
0Lisa M. Dillon
3 years
4,832,446
0
6,149
0
0George N. Gillett, Jr.
3 years
4,817,752
0
20,843
0
0Jack G. Haselbush
3 years
4,832,446
0
6,149
0
0Kent Myers
3 years
4,832,446
0
6,149
0
0


2.  Security holders voted to ratify the selection of Dalby, Wendland
& Co., P.C. as Vail Banks’ independent public accountants for the
fiscal year 2003.  The results of the vote were as follows:  votes cast for the
proposal were 4,816,151, votes cast against the proposal were 20,689, votes
withheld were 0, abstentions were 1,755, and broker non-votes were 0.

Item 6.      EXHIBITS AND
REPORTS ON FORM 8-K.

|(a) | Exhibits |                                                                                                                                                                                                                          
|--- | -------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |          |                                                                                                                                                                                                                          
|    | 31.1     | Certification by Lisa M. Dillon, President of the Company, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                          
|    | 31.2     | Certification by Peter G. Williston, Senior Executive Vice President and Chief
Financial Officer of the Company, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002                                    
|    | 32.1     | Certification by Lisa M. Dillon, President of the Company, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002                                                      
|    | 32.2     | Certification by Peter G. Williston, Senior Executive Vice President and Chief
Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



23

Table of Contents



|(b) | Reports on Form 8-K                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | The Company filed a Current Report on Form 8-K dated
April 23, 2003, under Item 9.  The report included a press release reporting
Vail Banks’ results of operations and financial condition for the first
quarter of 2003.













24

Table of Contents



SIGNATURES

Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.

|                       | VAIL BANKS, INC.                                           
|---------------------- | -----------------------------------------------------------
|                       |                                                            
|                       |                                                            
|Date:  August 13, 2003 | /s/   LISA M. DILLON                                       
|                       | Lisa M. Dillon                                             
|                       | President                                                  
|                       |                                                            
|                       |                                                            
|Date:  August 13, 2003 | /s/  PETER G. WILLISTON                                    
|                       | Peter G. Williston                                         
|                       | Senior Executive Vice President and Chief Financial Officer