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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934

(Mark One)

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2006

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECRUITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission File Number: 000-28342



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VALLEY FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)



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|                         |  |                                        
|------------------------ |  | ---------------------------------------
|VIRGINIA                 |  | 54-1702380                             
|(State of Incorporation) |  | (I.R.S. Employer Identification Number)

36 Church Avenue, S.W.

Roanoke, Virginia 24011

(Address of principal executive offices)

Registrants telephone number, including area code (540) 342-2265

Securities registered under Section 12(b) of the Exchange Act of 1934: None

Securities registered under Section 12(g) of the Exchange Act of 1934:



|                           |  |                                          
|-------------------------- |  | -----------------------------------------
|Title of Each Class        |  | Name of Each Exchange on Which Registered
|Common Stock, No par value |  | Nasdaq Capital Market                    



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ̈No   x

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No  x

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 if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K. ̈

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

Large Accelerated filer ̈Accelerated filer ̈Non-Accelerated filer  x

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

The number of shares of Valley Financial Corporation Common Stock outstanding as of March 5, 2007 was 4,125,068. The aggregate market value of Valley Financial
Corporation Common Stock held by non-affiliates of Valley Financial Corporation as of March 5, 2007 (2,736,228 shares) was $34,038,676.



|                                                                                                 |  |                                                                    
|------------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------
|Documents of Which Portions Are Incorporated by Reference                                        |  | Parts of Form 10-K into Which Portion of Documents Are Incorporated
|Proxy Statement for Valley Financial Corporations April 25, 2007 Annual Meeting of Shareholders |  | III                                                                



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##### Table of Contents

Table of Contents

VALLEY FINANCIAL CORPORATION

FORM 10-K

December 31, 2006

INDEX



|           |  |                                                                                       |  |   
|---------- |  | ------------------------------------------------------------------------------------- |  | --
|PART I.    |  |                                                                                      
|Item 1.    |  | Description of Business                                                               |  | 2 
|Item 1A.   |  | Risk Factors                                                                          |  | 11
|Item 1B.   |  | Unresolved Staff Comments                                                             |  | 12
|Item 2.    |  | Properties                                                                            |  | 12
|Item 3.    |  | Legal Proceedings                                                                     |  | 12
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                   |  | 12
|           | 
|PART II.   |  |                                                                                      
|Item 5.    |  | Market for Common Equity and Related Stockholder Matters                              |  | 12
|Item 6.    |  | Selected Financial Data                                                               |  | 14
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 15
|Item 8.    |  | Financial Statements and Supplementary Data                                           |  | 45
|Item 9.    |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure  |  | 85
|Item 9A.   |  | Disclosure Controls and Procedures                                                    |  | 85
|Item 9B.   |  | Other Information                                                                     |  | 85
|           | 
|PART III.  |  |                                                                                      
|Item 10.   |  | Directors and Executive Officers                                                      |  | 85
|Item 11.   |  | Executive Compensation                                                                |  | 85
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 86
|Item 13.   |  | Certain Relationships and Related Transactions                                        |  | 86
|Item 14.   |  | Principal Accountant Fees and Services                                                |  | 86
|           | 
|PART IV.   |  |                                                                                      
|Item 15    |  | Exhibits and Financial Statement Schedules                                            |  | 87
|           | 
|SIGNATURES |  |                                                                                      



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Cautionary Statement Regarding Forward-Looking Statements

This report contains statements concerning the Companys expectations, plans, objectives, future financial performance and other statements that are
not historical facts. These statements may constitute forward-looking statements as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management and risks and
uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not
limited to, changes in:



| | 1. | interest rates
| | -- | --------------



| | 2. | general economic conditions, either nationally or regionally
| | -- | ------------------------------------------------------------



| | 3. | the legislative/regulatory climate
| | -- | ----------------------------------



| | 4. | monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board
| | -- | --------------------------------------------------------------------------------------------------------------------------



| | 5. | demand for loan products
| | -- | ------------------------



| | 6. | deposit flows
| | -- | -------------



| | 7. | competitive pressures among depository and other financial institutions
| | -- | -----------------------------------------------------------------------



| | 8. | demand for financial services in our market area
| | -- | ------------------------------------------------



| | 9. | technology and
| | -- | --------------



| | 10. | accounting principles, policies and guidelines.
| | --- | -----------------------------------------------

These risks and
uncertainties should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.



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##### Table of Contents

PART I.



|Item 1. | Description of Business
|------- | -----------------------

Valley Financial
Corporation (the Company) was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of Valley Bank (the Bank). The Company posts all reports required to be
filed under the Securities Exchange Act of 1934 on its web site at www.myvalleybank.com.

The Bank opened for business on
May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15, 1997 in the City of Roanoke, its fourth office in the City of Salem on
April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of Roanoke on December 8, 2003, and its eighth office in the City of
Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23, 2005.

The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are
insured by the Federal Deposit Insurance Corporation (FDIC) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank.

Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of the Company for the purpose of
issuing trust preferred securities. Effective October 16, 2002, the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary
gives the Bank the right to utilize certain federal and state tax credits. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional
trust preferred securities. Effective December 15, 2006, Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the company for the purpose of issuing additional trust preferred securities. These entities are for
raising capital (in the case of the statutory trusts) or investment (in the case of the LLC) purposes.

Banking Services

We conduct a general commercial banking business while emphasizing the needs of small-to-medium sized businesses, professional concerns and individuals.

Deposit Services

We offer a full
range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to
longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the Banks principal market area at rates competitive to those offered in the area. In addition, we offer certain retirement account services,
such as Individual Retirement Accounts. All deposit accounts are insured by the FDIC up to the maximum amount allowed by law (generally, $100,000 per depositor, subject to aggregation rules). We solicit accounts from individuals, businesses,
associations and organizations and governmental authorities.



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Lending Activities

We offer a full range of lending services including commercial loans, residential real estate loans, construction and development loans, and consumer loans.

Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including
acquisition of real estate and improvements) and purchase of equipment and machinery. Loan requests are granted based upon several factors including credit history, past and present relationships with the bank, marketability of collateral and the
cash flow of the borrowers. Unsecured commercial loans must be supported by a satisfactory balance sheet, income statement and cash flow statement. Collateralized business loans may be secured by a security interest in marketable equipment, accounts
receivable, business equipment and/or general intangibles of the business. In addition, or as an alternative, the loan may be secured by a deed of trust lien on business real estate. The risks associated with commercial loans are related to the
strength of the individual business, the value of loan collateral, and the general health of the economy.

Residential real estate
loans are secured by deeds of trust on 1-4 family residential properties. The Bank also serves as a broker for residential real estate loans placed in the secondary market. There are occasions when a borrower or the real estate do not
qualify under secondary market criteria, but the loan request represents a reasonable credit risk. Also, an otherwise qualified borrower may choose not to have their mortgage loan sold. On these occasions, if the loan meets the Banks internal
underwriting criteria, the loan will be closed and placed in the Banks portfolio. Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

The Bank makes loans for the purpose of financing the construction of business and residential structures to financially responsible business
entities and individuals. Additionally, the Bank makes loans for the purpose of financing the acquisition and development of commercial and residential projects. These loans are subject to additional underwriting standards as compared to our
commercial and residential real estate loans, due to the following inherent risks associated with construction and development loans. Construction loans and acquisition and development loans bear the risks that the project will not be finished
according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans and acquisition and development loans also bear
the risk that the general contractor, who may or may not be the Banks loan customer, is unable to finish the construction project as planned because of financial pressures unrelated to the project. Loans to customers that are made as permanent
financing of construction loans may likewise under certain circumstances be affected by external financial pressures.

The Bank routinely
makes consumer loans, both secured and unsecured for financing automobiles, home improvements, education, and personal investments. The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit
decision. Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property. Negative changes in a customers financial circumstances due
to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk. In addition, deterioration in collateral value can add risk to consumer loans.

We will occasionally buy or sell all or a portion of a loan. We will consider selling a loan or a participation in a loan, if: (i) the full amount
of the loan will exceed our legal lending limit to a single borrower; (ii) the full amount of the loan, when combined with a borrowers previously outstanding loans, will exceed our legal lending limit to a single borrower; (iii) the
Board of Directors or an internal Loan Committee believes that a particular borrower has a sufficient level of debt with us; (iv) the borrower requests the sale; (v) the loan to deposit ratio is at or above the optimal level as determined
by bank management; and/or (vi) the loan may create too great a concentration of loans in one particular location or in one particular type of loan. We will consider purchasing a loan, or a participation in a loan, from another financial
institution (including from another subsidiary of the Company) if the loan meets all applicable credit quality standards and (i) the Banks loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a
common customer requests the purchase.



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Our lending activities are subject to a variety of lending limits imposed by state and federal laws and
regulations. In general, the Bank is subject to a loan-to-one borrower limit of an amount equal to 15% of the total of the Banks unimpaired capital, surplus, and allowance for loan loss. We may not make any extensions of credit to any
director, executive officer, or principal shareholder of the Bank or the Company, or to any related interest of such person, unless the extension of credit is approved by the Board of Directors of the Bank and the credit is made on terms not more
favorable to such person than would be available to an unaffiliated party.

Additionally, we offer leasing services for our small business,
private banking and business banking customers and prospects to access equipment, technology or other capital assets that they need to improve productivity and to facilitate growth without taking on debt or investing significant working capital.
Leasing facilities do generally incorporate above-average risk as they generally require minimal initial equity investments on the part of the lessee and may include residual value risks at the time of lease maturity.

We offer several forms of specialized asset-based lending to our commercial business customers, which include:



| |  |  | Accounts Receivable Financing  enables small businesses to unlock the cash typically frozen in accounts receivable which provides cash flow to support
operations. The Bank utilizes an automated software program to manage and monitor collateral values on a consistent and routine basis.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Automobile Floor Plan Financing  enables auto-related businesses to carry sufficient levels of inventories to support sales demand.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------

Asset-based loans require substantial risk management and monitoring processes which should help mitigate collateral
exposures; however, these types of financing have inherently higher risk due to the ever changing status of the underlying collateral.

Other Services

Other Bank services include safe deposit boxes, certain cash management services including overnight repurchase agreements, merchant
purchase and management programs, travelers checks, direct deposit of payroll and social security checks and automatic drafts for various accounts. We operate seven proprietary ATMs and are associated with the Honor, Cirrus and The
Exchange shared networks of automated teller machines that may be used by Bank customers throughout Virginia and other regions. We also offer VISA and MasterCard credit card services as well as a debit-check card. Our lockbox service provides a
simple and efficient way to collect accounts receivable payments locally for businesses and non-profit organizations.

Financial Services

On June 23, 2005, Valley Wealth Management Services, Inc., (VWM) a wholly-owned subsidiary of the Bank, began offering non-deposit
investment products and insurance products for sale to the public. VWM is working with Bankers Insurance, LLC, a joint effort of Virginia banks in which the Company has a small interest through its membership in the Virginia Bankers Association.

We have no immediate plans to obtain or exercise trust powers. We may in the future offer a full-service trust department, but cannot do
so without the prior approval of its primary regulators, the Federal Reserve Bank of Richmond and the Virginia State Corporation Commission, before exercise of trust powers.



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Operating Revenue

The following table sets forth, for the three fiscal years ended December 31, 2006, 2005, and 2004, the percentage of total operating revenue contributed by each class of similar services which contributed 15
percent or more of total consolidated revenues of the Company during such periods.



|                  |  |                                                   |  |                    
|----------------- |  | ------------------------------------------------- |  | -------------------
|Period            |  | Class of Service                                  |  | % of Total Revenues
|December 31, 2006 |  | Interest and fees on loans                        |  | 86.08%             
|                  |  |                                                  
|December 31, 2005 |  | Interest and fees on loans                        |  | 83.31%             
|                  |  |                                                  
|December 31, 2004 |  | Interest and fees on loans Interest on
securities |  | 77.46% 15.16%      

Location and Service Area

Our primary service area is the Roanoke Metropolitan Statistical Area (the Roanoke MSA), which is the regional center for southwest Virginia, and is located approximately 165 miles west of Richmond,
Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles east of Charleston, West Virginia and 222 miles southwest of Washington, D.C.

The population in the Roanoke MSA was estimated at 295,600 in 2005 per the Weldon Cooper Center for Public Services, University of Virginia. The Roanoke MSAs growth typically is slower than that in the Commonwealth overall and in
other key Virginia markets in particular. The Virginia Employment Commission reported that the Roanoke MSA had an unemployment rate of 2.9% in November 2006, compared with 4.3% nationally and 2.8% for Virginia.

The business community in the Roanoke MSA is well diversified by industry group. The principal components of the economy are retail trade, services,
transportation, manufacturing and finance, insurance and real estate. The Roanoke MSAs position as a regional center creates a strong medical, legal and business professional community. Carilion Health System, Advance Auto Parts, Lewis-Gale
Hospital, and the Veterans Administration Hospital are among Roanokes largest employers. Other large employers include Norfolk Southern Corporation, General Electric Co., Wachovia Corporation, The Kroger Company  Mid Atlantic, and ITT
Industries Night Vision.



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Competition

The banking and financial service business in Virginia and in our primary market area specifically, is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product
delivery systems and new competition from non-traditional financial services. We compete for loans and deposits with other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities
brokerage firms, insurance companies, money market mutual funds and other nonbank financial service providers. In order to compete, we rely upon a service-based business philosophy, personal relationships with customers, specialized services
tailored to meet customers needs and the convenience of office locations. In addition, we are generally competitive with other financial institutions in our market area with respect to interest rates paid on deposit accounts, interest rates
charged on loans and other service charges on loans and deposit accounts.

Our market area is a highly concentrated, highly branched
banking market. Currently, the Bank, Bank of Botetourt, Bank of Fincastle, and Hometown Bank are the only locally owned and operated commercial banks. Most competitors are subsidiaries of holding companies headquartered in North Carolina, Georgia,
Tennessee, and Northern Virginia. Numerous credit unions operate additional offices in the Roanoke MSA. Further, various other financial companies, ranging from local to national firms, provide financial services to residents of the Banks
market area.

We believe that the Bank will continue to be able to compete effectively in this market, and that the community reacts
favorably to our community bank focus and emphasis on service to small businesses, individuals and professional concerns.

Employees

At December 31, 2006 the Bank had 115 full-time employees and 5 part-time employees.

Supervision and Regulation

The Company and the Bank are subject to state and federal banking laws
and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. As a result of the substantial regulatory burdens on banking, financial
institutions, including the Company, are disadvantaged relative to other competitors who are not as highly regulated, and our costs of doing business are much higher. The following is a brief summary of the material provisions of certain statutes,
rules and regulations affecting the Company and the Bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below, and is not intended to be an exhaustive description of the
statutes or regulations which are applicable to the business of the Company and/or the Bank. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of the Company and/or the Bank.



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The Company

The Company is a bank holding company within the meaning of the Federal Bank Holding Company Act of 1956, as amended (the BHCA), and Chapter 13 of the Virginia Banking Act, as amended (the Virginia Act).

The BHCA.The BHCA is administered by the Board of Governors of the Federal Reserve System (the Federal Reserve), and the Company
is required to file periodic reports and such additional information as the Federal Reserve may require. The Federal Reserve Board also is authorized to examine the Company and its subsidiaries. The BHCA, with limited exceptions, requires every bank
holding company to obtain prior Federal Reserve approval before the Company can acquire the assets or more than 5% of the voting shares of another bank or merge with another bank holding company.

The BHCA and the Change in Bank Control Act also generally require regulatory approval before control of the Company can be acquired as
defined in the statutes and regulations.

Under the BHCA, the Company is generally limited to conducting directly or indirectly only
banking activities or nonbanking activities the Federal Reserve has found to be closely related to banking.

The Federal Reserve imposes
certain capital requirements on the Company under the BHCA, including a minimum leverage ratio and a minimum ratio of qualifying capital to risk-weighted assets.

The Virginia Banking Act. .The Company is a registered bank holding company with the Bureau of Financial Institutions of the State Corporation
Commission of Virginia (the Virginia Commission) under the Virginia Act. The Company must provide the Virginia Commission with information concerning its financial condition, operations, management, intercompany relationships of the
holding company and its subsidiaries and with other information required by the Virginia Commission. The Company and its subsidiaries are also examined by the Virginia Commission. The Virginia Act requires prior approval of the Virginia commission
for the Company to acquire direct or indirect ownership or control of more than 5% of the voting shares of any Virginia bank or any other bank holding company. The Virginia Act generally permits bank holding companies from throughout the United
States to enter the Virginia market, subject to federal and state approval.

Financial Modernization Legislation/Gramm-Leach-Bliley
Act. The Gramm-Leach-Bliley Act (the GLBA), enacted on November 12, 1999, broadly rewrote financial services legislation. The GLBA repealed affiliation and management interlock prohibitions of the Depression-era Glass-Steagall
Act and added new substantive provisions to the non-banking activities permitted under the BHCA with the creation of the financial holding company. Subject to restrictions the GLBA permits financial holding companies to directly engage in a broader
range of activities than are permissible for a bank holding company. These include underwriting insurance, providing investment advice and underwriting securities among others.

In order for a bank holding company to qualify as a financial holding company, all of its depository subsidiaries (i.e., banks and thrifts) must be well
capitalized and well managed, and must have a satisfactory Community Reinvestment Act (CRA) rating. The bank holding company also must declare its intention to become a financial holding company to the Federal Reserve.

The Company meets all of the requirements to become a financial holding company, but currently has not made an election with the Federal Reserve to
become a financial holding company.



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Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 was signed into law on July 30,
2002. It comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies with equity or debt securities registered under the Securities Exchange Act of 1934. Compliance with this complex
legislation and with subsequent Securities and Exchange Commission rules has since been a major focus of all public corporations in the United States, including the Company. Among the many significant provisions of the Sarbanes-Oxley Act,
Section 404 and related Securities and Exchange Commission rules created increased scrutiny by internal and external auditors of our systems of internal controls over financial reporting. These ongoing and extensive efforts are designed to
insure that our internal controls are effective in terms of both design and operation, but compliance is very costly, especially for community banking companies like ours.

The Bank

General.The Bank is a state-chartered commercial bank organized under the laws of
the Commonwealth of Virginia, and is subject to examination by the Federal Reserve and the Virginia Commission. The regulators monitor all areas of the Banks operations. The Bank is required to prepare quarterly and annual reports on the
Banks financial condition and results of operations. The Bank also is required to adopt internal control structures and procedures in order to safeguard assets and monitor and reduce risk exposure. While considered appropriate for the safety
and soundness of banks, these requirements adversely impact overhead costs.

The Bank Insurance Fund (the BIF) is maintained
for commercial banks with insurance premiums from the industry, including the Bank, used to offset losses from insurance payouts when banks fail. Also, the Bank is charged a deposit-based assessment by the FDIC in connection with the so-called
Financing Corporation (FICO) bonds issued by the federal government to finance the savings and loan industry bailout. Deposit insurance premiums vary with the strength of the banking industry, the level of the BIF insurance fund and the
Banks individual risk rating as determined by the FDIC, and there can be no assurance that premiums will remain at their current level.

Transactions with Affiliates. The Federal Reserve Act restricts the amount and prescribes conditions with respect to loans, investments, asset purchases and other transactions between the Company and the Bank. These restrictions
limit the freedom of the Company and the Bank to engage in transactions between them.

The Bank is subject to restrictions on the aggregate
amount, terms and risks associated with extensions of credit to executive officers, directors, principal shareholders, and their related interests.

Branching and Bank Acquisitions.The Bank may branch without geographic restriction in Virginia. In addition, the federal Interstate Banking and Branching Efficiency Act of 1994 allows bank holding companies to acquire banks in any
state, without regard to state law, except for state laws relating to the minimum amount of time a bank must be in existence to be acquired. While giving the Bank increased expansion opportunities, these laws also increase competition in the
Banks markets.

Community Reinvestment Act. The federal Community Reinvestment Act (CRA) requires that the federal
banking regulators evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. The
regulations place substantial importance on a banks product delivery system, particularly branch locations and require banks to comply with significant data collection requirements. A CRA assessment is required for any bank to, among other
things, establish a new or relocate a branch office or merge or acquire the assets or assume the liabilities of a federally regulated financial institution. It is likely that banks compliance with the CRA, as well as other fair lending laws,
will face ongoing government scrutiny and that costs associated with compliance will continue to increase. The Bank received a Satisfactory rating pursuant to its latest CRA examination.



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Other Regulations. Laws restrict the interest and charges which the Bank may impose for certain
loans. The Banks loan operations also are subject to certain federal laws, such as the Truth in Lending Act, the Home Mortgage Disclosure Act, the Equal Credit Opportunity Act, and the Fair Credit Reporting Act. The deposit operations of the
Bank also are subject to the Truth in Savings Act, the Right to Financial Privacy Act, the Electronic Funds Transfer Act and Regulation E, the Expedited Funds Availability Act and Regulation CC, and the Bank Secrecy Act. These and other similar laws
result in significant costs to financial institutions and create the potential for liability to customers and regulatory authorities. Recently regulatory authorities have imposed significant penalties for inadequate compliance.

Dividends. The Bank began paying dividends to the Company in 2003 to cover the interest expense due on the guaranteed preferred beneficial
interests in the Companys junior subordinated debentures. The amount of dividends that may be paid by the Bank to the Company will depend on the Banks earnings and capital position and is limited by state law, regulations and policies.
See Capital Regulations below, Item 5. Market for Common Equity and Related Stockholder Matters and Note 15 to the Consolidated Financial Statements.

Capital Regulations. The federal bank regulatory authorities impose certain capital requirements on the Company and the Bank. In addition to
minimum capital levels prescribed by regulation, the Virginia Commission and the Federal Reserve have authority to require higher capital levels on a case-by-case basis as part of their supervisory and enforcement powers, including approval of
expansion programs.

An institutions qualifying total capital consists of three componentsCore or Tier 1 capital, Supplementary
or Tier 2 capital, and Market Risk Allocated or Tier 3 capital. Tier 1 capital is essentially equal to common stockholders equity, qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries,
less disallowed intangibles. Tier 2 capital, generally includes certain types of preferred stock and debt securities, hybrid capital instruments and a limited amount, not to exceed 1.25% of gross risk-weighted assets, of the allowance for loan and
lease losses. Tier 3 capital is only applicable to banks which are subject to the market risk capital guidelines. The amount reported in this item may only be used to satisfy the banks market risk capital requirement and may not be used to
support credit risk.

In an effort to achieve a measure of capital adequacy that is more sensitive to the individual risk profiles of
financial institutions, the federal bank regulatory authorities have adopted risk-based capital adequacy guidelines that define capital ratios to take into account assessments of risks related to each balance sheet category, as well as off-balance
sheet financing activities.

To supplement the risk-based capital guidelines, the federal bank regulatory agencies also have imposed a
leverage ratio. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank or bank holding company may leverage its equity capital base. Institutions receiving less than the highest composite
examination ratings are required to maintain a leverage ratio of at least 100 basis points above the regulatory minimum.



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At December 31, 2006, the Company and the Bank had the following risk-based capital and leverage
ratios relative to regulatory minimums:

Capital Ratios



|         |  |                  |  |               |  |                                              
|-------- |  | ---------------- |  | ------------- |  | ---------------------------------------------
|Ratio    |  | Company 12/31/06 |  | Bank 12/31/06 |  | Minimum Required for CapitalAdequacy
Purposes
|Tier 1   |  | 9.1%             |  | 9.1%          |  | 4%                                           
|         |  |                  | 
|Total    |  | 11.2%            |  | 10.2%         |  | 8%                                           
|         |  |                  | 
|Leverage |  | 7.9%             |  | 7.9%          |  | 4%                                           

The regulations define five categories of compliance with regulatory capital requirements, ranging
from well capitalized to critically undercapitalized. To qualify as a well capitalized institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total
risk-based ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 2006 the Company and the Bank qualified as
well-capitalized institutions (see Note 16 to the Consolidated Financial Statements).

The degree of regulatory scrutiny of a
financial institution increases, and the permissible activities of the institution decreases, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to take
certain corrective measures, including adopting a capital restoration plan. Bank holding companies can be called upon to boost their subsidiary banks capital and to partially guarantee the institutions performance under their capital
restoration plans. If this occurs, capital which otherwise would be available for holding company purposes, including possible distribution to shareholders, would be required to be down streamed to one or more subsidiary banks.

International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (USA Patriot Act).The USA Patriot Act of 2001 (the
Patriot Act) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such financial institutions to implement policies and
procedures to combat money laundering and the financing of terrorism, including the adoption of effective customer identification programs. Federal bank regulatory agencies must consider the effectiveness of anti-money laundering activities by a
financial institution when reviewing bank mergers and bank holding company acquisitions. Compliance with the Patriot Act by the Company has not had a material impact on its results of operations or financial condition.

Effect of Governmental Monetary Policies

The
earnings of the Bank are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserves monetary policies have had, and will likely continue to have, an
important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major
effects upon the levels of bank loans, investments, deposits, interest income and interest expense through its open market operations in United States government securities and through its regulation of interest rates and the reserve requirements
against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.



10



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Company Website

The Company and the Bank maintain a website at www.myvalleybank.com. The Company makes available through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
and all amendments to those reports as soon as reasonably practicable after the material is electronically filed with the Securities and Exchange Commission.



|Item 1A. | Risk Factors.
|-------- | -------------

If there is a significant economic downturn in
our primary market area, our credit risk could be adversely affected and result in loss.

Because 93% of our loans are made in our
primary market area and we have a concentration in commercial real estate, our loan portfolio, as a whole, could be more severely impacted and our performance adversely affected if the primary market area suffers a significant or prolonged period of
economic downturn.

If market interest rates increase, our net interest income can be negatively affected in the short term.

Because we have recently become more liability sensitive during 2006, our interest-bearing liabilities (deposits) reprice sooner than our
interest-bearing assets (loans). As a result, in a period of increasing interest rates, our net interest income can be negatively affected in the short term.

Our market has a concentration of large and small banks. If the large bank competition increases or focuses more heavily on our market, our business could suffer. Additionally, our ability to attract and retain deposits without adverse
margin compression could be affected by competition from smaller banks.

Financial services in our market area is highly competitive,
with a number of commercial banks, credit unions, insurance companies and stockbrokers seeking to do business with our customers. The large banks in our market can achieve greater economies of scale due to their financial strength and marketing
clout. If these large banks focus more attention on our market, we could lose customers and our business could suffer. At the same time, our net interest margin could come under pressure if we are forced to compete locally with the smaller banks for
deposits.

We offer several forms of specialized asset-based lending to our commercial business customers which require substantial risk management and
monitoring processes. Therefore, our credit administration process becomes a more critical function in maintaining asset quality. A failure in the effectiveness of this process may adversely impact our loan underwriting or monitoring and in either
case, negatively affect our asset quality.

Asset quality is a core value of our Company and the credit administration process is
critical to maintaining that core value in both the underwriting of new loans as well as the monitoring of existing loans. We have established policies, procedures, and systems that are designed to enhance our ability to perform the credit
administration function effectively to preserve asset quality. However, if the policies, procedures and/or systems fail or are inadequately followed, we may face the potential of loss, which could have a material impact on our results from
operations.



11



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If we experience a further deterioration in our asset quality, our performance, our ability to raise capital, and the
value of our common stock could be negatively affected.

Our business strategy calls for continued growth and our growth may be
constrained if we are unable to raise additional capital as needed. While we anticipate that we will be able to support our growth through the generation of net income, additional deposits, and investment opportunities. However, we may need to raise
additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities in the public market will depend primarily upon our financial condition and
the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us.



|Item 1B. | Unresolved Staff Comments.
|-------- | --------------------------

None.



|Item 2. | Properties.
|------- | -----------

Our main office is located in a
seven-story office building at 36 Church Avenue, S.W., in downtown Roanoke, Virginia 24011, which we lease five floors. The lease on all floors terminates on December 31, 2009 with options to renew for three additional five-year terms at the
end of the December 31, 2009 extension period. Additionally, we lease our South Roanoke, Salem and our Grandin Road offices. We own our Starkey Road, Hershberger, Vinton and Lewis Gale offices.

In the opinion of management of the Company, its properties are adequate for its current operations and adequately covered by insurance.



|Item 3. | Legal Proceedings.
|------- | ------------------

Neither the Company nor the
Bank is a party to, nor is any of their property the subject of, any material pending legal proceedings other than routine litigation incidental to the Banks business.



|Item 4. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------

None.

PART II.



|Item 5. | Market for Common Equity and Related Stockholder Matters.
|------- | ---------------------------------------------------------

Market information.The Company is authorized to issue up to 10,000,000 shares of Common Stock, no par value, of which 4,125,068 shares were issued and outstanding and held of record by approximately 447 shareholders at March 5,
2007.

The Common Stock is quoted under the symbol VYFC on the Nasdaq Capital Market. According to information obtained by Company
management and believed to be reliable, the quarterly range of closing prices per share for the Common Stock during the last two fiscal years was as follows:



|              |  |           |       |          |   |           |  |           |       |  |   |      
|------------- |  | --------- | ----- | -------- | - | --------- |  | --------- | ----- |  | - | -----
|              |  | 2006      |       | 2005    
|Quarter Ended |  | HighClose |       | LowClose |   | HighClose |  | Low Close
|March 31      |  | $         | 13.80 |          | $ | 13.80     |  | $         | 14.25 |  | $ | 12.93
|June 30       |  | $         | 13.67 |          | $ | 13.67     |  | $         | 13.18 |  | $ | 11.93
|September 30  |  | $         | 13.00 |          | $ | 13.00     |  | $         | 13.18 |  | $ | 11.93
|December 31   |  | $         | 13.10 |          | $ | 13.10     |  | $         | 13.00 |  | $ | 11.44



12



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Dividends.On April 26, 2006 the Company declared a $0.07 per share cash dividend, payable
July 1, 2006 to shareholders of record June 1, 2006. On November 16, 2006 the Company declared a $0.07 per share cash dividend, payable January 2, 2007 to shareholders of record December 1, 2006. The Company declared two
semi-annual dividends, one at $0.06 per share and the second at $0.07 per share during the year ended December 31, 2005. See Supervision and Regulation and Note 15 to the Consolidated Financial Statements for restrictions on the
payment of dividends.

Securities authorized for issuance under equity compensation plans.

Equity Compensation Plan Information



|                                                                                        |  |                                                                                      |  |                                                                      |      |                                                                                                                                       |        
|--------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------- | -------
|Plan Category                                                                           |  | Number ofsecuritiesto be issueduponexercise ofoutstandingoptions,warrants,and rights |  | Weightedaverageexercise priceofoutstandingoptions,warrants andrights |      | Number ofsecurities remainingavailable for
futureissuance under equity compensationplans (excludingsecurities reflected incolumn (a))
|Valley Financial Corporation Key Employee Incentive Plan (approved by security holders) |  | 256,402                                                                              |  | $                                                                    | 7.21 |                                                                                                                                       | 200,258
|Individual Stock Option Agreements (approved by security holders)                       |  | 82,098                                                                               |  | $                                                                    | 3.18 |                                                                                                                                       | 0      
|Equity compensation plans not approved by security holders                              |  | 0                                                                                    |  | $                                                                    | 0.00 |                                                                                                                                       | 0      
|                                                                                        |  |                                                                                      |  |                                                                      |      |                                                                                                                                       |        
|Total                                                                                   |  | 338,500                                                                              |  |                                                                      |      |                                                                                                                                       | 200,258
|                                                                                        |  |                                                                                      |  |                                                                      |      |                                                                                                                                       |        

As of December 31, 2006 there were no compensation plans, including individual compensation
arrangements, under which equity securities of the Company are authorized for issuance that have not been approved by a vote of security holders.



13



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##### Table of Contents

|Item 6. | Selected Financial Data
|------- | -----------------------

Selected Financial Data

(000s omitted)



|                                                                                                                                      |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                                                      |  | 2006 |         |   | 2005 |   |         | 2004 |  |   | 2003    |   |  | 2002 |        
|For the Year                                                                                                                          |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income                                                                                                                   |  | $    | 15,680  |   |      | $ | 13,599  |      |  | $ | 10,929  |   |  | $    | 9,465   |   |  | $ | 8,274   |  
|Noninterest income                                                                                                                    |  |      | 2,212   |   |      |   | 1,596   |      |  |   | 1,358   |   |  |      | 1,326   |   |  |   | 837     |  
|                                                                                                                                      |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total revenue                                                                                                                         |  |      | 17,892  |   |      |   | 15,195  |      |  |   | 12,287  |   |  |      | 10,791  |   |  |   | 9,111   |  
|Noninterest expense                                                                                                                   |  |      | 12,051  |   |      |   | 9,192   |      |  |   | 7,807   |   |  |      | 6,454   |   |  |   | 5,371   |  
|Provision for loan losses                                                                                                             |  |      | 2,796   |   |      |   | 1,297   |      |  |   | 633     |   |  |      | 966     |   |  |   | 610     |  
|Tax provision                                                                                                                         |  |      | 163     |   |      |   | 1,314   |      |  |   | 1,023   |   |  |      | 771     |   |  |   | 871     |  
|                                                                                                                                      |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income                                                                                                                            |  | $    | 2,882   |   |      | $ | 3,392   |      |  | $ | 2,824   |   |  | $    | 2,600   |   |  | $ | 2,259   |  
|                                                                                                                                      |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Per Common Share                                                                                                                      |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Basic net income                                                                                                                      |  | $    | 0.70    |   |      | $ | 0.83    |      |  | $ | 0.75    | * |  | $    | 0.71    | * |  | $ | 0.62    | *
|Diluted net income                                                                                                                    |  |      | 0.68    |   |      |   | 0.80    |      |  |   | 0.70    | * |  |      | 0.67    | * |  |   | 0.60    | *
|Cash dividends declared                                                                                                               |  |      | 0.14    |   |      |   | 0.13    |      |  |   | 0.12    |   |  |      | 0.00    |   |  |   | 0.00    |  
|*  adjusted as
necessary to reflect the 3 for 2 stock split effective May 30, 2002 and the 2 for 1 stock split effective May 31, 2004 | 
|                                                                                                                                      |  |      |         |   |     
|At Year-End                                                                                                                           |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Assets                                                                                                                                |  | $    | 591,936 |   |      | $ | 498,949 |      |  | $ | 373,979 |   |  | $    | 309,133 |   |  | $ | 248,846 |  
|Securities                                                                                                                            |  |      | 73,617  |   |      |   | 57,989  |      |  |   | 71,475  |   |  |      | 66,195  |   |  |   | 42,405  |  
|Loans, gross                                                                                                                          |  |      | 471,052 |   |      |   | 414,377 |      |  |   | 282,774 |   |  |      | 222,598 |   |  |   | 185,647 |  
|Reserve for loan losses                                                                                                               |  |      | (5,658  | ) |      |   | (4,124  | )    |  |   | (2,989  | ) |  |      | (2,566  | ) |  |   | (2,014  | )
|Deposits                                                                                                                              |  |      | 441,489 |   |      |   | 365,316 |      |  |   | 279,333 |   |  |      | 223,022 |   |  |   | 182,243 |  
|Short-term borrowings                                                                                                                 |  |      | 25,000  |   |      |   | 23,000  |      |  |   | 15,000  |   |  |      | 15,000  |   |  |   | 10,000  |  
|Long-term debt                                                                                                                        |  |      | 48,000  |   |      |   | 37,000  |      |  |   | 37,000  |   |  |      | 37,000  |   |  |   | 30,000  |  
|Trust preferred securities                                                                                                            |  |      | 16,496  |   |      |   | 11,341  |      |  |   | 4,124   |   |  |      | 4,124   |   |  |   | 0       |  
|Total shareholders equity                                                                                                            |  |      | 33,401  |   |      |   | 30,715  |      |  |   | 28,316  |   |  |      | 21,562  |   |  |   | 19,024  |  
|                                                                                                                                      |  |      |         |   |     
|Ratios                                                                                                                                |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Return on average assets                                                                                                              |  |      | 0.54    | % |      |   | 0.79    | %    |  |   | 0.82    | % |  |      | 0.93    | % |  |   | 1.02    | %
|Return on average equity                                                                                                              |  |      | 8.67    | % |      |   | 11.42   | %    |  |   | 12.00   | % |  |      | 12.89   | % |  |   | 12.89   | %
|Dividend payout ratio                                                                                                                 |  |      | 20.51   | % |      |   | 16.25   | %    |  |   | 17.14   | % |  |      | 0.0     | % |  |   | 0.0     | %
|Average equity to average assets                                                                                                      |  |      | 6.11    | % |      |   | 6.93    | %    |  |   | 6.81    | % |  |      | 7.18    | % |  |   | 7.90    | %



14



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|Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

The following is managements discussion and analysis of the financial condition and results of operations of the Company as of and for the years
ended December 31, 2006, 2005 and 2004. The discussion should be read in conjunction with the Companys Consolidated Financial Statements and Notes thereto.

Critical Accounting Policies

The preparation of financial statements requires us to make estimates
and assumptions. Those accounting policies that require our most difficult, subjective or complex judgments and uncertainties include (1) the allowance for loan losses and (2) impaired loans. Further information about these critical
policies is described below.

Allowance for Loan Losses: Certain credit risks are inherent in making loans. We seek to prudently
assess these risks and manage them effectively. We have internal credit policies and procedures in place to reduce repayment risks. These policies and procedures include:



| |  |  | Officer and customer limits
| | - |  | ---------------------------



| |  |  | Periodic loan documentation review, and
| | - |  | ---------------------------------------



| |  |  | Follow-up on exceptions to credit policies.
| | - |  | -------------------------------------------

We establish the allowance for loan losses through charges to earnings through a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent
recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb probable losses on existing loans that may become uncollectible.
Some of the factors we consider in determining the appropriate level of the allowance for loan losses are as follows:



| |  |  | An evaluation of the current loan portfolio
| | - |  | -------------------------------------------



| |  |  | Identified loan problems
| | - |  | ------------------------



| |  |  | Loan volume outstanding
| | - |  | -----------------------



| |  |  | Past loss experience
| | - |  | --------------------



| |  |  | Present and expected industry and economic conditions and, in particular, how such conditions relate to our market area.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | Problem loan trends over a 3-year historical time period
| | - |  | --------------------------------------------------------



| |  |  | Loan growth trends over a 3-year historical time period
| | - |  | -------------------------------------------------------

Bank regulators also periodically review the loan portfolio and other assets to assess their quality, and we employ independent, third party loan reviewers (semi-annually) as well. This evaluation is inherently
subjective because it requires estimates that may be significantly revised as more information becomes available. We believe the allowance for loan losses is appropriate to provide for expected losses in the loan portfolio, but there are no
assurances that it will be.

Impairment of Loans: We consider a loan impaired when it is probable that we will be unable to collect
all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. An allowance is established when the discounted
cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component of the reserve covers non-classified loans and is based on historical loss experience adjusted for
qualitative factors. The allowance for loan losses is evaluated on a regular basis by management. On a quarterly basis, we perform a detailed analysis of the allowance for loan losses to verify the adequacy and appropriateness of the allowance in
meeting possible losses in the loan portfolio.



15



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Overview

The Company was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of the Bank. The Bank opened for business on May 15, 1995. There are currently eight
full-service branch locations, operating in various locations throughout the Cities of Roanoke and Salem, Town of Vinton, and the County of Roanoke.

During the second quarter of 2005, we opened our eighth full-service branch location in the Grandin Village area and started a wealth management subsidiary, Valley Wealth Management Services, Inc. which markets
investment and insurance products. Net income derived from the new subsidiary is not significant at this time.

The Companys
investment in the Bank was $44.4 million as of December 31, 2006 and $39.0 million as of December 31, 2005.

Performance Summary

The following table shows our key performance ratios for the years ended December 31, 2006, 2005, and 2004:



|                               |  |                          |      |   |                          |   |       |                          |  |   |       |  
|------------------------------ |  | ------------------------ | ---- | - | ------------------------ | - | ----- | ------------------------ |  | - | ----- | -
|Key Performance
Ratios         | 
|                               |  | 12 Months Ended 12/31/06 |      |   | 12 Months Ended 12/31/05 |   |       | 12 Months Ended 12/31/04 | 
|Return on average assets       |  |                          | 0.54 | % |                          |   | 0.79  | %                        |  |   | 0.82  | %
|Return on average equity (1)   |  |                          | 8.67 | % |                          |   | 11.42 | %                        |  |   | 12.00 | %
|Net interest margin (2)        |  |                          | 3.14 | % |                          |   | 3.42  | %                        |  |   | 3.45  | %
|Cost of funds                  |  |                          | 3.85 | % |                          |   | 2.76  | %                        |  |   | 2.17  | %
|Yield on earning assets        |  |                          | 6.93 | % |                          |   | 6.13  | %                        |  |   | 5.57  | %
|Basic net earnings per share   |  | $                        | 0.70 |   |                          | $ | 0.83  |                          |  | $ | 0.75  |  
|Diluted net earnings per share |  | $                        | 0.68 |   |                          | $ | 0.80  |                          |  | $ | 0.70  |  

---

All percentage calculations are on an annualized
basis.

|1. | The calculation of ROE excludes the effect of any unrealized gains or losses on investment securities available-for-sale.
|-- | -------------------------------------------------------------------------------------------------------------------------

|2. | Calculated on a fully taxable equivalent basis (FTE)
|-- | ------------------------------------------------------

Our performance has been adversely affected by three major factors during 2006. First, as shown above, our net interest margin continues to experience compression from the flat yield curve and the intense competition for deposits. As such,
our cost of funds has increased by 109 basis points as compared with an increase of only 80 basis points in our yield on earning assets. Although we do believe this compression pressure may continue to be a challenge in 2007, we do not anticipate we
will experience the level of deterioration that occurred in 2006. Second, we continue to experience minimal growth in our noninterest-bearing accounts. This is an industry-wide phenomenon and one not likely to change anytime soon. Finally, our
performance was significantly impacted by the actions taken during the fourth quarter due to an increase in non-performing loans. Five loans aggregating an approximate outstanding principal balance of $4.1 million to a commercially oriented
enterprise and its majority owner were placed on non-accrual status effective December 1, 2006, which resulted in a loss of interest income of $30,000 in December. The borrowers failed to meet the principal repayment terms of their loans and
actions to collect the loans were initiated on December 12, 2006. At this time, we believe the loans are not adequately secured; therefore, a special provision was made to the loan loss reserve in the amount of



16



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##### Table of Contents

$776,200 to reflect the potential exposure that we deem to exist. Additionally, during the fourth quarter of 2006, we charged off $1.25 million of a
previously disclosed commercial credit relationship that had been placed on non-accrual status during the first quarter of 2006. A successful resolution of this credit situation did not occur prior to December 31, 2006, resulting in the
charge-off. We had reserved $1.2 million earlier in 2006 in anticipation of this loss. As of December 31, 2006, we had three loans aggregating a total of $2.2 million included in our investment of impaired loans related to this commercial
credit relationship. We continue to monitor this relationship very closely due to the high level of risk and recognize that we may record additional losses if the customer is not able to become profitable. In total, the Company had lost interest
income of $293,700 for the year as a result of this credit.

Our return on average assets for the three months ended December 31, 2006
dropped from 0.72% in September to 0.12% and our return on average equity dropped to 1.92% for the three months ended December 31, 2006 as compared to 11.61% during the third quarter of 2006.

Growth

The following table shows our key growth
indicators:



|                                      |  |                          |         |                          |   |                          |  |   |        
|------------------------------------- |  | ------------------------ | ------- | ------------------------ | - | ------------------------ |  | - | -------
|Key Growth Indicators (000s omitted)
|                                      |  | 12 Months Ended 12/31/06 |         | 12 Months Ended 12/31/05 |   | 12 Months Ended 12/31/04
|Investment securities                 |  | $                        | 73,617  |                          | $ | 57,989                   |  | $ | 71,475 
|Loans, net                            |  | $                        | 465,394 |                          | $ | 410,253                  |  | $ | 279,785
|Deposits                              |  | $                        | 441,489 |                          | $ | 365,316                  |  | $ | 279,333
|Total assets                          |  | $                        | 591,936 |                          | $ | 498,949                  |  | $ | 373,979

Total assets at December 31, 2006 were $591.9 million, up $93.0 million or 19% from $498.9
million at December 31, 2005. The principal components of the Companys assets at the end of the period were $16.6 million in federal funds sold, $53.5 million in securities available-for-sale, including restricted equity securities, $20.1
million in securities held-to-maturity, and $471.0 million in gross loans. Total assets at December 31, 2005 were up $125.0 million or 33% from $374.0 million at December 31, 2004. The principal components of the Companys assets at
December 31, 2005 were $37.6 million in securities available-for-sale, including restricted equity securities, $20.8 million in securities held to maturity, and $414.4 million in gross loans.

Total liabilities at December 31, 2006 were $558.5 million, up from $468.2 million at December 31, 2005, an increase of $90.3 million or 19.3%,
with the increase primarily represented by an $76.1 million growth in deposits, a $5.2 million increase in guaranteed preferred beneficial interests in the Companys junior subordinated debentures, an $2.0 million increase in short-term
borrowings, an $11.0 million increase in long term borrowings, a $10.8 million increase in securities sold under agreements to repurchase, a $2.2 million increase in other liabilities, offset by a $17.0 million decrease in federal funds purchased.
Total liabilities at December 31, 2005 were $468.2 million, up from $345.7 million at December 31, 2004, an increase of $122.5 million or 35%. Deposits increased $86 million or 31% to $365.3 million from the $279.3 million level at
December 31, 2004.

We intend to continue to execute our business model by focusing on our core business and stressing personal
service to satisfy customers, although we constantly evaluate the effectiveness of the model. We have intentionally slowed the growth of the Bank as compared to 2005. Annualized growth rates for assets, loans and deposits during 2006 are
substantially less than the growth rates achieved in 2005. However, the rates of growth remained at double-digit levels. Competition for deposits has heightened significantly and our ability to fund loan growth will be dependent upon our ability to
grow our deposit base at a reasonable cost. During 2006, we were successful in reducing our overall reliance



17



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##### Table of Contents

on certificates of deposits by raising approximately $50 million of new deposits in our new money market product, which is tied to the WSJ Prime rate.
Additionally, as intended, 2006 was the first year since 2003 that our deposit growth outpaced our loan growth. We believe our consistent double-digit growth rates in both loans and deposits demonstrate the preference of local businesses and
individuals to seek the high degree of personalized service and local decision-making offered by Valley Bank.

Shareholders Equity

Total shareholders equity at December 31, 2006 was $33.4 million, an increase of $2.7 million or 9% over the $30.7 million level at
December 31, 2005. The increase is attributable to net income of $2.9 million, proceeds from the exercise of stock options of $0.1 million, $0.1 million due to the expensing of stock options, an increase in accumulated other comprehensive
income of $0.2 million, all offset by dividends declared of $0.6 million. Total shareholders equity at December 31, 2005 was $30.7 million, an increase of $2.4 million or 8% in 2005 from the December 31, 2004 level of $28.3 million.
The increase from December 31, 2004 to December 31, 2005 was attributable to an increase of $3.4 million in retained earnings, offset by the decrease in accumulated other comprehensive income of $0.5 million and dividends declared of $0.5
million.

Net Income

We earned net
income of $2.9 million for the year ended December 31, 2006, a decrease of 15% over the $3.4 million reported for the same period in 2005. Net income for the three months ended December 31, 2006 was $0.2 million, a decrease of 86% over the
$1.1 million reported for the fourth quarter of 2005. The biggest factor contributing to the decrease in net income for both periods is significant increase in the provision for loan loss as a result of the increase in non-performing loans.

We earned net income of $3.4 million for the year ended December 31, 2005 compared with $2.8 million for the year ended
December 31, 2004, an increase of $0.6 million or 21%. Net income for the three months ended December 31, 2005 was $1.1 million, an increase of 22% over the $0.9 million reported for the fourth quarter of 2004.

Net Interest Income

Net interest income is our
principal source of earnings and is calculated as the amount which loan and investment (earning assets) income exceeds the interest expense on deposits and borrowings (interest-bearing liabilities). Changes in the volume and mix of earning assets
and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Changes in the interest rate environment and the Companys cost of funds also affect net interest
income.

Net interest income for the year ended December 31, 2006 was $15.7 million, a 15% increase when compared to December 31,
2005. Net interest income for the quarter ended December 31, 2006 was $4.0 million, a 3% increase over the same period last year. Net interest income for the year ended December 31, 2005 was $13.6 million, a 25% increase over the $10.9
million level at December 31, 2004. Net interest income for the quarter ended December 31, 2005 was $3.9 million, a 26% increase when compared to the quarter ended December 31, 2004. The yield on average loans increased in 2006 by
0.12% to 7.21% from its level of 6.42% in 2005. The overall tax equivalent yield on earning assets was 6.93% for the year ended 2006, as compared to 6.13% for the prior year. The yield on average loans increased in 2005 by 0.47% to 6.42% from its
level of 5.95% in 2004. The overall tax equivalent yield on earning assets was 6.13% for the year ended 2005, as compared to 5.57% for the prior year.

The following table presents the major categories of interest-earning assets, interest-bearing liabilities and shareholders equity with corresponding average balances, related interest income or expense, and
resulting yields and rates for the periods indicated. Where appropriate, income categories and yields have been adjusted in the table to their fully taxable equivalent basis.



18



---

##### Table of Contents

NET INTEREST INCOME AND AVERAGE BALANCES (1)

(000s omitted)



|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|---------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ------------------------ | - | --------- | ---- | ---- | -------------- |  | - | ------------------------ | - | --------- | - | ------ | -------------- | ---- | - | ------------------------ | - | --------- | - |  | - | ------ |  | ---- | -
|                                                                             |  | Years Ended December 31 |        
|                                                                             |  | 2006                    |         |   | 2005                     |   |           | 2004 |     
|                                                                             |  | Average Balance         |         |   | Interest Income/ Expense |   | Rate Paid |      |      | AverageBalance |  |   | Interest Income/ Expense |   | Rate Paid |   |        | AverageBalance |      |   | Interest Income/ Expense |   | Rate Paid |  
|Assets                                                                       |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Interest-earning assets:                                                     |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Loans (2) (5)                                                                |  | $                       | 443,047 |   |                          | $ | 31,959    |      | 7.21 | %              |  | $ | 339,665                  |   |           | $ | 21,806 |                | 6.42 | % |                          | $ | 250,020   |   |  | $ | 14,884 |  | 5.95 | %
|Investment securities                                                        |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Taxable                                                                      |  |                         | 49,431  |   |                          |   | 2,340     |      | 4.73 | %              |  |   | 48,539                   |   |           |   | 2,104  |                | 4.33 | % |                          |   | 55,308    |   |  |   | 2,270  |  | 4.10 | %
|Nontaxable (3)                                                               |  |                         | 14,008  |   |                          |   | 828       |      | 5.91 | %              |  |   | 14,936                   |   |           |   | 903    |                | 6.05 | % |                          |   | 16,500    |   |  |   | 976    |  | 5.92 | %
|Money market investments                                                     |  |                         | 1,444   |   |                          |   | 59        |      | 4.09 | %              |  |   | 2,689                    |   |           |   | 73     |                | 2.71 | % |                          |   | 4,775     |   |  |   | 60     |  | 1.26 | %
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Total interest-earning assets                                                |  |                         | 507,930 |   |                          |   | 35,187    |      | 6.93 | %              |  |   | 405,829                  |   |           |   | 24,886 |                | 6.13 | % |                          |   | 326,603   |   |  |   | 18,190 |  | 5.57 | %
|                                                                             |  |                         |         |   |                          |   |           |      |     
|Other Assets:                                                                |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Reserve for loan losses                                                      |  |                         | (4,810  | ) |                          |   |           |      |      |                |  |   | (3,558                   | ) |           |   |        |                |      |   |                          |   | (2,815    | ) |  |   |        |  |      |  
|Cash and due from banks                                                      |  |                         | 8,432   |   |                          |   |           |      |      |                |  |   | 8,458                    |   |           |   |        |                |      |   |                          |   | 6,904     |   |  |   |        |  |      |  
|Premises and equipment, net                                                  |  |                         | 6,900   |   |                          |   |           |      |      |                |  |   | 6,403                    |   |           |   |        |                |      |   |                          |   | 6,135     |   |  |   |        |  |      |  
|Other assets                                                                 |  |                         | 15,990  |   |                          |   |           |      |      |                |  |   | 11,102                   |   |           |   |        |                |      |   |                          |   | 8,523     |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Total assets                                                                 |  |                         | 534,442 |   |                          |   |           |      |      |                |  |   | 428,234                  |   |           |   |        |                |      |   |                          |   | 345,350   |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |     
|Liabilities and Shareholders Equity                                         |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Interest-bearing liabilities                                                 |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Savings, NOW and MMA                                                         |  |                         | 90,665  |   |                          |   | 2,930     |      | 3.23 | %              |  |   | 65,820                   |   |           |   | 1,462  |                | 2.22 | % |                          |   | 55,077    |   |  |   | 467    |  | 0.85 | %
|Time deposits                                                                |  |                         | 254,011 |   |                          |   | 11,340    |      | 4.46 | %              |  |   | 207,219                  |   |           |   | 6,660  |                | 3.21 | % |                          |   | 161,941   |   |  |   | 4,395  |  | 2.71 | %
|Repurchase agreements                                                        |  |                         | 14,938  |   |                          |   | 534       |      | 3.57 | %              |  |   | 8,063                    |   |           |   | 145    |                | 1.80 | % |                          |   | 5,930     |   |  |   | 42     |  | 0.71 | %
|Federal funds purchased                                                      |  |                         | 8,316   |   |                          |   | 440       |      | 5.29 | %              |  |   | 4,077                    |   |           |   | 152    |                | 3.73 | % |                          |   | 1,375     |   |  |   | 23     |  | 1.67 | %
|Trust preferred                                                              |  |                         | 11,526  |   |                          |   | 815       |      | 7.07 | %              |  |   | 5,841                    |   |           |   | 364    |                | 6.23 | % |                          |   | 4,000     |   |  |   | 186    |  | 4.65 | %
|Long-term FHLB                                                               |  |                         | 38,915  |   |                          |   | 2,033     |      | 5.22 | %              |  |   | 34,282                   |   |           |   | 1,576  |                | 4.60 | % |                          |   | 37,000    |   |  |   | 1,580  |  | 4.27 | %
|Short-term FHLB                                                              |  |                         | 29,145  |   |                          |   | 1,145     |      | 3.93 | %              |  |   | 20,200                   |   |           |   | 621    |                | 3.07 | % |                          |   | 15,000    |   |  |   | 236    |  | 1.57 | %
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                           |  |                         | 447,516 |   |                          |   | 19,237    |      | 3.85 | %              |  |   | 345,502                  |   |           |   | 10,980 |                | 3.18 | % |                          |   | 280,323   |   |  |   | 6,929  |  | 2.47 | %
|                                                                             |  |                         |         |   |                          |   |           |      |     
|Noninterest-bearing liabilities                                              |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Demand deposits                                                              |  |                         | 52,020  |   |                          |   |           |      |      |                |  |   | 51,637                   |   |           |   |        |                |      |   |                          |   | 39,843    |   |  |   |        |  |      |  
|Other liabilities                                                            |  |                         | 1,691   |   |                          |   |           |      |      |                |  |   | 1,403                    |   |           |   |        |                |      |   |                          |   | 1,652     |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Total liabilities                                                            |  |                         | 501,227 |   |                          |   |           |      |      |                |  |   | 398,542                  |   |           |   |        |                |      |   |                          |   | 321,818   |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |     
|Shareholders Equity, exclusive of unrealized gains/losses on AFS securities |  |                         | 33,215  |   |                          |   |           |      |      |                |  |   | 29,692                   |   |           |   |        |                |      |   |                          |   | 23,532    |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Total liabilities and shareholders equity                                   |  | $                       | 534,442 |   |                          |   |           |      |      |                |  | $ | 428,234                  |   |           |   |        |                |      |   |                          | $ | 345,350   |   |  |   |        |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Net interest income                                                          |  |                         |         |   |                          | $ | 15,950    |      |      |                |  |   |                          |   |           | $ | 13,906 |                |      |   |                          |   |           |   |  | $ | 11,261 |  |      |  
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  
|Net interest margin (4)                                                      |  |                         |         |   |                          |   |           |      | 3.14 | %              |  |   |                          |   |           |   |        |                | 3.42 | % |                          |   |           |   |  |   |        |  | 3.45 | %
|                                                                             |  |                         |         |   |                          |   |           |      |      |                |  |   |                          |   |           |   |        |                |      |   |                          |   |           |   |  |   |        |  |      |  

---

Legends for the table are as follows:

| | (1) | Averages are daily averages.
| | --- | ----------------------------

| | (2) | Loan interest income includes loan fees of $1.1 million, $1.1 million and $1.7 million for the years ended 2006, 2005, and 2004, respectively.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Nontaxable interest income is adjusted to its fully taxable equivalent basis using a federal tax rate of 34 percent.
| | --- | --------------------------------------------------------------------------------------------------------------------

| | (4) | The net interest margin is calculated by dividing net interest income (tax equivalent basis) by average total earning assets.
| | --- | -----------------------------------------------------------------------------------------------------------------------------

| | (5) | Non-accrual loans are included in the above yield calculation.
| | --- | --------------------------------------------------------------



19



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##### Table of Contents

As discussed above, the Companys net interest income is affected by the change in the amount and
mix of interest-earning assets and interest-bearing liabilities (referred to as volume change) as well as by changes in yields earned on interest-earning assets and rates paid on deposits and borrowed funds (referred to as rate
change). The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities and the amounts of change
attributable to variations in volumes and rates. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

RATE/VOLUME ANALYSIS

(000s
omitted)



|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  
|----------------------------------------------------------------------------------------- |  | --------------------------------------------- | ----- | - | ---- | - | ------ | --- |  | - | ------ | -
|                                                                                          |  | Year Ended December 31, 2006 compared to 2005 |      
|                                                                                          |  | Volume                                        |       |   | Rate |   |        | Net | 
|Interest earned on interest-earning assets:                                               |  |                                               |       |   |      |   |        |     |  |   |        |  
|Loans                                                                                     |  | $                                             | 7,220 |   |      | $ | 2,933  |     |  | $ | 10,153 |  
|Investment securities:                                                                    |  |                                               |       |   |      |   |        |     |  |   |        |  
|Taxable                                                                                   |  |                                               | 39    |   |      |   | 197    |     |  |   | 236    |  
|Nontaxable                                                                                |  |                                               | (55   | ) |      |   | (19    | )   |  |   | (74    | )
|Money market investments                                                                  |  |                                               | 153   |   |      |   | (167   | )   |  |   | (14    | )
|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  
|Total interest earned on interest-earning assets                                          |  |                                               | 7,357 |   |      |   | 2,944  |     |  |   | 10,301 |  
|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  
|Interest paid on interest-bearing liabilities:                                            |  |                                               |       |   |      |   |        |     |  |   |        |  
|Savings, NOW, and money markets                                                           |  |                                               | 666   |   |      |   | 802    |     |  |   | 1,468  |  
|Time deposits                                                                             |  |                                               | 1,719 |   |      |   | 2,961  |     |  |   | 4,680  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                                               | 396   |   |      |   | 55     |     |  |   | 451    |  
|Securities sold under agreements to repurchase                                            |  |                                               | 180   |   |      |   | 209    |     |  |   | 389    |  
|Federal funds purchased                                                                   |  |                                               | 205   |   |      |   | 83     |     |  |   | 288    |  
|Long-term FHLB advances                                                                   |  |                                               | 227   |   |      |   | 230    |     |  |   | 457    |  
|Short-term FHLB advances                                                                  |  |                                               | 322   |   |      |   | 202    |     |  |   | 524    |  
|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  
|Total interest paid on interest-bearing liabilities                                       |  |                                               | 3,715 |   |      |   | 4,542  |     |  |   | 8,257  |  
|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  
|Change in net interest income                                                             |  | $                                             | 3,642 |   |      | $ | (1,598 | )   |  | $ | 2,044  |  
|                                                                                          |  |                                               |       |   |      |   |        |     |  |   |        |  



20



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##### Table of Contents

RATE/VOLUME ANALYSIS

(000s omitted)



|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  
|----------------------------------------------------------------------------------------- |  | -------------------------------------------- | ----- | - | ---- | - | ----- | --- |  | - | ----- | -
|                                                                                          |  | Year Ended December 31,2005 compared to 2004 |      
|                                                                                          |  | Volume                                       |       |   | Rate |   |       | Net | 
|Interest earned on interest-earning assets:                                               |  |                                              |       |   |      |   |       |     |  |   |       |  
|Loans                                                                                     |  | $                                            | 5,671 |   |      | $ | 1,251 |     |  | $ | 6,922 |  
|Investment securities:                                                                    |  |                                              |       |   |      |   |       |     |  |   |       |  
|Taxable                                                                                   |  |                                              | (309  | ) |      |   | 143   |     |  |   | (166  | )
|Nontaxable                                                                                |  |                                              | (94   | ) |      |   | 21    |     |  |   | (73   | )
|Money market investments                                                                  |  |                                              | (8    | ) |      |   | 21    |     |  |   | 13    |  
|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  
|Total interest earned on interest-earning assets                                          |  |                                              | 5,260 |   |      |   | 1,436 |     |  |   | 6,696 |  
|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  
|Interest paid on interest-bearing liabilities:                                            |  |                                              |       |   |      |   |       |     |  |   |       |  
|Savings, NOW, and money markets                                                           |  |                                              | 107   |   |      |   | 888   |     |  |   | 995   |  
|Time deposits                                                                             |  |                                              | 1,358 |   |      |   | 907   |     |  |   | 2,265 |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                                              | 114   |   |      |   | 64    |     |  |   | 178   |  
|Securities sold under agreements to repurchase                                            |  |                                              | 20    |   |      |   | 83    |     |  |   | 103   |  
|Federal funds purchased                                                                   |  |                                              | 79    |   |      |   | 50    |     |  |   | 129   |  
|Long-term FHLB advances                                                                   |  |                                              | (123  | ) |      |   | 119   |     |  |   | (4    | )
|Short-term FHLB advances                                                                  |  |                                              | 102   |   |      |   | 283   |     |  |   | 385   |  
|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  
|Total interest paid on interest-bearing liabilities                                       |  |                                              | 1,657 |   |      |   | 2,394 |     |  |   | 4,051 |  
|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  
|Change in net interest income                                                             |  | $                                            | 3,603 |   |      | $ | (958  | )   |  | $ | 2,645 |  
|                                                                                          |  |                                              |       |   |      |   |       |     |  |   |       |  

Interest Rate Risk

Interest rate risk is the risk to earnings or capital generated by the effects of changes in interest rates on our on- and off-balance sheet positions, and can take one or more of several forms:



| |  |  | Repricing risk comes from timing mismatches in the ability to alter contractual rates earned on financial assets held or paid on interest-bearing liabilities
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Basis risk refers to changes in the underlying relationships between market rates or indices, which result in a narrowing of the spread earned on a loan or
investment relative to its cost of funds.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option risk arises from embedded options in many financial instruments such as:
| | - |  | ---------------------------------------------------------------------------------



| |  |  | interest rate options,
| | - |  | ----------------------



| |  |  | loan prepayment options,
| | - |  | ------------------------



| |  |  | deposit early withdrawal options,
| | - |  | ---------------------------------



| |  |  | callable Federal Home Loan Bank advances, and
| | - |  | ---------------------------------------------



| |  |  | pre-payment of the underlying collateral of asset-backed securities.
| | - |  | --------------------------------------------------------------------

Embedded options are complex risk positions that are difficult to predict and offset, and are a large component of our overall interest rate risk.

We have established risk measures, limits, policy guidelines and internal control mechanisms for managing our overall asset/liability
management (ALM) position. The responsibility for interest rate risk control resides with management, with oversight by the board of directors and the ALCO Oversight Committee. We seek to balance the return potential of the ALM position
against the desire to limit volatility in earnings.



21



---

##### Table of Contents

At least quarterly, we measure the ALM position using earnings simulation modeling to estimate what
assets and liabilities would re-price, and to what extent, within a one-year period in response to an immediate 200 and 100 basis point change in the Prime Rate, as well as in response to more gradual interest rate changes. Our objective is to keep
the change in net interest income over twelve months at or below 5%, and the change in net income at or below 10%, under an immediate 200 basis point interest rate shock scenario.

The model also incorporates managements forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios
are used for analytical purposes and do not necessarily represent managements view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to our earnings.
Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates managements best estimate of interest rate and
balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.

We also estimate interest sensitivity by calculating the net present value of the balance sheets cash flows or the residual value of future cash flows ultimately due to shareholders. This calculation is known as
Economic Value of Equity or EVE and is generally considered a better measure of long-term interest sensitivity than is IRS. Our objective is for the result to change 25% or less in an immediate 200 basis point interest rate shock
scenario.

The following table shows the sensitivity of the Companys balance sheet at the date indicated, but is not necessarily
indicative of the position on other dates.



22



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##### Table of Contents

INTEREST RATE SENSITIVITY

Maturities/Repricing

(000s omitted)



|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|----------------------------------------------------------------------------------------- |  | ----------------- | -- |  | ------------ | -- |  | ------------- | -- |  | -------------- | - |  | ------- | -
|                                                                                          |  | December 31, 2006 |   
|                                                                                          |  | 1  3Months       |    |  | 4  12Months |    |  | 13  60Months |    |  | Over 60 Months |   |  | Total   |  
|Earning Assets:                                                                           |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Loans, excluding nonaccruals                                                              |  | 189,124           |    |  | 27,609       |    |  | 135,177       |    |  | 112,798        |   |  | 464,708 |  
|Investment securities                                                                     |  | 369               |    |  | 198          |    |  | 10,017        |    |  | 57,954         |   |  | 68,538  |  
|Restricted equity securities                                                              |  |                  |    |  |             |    |  |              |    |  | 5,079          |   |  | 5,079   |  
|Interest-bearing deposits in banks                                                        |  | 91                |    |  |             |    |  |              |    |  |               |   |  | 91      |  
|Federal funds sold                                                                        |  | 16,630            |    |  |             |    |  |              |    |  |               |   |  | 16,630  |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Total earning assets                                                                      |  | 206,214           |    |  | 27,807       |    |  | 145,194       |    |  | 175,831        |   |  | 555,046 |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Interest Bearing Liabilities:                                                             |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|NOW accounts                                                                              |  | 21,951            |    |  |             |    |  |              |    |  |               |   |  | 21,951  |  
|Money market accounts                                                                     |  | 90,157            |    |  |             |    |  |              |    |  |               |   |  | 90,157  |  
|Savings                                                                                   |  | 66,258            |    |  |             |    |  |              |    |  |               |   |  | 66,258  |  
|Time deposits                                                                             |  | 58,389            |    |  | 184,688      |    |  | 20,046        |    |  |               |   |  | 263,123 |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Total deposits                                                                            |  | 236,755           |    |  | 184,688      |    |  | 20,046        |    |  |               |   |  | 441,489 |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Repurchase agreements                                                                     |  | 21,635            |    |  |             |    |  |              |    |  |               |   |  | 21,635  |  
|FHLB advances                                                                             |  | 8,000             |    |  | 25,000       |    |  | 15,000        |    |  | 25,000         |   |  | 73,000  |  
|Federal funds purchased                                                                   |  |                  |    |  |             |    |  |              |    |  |               |   |  |        |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  | 16,496            |    |  |             |    |  |              |    |  |               |   |  | 16,496  |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Total interest bearing liabilities                                                        |  | 282,886           |    |  | 209,688      |    |  | 35,046        |    |  | 25,000         |   |  | 552,620 |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Interest Rate Gap                                                                         |  | (76,672           | )  |  | (181,881     | )  |  | 110,148       |    |  | 150,831        |   |  | 2,426   |  
|                                                                                          |  |                   |    |  |              |    |  |               |    |  |                |   |  |         |  
|Cumulative interest sensitivity gap                                                       |  | (76,672           | )  |  | (258,553     | )  |  | (148,405      | )  |  | 2,426          |   |  |         |  
|                                                                                          |  |                   |    |  |             
|Ratio of sensitivity gap to total earning assets                                          |  | (13.81            | )% |  | (32.77       | )% |  | 19.84         | %  |  | 27.17          | % |  | 0.44    | %
|                                                                                          |  |                   |    |  |             
|Cumulative ratio of sensitivity gap to total earning assets                               |  | (13.81            | )% |  | (46.58       | )% |  | (26.74        | )% |  | 0.44           | % |  |         |  



23



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##### Table of Contents

Derivative Financial Instruments

For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates. Such derivatives are used as part of the asset/liability management process
and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.

Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional amount. The
notional amount on which the interest payments are based is not exchanged. The Company entered into its first such derivative instrument in April 2006 when it entered into a forward-start interest rate swap agreement (Agreement) to
convert a portion of its variable rate loans to a fixed rate (cash flow hedge). We entered into this agreement to protect the Bank from interest rate exposure during a period of declining rates. The effective period of the Agreement is
April 19, 2007 through April 19, 2009. As of December 31, 2006, the mark-to-market adjustment, net of taxes, included in other comprehensive income for this Agreement was $70,087.

Subsequent to December 31, 2006, we terminated this interest rate swap agreement due to the shift of the Banks balance sheet to a more
liability-sensitive position and the changing interest rate environment as compared to when the Bank entered into the Agreement. The Bank recorded a realized gain on the termination of the Agreement of $50,629.

Noninterest Income

Noninterest income is made up of
several categories as shown in the following table:

Noninterest Income

(000s omitted)



|                                     |  |                         |       |   |                         |   |       |                                    |  |      |                         |  |   |                                   |   |  |      |   
|------------------------------------ |  | ----------------------- | ----- | - | ----------------------- | - | ----- | ---------------------------------- |  | ---- | ----------------------- |  | - | --------------------------------- | - |  | ---- | --
|                                     |  | 12months Ended 12/31/06 |       |   | 12months Ended 12/31/05 |   |       | 2006 - 2005 % Increase/ (Decrease) |  |      | 12months Ended 12/31/04 |  |   | 2005 2004 % Increase/ (Decrease) |  
|                                     |  |                         |       |  
|                                     |  |                         |       |  
|Service charges on deposits          |  | $                       | 992   |   |                         | $ | 914   |                                    |  | 9    | %                       |  | $ | 801                               |   |  | 14   | % 
|Gain/(loss) on disposal of equipment |  |                         | 3     |   |                         |   | (7    | )                                  |  | 143  | %                       |  |   | (1                                | ) |  | (600 | %)
|Other income                         |  |                         | 1,220 |   |                         |   | 636   |                                    |  | 92   | %                       |  |   | 541                               |   |  | 18   | % 
|Realized securities gains/(losses)   |  |                         | (3    | ) |                         |   | 53    |                                    |  | (106 | %)                      |  |   | 17                                |   |  | 212  | % 
|                                     |  |                         |       |   |                         |   |       |                                    |  |      |                         |  |   |                                   |   |  |      |   
|Total noninterest income             |  | $                       | 2,212 |   |                         | $ | 1,596 |                                    |  | 39   | %                       |  | $ | 1,358                             |   |  | 18   | % 
|                                     |  |                         |       |   |                         |   |       |                                    |  |      |                         |  |   |                                   |   |  |      |   

Service charges on deposit accounts consist of a variety of charges imposed on demand
deposits, interest-bearing deposits and savings deposit accounts. These include, but are not limited to, the following:



| |  |  | Demand deposit monthly activity fees
| | - |  | ------------------------------------



| |  |  | Service charges for checks for which there are non-sufficient funds or overdraft charges
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | ATM transaction fees
| | - |  | --------------------



| |  |  | Debit card transaction fees
| | - |  | ---------------------------



24



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##### Table of Contents

The principal factors that may affect current or future income for service charges on deposit accounts
are:



| |  |  | Internally generated growth
| | - |  | ---------------------------



| |  |  | Acquisitions of other banks/branches or de novo branches
| | - |  | --------------------------------------------------------



| |  |  | Adjustments to service charge structures
| | - |  | ----------------------------------------

Other income consists of several categories, primarily the following:



| |  |  | Income earned on insurance policies owned by the bank on key executives
| | - |  | -----------------------------------------------------------------------



| |  |  | Fees for the issuance of official checks
| | - |  | ----------------------------------------



| |  |  | Fees for wire transfers
| | - |  | -----------------------



| |  |  | Safe deposit box rent
| | - |  | ---------------------



| |  |  | Income from the sale of customer checks
| | - |  | ---------------------------------------



| |  |  | Income on real estate loans
| | - |  | ---------------------------



| |  |  | Extension fees, insurance premiums, and letter of credit fees
| | - |  | -------------------------------------------------------------

Levels of income derived from these categories vary. For example, general market conditions and new insurance premiums purchased affect the income earned on bank owned life insurance. Fees for the issuance of official
checks and customer check sales tend to grow as new branches are added. Fee schedules, while subject to change, generally do not alone yield a significant or discernable increase in income when they change. Additionally, with rising interest rates,
mortgage originations and re-financings have slowed down, which decreases the fee income earned on real estate loans.

Noninterest Expense

Noninterest Expense

(000s omitted)



|                                           |  |                        |        |                       |   |                                   |  |     |                       |  |                                   |       |  |     |   
|------------------------------------------ |  | ---------------------- | ------ | --------------------- | - | --------------------------------- |  | --- | --------------------- |  | --------------------------------- | ----- |  | --- | --
|                                           |  | 12MonthsEnded 12/31/06 |        | 12MonthsEnded12/31/05 |   | 2006  2005 % Increase/(Decrease) |  |     | 12MonthsEnded12/31/04 |  | 2005  2004 % Increase/(Decrease) |      
|Compensation                               |  | $                      | 6,040  |                       | $ | 4,743                             |  | 27  | %                     |  | $                                 | 4,292 |  | 11  | % 
|Occupancy                                  |  |                        | 690    |                       |   | 611                               |  | 13  | %                     |  |                                   | 494   |  | 24  | % 
|Equipment                                  |  |                        | 544    |                       |   | 469                               |  | 16  | %                     |  |                                   | 429   |  | 9   | % 
|Data processing                            |  |                        | 611    |                       |   | 583                               |  | 5   | %                     |  |                                   | 506   |  | 15  | % 
|Advertising and marketing                  |  |                        | 384    |                       |   | 278                               |  | 38  | %                     |  |                                   | 138   |  | 101 | % 
|Audit fees                                 |  |                        | 276    |                       |   | 262                               |  | 5   | %                     |  |                                   | 137   |  | 91  | % 
|Franchise and purchased tax credit expense |  |                        | 982    |                       |   | 186                               |  | 428 | %                     |  |                                   | 196   |  | (5  | )%
|Business manager                           |  |                        | 319    |                       |   | 244                               |  | 31  | %                     |  |                                   | 288   |  | (15 | )%
|Deposit expense                            |  |                        | 290    |                       |   | 304                               |  | (5  | )%                    |  |                                   | 199   |  | 53  | % 
|Loan expense                               |  |                        | 197    |                       |   | 199                               |  | (1  | )%                    |  |                                   | 140   |  | 42  | % 
|Computer software                          |  |                        | 384    |                       |   | 316                               |  | 22  | %                     |  |                                   | 218   |  | 45  | % 
|Other expense                              |  |                        | 1,334  |                       |   | 997                               |  | 34  | %                     |  |                                   | 770   |  | 29  | % 
|                                           |  |                        |        |                       |   |                                   |  |     |                       |  |                                   |       |  |     |   
|Total noninterest expense                  |  | $                      | 12,051 |                       | $ | 9,192                             |  | 31  | %                     |  |                                   | 7,807 |  | 18  | % 
|                                           |  |                        |        |                       |   |                                   |  |     |                       |  |                                   |       |  |     |   



25



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##### Table of Contents

As seen in the tables above, for the year ended December 31, 2006, the franchise and purchased tax
credit expense is the largest percentage increase over the prior year. This is due to the purchase and subsequent write-off of a historical tax credit during the fourth quarter of 2006. We also experienced an increase in our advertising and
marketing expenses which is primarily attributable to the television advertising costs associated with the new Prime money market account. Compensation expense continues to increase as anticipated due to the growth of the Bank. The increase in 2006
is a result of new hires as well as merit and promotional increases to all employees during the year. However, all year-end performance bonuses for 2006 for executive officers were eliminated as a result of the Companys performance for 2006.
This elimination totaled approximately $350,000. Our business manager expenses increased as compared to the prior year due to the growth of that program.

Noninterest expense for 2005 was $9.2 million, an increase of $1.4 million or 18% over their level in 2004. For 2005, advertising and marketing is the largest percentage increase due primarily to the costs associated
with promoting the new branch opening, deposit generating promotions, and our new wealth management subsidiary, Valley Wealth Management Services, Inc. Additionally, audit fees increased due to the fees associated with the Sarbanes Oxley Act of
2002. Occupancy expense also increased due to the expansion of our commercial and business banking departments and loan expense increased due to the rapid growth in our loan portfolio. Compensation expense increased over the prior year due to the
addition of new employees and due to merit increases throughout the year. Deposit and loan expenses both increased as a result of the rapid growth trends we experienced during 2005.

Noninterest expenses are expected to continue to increase as a direct result of business growth and expansion as well as the impact of additional
regulatory burdens.

Income Taxes

During 2006, 2005, and 2004 the Company recorded federal income tax provision in the amounts of $0.2 million, $1.3 million, and $1.0 million, respectively. The anticipated federal income tax liability equates to an effective tax rate of
5.4%, 27.9%, and 26.6%, respectively. During the fourth quarter of 2006, the Bank purchased a federal historical tax credit in the amount of $838,000. The tax credit was purchased at a total cost of $713,000 and was expensed in total during 2006.
Other factors contributing to the difference between the effective tax rate and the statutory rate of 34 percent include tax-exempt interest income on municipal securities, net of disallowance, and tax-exempt income earned on bank owned life
insurance.

Earning Assets

Average
earning assets were $507.9 million at December 31, 2006, an increase of $102.1 million or 25% over 2005. Total average earning assets were 95% of total average assets at December 31, 2006. Average loans represented the largest component of
average earning assets and increased $103.3 million or 30% to $443.0 million at December 31, 2006. Average loans were 87% of average earning assets and 83% of average total assets as of December 31, 2006. Average investment securities,
both taxable and nontaxable, remained relatively constant as compared December 31, 2005. Average investment securities were 12% of average earning assets and 12% of average total assets as of December 31, 2006.

Average earning assets were $405.8 million at December 31, 2005, an increase of $79.2 million or 24.3% over 2004. Total average earning assets were
95% of total average assets at December 31, 2005. Average loans represented the largest component of average earning assets and increased $89.6 million or 35.9% to $339.7 million at December 31, 2005. Average loans were 83.6% of average
earning assets and 79.3% of average total assets as of December 31, 2005. Average investment securities, both taxable and nontaxable, decreased $8.3 million or 11.6% from their level as of December 31, 2004. Average investment securities
were 15.7% of average earning assets and 14.9% of average total assets as of December 31, 2005.



26



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##### Table of Contents

Investment Securities

Our investment portfolio is used both for investment income and liquidity purposes. Unrealized gains and losses on securities available-for-sale are recognized as direct increases or decreases in net
shareholders equity. Funds not used for capital expenditures or lending activities are invested in the following:



| |  |  | Securities of the U.S. Government and its agencies
| | - |  | --------------------------------------------------



| |  |  | Treasury notes
| | - |  | --------------



| |  |  | Callable agency bonds
| | - |  | ---------------------



| |  |  | Noncallable agency bonds
| | - |  | ------------------------



| |  |  | Small business association pools
| | - |  | --------------------------------



| |  |  | Government-Sponsored Enterprises
| | - |  | --------------------------------



| |  |  | Bonds and mortgage pools issued by the following:
| | - |  | -------------------------------------------------



| |  |  | Federal Farm Credit Bank (FFCB)
| | - |  | -------------------------------



| |  |  | Federal Home Loan Bank (FHLB)
| | - |  | -----------------------------



| |  |  | Federal Home Loan Mortgage Corporation (FHLMC) or Freddie Mac
| | - |  | -------------------------------------------------------------



| |  |  | Fannie Mae
| | - |  | ----------



| |  |  | Mortgage-backed securities and collateralized mortgage obligations
| | - |  | ------------------------------------------------------------------



| |  |  | Pools issued by government agencies
| | - |  | -----------------------------------



| |  |  | AAA rated corporate mortgage pools
| | - |  | ----------------------------------



| |  |  | Municipal bonds
| | - |  | ---------------



| |  |  | Taxable general obligation and revenue issues
| | - |  | ---------------------------------------------



| |  |  | Tax-exempt general obligation and revenue issues
| | - |  | ------------------------------------------------



| |  |  | Investment grade corporate bonds
| | - |  | --------------------------------



| |  |  | Restricted equity securities
| | - |  | ----------------------------



| |  |  | Federal Reserve Bank of Richmond shares
| | - |  | ---------------------------------------



| |  |  | Federal Home Loan Bank of Atlanta shares
| | - |  | ----------------------------------------



| |  |  | Community Bankers Bank shares
| | - |  | -----------------------------

Investment securities (available for sale and held to maturity), including restricted equity securities, at December 31, 2006 were $73.6 million, an increase of $15.6 million or 27% from their level of $58.0 million on
December 31, 2005. The increase is attributable to purchases of $21.5 million, offset by principal prepayments, called proceeds and sales in the amount of $5.9 million. See Note 3 to the Consolidated Financial Statements.

Investment securities (available-for-sale and held-to-maturity), including restricted equity securities, at December 31, 2005 were $58.0 million, a
decrease of $13.5 million or 18.9% from their level on December 31, 2004. The decrease is attributable to the principal prepayments on mortgage-backed securities and the sale of a portion of our investment portfolio to help fund our rapid loan
growth.

The following table presents the composition of securities available-for-sale, which is carried at approximate market value at
December 31, 2006, 2005 and 2004.



27



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##### Table of Contents

AVAILABLE FOR SALE INVESTMENT PORTFOLIO

CATEGORY DISTRIBUTION

(000s omitted)



|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       
|----------------------------------- |  | ----------------- | ------ | ----------------------- | - | ----------------- |  | ----------------------- | ------ | ------------- | - | ----------------------- |  | - | ------ |  | - | ------
|                                    |  | December 31, 2006 |        | December 31, 2005       |   | December 31, 2004
|                                    |  | Amortized Cost    |        | Approximate Fair Values |   | AmortizedCost     |  | Approximate Fair Values |        | AmortizedCost |   | Approximate Fair Values
|U.S. Government and federal agency  |  | $                 | 1,023  |                         | $ | 1,021             |  | $                       | 1,293  |               | $ | 1,286                   |  | $ | 1,431  |  | $ | 1,445 
|Government-sponsored enterprises    |  |                   | 19,435 |                         |   | 19,269            |  |                         | 5,472  |               |   | 5,378                   |  |   | 8,422  |  |   | 8,459 
|Mortgage-backed securities          |  |                   | 8,338  |                         |   | 8,259             |  |                         | 5,211  |               |   | 5,025                   |  |   | 6,953  |  |   | 6,879 
|Collateralized mortgage obligations |  |                   | 13,375 |                         |   | 13,014            |  |                         | 14,661 |               |   | 14,194                  |  |   | 19,360 |  |   | 19,120
|States and political subdivisions   |  |                   | 6,594  |                         |   | 6,644             |  |                         | 7,047  |               |   | 7,127                   |  |   | 9,422  |  |   | 9,718 
|Corporate debt securities           |  |                   | 200    |                         |   | 198               |  |                         | 200    |               |   | 196                     |  |   | 200    |  |   | 199   
|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       
|Total securities available for sale |  | $                 | 48,965 |                         | $ | 48,405            |  | $                       | 33,884 |               | $ | 33,206                  |  | $ | 45,788 |  | $ | 45,820
|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       

The following table sets forth the composition of securities held-to-maturity, which is carried at
amortized cost at December 31, 2006, 2005 and 2004.

HELD TO MATURITY INVESTMENT PORTFOLIO

CATEGORY DISTRIBUTION

(000s
omitted)



|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       
|----------------------------------- |  | ----------------- | ------ | ----------------------- | - | ----------------- |  | ----------------------- | ------ | ------------- | - | ----------------------- |  | - | ------ |  | - | ------
|                                    |  | December 31, 2006 |        | December 31, 2005       |   | December 31, 2004
|                                    |  | Amortized Cost    |        | Approximate Fair Values |   | AmortizedCost     |  | Approximate Fair Values |        | AmortizedCost |   | Approximate Fair Values
|U.S. Government and federal agency  |  | $                 |       |                         | $ |                  |  | $                       |       |               | $ |                        |  | $ | 199    |  | $ | 198   
|Government-sponsored enterprises    |  |                   | 9,946  |                         |   | 9,784             |  |                         | 9,938  |               |   | 9,745                   |  |   | 9,930  |  |   | 9,827 
|Mortgage-backed securities          |  |                   | 2,360  |                         |   | 2,297             |  |                         | 2,898  |               |   | 2,836                   |  |   | 4,016  |  |   | 4,023 
|Collateralized mortgage obligations |  |                   | 551    |                         |   | 524               |  |                         | 602    |               |   | 574                     |  |   | 786    |  |   | 783   
|States and political subdivisions   |  |                   | 7,276  |                         |   | 7,335             |  |                         | 7,358  |               |   | 7,369                   |  |   | 7,223  |  |   | 7,253 
|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       
|Total securities held to maturity   |  | $                 | 20,133 |                         | $ | 19,940            |  | $                       | 20,796 |               | $ | 20,524                  |  | $ | 22,154 |  | $ | 22,084
|                                    |  |                   |        |                         |   |                   |  |                         |        |               |   |                         |  |   |        |  |   |       

The following table presents the maturity ranges of securities available-for-sale as
of December 31, 2006 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may
be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of
each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.



28



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##### Table of Contents

INVESTMENT PORTFOLIO  MATURITY DISTRIBUTION

(000s omitted)



|                                        |  |                    |        |            |   |        |  |     |  
|--------------------------------------- |  | ------------------ | ------ | ---------- | - | ------ |  | --- | -
|                                        |  | Available for Sale |       
|                                        |  | December 31, 2006  |       
|                                        |  | Amortized Costs    |        | Fair Value |   | Yield  | 
|U.S.Government and federal agency:      |  |                    |        |            |   |        |  |     |  
|Within one year                         |  | $                  | 200    |            | $ | 198    |  | 4.3 | %
|After one but within five years         |  |                    | 538    |            |   | 538    |  | 5.8 | %
|After five but within ten years         |  |                    |       |            |   |       |  |    |  
|After ten years                         |  |                    | 285    |            |   | 285    |  | 7.5 | %
|                                        |  |                    |       
|Government-sponsored enterprises:       |  |                    |        |            |   |        |  |     |  
|Within one year                         |  |                    |       |            |   |       |  |    |  
|After one but within five years         |  |                    | 2,989  |            |   | 2,934  |  | 4.6 | %
|After five but within ten years         |  |                    | 4,476  |            |   | 4,453  |  | 5.4 | %
|After ten years                         |  |                    | 11,970 |            |   | 11,882 |  | 6.1 | %
|                                        |  |                    |       
|Obligations of states and subdivisions: |  |                    |        |            |   |        |  |     |  
|Within one year                         |  |                    |       |            |   |       |  |    |  
|After one but within five years         |  |                    | 1,084  |            |   | 1,088  |  | 4.1 | %
|After five but within ten years         |  |                    | 1,933  |            |   | 1,950  |  | 4.5 | %
|After ten years                         |  |                    | 3,577  |            |   | 3,606  |  | 4.5 | %
|                                        |  |                    |       
|Corporate debt securities:              |  |                    |        |            |   |        |  |     |  
|Within one year                         |  |                    | 100    |            |   | 100    |  | 4.2 | %
|After one but within five years         |  |                    | 100    |            |   | 98     |  | 4.1 | %
|After five but within ten years         |  |                    |       |            |   |       |  |    |  
|After ten years                         |  |                    |       |            |   |       |  |    |  
|                                        |  |                    |       
|Mortgage-backed securities              |  |                    | 8,338  |            |   | 8,259  |  | 5.1 | %
|                                        |  |                    |       
|Collateralized mortgage obligations     |  |                    | 13,375 |            |   | 13,014 |  | 4.5 | %
|                                        |  |                    |        |            |   |        |  |     |  
|Total                                   |  | $                  | 48,965 |            | $ | 48,405 |  |     |  
|                                        |  |                    |        |            |   |        |  |     |  
|Total Securities by Maturity Period *   |  |                    |        |            |   |        |  |     |  
|Within one year                         |  | $                  | 300    |            | $ | 298    |  |     |  
|After one but within five years         |  |                    | 4,711  |            |   | 4,658  |  |     |  
|After five but within ten years         |  |                    | 6,409  |            |   | 6,403  |  |     |  
|After ten years                         |  |                    | 15,832 |            |   | 15,773 |  |     |  
|Mortgage-backed securities              |  |                    | 8,338  |            |   | 8,259  |  |     |  
|Collateralized mortgage obligations     |  |                    | 13,375 |            |   | 13,014 |  |     |  
|                                        |  |                    |        |            |   |        |  |     |  
|Total by Maturity Period                |  | $                  | 48,965 |            | $ | 48,405 |  |     |  
|                                        |  |                    |        |            |   |        |  |     |  

---

|* | Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual
terms due to early repayments of principal.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



29



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##### Table of Contents

The following table presents the maturity ranges of securities held-to-maturity as of
December 31, 2006 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be
repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of
each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.

INVESTMENT PORTFOLIO  MATURITY DISTRIBUTION

(000s omitted)



|                                        |  |                   |        |            |   |        |  |     |  
|--------------------------------------- |  | ----------------- | ------ | ---------- | - | ------ |  | --- | -
|                                        |  | Held to Maturity  |       
|                                        |  | December 31, 2006 |       
|                                        |  | Amortized Costs   |        | Fair Value |   | Yield  | 
|U.S.Government and federal agency:      |  |                   |        |            |   |        |  |     |  
|Within one year                         |  | $                 |       |            | $ |       |  |    |  
|After one but within five years         |  |                   |       |            |   |       |  |    |  
|After five but within ten years         |  |                   |       |            |   |       |  |    |  
|After ten years                         |  |                   |       |            |   |       |  |    |  
|                                        |  |                   |       
|Government-sponsored enterprises:       |  |                   |        |            |   |        |  |     |  
|Within one year                         |  |                   |       |            |   |       |  |    |  
|After one but within five years         |  |                   | 981    |            |   | 965    |  | 4.5 | %
|After five but within ten years         |  |                   | 3,966  |            |   | 3,917  |  | 5.2 | %
|After ten years                         |  |                   | 5,000  |            |   | 4,902  |  | 6.1 | %
|                                        |  |                   |       
|Obligations of states and subdivisions: |  |                   |        |            |   |        |  |     |  
|Within one year                         |  |                   |       |            |   |       |  |    |  
|After one but within five years         |  |                   | 1,410  |            |   | 1,407  |  | 3.4 | %
|After five but within ten years         |  |                   | 1,060  |            |   | 1,073  |  | 4.0 | %
|After ten years                         |  |                   | 4,805  |            |   | 4,855  |  | 5.2 | %
|                                        |  |                   |       
|Corporate debt securities:              |  |                   |        |            |   |        |  |     |  
|Within one year                         |  |                   |       |            |   |       |  |    |  
|After one but within five years         |  |                   |       |            |   |       |  |    |  
|After five but within ten years         |  |                   |       |            |   |       |  |    |  
|After ten years                         |  |                   |       |            |   |       |  |    |  
|                                        |  |                   |       
|Mortgage-backed securities              |  |                   | 2,360  |            |   | 2,297  |  | 4.5 | %
|                                        |  |                   |       
|Collateralized mortgage obligations     |  |                   | 551    |            |   | 524    |  | 4.2 | %
|                                        |  |                   |        |            |   |        |  |     |  
|Total                                   |  | $                 | 20,133 |            | $ | 19,940 |  |     |  
|                                        |  |                   |        |            |   |        |  |     |  
|Total Securities by Maturity Period *   |  |                   |        |            |   |        |  |     |  
|After one but within five years         |  | $                 | 2,391  |            | $ | 2,372  |  |     |  
|After five but within ten years         |  |                   | 5,026  |            |   | 4,990  |  |     |  
|After ten years                         |  |                   | 9,805  |            |   | 9,757  |  |     |  
|Mortgage-backed securities              |  |                   | 2,360  |            |   | 2,297  |  |     |  
|Collateralized mortgage obligations     |  |                   | 551    |            |   | 524    |  |     |  
|                                        |  |                   |        |            |   |        |  |     |  
|Total by Maturity Period                |  | $                 | 20,133 |            | $ | 19,940 |  |     |  
|                                        |  |                   |        |            |   |        |  |     |  

---

|* | Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms
due to early repayments of principal.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Loan Portfolio

Our total gross loans were $471.1 million at December 31, 2006, an increase of $56.7 million or 14% from the $414.4 million reported one year earlier. Our ratio of total loans to total funding sources (customer
deposits, securities sold under agreements to repurchase, federal funds purchased, Federal Home Loan Bank advances, and trust preferred securities) stood at 85.2% at December 31, 2006, 89.2% at December 31, 2005, and 82.4% at
December 31, 2004. Management seeks to maintain the ratio of loans to funding sources at a maximum of 85%.

The loan portfolio
primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. We adjust the mix of lending and
the terms of our loan programs according to economic and market conditions, asset/liability management considerations and other factors. Loans typically (in excess of 90%) are made to businesses and individuals located within our primary market
area, most of whom maintain deposit accounts with the Bank. There is no concentration of loans exceeding 10% of total loans, which is not disclosed in the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements or
discussed below.

The following table summarizes the loan portfolio by category for the five years ended December 31, 2006.

LOAN PORTFOLIO SUMMARY

(000s omitted)



|                                                           |  |                         |  |       |      |  |         |  |       |  |         |  |       |  |         |  |       |  |         |  |      
|---------------------------------------------------------- |  | ----------------------- |  | ----- | ---- |  | ------- |  | ----- |  | ------- |  | ----- |  | ------- |  | ----- |  | ------- |  | -----
|                                                           |  | Year Ended December 31,
|                                                           |  | 2006                    |  |       | 2005 |  | 2004    |  | 2003  |  | 2002   
|                                                           |  | $                       |  | %     |      |  | $       |  | %     |  | $       |  | %     |  | $       |  | %     |  | $       |  | %    
|Commercial                                                 |  | 93,400                  |  | 19.8  | %    |  | 97,904  |  | 23.6  |  | 71,580  |  | 25.3  |  | 52,489  |  | 23.6  |  | 44,668  |  | 24.1 
|Commercial real estate                                     |  | 174,882                 |  | 37.2  | %    |  | 149,684 |  | 36.1  |  | 107,186 |  | 37.9  |  | 92,563  |  | 41.6  |  | 75,378  |  | 40.6 
|Real estate construction                                   |  | 82,537                  |  | 17.5  | %    |  | 55,810  |  | 13.5  |  | 25,404  |  | 9.0   |  | 17,622  |  | 7.9   |  | 15,727  |  | 8.5  
|Residential real estate                                    |  | 112,022                 |  | 23.8  | %    |  | 103,272 |  | 24.9  |  | 69,819  |  | 24.7  |  | 51,917  |  | 23.3  |  | 43,541  |  | 23.4 
|Loans to individuals (except those secured by real estate) |  | 8,211                   |  | 1.7   | %    |  | 7,744   |  | 1.9   |  | 8,787   |  | 3.1   |  | 8,012   |  | 3.6   |  | 6,347   |  | 3.4  
|                                                           |  |                         |  |       |      |  |         |  |       |  |         |  |       |  |         |  |       |  |         |  |      
|Total loans                                                |  | 471,052                 |  | 100.0 |      |  | 414,414 |  | 100.0 |  | 282,776 |  | 100.0 |  | 222,603 |  | 100.0 |  | 185,661 |  | 100.0
|                                                           |  |                         |  |       |      |  |         |  |       |  |         |  |       |  |         |  |       |  |         |  |      

The following table presents maturity information (based upon interest rate repricing dates) on
the loan portfolio based upon scheduled repayments at December 31, 2006.

LOAN MATURITY

(000s omitted)



|                         |  |                     |         |                       |   |                      |  |       |         |  |   |        
|------------------------ |  | ------------------- | ------- | --------------------- | - | -------------------- |  | ----- | ------- |  | - | -------
|                         |  | December 31, 2006  
|                         |  | Due within One Year |         | Due One to Five Years |   | Due After Five Years |  | Total
|Commercial               |  | $                   | 78,889  |                       | $ | 13,467               |  | $     | 1,044   |  | $ | 93,400 
|Commercial real estate   |  |                     | 33,808  |                       |   | 106,671              |  |       | 34,403  |  |   | 174,882
|Real estate construction |  |                     | 54,117  |                       |   | 14,957               |  |       | 13,463  |  |   | 82,537 
|Residential real estate  |  |                     | 12,681  |                       |   | 36,386               |  |       | 62,955  |  |   | 112,022
|Loans to individuals     |  |                     | 4,694   |                       |   | 2,631                |  |       | 886     |  |   | 8,211  
|                         |  |                     |         |                       |   |                      |  |       |         |  |   |        
|Total loans              |  | $                   | 184,189 |                       | $ | 174,112              |  | $     | 112,751 |  | $ | 471,052
|                         |  |                     |         |                       |   |                      |  |       |         |  |   |        



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##### Table of Contents

The following table presents maturity information based upon contractual terms and scheduled repayments
at December 31, 2006.

FIXED AND VARIABLE RATE LOANS

(000s omitted)



|                         |  |                       |         |                      |   |                       |  |                      |         |  |   |       
|------------------------ |  | --------------------- | ------- | -------------------- | - | --------------------- |  | -------------------- | ------- |  | - | ------
|                         |  | Fixed                 |         | Variable            
|                         |  | Due Within Five Years |         | Due After Five Years |   | Due Within Five Years |  | Due After Five Years
|Commercial               |  | $                     | 28,333  |                      | $ | 762                   |  | $                    | 64,023  |  | $ | 282   
|Commercial real estate   |  |                       | 109,465 |                      |   | 29,127                |  |                      | 31,014  |  |   | 5,276 
|Real estate construction |  |                       | 5,968   |                      |   | 5,436                 |  |                      | 63,106  |  |   | 8,027 
|Residential real estate  |  |                       | 34,534  |                      |   | 44,811                |  |                      | 14,533  |  |   | 18,144
|Loans to individuals     |  |                       | 3,943   |                      |   | 870                   |  |                      | 3,382   |  |   | 16    
|                         |  |                       |         |                      |   |                       |  |                      |         |  |   |       
|Total loans              |  | $                     | 182,243 |                      | $ | 81,006                |  | $                    | 176,058 |  | $ | 31,745
|                         |  |                       |         |                      |   |                       |  |                      |         |  |   |       

Loan Category Analysis

Commercial Loans. Commercial loans generally are made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes. The credit worthiness of the
borrower is analyzed and re-evaluated on a periodic basis. Most commercial loans are collateralized with business assets such as accounts receivable, inventory and equipment. Even with substantial collateral, such as all the assets of the business
and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.

Commercial Real Estate Loans.Commercial real estate construction and commercial real estate mortgages represent interim and permanent financing of commercial properties that are secured by real estate. The Company prefers to make
commercial real estate loans secured by owner-occupied properties. These borrowers are engaged in business activities other than real estate, and the primary source of repayment is not solely dependent on conditions in the real estate market.

Real Estate Construction Loans. Real estate construction loans represent interim financing on residential and commercial properties
under construction, and are secured by real estate. This category also includes acquisition and development financing for residential and commercial projects. Once construction is completed and the loan becomes permanent, the loans are reclassified
as either commercial real estate loans, which are secured by commercial property, or residential real estate loans, which are secured by first deeds of trust.

Residential Real Estate Loans. Residential real estate loans are secured by deeds of trust on 1-4 family residential properties. To mitigate interest rate risk, the Company usually limits the final maturity of
residential real estate loans held for its own portfolio to 15-20 years, although exceptions are made for competitive reasons and under special programs. Residential real estate lending involves risk elements when there is lack of timely payment
and/or a decline in the value of the collateral.

Loans to Individuals.We offer various secured and unsecured consumer loans,
including unsecured personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, letters of credit, and home equity loans.



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##### Table of Contents

Asset Quality

Summary of Allowance for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be
adequate to absorb any losses on existing loans that may become uncollectible, although there can be no assurance that this will be so. The provision for loan losses increases the allowance, and loans charged off (net of recoveries) reduce the
allowance.

A provision for loan losses of $2.8 million was made during 2006, an increase of $1.5 million or 115% from the $1.3 million
provided during 2005. The increase in the loan loss provision is a result of an increase in non-performing loans. For the year ended December 31, 2006, our non-performing assets to total assets ratio increased from 0.72% at December 31,
2005 to 1.56%. Additionally, our loans past due more than 90 days to total loans increased from 0.10% at December 31, 2005 to 0.13% at December 31, 2006. Net charge-offs for the year ended December 31, 2006 amounted to $1.26 million.
The increasing trends in our problem loans are concerning and resolving these problem credits are the top priority for senior management in 2007. As a result of these problem loan trends, management has taken several steps to strengthen the lending
department, including strengthening the independence of the credit administration function, the implementation of additional training and monitoring procedures with respect to asset-based lending, and enhanced financial statement review process
requiring documentation of review in a timely manner.

Effective December 1, 2006, five loans aggregating an approximate outstanding
balance of $4.1 million were placed on non-accrual status. The borrowers failed to meet the principal repayment terms of their loans and actions to collect the loans were initiated on December 12, 2006. At this time, we believe the loans are
not adequately secured; therefore a special provision was made to the loan loss reserve in the amount of $776,200 to reflect the potential exposure that we deem to exist. Additionally, during the fourth quarter of 2006, we charged off $1.25 million
of a previously disclosed commercial credit relationship that had been placed on non-accrual status during the first quarter of 2006. We had reserved $1.2 million earlier in 2006 in anticipation of this loss. As of December 31, 2006, we had
three loans aggregating a total of $2.2 million included in our investment of impaired loans related to this commercial credit relationship. We continue to monitor this relationship very closely due to the high level of risk and recognize that we
may record additional losses if the customer is not able to become profitable.

Net charge-offs to average loans outstanding for the year
ended December 31, 2006 was 0.29%.

A provision for loan losses of $1.3 million was made during 2005, an increase of $0.7 million or
105% from the $0.6 million provided during 2004, in recognition of our estimate of inherent risks associated with lending activities.

The
allowance for loan losses was $5.7 million, $4.1 million, and $3.0 million as of December 31, 2006, 2005 and 2004, respectively. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.2% at December 31,
2006, which compares to approximately 1.0% of total loans at December 31, 2005, and 1.1% of total loans at December 31, 2004 (see Note 4 to the Consolidated Financial Statements). These estimates are primarily based on our historical loss
experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $1.1 million in special reserves was included in the balance of the allowance for loan losses as of December 31, 2006 for impaired loans,
which compares to a total of $0.3 million as of December 31, 2005 and $0 million as of December 31, 2004. The $1.1 million in special reserves were concentrated in two large relationships within our overall loan portfolio.



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##### Table of Contents

We regularly review asset quality and re-evaluate the allowance for loan losses. However, no assurance
can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future. Additionally, regulatory examiners may require us to recognize additions or reductions to the allowance based upon
their judgment about the loan portfolio and other information available to them at the time of their examinations. (See Allowance for Loan Losses under Critical Accounting Policies.)

The following table summarizes the loan loss experience for the five years ended December 31, 2006.

ALLOWANCE FOR LOAN LOSSES

(000s
omitted)



|                          |  |                         |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|------------------------- |  | ----------------------- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | - |  | ---- | ----- | - |  | - | ----- | -
|                          |  | Year Ended December 31, |       
|                          |  | 2006                    |        |   | 2005 |   |       | 2004 |  |   | 2003  |   |  | 2002 |      
|Balance at January 1      |  | $                       | 4,124  |   |      | $ | 2,989 |      |  | $ | 2,566 |   |  | $    | 2,014 |   |  | $ | 1,468 |  
|                          |  |                         |        |   |     
|Provision for loan losses |  |                         | 2,796  |   |      |   | 1,297 |      |  |   | 633   |   |  |      | 966   |   |  |   | 610   |  
|Recoveries:               |  |                         |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Commercial                |  |                         | 2      |   |      |   | 30    |      |  |   | 1     |   |  |      | 1     |   |  |   | 0     |  
|Loans to individuals      |  |                         | 0      |   |      |   | 1     |      |  |   | 0     |   |  |      | 0     |   |  |   | 0     |  
|                          |  |                         |        |   |     
|Charged off loans:        |  |                         |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Commercial                |  |                         | (1,253 | ) |      |   | (187  | )    |  |   | (188  | ) |  |      | (284  | ) |  |   | (58   | )
|Loans to individuals      |  |                         | (11    | ) |      |   | (6    | )    |  |   | (23   | ) |  |      | (131  | ) |  |   | (6    | )
|                          |  |                         |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Balance at December 31    |  | $                       | 5,658  |   |      | $ | 4,124 |      |  | $ | 2,989 |   |  | $    | 2,566 |   |  | $ | 2,014 |  
|                          |  |                         |        |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  

The following table summarizes the allocation of the allowance for loan losses for the five years
ended December 31, 2006. The percentage in the table below refers to the percent of loans in each category to total loans.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

(000s omitted)



|                                        |  |                         |       |   |       |   |   |      |       |  |       |   |  |      |       |  |       |   |   |   |       |   |       |   |  |   |       |  |       |  
|--------------------------------------- |  | ----------------------- | ----- | - | ----- | - | - | ---- | ----- |  | ----- | - |  | ---- | ----- |  | ----- | - | - | - | ----- | - | ----- | - |  | - | ----- |  | ----- | -
|                                        |  | Year Ended December 31, |      
|                                        |  | 2006                    |       |   | 2005  |   |   | 2004 |       |  | 2003  |   |  | 2002 |      
|                                        |  | $                       |       | % |       |   | $ |      | %     |  |       | $ |  | %    |       |  | $     |   | % |   |       | $ |       | % | 
|Balance at end of period applicable to: |  |                         |       |   |       |   |   |      |       |  |       |   |  |      |       |  |       |   |   |   |       |   |       |   |  |   |       |  |       |  
|Commercial                              |  |                         | 1,122 |   | 19.8  | % |   |      | 974   |  | 23.6  | % |  |      | 756   |  | 25.3  | % |   |   | 613   |   | 23.9  | % |  |   | 485   |  | 24.1  | %
|Commercial real estate                  |  |                         | 2,102 |   | 37.2  | % |   |      | 1,490 |  | 36.1  | % |  |      | 1,133 |  | 37.9  | % |   |   | 1,067 |   | 41.6  | % |  |   | 818   |  | 40.6  | %
|Real estate construction                |  |                         | 991   |   | 17.5  | % |   |      | 555   |  | 13.5  | % |  |      | 269   |  | 9.0   | % |   |   | 203   |   | 7.9   | % |  |   | 171   |  | 8.5   | %
|Residential real estate                 |  |                         | 1,346 |   | 23.8  | % |   |      | 1,028 |  | 24.9  | % |  |      | 463   |  | 15.5  | % |   |   | 345   |   | 13.4  | % |  |   | 260   |  | 12.9  | %
|Loans to individuals                    |  |                         | 99    |   | 1.7   | % |   |      | 77    |  | 1.9   | % |  |      | 368   |  | 12.3  | % |   |   | 338   |   | 13.2  | % |  |   | 280   |  | 13.9  | %
|                                        |  |                         |       |   |       |   |   |      |       |  |       |   |  |      |       |  |       |   |   |   |       |   |       |   |  |   |       |  |       |  
|Total Allowance                         |  | $                       | 5,658 |   | 100.0 | % |   | $    | 4,124 |  | 100.0 | % |  | $    | 2,989 |  | 100.0 | % |   | $ | 2,566 |   | 100.0 | % |  | $ | 2,014 |  | 100.0 | %
|                                        |  |                         |       |   |       |   |   |      |       |  |       |   |  |      |       |  |       |   |   |   |       |   |       |   |  |   |       |  |       |  

Nonperforming Assets.Nonperforming assets include nonaccrual loans, loans past due 90 days
or more, restructured loans and foreclosed/repossessed property. A loan will be placed on nonaccrual status when collection of all principal or interest is deemed unlikely. A loan will automatically be placed on nonaccrual status when principal or
interest is past due 90 days or more, unless the loan is both well secured and in the process of being collected. In this case, the loan will continue to accrue interest despite its past due status.



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##### Table of Contents

A restructured loan is a loan in which the original contract terms have been modified due to a
borrowers financial condition or there has been a transfer of assets in full or partial satisfaction of the loan. A modification of original contractual terms is generally a concession to a borrower that a lending institution would not
normally consider.

An impaired loan as defined in SFAS 114 is a loan when, based on current information and events, it is likely that a
lending institution will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement.

Nonperforming assets for the five years ended December 31, 2006 are detailed as follows:

NONPERFORMING ASSETS

(000s omitted)



|                                             |  |              |       |      |   |       |  |      |     |      |   |       |  |   |    
|-------------------------------------------- |  | ------------ | ----- | ---- | - | ----- |  | ---- | --- | ---- | - | ----- |  | - | ---
|                                             |  | December 31,
|                                             |  | 2006         |       | 2005 |   | 2004  |  | 2003 |     | 2002
|Nonaccrual loans                             |  | $            | 6,343 |      | $ | 104   |  | $    | 150 |      | $ | 1,094 |  | $ |   
|Loans past due 90 days or more               |  |              | 616   |      |   | 423   |  |      | 240 |      |   |      |  |   | 390
|Restructured loans                           |  |              |      |      |   |      |  |      |    |      |   | 152   |  |   |   
|Other nonperforming loans (1)                |  |              | 2,265 |      |   | 3,062 |  |      |    |      |   |      |  |   |   
|                                             |  |              |       |      |   |       |  |      |     |      |   |       |  |   |    
|Total nonperforming loans                    |  | $            | 9,224 |      | $ | 3,589 |  | $    | 390 |      | $ | 1,246 |  | $ | 390
|                                             |  |              |       |      |   |       |  |      |     |      |   |       |  |   |    
|Foreclosed, repossessed and idled properties |  |              |      |      |   |      |  |      | 1   |      |   |      |  |   | 196
|                                             |  |              |       |      |   |       |  |      |     |      |   |       |  |   |    
|Total nonperforming assets                   |  | $            | 9,224 |      | $ | 3,589 |  | $    | 391 |      | $ | 1,246 |  | $ | 586
|                                             |  |              |       |      |   |       |  |      |     |      |   |       |  |   |    

---

|(1) | Other nonperforming loans include impaired loans which are not on nonaccrual status nor past due 90 days or more.
|--- | -----------------------------------------------------------------------------------------------------------------

Each quarter, the Directors Loan Committee, composed of eight directors, will review all loans on our watch list to determine proper action and
reporting of any loans identified as substandard by the credit quality review. We believe that the above allocated reserves are appropriate for the impaired loans in our portfolio based upon a detailed review of the quality and pledged collateral of
each individual loans considered impaired at each of the above-referenced periods. (See Impairment of Loans under Critical Accounting Policies.)

If the non-accrual loans disclosed above had performed in accordance with their original terms, additional interest income in the amount of $300,727, $1,230, and $6,000 would have been recorded for the years ended
December 31, 2006, 2005 and 2004, respectively.

Additionally, the Banks credit risk process provides ongoing assessment of the
loan portfolios risk profile in accordance with standard industry practices. Loan assets which do not support satisfactory risk ratings under this basis are subjected to a well-defined, ongoing management and reporting process. These
Watch List loan assets were as follows for the five years ended December 31, 2006:



|                   |  |      |        |   |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ----- | - |  | - | ----- | -
|                   |  | 2006 |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |      
|Watch List Credits |  | $    | 19,562 |   |      | $ | 16,334 |      |  | $ | 17,414 |   |  | $    | 9,025 |   |  | $ | 3,094 |  
|% of Total Loans   |  |      | 4.15   | % |      |   | 3.94   | %    |  |   | 6.16   | % |  |      | 4.05  | % |  |   | 1.67  | %



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##### Table of Contents

Other Assets

We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Companys Supplemental Executive Retirement Plan (SERP) and other employee benefit costs including
health insurance, dental insurance, life insurance, and 401(k) employer match. Bank owned life insurance was $11.1 million at December 31, 2006, an increase of $2.2 million over the $8.9 million reported as of December 31, 2005. The
increase is due to the $1.7 million purchase of additional life insurance contracts on key employees and a $0.5 million increase in the cash surrender value of the life insurance contracts.

Deposits

The levels and mix of deposits are
influenced by such factors as customer service, interest rates paid, service charges and the convenience of banking locations. Competition for deposits is intense from other depository institutions and money market funds, some of which offer
interest rates higher than we pay. We attempt to identify and implement pricing and marketing strategies designed to control the overall cost of deposits and to maintain a stable deposit mix.

The following table summarizes our total deposits for the years ended December 31, 2006, 2005 and 2004:

Deposit Summary

(000s omitted)



|                                     |  |          |  |          |  |          |  |        |  |         |  |       
|------------------------------------ |  | -------- |  | -------- |  | -------- |  | ------ |  | ------- |  | ------
|                                     |  | 12/31/06 |  | 12/31/05 |  | 12/31/04
|                                     |  | $        |  | %        |  | $        |  | %      |  | $       |  | %     
|Time deposits                        |  | 263,123  |  | 59.60    |  | 234,809  |  | 64.28  |  | 170,919 |  | 61.19 
|Interest bearing & money market      |  | 93,444   |  | 21.17    |  | 50,279   |  | 13.76  |  | 56,349  |  | 20.17 
|Savings                              |  | 66,259   |  | 15.00    |  | 60,762   |  | 16.63  |  | 4,957   |  | 1.78  
|                                     |  |          |  |          |  |          |  |        |  |         |  |       
|Total interest bearing deposits      |  | 422,826  |  | 95.77    |  | 345,850  |  | 94.67  |  | 232,225 |  | 83.14 
|Noninterest demand & official checks |  | 18,663   |  | 4.23     |  | 19,466   |  | 5.33   |  | 47,108  |  | 16.86 
|                                     |  |          |  |          |  |          |  |        |  |         |  |       
|Total deposits                       |  | 441,489  |  | 100.00   |  | 365,316  |  | 100.00 |  | 279,333 |  | 100.00
|                                     |  |          |  |          |  |          |  |        |  |         |  |       

In September 2005, we implemented a deposit reclassification program that restructures interest
and non-interest checking accounts so that a certain portion of the balance in each account is actually maintained in a linked Savings sub-account. The Savings portion of the combined account balance is not subject to the 10% reserve that is
required for checking balances, therefore the overall daily cash reserve requirement for the Federal Reserve has been reduced. As such, for financial reporting purposes, our interest and non-interest bearing demand deposits have been reduced and our
savings deposits have been increased. Had we not implemented the deposit reclassification program, at December 31, 2006, our total interest bearing and money market accounts would have been $113.6 million, savings $3.3 million, and noninterest
demand and official checks $61.5 million. For December 31, 2005, our interest bearing and money market accounts would have been $66.4 million, savings $4.9 million, and noninterest demand and official checks $59.2 million.

As can be seen from the table above, we have been successful in reducing our reliance on higher-cost certificates of deposits in 2006. The Prime money
market account was the primary driver to our interest bearing and money market account growth for 2006. Within the certificate of deposit category, we have marketed CDs nationally to institutional depositors, primarily banks, thrift institutions and
credit unions through an Internet-based rate posting service. National market CDs at December 31, 2006 were $12.9 million, a decrease of $3.6 million from the $16.5 million reported at December 31, 2005 and represent 5% of total CDs and 3%
of total deposits at December 31, 2006, as compared to 7% of total CDs and 5% of total deposits at December 31, 2005.



36



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##### Table of Contents

The following table summarizes average deposits for the years ended December 31, 2006, 2005 and
2004, not including the deposit reclassification noted above.

AVERAGE DEPOSIT MIX

(000s omitted)



|                                |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|------------------------------- |  | ----------------- | ------- | ----------------- | ----------------- | - | -------------- | ----------------- | ----------------- |  | --- | -------------- |  | ----------------- | ------- |  | --- | -
|                                |  | December 31, 2006 |         |                   | December 31, 2005 |   |                | December 31, 2004 |                  
|                                |  | Average Balance   |         | Average Rate Paid |                   |   | AverageBalance |                   | Average Rate Paid |  |     | AverageBalance |  | Average Rate Paid |        
|Interest bearing deposits:      |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|NOW accounts                    |  | $                 | 21,929  |                   | 1.9               | % |                | $                 | 19,212            |  | 1.2 | %              |  | $                 | 17,019  |  | 0.6 | %
|Money market accts              |  |                   | 64,711  |                   | 3.8               | % |                |                   | 41,928            |  | 2.1 | %              |  |                   | 33,466  |  | 1.0 | %
|Savings                         |  |                   | 4,026   |                   | 0.5               | % |                |                   | 4,680             |  | 0.4 | %              |  |                   | 4,592   |  | 0.2 | %
|Time deposits > = $100,000      |  |                   | 57,683  |                   | 4.5               | % |                |                   | 44,521            |  | 3.4 | %              |  |                   | 37,855  |  | 2.6 | %
|Other time deposits             |  |                   | 196,327 |                   | 4.4               | % |                |                   | 162,698           |  | 3.2 | %              |  |                   | 124,086 |  | 2.5 | %
|                                |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|Total interest bearing deposits |  |                   | 344,676 |                   | 4.1               | % |                |                   | 273,039           |  | 2.9 | %              |  |                   | 217,018 |  | 2.1 | %
|                                |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|Noninterest bearing deposits    |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|Demand deposits                 |  |                   | 52,020  |                   | 0.0               | % |                |                   | 51,637            |  | 0.0 | %              |  |                   | 39,843  |  | 0.0 | %
|                                |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  
|Total average deposits          |  | $                 | 396,696 |                   | 3.6               | % |                | $                 | 324,676           |  | 2.4 | %              |  | $                 | 256,861 |  | 1.8 | %
|                                |  |                   |         |                   |                   |   |                |                   |                   |  |     |                |  |                   |         |  |     |  

The following table presents the maturity schedule of certificates of deposit of $100,000 or more
as of December 31, 2006, 2005 and 2004.

MATURITY SCHEDULE OF CERTIFICATES

OF DEPOSIT OF $100,000 OR MORE

(000s omitted)



|                            |  |              |        |      |   |        |  |   |       
|--------------------------- |  | ------------ | ------ | ---- | - | ------ |  | - | ------
|                            |  | December 31,
|                            |  | 2006         |        | 2005 |   | 2004  
|Three months or less        |  | $            | 16,372 |      | $ | 10,268 |  | $ | 9,410 
|Over three through 6 months |  |              | 21,781 |      |   | 8,316  |  |   | 6,086 
|Over six through 12 months  |  |              | 23,091 |      |   | 15,415 |  |   | 9,696 
|Over 12 months              |  |              | 8,107  |      |   | 18,519 |  |   | 14,594
|                            |  |              |        |      |   |        |  |   |       
|Total                       |  | $            | 69,351 |      | $ | 52,518 |  | $ | 39,786
|                            |  |              |        |      |   |        |  |   |       



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##### Table of Contents

Short-Term Borrowings

Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) decreased by $4.2 million from their level of $50.8 million at December 31, 2005 to a total of
$46.6 million as of December 31, 2006. Short-term borrowings at December 31, 2006 include federal funds purchased of $0 million, Federal Home Loan Bank of Atlanta (FHLB) borrowings in the amount of $25 million, and a commercial
sweep account program in the amount of $21.6 million.

The FHLB borrowings include a $10 million adjustable rate credit which matures on
December 18, 2007 and reprices quarterly on the date of each quarterly interest payment (rate of 5.35% on December 31, 2006). The second FHLB credit of $5 million matures on January 30, 2007 and reprices monthly at the 1-month LIBOR
flat less one basis point (rate of 5.34% on December 31, 2006). The third FHLB borrowing is a $10 million convertible credit which matures on September 4, 2007 (rate of 3.09% on December 31, 2006). See the liquidity section for
further information on the preceding borrowings.

Total short-term borrowings (including federal funds purchased and securities sold under
agreements to repurchase) increased by $27.8 million from their level of $23.0 million at December 31, 2004 to a total of $50.8 million as of December 31, 2005. Short-term borrowings at December 31, 2005 included federal funds
purchased of $17.0 million, FHLB borrowings in the amount of $23.0 million, and a commercial sweep account program in the amount of $10.8 million.

The commercial sweep program involves balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured. The balance in the program increased 100% from the $10.8
million reported at December 31, 2005 and increased by $5 million from $5.8 million reported at December 31, 2004. The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight
basis subject to repurchase. On the following business day, we repurchase from the customer the securities for an amount equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for
each overnight period; however, it is posted to the customer accounts only once per month.



38



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##### Table of Contents

The following table presents information on each category of the Companys short-term debt, which
generally mature within one to seven days from the transaction date.

SHORT-TERM BORROWINGS

(000s omitted)



|                                                       |  |              |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------ |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                       |  | December 31, |       
|                                                       |  | 2006         |        |   | 2005 |   |        | 2004 | 
|Actual amount outstanding at period end:               |  |              |        |   |      |   |        |      |  |   |        |  
|Federal funds purchased                                |  | $            |       |   |      | $ | 17,027 |      |  | $ | 2,187  |  
|Securities sold under agreements to repurchase         |  |              | 21,635 |   |      |   | 10,802 |      |  |   | 5,817  |  
|Short-term FHLB Borrowings                             |  |              | 25,000 |   |      |   | 23,000 |      |  |   | 15,000 |  
|                                                       |  |              |       
|Weighted average actual interest rate at period end:   |  |              |        |   |      |   |        |      |  |   |        |  
|Federal funds purchased                                |  |              |       |   |      |   | 4.26   | %    |  |   | 2.48   | %
|Securities sold under agreements to repurchase         |  |              | 4.14   | % |      |   | 2.58   | %    |  |   | 0.71   | %
|Short-term FHLB Borrowings                             |  |              | 4.53   | % |      |   | 4.38   | %    |  |   | 2.39   | %
|                                                       |  |              |       
|Maximum amount outstanding at any month-end in period: |  |              |        |   |      |   |        |      |  |   |        |  
|Federal funds purchased                                |  | $            | 18,921 |   |      | $ | 17,027 |      |  | $ | 8,203  |  
|Securities sold under agreements to repurchase         |  |              | 21,635 |   |      |   | 11,664 |      |  |   | 8,131  |  
|Short-term FHLB Borrowings                             |  |              | 30,000 |   |      |   | 23,000 |      |  |   | 15,000 |  
|                                                       |  |              |       
|Average amount outstanding during period end:          |  |              |        |   |      |   |        |      |  |   |        |  
|Federal funds purchased                                |  | $            | 8,316  |   |      | $ | 4,077  |      |  | $ | 1,375  |  
|Securities sold under agreements to repurchase         |  |              | 14,938 |   |      |   | 8,063  |      |  |   | 5,930  |  
|Short-term FHLB Borrowings                             |  |              | 46,837 |   |      |   | 20,200 |      |  |   | 15,000 |  
|                                                       |  |              |       
|Weighted average interest rate during the period:      |  |              |        |   |      |   |        |      |  |   |        |  
|Federal funds purchased                                |  |              | 5.29   | % |      |   | 3.71   | %    |  |   | 1.70   | %
|Securities sold under agreements to repurchase         |  |              | 3.58   | % |      |   | 1.80   | %    |  |   | 0.72   | %
|Short-term FHLB Borrowings                             |  |              | 4.86   | % |      |   | 3.07   | %    |  |   | 1.57   | %

Long-Term Borrowings

Federal Home Loan Bank advances are relatively cost-effective funding sources and provide the Company with the flexibility to structure borrowings in a manner that aids in the management of interest rate risk and
liquidity. The increase in advances during the year reflects the funding to support investment growth.

The Company had outstanding
long-term debt with the Federal Home Bank of Atlanta in the amount of $48.0 million as of December 31, 2006, an increase of $11.0 million from the $37.0 million reported as of December 31, 2005 and December 31, 2004, respectively.
This increase is made up of a $13 million convertible advance and an $8.0 million variable rate advance offset by the movement of a $10 million fixed rate advance from long-term to short-term borrowings as of December 31, 2006. See Footnote 9
of the Companys Consolidated Financial Statements for more information on the long-term advances.



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##### Table of Contents

Guaranteed Preferred Beneficial Interests in the Companys Junior Subordinated Debentures

Valley Financial (VA) Statutory Trust I, a statutory business trust (Trust I), was created on June 26, 2003, at which time the Trust
issued $4.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature June 26, 2033. Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate
(LIBOR) plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by Trust I at any time after June 26, 2008. The principal assets of Trust I are $4.1 million of the Companys junior subordinated debentures which
mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and which are callable by the Company after June 26, 2008. All $124,000 in aggregation liquidation amount of Trust
Is common securities are held by the Company.

Valley Financial (VA) Statutory Trust II, a statutory business trust (Trust
II), was created on September 26, 2005, at which time Trust II issued $7.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature December 15, 2035. Distributions are payable on the
securities at a floating rate equal to 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any time after December 15, 2010. The principal assets of Trust II are $7.2 million of the Companys junior
subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%, and which are callable by the Company after December 15, 2010. All $217,000 in aggregation liquidation
amount of Trust IIs common securities are held by the Company.

Valley Financial Statutory Trust III, a statutory business trust
(Trust III) was created by the Company on December 15, 2006, at which time Trust III issued $5.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature January 30, 2036.
Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any time after January 30, 2012. The principal assets of Trust III are $5,155 of the
Companys junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%, and which are callable by the Company after January 30, 2012. All $155 in
aggregation liquidation amount of Trust IIIs common securities are held by the Company.

The debenture proceeds from Trust I, Trust
II, and Trust III are included in our Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of our total Tier I capital including the securities. This amount totaled $11.2 million (of the $16 million
outstanding) at December 31, 2006. The remaining $4.8 is included in the calculation of our total risk-based capital ratio as Tier 2 capital. Our obligations with respect to the issuance of Trust I, Trust II, and Trust IIIs preferred
securities and common securities constitute a full and unconditional guarantee of Trust I, Trust II, and Trust IIIs obligations with respect to the preferred securities and common securities. Subject to certain exceptions and limitations, we
may elect from time to time to defer interest payments on its junior subordinated debentures, which would result in a deferral of distribution payments on Trust I, Trust II, or Trust IIIs preferred trust securities and common securities. As a
result of the Companys adoption of FIN 46, the Trusts common securities have been presented as a component of other assets.



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##### Table of Contents

Contractual Obligations, Commitments, Contingent Liabilities, Off-Balance Sheet Arrangements, and Related Party
Transactions

A summary of the Companys significant contractual obligations and commitments is presented in the following table,
with a reference to the footnote disclosure in Item 8 detailing the dollar amount by maturity.

CONTRACTUAL OBLIGATIONS AND OTHER
COMMITMENTS



|                                       |  |                                                                         
|-------------------------------------- |  | ------------------------------------------------------------------------
|Contractual Cash Obligations           |  | Footnote Disclosure in Item 8 Notes to Consolidated Financial Statements
|Federal Home Loan Bank advances        |  | Footnote 9                                                              
|Trust preferred securities debt        |  | Footnote 9                                                              
|Operating Leases                       |  | Footnote 7                                                              
|Supplemental Executive Retirement Plan |  | Footnote 12                                                             
|                                       | 
|Other Commitments                      |  |                                                                         
|Commitments to extend credit           |  | Footnote 15                                                             
|Standby Letters of Credit              |  | Footnote 15                                                             
|Derivative Financial Instruments       |  | Footnote 15                                                             
|                                       | 
|Related Party Transactions             |  |                                                                         
|Related Party Transactions             |  | Footnote 17                                                             

Capital Adequacy

Our financial position at December 31, 2006, 2005 and 2004 reflects liquidity and capital levels currently adequate to fund anticipated near-term business expansion. Capital ratios are in line with required
regulatory minimums for a well-capitalized institution. We review the adequacy of our capital on an ongoing basis. We seek to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses
and will continue to monitor the Bank capital ratios very closely due to the impact our non-accrual loans have on retained earnings and capital.

To support a continuing strong level of growth, the Company did issue on December 15, 2006, $5,000,000 of trust preferred securities through the Companys newly formed and wholly-owned special purpose finance subsidiary, Valley
Financial Statutory Trust III, a Connecticut Statutory Trust.

For the periods indicated, we had the following risk-based capital and
leverage ratios:

Capital Ratios



|         |  |          |  |          |  |         
|-------- |  | -------- |  | -------- |  | --------
|Ratio    |  | 12/31/06 |  | 12/31/05 |  | 12/31/04
|Tier 1   |  | 9.1%     |  | 9.7%     |  | 10.5%   
|         |  |          | 
|Total    |  | 11.2%    |  | 10.8%    |  | 11.5%   
|         |  |          | 
|Leverage |  | 7.9%     |  | 8.8%     |  | 8.8%    



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##### Table of Contents

Liquidity

Asset/liability management activities are designed to ensure that adequate liquidity is available to meet loan demand or deposit outflows and, through the management of our interest sensitivity position, to manage the impact of interest
rate fluctuations on net interest income.

Liquidity measures our ability to meet our maturing obligations and existing commitments, to
withstand fluctuations in deposit levels, to fund our operations and to provide for customers credit needs. Liquidity represents a financial institutions ability to meet present and future financial obligations through either the sale or
maturity of existing assets or the acquisition of additional funds from alternative funding sources.

The level of deposits may fluctuate,
perhaps significantly so, due to seasonal cycles of depositing customers and the promotional activities of competitor financial institutions. Similarly, the level of demand for loans may vary significantly and at any given time may increase or
decrease substantially. However, unlike the level of deposits, management has more direct control over lending activities and if necessary can adjust the level of those activities according to the amounts of available funds.

Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and non-pledged securities available-for-sale, at
December 31, 2006, totaled $35.6 million. Our funding sources consist of an established federal funds lines with a regional correspondent bank totaling $12 million that had a $0 million balance as of December 31, 2006, three
established federal funds lines with third party banks totaling $22.0 million that had outstanding balances totaling $0 million as of December 31, 2006, and an established line with the FHLB that had $73.0 million outstanding under a
total line of $89.3 million as of December 31, 2006. We believe these arrangements will be renewed at maturity.

As of
December 31, 2006, we had pledged approximately $89.3 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. As of that date, we had approximately $16.3 million in remaining credit
availability from the Federal Home Loan Bank. As of December 31, 2005 we had pledged approximately $98.6 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. As of that date, we had
approximately $38.6 million in remaining credit availability from the Federal Home Loan Bank.

We sell excess funds as overnight federal
funds sold to provide an immediate source of liquidity. We had federal funds sold of $16.6 million at December 31, 2006, as compared to $0 at December 31, 2005 and 2004.

As a result of our management of liquid assets and our ability to generate liquidity through alternative funding sources, we believe we maintain overall
liquidity sufficient to meet our depositors requirements and satisfy our customers credit needs.

Impact of Inflation

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles,
which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all
the assets and liabilities of the Company and the Bank are monetary in nature. As a result, interest rates have a greater impact on the Companys performance than do the effects of changes in the general rate of inflation and changes in prices.
In addition, interest rates do not necessarily move in the same direction or in the same magnitude as do the prices of goods and services. Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to
protect against wide interest rate fluctuations, including those resulting from inflation.



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##### Table of Contents

Recent and Future Accounting Considerations

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the impact of this pronouncement.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans 
an amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS 158 requires an employer to recognize the funded status of a benefit plan on its balance sheet and to recognize the gains or losses and prior service costs, not already
recognized, as a component of other comprehensive income effective for fiscal years ending after December 15, 2006. Additionally, SFAS 158 requires that the defined benefit plan assets and obligations be measured as of the date of the
employers fiscal year-end balance sheet effective for fiscal years ending after December 15, 2008.

In September 2006, the
Emerging Issues Task Force affirmed and ratified EITF Issue No. 06-04 Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. For endorsement split-dollar life
insurance arrangements that provide a benefit to an employee that extends to postretirement periods, an employer should recognize a liability for future benefits in accordance with Statement 106 or Opinion 12 (depending on whether a substantive plan
is deemed to exist) based on the substantive agreement with the employee. For example, if the employer has effectively agreed to maintain a life insurance policy during the employees retirement, the cost of the insurance policy during the
postretirement periods should be accrued in accordance with either Statement 106 or Opinion 12. Similarly, if the employer has effectively agreed to provide the employee with a death benefit, the employer should recognize a liability for the future
death benefit in accordance with either Statement 106 or Opinion 12. This EITF is effective for fiscal years beginning after December 15, 2007 and will impact on the Companys financial statements for fiscal year 2008.

In September 2006, the SEC issued Staff Accounting Bulleting No. 108 (SAB 108). SAB 108 provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either
the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a companys
balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are
material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  Including an
amendment of FASB Statement No. 115. This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report
unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and
5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS No. 115, available-for-sale and held-to-maturity securities at the effective
date are eligible for the fair value



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##### Table of Contents

option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date
shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS No. 159 is effective for the Company on January 1, 2008. Earlier adoption is permitted in 2007 if the
Company also elects to apply the provisions of SFAS No. 157, Fair Value Measurement. The Company is currently analyzing the fair value option provided under SFAS No. 159.



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##### Table of Contents

|Item 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Valley Financial Corporation

Roanoke, Virginia

We have audited the consolidated balance sheets of Valley Financial Corporation and its subsidiary (Valley Bank) as of December 31, 2006 and 2005 and the related
consolidated statements of income, changes in shareholders equity, and cash flows for each of the years in the three year period ending December 31, 2006. These consolidated financial statements are the responsibility of the
Corporations management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted
our audits in accordance with auditing standards established by the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Valley Financial Corporation and subsidiary as of December 31, 2006 and
2005, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.



|                  
|------------------
|Elliott Davis, LLC
|Galax, Virginia   
|March 9, 2007     



45



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Valley Financial Corporation

Consolidated Balance Sheets

December 31, 2006 and 2005

(In thousands, except share data)

---



|                                                                                                                                                            |  |      |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                            |  | 2006 |         |   | 2005 |  
|Assets                                                                                                                                                      |  |      |         |   |      |   |         |  
|Cash and due from banks                                                                                                                                     |  | $    | 9,778   |   |      | $ | 9,746   |  
|Interest-bearing deposits in banks                                                                                                                          |  |      | 91      |   |      |   | 336     |  
|Federal funds sold                                                                                                                                          |  |      | 16,630  |   |      |   |        |  
|Securities available-for-sale                                                                                                                               |  |      | 48,405  |   |      |   | 33,206  |  
|Securities held-to-maturity (approximate market values of $19,940 and $20,524 in 2006 and 2005, respectively)                                               |  |      | 20,133  |   |      |   | 20,796  |  
|Restricted equity securities                                                                                                                                |  |      | 5,079   |   |      |   | 3,987   |  
|Loans, net of allowance for loan losses of $5,658 at December 31, 2006 and $4,124 at December 31, 2005                                                      |  |      | 465,394 |   |      |   | 410,253 |  
|Premises and equipment, net                                                                                                                                 |  |      | 6,873   |   |      |   | 6,590   |  
|Bank owned life insurance                                                                                                                                   |  |      | 11,117  |   |      |   | 8,950   |  
|Accrued interest receivable                                                                                                                                 |  |      | 2,954   |   |      |   | 2,073   |  
|Other assets                                                                                                                                                |  |      | 5,482   |   |      |   | 3,012   |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Total assets                                                                                                                                                |  | $    | 591,936 |   |      | $ | 498,949 |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Liabilities and Shareholders Equity                                                                                                                        |  |      |         |   |      |   |         |  
|Liabilities:                                                                                                                                                |  |      |         |   |      |   |         |  
|Noninterest-bearing deposits                                                                                                                                |  | $    | 18,663  |   |      | $ | 19,466  |  
|Interest-bearing deposits                                                                                                                                   |  |      | 422,826 |   |      |   | 345,850 |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Total deposits                                                                                                                                              |  |      | 441,489 |   |      |   | 365,316 |  
|Federal funds purchased and securities sold under agreements to repurchase                                                                                  |  |      | 21,635  |   |      |   | 27,829  |  
|Short-term borrowings                                                                                                                                       |  |      | 25,000  |   |      |   | 23,000  |  
|Long-term borrowings                                                                                                                                        |  |      | 48,000  |   |      |   | 37,000  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures                                                                   |  |      | 16,496  |   |      |   | 11,341  |  
|Accrued interest payable                                                                                                                                    |  |      | 3,133   |   |      |   | 2,129   |  
|Other liabilities                                                                                                                                           |  |      | 2,782   |   |      |   | 1,619   |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Total liabilities                                                                                                                                           |  |      | 558,535 |   |      |   | 468,234 |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Commitments and contingencies                                                                                                                               |  |      |        |   |      |   |        |  
|                                                                                                                                                            |  |     
|Shareholders equity:                                                                                                                                       |  |      |         |   |      |   |         |  
|Preferred stock, no par value; 10,000,000 shares authorized; none issued and outstanding                                                                    |  |      |        |   |      |   |        |  
|Common stock, no par value; 10,000,000 shares authorized; 4,112,074 and 4,076,993 shares issued and outstanding at December 31, 2006 and
2005, respectively |  |      | 17,212  |   |      |   | 16,981  |  
|Retained earnings                                                                                                                                           |  |      | 16,488  |   |      |   | 14,181  |  
|Accumulated other comprehensive income (loss)                                                                                                               |  |      | (299    | ) |      |   | (447    | )
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Total shareholders equity                                                                                                                                  |  |      | 33,401  |   |      |   | 30,715  |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                  |  | $    | 591,936 |   |      | $ | 498,949 |  
|                                                                                                                                                            |  |      |         |   |      |   |         |  

See accompanying notes to consolidated financial statements.



46



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---

Valley Financial Corporation

Consolidated Statements of Income

For the Years Ended December 31,
2006, 2005, and 2004

(In thousands, except share data)

---



|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|----------------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                                      |  | 2006 |           |   | 2005 |   |           | 2004 | 
|Interest income                                                                                       |  |      |           |   |      |   |           |      |  |   |           |  
|Interest and fees on loans                                                                            |  | $    | 31,959    |   |      | $ | 21,806    |      |  | $ | 14,884    |  
|Interest on securities  taxable                                                                      |  |      | 2,340     |   |      |   | 2,104     |      |  |   | 2,270     |  
|Interest on securities  nontaxable                                                                   |  |      | 547       |   |      |   | 596       |      |  |   | 644       |  
|Interest on deposits in banks                                                                         |  |      | 71        |   |      |   | 73        |      |  |   | 60        |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Total interest income                                                                                 |  |      | 34,917    |   |      |   | 24,579    |      |  |   | 17,858    |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Interest expense                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Interest on deposits                                                                                  |  |      | 14,270    |   |      |   | 8,122     |      |  |   | 4,862     |  
|Interest on long-term borrowings                                                                      |  |      | 2,033     |   |      |   | 1,576     |      |  |   | 1,580     |  
|Interest on short-term borrowings                                                                     |  |      | 1,145     |   |      |   | 621       |      |  |   | 236       |  
|Interest on guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |      | 815       |   |      |   | 364       |      |  |   | 186       |  
|Interest on federal funds purchased and securities sold under agreements to repurchase                |  |      | 974       |   |      |   | 297       |      |  |   | 65        |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Total interest expense                                                                                |  |      | 19,237    |   |      |   | 10,980    |      |  |   | 6,929     |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net interest income                                                                                   |  |      | 15,680    |   |      |   | 13,599    |      |  |   | 10,929    |  
|                                                                                                      |  |      |          
|Provision for loan losses                                                                             |  |      | 2,796     |   |      |   | 1,297     |      |  |   | 633       |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net interest income after provision for loan losses                                                   |  |      | 12,884    |   |      |   | 12,302    |      |  |   | 10,296    |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Noninterest income                                                                                    |  |      |           |   |      |   |           |      |  |   |           |  
|Service charges on deposit accounts                                                                   |  |      | 992       |   |      |   | 914       |      |  |   | 801       |  
|Realized gains (losses) on sale of securities available-for-sale                                      |  |      | (3        | ) |      |   | 53        |      |  |   | 17        |  
|Income earned on bank owned life insurance                                                            |  |      | 467       |   |      |   | 325       |      |  |   | 290       |  
|Other income on real estate loans                                                                     |  |      | 135       |   |      |   | 86        |      |  |   | 91        |  
|Gain (loss) on disposal of equipment                                                                  |  |      | 3         |   |      |   | (7        | )    |  |   | (1        | )
|Other income                                                                                          |  |      | 618       |   |      |   | 225       |      |  |   | 160       |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Total noninterest income                                                                              |  |      | 2,212     |   |      |   | 1,596     |      |  |   | 1,358     |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Noninterest expense                                                                                   |  |      |           |   |      |   |           |      |  |   |           |  
|Compensation expense                                                                                  |  |      | 6,040     |   |      |   | 4,743     |      |  |   | 4,292     |  
|Occupancy expense                                                                                     |  |      | 690       |   |      |   | 611       |      |  |   | 494       |  
|Equipment expense                                                                                     |  |      | 544       |   |      |   | 469       |      |  |   | 429       |  
|Data processing expense                                                                               |  |      | 611       |   |      |   | 583       |      |  |   | 506       |  
|Advertising and marketing expense                                                                     |  |      | 384       |   |      |   | 278       |      |  |   | 138       |  
|Audit fees                                                                                            |  |      | 276       |   |      |   | 262       |      |  |   | 137       |  
|Franchise and purchased tax credit expense                                                            |  |      | 982       |   |      |   | 186       |      |  |   | 196       |  
|Business manager program expense                                                                      |  |      | 319       |   |      |   | 244       |      |  |   | 288       |  
|Deposit expense                                                                                       |  |      | 290       |   |      |   | 304       |      |  |   | 199       |  
|Loan expense                                                                                          |  |      | 197       |   |      |   | 199       |      |  |   | 140       |  
|Foreclosed properties expense, net                                                                    |  |      |          |   |      |   | (141      | )    |  |   | 12        |  
|Computer software expense                                                                             |  |      | 384       |   |      |   | 316       |      |  |   | 218       |  
|Other expense                                                                                         |  |      | 1,334     |   |      |   | 1,138     |      |  |   | 758       |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Total noninterest expense                                                                             |  |      | 12,051    |   |      |   | 9,192     |      |  |   | 7,807     |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Income before income taxes                                                                            |  |      | 3,045     |   |      |   | 4,706     |      |  |   | 3,847     |  
|                                                                                                      |  |      |          
|Income tax expense                                                                                    |  |      | 163       |   |      |   | 1,314     |      |  |   | 1,023     |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net income                                                                                            |  | $    | 2,882     |   |      | $ | 3,392     |      |  | $ | 2,824     |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Earnings per share                                                                                    |  |      |           |   |      |   |           |      |  |   |           |  
|Basic earnings per share                                                                              |  | $    | 0.70      |   |      | $ | 0.83      |      |  | $ | 0.75      |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted earnings per share                                                                            |  | $    | 0.68      |   |      | $ | 0.80      |      |  | $ | 0.70      |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Weighted average shares                                                                               |  |      | 4,101,634 |   |      |   | 4,075,812 |      |  |   | 3,782,816 |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted average shares                                                                                |  |      | 4,215,241 |   |      |   | 4,251,370 |      |  |   | 4,024,813 |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Dividends declared per share                                                                          |  | $    | 0.14      |   |      | $ | 0.13      |      |  | $ | 0.12      |  
|                                                                                                      |  |      |           |   |      |   |           |      |  |   |           |  

See accompanying notes to consolidated financial statements.



47



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Valley Financial Corporation

Consolidated Statements of Shareholders Equity

For the Years Ended
December 31, 2006, 2005, and 2004

(In thousands, except share data)

---



|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|--------------------------------------------------------------------------------------- |  | ------------ |  | ----------- | ------ | - | ---------------- | - | ------ | ------------------------------------------ |  | - | ------------------------- | - |  | - | ------ | -
|                                                                                        |  | CommonShares |  | CommonStock |        |   | RetainedEarnings |   |        | AccumulatedOtherComprehensiveIncome (Loss) |  |   | TotalShare-holdersEquity |  
|Balances at December 31, 2003                                                           |  | 3,665,502    |  | $           | 12,396 |   |                  | $ | 8,969  |                                            |  | $ | 197                       |   |  | $ | 21,562 |  
|                                                                                        |  |              |  |             |       
|Comprehensive income:                                                                   |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Net income                                                                              |  |             |  |             |       |   |                  |   | 2,824  |                                            |  |   |                          |   |  |   | 2,824  |  
|Unrealized losses on securities available-for-sale, net of deferred tax benefit of $84  |  |             |  |             |       |   |                  |   |       |                                            |  |   | (165                      | ) |  |   | (165   | )
|Reclassification adjustment, net of deferred tax benefit of $6                          |  |             |  |             |       |   |                  |   |       |                                            |  |   | (11                       | ) |  |   | (11    | )
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Total comprehensive income                                                              |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   | 2,648  |  
|Issuance of stock                                                                       |  | 275,000      |  |             | 3,850  |   |                  |   |       |                                            |  |   |                          |   |  |   | 3,850  |  
|Stock issuance costs                                                                    |  |             |  |             | (26    | ) |                  |   |       |                                            |  |   |                          |   |  |   | (26    | )
|Cash dividends declared ($0.12 per share)                                               |  |             |  |             |       |   |                  |   | (472   | )                                          |  |   |                          |   |  |   | (472   | )
|Exercise of stock options                                                               |  | 134,128      |  |             | 754    |   |                  |   |       |                                            |  |   |                          |   |  |   | 754    |  
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Balances at December 31, 2004                                                           |  | 4,074,630    |  |             | 16,974 |   |                  |   | 11,321 |                                            |  |   | 21                        |   |  |   | 28,316 |  
|                                                                                        |  |              |  |             |       
|Comprehensive income:                                                                   |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Net income                                                                              |  |             |  |             |       |   |                  |   | 3,392  |                                            |  |   |                          |   |  |   | 3,392  |  
|Unrealized losses on securities available-for-sale, net of deferred tax benefit of $241 |  |             |  |             |       |   |                  |   |       |                                            |  |   | (433                      | ) |  |   | (433   | )
|Reclassification adjustment, net of deferred tax benefit of $18                         |  |             |  |             |       |   |                  |   |       |                                            |  |   | (35                       | ) |  |   | (35    | )
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Total comprehensive income                                                              |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   | 2,924  |  
|                                                                                        |  |              |  |             |       
|Cash dividends declared ($0.13 per share)                                               |  |             |  |             |       |   |                  |   | (532   | )                                          |  |   |                          |   |  |   | (532   | )
|Exercise of stock options                                                               |  | 2,363        |  |             | 7      |   |                  |   |       |                                            |  |   |                          |   |  |   | 7      |  
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Balances at December 31, 2005                                                           |  | 4,076,993    |  |             | 16,981 |   |                  |   | 14,181 |                                            |  |   | (447                      | ) |  |   | 30,715 |  
|                                                                                        |  |              |  |             |       
|Comprehensive income:                                                                   |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Net income                                                                              |  |             |  |             |       |   |                  |   | 2,882  |                                            |  |   |                          |   |  |   | 2,882  |  
|Unrealized gains on securities available-for-sale, net of deferred tax benefit of $40   |  |             |  |             |       |   |                  |   |       |                                            |  |   | 76                        |   |  |   | 76     |  
|Unrealized gains on derivative not held for trading                                     |  |              |  |             |        |   |                  |   |        |                                            |  |   | 70                        |   |  |   | 70     |  
|Reclassification adjustment, net of deferred tax benefit of $1                          |  |             |  |             |       |   |                  |   |       |                                            |  |   | 2                         |   |  |   | 2      |  
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Total comprehensive income                                                              |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   | 3,030  |  
|                                                                                        |  |              |  |             |       
|Stock compensation expense                                                              |  |             |  |             | 82     |   |                  |   |       |                                            |  |   |                          |   |  |   | 82     |  
|Cash dividends declared ($0.14 per share)                                               |  |              |  |             |        |   |                  |   | (575   | )                                          |  |   |                           |   |  |   | (575   | )
|Exercise of stock options                                                               |  | 35,081       |  |             | 149    |   |                  |   |       |                                            |  |   |                           |   |  |   | 149    |  
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  
|Balances at December 31, 2006                                                           |  | 4,112,074    |  | $           | 17,212 |   |                  | $ | 16,488 |                                            |  | $ | (299                      | ) |  | $ | 33,401 |  
|                                                                                        |  |              |  |             |        |   |                  |   |        |                                            |  |   |                           |   |  |   |        |  

See accompanying notes to consolidated financial statements



48



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##### Table of Contents

---

Valley Financial Corporation

Consolidated Statements of Cash Flows

For the Years Ended
December 31, 2006, 2005, and 2004

(In thousands, except share data)

---



|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                                                                                                    |  | 2006 |         |   | 2005 |   |          | 2004 | 
|Cash flows from operating activities                                                                                |  |      |         |   |      |   |          |      |  |   |         |  
|Net income                                                                                                          |  | $    | 2,882   |   |      | $ | 3,392    |      |  | $ | 2,824   |  
|Adjustments to reconcile net income to net cash provided by operating Activities:                                   |  |      |         |   |      |   |          |      |  |   |         |  
|Provision for loan losses                                                                                           |  |      | 2,796   |   |      |   | 1,297    |      |  |   | 633     |  
|Depreciation and amortization of bank premises, equipment and software                                              |  |      | 762     |   |      |   | 698      |      |  |   | 625     |  
|Stock compensation expense                                                                                          |  |      | 82      |   |      |   |         |      |  |   |        |  
|Deferred income tax                                                                                                 |  |      | (1,312  | ) |      |   | (249     | )    |  |   | (233    | )
|Net (gains) / losses on sale of securities                                                                          |  |      | 3       |   |      |   | (53      | )    |  |   | (17     | )
|Net (gains) / losses on foreclosed properties                                                                       |  |      |        |   |      |   | (131     | )    |  |   | 8       |  
|Net (gains) / losses on equipment disposals                                                                         |  |      | (3      | ) |      |   | 7        |      |  |   |        |  
|Net amortization of bond premiums/discounts                                                                         |  |      | 175     |   |      |   | 192      |      |  |   | 284     |  
|(Increase) in unearned fees                                                                                         |  |      | (65     | ) |      |   |         |      |  |   | (3      | )
|(Increase) in accrued interest receivable                                                                           |  |      | (881    | ) |      |   | (639     | )    |  |   | (230    | )
|(Increase) in other assets                                                                                          |  |      | (1,163  | ) |      |   | (981     | )    |  |   | (485    | )
|(Increase) in value of life insurance contracts                                                                     |  |      | (467    | ) |      |   | (325     | )    |  |   | (290    | )
|Increase in accrued interest payable                                                                                |  |      | 1,004   |   |      |   | 1,079    |      |  |   | 314     |  
|Increase in other liabilities                                                                                       |  |      | 1,229   |   |      |   | 519      |      |  |   | 502     |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Net cash provided by operating activities                                                                           |  |      | 5,042   |   |      |   | 4,806    |      |  |   | 3,932   |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Cash flows from investing activities                                                                                |  |      |         |   |      |   |          |      |  |   |         |  
|(Increase) / decrease in interest bearing deposits in banks                                                         |  |      | 245     |   |      |   | (274     | )    |  |   | 651     |  
|(Increase) in federal funds sold                                                                                    |  |      | (16,630 | ) |      |   |         |      |  |   |        |  
|Purchases of bank premises, equipment and software                                                                  |  |      | (1,045  | ) |      |   | (1,100   | )    |  |   | (538    | )
|Purchases of securities available-for-sale                                                                          |  |      | (20,186 | ) |      |   | (799     | )    |  |   | (20,211 | )
|Purchases of securities held-to-maturity                                                                            |  |      |        |   |      |   | (215     | )    |  |   | (2,368  | )
|Purchases on restricted equity securities                                                                           |  |      | (1,317  | ) |      |   | (801     | )    |  |   | (358    | )
|Proceeds from sales/calls/paydowns/maturities of securities available-for-sale                                      |  |      | 4,979   |   |      |   | 12,908   |      |  |   | 14,153  |  
|Proceeds from paydowns on securities held-to-maturity                                                               |  |      | 573     |   |      |   | 1,471    |      |  |   | 3,061   |  
|Principal repayments of restricted equity securities                                                                |  |      | 225     |   |      |   | 315      |      |  |   |        |  
|Purchase of bank owned life insurance                                                                               |  |      | (1,700  | ) |      |   | (2,500   | )    |  |   |        |  
|Proceeds from sale of foreclosed properties                                                                         |  |      |        |   |      |   | 1,349    |      |  |   | 287     |  
|Proceeds from sale of equipment                                                                                     |  |      | 8       |   |      |   |         |      |  |   |        |  
|Increase in loans, net                                                                                              |  |      | (57,872 | ) |      |   | (132,983 | )    |  |   | (60,383 | )
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Net cash used in investing activities                                                                               |  |      | (92,720 | ) |      |   | (122,629 | )    |  |   | (65,706 | )
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Cash flows from financing activities                                                                                |  |      |         |   |      |   |          |      |  |   |         |  
|Increase / (decrease) in non-interest bearing deposits                                                              |  |      | (803    | ) |      |   | (27,642  | )    |  |   | 10,440  |  
|Increase in interest bearing deposits                                                                               |  |      | 76,976  |   |      |   | 113,625  |      |  |   | 45,871  |  
|Proceeds from short-term borrowings                                                                                 |  |      | 15,000  |   |      |   | 8,000    |      |  |   |        |  
|Principal repayments of short-term borrowings                                                                       |  |      | (23,000 | ) |      |   |         |      |  |   |        |  
|Increase / (decrease) in federal funds purchased and securities sold under agreements to repurchase                 |  |      | (6,194  | ) |      |   | 19,825   |      |  |   | 721     |  
|Proceeds from long-term borrowings                                                                                  |  |      | 26,000  |   |      |   |         |      |  |   |        |  
|Principal repayments of long-term borrowings                                                                        |  |      | (5,000  | ) |      |   |         |      |  |   |        |  
|Proceeds from issuance of guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |      | 5,155   |   |      |   | 7,124    |      |  |   |        |  
|Cash dividends paid                                                                                                 |  |      | (573    | ) |      |   | (489     | )    |  |   | (228    | )
|Proceeds from issuance of common stock                                                                              |  |      | 149     |   |      |   | 7        |      |  |   | 4,578   |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Net cash provided by financing activities                                                                           |  |      | 87,710  |   |      |   | 120,450  |      |  |   | 61,382  |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Net increase (decrease) in cash and due from banks                                                                  |  |      | 32      |   |      |   | 2,627    |      |  |   | (392    | )
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Cash and due from banks at beginning of year                                                                        |  |      | 9,746   |   |      |   | 7,119    |      |  |   | 7,511   |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  
|Cash and due from banks at end of year                                                                              |  | $    | 9,778   |   |      | $ | 9,746    |      |  | $ | 7,119   |  
|                                                                                                                    |  |      |         |   |      |   |          |      |  |   |         |  

See accompanying notes to the consolidated financial statements.



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Valley Financial Corporation

Consolidated Statements of Cash Flows

For the Years Ended
December 31, 2006, 2005, and 2004

(In thousands, except share data)

---



|                                                            |  |   |        |  |   |       |  |   |      
|----------------------------------------------------------- |  | - | ------ |  | - | ----- |  | - | -----
|Supplemental disclosure of cash flows information           |  |   |        |  |   |       |  |   |      
|Cash paid during the year for interest                      |  | $ | 18,233 |  | $ | 9,901 |  | $ | 6,615
|                                                            |  |   |        |  |   |       |  |   |      
|Cash paid during the year for income taxes                  |  | $ | 2,039  |  | $ | 1,754 |  | $ | 889  
|                                                            |  |   |        |  |   |       |  |   |      
|Noncash financing and investing activities                  |  |   |        |  |   |       |  |   |      
|Transfer of loans to foreclosed property                    |  | $ |       |  | $ | 1,218 |  | $ | 295  
|                                                            |  |   |        |  |   |       |  |   |      
|Reclassification of borrowings from long-term to short-term |  | $ | 10,000 |  | $ |      |  | $ |     
|                                                            |  |   |        |  |   |       |  |   |      

See accompanying notes to consolidated financial statements.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies

General

The Bank provides traditional commercial banking
services concentrated primarily in the Roanoke Valley of Virginia. However, the Bank does not currently offer trust services. As a state chartered, Federal Reserve member bank, the Bank is subject to regulation by the Virginia Bureau of Financial
Institutions and the Federal Reserve. The Bank opened for business on May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15,
1997 in the City of Roanoke, its fourth office in the City of Salem on April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of
Roanoke on December 8, 2003, and its eighth office in the City of Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23,
2005.

The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are
insured by the Federal Deposit Insurance Corporation (FDIC) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank.

Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of the Company for the purpose of issuing trust preferred securities. Effective October 16, 2002,
the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary gives the Bank the right to utilize certain federal and state tax
credits. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. Effective December 15, 2006,
Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the company for the purpose of issuing additional trust preferred securities. These entities are for raising capital (in the case of the statutory trusts) or
investment (in the case of the LLC) purposes.

Critical Accounting Policies

The accounting and reporting policies of Valley Financial Corporation (the Company), Valley Bank (the Bank), and the Banks Statutory Trusts as discussed in Note 9, conform to generally
accepted accounting principles (GAAP) and to general banking industry practices. Our policies, with respect to the methodology for determination of the allowance for loan losses, involve a high degree of complexity. Management must make difficult
and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions, or estimates would cause reported results to differ materially. These critical policies and their
application are reviewed periodically with our Audit Committee and Board of Directors. The following is a summary of the more significant accounting policies:

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and the Bank, thereafter
referred to collectively as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.

Business
Segments

The Company reports its activities in one business segment. In determining the appropriateness of segment definition, the Company
considers the materiality of potential business segments and components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.

Advertising Costs

The Company expenses all advertising and
business promotion costs as incurred.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

Use of Estimates, continued

Material estimates that are
particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination
of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties.

Substantially all of
the Banks loan portfolio consists of loans in the Roanoke Valley. Accordingly, the ultimate collectibility of a substantial portion of the Banks loan portfolio and the recovery of a substantial portion of the carrying amount of
foreclosed real estate are susceptible to changes in local market conditions. The regional economy is reasonably diverse.

While management uses available
information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process,
periodically review the Banks allowances for loan and foreclosed real estate losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their
examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.

Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash
and cash equivalents are defined as those amounts included in the balance sheet caption cash and due from banks.

Interest-Bearing
Deposits in Banks

Interest bearing deposits in banks mature within one year and are carried at cost.

Trading Securities

The Company does not hold securities for
short-term resale and therefore does not maintain a trading securities portfolio.

Securities Held-to-Maturity

Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are
recognized in interest income using the interest method over the period to maturity or to call dates.

Securities Available-for-Sale

Available-for-sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as
trading securities or as held-to-maturity securities.

Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a
net amount in a separate component of shareholders equity. Realized gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income
using the interest method over the period to maturity or to call dates.

Declines in the fair value of individual held-to-maturity and available-for-sale
securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

Loans Receivable

Loans receivable that management has the
intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized
premiums or discounts on purchased loans.

Loan origination fees and costs are capitalized and recognized as an adjustment to the yield on the related
loan. Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any
purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

Interest is accrued and
credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in managements opinion, the borrower is unlikely 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. When facts and circumstances indicate the borrower has regained the ability to meet required payments,
the loan is returned to accrual status. Past due status of loans is determined based on contractual terms.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on three basic
principles of accounting: (i) Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable,
(ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are
observable in the secondary market, and the loan balance, and (iii) SFAS No. 118, Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures  an amendment of SFAS 114, which allows a creditor to
use existing methods for recognizing interest income on an impaired loan.

The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged
against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

Allowance for Loan Losses, continued

A loan is considered
impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally
are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length
of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans
by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, and from time to time, we may evaluate one or more homogeneous loans as
impaired. The Bank does not separately identify individual consumer and residential loans for impairment disclosures.

Premises and Equipment

Land is carried at cost. Bank premises, furniture and equipment, and leasehold improvements are carried at cost, less accumulated depreciation and
amortization computed principally by the straight-line method over the following estimated useful lives:



|                           |  |      
|-------------------------- |  | -----
|                           |  | Years
|Buildings and improvements |  | 30   
|Computer equipment         |  | 3    
|Computer software          |  | 3    
|Furniture and fixtures     |  | 10   
|Other equipment            |  | 3-10 
|Leasehold improvements     |  | 3-15 

Foreclosed Properties

Assets acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure establishing a new cost basis. After
foreclosure, valuations are periodically performed by management and the asset is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in
foreclosed asset expense.

Stock-based Compensation

During the first quarter of fiscal 2006, we adopted the provisions of, and account for stock-based compensation in accordance with, the Financial Accounting Standards Boards (FASB) Statement of Financial Accounting
Standards No. 123  revised 2004, Share-Based Payment, (SFAS 123R) which replaced SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB No. 25, Accounting for Stock
Issued to Employees, and its related interpretations. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense
on a straight-line basis over the requisite service period, which is the vesting period. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to
new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the
compensation cost estimated for the SFAS 123 pro forma disclosures. See Note 13 for further information regarding our stock-based compensation assumptions and expenses, including pro forma disclosures for prior periods as if we had recorded
stock-based compensation expense.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

Transfers of Financial Assets

Transfers of financial assets
are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before
their maturity.

Income Taxes

Provision for
income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities and income earned on bank-owned life insurance) and consists of taxes currently due plus
deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset in the case of unrealized depreciation) on investment securities
available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not included in income determination until realized. Accordingly, the
resulting deferred income tax liability or asset is also recorded as an adjustment to equity.

Basic Earnings per Share

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period,
after giving retroactive effect to stock splits and dividends.

Diluted Earnings per Share

The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if dilutive potential common shares had been issued. These additional common shares would include employee equity share options, nonvested shares and similar equity instruments granted to
employees. Diluted earnings per share is based upon the actual number of options or shares granted and not yet forfeited unless doing so would be antidilutive. The numerator is adjusted for any changes in income or loss that would result from the
assumed conversion of those potential common shares.

Comprehensive Income

Annual comprehensive income reflects the change in the Companys equity during the year arising from transactions and events other than investments by and distributions to shareholders. It consists of net income
plus certain other changes in assets and liabilities that are reported as separate components of shareholders equity rather than as income or expense.

Financial Instruments

For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk
exposure to declining rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and
throughout the hedge period. In addition, forwards and option contracts must reduce an exposures risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the
transactions must be probable of occurring. All derivative financial instruments held or issued by the Company are held or issued for purposes other than trading.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

In the ordinary course of business the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial and standby
letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.

Interest Rate Swap Agreements

For asset/liability management purposes, the Company may use interest rate swap agreements to hedge
various exposures or to modify interest rate characteristics of various balance sheet accounts. Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional amount. The
notional amount on which the interest payments are based is not exchanged. These swap agreements are derivative instruments and generally convert a portion of the Companys variable-rate loans to a fixed rate (cash flow hedge), and convert a
portion of its fixed-rate loans to a variable rate (fair value hedge).

The Company entered into its first cash flow hedge in April 2006 when it entered
into a forward-start interest rate swap agreement (Agreement) to convert a portion of its variable rate loans to a fixed rate. We entered into this Agreement to protect the Bank from interest rate exposure during a period of declining
rates.

Cash flows resulting from derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash
flow statement in the same category as the cash flows of the items being hedged.

Fair Value of Financial Instruments

Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could
not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do
not represent the underlying value of the Company.

The following methods and assumptions were used by the Company in estimating its fair value disclosures
for financial instruments:

Cash and due from banks: The carrying amounts reported in the balance sheet for cash and due from banks approximate their
fair values.

Interest-bearing deposits in banks: Fair values for time deposits are estimated using a discounted cash flow analysis that applies
interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.

Federal funds sold:
Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value.

Available-for-sale and
held-to-maturity securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of
comparable instruments. The carrying values of restricted equity securities approximate fair values.

Loans receivable: For variable-rate loans that
reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

Note 1. Summary of Significant Accounting Policies, continued



analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates
include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The carrying amount of accrued
interest receivable approximates its fair value.

Bank owned life insurance: The carrying amount reported in the balance sheet approximate
fair value as it represents the cash surrender value of the life insurance.

Deposit liabilities: The fair values disclosed for demand and savings
deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value.

Federal funds purchased and securities sold under agreements to repurchase: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value.

Short-term debt: The carrying amounts of short-term debt approximate their fair values.

Other debt: The fair values of other debt is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt.

Guaranteed preferred beneficial interests in the Companys junior subordinated debentures:The fair values of guaranteed preferred beneficial
interests in the Companys junior subordinated debentrues is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt.

Other liabilities: For fixed-rate loan commitments, fair value considers the difference between current levels of interest rates and the committed rates. The
carrying amount of other liabilities approximates fair value as the estimated value of loan commitments approximates the fees charged.

Reclassification

Certain reclassifications have been made to the financial statements of the prior year to place them on a
comparable basis with the current year. Net income and shareholders equity previously reported were not affected by these reclassifications.

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income
Taxes. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the impact of this
pronouncement.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement
Plans  an amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS 158 requires an employer to recognize the funded status of a benefit plan on its balance sheet and to recognize the gains or losses and prior service costs,
not already recognized, as a component of other comprehensive income effective for fiscal years ending after December 15, 2006. Additionally, SFAS 158 requires that the defined benefit plan assets and obligations be measured as of the date of
the employers fiscal year-end balance sheet effective for fiscal years ending after December 15, 2008. Management is currently evaluating the impact of this pronouncement.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 1. Summary of Significant Accounting Policies, continued

Recent Accounting Pronouncements, continued

In September 2006,
the Emerging Issues Task Force affirmed and ratified EITF Issue No. 06-04 Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. For endorsement split-dollar
life insurance arrangements that provide a benefit to an employee that extends to postretirement periods, an employer should recognize a liability for future benefits in accordance with Statement 106 or Opinion 12 (depending on whether a substantive
plan is deemed to exist) based on the substantive agreement with the employee. For example, if the employer has effectively agreed to maintain a life insurance policy during the employees retirement, the cost of the insurance policy during the
postretirement periods should be accrued in accordance with either Statement 106 or Opinion 12. Similarly, if the employer has effectively agreed to provide the employee with a death benefit, the employer should recognize a liability for the future
death benefit in accordance with either Statement 106 or Opinion 12. This EITF is effective for fiscal years beginning after December 15, 2007 and will impact on the Companys financial statements for fiscal year 2008.

In September 2006, the SEC issued Staff Accounting Bulleting No. 108 (SAB 108). SAB 108 provides interpretive guidance on how the effects of the
carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either the income
statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a companys balance
sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material
according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  Including an amendment of FASB
Statement No. 115. This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains
and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to
entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS No. 115, available-for-sale and held-to-maturity securities at the effective date are eligible for
the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such
securities will be accounted for as trading securities. SFAS No. 159 is effective for the Company on January 1, 2008. Earlier adoption is permitted in 2007 if the Company also elects to apply the provisions of SFAS No. 157, Fair
Value Measurement. The Company is currently analyzing the fair value option provided under SFAS No. 159.

Note 2. Restrictions on Cash

To comply with Federal Reserve regulations, the Bank is required to maintain certain average reserve balances. The daily cash reserve requirement for
the week including December 31, 2006 was $65, less cash on hand in the amount of $1,152, or a net of $0. The daily cash reserve requirement for the week including December 31, 2005 was $211, less cash on hand in the amount of $1,067, or a
net of $0.

As a condition of our correspondent bank agreement, the Bank is also required to maintain a target balance. The target balance as of
December 31, 2006 and December 31, 2005 was $250.



58



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 3. Securities

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale as of December 31, 2006 and 2005 were as follows:



|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|---------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------- | --- |  | - | ------
|                                   |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | FairValues
|2006                               |  |                |        |                 |   |                  |  |            |     |  |   |       
|U.S. Government and federal agency |  | $              | 1,023  |                 | $ |                 |  | $          | 2   |  | $ | 1,021 
|Government-sponsored enterprises*  |  |                | 19,435 |                 |   | 21               |  |            | 187 |  |   | 19,269
|Mortgage-backed securities         |  |                | 21,713 |                 |   | 111              |  |            | 551 |  |   | 21,273
|States and political subdivisions  |  |                | 6,594  |                 |   | 64               |  |            | 14  |  |   | 6,644 
|Corporate debt                     |  |                | 200    |                 |   |                 |  |            | 2   |  |   | 198   
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|                                   |  | $              | 48,965 |                 | $ | 196              |  | $          | 756 |  | $ | 48,405
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|2005                               |  |                |        |                 |   |                  |  |            |     |  |   |       
|U.S. Government and federal agency |  | $              | 1,293  |                 | $ |                 |  | $          | 7   |  | $ | 1,286 
|Government-sponsored enterprises*  |  |                | 5,472  |                 |   |                 |  |            | 94  |  |   | 5,378 
|Mortgage-backed securities         |  |                | 19,872 |                 |   |                 |  |            | 653 |  |   | 19,219
|States and political subdivisions  |  |                | 7,047  |                 |   | 105              |  |            | 25  |  |   | 7,127 
|Corporate debt                     |  |                | 200    |                 |   |                 |  |            | 4   |  |   | 196   
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|                                   |  | $              | 33,884 |                 | $ | 105              |  | $          | 783 |  | $ | 33,206
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity
as of December 31, 2006 and 2005 were as follows:



|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|---------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------- | --- |  | - | ------
|                                   |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | FairValues
|2006                               |  |                |        |                 |   |                  |  |            |     |  |   |       
|U.S. Government and federal agency |  | $              |       |                 | $ |                 |  | $          |    |  | $ |      
|Government-sponsored enterprises*  |  |                | 9,946  |                 |   |                 |  |            | 162 |  |   | 9,784 
|Mortgage-backed securities         |  |                | 2,911  |                 |   |                 |  |            | 90  |  |   | 2,821 
|States and political subdivisions  |  |                | 7,276  |                 |   | 89               |  |            | 30  |  |   | 7,335 
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|                                   |  | $              | 20,133 |                 | $ | 89               |  | $          | 282 |  | $ | 19,940
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|2005                               |  |                |        |                 |   |                  |  |            |     |  |   |       
|U.S. Government and federal agency |  | $              |       |                 | $ |                 |  | $          |    |  | $ |      
|Government-sponsored enterprises*  |  |                | 9,938  |                 |   |                 |  |            | 193 |  |   | 9,745 
|Mortgage-backed securities         |  |                | 3,500  |                 |   |                 |  |            | 90  |  |   | 3,410 
|States and political subdivisions  |  |                | 7,358  |                 |   | 52               |  |            | 41  |  |   | 7,369 
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       
|                                   |  | $              | 20,796 |                 | $ | 52               |  | $          | 324 |  | $ | 20,524
|                                   |  |                |        |                 |   |                  |  |            |     |  |   |       

---

|* | Such as FNMA, FHLMC and FHLB.
|- | -----------------------------

The following tables detail unrealized
losses and related fair values in the Banks available-for-sale and held-to-maturity investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss
position as of December 31, 2006.



59



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 3. Securities, continued

Temporarily Impaired Securities in AFS Portfolio



|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|2006                                  |  | Less than 12 Months |       | 12 Months or More |   | Total    
|                                      |  | FairValue           |       | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |        | FairValue |   | UnrealizedLosses
|Government-sponsored enterprises*     |  | $                   | 6,904 |                   | $ | 95        |  | $                | 12,216 |           | $ | 379              |  | $ | 19,120 |  | $ | 474
|Mortgage-backed securities            |  |                     |      |                   |   |          |  |                  | 9,220  |           |   | 266              |  |   | 9,220  |  |   | 266
|Corporate debt                        |  |                     |      |                   |   |          |  |                  | 198    |           |   | 2                |  |   | 198    |  |   | 2  
|State and political Subdivisions      |  |                     | 1,214 |                   |   | 4         |  |                  | 1,103  |           |   | 10               |  |   | 2,317  |  |   | 14 
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                   | 8,118 |                   | $ | 99        |  | $                | 22,737 |           | $ | 657              |  | $ | 30,855 |  | $ | 756
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    

Temporarily Impaired Securities in HTM Portfolio



|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|2006                                  |  | Less than 12 months |       | 12 Months or More |   | Total    
|                                      |  | FairValue           |       | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |        | FairValue |   | UnrealizedLosses
|Government-sponsored enterprises*     |  | $                   |      |                   | $ |          |  | $                | 10,308 |           | $ | 189              |  | $ | 10,308 |  | $ | 189
|Mortgage-backed securities            |  |                     |      |                   |   |          |  |                  | 2,297  |           |   | 63               |  |   | 2,297  |  |   | 63 
|State and political subdivisions      |  |                     | 1,754 |                   |   | 3         |  |                  | 1,913  |           |   | 27               |  |   | 3,667  |  |   | 30 
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                   | 1,754 |                   | $ | 3         |  | $                | 14,518 |           | $ | 279              |  | $ | 16,272 |  | $ | 282
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    

This information is aggregated by the length of time that individual securities have been in a continuous
unrealized loss position as of December 31, 2006.

Temporarily Impaired Securities in AFS Portfolio



|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|2005                                  |  | Less than 12 Months |       | 12 Months or More |   | Total    
|                                      |  | FairValue           |       | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |        | FairValue |   | UnrealizedLosses
|Government-sponsored enterprises*     |  | $                   | 3,865 |                   | $ | 53        |  | $                | 2,452  |           | $ | 48               |  | $ | 6,317  |  | $ | 101
|Mortgage-backed securities            |  |                     | 2,790 |                   |   | 47        |  |                  | 16,413 |           |   | 606              |  |   | 19,203 |  |   | 653
|Corporate debt                        |  |                     | 98    |                   |   | 1         |  |                  | 98     |           |   | 3                |  |   | 196    |  |   | 4  
|State and political subdivisions      |  |                     | 1,548 |                   |   | 13        |  |                  | 597    |           |   | 12               |  |   | 2,145  |  |   | 25 
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                   | 8,301 |                   | $ | 114       |  | $                | 19,560 |           | $ | 669              |  | $ | 27,861 |  | $ | 783
|                                      |  |                     |       |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    



60



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 3. Securities, continued

Temporarily Impaired Securities in HTM Portfolio



|                                      |  |                     |       |                   |   |            |  |                   |       |            |   |                   |  |   |        |  |   |    
|------------------------------------- |  | ------------------- | ----- | ----------------- | - | ---------- |  | ----------------- | ----- | ---------- | - | ----------------- |  | - | ------ |  | - | ---
|2005                                  |  | Less than 12 Months |       | 12 Months or More |   | Total     
|                                      |  | Fair Value          |       | Unrealized Losses |   | Fair Value |  | Unrealized Losses |       | Fair Value |   | Unrealized Losses
|                                      |  |                     |       |                   |  
|Government-sponsored enterprises*     |  | $                   | 3,899 |                   | $ | 39         |  | $                 | 5,846 |            | $ | 154               |  | $ | 9,745  |  | $ | 193
|Mortgage-backed securities            |  |                     | 2,263 |                   |   | 42         |  |                   | 1,147 |            |   | 48                |  |   | 3,410  |  |   | 90 
|State and political subdivisions      |  |                     | 1,382 |                   |   | 7          |  |                   | 1,245 |            |   | 34                |  |   | 2,627  |  |   | 41 
|                                      |  |                     |       |                   |   |            |  |                   |       |            |   |                   |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                   | 7,544 |                   | $ | 88         |  | $                 | 8,238 |            | $ | 236               |  | $ | 15,782 |  | $ | 324
|                                      |  |                     |       |                   |   |            |  |                   |       |            |   |                   |  |   |        |  |   |    

---

|* | Such as FNMA, FHLMC and FHLB.
|- | -----------------------------

Management considers the nature of the
investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient
to allow for any anticipated recovery in fair value. Based upon this evaluation, there are three mortgage-backed securities with net additional unrealized losses greater than $5 at December 31, 2006 when compared to December 31, 2005. In
all cases, these specific mortgage-backed securities were purchased in the summer of 2003 when interest rates were at their lowest. The prepayment speeds have decreased on these loans due to the increase in interest rates and as a result, the yield
curve has been pushed out on these loans. There are no issues with the underlying collateral for these investments. Management believes all unrealized losses presented in the tables above are not related to an issuers financial condition but
are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.

The amortized costs and approximate
fair values of available-for-sale securities as of December 31, 2006, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with
or without call or prepayment penalties.



|                                       |  |                |        |            |   |       
|-------------------------------------- |  | -------------- | ------ | ---------- | - | ------
|2006                                   |  | AmortizedCosts |        | FairValues
|Due in one year or less                |  | $              | 300    |            | $ | 298   
|Due after one year through five years  |  |                | 4,711  |            |   | 4,658 
|Due after five years through ten years |  |                | 6,410  |            |   | 6,403 
|Due after ten years                    |  |                | 15,832 |            |   | 15,773
|Mortgage-backed securities             |  |                | 21,712 |            |   | 21,273
|                                       |  |                |        |            |   |       
|                                       |  | $              | 48,965 |            | $ | 48,405
|                                       |  |                |        |            |   |       

The amortized costs and approximate fair values of held-to-maturity securities as of December 31, 2006, by
contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                       |  |                |        |            |   |       
|-------------------------------------- |  | -------------- | ------ | ---------- | - | ------
|2006                                   |  | AmortizedCosts |        | FairValues
|Due after one year through five years  |  | $              | 2,391  |            | $ | 2,371 
|Due after five years through ten years |  |                | 5,026  |            |   | 4,991 
|Due after ten years                    |  |                | 9,806  |            |   | 9,758 
|Mortgage-backed securities             |  |                | 2,910  |            |   | 2,820 
|                                       |  |                |        |            |   |       
|                                       |  | $              | 20,133 |            | $ | 19,940
|                                       |  |                |        |            |   |       



61



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 3. Securities, continued

Securities (excluding restricted equity securities) with amortized costs of $58,329 and $40,604 as of December 31, 2006 and 2005, respectively, were pledged as collateral for public deposits and for other
purposes as required or permitted by law.

Restricted equity securities consist of Federal Home Loan Bank stock in the amount of $4,275 and $3,443, Federal
Reserve Bank stock in the amount of $744 and $483, and Community Bankers Bank stock in the amount of $60 as of December 31, 2006 and 2005, respectively. Restricted equity securities are carried at cost. The Federal Home Loan Bank requires the
Bank to maintain stock in an amount equal to 0.20% of total assets as of December 31 of the prior year and 4.5% of outstanding borrowings. The Federal Reserve Bank of Richmond requires the Bank to maintain stock with a par value equal to 6% of
its outstanding capital; however, the Federal Reserve Bank only requires the Bank to pay 50% of the par value of the stock. Community Bankers Bank stock is restricted in the fact that the stock may only be repurchased by that Company.

Note 4. Loans Receivable

The major components of loans in the
consolidated balance sheets at December 31, 2006 and 2005 are as follows:



|                                             |  |      |         |   |      |   |         |  
|-------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                             |  | 2006 |         |   | 2005 |  
|Commercial                                   |  | $    | 93,400  |   |      | $ | 97,904  |  
|Real estate:                                 |  |      |         |   |      |   |         |  
|Construction and land development            |  |      | 82,537  |   |      |   | 55,810  |  
|Residential, 1-4 families                    |  |      | 112,022 |   |      |   | 103,272 |  
|Commercial                                   |  |      | 174,848 |   |      |   | 149,684 |  
|Consumer                                     |  |      | 8,211   |   |      |   | 7,744   |  
|                                             |  |      |         |   |      |   |         |  
|                                             |  |      | 471,018 |   |      |   | 414,414 |  
|                                             |  |     
|Unearned loan origination costs, net of fees |  |      |        |   |      |   | (2      | )
|Deferred loan fees                           |  |      | 34      |   |      |   | (35     | )
|Allowance for loan losses                    |  |      | (5,658  | ) |      |   | (4,124  | )
|                                             |  |      |         |   |      |   |         |  
|                                             |  | $    | 465,394 |   |      | $ | 410,253 |  
|                                             |  |      |         |   |      |   |         |  

Substantially all one-four family residential and commercial real estate loans collateralize the line of credit
available from the Federal Home Loan Bank.

The aggregate amount of deposits that have been reclassified as loans and included in the consumer category in
the above table as of December 31, 2006 was $128.

Note 5. Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:



|                                  |  |      |        |   |      |   |       |      |  |   |       |  
|--------------------------------- |  | ---- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                  |  | 2006 |        |   | 2005 |   |       | 2004 | 
|Balance, beginning                |  | $    | 4,124  |   |      | $ | 2,989 |      |  | $ | 2,566 |  
|Provision charged to expense      |  |      | 2,796  |   |      |   | 1,297 |      |  |   | 633   |  
|Recoveries of amounts charged off |  |      | 5      |   |      |   | 31    |      |  |   | 1     |  
|Amounts charged off               |  |      | (1,267 | ) |      |   | (193  | )    |  |   | (211  | )
|                                  |  |      |        |   |      |   |       |      |  |   |       |  
|Balance, ending                   |  | $    | 5,658  |   |      | $ | 4,124 |      |  | $ | 2,989 |  
|                                  |  |      |        |   |      |   |       |      |  |   |       |  



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---

Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 5. Allowance for Loan Losses, continued

An allowance determined in accordance with SFAS No. 114 and No. 118 is provided for all impaired loans. The total recorded investment in impaired loans and the related allowance for loan losses at
December 31, 2006, 2005, and 2004 is as follows:



|                                              |  |      |       |      |   |       |  |   |    
|--------------------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | ---
|                                              |  | 2006 |       | 2005 |   | 2004 
|Impaired loans without a valuation allowance  |  | $    | 2,817 |      | $ |      |  | $ | 331
|Impaired loans with a valuation allowance     |  |      | 6,407 |      |   | 3,062 |  |   | 59 
|                                              |  |      |       |      |   |       |  |   |    
|Total impaired loans                          |  | $    | 9,224 |      | $ | 3,062 |  | $ | 390
|                                              |  |      |       |      |   |       |  |   |    
|Valuation allowance related to impaired loans |  | $    | 1,050 |      | $ | 344   |  | $ | 31 
|                                              |  |      |       |      |   |       |  |   |    

The average annual recorded investment in impaired loans and interest income recognized on impaired loans for the
years ended December 31, 2006, 2005, and 2004 (all approximate) is summarized below:



|                                                             |  |      |       |      |   |      |  |   |    
|------------------------------------------------------------ |  | ---- | ----- | ---- | - | ---- |  | - | ---
|                                                             |  | 2006 |       | 2005 |   | 2004
|Average investment in impaired loans                         |  | $    | 6,265 |      | $ | 343  |  | $ | 162
|                                                             |  |      |       |      |   |      |  |   |    
|Interest income recognized on impaired loans                 |  | $    | 266   |      | $ | 27   |  | $ | 7  
|                                                             |  |      |       |      |   |      |  |   |    
|Interest income recognized on a cash basis on impaired loans |  | $    | 306   |      | $ | 7    |  | $ | 5  
|                                                             |  |      |       |      |   |      |  |   |    

Except for adequately secured advances under an asset-based lending program, no additional funds are committed to
be advanced in connection with impaired loans.

Nonaccrual loans totaled $6,343 and $104 as of December 31, 2006 and 2005, respectively. Loans past
due more than ninety days and still accruing totaled $616 and $423 as of December 31, 2006 and 2005, respectively. Restructured loans totaled $0 as of December 31, 2006 and 2005.

Note 6. Foreclosed Properties

Expenses applicable to foreclosed
properties include the following:



|                                         |  |                         |   |      |   |      |      |  |   |   
|---------------------------------------- |  | ----------------------- | - | ---- | - | ---- | ---- |  | - | --
|                                         |  | Years Ended December 31
|                                         |  | 2006                    |   | 2005 |   |      | 2004
|Net loss (gain) on sales of real estate  |  | $                       |  |      | $ | (131 | )    |  | $ | 12
|Operating expenses, net of rental income |  |                         |  |      |   | (10  | )    |  |   |  
|                                         |  |                         |   |      |   |      |      |  |   |   
|                                         |  | $                       |  |      | $ | (141 | )    |  | $ | 12
|                                         |  |                         |   |      |   |      |      |  |   |   



63



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 7. Premises and Equipment

Components of premises and equipment and total accumulated depreciation and amortization as of December 31, 2006 and 2005 are as follows:



|                                   |  |      |        |   |      |   |        |  
|---------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                   |  | 2006 |        |   | 2005 |  
|Land and improvements              |  | $    | 1,697  |   |      | $ | 1,697  |  
|Building                           |  |      | 3,330  |   |      |   | 3,335  |  
|Furniture, fixtures, and equipment |  |      | 3,856  |   |      |   | 3,332  |  
|Leasehold improvements             |  |      | 1,335  |   |      |   | 1,005  |  
|Construction in progress           |  |      | 61     |   |      |   | 105    |  
|                                   |  |      |        |   |      |   |        |  
|                                   |  |      | 10,279 |   |      |   | 9,474  |  
|                                   |  |     
|Less accumulated depreciation      |  |      | (3,406 | ) |      |   | (2,884 | )
|                                   |  |      |        |   |      |   |        |  
|                                   |  | $    | 6,873  |   |      | $ | 6,590  |  
|                                   |  |      |        |   |      |   |        |  

Depreciation expense for the years ended December 31, 2006, 2005, and 2004 amounted to $650, $579, and $529,
respectively.

The Company currently leases its main office location under a non-cancelable operating lease. The lease for the main office has a term of
six years with the option of three additional renewal terms of five years each. In addition, the Company currently leases two of its branch locations. The first branch has an initial lease term of twelve years with the option of one additional
renewal term of five years. The second branch has an initial lease term of five years with the option to renew for four additional five year periods. Rental expenses under operating leases were approximately $291, $231 and $155 for 2006, 2005, and
2004, respectively. Future minimum lease payments under non-cancelable operating leases at December 31, 2006 were as follows:



|     |  |   |    
|---- |  | - | ---
|2007 |  |   | 313
|2008 |  |   | 335
|2009 |  |   | 320
|2010 |  |   | 13 
|     |  |   |    
|     |  | $ | 981
|     |  |   |    

Note 8. Time Deposits

At December 31, 2006 the approximate scheduled maturities of time deposits are as follows:



|                      |  |   |        
|--------------------- |  | - | -------
|Three months or less  |  | $ | 51,378 
|Four to twelve months |  |   | 184,693
|One to three years    |  |   | 23,282 
|Over three years      |  |   | 3,769  
|                      |  |   |        
|                      |  | $ | 263,122
|                      |  |   |        

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2006 and 2005 was
$69,352 and $52,518, respectively.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 9. Borrowed Funds

Short-term debt

Short-term debt includes Federal Home Loan Bank Advances that mature in 12 months or less, securities sold under
agreements to repurchase and federal funds purchased generally maturing within one to seven days from the transaction date. Short-term Federal Home Loan Bank of Atlanta advances totaled $25,000 and $23,000 at December 31, 2006 and 2005,
respectively. The $25,000 balance as of December 31, 2006 is comprised of a convertible credit of $10,000, an adjustable rate credit in the amount of $5,000 and a second adjustable rate credit in the amount of $10,000. The $10,000 convertible
credit was borrowed in September of 2002 and matures September 4, 2007. The advance is convertible to a floating rate of three month LIBOR by the FHLB on the maturity date. The current rate is 3.09%. The $5,000 adjustable rate credit was
renewed for another year in October 2006. The new maturity date is October 31, 2007. The advance reprices quarterly on the date of each quarterly interest payment. The current rate is 5.339%. The $10,000 adjustable rate credit was renewed for
another year in December 2006. The new maturity date is December 18, 2007. The advance reprices quarterly on the date of each quarterly interest payment. The current rate is 5.345%. At December 31, 2006, the Company had $35,000 available
under short-term unsecured lines of credit and $16,274 available under short-term secured lines of credit.

Additional information is summarized below:



|                                                       |  |      |        |   |      |   |        |  
|------------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                                       |  | 2006 |        |   | 2005 |  
|Outstanding balance at December 31                     |  | $    | 46,635 |   |      | $ | 50,829 |  
|                                                       |  |      |        |   |      |   |        |  
|Year-end weighted average rate                         |  | $    | 4.35   | % |      | $ | 3.90   | %
|                                                       |  |      |        |   |      |   |        |  
|Daily average outstanding during the period            |  | $    | 46,837 |   |      | $ | 32,340 |  
|                                                       |  |      |        |   |      |   |        |  
|Average rate for the period                            |  | $    | 4.52   | % |      | $ | 2.84   | %
|                                                       |  |      |        |   |      |   |        |  
|Maximum outstanding at any month-end during the period |  | $    | 70,556 |   |      | $ | 51,691 |  
|                                                       |  |      |        |   |      |   |        |  

Securities with a fair market value of $39,122 and $19,871 collateralized securities sold under agreements to
repurchase at December 31, 2006 and 2005, respectively.

Long-term debt

The Company has outstanding long-term debt with the Federal Home Loan Bank of Atlanta in the amount of $48.0 million as of December 31, 2006. There are four convertible advances in the amount of $5,000 each and
one convertible advance in the amount of $7,000. The Federal Home Loan Bank of Atlanta has the option to convert $27,000 in convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two
business days notice. If called, the four $5,000 convertible advances and the one $7,000 convertible advance will be converted into a 3-month London Interbank Offered Rate (LIBOR) based adjustable rate credit (ARC) at 3-month LIBOR.

Additionally, during the second quarter of 2006, the Bank entered into two new structured advances with the Federal Home Loan Bank of Atlanta. The first
advance is a variable rate advance in the amount of $8,000, the proceeds of which were used to offset overnight borrowings. It is priced at the Prime Rate minus 2.855% per annum. It has a 2-year maturity date. The second advance is convertible
advance in the amount of $13,000 at 3-month LIBOR minus 0.50% per annum. The advance may be called on the two-year anniversary date by the issuer. If it is not called, it will automatically convert to a fixed rate of 5.03% for the remaining
eight year maturity. The proceeds of these advances were used to pay off the $11,000 short-term daily rate credit and to offset overnight borrowings.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 9. Borrowed Funds, continued

The following table provides more information on the outstanding advances as of December 31, 2006 and 2005:

LONG-TERM FEDERAL HOME LOAN BANK ADVANCES

(dollars in thousands)



|                  |  |                    |  |                   |  |             |   |  |                 |        |                 |   |       
|----------------- |  | ------------------ |  | ----------------- |  | ----------- | - |  | --------------- | ------ | --------------- | - | ------
|Advance Date      |  | Maturity Date      |  | Conversion Date   |  | CurrentRate |   |  | 12/31/06Balance |        | 12/31/05Balance
|December 2, 1999  |  | December 2, 2009   |  | Quarterly         |  | 5.46        | % |  | $               | 5,000  |                 | $ | 5,000 
|May 24, 2000      |  | May 24, 2010       |  | Quarterly         |  | 6.49        | % |  | $               | 5,000  |                 | $ | 5,000 
|February 9, 2001  |  | February 9, 2011   |  | Quarterly         |  | 4.97        | % |  | $               | 5,000  |                 | $ | 5,000 
|November 7, 2001  |  | November 7, 2011   |  | Quarterly         |  | 3.91        | % |  | $               | 0      |                 | $ | 5,000 
|September 4, 2002 |  | September 4, 2007* |  | Quarterly         |  | 3.09        | % |  | $               | 0      |                 | $ | 10,000
|March 11, 2003    |  | March 11, 2013     |  | March 11, 2008    |  | 2.91        | % |  | $               | 7,000  |                 | $ | 7,000 
|June 27, 2006     |  | June 27, 2008      |  | None              |  | 5.395       | % |  | $               | 8,000  |                 | $ | 0     
|June 29, 2006     |  | June 29, 2016      |  | June 29, 2008     |  | 4.85        | % |  | $               | 13,000 |                 | $ | 0     
|November 9, 2006  |  | November 9, 2016   |  | November 10, 2008 |  | 4.28        | % |  | $               | 5,000  |                 | $ | 0     
|                  |  |                    |  |                   |  |             |   |  |                 |        |                 |   |       
|                  |  |                    |  |                   |  | TOTAL       |   |  | $               | 48,000 |                 | $ | 37,000
|                  |  |                    |  |                   |  |             |   |  |                 |        |                 |   |       

---

|* | Advance reclassified as short-term debt as of September 4, 2006.
|- | ----------------------------------------------------------------

Guaranteed Preferred Beneficial Interests in the Companys Junior Subordinated Debentures

Valley Financial (VA) Statutory Trust
I, a statutory business trust (the Trust), was created by the Company on June 26, 2003, at which time the Trust issued $4,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature
June 26, 2033. Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate (LIBOR) plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by the Trust at any time
after June 26, 2008. The principal assets of the Trust are $4,124 of the Companys junior subordinated debentures which mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at
11.75%, and which are callable by the Company after June 26, 2008. All $124 in aggregation liquidation amount of the Trusts common securities are held by the Company.

Valley Financial (VA) Statutory Trust II, a statutory business trust (Trust II), was created by the Company on September 26, 2005, at which time Trust II issued $7,000 in aggregate liquidation amount
of $1 par value preferred capital trust securities which mature December 15, 2035. Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any
time after December 15, 2010. The principal assets of Trust II are $7,217 of the Companys junior subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%,
and which are callable by the Company after December 15, 2010. All $217 in aggregation liquidation amount of Trust IIs common securities are held by the Company.

Valley Financial Statutory Trust III, a statutory business trust (Trust III) was created by the Company on December 15, 2006, at which time Trust III issued $5,000 in aggregate liquidation amount of
$1 par value preferred capital trust securities which mature January 30, 2037. Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any
time after January 20, 2012. The principal assets of Trust III are $5,155 of the Companys junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%,
and which are callable by the Company after January 30, 2012. All $155 in aggregation liquidation amount of Trust IIIs common securities are held by the Company.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 9. Borrowed Funds, continued

The preferred securities and common securities of all three trusts may be included in the Companys Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of the
Companys total Tier I capital excluding the securities. Amounts in excess of this ratio will not be considered Tier 1 capital but may be included in the calculation of the Companys total risk-based capital ratio. The Companys
obligations with respect to the issuance of the preferred securities and common securities of both trusts constitute a full and unconditional guarantee by the Company of the trusts obligations with respect to the preferred securities and common
securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on its junior subordinated debentures, which would result in a deferral of distribution payments on the trusts
preferred trust securities and common securities. As a result of the Companys adoption of FIN 46, all three Trusts common securities have been presented as a component of other assets.

Note 10. Fair Value of Financial Instruments

The carrying amounts
and approximate fair values of the Corporations financial instruments are as follows at December 31, 2006 and 2005:



|                                                                                          |  |                 |         |                        |   |                 |  |                        |         |  |   |        
|----------------------------------------------------------------------------------------- |  | --------------- | ------- | ---------------------- | - | --------------- |  | ---------------------- | ------- |  | - | -------
|                                                                                          |  | 2006            |         | 2005                  
|                                                                                          |  | CarryingAmounts |         | ApproximateFair Values |   | CarryingAmounts |  | ApproximateFair Values
|Financial assets                                                                          |  |                 |         |                        |   |                 |  |                        |         |  |   |        
|Cash and due from banks                                                                   |  | $               | 9,778   |                        | $ | 9,778           |  | $                      | 9,746   |  | $ | 9,746  
|Interest-bearing deposits in banks                                                        |  |                 | 91      |                        |   | 91              |  |                        | 336     |  |   | 336    
|Federal funds sold                                                                        |  |                 | 16,630  |                        |   | 16,630          |  |                        |        |  |   |       
|Securities available-for-sale                                                             |  |                 | 48,405  |                        |   | 48,405          |  |                        | 33,206  |  |   | 33,206 
|Securities held-to-maturity                                                               |  |                 | 20,133  |                        |   | 19,940          |  |                        | 20,796  |  |   | 20,524 
|Restricted equity securities                                                              |  |                 | 5,079   |                        |   | 5,079           |  |                        | 3,987   |  |   | 3,987  
|Loans, net                                                                                |  |                 | 465,394 |                        |   | 463,699         |  |                        | 410,253 |  |   | 405,451
|Bank owned life insurance                                                                 |  |                 | 11,117  |                        |   | 11,117          |  |                        | 8,950   |  |   | 8,950  
|                                                                                          |  |                 |         |                       
|Financial liabilities                                                                     |  |                 |         |                        |   |                 |  |                        |         |  |   |        
|Total deposits                                                                            |  |                 | 441,489 |                        |   | 441,665         |  |                        | 365,316 |  |   | 365,279
|Short-term borrowings                                                                     |  |                 | 25,000  |                        |   | 25,000          |  |                        | 23,000  |  |   | 23,000 
|Securities sold under agreements to repurchase                                            |  |                 | 21,635  |                        |   | 21,635          |  |                        | 10,802  |  |   | 10,802 
|Federal funds purchased                                                                   |  |                 |        |                        |   |                |  |                        | 17,027  |  |   | 17,027 
|Long-term borrowings                                                                      |  |                 | 48,000  |                        |   | 56,179          |  |                        | 37,000  |  |   | 37,049 
|Guaranteed preferred beneficial interests in the Companys junior Subordinated debentures |  |                 | 16,496  |                        |   | 16,496          |  |                        | 11,341  |  |   | 11,341 

Note 11. Earnings per Share

Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. The weighted average shares outstanding for the diluted earnings per share computations were adjusted
to reflect the assumed conversion of shares available under stock options. The following table details the computation of basic and diluted earnings per share for each year ended December 31.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 11. Earnings per Share, continued



|                                 |  |           |       |                       |   |                |  |   |     
|-------------------------------- |  | --------- | ----- | --------------------- | - | -------------- |  | - | ----
|                                 |  | NetIncome |       | WeightedAverageShares |   | PerShareAmount
|Year Ended December 31, 2006     |  |           |       |                       |   |                |  |   |     
|Basic earnings per share         |  | $         | 2,882 |                       | $ | 4,101,634      |  | $ | 0.70
|Effect of dilutive stock options |  |           |      |                       |   | 113,607        |  |   |     
|                                 |  |           |       |                       |   |                |  |   |     
|Diluted earnings per share       |  | $         | 2,882 |                       | $ | 4,215,241      |  | $ | 0.68
|                                 |  |           |       |                       |   |                |  |   |     
|                                 |  |           |      
|Year Ended December 31, 2005     |  |           |       |                       |   |                |  |   |     
|Basic earnings per share         |  | $         | 3,392 |                       | $ | 4,075,812      |  | $ | 0.83
|Effect of dilutive stock options |  |           |      |                       |   | 175,558        |  |   |     
|                                 |  |           |       |                       |   |                |  |   |     
|Diluted earnings per share       |  | $         | 3,392 |                       | $ | 4,251,370      |  | $ | 0.80
|                                 |  |           |       |                       |   |                |  |   |     
|                                 |  |           |      
|Year Ended December 31, 2004     |  |           |       |                       |   |                |  |   |     
|Basic earnings per share         |  | $         | 2,824 |                       | $ | 3,782,816      |  | $ | 0.75
|Effect of dilutive stock options |  |           |      |                       |   | 241,997        |  |   |     
|                                 |  |           |       |                       |   |                |  |   |     
|Diluted earnings per share       |  | $         | 2,824 |                       | $ | 4,024,813      |  | $ | 0.70
|                                 |  |           |       |                       |   |                |  |   |     

Note 12. Employee Benefit Plan

The Company has a defined contribution plan (the Plan) qualifying under IRS Code Section 401(k). Eligible participants in the Plan can contribute up to the maximum percentage allowable not to exceed the dollar
limit under IRC Section 401(k). Employee contributions are matched by the Company based on 100 percent of the first three percent of an employees contribution and 50 percent of employee contributions which exceed three percent but do not
exceed six percent. For the years ended December 31, 2006, 2005, and 2004, the Company contributed $185, $126, and $94 to the Plan, respectively.

During 2002, the Company adopted a deferred compensation plan to provide future compensation to certain members of management. Under plan provisions, payments projected to range from $39 to $249 are payable for 15 years certain, generally
beginning at age 65. The liability accrued for compensation deferred under the plan was $880 at December 31, 2006 and $663 at December 31, 2005. Deferred compensation expense, an actuarially determined amount, was $144 during 2006, $180
during 2005, and $208 during 2004. Assumed discount rate, rate of compensation increase, and expected after-tax long-term rate of return on plan assets were 7.25%, 5%, and 4.5%, respectively at December 31, 2006. Assumed discount rate, rate of
compensation increase, and expected long-term rate of return on plan assets were 7.25%, 5%, and 4.8%, respectively at December 31, 2005. Assumed discount rate, rate of compensation increase, and expected long-term rate of return on plan assets
were 7.25%, 5%, and 5%, respectively at December 31, 2004.

The Company has purchased and is the beneficiary of life insurance policies that are
indirectly related to funding of our employee benefit plans. The cash value totaled approximately $11,117 and $8,950 at December 31, 2006 and 2005, respectively.

Note 13. Stock Based Compensation

During the first quarter of fiscal year 2006, we adopted the provisions of, and
account for stock-based compensation in accordance with, the Financial Accounting Standards Boards (FASB) Statement of Financial Accounting Standards No 123  revised 2004 (SFAS 123R), Share-Based
Payment, (SFAS No. 123R) which replaced SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees, and its related
interpretations. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---

Note 13. Stock Based Compensation, continued



recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. We elected the modified-prospective method,
under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for
grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures. Under the transition method, compensation cost recognized during
2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and
(b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results for prior periods have not been restated.

As a result of adopting Statement 123(R) on January 1, 2006, the Companys income before income taxes and net income for the year ended
December 31, 2006, are $80 and $80 lower, respectively, than if it had continued to account for share-based compensation under Opinion 25.

We
currently use the Black-Scholes option pricing model to determine the fair value of stock options and restricted stock grants. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is
affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise
behaviors, risk-free interest rate and expected dividends.

Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as
prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the
Companys common stock on the date of grant.

The Company has two share-based compensation plans, which are described below. The compensation cost
that has been charged against income for those plans was approximately $80 for the year ended December 31, 2006, and $0 for the years ended December 31, 2005 and 2004. The total recognized tax benefit related to the compensation expense
was $0 for the years ended December 31, 2006, 2005 and 2004. The Company currently has 82,098 nonqualified stock options outstanding at December 31, 2006, which were fully vested as of January 1, 2006; therefore, there are no income
tax implications for share-based compensation for the year ended December 31, 2006 for these nonqualified options.

Stock Option Plans

The Company has a 2005 Key Employee Equity Award Plan (the 2005 Plan). The 2005 Plan gives the Company flexibility in tailoring equity-based
compensation awards for employees from time to time to the continuing objective of aligning employee incentives with the interests of shareholders as the Company grows and develops. In addition to incentive and nonqualified stock options, the 2005
Plan permits the grant of restricted stock, stock appreciation rights and stock units to persons designated as Key Employees. The 2005 Plan will remain in effect for ten years, subject to the right of the Board of Directors to terminate
the 2005 Plan earlier, except with respect to maximum awards made prior to and outstanding on that date which remain valid in accordance with their terms. The aggregate number of shares of the Companys common stock (no par value) that may be
issued pursuant to awards made under the Plan may not exceed 250,000. Accordingly, 250,000 shares of authorized but unissued common stock are reserved for use in the 2005 Plan. Within the maximum limits, the Plan specifies that stock appreciation
rights may not be granted with respect to more than 500 shares per recipient (2,000 shares for a new employee recipient) per year; and restricted shares and stock units, respectively, may not be granted for more than 5,000 shares per year per
recipient.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 13. Stock Based Compensation, continued

Additionally, the Company has a 1995 Incentive Stock Plan (the 1995 Plan) pursuant to which the Human Resources Committee of the Companys Board of Directors may grant stock options to officers and key employees.
The 1995 Plan authorizes grants of options to purchase up to 311,850 shares (adjusted for stock splits) of the Companys authorized but unissued common stock. Accordingly, 311,850 shares of authorized but unissued common stock are reserved for
use in the Plan.

Under the 2005 Plan, there are options for 50,600 shares granted to officers and key employees currently outstanding as of
December 31, 2006. Under the 1995 Plan, there are options for 205,802 shares granted to officers and key employees currently outstanding as of December 31, 2006. All stock options (for both plans) have been granted with an exercise price
equal to the stocks fair market value at the date of the grant. Stock options under the Plan generally have 10-year terms, vest at the rate of 20 percent per year, and become fully exercisable five years from the date of the grant.
Additionally under the 2005 Plan, there are 15,075 restricted stock grants (RSGs) that have been granted to officers and key employees currently outstanding as of December 31, 2006. These RSGs will vest 100% on
January 31, 2008 (Vesting Date) based upon successfully meeting certain performance criteria. The Company has determined as of December 31, 2006 that it is no longer probable that the Company will meet the performance criteria
related to the vesting of the RSGs; therefore no compensation expense for RSGs has been recognized for the year ending December 31, 2006.

As of December 31, 2006, there are 5,358 shares available for grant under the 1995 Plan and 184,325 shares available for grant under the 2005 Plan. In addition, certain other options for 182,196 shares (adjusted for stock splits), of
which 82,098 are outstanding, based on meeting certain past performance criteria have been granted.

The share-based awards granted under the
aforementioned Plans have similar characteristics, except that some awards have been granted in options and certain awards have been granted in restricted stock. Therefore, the following disclosures have been disaggregated for the stock option and
restricted stock awards of the Plans due to their dissimilar characteristics.

The fair value of each option award is estimated on the date of grant using
the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. The risk-free interest rates used in the calculation of fair value ranges from 1.25% to 5.01% for
grants remaining vesting on or after the implementation date. Volatility is based on the volatilities of our trading history of our Companys stock. The expected life is based on the shortcut method as described in SAB 107 which
uses the average life of the options of 10 years and the weighted average vesting period of 5 years divided by two. Forfeitures are estimated based on the Companys history. The dividend rate is calculated by using the historical
dividends paid and a projection of dividends to be paid in the future through the expiration date of the most recent option grant. The projection is based upon historical trends of dividends paid.

The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees for years ended
December 31, 2006, 2005 and 2004.



|                                    |  |      |   |  |      |   |  |      |  
|----------------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|                                    |  | 2006 |   |  | 2005 |   |  | 2004 |  
|Expected dividend yield             |  | 1.15 | % |  | 0.96 | % |  | 0.0  | %
|Risk-free interest rate             |  | 4.62 | % |  | 3.99 | % |  | 3.94 | %
|Expected life of options (in years) |  | 7.5  |   |  | 10   |   |  | 10   |  
|Expected volatility of stock price  |  | 21   | % |  | 29   | % |  | 27   | %



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Valley Financial Corporation

Notes to Consolidated Financial Statements

(In thousands, except share
data)

---



Note 13. Stock Based Compensation, continued

Total stock-based compensation recognized as compensation expense on our consolidated statement of income is as follows:



|                           |  |                                                          |    |                                                          |   |                                                          |  |   |  
|-------------------------- |  | -------------------------------------------------------- | -- | -------------------------------------------------------- | - | -------------------------------------------------------- |  | - | -
|                           |  | 12 Months Ended December 31, 2006 (dollars in thousands) |    | 12 Months Ended December 31, 2005 (dollars in thousands) |   | 12 Months Ended December 31, 2004 (dollars in thousands)
|Option Grants              |  | $                                                        | 80 |                                                          | $ | 0                                                        |  | $ | 0
|Restricted Stock Grants    |  | $                                                        | 0  |                                                          | $ | 0                                                        |  | $ | 0
|                           |  |                                                          |    |                                                          |   |                                                          |  |   |  
|Total Compensation Expense |  | $                                                        | 80 |                                                          | $ | 0                                                        |  | $ | 0
|                           |  |                                                          |    |                                                          |   |                                                          |  |   |  

At December 31, 2005 and 2004, we accounted for our stock-based compensation using the accounting prescribed
by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. We were not required to adopt the fair value based recognition provisions prescribed under SFAS No. 123, Accounting for Stock-Based
Compensation,but complied with the disclosure requirements set forth in SFAS No. 148, which included disclosing pro forma net income as if the fair value based method of accounting had been applied. This information for the twelve month
periods ended December 31, 2005 and 2004 is as follows:



|                                                                                                                                     |  |                                                |       |                                                |   |      
|------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------------------------- | ----- | ---------------------------------------------- | - | -----
|                                                                                                                                     |  | 12 Months Ended12/31/2005(dollars inthousands) |       | 12 Months Ended12/31/2004(dollars inthousands)
|Net income                                                                                                                           |  | $                                              | 3,392 |                                                | $ | 2,824
|                                                                                                                                     |  |                                               
|Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
benefits |  | $                                              | 56    |                                                | $ | 44   
|                                                                                                                                     |  |                                                |       |                                                |   |      
|Pro forma net income                                                                                                                 |  | $                                              | 3,336 |                                                | $ | 2,780
|                                                                                                                                     |  |                                               
|Earnings per share                                                                                                                   |  |                                                |       |                                                |   |      
|Basic, reported                                                                                                                      |  | $                                              | 0.83  |                                                | $ | 0.75 
|Basic, pro forma                                                                                                                     |  | $                                              | 0.82  |                                                | $ | 0.73 
|Diluted, reported                                                                                                                    |  | $                                              | 0.80  |                                                | $ | 0.70 
|Diluted, pro forma                                                                                                                   |  | $                                              | 0.79  |                                                | $ | 0.68 

As of December 31, 2006, there was $248 of unrecognized compensation cost, adjusted for estimated
forfeitures, related to non-vested stock-based payments granted to employees. A maturity schedule of the unrecognized compensation cost (dollars in thousands) as of December 31, 2006 is as follows:



|                  |  |      |    |      |   |      |  |      |    |      |   |       |  |   |   |  |   |    
|----------------- |  | ---- | -- | ---- | - | ---- |  | ---- | -- | ---- | - | ----- |  | - | - |  | - | ---
|                  |  | 2007 |    | 2008 |   | 2009 |  | 2010 |    | 2011 |   | Total
|Compensation Cost |  | $    | 77 |      | $ | 72   |  | $    | 65 |      | $ | 32    |  | $ | 2 |  | $ | 248

Total unrecognized compensation cost will be adjusted for future grants and future changes in estimated
forfeitures.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 13. Stock Based Compensation, continued

General Stock Option Information

A summary of option activity under the stock option plans during the years ended
December 31, 2006, 2005 and 2004 is presented below:



|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|----------------------- |  | ------------------- | - |  | ------------------------------ | ----- | ------------------------------------- | - | --------------------------------- |  | --------------------------------- | ----- |  | ----------
|                        |  | Options Outstanding |   |  | WeightedAverage Exercise Price |       | Weighted Average GrantDate
Fair Value |   | IntrinsicValue ofOptionsExercised |  | Weighted Average Contractual Term
|Balance at 12/31/03     |  | 453,125             |   |  | $                              | 4.58  |                                       |   |                                   |  |                                   |       |  |           
|                        |  |                     |   |  |                               
|Granted                 |  | 26,300              |   |  | $                              | 14.20 |                                       |   |                                   |  |                                   |       |  |           
|Exercised               |  | (134,127            | ) |  | $                              | 3.48  |                                       |   |                                   |  | $                                 | 1,371 |  |           
|Forfeited               |  | (8,755              | ) |  | $                              | 6.81  |                                       |   |                                   |  |                                   |       |  |           
|Authorized              |  |                    |   |  |                                |      |                                       |   |                                   |  |                                   |       |  |           
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Balance at 12/31/04     |  | 336,543             |   |  | $                              | 5.71  |                                       | $ | 5.03                              |  | $                                 | 1,371 |  | 5.00 years
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Granted                 |  | 73,827              |   |  | $                              | 9.01  |                                       |   |                                   |  |                                   |       |  |           
|Exercised               |  | (2,363              | ) |  | $                              | 3.17  |                                       |   |                                   |  | $                                 | 22    |  |           
|Forfeited               |  | (42,626             | ) |  | $                              | 6.46  |                                       |   |                                   |  |                                   |       |  |           
|Authorized              |  |                    |   |  |                                |      |                                       |   |                                   |  |                                   |       |  |           
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Balance 12/31/05        |  | 365,381             |   |  | $                              | 6.30  |                                       | $ | 2.09                              |  | $                                 | 22    |  | 4.61 years
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Granted                 |  | 8,200               |   |  | $                              | 13.17 |                                       |   |                                   |  |                                   |       |  |           
|Exercised               |  | (35,081             | ) |  | $                              | 4.25  |                                       |   |                                   |  | $                                 | 318   |  |           
|Forfeited               |  |                    |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Authorized              |  |                    |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Balance at 12/31/06     |  | 338,500             |   |  | $                              | 6.68  |                                       | $ | 4.03                              |  | $                                 | 318   |  | 3.99 years
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           
|Exercisable at 12/31/06 |  | 264,060             |   |  | $                              | 5.28  |                                       |   | n/a                               |  |                                   | n/a   |  | 2.89 years
|                        |  |                     |   |  |                                |       |                                       |   |                                   |  |                                   |       |  |           

Information regarding shares vested during the years ended December 31, 2006, 2005 and 2004 are as follows:



|                  |  |                        |  |                                  |    
|----------------- |  | ---------------------- |  | -------------------------------- | ---
|Year Ending       |  | Number of SharesVested |  | Total Fair Valueof Shares Vested
|December 31, 2006 |  | 31,039                 |  | $                                | 78 
|December 31, 2005 |  | 68,386                 |  | $                                | 244
|December 31, 2004 |  | 49,905                 |  | $                                | 162



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 13. Stock Based Compensation, continued

Information regarding the stock options outstanding at December 31, 2006 is summarized below:



|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                 |   |      
|------------------------ |  | ------------------ |  | ------------------------------------------- |  | ------------------------------- | ----- | ------------------ | ------- | ------------------------------- | - | -----
|Range of Exercise Prices |  | Number Outstanding |  | Weighted Average Remaining Contractual Life |  | Weighted Average Exercise Price |       | Number Exercisable |         | Weighted Average Exercise Price
|$  3.18 - $  3.81        |  | 106,905            |  | 1.11 years                                  |  | $                               | 3.24  |                    | 106,905 |                                 | $ | 3.24 
|$  5.08 - $  5.94        |  | 129,695            |  | 3.16 years                                  |  | $                               | 5.32  |                    | 121,895 |                                 | $ | 5.31 
|$  7.14 - $12.85         |  | 71,350             |  | 7.14 years                                  |  | $                               | 11.29 |                    | 26,830  |                                 | $ | 10.57
|$13.00 - $14.23          |  | 30,550             |  | 7.99 years                                  |  | $                               | 13.76 |                    | 8,430   |                                 | $ | 14.02
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                 |   |      
|Totals                   |  | 338,500            |  | 3.99 years                                  |  | $                               | 6.68  |                    | 264,060 |                                 | $ | 5.28 
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                 |   |      

The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2006 was
$2,217 and $2,099, respectively.

A summary of the status of the Companys non-vested options as of December 31, 2006, 2005, and 2004 and changes
during the years then ended is presented below:



|                             |  |                                |   |  |                                       |     
|---------------------------- |  | ------------------------------ | - |  | ------------------------------------- | ----
|                             |  | Non-Vested Options Outstanding |   |  | WeightedAverage Grant Date Fair
Value
|Non-vested Options, 12/31/04 |  | 91,840                         |   |  | $                                     | 1.94
|                             |  |                                |   |  |                                       |     
|Granted                      |  | 73,827                         |   |  |                                       |     
|Vested                       |  | (23,398                        | ) |  |                                       |     
|Exercised                    |  | (2,363                         | ) |  |                                       |     
|Forfeited                    |  | (42,626                        | ) |  |                                       |     
|                             |  |                                |   |  |                                       |     
|Non-vested options, 12/31/05 |  | 97,280                         |   |  | $                                     | 3.37
|                             |  |                                |   |  |                                       |     
|Granted                      |  | 8,200                          |   |  |                                       |     
|Vested                       |  | 4,041                          |   |  |                                       |     
|Exercised                    |  | (35,081                        | ) |  |                                       |     
|Forfeited                    |  |                               |   |  |                                       |     
|                             |  |                                |   |  |                                       |     
|Non-vested options, 12/31/06 |  | 74,440                         |   |  | $                                     | 3.79
|                             |  |                                |   |  |                                       |     



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 13. Stock Based Compensation, continued

A summary of the status of the Companys non-vested restricted stock as of December 31, 2006, 2005, and 2004 and changes during the years then ended is presented below:



|                        |  |                                         |   |  |                                       |      
|----------------------- |  | --------------------------------------- | - |  | ------------------------------------- | -----
|                        |  | Non-Vested Restricted Stock Outstanding |   |  | WeightedAverage Grant Date Fair
Value
|Balance, 12/31/04       |  |                                        |   |  |                                       |     
|                        |  |                                         |   |  |                                       |      
|Granted                 |  | 15,025                                  |   |  |                                       |      
|Forfeited               |  | (350                                    | ) |  |                                       |      
|                        |  |                                         |   |  |                                       |      
|Balance, 12/31/05       |  | 14,675                                  |   |  | $                                     | 12.53
|                        |  |                                         |   |  |                                       |      
|Granted                 |  | 400                                     |   |  | $                                     | 13.34
|Forfeited               |  |                                        |   |  |                                       |     
|                        |  |                                         |   |  |                                       |      
|Outstanding at 12/31/06 |  | 15,075                                  |   |  | $                                     | 12.55
|                        |  |                                         |   |  |                                       |      

The Company determined at December 31, 2006 that the performance goals related to the vesting of the
restricted stock grants are no longer probable of being met, therefore previously recognized compensation cost in the amount of $76 was reversed as of December 31, 2006 and no further compensation expense will be recognized in relation to these
grants.

Modifications

Effective July 31, 2005,
the Human Resources Committee of the Board of Directors (HR Committee) voted to accelerate the vesting of stock options granted and outstanding to Wayne Lewis so that all options outstanding would be fully vested as of July 31, 2005
as a part of his retirement agreement. The HR Committee also voted to modify the terms so that all options granted and outstanding to Mr. Lewis would have an expiration date of July 31, 2008, the result of this modification was that the
period in which Mr. Lewis incentive stock options could be exercised was shortened, whereas the period in which Mr. Lewis non-qualified stock options could be exercised was lengthened. Since the above events transpired in 2005,
before FAS 123R became effective, there was no incremental compensation cost recognized as a result of the modifications.

Policy for issuing shares
upon option exercise

Options shall be exercised by the delivery of a written notice to the Company in the form prescribed by the HR Committee setting
forth the number of shares with respect to which the option is to be exercised, accompanied by full payment for the shares. The option price shall be payable to the Company in full either in cash, by delivery of shares of stock valued at fair market
value at the time of exercise, delivery of a promissory note (in the HR Committees sole discretion) or by a combination of the foregoing. As soon as practicable, after receipt of written notice and payment, the Company shall deliver to the
participant, stock certificates (new shares) in an appropriate amount based upon the number of options exercised, issued in the participants name. No participant who is awarded options shall have rights as a shareholder in connection with the
shares subject to such options until the date of exercise of the options.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 14. Income Taxes

Purchased Tax Credits

The Company periodically invests in tax credits. During the year ended December 31, 2006, an investment
was made in Dumas Center, L.P. The investment was recorded in accordance with APB Opinion No. 18 which states that the equity method of accounting best enables an investor in a corporate joint venture to recognize the underlying nature of the
investment regardless of duration. In accordance with APB Opinion No. 2, the allowable investment credit should be reflected over the productive life of acquired property. A federal tax credit of $838 was recognized in 2006.

APB Opinion No. 18 also states that in applying the equity method, a loss in value of an investment which is other than a temporary decline should be recognized the
same as a loss in value of other long-term assets. Since the value of the asset was based on tax credits, the value of the asset declined as the tax credits were consumed. Therefore, no balance remained at December 31, 2006 for book purposes.

Current and Deferred Income Tax Components

Total income tax expense (benefit) for the years ended December 31, 2006, 2005, and 2004 consists of the following:



|         |  |      |        |   |      |   |       |      |  |   |       |  
|-------- |  | ---- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|         |  | 2006 |        |   | 2005 |   |       | 2004 | 
|Current  |  | $    | 1,305  |   |      | $ | 1,563 |      |  | $ | 1,256 |  
|Deferred |  |      | (1,142 | ) |      |   | (249  | )    |  |   | (233  | )
|         |  |      |        |   |      |   |       |      |  |   |       |  
|         |  | $    | 163    |   |      | $ | 1,314 |      |  | $ | 1,023 |  
|         |  |      |        |   |      |   |       |      |  |   |       |  

Rate Reconciliation

Total income tax expense (benefit) differed from the expected amount computed by applying the U.S. Federal income tax rate of 34 percent to income before income taxes as a result of the following:



|                                       |  |      |       |   |      |   |       |      |  |   |       |  
|-------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                       |  | 2006 |       |   | 2005 |   |       | 2004 | 
|Tax at statutory federal rate          |  | $    | 1,035 |   |      | $ | 1,602 |      |  | $ | 1,308 |  
|Tax-exempt interest income             |  |      | (186  | ) |      |   | (203  | )    |  |   | (219  | )
|Tax-exempt interest disallowance       |  |      | 33    |   |      |   | 25    |      |  |   | 22    |  
|Cash surrender value of life insurance |  |      | (159  | ) |      |   | (110  | )    |  |   | (99   | )
|Tax Credits                            |  |      | (838  | ) |      |   |      |      |  |   |      |  
|Other                                  |  |      | 278   |   |      |   |      |      |  |   | 11    |  
|                                       |  |      |       |   |      |   |       |      |  |   |       |  
|                                       |  | $    | 163   |   |      | $ | 1,314 |      |  | $ | 1,023 |  
|                                       |  |      |       |   |      |   |       |      |  |   |       |  

Deferred Income Tax Analysis

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 are as follows:



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



|                                                       |  |      |       |   |      |   |       |  
|------------------------------------------------------ |  | ---- | ----- | - | ---- | - | ----- | -
|                                                       |  | 2006 |       |   | 2005 |  
|Deferred tax assets                                    |  |      |       |   |      |   |       |  
|Net unrealized losses on available-for-sale securities |  | $    | 190   |   |      | $ | 230   |  
|Allowance for loan losses                              |  |      | 1,852 |   |      |   | 1,179 |  
|Depreciation                                           |  |      |      |   |      |   |      |  
|Tax credit                                             |  |      | 659   |   |      |   |      |  
|Employee benefits                                      |  |      | 299   |   |      |   | 262   |  
|                                                       |  |      |       |   |      |   |       |  
|                                                       |  |      | 3,000 |   |      |   | 1,671 |  
|                                                       |  |      |       |   |      |   |       |  
|Deferred tax liabilities                               |  |      |       |   |      |   |       |  
|Net unrealized gains on available-for-sale securities  |  |      |      |   |      |   |      |  
|Net unrealized gains on derivatives                    |  |      | (36   | ) |      |   |      |  
|Depreciation                                           |  |      | (63   | ) |      |   | (5    | )
|Accretion of bond discount                             |  |      | (27   | ) |      |   | (28   | )
|                                                       |  |      |       |   |      |   |       |  
|Total deferred tax liabilities                         |  |      | (126  | ) |      |   | (33   | )
|                                                       |  |      |       |   |      |   |       |  
|Net deferred tax assets                                |  | $    | 2,874 |   |      | $ | 1,638 |  
|                                                       |  |      |       |   |      |   |       |  

No valuation allowance has been used because we believe we will recognize the full benefit of the deferred tax
asset shown above.

Concentrations of Credit Risk

The Bank grants commercial, residential and consumer loans to customers primarily in the Roanoke Valley area. The Bank has a diversified loan portfolio which is not dependent upon any particular economic or industry sector. As a whole, the
portfolio could be affected by general economic conditions in the Roanoke Valley region.

A detailed composition of the Banks loan portfolio is
provided in the consolidated financial statements. The Banks commercial loan portfolio is diversified, with no significant concentrations of credit. Commercial real estate loans are generally collateralized by the related property. The
residential real estate loan portfolio consists principally of loans collateralized by 1-4 family residential property. The loans to individuals portfolio consist of consumer loans primarily for home improvements, automobiles, personal
property and other consumer purposes. These loans are generally collateralized by the related property. Overall, the Banks loan portfolio is not concentrated within a single industry or group of industries, the loss of any one or more of which
would generate a materially adverse impact on the business of the Bank.

The Bank has established operating policies relating to the credit process and
collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property. Credit approval is principally a function of collateral and the evaluation of the creditworthiness of the borrower
based on available financial information.

Litigation

In the normal course of business the Bank may be involved in various legal proceedings. After consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the financial
statements.

Note 15. Commitments and Contingencies

The federal income tax returns of the Company for 2003, 2004, and 2005 remain subject to examination by the IRS, generally for three years after they are filed. The Company will file its 2006 tax return by the legal filing deadline.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 15. Commitments and Contingencies, continued

Financial Instruments with Off-Balance-Sheet Risk

The Bank is
a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These
instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial
instruments.

Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in
accordance with the terms of the contract. The Banks maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit
policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The Bank requires collateral to support financial
instruments when it is deemed necessary. The Bank evaluates customers creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on managements credit evaluation of the customer.
Collateral may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, real estate, accounts receivable, inventory, and property, plant and equipment. Financial instruments whose contract amounts
represent credit risk as of December 31 are as follows:



|                             |  |      |         |      |   |        
|---------------------------- |  | ---- | ------- | ---- | - | -------
|                             |  | 2006 |         | 2005
|Commitments to extend credit |  | $    | 156,580 |      | $ | 124,262
|Standby letters of credit    |  |      | 16,799  |      |   | 12,109 
|                             |  |      |         |      |   |        
|                             |  | $    | 173,379 |      | $ | 136,371
|                             |  |      |         |      |   |        

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments may be at fixed or variable rates and generally expire within one year. Since many of
the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond
financing and similar transactions. Unless renewed, substantially all of the Banks credit commitments at December 31, 2006 will expire within one year. Management does not anticipate any material losses as a result of these transactions.
The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

Derivative Financial
Instruments

For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining
rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge
period.

Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional
amount. The notional amount on which the interest payments are based is not exchanged. The Company entered into its first such derivative instrument in April 2006 when it entered into a forward-start interest rate swap agreement
(Agreement) to convert a portion of its variable rate loans to a fixed rate (cash flow hedge). We entered into this agreement to protect the Bank from interest rate exposure during a period of declining rates. The effective period of the
Agreement is April 19, 2007 through April 19, 2009.



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---

Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 15. Commitments and Contingencies, continued

Under SFAS 133, the effective portion of the gain or loss on a derivative designated and qualifying as a cash flow hedging instrument is initially reported as
a component of other comprehensive income and subsequently reclassified into earnings in the same period or periods during which cash flows are exchanged. The ineffective portion of the gain or loss on the derivative instrument, if any,
is recognized currently in earnings. As of December 31, 2006, the mark-to-market adjustment, net of taxes, included in other comprehensive income for this Agreement was $70.

Interest rate derivative financial instruments receive hedge accounting treatment only if they are designated as a hedge and are expected to be, and are, effective in substantially reducing interest rate risk
arising from assets and liabilities identified as exposing the Company to risk. Those derivative financial instruments that do not meet the hedging criteria discussed below would be classified as trading activities and would be recorded at fair
value with changes in fair value recorded in income. Derivative hedge contracts must meet specific effectiveness tests ( i.e., over time the change in their fair values due to the designated hedge risk must be within 80 to 125 percent of the
opposite change in the fair values of the hedged assets or liabilities). Changes in the fair value of the derivative financial instruments must be effective at offsetting changes in the fair value of the hedged items due to the designated hedge risk
during the term of the hedge. For the year ended December 31, 2006, the cash flow derivative was deemed to be highly effective.

In accordance with
SFAS No. 133, hedges of variable-rate loans are accounted for as cash flow hedges, with changes in fair values recorded in derivative assets or liabilities and other comprehensive income. The net settlement (upon close or termination) that
offsets changes in the value of the hedged asset or liability is recognized immediately in non-interest income. For the year ended December 31, 2006, there was no net settlement amount recognized in non-interest income.

Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in
the same category as the cash flow of the items being hedged.

Employment Agreements

The Company has entered into employment agreements with certain executive officers. The employment agreements provide for a certain minimum salary level that may be
increased, but not decreased, by the Board pursuant to an annual evaluation and also contain change-in-control provisions entitling the executive officer to certain benefits in the event employment is terminated within three years of a change in
control of the Company for reasons other than death, retirement, disability, cause, voluntary resignation other than for good reason, or pursuant to notice of termination given prior to the change in control.

Note 16. Regulatory Restrictions

Dividends

The Companys principal source of funds for dividend payments is dividends received from the Bank. The amount of dividends that may be paid by the Bank to the
Company will depend on the Banks earnings and capital position and is limited by state law, regulations and policies. A state bank may not pay dividends from its capital; all dividends must be paid out of net undivided profits then on hand.
Before any dividend is declared, any deficit in capital funds originally paid in shall have been restored by earnings to their initial level, and no dividend shall be declared or paid by any bank which would impair the paid-in-capital of the bank.
As of December 31, 2006 and 2005, the amount available for payment of dividends was $18,527 and $15,133, respectively.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 16. Regulatory Restrictions, continued

Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements
administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect
on the Companys consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures
of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Companys and the Banks capital amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as
defined). Management believes, as of December 31, 2006 and 2005 that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2006 and 2005, the Company and the Bank were categorized as well capitalized as defined by applicable regulations. To be categorized as well capitalized, the Company and
Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that date that management believes have changed the Companys or the Banks
category.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 16. Regulatory Restrictions, continued

The Companys and the Banks actual capital amounts and ratios are also presented in the table below.



|                                               |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|---------------------------------------------- |  | ------ | ------ | ----- | -------------------------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                               |  | Actual |        |       | Minimum RequiredFor CapitalAdequacy Purposes |   |        | Minimum to be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                               |  | Amount |        | Ratio |                                              |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio |       
|December 31, 2006                              |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk Weighted Assets):       |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 55,358 |       | 11.17                                        | % |        | $                                                                     | 39,657 |  | 8.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 50,324 |       | 10.23                                        | % |        | $                                                                     | 39,347 |  | 8.0 | %      |  | $     | 49,184 |  | 10.0 | %
|Tier 1 Capital (to Risk Weighted Assets):      |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 44,935 |       | 9.06                                         | % |        | $                                                                     | 19,828 |  | 4.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 44,666 |       | 9.08                                         | % |        | $                                                                     | 19,674 |  | 4.0 | %      |  | $     | 29,510 |  | 6.0  | %
|Tier 1 Capital (Leverage) (to Average Assets): |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 44,935 |       | 7.95                                         | % |        | $                                                                     | 22,595 |  | 4.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 44,666 |       | 7.94                                         | % |        | $                                                                     | 22,511 |  | 4.0 | %      |  | $     | 28,138 |  | 5.0  | %
|                                               |  |        |        |       |                                              |  
|December 31, 2005                              |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk Weighted Assets):       |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 46,285 |       | 10.76                                        | % |        | $                                                                     | 34,409 |  | 8.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 42,946 |       | 10.08                                        | % |        | $                                                                     | 34,095 |  | 8.0 | %      |  | $     | 42,619 |  | 10.0 | %
|Tier 1 Capital (to Risk Weighted Assets):      |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 41,552 |       | 9.66                                         | % |        | $                                                                     | 17,204 |  | 4.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 38,822 |       | 9.11                                         | % |        | $                                                                     | 17,048 |  | 4.0 | %      |  | $     | 25,571 |  | 6.0  | %
|Tier 1 Capital (Leverage) (to Average Assets): |  |        |        |       |                                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                                   |  | $      | 41,552 |       | 8.75                                         | % |        | $                                                                     | 18,993 |  | 4.0 | %      |  |       | n/a    |  | n/a  |  
|Valley Bank                                    |  | $      | 38,822 |       | 8.23                                         | % |        | $                                                                     | 18,874 |  | 4.0 | %      |  | $     | 23,594 |  | 5.0  | %

Inter-company transactions

Legal lending limits on loans by the Bank to the Company are governed by Federal Reserve Act 23A, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its
capital and surplus to its parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least 20% more than the amount of the loan, and if
obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts,
bills of exchange or bankers acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to
the Company was approximately $7.5 million at December 31, 2006. There were no loans from the Bank to the Company at December 31, 2006.



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---

Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 17. Related Party Transactions

The Company has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same
terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other
unfavorable features.

Aggregate 2006 and 2005 loan transactions with directors and executive officers were as follows:



|                              |  |      |         |   |      |   |         |  
|----------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                              |  | 2006 |         |   | 2005 |  
|Balances at beginning of year |  | $    | 17,090  |   |      | $ | 10,449  |  
|Addition of new director(s)   |  |      | 14      |   |      |   | 3,209   |  
|Advances                      |  |      | 14,554  |   |      |   | 14,091  |  
|Repayments                    |  |      | (11,403 | ) |      |   | (10,659 | )
|                              |  |      |         |   |      |   |         |  
|Balances at end of year       |  | $    | 20,255  |   |      | $ | 17,090  |  
|                              |  |      |         |   |      |   |         |  

Note 18. Parent Company Financial Information

Condensed financial information of Valley Financial Corporation is presented below:

Condensed Balance
Sheets

December 31, 2006 and 2005



|                                                                                                                                                     |  |      |        |   |      |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                                                                                                     |  | 2006 |        |   | 2005 |  
|Assets                                                                                                                                               |  |      |        |   |      |   |        |  
|Cash                                                                                                                                                 |  | $    | 1,612  |   |      | $ | 66     |  
|Loans                                                                                                                                                |  |      | 2,989  |   |      |   | 3,494  |  
|Investment in bank subsidiary, at equity                                                                                                             |  |      | 44,367 |   |      |   | 38,375 |  
|Investment in non-bank subsidiaries                                                                                                                  |  |      | 496    |   |      |   | 341    |  
|Other assets                                                                                                                                         |  |      | 784    |   |      |   | 81     |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Total assets                                                                                                                                         |  | $    | 50,248 |   |      | $ | 42,357 |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Liabilities                                                                                                                                          |  |      |        |   |      |   |        |  
|Balance due to non-bank subsidiaries                                                                                                                 |  | $    | 16,496 |   |      | $ | 11,341 |  
|Other liabilities                                                                                                                                    |  |      | 351    |   |      |   | 301    |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Total liabilities                                                                                                                                    |  |      | 16,847 |   |      |   | 11,642 |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Commitments and contingencies                                                                                                                        |  |      |       |   |      |   |       |  
|                                                                                                                                                     |  |     
|Shareholders equity                                                                                                                                 |  |      |        |   |      |   |        |  
|Common stock no par value; 10,000,000 shares authorized; issued and outstanding 4,112,074 shares and 4,076,993 shares in 2006 and 2005,
respectively |  |      | 17,212 |   |      |   | 16,981 |  
|Retained earnings                                                                                                                                    |  |      | 16,488 |   |      |   | 14,181 |  
|Accumulated other comprehensive income (loss)                                                                                                        |  |      | (299   | ) |      |   | (447   | )
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Total shareholders equity                                                                                                                           |  |      | 33,401 |   |      |   | 30,715 |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  
|Total liabilities and shareholders equity                                                                                                           |  | $    | 50,248 |   |      | $ | 42,357 |  
|                                                                                                                                                     |  |      |        |   |      |   |        |  



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---

Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 18. Parent Company Financial Information, continued

Condensed Statements of Income

Years Ended December 31, 2006, 2005, and 2004



|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|----------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                              |  | 2006 |       |   | 2005 |   |       | 2004 | 
|Income                                                                        |  |      |       |   |      |   |       |      |  |   |       |  
|Interest income                                                               |  | $    | 168   |   |      | $ | 122   |      |  | $ | 15    |  
|Dividend income from bank subsidiary                                          |  |      |      |   |      |   | 367   |      |  |   | 43    |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|                                                                              |  |      | 168   |   |      |   | 489   |      |  |   | 58    |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|Expenses                                                                      |  |      |       |   |      |   |       |      |  |   |       |  
|Interest expense on balance due to non-bank subsidiaries                      |  |      | 815   |   |      |   | 364   |      |  |   | 186   |  
|Other expenses                                                                |  |      | 134   |   |      |   | 169   |      |  |   | 97    |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|                                                                              |  |      | 949   |   |      |   | 533   |      |  |   | 283   |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|Loss before income taxes and equity in Undistributed net income of subsidiary |  |      | (781  | ) |      |   | (44   | )    |  |   | (225  | )
|                                                                              |  |      |      
|Income tax benefit                                                            |  |      | 268   |   |      |   | 140   |      |  |   | 91    |  
|Income (loss) before equity in undistributed net income of subsidiary         |  |      | (513  | ) |      |   | 96    |      |  |   | (134  | )
|Equity in undistributed net income of subsidiary                              |  |      | 3,395 |   |      |   | 3,296 |      |  |   | 2,958 |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  
|Net income                                                                    |  | $    | 2,882 |   |      | $ | 3,392 |      |  | $ | 2,824 |  
|                                                                              |  |      |       |   |      |   |       |      |  |   |       |  



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---

Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



Note 18. Parent Company Financial Information, continued

Condensed Statements of Cash Flows

Years Ended December 31, 2006, 2005, and 2004



|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                              |  | 2006 |        |   | 2005 |   |        | 2004 | 
|Cash flows from operating activities                                          |  |      |        |   |      |   |        |      |  |   |        |  
|Net income                                                                    |  | $    | 2,882  |   |      | $ | 3,392  |      |  | $ | 2,824  |  
|Adjustments to reconcile net income to net cash used in operating activities: |  |      |        |   |      |   |        |      |  |   |        |  
|Equity in undistributed net income of subsidiary                              |  |      | (3,395 | ) |      |   | (3,296 | )    |  |   | (2,958 | )
|Stock compensation expense                                                    |  |      | 82     |   |      |   |       |      |  |   |       |  
|(Increase) decrease in other assets                                           |  |      | (703   | ) |      |   | (176   | )    |  |   | 38     |  
|Increase in other liabilities                                                 |  |      | 49     |   |      |   | 186    |      |  |   | 41     |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net (cash used) provided by in operating activities                           |  |      | (1,085 | ) |      |   | 106    |      |  |   | (55    | )
|                                                                              |  |      |       
|Cash flows from investing activities                                          |  |      |        |   |      |   |        |      |  |   |        |  
|(Increase) / decrease in loans                                                |  |      | 505    |   |      |   | (1,944 | )    |  |   | (1,550 | )
|Investment in non-bank subsidiaries                                           |  |      | (155   | ) |      |   |       |      |  |   |       |  
|Investment in bank subsidiary                                                 |  |      | (2,450 | ) |      |   | (7,579 | )    |  |   |       |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                         |  |      | (2,100 | ) |      |   | (9,523 | )    |  |   | (1,550 | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|                                                                              |  |      |       
|Cash flows from financing activities                                          |  |      |        |   |      |   |        |      |  |   |        |  
|Trust preferred proceeds from non-bank subsidiaries                           |  |      | 5,155  |   |      |   | 7,000  |      |  |   |       |  
|Net proceeds from issuance of common stock                                    |  |      | 149    |   |      |   | 7      |      |  |   | 4,578  |  
|Cash dividends paid                                                           |  |      | (573   | ) |      |   | (489   | )    |  |   | (228   | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                                     |  |      | 4,731  |   |      |   | 6,518  |      |  |   | 4,350  |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net increase in cash                                                          |  |      | 1,546  |   |      |   | (2,899 | )    |  |   | 2,745  |  
|Cash at beginning of year                                                     |  |      | 66     |   |      |   | 2,965  |      |  |   | 220    |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Cash at end of year                                                           |  | $    | 1,612  |   |      | $ | 66     |      |  | $ | 2,965  |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  

Note 19. Subsequent Events

On February 15, 2007, Valley Bank (Bank), the wholly-owned subsidiary of Valley Financial Corporation (Company) terminated its forward start interest rate swap agreement
(Agreement) with Compass Bank of Birmingham, Alabama. The Agreement was entered into on April 17, 2006 to provide an additional method of managing interest rate risk. The Bank terminated the Agreement due to the shift of the
Banks balance sheet to a more liability-sensitive position and the changing interest rate environment as compared to when the Bank entered into the Agreement. The Bank recorded a realized gain on the termination of the Agreement of $50,629.



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Valley Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December
31, 2006, 2005, and 2004

(In thousands, except share data)

---



|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|---------------------------------------------------------------------------------------------------- |  | ---- | --------------------------------- | -- | ---- | ----- |  | -- | ----- |  | -- | ----- | -- |  | -- | ----- |  | -- | ----- |  | - | ----- | - |  | - | ----- | -
|Note 20.                                                                                             |  |      | Selected Quarterly Financial Data |   
|                                                                                                     |  |      | (000s omitted)                   |   
|                                                                                                     |  | 2006 |                                   |    | 2005 |      
|                                                                                                     |  | 1Q   |                                   | 2Q |      | 3Q    |  | 4Q |       |  | 1Q |       | 2Q |  | 3Q |       |  | 4Q |      
|Interest income                                                                                      |  | $    | 7,831                             |    | $    | 8,436 |  | $  | 9,109 |  | $  | 9,541 |    |  | $  | 5,044 |  | $  | 5,729 |  | $ | 6,435 |   |  | $ | 7,371 |  
|Interest expense                                                                                     |  |      | 4,034                             |    |      | 4,505 |  |    | 5,140 |  |    | 5,558 |    |  |    | 2,098 |  |    | 2,468 |  |   | 2,912 |   |  |   | 3,502 |  
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Net interest income                                                                                  |  |      | 3,797                             |    |      | 3,931 |  |    | 3,969 |  |    | 3,983 |    |  |    | 2,946 |  |    | 3,261 |  |   | 3,523 |   |  |   | 3,869 |  
|Provision for loan losses                                                                            |  |      | 587                               |    |      | 119   |  |    | 387   |  |    | 1,703 |    |  |    | 324   |  |    | 401   |  |   | 455   |   |  |   | 117   |  
|Noninterest income                                                                                   |  |      | 456                               |    |      | 526   |  |    | 682   |  |    | 548   |    |  |    | 332   |  |    | 440   |  |   | 419   |   |  |   | 424   |  
|Noninterest expense                                                                                  |  |      | 2,721                             |    |      | 2,852 |  |    | 2,886 |  |    | 3,592 |    |  |    | 2,051 |  |    | 2,311 |  |   | 2,257 |   |  |   | 2,592 |  
|Tax provision                                                                                        |  |      | 245                               |    |      | 446   |  |    | 392   |  |    | (920  | )  |  |    | 233   |  |    | 267   |  |   | 352   |   |  |   | 462   |  
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Net income                                                                                           |  | $    | 700                               |    | $    | 1,040 |  | $  | 986   |  | $  | 156   |    |  | $  | 670   |  | $  | 722   |  | $ | 878   |   |  | $ | 1,122 |  
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Basic EPS                                                                                            |  | $    | 0.17                              |    | $    | 0.25  |  | $  | 0.24  |  | $  | 0.04  |    |  | $  | 0.16  |  | $  | 0.18  |  | $ | 0.22  |   |  | $ | 0.27  |  
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Diluted EPS                                                                                          |  | $    | 0.17                              |    | $    | 0.25  |  | $  | 0.23  |  | $  | 0.04  |    |  | $  | 0.16  |  | $  | 0.17  |  | $ | 0.21  |   |  | $ | 0.27  |  
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|                                                                                                    
|Reclasses made to properly account for reclassification of foreclosed asset expense, net as follows: | 
|                                                                                                     |  |      |                                   |    |      |       |  |   
|Non interest income, reported                                                                        |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    | 332   |  |    | 440   |  |   | 548   |   |  |   | 426   |  
|Reclass                                                                                              |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |      |  |    |      |  |   | (129  | ) |  |   | (2    | )
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Revised                                                                                              |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    | 332   |  |    | 440   |  |   | 419   |   |  |   | 424   |  
|                                                                                                     |  |      |                                   |    |      |       |  |   
|Noninterest expense, reported                                                                        |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    | 2,051 |  |    | 2,311 |  |   | 2,386 |   |  |   | 2,594 |  
|Reclass                                                                                              |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |      |  |    |      |  |   | (129  | ) |  |   | (2    | )
|                                                                                                     |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    |       |  |    |       |  |   |       |   |  |   |       |  
|Revised                                                                                              |  |      |                                   |    |      |       |  |    |       |  |    |       |    |  |    | 2,051 |  |    | 2,311 |  |   | 2,257 |   |  |   | 2,592 |  



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|Item 9. | Changes in and Disagreements on Accounting and Financial Disclosures
|------- | --------------------------------------------------------------------

None.



|Item 9A. | Disclosure Controls and Procedures
|-------- | ----------------------------------

As of the end
of the period covered by this annual report, an evaluation was performed under the supervision and with the participation of the Companys management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure
controls and procedures were effective. We continue to evaluate our internal controls each year. As part of this process, we made the following enhancements to our internal controls related to lending:



| |  |  | Realignment of supervisory response with respect to credit administration;
| | - |  | --------------------------------------------------------------------------



| |  |  | Strengthening the independence of the credit administration function; and
| | - |  | -------------------------------------------------------------------------



| |  |  | Implementation of additional training and monitoring procedures with respect to asset-based lending.
| | - |  | ----------------------------------------------------------------------------------------------------

These controls will further ensure the effectiveness of our disclosure controls and procedures in future periods.

Disclosure controls and procedures are our controls and procedures that are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required
disclosure.

The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There
can be no assurance that any design will succeed in achieving its stated goal under every potential condition, regardless of how remote. In addition, the operation of any system of controls and procedures is dependent upon the employees responsible
for executing it. While we have evaluated the operation of our disclosure controls and procedures and found them effective, there can be no assurance that they will succeed in every instance to achieve their objective.



|Item 9B. | Other Information
|-------- | -----------------

None.

PART III.



|Item 10. | Directors and Executive Officers.
|-------- | ---------------------------------

The information
required by Items 401, 405, and 406 of Regulation S-K is set forth under the captions Information Concerning Directors and Nominees, Certain Relationships and Related Transactions, Audit Committee Information,
Nominating Committee, Audit Committee Financial Expert, Section 16(a) Beneficial Ownership Reporting Compliance, and Code of Ethics of the Companys Proxy Statement dated March 15, 2007 and
is incorporated herein by reference.



|Item 11. | Executive Compensation.
|-------- | -----------------------

The information required
by Item 402 of Regulation S-K is set forth under the caption Executive Compensation of the Companys Proxy Statement dated March 15, 2007 and is incorporated herein by reference.



85



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|Item 12. | Security Ownership of Certain Beneficial Owners and Management.
|-------- | ---------------------------------------------------------------

The information required by Items 201(d) and 403 of Regulation S-K is set forth under the caption Security Ownership of Certain Beneficial Owners of the Companys Proxy Statement dated March 15,
2007 and is incorporated herein by reference.



|Item 13. | Certain Relationships and Related Transactions.
|-------- | -----------------------------------------------

The information required by Item 404 of Regulation S-K is set forth under the caption Certain Relationships and Related Transactions of the Companys Proxy Statement dated March 15, 2007 and is incorporated herein
by reference.



|Item 14. | Principal Accountant Fees and Services.
|-------- | ---------------------------------------

The
information required by item 9(e) of Schedule 14A is set forth under the caption Audit Committee Information of the Companys Proxy Statement dated March 15, 2007 and is incorporated herein by reference.



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PART IV.



|Item 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------



|(a) | The following documents are filed as part of this Report and can be found on our Company website at www.myvalleybank.com:
|--- | -------------------------------------------------------------------------------------------------------------------------



| | 1. | Financial Statements:
| | -- | ---------------------

Independent Auditors Report.

Consolidated Balance Sheets as of December 31, 2006 and 2005.

Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004.

Consolidated Statements of Shareholders Equity for the Years Ended December 31, 2006, 2005 and 2004.

Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004.

Notes to Consolidated Financial Statements.



| | 2. | Financial Statement Schedules:
| | -- | ------------------------------

All schedules are omitted as the required
information is inapplicable or the information is presented in the Financial Statements or related notes.



| | 3. | Exhibits and Reports on Form 8-K:
| | -- | ---------------------------------



|      |  |                                                                                                                                                                                                                
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on form S-1, as amended).                                                               
|      | 
|3.2   |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                  
|      | 
|3.3   |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit No. 3.3 of Form 10-KSB filed March 30, 2004, File No. 33-77568).                                                                  
|      | 
|*10.2 |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March 27, 1997, File
No. 33-77568).
|      | 
|*10.3 |  | Stock Option Agreement dated December 16, 1999, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-K filed March 28, 2006, File No.
33-77568)   



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|       |  |                                                                                                                                                                                                                                   
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|*10.4  |  | Stock Option Agreement dated January 29, 2001, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-K filed March 28, 2006,
File No. 33-77568)                       
|       | 
|*10.5  |  | Stock Option Agreement dated January 10, 2002, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.5 of Form 10-K filed March 28, 2006, File No.
33-77568)                       
|       | 
|*10.6  |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.6 of Form 10-K filed March 28, 2006, File No.
33-77568)                           
|       | 
|*10.7  |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.7 of Form 10-K filed March 28, 2006, File No.
33-77568)                       
|       | 
|*10.8  |  | Employment agreement dated September 21, 2000, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.2 of Form SB-2, filed September 27, 2000, and Form
SB-2/A filed October 25, 2000).
|       | 
|*10.9  |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                       
|       | 
|*10.10 |  | Employment agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.15 of Form 10-QSB filed November 14, 2002, File No.
33-77568).                      
|       | 
|*10.11 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).              
|       | 
|*10.12 |  | Stock Option Agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 28, 2006, File
No. 33-77568)                     
|       | 
|*10.13 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (incorporated herein by reference to Exhibit 10.18 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).            
|       | 
|*10.14 |  | Stock Option Agreement dated January 21, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.14 of Form 10-K filed March 28, 2006, File
No. 33-77568)                     
|       | 
|*10.15 |  | Stock Option Agreement dated December 16, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.15 of Form 10-K filed March 28, 2006, File
No. 33-77568)                    
|       | 
|*10.16 |  | Stock Option Agreement dated January 29, 2001, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.16 of Form 10-K filed March 28, 2006, File
No. 33-77568)                     



88



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|       |  |                                                                                                                                                                                                                                               
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.17 |  | Stock Option Agreement dated January 10, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.17 of Form 10-K filed March 28,
2006, File No. 33-77568)                                 
|       | 
|*10.18 |  | Stock Option Agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.18 of Form 10-K filed March 28, 2006, File No.
33-77568)                                  
|       | 
|*10.19 |  | Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.20 of Form
10-KSB filed March 30, 2004, File No. 33-77568).
|       | 
|*10.20 |  | Stock Option Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.20 of Form 10-K filed March 28, 2006, File No.
33-77568)                                     
|       | 
|*10.21 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.21 of Form 10-K filed March 28, 2006, File
No. 33-77568)                                 
|       | 
|*10.22 |  | Stock Option Agreement dated November 11, 2004, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.22 of Form 10-K filed March 28, 2006, File No.
33-77568)                                   
|       | 
|*10.23 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.23 of Form 10-K filed March 28, 2006, File No.
33-77568)                                    
|       | 
|*10.24 |  | Stock Option Agreement dated November 11, 2004, by and between the Company and Andrew B. Agee (incorporated herein by reference to Exhibit No. 10.24 of Form 10-K filed March 28, 2006, File No.
33-77568)                                    
|       | 
|*10.25 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Andrew Agee (incorporated herein by reference to Exhibit No. 10.25 of Form 10-K filed March 28, 2006, File No.
33-77568)                                        
|       | 
|10.26  |  | Letter agreement regarding retirement of A. Wayne Lewis dated July 22, 2005, by and among the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.21 of Form 10-Q filed
November 14, 2005, File No. 33-77568).         
|       | 
|*10.27 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                            
|       | 
|*10.28 |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                                
|       | 
|*10.29 |  | Restricted Stock Agreement dated August 10, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                         
|       | 
|*10.30 |  | Stock Option Agreement dated August 10, 2005 by, and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                             



89



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|     |  |                                                                                                                                                                 
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|11.  |  | Statement re Computation of Earnings per Share (filed herewith as Note 10).                                                                                     
|     | 
|21.  |  | Subsidiaries of the Registrant.                                                                                                                                 
|     | 
|24.  |  | Power of Attorney.                                                                                                                                              
|     | 
|31.1 |  | Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                               
|     | 
|31.2 |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                               
|     | 
|32.1 |  | Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
|     | 
|32.2 |  | Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

---

|* | Management contract or compensatory plan or agreement required to be filed as an Exhibit to this Form 10-K pursuant to Item 13(a).
|- | ----------------------------------------------------------------------------------------------------------------------------------



90



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 on March 15, 2007.



Valley Financial CorporationBy:

/s/ Ellis L. GutshallEllis L. GutshallPresident and Chief Executive Officer


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 following persons in the capacities indicated as of March 15, 2007.



|                                                  |  |                                                                                               
|------------------------------------------------- |  | ----------------------------------------------------------------------------------------------
|Signature                                         |  | Title                                                                                         
|                                                  | 
|/s/ Ellis L. Gutshall (Ellis L.
Gutshall)         |  | President, Chief Executive Officer and Director (Principal Executive Officer)                 
|                                                  | 
|/s/ Kimberly B. Snyder (Kimberly B.
Snyder)       |  | Executive Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)
|                                                  | 
|/s/ J. Randy Woodson (J. Randy
Woodson)           |  | Executive Vice President, Chief Operating Officer                                             
|                                                  | 
|/s/ Abney S. Boxley, III * (Abney S.
Boxley, III) |  | Director                                                                                      
|                                                  | 
|/s/ William D. Elliot * (William D.
Elliot)       |  | Director                                                                                      
|                                                  | 
|/s/ James S. Frantz, Jr. (James S.
Frantz, Jr.)   |  | Director                                                                                      
|                                                  | 
|/s/ Mason Haynesworth * (Mason
Haynesworth)       |  | Director                                                                                      
|                                                  | 
|/s/ Eddie F. Hearp * (Eddie F.
Hearp)             |  | Director                                                                                      
|                                                  | 
|/s/ Anna L. Lawson * (Anna L.
Lawson)             |  | Director                                                                                      
|                                                  | 
|/s/ Barbara B. Lemon * (Barbara B.
Lemon)         |  | Director                                                                                      



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##### Table of Contents

|                                                            |  |                   
|----------------------------------------------------------- |  | ------------------
|/s/ A. Wayne Lewis * (A. Wayne
Lewis)                       |  | Director          
|                                                            | 
|/s/ Samuel L. Lionberger, Jr. * (Samuel
L. Lionberger, Jr.) |  | Director          
|                                                            | 
|/s/ George W. Logan * (George W.
Logan)                     |  | Chairman, Director
|                                                            | 
|/s/ Geoffrey M. Ottaway * (Geoffrey M.
Ottaway)             |  | Director          
|                                                            | 
|/s/ John W. Starr * (John W.
Starr)                         |  | Director          
|                                                            | 
|/s/ Ward W. Stevens * (Ward W.
Stevens)                     |  | Director          
|                                                            | 
|/s/ Michael E. Warner * (Michael E.
Warner)                 |  | Director          

|      |  |                        |  | 
|----- |  | ---------------------- |  | 
|      |  |                       
|* By: |  | /s/ Kimberly B. Snyder |  | 
|      |  | (Kimberly B. Snyder)   |  | 
|      |  | (Attorney in Fact)     |  | 



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INDEX TO EXHIBITS



|       |  |                                                                                                                                                                                                                                   
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1    |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                  
|       | 
|3.2    |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                                     
|       | 
|3.3    |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit No. 3.3 of Form 10-KSB filed March 30, 2004, File No. 33-77568).                                                                                     
|       | 
|*10.2  |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March 27, 1997, File
No. 33-77568).                   
|       | 
|*10.3  |  | Stock Option Agreement dated December 16, 1999, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-K filed March 28, 2006, File No.
33-77568)                      
|       | 
|*10.4  |  | Stock Option Agreement dated January 29, 2001, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-K filed March 28, 2006, File No.
33-77568)                       
|       | 
|*10.5  |  | Stock Option Agreement dated January 10, 2002, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.5 of Form 10-K filed March 28, 2006, File No.
33-77568)                       
|       | 
|*10.6  |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.6 of Form 10-K filed March 28, 2006, File No.
33-77568)                           
|       | 
|*10.7  |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.7 of Form 10-K filed March 28, 2006, File No.
33-77568)                       
|       | 
|*10.8  |  | Employment agreement dated September 21, 2000, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.2 of Form SB-2, filed September 27, 2000, and Form
SB-2/A filed October 25, 2000).
|       | 
|*10.9  |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                       
|       | 
|*10.10 |  | Employment agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.15 of Form 10-QSB filed November 14, 2002, File No.
33-77568).                      
|       | 
|*10.11 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).              
|       | 
|*10.12 |  | Stock Option Agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 28, 2006, File
No. 33-77568)                     



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|       |  |                                                                                                                                                                                                                       
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.13 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (incorporated herein by reference to Exhibit 10.18 of Form 10-QSB filed
November 14, 2003, File No. 33-77568).
|       | 
|*10.14 |  | Stock Option Agreement dated January 21, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.14 of Form 10-K filed March 28, 2006, File
No. 33-77568)         
|       | 
|*10.15 |  | Stock Option Agreement dated December 16, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.15 of Form 10-K filed March 28, 2006, File
No. 33-77568)        
|       | 
|*10.16 |  | Stock Option Agreement dated January 29, 2001, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.16 of Form 10-K filed March 28, 2006, File
No. 33-77568)         
|       | 
|*10.17 |  | Stock Option Agreement dated January 10, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.17 of Form 10-K filed March 28, 2006, File
No. 33-77568)         
|       | 
|*10.18 |  | Stock Option Agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.18 of Form 10-K filed March 28, 2006, File No.
33-77568)          



94



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|       |  |                                                                                                                                                                                                                                               
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.19 |  | Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.20 of
Form 10-KSB filed March 30, 2004, File No. 33-77568).
|       | 
|*10.20 |  | Stock Option Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.20 of Form 10-K filed March 28, 2006, File No.
33-77568)                                     
|       | 
|*10.21 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.21 of Form 10-K filed March 28, 2006, File
No. 33-77568)                                 
|       | 
|*10.22 |  | Stock Option Agreement dated November 11, 2004, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.22 of Form 10-K filed March 28, 2006, File No.
33-77568)                                   
|       | 
|*10.23 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.23 of Form 10-K filed March 28, 2006, File No.
33-77568)                                    
|       | 
|*10.24 |  | Stock Option Agreement dated November 11, 2004, by and between the Company and Andrew B. Agee (incorporated herein by reference to Exhibit No. 10.24 of Form 10-K filed March 28, 2006, File No.
33-77568)                                    
|       | 
|*10.25 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Andrew Agee (incorporated herein by reference to Exhibit No. 10.25 of Form 10-K filed March 28, 2006, File No.
33-77568)                                        
|       | 
|10.26  |  | Letter agreement regarding retirement of A. Wayne Lewis dated July 22, 2005, by and among the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.21 of Form 10-Q filed
November 14, 2005, File No. 33-77568).         
|       | 
|*10.27 |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                            
|       | 
|*10.28 |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                                
|       | 
|*10.29 |  | Restricted Stock Agreement dated August 10, 2005, by and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                         
|       | 
|*10.30 |  | Stock Option Agreement dated August 10, 2005 by, and between the Company and Kimberly B. Snyder (filed herewith).                                                                                                                             
|       | 
|11.    |  | Statement re Computation of Earnings per Share (filed herewith as Note 10).                                                                                                                                                                   
|       | 
|21.    |  | Subsidiaries of the Registrant (filed herewith).                                                                                                                                                                                              
|       | 
|24.    |  | Power of Attorney (filed herewith).                                                                                                                                                                                                           



95



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|     |  |                                                                                                                                                                 
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                               
|     | 
|31.2 |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                               
|     | 
|32.1 |  | Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
|     | 
|32.2 |  | Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

---

|* | Management contract or compensatory plan or agreement required to be filed as an Exhibit to this Form 10-K pursuant to Item 13(a).
|- | ----------------------------------------------------------------------------------------------------------------------------------



96