**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**_______________________**





**FORM
      10-Q**






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




For
      the quarterly period ended
      March 31, 2006


**or**






**o   TRANSITION
      REPORT PURSUANT TO SECTION
      13 OR 15(** **d** **)
      OF THE SECURITIES EXCHANGE ACT OF 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.
      Employer


incorporation
      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)





**N/A**


(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. Yes  x No
o .





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 o     Non-accelerated
      filer x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes
       o No 
      x




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




**As
      of May 3, 2006, there were 5,606,235 common shares ($1.00 par value per share)
      outstanding.**





**VAIL
      BANKS, INC.**





**FORM
      10-Q**


**FOR
      THE QUARTER ENDED MARCH 31, 2006**





**TABLE
      OF CONTENTS**









**PART
                  I**
              **FINANCIAL
                  INFORMATION**ITEM
                  1.
              FINANCIAL
                  STATEMENTS*Consolidated
                  Balance Sheet (unaudited)*
              *3**Consolidated
                  Statement of Income and Comprehensive Income
                  (unaudited)*
              *4**Consolidated
                  Statement of Cash Flows (unaudited)*
              *5**Notes
                  to Unaudited Consolidated Financial Statements*
              *7*ITEM
                  2.
              MMANAGEMENT’S
                  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                  OPERATIONS*Forward
                  Looking Statements*
              *15**Basis
                  of Presentation*
              *15**Overview*
              *15**Results
                  of Operations - Quarter and Year to Date*
              *15**Financial
                  Condition*
              *16**Asset
                  Quality*
              *17**Financial
                Instruments With Off-Balance-Sheet Risk*
              *18**Liquidity*
              *19**Capital
                  Resources*
              *20*ITEM
                  3.
              QUANTITATIVE
                  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
              21ITEM
                  4.
              CONTROLS
                  AND PROCEDURES
              21**PART
                  II**
              **OTHER
                  INFORMATION**ITEM
                  1.
              LEGAL
                  PROCEEDINGS
              22ITEM
                  1A.
              RISK
                FACTORS
              22ITEM
                  2.
              UNREGISTERED
                  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
              22ITEM
                  3.
              DEFAULTS
                  UPON SENIOR SECURITIES
              22ITEM
                  4.
              SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY HOLDERS
              22ITEM
                  5.
              OTHER
                  INFORMATION
              22ITEM
                  6.
              EXHIBIITS
              22SIGNATURES


2


PART
      1FINANCIAL
      INFORMATION





**Item
      1.**  **FINANCIAL
      STATEMENTS**





**VAIL
                BANKS, INC.****Consolidated
                Balance Sheet**
              (unaudited)**March
                31,**
            
            December
                31,(dollars
                in thousands, except share data)
            
            **2006**
            
            2005**ASSETS**Cash
                and due from banks
            
            **$**
            **18,854**
            
            $
            20,728Federal
                funds sold
            
            
            **13,520**
            
            
            10,630Total
                cash and cash equivalents
            
            
            **32,374**
            
            
            31,358Investment
                securities, available-for-sale
            
            
            **83,852**
            
            
            87,265Investment
                securities, held-to-maturity
            
            
            **166**
            
            
            175Investments
                in Trust I and Trust II
            
            
            **743**
            
            
            743Loans,
                net
            
            
            **501,702**
            
            
            481,511Investments
                in bank stocks, at cost
            
            
            **4,583**
            
            
            4,558Premises
                and equipment, net
            
            
            **38,383**
            
            
            38,686Interest
                receivable
            
            
            **3,019**
            
            
            2,796Goodwill
            
            
            **35,970**
            
            
            35,970Core
                deposit intangible
            
            
            **109**
            
            
            119Other
                assets
            
            
            **4,069**
            
            
            3,138**$**
            **704,970**
            
            $
            686,319**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**LiabilitiesDepositsNon-interest
                bearing
            
            **$**
            **124,010**
            
            $
            133,250Interest
                bearing
            
            
            **433,465**
            
            
            419,258Total
                deposits
            
            
            **557,475**
            
            
            552,508Securities
                sold under agreements to repurchase
            
            
            **28,021**
            
            
            12,470Federal
                Home Loan Bank advances
            
            
            **23,967**
            
            
            25,759Subordinated
                notes to Trust I and Trust II
            
            
            **24,743**
            
            
            24,743Interest
                payable and other liabilities
            
            
            **3,535**
            
            
            4,606Total
                liabilities
            
            
            **637,741**
            
            
            620,086Minority
                interest
            
            
            **2,523**
            
            
            2,500Commitments
                and contingencies (Notes 6 and 10)Shareholders’
                equityPreferred
                shares - $1 par value; 2,250,000 shares authorized, no shares issued
                and
              outstanding
                at March 31, 2006 and December 31, 2005, respectively
            
            
            **—**
            
            
            —Common
                shares - $1 par value; 20,000,000 shares authorized, 5,606,235 shares
                issued and outstanding at March 31, 2006 and December 31,
                2005
            
            
            **5,606**
            
            
            5,606Additional
                paid-in capital
            
            
            **36,144**
            
            
            35,976Retained
                earnings
            
            
            **24,108**
            
            
            23,188Accumulated
                other comprehensive loss, net of tax benefit of
              **$579**and $364 at March 31, 2006 and December 31, 2005, respectively
            
            
            **(1,152**
            **)**
            
            (1,037
            )Total
                shareholders’ equity
            
            
            **64,706**
            
            
            63,733**$**
            **704,970**
            
            $
            686,319The
                accompanying notes are an integral part of these unaudited consolidated
                financial statements.







3




VAIL
        BANKS, INC.
 **Consolidated** **Statementof
        Income
        and Comprehensive Income**
 (dollars
        in thousands, except share data)
 (unaudited)
   Three
                    months ended
                  March
                    31,**2006**
                
                2005Interest
                    incomeInterest
                    and fees on loans
                
                **$**
                **10,863**
                
                $
                7,614Interest
                    on investment securities
                
                
                **845**
                
                
                1,371Interest
                    on federal funds sold
                
                
                **79**
                
                
                192Investments
                    in Trust I and Trust II
                
                
                **19**
                
                
                19Total
                    interest income
                
                
                **11,806**
                
                
                9,196Interest
                    expenseDeposits
                
                
                **2,667**
                
                
                1,329Securities
                    sold under agreements to repurchase
                
                
                **221**
                
                
                25Borrowings
                
                
                **255**
                
                
                364Federal
                    funds purchased
                
                
                **7**
                
                
                —Subordinated
                    notes to Trust I and Trust II
                
                
                **631**
                
                
                631Total
                    interest expense
                
                
                **3,781**
                
                
                2,349Net
                    interest income
                
                
                **8,025**
                
                
                6,847Provision
                    for loan losses
                
                
                **215**
                
                
                65Net
                    interest income after provision for loan losses
                
                
                **7,810**
                
                
                6,782Non-interest
                    incomeDeposit
                    related
                
                
                **647**
                
                
                620Mortgage
                    broker fees
                
                
                **403**
                
                
                394Net
                    loss on sale or call of investment securities
                
                
                —
                
                
                (8
                )Other
                
                
                **464**
                
                
                429Total
                    non-interest income
                
                
                **1,514**
                
                
                1,435Non-interest
                    expenseSalaries
                    and employee benefits
                
                
                **4,578**
                
                
                4,195Occupancy
                
                
                **976**
                
                
                864Furniture
                    and equipment
                
                
                **616**
                
                
                683Amortization
                    of core deposit intangible
                
                
                **10**
                
                
                10Other
                
                
                **1,281**
                
                
                1,214Total
                    non-interest expense
                
                
                **7,461**
                
                
                6,966Income
                    before income taxes
                
                
                **1,863**
                
                
                1,251Provision
                    for income taxes
                
                
                **550**
                
                
                366Net
                    income
                
                
                **1,313**
                
                
                885Net
                    change in unrealized losses on investment securities
                    available-for-sale,
                  net
                    of taxes of $68 and $277, respectively
                
                
                **(115**
                **)**
                
                (471
                )Comprehensive
                    income
                
                $
                **1,198**
                
                $
                414Earnings
                    per shareBasic
                
                $
                **0.25**
                
                $
                0.17Diluted
                
                $
                **0.24**
                
                $
                0.16Weighted
                    average common sharesBasic
                
                
                **5,233,523**
                
                
                5,084,048Diluted
                
                
                **5,464,685**
                
                
                5,471,864The
                    accompanying notes are an integral part of these unaudited consolidated
                    financial statements.








4






VAIL
        BANKS, INC.
 **ConsolidatedStatement
        of Cash Flows**
 (dollars
        in thousands)
 (unaudited)


Three
                months ended
              March
                31,**2006**
            
            2005Cash
                flows from operating activitiesNet
                income
            
            **$**
            **1,313**
            
            $
            885Adjustments
                to reconcile net income to net cash provided by operating
                activitiesNet
                amortization of premiums on investment securities
            
            
            **123**
            
            
            204Provision
                for loan losses
            
            
            **215**
            
            
            65Amortization
                of deferred loan fees
            
            
            **(307**
            **)**
            
            (331
            )Net
                loss on disposition of premises and equipment
            
            
            **—**
            
            
            7Depreciation
                and amortization
            
            
            **541**
            
            
            520Gain
                on sale of foreclosed properties
            
            
            **—**
            
            
            (5
            )Recognition
                of stock compensation on restricted common stock andstock
                options
            
            
            **168**
            
            
            97Minority
                interest expense
            
            
            **23**
            
            
            21Federal
                Home Loan Bank stock dividends
            
            
            **(26**
            **)**
            
            (24
            )Changes
                in operating assets and liabilitiesLoans
                held for sale
            
            
            **—**
            
            
            6,660Interest
                receivable
            
            
            **(223**
            **)**
            
            (133
            )Other
                assets
            
            
            **(423**
            **)**
            
            (330
            )Interest
                payable and other liabilities
            
            
            **(1,082**
            **)**
            
            (515
            )Net
                cash provided by operating activities
            
            
            **322**
            
            
            7,121Cash
                flows from investing activitiesPurchases
                of investment securities, available-for-sale
            
            
            **(400**
            **)**
            
            (30,316
            )Proceeds
                from maturities/calls of investment securities,
                held-to-maturity
            
            
            **9**
            
            
            —Proceeds
                from maturities/calls of investment securities,
                available-for-sale
            
            
            **3,508**
            
            
            3,531Net
                (increase) decrease in loans
            
            
            **(20,528**
            **)**
            
            3,925Purchases
                of premises and equipment
            
            
            **(228**
            **)**
            
            (325
            )Proceeds
                from sales of premises and equipment
            
            
            **—**
            
            
            56Proceeds
                from sales of foreclosed properties
            
            
            **—**
            
            
            13Net
                cash used by investing activities
            
            
            **(17,639**
            **)**
            
            (23,116
            )Cash
                flows from financing activitiesNet
                increase in deposits
            
            
            **4,967**
            
            
            54,208Net
                increase in securities sold under agreements to repurchase
            
            
            **15,551**
            
            
            10,628Net
                decrease in Federal Home Loan Bank advances
            
            
            **(1,792**
            **)**
            
            (12,706
            )Proceeds
                from issuance of common stock
            
            
            **—**
            
            
            462Distribution
                to minority partners
            
            
            **—**
            
            
            (42
            )Payment
                of cash dividends on common stock
            
            
            **(393**
            **)**
            
            (374
            )Net
                cash provided by financing activities
            
            
            **18,333**
            
            
            52,176Net
                increase in cash and cash equivalents
            
            
            **1,016**
            
            
            36,181Cash
                and cash equivalents at beginning of period
            
            
            **31,358**
            
            
            35,655Cash
                and cash equivalents at end of period
            
            **$**
            **32,374**
            
            $
            71,836The
                accompanying notes are an integral part of these unaudited consolidated
                financial statements.





5




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


Three
                months ended
              March
                31,**2006**
            
            2005Supplemental
                disclosures of cash flow informationCash
                paid during the period for:Interest
                on deposits and borrowed funds
            
            **$**
            **3,957**
            
            $
            2,510Income
                taxes
            
            **$**
            **415**
            
            $
            —Non-cash
                investing and financing transactions
              Foreclosure
                of collateralized loans, net of reserve
            
            **$**
            **429**
            
            $
            25Unrealized
                loss on investment securities available-for-sale, net of
                taxes
            
            **$**
            **(115**
            **)**
            $
            (471
            )





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





6
 **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 subsidiary, WestStar Bank
      (WestStar). Vail Banks and WestStar own a combined 54.04% interest in Avon
      56
      Limited and 74.94% of Glenwood/Rose L.P. which are consolidated in the financial
      statements of Vail Banks in accordance with Statement of Financial Accounting
      Standards (SFAS) No. 94, *Consolidation
      of All Majority-Owned Subsidiaries* (SFAS
      94). Avon 56 Limited and Glenwood/Rose L.P. are partnerships that own bank
      buildings in Avon, Colorado and Glenwood Springs, Colorado, respectively. As
      a
      result of the fact that these partnerships are not fully-owned, the
      non-controlling interest in the partnerships is reflected as minority interest
      in the consolidated financial statements. All entities are collectively referred
      to as the Company. All significant intercompany balances 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, 2005. 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, 2005. In
      the
      opinion of management, 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 months ended
      March 31, 2006 are not necessarily indicative of the results that may be
      expected for the full year.





Certain
      reclassifications have been made to the 2005 financial statements to conform
      to
      the 2006 presentation.





**2.
      INVESTMENT SECURITIES**




Investment
      securities consist of the following:




**March
                31, 2006**
            
            December
                31, 2005**Amortized**
            
            **Estimated**
            
            Amortized
            
            Estimated(dollars
                in thousands)
            
            **Cost**
            
            **Fair
                Value**
            
            Cost
            
            Fair
                ValueSecurities
                available-for-saleGovernment
                agencies (1)
            
            **$**
            **20,939**
            
            **$**
            **20,564**
            
            $
            22,039
            
            $
            21,632State
                and municipal obligations
            
            
            **21,620**
            
            
            **21,760**
            
            
            21,225
            
            
            21,548Mortgage-backed
                securities
            
            
            **38,123**
            
            
            **36,855**
            
            
            40,647
            
            
            39,469Agency
                preferred stock
            
            
            **4,500**
            
            
            **4,183**
            
            
            4,500
            
            
            4,116Other
            
            
            **500**
            
            
            **490**
            
            
            500
            
            
            500Total
                securities available-for-sale
            
            **$**
            **85,682**
            
            **$**
            **83,852**
            
            $
            88,911
            
            $
            87,265Securities
                held-to-maturityMortgage-backed
                securities
            
            **$**
            **166**
            
            **$**
            **173**
            
            $
            175
            
            $
            184(1)
                Includes mortgage-backed government
                agencies.





After-tax
      net unrealized losses on investment securities increased $115,000 during the
      first quarter of 2006 from an unrealized loss of $1.0 million at December 31,
      2005 to an unrealized loss of $1.2 million at March 31, 2006. The increase
      in
      the after-tax net unrealized losses on available-for-sale securities relates
      primarily to the 50 basis point increase in interest rates implemented by the
      Federal Reserve during the first quarter of 2006. Management does not believe
      any individual unrealized loss as of March 31, 2006 represents an
      other-than-temporary impairment.














7
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





The
      following table presents the components of investment income for the three
      months ended March 31, 2006 and 2005.





Three
                months ended
              March
                31,****(dollars
                in thousands)
            
            **2006**
            
            2005Taxable
                interest income
            
            **$**
            **506**
            
            $
            970Nontaxable
                interest income
            
            
            **278**
            
            
            343Dividends
            
            
            **61**
            
            
            58**$**
            **845**
            
            $
            1,371





**3.
      LOANS**




Loans
      consist of the following:





(dollars
                in thousands)
            
            **March
                31,**
              **2006**
            
            December
                31,
              2005Real
                estate - construction
            
            **$**
            **229,472**
            
            $
            222,857Commercial,
                industrial and agricultural
            
            
            **172,585**
            
            
            168,110Real
                estate - mortgage
            
            
            **99,404**
            
            
            88,679Consumer
                and other
            
            
            **6,000**
            
            
            7,455Gross
                loans
            
            
            **507,461**
            
            
            487,101Less:Allowance
                for loan losses
            
            
            **(4,685**
            **)**
            
            (4,473
            )Deferred loan fees, net
            
            
            **(1,074**
            **)**
            
            (1,117
            )Loans,
                net
            
            **$**
            **501,702**
            
            $
            481,511





Two
      loans, with total carrying values of $516,000, were transferred to foreclosed
      properties during the first quarter of 2006. One loan with a carrying value
      of
      $16,000 was transferred to foreclosed properties during the first quarter of
      2005.





The
      principal balance of loans on which the accrual of interest has been
      discontinued was $188,000 and $1.4 million at March 31, 2006 and 2005,
      respectively. As of March 31, 2006, $247,000 of loans were past due 90 days
      and
      still accruing interest. In comparison, as of March 31, 2005, $1.0 million
      of
      loans were past due 90 days and still accruing interest.





The
      majority of impaired loans requiring an allowance are measured using the fair
      value of the underlying collateral since these loans are considered collateral
      dependent. Any unsecured loans are measured using discounted cash flow analyses
      of the payments expected over the life of the loan considering any internal
      or
      external factors that currently exist that would impact the amount or timing
      of
      cash flows.





The
      following is a summary of information pertaining to impaired loans:





**March
                31,**
            
            December
                31,(dollars
                in thousands)
            
            **2006**
            
            2005Impaired
                loans without a valuation allowance
            
            **$**
            **3,544**
            
            $
            3,781Impaired
                loans with a valuation allowance
            
            
            **3,865**
            
            
            725Total
                impaired loans
            
            **$**
            **7,409**
            
            $
            4,506Valuation
                allowance related to impaired loans
            
            **$**
            **299**
            
            $
            173





8
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





The
      increase in impaired loans with a valuation allowance is primarily related
      to
      one relationship for which the Company is well secured and in the process of
      foreclosure.





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:





(dollars
                in thousands)
            
            **2006**Balance
                at January 1, 2006
            
            **$**
            **13,243**New
                loans
            
            
            **2,978**Payments
            
            
            **(3,398**
            **)**Balance
                at March 31, 2006
            
            **$**
            **12,823**







**4.
      ALLOWANCE FOR LOAN LOSSES**




Activity
      in the allowance is summarized as follows:




(dollars
                in thousands)
            
            **2006**
            
            2005Allowance
                at January 1,
            
            **$**
            **4,473**
            
            $
            3,895Loans
                charged off
            
            
            **(4**
            **)**
            
            (24
            )Recoveries
                on loans previously charged off
            
            
            **1**
            
            
            53Provision
                for loan losses
            
            
            **215**
            
            
            65Allowance
                at March 31,
            
            **$**
            **4,685**
            
            $
            3,989




**5.
        SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE**




Securities
      sold under agreements to repurchase, which are classified as secured borrowings,
      generally mature within one to four days from the transaction date. At March
      31,
      2006 and December 31, 2005, the carrying amount of securities sold to secure
      repurchase agreements was $28.0 million and $12.5 million, respectively. This
      $15.5 million increase is due to the Company’s recent marketing efforts focused
      on increasing the use of this product. Securities sold under agreements to
      repurchase are reported as the amount of cash received in connection with the
      transaction. The Company may be required to provide additional collateral based
      on the fair value of the underlying securities.





**6.
      BORROWINGS**




As
      a
      member of the Federal Home Loan Bank (FHLB), and as a regular part of its
      business, WestStar obtains both short and long-term advances from the FHLB
      of
      Topeka. Advances are collateralized primarily by FHLB stock owned by WestStar
      and loans secured by certain mortgages or deeds of trust. As of March 31, 2006,
      the Company’s total borrowing capacity was $172.6 million of which $24.0 million
      of borrowings were outstanding. Additionally, the Company had $21.0 million
      in
      stand-by irrevocable letters of credit issued by the FHLB and pledged as
      collateral for uninsured public fund deposits at March 31, 2006. As of December
      31, 2005, the authorized borrowing line totaled $175.2 million of which $25.8
      million was outstanding. Additionally, as of December 31, 2005, the Company
      had
      a $5.0 million stand-by irrevocable letter of credit from the FHLB 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, 2006. As of March 31, 2006 and December
      31,
      2005 this authorized borrowing line totaled $40.1 million with no amounts
      outstanding.




WestStar
      has also established an unsecured, overnight federal funds line with First
      Tennessee Bank, N.A. that expires on September 30, 2006. As of March 31, 2006
      and December 31, 2005 the authorized borrowing line totaled $20.0 million with
      no amounts outstanding. This line is subject to cancellation by First Tennessee
      at any time upon the occurrence of certain conditions.




9
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements







**7.
      SHAREHOLDERS’ EQUITY**







***Shares
      Repurchase Plan***




At
      its
      meeting on January 16, 2006, the Company’s Board of Directors reauthorized the
      Company’s common shares repurchase program that was originally approved in
      February 2001. Since inception of the program through March 31, 2006, the
      Company has repurchased 1,535,380 common shares at an average price of $12.10
      per share, for a total of approximately $19 million. The total amount of
      repurchases under the program, both previously completed and allowable up to
      January 2007, aggregate to approximately $29 million. During the first quarter
      of 2006, the Company did not repurchase any of its common shares.




***Restricted
      Shares***




On
      January 1, 2006, the Company adopted SFAS No. 123(R), *Share-Based
      Payment* (SFAS
      123(R)), under the modified prospective approach. Adoption of this standard
      had
      no impact on the Company’s accounting for its restricted stock grants. The
      financial statements for prior interim periods and fiscal years have not been
      restated. Accordingly, compensation expense is recorded over the vesting period
      of the restricted shares equal to the value of the restricted shares using
      the
      market price of the shares on the grant date. Generally, the restricted stock
      awards vest ratably over the service period; however, vesting may also be based
      upon attainment of certain performance measures.





The
      following table summarizes information related to restricted stock grants for
      the three months ended March 31, 2006:





Non-vested
              Shares
            
            Weighted-
              Average
              Grant
                Date
              Fair
                ValueBalance
                at December 31, 2005
            
            
            **382,974**
            
            **$**
            **13.25**Granted
            
            
            **—**
            
            
            **—**Vested
            
            
            **14,714**
            
            
            **10.74**Fair
                value adjustments to performance-based awards
            
            
            **—**
            
            
            **—**Balance
                at March 31, 2006
            
            
            **368,260**
            
            **$**
            **13.80**








***Stock
      Options***




In
      January 1998, the Company adopted a stock incentive plan pursuant to which
      the
      Compensation Committee (the Committee) of the Board may grant incentive stock
      options, nonqualified stock options, restricted stock awards and performance
      share awards to certain employees, directors and others who perform services
      for
      the Company.





The
      number of shares available for grant of awards under such plan, if any, must
      be
      approved by the Company’s shareholders. On May 17, 2004, shareholders approved
      an amendment to the Amended and Restated Stock Incentive Plan, as amended (the
      Plan), to increase the number of shares available under the Plan from 1,000,000
      to 1,250,000 shares and to provide that the new total number of shares will
      increase on January 1 st of each
      year using a formula based on increases in the total number of shares
      outstanding. The amendment also increased the number of shares reserved for
      the
      grant of incentive stock options from 500,000 to 625,000 shares. If granted,
      outstanding options will be counted against the authorized pool of shares,
      regardless of their vested status. At March 31, 2006 and December 31, 2005,
      there were 287,192 shares available for grant under the Plan.





The
      option exercise price for each stock option grant will not be less than the
      fair
      market value on the date the option is granted. The Committee may determine
      the
      restrictions and conditions under which options may be exercised. Options must
      be exercised within ten years of the date granted.


10
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





The
      Company accounts for its stock options in accordance with the provisions of
      SFAS
      123(R), which was adopted on January 1, 2006 under the modified prospective
      approach. In accordance with SFAS 123(R), the compensation cost that has been
      charged against income for stock-based compensation was $18,000 for the three
      months ended March 31, 2006. A tax benefit of $3,000 associated with this
      expense was recognized for the compensation expense related to the non-qualified
      stock options. The financial statements for prior interim periods and fiscal
      years have not been restated.





In
      accordance with SFAS No. 148, *Accounting
      for Stock-Based Compensation - Transition and Disclosure, an Amendment to SFAS
      No. 123* ,
      the
      following table illustrates the effect on net income and earnings per share
      as
      if the Company had applied the fair value recognition provisions of SFAS 123
      to
      stock-based compensation in prior periods.





(dollars
                in thousands, except share data)
            
            **Three
                months**
              **ended**
              **March
                31, 2005**Net
                incomeAs
                reported
            
            **$**
            **885**Add
                back: Total stock-based compensation recorded, net of tax
            
            
            **61**Deduct:
                Total stock-based compensation determined under the fair value method,
                net
                of tax
            
            
            **(80**
            **)**Pro
                forma
            
            **$**
            **866**Earnings
                per share - basicAs
                reported
            
            **$**
            **0.17**Pro
                forma
            
            **$**
            **0.17**Earnings
                per share - dilutedAs
                reported
            
            **$**
            **0.16**Pro
                forma
            
            **$**
            **0.15**





The
      fair
      value of employee stock option grants are estimated on the date of grant using
      the Black-Scholes option-pricing model. The following weighted-average
      assumptions were used for the 31,000 stock options granted during the first
      quarter of 2005. No stock options were granted during the first quarter of
      2006.





**Three
                months**
              **ended**
              **March
                31, 2005**Dividend
                yield
            2.17%Expected
                term
            7
                yearsExpected
                volatility
            24.9%Risk-free
                interest rate
            4.2%Weighted-average
                grant date fair value
            $3.42





The
      dividend yield is calculated by taking the Company’s historical dividend payment
      amount per year divided by the average market price of the Company’s stock. The
      expected term is determined using historical data which uses option exercises
      and employee terminations to calculate an expected term. Expected volatility
      is
      based on the historical volatility of the Company’s stock over the expected term
      of the options. The risk-free interest rate is based on the U.S. Treasury yield
      curve for a similar expected term in effect at the time of the grant.


11
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





A
      summary
      of the Company’s stock incentive plan activity as of March 31, 2006 and changes
      during the quarter then ended is presented below:





Options
            
            Shares
            
            Weighted
              Average
              Exercise
                Price
            
            Weighted-Average
                Remaining Contractual Term
            
            Aggregate
                Intrinsic Value
              ($000)Outstanding
                at January 1, 2006
            
            
            465,349
            
            $
            10.06
            
            
            4
                years
            
            $
            2,815Granted
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Exercised
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Forfeited
                or expired
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Outstanding
                at March 31, 2006
            
            
            465,349
            
            $
            10.06
            
            
            4
                years
            
            $
            2,815Exercisable
                at March 31, 2006
            
            
            429,599
            
            $
            9.78
            
            
            3
                years
            
            $
            2,720





As
      of
      March 31, 2006, there was $104,000 of total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted as stock
      options. Management does not anticipate any forfeitures for the remaining
      non-vested options. This cost is expected to be amortized on a straight-line
      basis over a weighted-average period of approximately 2.7 years and will be
      adjusted for subsequent changes in estimated forfeitures. The total fair value
      of shares vested during the three months ended March 31, 2006 was $16,000.





*Inducement
      Stock Options*





A
      summary
      of the Company’s inducement stock option activity as of March 31, 2006 and
      changes during the quarter then ended is presented below:





Options
            
            Shares
            
            Weighted
                Average
              Exercise
                Price
            
            Weighted
                Average Remaining Contractual Term
            
            Aggregate
                Intrinsic Value
              ($000)Outstanding
                at January 1, 2006
            
            
            8,750
            
            $
            12.86
            
            
            8
                years
            
            $
            28Granted
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Exercised
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Forfeited
                or expired
            
            
            **—**
            
            
            **—**
            
            
            **—**
            
            
            **—**Outstanding
                at March 31, 2006
            
            
            8,750
            
            $
            12.86
            
            
            8
                years
            
            $
            28Exercisable
                at March 31, 2006
            
            
            3,125
            
            $
            12.69
            
            
            8
                years
            
            $
            11





As
      of
      March 31, 2006, there was $16,000 of total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted as
      inducement stock options. Management does not anticipate any forfeitures for
      the
      remaining non-vested inducement options. This cost is expected to be amortized
      on a straight-line basis over a weighted-average period of approximately 2.7
      years and will be adjusted for subsequent changes in estimated forfeitures.
      The
      total fair value of shares vested during the three months ended March 31, 2006
      was $2,000.





***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.


12
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





The
      following table presents the net income and weighted average common shares
      outstanding used to calculate earnings per share for the three months ended
      March 31, 2006 and 2005:





March
                31,(dollars
                in thousands, except share and per share data)
            
            **2006**
            
            2005Basic
                earnings per share computationNet
                income available to common shareholders
            
            **$**
            **1,313**
            
            $
            885Weighted
                average shares - basic
            
            
            **5,233,523**
            
            
            5,084,048Basic
                earnings per share
            
            **$**
            **0.25**
            
            $
            0.17Diluted
                earnings per share computationNet
                income available to common shareholders
            
            **$**
            **1,313**
            
            $
            885Weighted
                average shares - basic
            
            
            **5,233,523**
            
            
            5,084,048Shares
                assumed issued:Stock
                options
            
            
            **160,554**
            
            
            124,110Restricted
                stock
            
            
            **70,608**
            
            
            263,706Weighted
                average shares - diluted
            
            
            **5,464,685**
            
            
            5,471,864Diluted
                earnings per share
            
            **$**
            **0.24**
            
            $
            0.16








There
      were no anti-dilutive options for the three months ended March 31, 2006 and
      31,000 anti-dilutive options for the three months ended March 31, 2005.





**8.
      REGULATORY MATTERS**




As
      of
      March 31, 2006, 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 9.87% and 11.18%, respectively, and a Leverage ratio of 8.14%.
      Regulatory guidelines permit the Company’s trust preferred securities to be
      included in the calculation of Tier 1, Total Risk-Based Capital, and Leverage
      ratios, subject to certain limitations.





As
      of
      March 31, 2006, WestStar met all capital adequacy requirements to which it
      was
      subject and exceeded the minimum ratios to be designated as “well-capitalized.”
As of March 31, 2006, WestStar had Tier 1 and Total Risk-Based Capital ratios
      of
      9.97% and 10.83%, respectively, and a Leverage ratio of 8.25%.





**9.**  **RECENT
      ACCOUNTING PRONOUNCEMENTS**




In
      March
      2006, the Financial Accounting Standards Board (FASB) issued Statement No.
      156
      (SFAS 156), *Accounting
      for Servicing of Financial Assets - An Amendment of FASB Statement No.
      140* .
      SFAS
      156 (1) requires that a servicing asset or liability be recognized each time
      a
      contract to service a financial asset is entered into, (2) requires that all
      separately recognized servicing assets and servicing liabilities be initially
      measured at fair value, if practicable, and (3) permits the subsequent
      measurement of servicing assets and servicing liabilities based on the
      amortization method or the fair value measurement method. SFAS 156 also permits
      a one-time reclassification of available-for-sale securities to trading
      securities provided that the available-for-sale securities are identified in
      some manner as offsetting the entity’s exposure to changes in the fair value of
      servicing assets or servicing liabilities that are subsequently measured at
      fair
      value. SFAS 156 will become effective as of the beginning of the first fiscal
      year that begins after September 15, 2006. Earlier adoption is permitted at
      the
      beginning of an entity’s fiscal year provided the entity has not yet issued
      financial statements, including interim financial statements, for any period
      of
      that fiscal year.





The
      Company will apply the requirements for recognition and initial measurement
      of
      servicing assets and servicing liabilities prospectively to all transactions
      entered into on or after January 1, 2007. Management has not completed its
      evaluation of the impact of SFAS 156 but believes that the effect on the
      Company’s financial position and results of operations will not be
      material.


13
 **VAIL
          BANKS, INC.**
 Notes
          to Unaudited Consolidated Financial Statements





**10.
      LEGAL CONTINGENCIES**




From
      time
      to time, the Company is party to or otherwise involved in legal proceedings
      arising in the normal course of business, such as claims to enforce liens,
      claims involving the making and servicing of real property loans and other
      issues relating to the business of the Company. Management of the Company does
      not believe that there is any pending or threatened proceeding against the
      Company which would have a material effect on the Company’s consolidated
      financial statements.





**11.
      SUBSEQUENT EVENTS**




On
      April
      17, 2006, the Board of Directors declared a regular quarterly dividend of $0.07
      per share payable on May 12, 2006 to shareholders of record on April 28, 2006.


14






**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 March 31, 2006 compared to December 31, 2005, and
      its
      results of operations for the three months ended March 31, 2006, in comparison
      to the three months ended March 31, 2005. 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, 2005.





**Overview** ****





Net
      income was $1.3 million for the three months ended March 31, 2006, an increase
      of $428,000, or 48%, from $885,000 in the first quarter of 2005.





Diluted
      earnings per share for the three months ended March 31, 2006 were $0.24 compared
      to $0.16 for the first quarter of 2005, an increase of 50%.





The
      annualized return on average assets was 0.77% for the three months ended March
      31, 2006 compared to 0.55% for the three months ended March 31, 2005, a 40%
      increase.




The
      annualized return on average equity was 8.29% for the three months ended March
      31, 2006 compared to 5.95% for the three months ended March 31, 2005, a 39%
      increase.




**Results
      of Operations** **- Quarter** **and
      Year to Date**




*Net
      Interest Income.* Net
      interest income, on a fully tax-equivalent basis (FTE), increased by $1.1
      million, or 16%, to $8.1 million for the three months ended March 31, 2006
      from
      $7.0 million for the three months ended March 31, 2005. The net interest margin
      on an FTE basis was 5.49% for the three months ended March 31, 2006 as compared
      to 5.11% for the three months ended March 31, 2005. Net interest margin is
      influenced by the level and relative mix of earning assets and interest bearing
      liabilities as well as the cost of interest bearing liabilities as compared
      to
      the yield on earning assets. The increase in net interest margin during the
      first quarter of 2006 as compared to the first quarter of 2005 was due to the
      increase in the average yield on earning assets exceeding the increase in the
      average cost of interest bearing liabilities, as explained in more detail in
      the
      following two paragraphs.


15




Average
      loans increased $96.3 million, a 24% increase since March 31, 2005, as a result
      of Colorado’s
      improved economy and an internal focus on building the loan portfolio. The
      growth in average deposits, up $33.4 million, or 6%, from March 31, 2005 enabled
      the Company to grow the loan portfolio without increasing higher-rate debt.
      Average FHLB bank advances decreased $13.7 million, or 36%, since March 31,
      2005
      to an average balance of $24.9 million for the first quarter 2006. The
      200
      basis point interest rate increases implemented by the Federal Reserve from
      March 31, 2005 through March 31, 2006 have also contributed to the increase
      in
      the net interest margin. Interest income FTE increased to $11.9 million for
      the
      three months ended March 31, 2006 from $9.3 million for the three months ended
      March 31, 2005. During this time, average earning assets increased $46.6
      million, or 8%, from $554.2 million for the three months ended March 31, 2005
      to
      $600.8 million for the three months ended March 31, 2006. During the first
      quarter of 2006, loans had an average yield of 8.84%, an increase of 117 basis
      points from a yield of 7.67% for the first quarter of 2005. The average yield
      on
      federal funds sold also increased during the first quarter of 2006 as compared
      to the first quarter of 2005, rising 166 basis points to 4.25% for the first
      quarter of 2006. As a result of these increases in average yields, the total
      yield on average earning assets increased 121 basis points to 8.04% for the
      first quarter of 2006, as compared to 6.83% for the first quarter of 2005.




Interest
      expense increased to $3.8 million, a change of $1.5 million or 65%, for the
      three months ended March 31, 2006, as compared to $2.3 million for the
      corresponding period in 2005. This increase was comprised primarily of a $1.3
      million, or 101%, increase in interest expense on deposits, due to an increase
      in average balances and an increase in cost of funds due to rising interest
      rates during the three months ended March 31, 2006, as compared to the
      corresponding period in 2005. The Company has also incurred increased expense
      related to its overnight sweep products (securities sold under agreements to
      repurchase). Due to an internal focus to market this product, the average
      balance has increased 403%, or $17.7 million, since March 31, 2005. Accordingly,
      the interest expense associated with overnight sweep products has increased
      from
      $25,000 for the quarter ended March 31, 2005 to $221,000 for the quarter ended
      March 31, 2006. Average interest bearing deposits increased $27.1 million,
      or
      7%, in 2006 over the corresponding period in 2005. As a result, the total cost
      of interest-bearing liabilities increased 104 basis points to 3.09% for the
      first quarter of 2006, as compared to 2.05% for the first quarter of 2005.
      This
      increase in cost of interest bearing liabilities, however, was not in proportion
      to the increase in yield on average earning assets, resulting in an overall
      increase in net interest income and net interest margin for the first quarter
      of
      2006.





*Non-Interest
      Income* .
      During
      the three months ended March 31, 2006, non-interest income increased by $79,000,
      or 6%, to $1.5 million from $1.4 million for the three months ended March 31,
      2005. This increase was primarily attributable to increases in service charges
      and other deposit related fees.





*Non-Interest
      Expense* .
      Non-interest expense increased $495,000, or 7%, to $7.5 million for the three
      months ended March 31, 2006, from $7.0 million for the three months ended March
      31, 2005. This increase was attributable to the following: (1) an increase
      in
      salaries and benefits of $383,000, or 9%, compared to first quarter 2005 due
      to
      increased salaries and increased health insurance costs; (2) an increase of
      $112,000 in occupancy expenses which reflects the opening of the Fruita branch
      in June 2005 and increases in common area maintenance costs, gas and electrical
      services.





The
      efficiency ratio was 78% for the three months ended March 31, 2006 compared
      to
      84% for the three months ended March 31, 2005. The improvement in the efficiency
      ratio was due to the increase in revenue (net interest income plus non-interest
      income) of $1.3 million, or 15%, for the three months ended March 31, 2006
      compared to the three months ended March 31, 2005, while at the same time
      non-interest expenses increased by a lesser degree, 7% or $495,000.





*Income
      Taxes.* The
      Company’s effective income tax rate (income tax expense as a percentage of
      pre-tax income) was 29.5% for the three months ended March 31, 2006, as compared
      to 29.3% for the three months ended March 31, 2005.




**Financial
      Condition**





The
      Company's assets increased by $18.7 million, or 3%, to $705.0 million as of
      March 31, 2006, from $686.3 million as of December 31, 2005.





Federal
      funds sold balances increased by $2.9 million, or 27%, to $13.5 million as
      of
      March 31, 2006 from $10.6 million at December 31, 2005. Investment securities
      decreased to $84.0 million as of March 31, 2006, compared to $87.4 million
      as of
      December 31, 2005, a 4% decrease. The decrease in investment securities is
      due
      to maturities and principal payments received on mortgage-backed securities
      in
      the portfolio.


16





The
      Company originates consumer mortgage loans with the intent to sell those loans
      to third parties. As of March 31, 2006 and December 31, 2005, the Company did
      not have any loans held for sale. The ending balance of loans held for sale
      at
      any particular date is dependent on the timing of the closing and ultimate
      funding of the loans by third parties. Thus, an increase or decrease in the
      ending balance is primarily a function of timing and may not be indicative
      of
      trends in mortgage loan demand.




Deposits
      increased by $5.0 million, or 1%, from $552.5 million as of December 31, 2005,
      to $557.5 million as of March 31, 2006. The largest increase was in money market
      deposits, with a $19.1 million, or 9% increase. This was partially offset with
      decreases in both certificates of deposits and non-interest bearing checking.
      Core deposits, which exclude certificates of deposits, increased $7.6 million,
      or 2%, since December 31, 2005 to $470.1 million at March 31, 2006.




**Asset
      Quality**





*Provision
      and Allowance for Loan Losses.* Provision expense for the three months ended March 31, 2006 was $215,000
      compared to $65,000 for the three months ended March 31, 2005. This increase
      of
      $150,000 was primarily due to the Company’s loan growth. The allowance for loan
      losses of $4.7 million as of March 31, 2006 was up from $4.5 million as of
      December 31, 2005, and represents 0.93% of total loans as of March 31, 2006,
      as
      compared to 0.92% of total loans at December 31, 2005. Since December 31, 2005,
      average loans have increased $40.5 million, or 9%. Loans
      past due 90 days or more and still accruing interest increased to $247,000
      at
      March 31, 2006 compared to $83,000 at December 31, 2005.





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, 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**(dollars in thousands)
            
            Three
                months ended
              March
                31,**2006**
            
            2005Average
                total loans
            
            **$**
            **498,619**
            
            $
            402,340Total
                loans at end of period
            
            **$**
            **506,387**
            
            $
            402,763Allowance
                at beginning of period
            
            **$**
            **4,473**
            
            $
            3,895Loans
                charged off
            
            
            **(4**
            **)**
            
            (24
            )Recoveries
                on loans previously charged off
            
            
            **1**
            
            
            53Provision
                for loan losses
            
            
            **215**
            
            
            65Allowance
                at end of period
            
            **$**
            **4,685**
            
            $
            3,989Annualized
                net (charge-offs) recoveries to average loans
            
            
            **0.00**
            **%**
            
            0.03
            %Allowance
                to total loans at end of period
            
            
            **0.93**
            **%**
            
            0.99
            %





17


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





**Non-Performing
                Assets**(dollars
                in thousands)****
            
            March
                31,**2006**
            
            2005Nonaccrual
                loans
            
            **$**
            **188**
            
            $
            1,391Restructured
                loans
            
            
            **—**
            
            
            —Total
                non-performing loans
            
            
            **188**
            
            
            1,391Foreclosed
                properties
            
            
            **1,093**
            
            
            802Total
                non-performing assets
            
            
            **1,281**
            
            
            2,193Loans
                90 days or more past due and accruing
            
            
            **247**
            
            
            1,053Total
                risk assets
            
            **$**
            **1,528**
            
            $
            3,246Non-performing
                loans to total loans
            
            
            **0.04**
            **%**
            
            0.35
            %Non-performing
                assets to loan related assets
            
            
            **0.25**
            **%**
            
            0.54
            %Non-performing
                assets to total assets
            
            
            **0.18**
            **%**
            
            0.32
            %Risk
                assets to loan related assets
            
            
            **0.30**
            **%**
            
            0.80
            %





Foreclosed
      properties are recorded at fair value less estimated costs to sell. 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.





**Financial
      Instruments With Off-Balance-Sheet Risk**





The
      Company is a party to credit related 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 and letters of credit. Such commitments involve, to varying
      degrees, elements of credit and interest rate risk in excess of the amount
      recognized in the consolidated balance sheet. The Company’s exposure to credit
      loss is represented by the contractual amount of these commitments. The Company
      follows the same credit policies in making commitments as it does for
      on-balance-sheet instruments.





The
      following financial instruments represent off-balance-sheet risk:





(dollars
                in thousands)
            
            **March
                31,**
              **2006**
            
            December
                31,
              2005Financial
                instruments whose contractualamounts
                represent credit riskCommitments
                to extend credit
            
            **$**
            **112,258**
            
            $
            124,111Letters
                of credit
            
            
            **22,869**
            
            
            20,363Total
                commercial commitments
            
            **$**
            **135,127**
            
            $
            144,474





Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      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 commitments 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 is based on management’s
      credit evaluation. Collateral held varies, but may include accounts receivable,
      inventory, property, plant and equipment and income producing commercial
      properties.




Letters
      of credit are conditional commitments issued by the Company to guarantee the
      performance of a customer to a third party. Letters of credit are used to
      guarantee performance primarily on development and construction projects. The
      credit risk involved in issuing letters of credit is essentially the same as
      that involved in extending loan facilities to customers. Those commitments
      are
      primarily issued on behalf of local businesses.


18








**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 also 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 volatile. 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
      March 31, 2006, the Company had cash and cash equivalents (including federal
      funds sold) of $32.4 million and investment securities of $84.0 million.
      Approximately $83.9 million of the Company’s investment portfolio is classified
      as available-for-sale and can be readily sold. $40.1 million of this amount
      has
      been pledged to secure uninsured public fund deposits and $38.3 million has
      been
      pledged to secure securities sold under agreements to repurchase .
      Accordingly, these pledged amounts 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.





***Borrowings***





As
      a
      member of the FHLB and, as a regular part of its business, WestStar obtains
      both
      short and long-term advances from the FHLB. Advances are collateralized
      primarily by FHLB stock owned by WestStar and loans secured by certain mortgages
      or deeds of trust. As of March 31, 2006, the Company’s total borrowing capacity
      was $172.6 million of which $24.0 million of borrowings were outstanding.
      Additionally, the Company had $21.0 million in the form of stand-by irrevocable
      letters of credit issued by the FHLB and pledged as collateral for uninsured
      public fund deposits as of March 31, 2006.




WestStar
      has established an unsecured, overnight federal funds line with Bankers’ Bank of
      the West that expires on August 31, 2006. As of March 31, 2006, the authorized
      borrowing line totaled $40.1 million, with no amounts outstanding.




WestStar
      has also established an unsecured, overnight federal funds line with First
      Tennessee Bank, N.A. that expires on September 30, 2006. As of March 31, 2006,
      the authorized borrowing line totaled $20.0 million, with no amounts
      outstanding. This line is subject to cancellation by First Tennessee at any
      time
      upon the occurrence of certain conditions.







***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. The payment of dividends by Vail Banks
      and WestStar may also be affected or limited by other factors, such as the
      requirement to maintain adequate capital to meet regulatory guidelines. In
      addition, if, in the opinion of the applicable regulatory authority, a bank
      under its jurisdiction is engaged in or is about to engage in an unsafe or
      unsound practice (which, depending upon the financial condition of the bank,
      could include the payment of dividends), such authority may require, after
      notice and hearing, that such bank cease and desist from such practice. Capital
      adequacy considerations could further limit the availability of dividends.
      Due
      to the volume of dividends paid relative to earnings in earlier years, any
      dividend payments from WestStar to Vail Banks required prior regulatory approval
      through December 31, 2005. Commencing January 1, 2006, WestStar is no longer
      required to obtain regulatory approval for dividend payments from WestStar
      to
      Vail Banks. A principal source of Vail Banks’ income is dividends from
      WestStar.





On
      April
      17, 2006, the Board declared a regular quarterly dividend of $0.07 per share
      payable on May 12, 2006 to Vail Banks’ shareholders of record on April 28, 2006.


19





***Shares
      Repurchase Plan***




At
      its
      meeting on January 16, 2006, the Company’s Board of Directors reauthorized the
      Company’s common shares repurchase program that was originally approved in
      February 2001. Since inception of the program through March 31, 2006, the
      Company has repurchased 1,535,380 common shares at an average price of $12.10
      per share, for a total of approximately $19.0 million. The total amount of
      repurchases under the program, both previously completed and allowable up to
      January 2006, equals in the aggregate approximately $29.0 million. The total
      amount of repurchases available under the program is approximately $10.0
      million. During the first three months of 2006, the Company did not repurchase
      any of its common shares.





**Capital
      Resources** ****





As
      of
      March 31, 2006, shareholders’ equity had increased $973,000, or 2%, to $64.7
      million from $63.7 million as of December 31, 2005. This increase is primarily
      related to the retention of earnings of $1.3 million; offset by an increase
      in
      accumulated other comprehensive loss of $115,000 due to the unrealized loss
      on
      available-for-sale securities, and the payment of dividends of $393,000.





As
      of
      March 31, 2006 and 2005, the Company met all capital adequacy requirements
      to
      which it was subject. As of March 31, 2006, the Company had Tier 1 and Total
      Risk-Based Capital ratios of 9.82% and 11.13%, respectively, and a Leverage
      ratio of 8.14%. As of March 31, 2005, the Company had Tier 1 and Total
      Risk-Based Capital ratios of 10.14% and 11.62%, respectively, and a Leverage
      ratio of 8.01%.





As
      of
      March 31, 2006 and 2005, WestStar met all capital adequacy requirements to
      which
      it was subject and exceeded the minimum ratios to be designated as
“well-capitalized **.** ”
As
      of
      March 31, 2006, WestStar had Tier 1 and Total Risk-Based Capital ratios of
      9.97%
      and 10.83%, respectively, and a Leverage ratio of 8.25%. As of March 31, 2005,
      WestStar had Tier 1 and Total Risk-Based Capital ratios of 10.36% and 11.21%,
      respectively, and a Leverage ratio of 7.91%.










20


**Item
      3.** **QUANTITATIVE
      AND 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.




The
      Company’s Asset/Liability 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. As of March 31, 2006, the Company has never used interest rate
      derivative financial instruments as an asset/liability management tool to hedge
      mismatches in interest rate exposures.





Management
      continually monitors the Company’s exposure to fluctuations in market rates. One
      of the tools management utilizes to estimate the sensitivity of net interest
      revenue to changes in interest rates is an interest rate simulation model.
      Such
      estimates are based upon a number of assumptions for each scenario, including
      the level of loan growth and deposit and loan repricing characteristics. The
      simulation model measures the potential change in net interest income for future
      periods under various interest rate scenarios. Based on these simulation models,
      if interest rates increased 200 basis points over the twelve month period ended
      March 31, 2007 and then remained constant thereafter, net interest income would
      increase an estimated $1.8 million for the year ended March 31, 2007 and an
      estimated $4.8 million for the twelve months ended March 31, 2008. On the
      contrary, if interest rates decreased 100 basis points over the twelve month
      period ended March 31, 2007 and then remained constant thereafter, net interest
      income would decrease an estimated $938,000 for the twelve months end March
      31,
      2007 and $2.5 million for the year ended March 31, 2008.




The
      increase in short-term rates by the Federal Reserve during 2005, and thus far
      in
      2006, has effectively repriced a significant portion of the Company’s loan
      portfolio. Due to the deposit growth during the first three months of 2006,
      the
      Company has been able to minimize increases to funding costs, while capitalizing
      on the increased yield on loans, thereby increasing the net interest margin.





**Item
      4.** **CONTROLS
      AND PROCEDURES**





Company
      management, including the Chief Executive Officer 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 March 31, 2006. Based on, and as of the date of, that
      evaluation, the Company’s Chief Executive Officer 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 Chief Executive Officer 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 have materially affected, or could significantly affect, these
      controls subsequent to the date of their evaluation.


21





**PART
      II**  **OTHER
      INFORMATION**





**Item
      1.**  **LEGAL
      PROCEEDINGS.**





Vail
      Banks and its banking subsidiary periodically are parties to or otherwise
      involved in legal proceedings arising in the normal course of business, such
      as
      claims to enforce liens, claims involving the making and servicing of real
      property loans and other issues incident to their business. Management does
      not
      believe that there is any pending or threatened proceeding against Vail Banks
      or
      its banking subsidiary which, if determined adversely, would have a material
      effect on the business, results of operations, or financial position of Vail
      Banks or its banking subsidiary.





**Item
      1A.**  **RISK FACTORS.**




There
      have been no material changes to the Company’s risk factors during the first
      quarter of 2006. For a complete discussion of the Company’s risk factors, please
      reference the Company’s Annual Report on Form 10-K as of and for the year ended
      December 31, 2005.





**Item
      2.**  **UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**





None.





**Item
      3.**  **DEFAULTS
      UPON SENIOR SECURITIES.**





None.





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





None.





**Item
      5.**  **OTHER
      INFORMATION.**





None.





**Item
      6. EXHIBITS.**







**Exhibit
                  No.**
              **Description**31.1
              Certification
                  by Gary S. Judd, Chief Executive Officer and President of the Company,
                  as
                  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200231.2
              Certification
                  by Brady T. Burt, Chief Financial Officer of the Company, as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200232.1
              Certification
                    byGary
                    S. Judd, Chief Executive Officer and President of the Company,
                    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                    906 of
                    the Sarbanes-Oxley Act of 200232.2
              Certification
                by Brady T. Burt, 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


22


**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:
                      May 15, 2006
                  /s/
                      GARY S. JUDDGary
                      S. Judd*Chief
                      Executive Officer and President**(Principal
                      Executive Officer)**May
                      15, 2006*Date:
                      May 15, 2006
                  /s/
                      BRADY T. BURTBrady
                      T. Burt*Chief
                      Financial Officer**(Principal
                      Financial Officer)**May
                      15, 2006*
 23
 **VAIL
          BANKS, INC.**


**Exhibit
      Index**








Exhibit
                  No.
              Description31.1
              Certification
                  by Gary S. Judd, Chief Executive Officer and President of the Company,
                  as
                  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200231.2
              Certification
                  by Brady T. Burt, Chief Financial Officer of the Company, as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200232.1
              Certification
                  by Gary S. Judd, Chief Executive Officer and President of the Company,
                  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                  906 of
                  the Sarbanes-Oxley Act of 200232.2
              Certification
                  by Brady T. Burt, 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









24