##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549




---



FORM 10-Q

(Mark One)

(X)
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934


For the Quarter ended September 30, 2003


(  )
    
    Transition report pursuant to Section 13 or 15(d)) of the Securities Exchange Act of 1934


For Transition Period from  toCommission File Number 000-30447




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VALLEY COMMUNITY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)


Washington
    
    91-1913479(State or other
jurisdiction
of incorporation or organization)
    
    (I.R.S. Employer Identification No.)1307 East Main, Puyallup, Washington
    
    98372(Address of principal executive offices)
    
    (Zip Code)


(253) 848-2316
(Registrants telephone number, including area code)



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



| |  | Yes [X] No [  ]
| |  | ---------------



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



| |  | Yes [  ] No [X]
| |  | ---------------



| |  | The number of shares of the issuers Common Stock, $1.00 par value,
outstanding at November 3, 2003 was 1,173,352.
| |  | ------------------------------------------------------------------------------------------------------------------





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TABLE OF CONTENTS



|                             |                                                                                               |                                                      |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|                             | Item 1. FINANCIAL STATEMENTS                                                                 
|                             |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEET                
|                             |                                                                                               | CONDENSED CONSOLIDATED STATEMENT OF INCOME          
|                             |                                                                                               | CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS      
|                             |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                             | Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                             | Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                             | Item 4. CONTROLS AND PROCEDURES                                                              
|                             | FORWARD-LOOKING STATEMENTS                                                                   
|PART II   OTHER INFORMATION
|                             | Item 1. LEGAL PROCEEDINGS                                                                    
|                             | Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                             | Item 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                             | Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                             | Item 5. OTHER INFORMATION                                                                    
|                             | Item 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                  
|Exhibit 31.1                
|Exhibit 31.2                
|Exhibit 32.1                



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##### Table of Contents



VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARY
INDEX TO QUARTERLY REPORT ON FORM 10-Q

PART I
    
    FINANCIAL INFORMATION


PageItem 1.
    
    Financial StatementsCondensed Consolidated Balance Sheet  September 30, 2003 and December 31, 2002
    
    
    1Condensed Consolidated Statement of Income  Three and Nine Months Ended September 30, 2003 and 2002
    
    
    2Condensed Consolidated Statement of Cash Flows  Nine Months Ended September 30, 2003 and 2002
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2.
    

Managements
Discussion and Analysis of Financial Condition And Results of Operation
    
    
    8Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    22FORWARD-LOOKING
STATEMENTS
    
    
    22PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    23Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    23Item 3.
    
    Defaults upon Senior Securities
    
    
    23Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    23Item 5.
    
    Other Information
    
    
    23Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    23Signatures
    
    
    24Certifications
    
    
    25


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##### Table of Contents






Item 1. FINANCIAL STATEMENTS




VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)
(dollars in thousands)

September 30,
    
    December 31,2003
    
    2002ASSETSCash and due from banks
    
    $
    6,673
    
    
    $
    4,847Interest-bearing deposits with banks
    
    
    15,127
    
    
    
    22,191Federal funds sold
    
    
    5,727
    
    
    
    1,734Securities available-for-sale
    
    
    40,475
    
    
    
    31,069Federal Home Loan Bank stock
    
    
    372
    
    
    
    39868,374
    
    
    
    60,239Loans
    
    
    112,235
    
    
    
    105,354Less allowance for loan losses
    
    
    1,388
    
    
    
    1,388Loans, net
    
    
    110,847
    
    
    
    103,966Accrued interest receivable
    
    
    720
    
    
    
    727Premises and equipment, net
    
    
    5,929
    
    
    
    6,096Real estate held for investment
    
    
    
    
    
    
    224Other assets
    
    
    405
    
    
    
    459Total assets
    
    $
    186,275
    
    
    $
    171,711LIABILITIESDepositsNoninterest-bearing
    
    $
    32,990
    
    
    $
    29,119Interest-bearing
    
    
    127,582
    
    
    
    118,317Total deposits
    
    
    160,572
    
    
    
    147,436Other borrowed funds
    
    
    618
    
    
    
    750Accrued interest payable
    
    
    189
    
    
    
    295Other liabilities
    
    
    1,645
    
    
    
    775Total liabilities
    
    
    163,024
    
    
    
    149,256STOCKHOLDERS EQUITYCommon stock, par value $1 per share; 5,000,000 shares authorized; 1,173,352 and 1,115,994
shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively
    
    
    1,173
    
    
    
    1,116Additional paid-in capital
    
    
    16,883
    
    
    
    15,527Retained earnings
    
    
    4,755
    
    
    
    5,219Accumulated other comprehensive income, net of tax
    
    
    440
    
    
    
    593Total stockholders equity
    
    
    23,251
    
    
    
    22,455Total liabilities and stockholders equity
    
    $
    186,275
    
    
    $
    171,711


The accompanying notes are an integral part of these financial statements

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##### Table of Contents






VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(unaudited)
(dollars in thousands, except for per share amounts)

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002INTEREST INCOMEInterest and fees on loans
    
    $
    1,897
    
    
    $
    2,081
    
    
    $
    5,743
    
    
    $
    6,027Interest on federal funds sold and deposits in banks
    
    
    83
    
    
    
    87
    
    
    
    269
    
    
    
    255Interest on securities
    
    
    266
    
    
    
    365
    
    
    
    821
    
    
    
    1,131Total interest income
    
    
    2,246
    
    
    
    2,533
    
    
    
    6,833
    
    
    
    7,413INTEREST EXPENSEInterest on deposits
    
    
    296
    
    
    
    467
    
    
    
    1,003
    
    
    
    1,443Interest on federal funds and other short-term borrowings
    
    
    1
    
    
    
    2
    
    
    
    4
    
    
    
    5Total interest expense
    
    
    297
    
    
    
    469
    
    
    
    1,007
    
    
    
    1,448Net interest income
    
    
    1,949
    
    
    
    2,064
    
    
    
    5,826
    
    
    
    5,965PROVISION FOR LOAN LOSSES
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    167Net interest income after provision
for loan losses
    
    
    1,949
    
    
    
    1,988
    
    
    
    5,826
    
    
    
    5,798NONINTEREST INCOMEService charges
    
    
    114
    
    
    
    121
    
    
    
    351
    
    
    
    344Gain on sale of investment securities, net
    
    
    
    
    
    
    1
    
    
    
    15
    
    
    
    54Gain on sale of real estate held for investment
    
    
    173
    
    
    
    
    
    
    
    211Origination fees on mortgage loans brokered
    
    
    119
    
    
    
    40
    
    
    
    320
    
    
    
    79Other operating income
    
    
    54
    
    
    
    40
    
    
    
    272
    
    
    
    184Total noninterest income
    
    
    460
    
    
    
    202
    
    
    
    1,169
    
    
    
    661NONINTEREST EXPENSESalaries
    
    
    644
    
    
    
    630
    
    
    
    1,955
    
    
    
    1,750Employee benefits
    
    
    165
    
    
    
    149
    
    
    
    504
    
    
    
    446Occupancy
    
    
    143
    
    
    
    128
    
    
    
    415
    
    
    
    383Equipment
    
    
    115
    
    
    
    102
    
    
    
    330
    
    
    
    340Other operating expenses
    
    
    464
    
    
    
    421
    
    
    
    1,461
    
    
    
    1,231Total noninterest expense
    
    
    1,531
    
    
    
    1,430
    
    
    
    4,665
    
    
    
    4,150INCOME BEFORE INCOME TAX
    
    
    878
    
    
    
    760
    
    
    
    2,330
    
    
    
    2,309PROVISION FOR INCOME TAX
    
    
    288
    
    
    
    257
    
    
    
    730
    
    
    
    747NET INCOME
    
    $
    590
    
    
    $
    503
    
    
    $
    1,600
    
    
    $
    1,562EARNINGS PER SHAREBasic
    
    $
    0.50
    
    
    $
    0.43
    
    
    $
    1.36
    
    
    $
    1.32Diluted
    
    $
    0.50
    
    
    $
    0.42
    
    
    $
    1.36
    
    
    $
    1.31Weighted average shares outstanding
    
    
    1,173,200
    
    
    
    1,183,116
    
    
    
    1,172,238
    
    
    
    1,183,097Weighted average diluted shares outstanding
    
    
    1,177,992
    
    
    
    1,193,927
    
    
    
    1,176,972
    
    
    
    1,194,204


The accompanying notes are an integral part of these financial statements

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VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
(dollars in thousands, except for per share amounts)

Nine Months EndedSeptember 30,2003
    
    2002CASH FLOWS FROM OPERATING ACTIVITIESNet income
    
    $
    1,600
    
    
    $
    1,562Adjustments to reconcile net income to net cash from operating activities:Provisions for loan losses
    
    
    
    
    
    
    167Depreciation
    
    
    356
    
    
    
    268Deferred income tax
    
    
    20
    
    
    
    6Net amortization on securities
    
    
    257
    
    
    
    136FHLB stock dividends
    
    
    (16
    )
    
    
    (24
    )Gain on sale of securities available-for-sale
    
    
    (15
    )
    
    
    (54
    )Loss on sale of premises and equipment
    
    
    
    
    
    
    41Amortization of intangible assets
    
    
    32
    
    
    
    18Gain on the sale of real estate
    
    
    (211
    )Amortization of deferred gain on sale of real estate
    
    
    211Changes in operating assets and liabilities:(Increase) decrease in accrued interest receivable
    
    
    7
    
    
    
    (18
    )Decrease) in accrued interest payable
    
    
    (106
    )
    
    
    (114
    )(Increase) decrease in other assets
    
    
    43
    
    
    
    (215
    )Increase in other liabilities
    
    
    929
    
    
    
    731Net cash from operating activities
    
    
    3,107
    
    
    
    2,504Net increase in federal funds sold
    
    
    (3,993
    )
    
    
    (1,247
    )Net decrease in interest-bearing deposits with banks
    
    
    7,064
    
    
    
    2,852Purchase of securities available-for-sale
    
    
    (28,626
    )
    
    
    (12,786
    )Proceeds from sales of securities available-for-sale
    
    
    2,672
    
    
    
    5,567Proceeds from maturities of securities available-for-sale
    
    
    16,074
    
    
    
    5,741Federal Home Loan Bank stock redeemed
    
    
    42
    
    
    
    104Net increase in loans
    
    
    (6,881
    )
    
    
    (10,903
    )Additions to premises and equipment
    
    
    (210
    )
    
    
    (468
    )Purchase of intangible assets
    
    
    
    
    
    
    (144
    )Sale of real estate held for investment
    
    
    224Net cash from investing activities
    
    
    (13,634
    )
    
    
    (11,284
    )CASH FLOWS FROM FINANCING ACTIVITIESNet increase in deposits
    
    
    13,136
    
    
    
    11,569Net increase (decrease) in other borrowed funds
    
    
    (84
    )
    
    
    186Increase in other borrowed money
    
    
    
    
    
    
    96Payment on other borrowed money
    
    
    (48
    )Cash dividends paid
    
    
    (675
    )
    
    
    (676
    )Stock options exercised
    
    
    24
    
    
    
    2Net cash from financing activities
    
    
    12,353
    
    
    
    11,177NET INCREASE IN CASH AND DUE FROM BANKS
    
    
    1,826
    
    
    
    2,397CASH AND DUE FROM BANKS, beginning of year
    
    
    4,847
    
    
    
    4,584CASH AND DUE FROM BANKS, at end of period
    
    $
    6,673
    
    
    $
    6,981SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONCash payments forInterest
    
    $
    1,113
    
    
    $
    1,562Income taxes
    
    
    691
    
    
    
    778SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIESUnrealized gains (losses) on securities available-for-sale
    
    $
    (232
    )
    
    $
    467Deferred tax on unrealized (gains) losses on securities available-for-sale
    
    
    79
    
    
    
    (159
    )


The accompanying notes are an integral part of these financial statements

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##### Table of Contents






VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1  Basis of Presentation

Valley Community Bancshares, Inc. (the Company) prepared the condensed
consolidated financial statements of the Company for the three-month and
nine-month periods ended September 30, 2003 and September 30, 2002 without
audit by the Companys independent auditors. However, the financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America for interim financial information and with
instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of
the Companys management, all adjustments consisting of normal recurring
accruals necessary for a fair presentation of the financial condition and
results of operations for the interim periods included herein have been made.
The consolidated balance sheet of the Company as of December 31, 2002 has been
derived from the audited consolidated balance sheet of the Company as of that
date. The results of operations for the three-months and nine-months ended
September 30, 2003, are not necessarily indicative of the results to be
anticipated for the year ending December 31, 2003.

Certain information and note disclosures normally included in the Companys
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. Therefore, these consolidated financial statements and notes thereto
should be read in conjunction with a reading of the financial statements for
the year ended December 31, 2002 and notes thereto included in the Companys
Form 10-K filed with the Securities and Exchange Commission. Certain amounts in
the 2002 financial statements have been reclassified to conform to the 2003
presentation.

The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect amounts reported in
the consolidated financial statements. Changes in these estimates and
assumptions are considered reasonably possible and may have a material impact
on the consolidated financial statements and thus actual results could differ
from the amounts reported and disclosed herein. The Company considers the
allowance for loan loss a critical accounting policy subject to estimate.

Stock Option Plan

The Company accounts for the stock option plan under recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees,and related Interpretations using the intrinsic value method. No
stock-based employee compensation cost is reflected in net income, as all
options granted under the plan had an exercise price equal to the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition method as provided under FASB Statement No.
123, Accounting for Stock-Based Compensation,to stock-based employee
compensation.

VALLEY COMMUNITY BANCSHARES, INC.
    
    Three Months Ended
    
    Nine Months EndedStock Option Plan
    
    September 30,
    
    September 30,In thousands, except for per-share amounts
    
    2003
    
    2002
    
    2003
    
    2002Pro forma disclosures:Net income as reported
    
    $
    590
    
    
    $
    503
    
    
    $
    1,600
    
    
    $
    1,562Additional compensation for fair
value of stock options
    
    
    3
    
    
    
    3
    
    
    
    7
    
    
    
    8Pro forma net income
    
    $
    587
    
    
    $
    500
    
    
    $
    1,593
    
    
    $
    1,554Earnings per share:BasicAs reported
    
    $
    0.50
    
    
    $
    0.43
    
    
    $
    1.36
    
    
    $
    1.32Pro forma
    
    $
    0.50
    
    
    $
    0.42
    
    
    $
    1.36
    
    
    $
    1.31DilutedAs reported
    
    $
    0.50
    
    
    $
    0.42
    
    
    $
    1.36
    
    
    $
    1.31Pro forma
    
    $
    0.50
    
    
    $
    0.42
    
    
    $
    1.35
    
    
    $
    1.30


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Note 2  Earnings per share

Basic earnings per share amounts are computed based on the weighted average
number of shares outstanding during the period after giving retroactive effect
to stock dividends and stock splits. Diluted earnings per share amounts are
computed by determining the number of additional shares that are deemed
outstanding due to stock options under the treasury stock method.

The following table sets forth the computation of basic and diluted earnings
per share for the three-months and nine-months ended September 30, 2003 and
2002 (dollars in thousands, except per share amounts):

VALLEY COMMUNITY BANCSHARES, INC.
    
    Three Months Ended
    
    Nine Months EndedEarnings Per Share
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002NUMERATOR:Net income
    
    $
    590
    
    
    $
    503
    
    
    $
    1,600
    
    
    $
    1,562DENOMINATOR:Denominator for basic earnings per share:Weighted average shares
    
    
    1,173,200
    
    
    
    1,183,116
    
    
    
    1,172,238
    
    
    
    1,183,097Effect of diluted securities  stock options
    
    
    4,792
    
    
    
    10,811
    
    
    
    4,734
    
    
    
    11,107Denominator for diluted earnings per share:Weighted average shares and assumed
conversion of diluted stock options
    
    
    1,177,992
    
    
    
    1,193,927
    
    
    
    1,176,972
    
    
    
    1,194,204Basic earnings per share
    
    $
    0.50
    
    
    $
    0.43
    
    
    $
    1.36
    
    
    $
    1.32Diluted earnings per share
    
    $
    0.50
    
    
    $
    0.42
    
    
    $
    1.36
    
    
    $
    1.31


Note 3 Comprehensive Income

Total comprehensive income, which includes net income and unrealized gains and
losses on the Companys available-for-sale securities, amounted to $479,000 and
$634,000, respectively, for the three months ended September 30, 2003 and 2002,
respectively. Total comprehensive income amounted to $1,447,000 and $1,870,000,
respectively, for the nine months ended September 30, 2003 and 2002,
respectively.

Note 4  Investment Securities

Investment securities have been classified as available-for-sale in according
with managements intent. The carrying amount of securities and their estimated
fair values are as follows (in thousands):

September 30, 2003Securities Available-For-Sale
    
    
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S. Treasury and U.S. Government
corporations and agencies
    
    $
    14,823
    
    
    $
    196
    
    
    $
    
    
    
    $
    15,019State and political subdivisions
    
    
    6,988
    
    
    
    366
    
    
    
    9
    
    
    
    7,345Mortgage-backed securities
    
    
    17,997
    
    
    
    176
    
    
    
    62
    
    
    
    18,111$
    39,808
    
    
    $
    738
    
    
    $
    71
    
    
    $
    40,475


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December 31, 2002Securities Available-For-Sale
    
    
    
    
    
    Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains
    
    Losses
    
    ValueU.S. Treasury and U.S. Government
corporations and agencies
    
    $
    10,662
    
    
    $
    226
    
    
    $
    
    
    
    $
    10,888State and political subdivisions
    
    
    5,404
    
    
    
    323
    
    
    
    
    
    
    
    5,727Mortgage-backed securities
    
    
    14,104
    
    
    
    350
    
    
    
    
    
    
    
    14,454$
    30,170
    
    
    $
    899
    
    
    $
    
    
    
    $
    31,069


Note 5  Loans

The major classifications of loans at September 30, 2003 and December 31, 2002
are summarized as follows (dollars in thousands):

|                                  |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |      |       |  
|--------------------------------- | ------------ | ------------- | ------ | ------------ | ------- | ------ | ---- | ------- | ----- | - | ------ | ------ | ------- |  | ---- | ---- | ----- | -
|VALLEY COMMUNITY BANCSHARES, INC. |              |               |        |             
|Loan Portfolio                    |              |               |        |             
|(dollars in thousands)            |              | September 30, |        | December 31,
|                                  |              |               |        |             
|                                  |              | 2003          |        | 2002        
|                                  |              |               |        |             
|                                  |              | Amount        |        | Percent      |         | Amount |      | Percent
|                                  |              |               |        |              |         |        |      |        
|Real
Estate                       |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |     
|                                  | Construction |               | $      | 11,735       |         |        |      | 10.4    | %     |   | $      | 9,276  |         |  |      | 8.8  | %    
|                                  | Mortgage     |               |        | 12,014       |         |        |      | 10.7    | %     |   |        | 15,080 |         |  |      | 14.3 | %    
|                                  | Commercial   |               |        | 61,371       |         |        |      | 54.6    | %     |   |        | 55,266 |         |  |      | 52.3 | %    
|Commercial                        |              |               | 24,919 |              |         |        | 22.1 | %       |       |   | 23,502 |        |         |  | 22.3 | %   
|Consumer and other                |              |               | 2,318  |              |         |        | 2.1  | %       |       |   | 2,339  |        |         |  | 2.2  | %   
|Lease financing                   |              |               | 69     |              |         |        | 0.1  | %       |       |   | 83     |        |         |  | 0.1  | %   
|                                  |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |     
|                                  |              | Total loans   |        |              | 112,426 |        |      |         | 100.0 | % |        |        | 105,546 |  |      |      | 100.0 | %
|                                  |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |     
|Deferred loan fees                |              |               | (191   | )            |         |        |      |         |       |   | (192   | )      |         |  |      |     
|                                  |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |     
|                                  |              | Net loans     |        | $            | 112,235 |        |      |         |       |   |        | $      | 105,354 |  |      |      |       |  
|                                  |              |               |        |              |         |        |      |         |       |   |        |        |         |  |      |     

Note 6  Allowance for Loan Losses

Management analyzes the loan portfolio to determine the adequacy of the
allowance for loan losses and the appropriate provision required to maintain an
adequate allowance. In assessing the adequacy of the allowance, management
reviews the size, quality and risks of loans in the portfolio and considers
factors such as specific known risks, past experience, the status and amount of
nonperforming assets and economic conditions. A specific percentage is
allocated to each major classification and not specifically reserved while
additional amounts are added for individual loans considered to have specific
loss potential. Loans identified as losses are charged-off. Based on total
allocations, the provision is recorded to maintain the allowance at a level
deemed appropriate by management. While management uses available information
to recognize losses on loans, there can be no assurance that future additions
to the allowance will not be necessary.

The allowance for loan losses at September 30, 2003 and December 31, 2002,
totaled $1,388,000. Management believes that the allowance for loan losses at
September 30, 2003 adequately reflects the risks in the loan portfolio.
Various regulatory agencies, as an integral part of their examination process,
periodically review the Banks allowance for loan losses. Such agencies may
require the Bank to recognize changes to the allowance based on their judgments
of information available to them at the time of their examination.

-6-



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##### Table of Contents



The following table summarizes the activity in the allowance for loan losses
(dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.Loan Loss ExperienceThree months September 30,
    
    Nine months September 30,2003
    
    2002
    
    2003
    
    2002Balance at beginning of period
    
    $
    1,388
    
    
    $
    1,249
    
    
    $
    1,388
    
    
    $
    1,156Charge-offs
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    5Recoveries:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Net recoveries
    
    
    -0-
    
    
    
    5
    
    
    
    -0-
    
    
    
    3Additions charged to operations
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    167Balance at end of period
    
    $
    1,388
    
    
    $
    1,320
    
    
    $
    1,388
    
    
    $
    1,320


Note 7  Business Segment Information

Beginning January 1999 and through December 2002, the Company owned two
community-banking institutions, Puyallup Valley Bank and Valley Bank. These
banks were managed at the subsidiary bank level. Each subsidiary bank had a
board of directors and an executive management team responsible for the
operation and performance of the respective subsidiary bank.

On January 17, 2003, the Company merged the subsidiary banks into one community
bank named Valley Bank. In addition, the company consolidated its board of
directors and executive management team into a new organizational structure,
while converting separated banking systems into a single operation. As a result
of these system and organizational changes, the financial information that is
used by the chief operating decision maker in allocating resources and
assessing performance is only provided for one reportable segment for the
three-month and nine-month period ended September 30, 2003.

Note 8  Change in Accounting Estimate

During the second quarter ended June 30, 2003, the Company sold real estate
held for investment at a profit of $211,000. Because the buyers initial
investment was inadequate the Company accounted for the transaction using the
installment sales method, as permitted by Financial Accounting Standard No. 66
Accounting for Real Estate.At that time $38,000 was recorded as income and
the remaining $173,000 was deferred. During the third quarter ended September
30, 2003, the buyer made additional payments to the Company resulting in an
adequate investment. As a result, as permitted by FAS-66, the Company changed
to the full accrual accounting method and recognized the remaining deferred
gross profit.

Note 9  Impact of New Accounting Issues

During the third quarter of 2003 the Financial Accounting Standard Board
(FASB) did not issue any new accounting pronouncements.


-7-Table of Contents




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


Valley Community Bancshares, Inc.

Valley Community Bancshares, Inc. (the Company) is a bank holding company
registered under the Bank Holding Company Act of 1956, as amended. The Company
was organized and incorporated under the laws of the State of Washington as a
holding company for its principal banking subsidiary, Valley Bank, a state
chartered, Federal Deposit Insurance Corporation (the FDIC) insured
commercial bank, through a reorganization completed on July 1, 1998.
Valley Bank is referred to as the Bank in this Form 10-Q.

The Companys main office is located in Puyallup, Washington, which also serves
as the main office of Valley Bank. The Bank provides a full range of
commercial banking services to small and medium-sized businesses, professionals
and other individuals through eight banking offices located in Puyallup,
Auburn, and Kent, Washington, and their environs.

The principal sources of the Companys revenue are (i) interest and fees on
loans; (ii) deposit service charges; (iii) merchant credit card processing
fees; (iv) interest bearing deposits with Bank; (v) interest on investments
(principally government securities) and (vi) origination fees on mortgage loans
brokered. The Banks lending activity consists of short-to-medium-term
commercial and consumer loans, including operating loans and lines of credit,
equipment loans, automobile loans, recreational vehicle and truck loans,
personal loans or lines of credit, home improvement loans and rehabilitation
loans. The Bank also offer cash management services, merchant credit card
processing, safe deposit boxes, wire transfers, direct deposit of payroll and
social security checks, automated teller machine access, and automatic drafts
for various accounts.

Valley Bank

Valley Bank is a Washington state-chartered commercial bank, which commenced
operations as Puyallup Valley Bank in October 1973. In January 1999 the
Company opened Valley Bank, a state chartered FDIC insured commercial bank
subsidiary located in Auburn, Washington. On January 17, 2003, in an effort to
consolidate operations, Puyallup Valley Bank and Valley Bank merged and renamed
the resulting institution Valley Bank.

The Bank provides full-service banking to businesses and residents within the
Puyallup, Auburn and Kent communities and its surrounding areas. The Bank
places particular emphasis on serving the small to medium-sized business
segment of the market by making available a line of banking products tailored
to their needs, with those services delivered by experienced professionals
concerned with building long-term relationships. The Bank conducts business out
of eight full-service offices and one drive-up facility.

On May 16, 2002, the Bank purchased various tangible and intangible assets of
Puget Sound Mortgage Brokers, Inc., a Washington Corporation located in
Puyallup Washington. The purchase price was not material to the consolidated
financial condition and results of operations of the Company or the Bank. The
purchase was made to further enhance the Banks mortgage banking operations.
The mortgage operation is operated as a division of the Bank using the name
Puget Sound Mortgage Brokers and operates in a leased facility.

On September 5, 2002, the Bank opened a new banking facility in Kent
Washington. The office operates in a temporary leased facility until a
permanent facility can be constructed, which should occur during the third
quarter of 2004.

During April 2003 the Bank opened a loan production office in Gig Harbor
Washington. The new office operates in a leased facility until a permanent
banking facility can be located.

Valley Bank is a wholly owned subsidiary of the Company.

-8-



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##### Table of Contents



Results of Operations

The Company earned net income of $590,000 or $0.50 per diluted share for the
three months ended September 30, 2003, compared to net income of $503,000 or
$0.42 per diluted share, for the three months ended September 30, 2002, an
increase of 17.3 percent. The Companys return on average assets was 1.29
percent for the three months ended September 30, 2003, compared to 1.19 percent
for the three months ended September 30, 2002.

The Company earned net income of $1,600,000 or $1.36 per diluted share for the
nine months ended September 30, 2003, compared to net income of $1,562,000 or
$1.31 per diluted share, for the nine months ended September 30, 2002, an
increase of 2.4 percent. The Companys return on average assets was 1.21
percent for the nine months ended September 30, 2003, compared to 1.29 percent
for the nine months ended September 30, 2002.

The increase in net income for the three and nine-month periods ended September
30, 2003 was primarily related to increased noninterest income and a lower
provision for loan losses, partially offset by increased noninterest expense.
The increase in noninterest income resulted from a significant increase in
origination fees on mortgage loans brokered and from the amortization of the
deferred gain on the sale of real estate held for investment. The increase in
noninterest expense resulted from the increased staffing levels of the Banks
new Kent and Gig Harbor offices and Puget Sound Mortgage Brokers, which
significantly increased salaries and employee benefits and occupancy expenses
during the three and nine-month periods. A decrease in the Companys net
interest margin also negatively impacted earnings during the three and
nine-month period.

The higher operating costs as a result of opening the new Kent and Gig Harbor
offices will continue to be negatively impact the profitability of the Company
until the new offices generate sufficient revenues to offset the added
operating costs. It is anticipated the new offices will not breakeven until
after 2003.

The Companys net income is derived principally from the operating results of
its banking subsidiary Valley Bank. Valley Bank is a well-established
commercial bank and generates substantially all of the Companys operating
income.

The following table shows the various performance ratios for the Company for
the three and nine months ended September 30, 2003 and 2002, respectively:

VALLEY COMMUNITY BANCSHARES, INC.
Selected Financial Data 1
(dollars in thousands, except per share amounts)

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Financial PerformanceNet Income
    
    $
    590
    
    
    $
    503
    
    
    $
    1,600
    
    
    $
    1,562Average Assets
    
    
    182,057
    
    
    
    168,391
    
    
    
    176,651
    
    
    
    162,316Average Stockholders Equity
    
    
    22,781
    
    
    
    22,145
    
    
    
    22,494
    
    
    
    21,563Return on Assets (net income divided by average assets)
    
    
    1.29
    %
    
    
    1.19
    %
    
    
    1.21
    %
    
    
    1.29
    %Return on Equity (net income divided by average equity)
    
    
    10.27
    %
    
    
    9.01
    %
    
    
    9.51
    %
    
    
    9.69
    %Net Interest Margin (net interest income (tax adjusted)
Divided by earning assets)
    
    
    4.64
    %
    
    
    5.34
    %
    
    
    4.83
    %
    
    
    5.41
    %Efficiency Ratio (noninterest expense divided by
noninterest income plus net interest income)
    
    
    63.55
    %
    
    
    63.11
    %
    
    
    66.69
    %
    
    
    62.63
    %Ratio of noninterest income to average assets
    
    
    3.34
    %
    
    
    3.37
    %
    
    
    3.53
    %
    
    
    3.42
    %


Net Interest Income

Net interest income is the most significant component contributing to net
income. It is the difference between interest earned on earning assets
(primarily loans and investments) and interest paid on interest bearing
liabilities (deposits and borrowings). The volume of and yields earned on
earning assets and the volume of and the rates paid on interest bearing
liabilities determine net interest income. Interest earned and interest paid is
also affected by general economic conditions, particularly changes in market
interest rates, and by government policies and the action of regulatory
authorities.



---

|1 |  | The computation of the ratios is based on the recorded assets and liabilities
after the effect of changes in market values of securities available for sale.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents



The earnings on certain assets are exempt from federal income tax. It is
customary in the financial services industry to analyze changes in net interest
income on a tax equivalent (TE) basis. TE is a non-GAAP performance measure
used by management in operating the business, which management believes
provides investors with a more accurate picture of the interest margin for
comparative purposes. Under this method, nontaxable income from loans and
investments is adjusted to an amount, which would have been earned if such
income were subject to federal income tax.

The discussion below presents an analysis based on tax equivalent amounts at a
34% tax rate.

VALLEY COMMUNITY BANCSHARES, INC.
Net Interest Income, adjusted to a Tax Equivalent Basis
(dollars in thousands),

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Interest income, as reported
    
    $
    2,246
    
    
    $
    2,533
    
    
    $
    6,833
    
    
    $
    7,413Effect of tax exempt income
    
    
    36
    
    
    
    39
    
    
    
    102
    
    
    
    116TE interest income
    
    
    2,282
    
    
    
    2,572
    
    
    
    6,935
    
    
    
    7,529interest expense
    
    
    297
    
    
    
    469
    
    
    
    1,007
    
    
    
    1,448TE net interest income
    
    $
    1,985
    
    
    $
    2,103
    
    
    $
    5,928
    
    
    $
    6,081


TE net interest income, divided by average earning assets is referred to as net
interest margin. For the three months ended September 30, 2003 the Companys
net interest margin was 4.64 percent compared to 5.34 percent for the three
months ended September 30, 2002. For the nine months ended September 30, 2003
the Companys net interest margin was 4.83 percent compared to 5.41 percent for
the nine months ended September 30, 2002.

TE interest income was $2,282,000 for the three months ended September 30, 2003
compared to $2,572,000 for the three months ended September 30, 2002. The
three-month decrease was primarily the result of a significant decrease in the
yield earned on earning assets. The yield on interest-earning assets decreased
to 5.34 percent for the three months ended September 30, 2003 compared to 6.53
percent during the same period a year ago. The yield decrease reflects an
overall decline in market interest rates.

TE interest income was $6,935,000 for the nine months ended September 30, 2003
compared to $7,529,000 for the nine months ended September 30, 2002. The
nine-month decrease was primarily the result of a significant decrease in the
yield earned on earning assets. The yield on interest-earning assets decreased
to 5.65 percent for the nine months ended September 30, 2003 compared to 6.70
percent during the same period a year ago. The yield decrease reflects an
overall decline in market interest rates.

Interest expense was $297,000 for the three months ended September 30, 2003
compared to $469,000 for the three months ended September 30, 2002. The cost of
funds decreased to 0.94 percent for the three months ended September 30, 2003
compared to 1.60 percent during the same period a year ago. The decrease for
the three-month period was due to a decrease in the Companys cost of funds
resulting from an overall decline in market interest rates.

Interest expense was $1,007,000 for the nine months ended September 30, 2003
compared to $1,448,000 for the nine months ended September 30, 2002. The cost
of funds decreased to 1.11 percent for the nine months ended September 30, 2003
compared to 1.73 percent during the same period a year ago. The decrease for
the nine-month period was due to a decrease in the Companys cost of funds
resulting from an overall decline in market interest rates.

Market interest rates continue to be at historical lows as a result of a slow
national and regional economy and because of an aggressively accommodating
Federal Reserve monetary policy. The decrease in market interest rates during
2002
had a positive impact on the Companys net interest margin. Because of the
Companys liability sensitive position at that time, the Company experienced a
greater reduction in deposit costs in comparison to the reduction in the
earnings on loans and investments. During 2003, market interest remained
relatively low resulting in a greater reduction in the earnings on loans and
investments compared to the reduction in deposit costs.

In the event of an increase market interest rates, the Companys TE net
interest income and margin may decrease because the Company has a significant
amount of interest bearing liabilities subject to repricing when compared to
interest earning assets. This may be somewhat offset because the rate paid on
deposits with administered interest rates generally do not increase as rapidly
as an account whose rates change with market interest rates. In the event of

-10-



---



##### Table of Contents



continued low market interest rates, the Company anticipates a further decrease
in net interest margin as interest-earning assets reprice to the lower interest
rate levels.

The following table sets forth information concerning the Companys average
balance and average interest rates earned or paid, interest rate spread and net
interest margin for the three months ended September 30, 2003 and 2002:

VALLEY COMMUNITY BANCSHARES, INC.
AVERAGE BALANCES AND INTEREST RATES EARNED/PAID
(dollars in thousands)

For the Three Months Ended September 30,2003
    
    2002Average
    
    Revenue/
    
    Yield/
    
    Average
    
    Revenue/
    
    Yield/ASSETS
    
    Balance
    
    Expense
    
    Rate
    
    Balance
    
    Expense
    
    RateInterest-earning assetsLoans (including fees) 1
    
    $
    112,349
    
    
    $
    1,897
    
    
    
    6.70
    %
    
    $
    110,616
    
    
    $
    2,081
    
    
    
    7.46
    %Investment securities 2 3
    
    
    36,473
    
    
    
    302
    
    
    
    3.28
    %
    
    
    32,215
    
    
    
    404
    
    
    
    4.97
    %Interest bearing deposits with banks
    
    
    15,848
    
    
    
    67
    
    
    
    1.68
    %
    
    
    12,175
    
    
    
    76
    
    
    
    2.48
    %Federal funds sold
    
    
    4,604
    
    
    
    11
    
    
    
    0.95
    %
    
    
    835
    
    
    
    3
    
    
    
    1.41
    %Federal Home Loan Bank Stock
    
    
    367
    
    
    
    5
    
    
    
    5.40
    %
    
    
    491
    
    
    
    8
    
    
    
    6.46
    %Total Interest-earning assets
    
    
    169,641
    
    
    
    2,282
    
    
    
    5.34
    %
    
    
    156,332
    
    
    
    2,572
    
    
    
    6.53
    %Total noninterest-earning assets
    
    
    12,416
    
    
    
    
    
    
    
    
    
    
    
    12,059TOTAL ASSETS
    
    $
    182,057
    
    
    
    
    
    
    
    
    
    
    $
    168,391Interest-bearing liabilitiesDeposits
    
    $
    124,798
    
    
    
    296
    
    
    
    0.94
    %
    
    $
    115,627
    
    
    
    467
    
    
    
    1.60
    %Other borrowed funds
    
    
    483
    
    
    
    1
    
    
    
    0.82
    %
    
    
    496
    
    
    
    2
    
    
    
    1.60
    %Total Interest-bearing liabilities
    
    
    125,281
    
    
    
    297
    
    
    
    0.94
    %
    
    
    116,123
    
    
    
    469
    
    
    
    1.60
    %Noninterest-bearing liabilities
    
    
    33,995
    
    
    
    
    
    
    
    
    
    
    
    30,123Stockholders equity
    
    
    22,781
    
    
    
    
    
    
    
    
    
    
    
    22,145TOTAL LIABILITIES AND
STOCKHOLDERS EQUITY
    
    $
    182,057
    
    
    
    
    
    
    
    
    
    
    $
    168,391Net interest spread
    
    
    
    
    
    $
    1,985
    
    
    
    4.40
    %
    
    
    
    
    
    $
    2,103
    
    
    
    4.92
    %Margin AnalysisTE interest income/ earning assets
    
    
    
    
    
    $
    2,282
    
    
    
    5.34
    %
    
    
    
    
    
    $
    2,572
    
    
    
    6.53
    %Interest expense/earning assets
    
    
    
    
    
    
    297
    
    
    
    0.69
    %
    
    
    
    
    
    
    469
    
    
    
    1.19
    %Net interest margin
    
    
    
    
    
    $
    1,985
    
    
    
    4.64
    %
    
    
    
    
    
    $
    2,103
    
    
    
    5.34
    %




---

|1 |  | Average loan balance includes nonaccrual loans, if any. Interest income on
nonaccrual loans has been included.
|- |  | --------------------------------------------------------------------------------------------------------------
| 
|2 |  | Tax-exempt income has been adjusted to a tax-equivalent basis using an
incremental rate of 34%.               
| 
|3 |  | The yield on investment securities is calculated using historical cost basis.                                 

-11-



---



##### Table of Contents



The following table sets forth information concerning the Companys average
balance and average interest rates earned or paid, interest rate spread and net
interest margin for the nine months ended September 30, 2003 and 2002:

VALLEY COMMUNITY BANCSHARES, INC.
AVERAGE BALANCES AND INTEREST RATES EARNED/PAID
(dollars in thousands)

For the Nine Months Ended September 30,2003
    
    2002Average
    
    Revenue/
    
    Yield/
    
    Average
    
    Revenue/
    
    Yield/ASSETS
    
    Balance
    
    Expense
    
    Rate
    
    Balance
    
    Expense
    
    RateInterest-earning assetsLoans (including fees) 1
    
    $
    109,874
    
    
    $
    5,743
    
    
    
    6.99
    %
    
    $
    105,546
    
    
    $
    6,027
    
    
    
    7.63
    %Investment securities 2 3
    
    
    33,850
    
    
    
    923
    
    
    
    3.65
    %
    
    
    32,363
    
    
    
    1,247
    
    
    
    5.15
    %Interest bearing deposits with banks
    
    
    17,194
    
    
    
    231
    
    
    
    1.80
    %
    
    
    11,559
    
    
    
    230
    
    
    
    2.66
    %Federal funds sold
    
    
    2,808
    
    
    
    22
    
    
    
    1.05
    %
    
    
    282
    
    
    
    3
    
    
    
    1.42
    %Federal Home Loan Bank Stock
    
    
    379
    
    
    
    16
    
    
    
    5.64
    %
    
    
    485
    
    
    
    22
    
    
    
    6.06
    %Total Interest-earning assets
    
    
    164,105
    
    
    
    6,935
    
    
    
    5.65
    %
    
    
    150,235
    
    
    
    7,529
    
    
    
    6.70
    %Total noninterest-earning assets
    
    
    12,546
    
    
    
    
    
    
    
    
    
    
    
    12,081TOTAL ASSETS
    
    $
    176,651
    
    
    
    
    
    
    
    
    
    
    $
    162,316Interest-bearing liabilitiesDeposits
    
    $
    121,331
    
    
    
    1,003
    
    
    
    1.11
    %
    
    $
    111,786
    
    
    
    1,443
    
    
    
    1.73
    %Other borrowed funds
    
    
    476
    
    
    
    4
    
    
    
    1.12
    %
    
    
    423
    
    
    
    5
    
    
    
    1.58
    %Total Interest-bearing liabilities
    
    
    121,807
    
    
    
    1,007
    
    
    
    1.11
    %
    
    
    112,209
    
    
    
    1,448
    
    
    
    1.73
    %Noninterest-bearing liabilities
    
    
    32,350
    
    
    
    
    
    
    
    
    
    
    
    28,544Stockholders equity
    
    
    22,494
    
    
    
    
    
    
    
    
    
    
    
    21,563TOTAL LIABILITIES AND
STOCKHOLDERS EQUITY
    
    $
    176,651
    
    
    
    
    
    
    
    
    
    
    $
    162,316Net interest spread
    
    
    
    
    
    $
    5,928
    
    
    
    4.54
    %
    
    
    
    
    
    $
    6,081
    
    
    
    4.98
    %Margin AnalysisTE interest income/ earning assets
    
    
    
    
    
    $
    6,935
    
    
    
    5.65
    %
    
    
    
    
    
    $
    7,529
    
    
    
    6.70
    %Interest expense/earning assets
    
    
    
    
    
    
    1,007
    
    
    
    0.82
    %
    
    
    
    
    
    
    1,448
    
    
    
    1.29
    %Net interest margin
    
    
    
    
    
    $
    5,928
    
    
    
    4.83
    %
    
    
    
    
    
    $
    6,081
    
    
    
    5.41
    %




---

|1 |  | Average loan balance includes nonaccrual loans, if any. Interest income on
nonaccrual loans has been included.
|- |  | --------------------------------------------------------------------------------------------------------------
| 
|2 |  | Tax-exempt income has been adjusted to a tax-equivalent basis using an
incremental rate of 34%.               
| 
|3 |  | The yield on investment securities is calculated using historical cost basis.                                 

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##### Table of Contents



The following table sets forth information concerning the Companys change in
TE net interest income for the periods that are attributable to changes in
interest rate and changes in volume for the three and nine month period ended
September 30, 2003 compared to the three and nine month period ended September
30, 2002:

VALLEY COMMUNITY BANCSHARES, INC.
Volume/Rate Analysis 1  For the Three Months ended September 30,
(dollars in thousands)

2003 Compared to 2002Volume
    
    Rate
    
    NetTE Interest incomeLoans (including fees) 2
    
    $
    32
    
    
    $
    (216
    )
    
    $
    (184
    )Investment securities 3
    
    
    48
    
    
    
    (150
    )
    
    
    (102
    )Interest bearing deposits with banks
    
    
    19
    
    
    
    (28
    )
    
    
    (9
    )Federal funds sold
    
    
    9
    
    
    
    (1
    )
    
    
    8Federal Home Loan Bank Stock
    
    
    (2
    )
    
    
    (1
    )
    
    
    (3
    )106
    
    
    
    (396
    )
    
    
    (290
    )Interest-bearing liabilitiesTotal deposits
    
    
    35
    
    
    
    (206
    )
    
    
    (171
    )Other borrowed funds
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )35
    
    
    
    (207
    )
    
    
    (172
    )$
    71
    
    
    $
    (189
    )
    
    $
    (118
    )


VALLEY COMMUNITY BANCSHARES, INC.
Volume/Rate Analysis 1  For the Nine Months ended September 30,
(dollars in thousands)

2003 Compared to 2002Volume
    
    Rate
    
    NetTE Interest incomeLoans (including fees) 2
    
    $
    240
    
    
    $
    (524
    )
    
    $
    (284
    )Investment securities 3
    
    
    55
    
    
    
    (379
    )
    
    
    (324
    )Interest bearing deposits with banks
    
    
    90
    
    
    
    (89
    )
    
    
    1Federal funds sold
    
    
    20
    
    
    
    (1
    )
    
    
    19Federal Home Loan Bank Stock
    
    
    (5
    )
    
    
    (1
    )
    
    
    (6
    )Total Interest-earning assets
    
    
    400
    
    
    
    (994
    )
    
    
    (594
    )Interest-bearing liabilitiesTotal deposits
    
    
    115
    
    
    
    (555
    )
    
    
    (440
    )Other borrowed funds
    
    
    1
    
    
    
    (2
    )
    
    
    (1
    )Total Interest-bearing liabilities
    
    
    116
    
    
    
    (557
    )
    
    
    (441
    )TE net interest income
    
    $
    284
    
    
    $
    (437
    )
    
    $
    (153
    )




---

|1 |  | The change in interest due to both volume and yield/rate has been allocated
to change due to volume and change due to yield/rate in proportion to the
absolute value of the change in each.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|2 |  | Balances of nonaccrual loans, if any, and related income recognized have been
included for computational purposes.                                                                         
| 
|3 |  | Tax-exempt income has been converted to a tax-equivalent basis using an
incremental rate of 34%.                                                                                           

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##### Table of Contents



Provision for loan losses

Provisions for loan losses reduce net interest income. The Company provided $0
for loan losses for the three months ended September 30, 2003 compared to
$76,000 during the same three-month period last year. The Company provided $0
for loan losses for the nine months ended September 30, 2003 compared to
$167,000 during the same nine-month period last year. The 2002 provision was
made as a result of increasing loans.

Management believes the amount of the allowance for loan losses to be adequate
to absorb losses in the current portfolio. This statement is based upon
managements continuing evaluation of inherent risks in the current loan
portfolio, current levels of classified assets, and economic factors. The
Company will continue to monitor the allowance and make future adjustments to
the allowance as conditions dictate. For further discussion regarding the
allowance for loan losses, see the discussion on allowance for loan losses
under Risk Elements.

Noninterest income and expense

Net income is increased by noninterest income (primarily service charges,
origination fees on mortgage loans brokered, and other operating income) and
reduced by noninterest expenses (primarily salaries and employee benefits,
occupancy, equipment, and other operating expenses).

Noninterest income was $460,000 for the three months ended September 30, 2003,
a 127.7 percent increase from $202,000 for the three months ended September 30,
2002. The increase in noninterest income for the three-month period ended
September 30, 2003 was the result of increased loan origination fees on
mortgage loans brokered, the amortization of the deferred gain on real estate
held for investment, and other operating income partially offset by lower
service charges.

Noninterest income was $1,169,000 for the nine months ended September 30, 2003,
a 76.9 percent increase from $661,000 for the nine months ended September 30,
2002. The increase in noninterest income for the nine month period ended
September 30, 2003 was the result of higher service charges, increased loan
origination fees on mortgage loans brokered, the amortization of the deferred
gain on real estate held for investment, and other operating income partially
offset by lower security gains. The purchase of Puget Sound Mortgage Brokers
resulted in a significant increase in the volume of mortgage loans brokered and
increased loan origination fees.

Noninterest expense was $1,531,000 for the three months ended September 30,
2003, a 7.1 percent increase from $1,430,000 for the three months ended
September 30, 2002. The increase in noninterest expense for the three-month
period ended September 30, 2003 was primarily the result of increased salaries
and employee benefits, operating, and other expenses associated with the
opening of the new Kent and Gig Harbor facilities and the operation of Puget
Sound Mortgage Brokers. The percentage of noninterest expense to average assets
was 3.34 percent for the three months ended September 30, 2003, compared to
3.37 percent during the same period last year.

Noninterest expense was $4,665,000 for the nine months ended September 30,
2003, a 12.4 percent increase from $4,150,000 for the nine months ended
September 30, 2002. The increase in noninterest expense for the nine-month
period ended September 30, 2003 was primarily the result of increased salaries
and employee benefits, occupancy, operating, and other expenses associated with
the opening of the new Kent and Gig Harbor facilities and the operation of
Puget Sound Mortgage Brokers. Occupancy expense also increased as a result of
higher depreciation expense resulting from the recently completed remodel of
the Main Office facility. The increase in professional fees resulted from the
merger of Puyallup Valley Bank and Valley Bank. The percentage of noninterest
expense to average assets was 3.53 percent for the nine months ended September
30, 2003, compared to 3.42 percent during the same period last year.

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##### Table of Contents



The following table sets forth information concerning the various components of
the Companys noninterest expense for the three and nine months ended September
30, 2003 and 2002, respectively:

VALLEY COMMUNITY BANCSHARES, INC.
Noninterest Expense
(dollars in thousands)

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Noninterest ExpenseSalaries
    
    $
    644
    
    
    $
    630
    
    
    $
    1,955
    
    
    $
    1,750Employee benefits
    
    
    165
    
    
    
    149
    
    
    
    504
    
    
    
    446Occupancy
    
    
    143
    
    
    
    128
    
    
    
    415
    
    
    
    383Equipment
    
    
    115
    
    
    
    102
    
    
    
    330
    
    
    
    340Operating
    
    
    126
    
    
    
    108
    
    
    
    404
    
    
    
    337Software
    
    
    46
    
    
    
    45
    
    
    
    151
    
    
    
    140Advertising and marketing
    
    
    49
    
    
    
    40
    
    
    
    124
    
    
    
    98Professional
    
    
    37
    
    
    
    43
    
    
    
    169
    
    
    
    145Business and occupation tax
    
    
    34
    
    
    
    46
    
    
    
    101
    
    
    
    104Other
    
    
    172
    
    
    
    139
    
    
    
    512
    
    
    
    407Total noninterest expense
    
    $
    1,531
    
    
    $
    1,430
    
    
    $
    4,665
    
    
    $
    4,150


The Companys efficiency ratio, which is the ratio of noninterest expense to
net interest income plus noninterest income, was 63.6 percent for the three
months ended September 30, 2003 compared to 63.1 percent for the three months
ended September 30, 2002. The Companys efficiency ratio was 66.7 percent for
the nine months ended September 30, 2003 compared to 62.6 percent for the nine
months ended September 30, 2002. The increase in the ratio was primarily due to
a significant increase in noninterest expense, partially offset by an increase
in noninterest income.

Provision for income tax

The Companys provision for income tax is a significant reduction of operating
income. The provision for the three months September 30, 2003, was $288,000
compared to $257,000 for the three month ended September 30, 2002. The
provision for the nine months September 30, 2003, was $730,000 compared to
$747,000 for the nine month ended September 30, 2002. The provision represents
an effective tax rate of 31 and 32 percent during 2003 and 2002, respectively.
The Companys marginal tax rate is currently 34 percent. The difference between
the Companys effective and marginal tax rate is primarily related to
investments made in tax-exempt securities.

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##### Table of Contents



Financial Condition

The Companys total consolidated assets increased 8.5 percent to $186.3 million
as of September 30, 2003, compared to $171.7 million as of December 31, 2002.
Loans and deposits increased 6.5 percent and 8.9 percent, respectively during
the nine month period ended September 30, 2003. The deposits not invested in
loans were invested in securities available-for-sale along with the funds
provided from the decrease in interest bearing deposits with banks. The result
was an increase in the percentage of securities held for investment to total
assets. Stockholders equity increased 3.5 percent as a result of earnings
during the nine-month period ended September 30, 2003, partially offset by the
payment of a 60¢ per share cash dividend to stockholders and a decrease in
other comprehensive income.

Investment Portfolio

The major classifications of investments at September 30, 2003 and December 31,
2002, are summarized in Note 4  Investment Securities in the Notes to
Condensed Consolidated Financial Statements.

At September 30, 2003, the Company had $40.5 million of securities
available-for-sale, compared to $31.1 million as of December 31, 2002. The
Company purchased approximately $28.6 million in securities this year, although
investment securities increased by $9.4 million during 2003, They were funded
primarily with $18.8 million of securities either maturing or sold during 2003
along with a decrease in interest bearing deposits with banks and from excess
deposits. All sectors of the portfolio increased during the nine month period.

At September 30, 2003, all of the Companys securities were classified as
available-for-sale. Management believes that holding securities as
available-for-sale provides greater flexibility to respond to interest rate
changes and liquidity needs to fund loan growth.

Loan Portfolio

The major classifications of loans at September 30, 2003 and December 31, 2002,
are summarized in Note 5  Loans in the Notes to Condensed Consolidated
Financial Statements.

In addition to the major classifications of loans summarized in Note 5, the
Company has additional loan concentrations exceeding 10 percent of total loans
at September 30, 2003. They include loans to medical doctors and dentists in
the amount of approximately $23.5 million.

Loans were $112.2 million as of September 30, 2003, compared to $105.4 million
as of December 31, 2002, an increase of 6.45 percent. The increase was
primarily in real estate construction and real estate commercial loans,
partially offset by a decrease in real estate mortgage loans. The percentage of
loans to total assets decreased slightly to 60.6 percent at September 30, 2003
compared to 61.4 percent at December 31, 2002. It continues to be managements
intent to grow the loan portfolio and to increase the percent of loans to
assets, which potentially could improve the Companys net interest margin.

Risk Elements

The following table sets forth information concerning the Companys
non-performing assets as of the dates indicated (dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.
Non-performing Assets

September 30,
    
    December 31,2003
    
    2002Non-performing assets:Nonaccrual loans
    
    $
    153
    
    
    $Loans 90 days or more past dueRestructured loans153
    
    
    
    -0-Other real estate ownedTotal non-performing assets
    
    $
    153
    
    
    $
    -0-


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##### Table of Contents



As of September 30, 2003, the Company had $153,000 in nonperforming assets,
which include nonaccrual loans, loans 90 days or more past due and still
accruing interest, and restructured loans. The Company had $0 in nonperforming
assets as of December 31, 2002.

The accrual of interest on nonaccrual and other impaired loans is discontinued
at 90 days or when, in the opinion of management, the borrower may be unable to
meet payments as they become due. When interest accrual is discontinued, all
unpaid accrued interest is reversed. Interest income is subsequently recognized
only to the extent cash payments are received. Interest income on restructured
loans is recognized pursuant to the terms of the new loan agreement. Interest
income on other impaired loans is monitored and based upon the terms of the
underlying loan agreement. However, the recorded net investment in impaired
loans, including accrued interest, is limited to the present value of the
expected cash flows of the impaired loan or the observable fair market value of
the loans collateral.

During the three-month period ended September 30, 2003 there were two loans on
nonaccrual status. During the nine-month period ended September 30, 2003 there
were three commercial loans on nonaccrual status. The gross income that would
have been recorded for the nine-month period ended September 30, 2003 if the
nonaccrual loan had been current and in accordance with its original term
approximates $3,000. Interest recognized on the loan for the year was
approximately $3,000.

During the three-month and nine-month period ended September 30, 2002 there was
one commercial loan on nonaccrual status. The gross income that would have been
recorded for the nine-month period ended September 30, 2002 if the nonaccrual
loan had been current and in accordance with its original term approximates
$3,000. Interest recognized on the loan for the year was insignificant.

Potential Problem Loans

At September 30, 2003 and December 31, 2002, the Company had two potential
problem commercial real estate loans totaling approximately $2,353,000 and
$2,464,000, respectively. The Company believes that the loans are secured by
sufficient collateral and guarantor financial strength to repay the loans,
although there can be no assurances given with respect to potential losses in
these credits. These loans are in addition to those categorized as
non-performing listed above. Although these loans are currently classified as
performing, management has information regarding credit weakness inherent in
the loans.

Summary of Loan Loss Experience

Changes in the Allowance for Loan Losses

The activity in the allowance for loan losses is summarized in Note 6 -
Allowance for Loan Losses in the Notes to Condensed Consolidated Financial
Statements.

The allowance for loan losses is increased by charges to income and decreased
by charge-offs (net of recoveries), and established through a provision for
loan losses charged to expense. Loans are charged against the allowance for
credit losses when management believes that the collectibility of the principal
is unlikely. The allowance is an amount that management believes will be
adequate to absorb losses inherent in existing loans, commitments to extend
credit and standby letters of credit based on evaluations of collectibility and
prior loss experience of loans, commitments to extend credit and standby
letters of credit. The evaluations take into consideration such factors as
changes in the nature and volume of the portfolio, overall portfolio quality,
loan concentrations, specific problem loans, commitments, standby letters of
credit and current economic conditions that may affect the borrowers ability
to pay.

The majority of the Companys loan portfolio consists of commercial loans and
single-family residential loans secured by real estate in the Puyallup and
Pierce County areas and also in the Auburn and King County areas. Real estate
prices in this market are stable at this time but may weaken as a result of a
slowing local and national economy. Therefore, the ultimate collectibility of a
substantial portion of the Companys loan portfolio may be susceptible to
change as local market conditions change in the future.

While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an

-17-



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##### Table of Contents



integral part of their examination process, periodically review the estimated
losses on loans. Such agencies may require the Company to recognize additional
losses based on their judgment about information available to them at the time
of their examination.

The following table sets forth other information regarding the allowance for
loan losses for the dates indicated (dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.
Loan Loss Experience

Analysis of the Allowance for Loan LossesThree months ended
    
    Nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Average Allowance for Loan Losses
    
    $
    1,388
    
    
    $
    1,278
    
    
    $
    1,388
    
    
    $
    1,216Average Loans Outstanding
    
    $
    112,349
    
    
    $
    110,616
    
    
    $
    109,874
    
    
    $
    105,546Ratio of net charge-offs during the
period to average loans outstanding
    
    
    0.00
    %
    
    
    0.01
    %
    
    
    0.00
    %
    
    
    0.01
    %Ratio of average allowance for loan losses
to average loans outstanding
    
    
    1.24
    %
    
    
    1.16
    %
    
    
    1.26
    %
    
    
    1.15
    %


There were no loan charge-offs during the three and nine months ended September
30, 2003. There were $5,000 in loan charge-offs during the three and nine
months ended September 30, 2002. The charge-off was in the Companys consumer
loan portfolio. The ratio of the average allowance for loan losses to average
loans outstanding totaled 1.26 percent for the nine months ended September 30,
2003 compared to 1.15 percent during the same period last year. The increase in
the ratio results from loan recoveries added to the allowance during the fourth
quarter of 2002 and also a significant reduction in the loan portfolio during
the fourth quarter of 2002. At September 30, 2003, the allowance for loan
losses as a percent of loans totaled 1.24 percent compared to 1.32 percent at
December 31, 2002.

Analysis of the Allowance for Loan Losses

The allowance for loan losses is maintained at a level considered adequate by
management to provide for loan losses inherent in the loan portfolio based on
managements assessment of various factors affecting the loan portfolio,
including, local economic conditions, growth of the loan portfolio and its
composition. Non-performing loans and net charge-offs during the periods
presented have been minimal demonstrating strong credit quality. Increases in
the allowance for loan losses made though provisions were primarily a result of
loan growth.

Management determines the amount of the allowance for loan losses by utilizing
a loan grading system to determine risk in the loan portfolio and by
considering the results of credit reviews. The loan portfolio is separated by
quality and then by loan type. Loans of acceptable quality are evaluated as a
group, by loan type, with a specific loss rate assigned to the total loans in
each type, but unallocated to any individual loan. Conversely, each adversely
classified loan is individually analyzed, to determine an estimated loss
amount. A valuation allowance is also assigned to these adversely classified
loans, but at a higher loss rate due to the greater risk of loss. For those
loans where the estimated loss is greater than the background percentage, the
estimated loss amount is considered specifically allocated to the allowance.
Although management has allocated a portion of the allowance to the loan
categories using the method described above, the adequacy of the allowance must
be considered as a whole. To mitigate the imprecision in most estimates of
expected loan losses, the allocated component of the allowance is supplemented
by an unallocated component. The unallocated portion includes managements
judgmental determination of the amounts necessary for qualitative factors such
as the consideration of new products and policies, economic conditions,
concentrations of credit risk, and the experience and abilities of lending
personnel. Loan concentrations, quality, terms and basic underlying assumptions
remained substantially unchanged during the period.

The Company uses the historical loss experience method in conjunction with the
specific identification method for calculation of the amount of allowance for
loan losses. A six-year average historical loan loss rate is calculated. This
experience loss rate is applied to graded loans that are not adversely
classified for a subtotal of needed allowance.

-18-



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##### Table of Contents



Loans adversely classified are analyzed for potential loss on an individual
basis. This subtotal is added to the experience subtotal and the total is
compared to the allowance for loan losses.

The Company also evaluates current conditions and may adjust the historical
loss estimate by qualitative factors that effect loan repayment. These factors
may include levels of, and trends in, delinquencies and non-accruals; trends in
volume and terms of loans; effects of any changes in lending policies;
experience, ability and depth of management and lending staff; national and
local economic trends; concentrations of credit; and any legal and regulatory
requirements.

Deposits

The Companys primary source of funds is customer deposits. The Company
attempts to maintain a high percentage of noninterest-bearing deposits, which
are a low cost funding source. In addition, the Company offers a variety of
interest-bearing accounts designed to attract both short-term and longer-term
deposits from customers. Interest-bearing accounts earn interest at rates
established by management based on competitive market factors and the Companys
need for funds. The Company traditionally has not purchased brokered deposits
and does not intend to do so in the future.

Deposits increased 8.9 percent to $160.6 million as of September 30, 2003,
compared to $147.4 million as of December 31, 2002. The increase occurred in
demand deposits, money market deposits, and savings deposits during the
nine-month period, partially offset by a reduction in time certificates of
deposit.

The following table sets forth the balances for each major category of deposit
by amount and percent during the periods indicated:

VALLEY COMMUNITY BANCSHARES, INC.
Deposits
(dollars in thousands)

Period ended,September 30, 2003
    
    December 31, 2002Amount
    
    Percent
    
    Amount
    
    PercentNoninterest bearing demand deposits
    
    $
    33,017
    
    
    $
    20.6
    %
    
    $
    29,119
    
    
    
    19.8
    %Interest bearing demand deposits
    
    
    23,189
    
    
    
    14.4
    %
    
    
    21,733
    
    
    
    14.7
    %Money market deposits
    
    
    43,893
    
    
    
    27.3
    %
    
    
    35,506
    
    
    
    24.1
    %Savings deposits
    
    
    16,495
    
    
    
    10.3
    %
    
    
    14,343
    
    
    
    9.7
    %Time certificates < $100,000
    
    
    22,195
    
    
    
    13.8
    %
    
    
    25,395
    
    
    
    17.2
    %Time certificates > $100,000
    
    
    21,783
    
    
    
    13.6
    %
    
    
    21,340
    
    
    
    14.5
    %$
    160,572
    
    
    $
    100.0
    %
    
    $
    147,436
    
    
    
    100.0
    %


Liquidity and Capital Resources

Management actively analyzes and manages the Companys liquidity position. The
objective of liquidity management is to ensure the availability of sufficient
cash flows to meet all financial commitments and to capitalize on opportunities
for profitable business expansion. Management believes that the Companys cash
flow will be sufficient to support its existing operations for the foreseeable
future.

Cash flows from operations contribute significantly to liquidity as well as
proceeds from maturities of securities and increasing customer deposits. As
indicated on the Companys Condensed Consolidated Statement of Cash Flows, net
cash from operating activities for the nine months ended September 30, 2003
contributed $3.1 million to liquidity compared to $2.5 million for the nine
months ended September 30, 2002. The majority of the Companys funding comes
from customer deposits within its operating region. Customer deposits provided
$13.1 million for the nine months ended September 30, 2003 compared to $11.6
million for the nine months ended September 30, 2002. For the nine months ended
September 30, 2003, demand deposits, money market deposits and savings deposits
provided the majority of the deposit growth. Another important source of
liquidity is investments in federal funds and interest-bearing deposits with
banks and the Companys securities portfolio. The Company maintains a ladder of
securities that provides prepayments and payments at maturity and a portfolio
of available-for-sale securities that could be converted to cash quickly.
Proceeds from maturity and sale of securities provided $18.7 million for the
nine months ended September 30, 2003 compared to $11.3 million for the nine
months ended September 30, 2002.

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At September 30, 2003, the Company held cash and due from banks,
interest-bearing deposits with banks, and federal funds sold of approximately
$27.5 million. In addition, at such date $40.55 million of the Companys
investments were classified as available for sale.

The Bank has the capacity to borrow funds, up to ten percent of assets, from
the Federal Home Loan Bank of Seattle (FHLB) through pre-approved credit
lines as a secondary source of liquidity. However, these credit lines have
pledge requirements whereby the Bank must maintain unencumbered collateral with
a value at least equal to the outstanding balance. In addition to the FHLB
credit line, the Bank has committed line of credit agreements totaling
approximately $9.5 million from unaffiliated banks. At September 30, 2003, the
Bank had no advances outstanding to the FHLB or from unaffiliated banks.

The Bank has commitments to extend credit, which may have an impact on the
Companys liquidity position. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition
established in the commitment. Commitments generally have fixed expiration
dates. Since some commitments are expected to expire without being drawn upon,
the total commitment amounts do not represent future cash requirements. The
Company experience suggests customers draw on approximately 75 percent of loan
commitments. Commitments to extend credit at September 30, 2003 and December
31, 2002 were $21.1 and $19.8 million, respectively.

The Companys total stockholders equity increased to $23.3 million at
September 30, 2003 from $22.5 million at December 31, 2002. The 3.5 percent
increase was the result net income earned during the nine months ended
September 30, 2003, partially offset by a 60¢ dividend per share paid to
stockholders of record on December 31, 2002 and lower unrealized gains recorded
on securities available for sale, net of income tax. At September 30, 2003,
stockholders equity was 12.6 percent of total assets, compared to 13.1 percent
at December 31, 2002.

The market value of available-for-sale securities was greater than book value
at both September 30, 2003 and December 31, 2002, primarily as a result of low
market interest rates, which resulted in unrealized gains in the investment
portfolio. In the event market interest rates increase, the market value of the
Companys investment portfolio may decrease. Because changes in the market
value of available-for-sale securities are a component of other comprehensive
income, within stockholders equity, a decrease in market value of securities
would negatively impact stockholders equity. At September 30, 2003, the
Company performed a simulation analysis of changes in the market value of the
investment portfolio given a 300 basis point increase in interest rates. The
analysis indicated a decrease in market value of approximately $1.5 million net
of federal income tax. Although stockholders equity would be reduced by
approximately 6.5 percent, the Company would still be well in excess on capital
adequacy requirements in the event the Company would be required to liquidate
these securities for unforeseen liquidity needs.

Capital Adequacy Requirements

The Federal Reserve and the FDIC have adopted risk-based capital guidelines for
banks and bank holding companies that are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and
bank holding companies and account for off-balance sheet items. The guidelines
are minimums, and the federal regulators have noted that banks and bank holding
companies contemplating significant expansion programs should not allow
expansion to diminish their capital ratios and should maintain ratios in excess
of the minimums. Failure to achieve and maintain adequate capital levels may
give rise to supervisory action through the issuance of a capital directive to
ensure the maintenance of required capital levels.

The current guidelines require all federally-regulated banks to maintain a
minimum risk-based total capital ratio equal to 8%, of which at least 4% must
be Tier 1 capital. Tier 1 capital includes common shareholders equity,
qualifying perpetual preferred stock, and minority interests in equity accounts
of consolidated subsidiaries, but excludes goodwill and most other intangibles
and the allowance for loan and lease losses. Tier 2 capital includes the
excess of any preferred stock not included in Tier 1 capital, mandatory
convertible securities, hybrid capital instruments, subordinated debt and
intermediate term-preferred stock, 20% of unrealized gain of equity securities,
and general reserves for loan and lease losses up to 1.25% of risk-weighted
assets. The Bank has not received any notice indicating that it will be
subject to higher capital requirements.

Under these guidelines, bank assets are given risk-weights of 0%, 20%, 50% or
100%. Most loans are assigned to the 100% risk category, except for first
mortgage loans fully secured by residential property and, under certain
circumstances, residential construction loans (both carry a 50% rating). Most
investment securities are assigned to the 20% category, except for municipal or
state revenue bonds (which have a 50% rating) and direct obligations of or

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obligations guaranteed by the United States Treasury or United States
Government Agencies (which have a 0% rating).
The Agencies have also implemented a leverage ratio, which is equal to Tier 1
capital as a percentage of average total assets less intangibles, to be used as
a supplement to the risk-based guidelines. The principal objective of the
leverage ratio is to limit the maximum degree to which a bank may leverage its
equity capital base. The minimum required leverage ratio for top-rated
institutions is 3%, but most institutions are required to maintain an
additional cushion of at least 100 to 200 basis points. Any institution
operating at or near the 3% level is expected to be a strong banking
organization without any supervisory, financial or operational weaknesses or
deficiencies. Any institutions experiencing or anticipating significant growth
would be expected to maintain capital ratios, including tangible capital
positions, well above the minimum levels.

The capital levels of the Company currently exceed applicable regulatory
guidelines, and the Bank is qualified as well-capitalized at September 30,
2003. Management believes that under the current regulations the Bank will
continue to meet well-capitalized capital requirements in the foreseeable
future. However, events beyond the control of the Bank such as a downturn in
the economy where the Bank have most of their loans, could adversely affect
future earnings and, consequently, the ability of the Bank to meet future
well-capitalized capital requirements.

The capital amounts and ratios for the Company and the Bank as of September 30,
2003, are presented in the following table (dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.
Capital

To Be WellCapitalized UnderFor Capital
    
    
    
    
    
    Prompt CorrectiveActual
    
    
    
    
    
    Adequacy Purposes
    
    
    
    
    
    Action ProvisionsAs of September 30, 2003
    
    Amount
    
    Ratio
    
    
    
    
    
    Amount
    
    Ratio
    
    
    
    
    
    Amount
    
    RatioTotal Capital(to Risk-Weighted Assets)Consolidated
    
    $
    24,116
    
    
    
    18.4
    %
    
    
    >
    
    
    $
    10,470
    
    
    
    8.0
    %
    
    
    >
    
    
    $
    13,087
    
    
    
    10.0
    %Valley Bank
    
    $
    22,765
    
    
    
    17.4
    %
    
    
    >
    
    
    $
    10,470
    
    
    
    8.0
    %
    
    
    >
    
    
    $
    13,087
    
    
    
    10.0
    %Tier I Capital(to Risk-Weighted Assets)Consolidated
    
    $
    22,728
    
    
    
    17.4
    %
    
    
    >
    
    
    $
    5,235
    
    
    
    4.0
    %
    
    
    >
    
    
    $
    7,852
    
    
    
    6.0
    %Valley Bank
    
    $
    21,377
    
    
    
    16.3
    %
    
    
    >
    
    
    $
    5,235
    
    
    
    4.0
    %
    
    
    >
    
    
    $
    7,852
    
    
    
    6.0
    %Tier I Capital(to Average Assets)Consolidated
    
    $
    22,728
    
    
    
    12.5
    %
    
    
    >
    
    
    $
    7,279
    
    
    
    4.0
    %
    
    
    >
    
    
    $
    9,099
    
    
    
    5.0
    %Valley Bank
    
    $
    21,377
    
    
    
    11.8
    %
    
    
    >
    
    
    $
    7,272
    
    
    
    4.0
    %
    
    
    >
    
    
    $
    9,091
    
    
    
    5.0
    %





Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Companys results of operation are dependent upon its ability to manage
interest rate risk. Management considers interest rate risk to be a significant
risk that could have a material effect on the Companys financial condition and
results of operations. The Company does not currently use derivatives to manage
market and interest rate risk.

A number of measures are used to monitor and manage interest rate risk,
including income simulations and interest sensitivity (gap) analyses. An
income simulation model is the primary tool used to assess the direction and
magnitude of changes in net interest income resulting from changes in interest
rates. Key assumptions in the model include repayment speeds on certain
assets, cash flows and maturities of other investment securities, loan and
deposit volumes and pricing. These assumptions are inherently uncertain and,
as a result, the model cannot precisely estimate net interest income or
precisely predict the impact of higher or lower interest rates on net interest
income.

Actual results will differ from simulated results due to timing, magnitude and
frequency of interest rate changes and changes in market conditions and
management strategies, among other factors. At September 30, 2003, based on
the measures used to monitor and manage interest rate risk, there has not been
a material change in the Companys interest rate risk since December 31, 2002.
For additional information, refer to the Companys annual report on Form 10-K
for the year ended December 31, 2002.

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Item 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the
Companys disclosure controls and procedures (as defined in Section 13(a)-14(c)
of the Securities Exchange Act of 1934 (the Act)) was carried out under the
supervision and with the participation of the Companys Chief Executive
Officer, Chief Financial Officer and several other members of the Companys
senior management within the 90-day period preceding the filing date of this
quarterly report. The Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls and procedures as
currently in effect are effective in ensuring that the information required to
be disclosed by the Company in the reports it files or submits under the Act is
(i) accumulated and communicated to the Companys management (including the
Chief Executive Officer and Chief Financial Officer) in a timely manner, and
(ii) recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms.

(b) Changes in Internal Controls: In the quarter ended September 30, 2003, the
Company did not make any significant changes in, nor take any corrective
actions regarding, its internal controls or other factors that could
significantly affect these controls.

Limitations on the Effectiveness of Controls.The Companys management,
including the CEO and CFO, does not expect that our Disclosure Controls or our
Internal Controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, control may become inadequate because
of changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and not be detected.




FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q includes forward-looking statements about
the future operations of the Company. These forward-looking statements involve
certain risks and uncertainties that could cause actual results to differ
materially from those in the forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following factors:
competitive pressure in the banking industry significantly increasing;
increases in the interest rate environment reducing margins; general economic
conditions, either nationally or regionally, are less favorable than expected,
resulting in, among other things, a deterioration in credit quality and an
increase in the provision for possible loan losses; changes in the regulatory
environment; loan delinquency rates; changes in business conditions; volatility
of rate sensitive deposits; operational risks including data processing system
failures or fraud; asset/liability matching risks and liquidity risks; and
changes in the securities markets. Because of these uncertainties, actual
future results may be materially different from the results indicated by these
forward-looking statements. In addition, the Companys past results do not
necessarily indicate its future results. See also the risk factors in the
Companys 2002 Annual Report on Form 10-K.

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PART II   OTHER INFORMATION




Item 1. LEGAL PROCEEDINGS

The Company faces ordinary routine litigation arising in the normal course of
business. In the opinion of management, liabilities (if any) arising from such
claims will not have a material adverse effect upon the business, results of
operations or financial condition of the Company.




Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable




Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable




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

Not applicable




Item 5. OTHER INFORMATION

Not applicable.




Item 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibits
| | --- |  | --------



| | 3.1 |  | Articles of Incorporation of Valley Community Bancshares,
Inc. *
| | --- |  | ----------------------------------------------------------------



| | 3.2 |  | Restated Bylaws of Valley Community Bancshares, Inc. ^
| | --- |  | ------------------------------------------------------



| | 10. |  | Material contracts of Valley Community Bancshares, Inc.
| | --- |  | -------------------------------------------------------



| | 10.1 |  | Severance agreement for Mr. Brown *
| | ---- |  | -----------------------------------



| | 10.2 |  | Severance agreement for Mr. Thompson *
| | ---- |  | --------------------------------------



| | 10.3 |  | Severance agreement for Mr. Riordan *
| | ---- |  | -------------------------------------



| | 10.4 |  | Severance agreement for Mr. Pickett *
| | ---- |  | -------------------------------------



| | 10.5 |  | Deferred Compensation Agreement for Mr. Brown *
| | ---- |  | -----------------------------------------------



| | 10.6 |  | Deferred Compensation Agreement for Mr. Thompson #
| | ---- |  | --------------------------------------------------



| | 10.7 |  | 1998 Stock Option Plan *
| | ---- |  | ------------------------



| | 10.8 |  | 401(k) Defined Contribution Plan and Noncontributory Profit Sharing Plan Adoption Agreement *
| | ---- |  | ---------------------------------------------------------------------------------------------



| | 31. |  | Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
| | --- |  | ------------------------------------------------------------------------



| | 31.1 |  | Certification of Chief Executive Officer
| | ---- |  | ----------------------------------------



| | 31.2 |  | Certification of Chief Financial Officer
| | ---- |  | ----------------------------------------



| | 32. |  | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| | --- |  | ------------------------------------------------------------------------



|* |  | Incorporated by reference to the Exhibits set forth on Registrants
Amended Registration Statement on Form 10 filed with the Securities and
Exchange Commission on September 6, 2000.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|# |  | Incorporated by reference to the Exhibits set forth on Registrants 2000
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 27, 2001.             
| 
|^ |  | Incorporated by reference to the Exhibits set forth on Registrants June
2002 Quarterly Report on Form 10-Q filed with the Securities and Exchange
Commission on August 9, 2002.     



|(b) |  | Reports on Form 8-K
|--- |  | -------------------

The Company filed a current report on Items 7 and 12 of Form 8-K on August 1,
2003. The report included a press release announcing second quarter 2003
financial results.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

VALLEY COMMUNITY BANCSHARES, INC.(Registrant)Date:
    
    November 3, 2003
    
    By
    
    /s/     David H. BrownDavid H. BrownPresident and Chief Executive OfficerDate:
    
    November 3, 2003
    
    By
    
    /s/     Joseph E. RiordanJoseph E. RiordanExecutive Vice President and Chief Financial Officer


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