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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the Quarterly Period Ended March 31, 2006



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

For the transition period from  to

Commission File Number: 000-28342



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VALLEY FINANCIAL CORPORATION



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|                         |  |                                     
|------------------------ |  | ------------------------------------
|VIRGINIA                 |  | 54-1702380                          
|(State of Incorporation) |  | (I.R.S. Employer Identification No.)

36 Church Avenue, S.W.

Roanoke, Virginia 24011

(Address of principal executive offices)

(540) 342-2265

(Issuers telephone number, including area code)



---

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 checkmark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated 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 checkmark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act.)    Yes ̈No  x

Transitional small business disclosure format:    Yes ̈No  x.

At May 9, 2006, 4,108,493 shares of common stock, no par value, of the registrant were outstanding.



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

FORM 10-Q

March 31, 2006

TABLE OF CONTENTS



|               |  |                                                                     |  |   
|-------------- |  | ------------------------------------------------------------------- |  | --
|Part I.        |  | FINANCIAL INFORMATION                                               |  |   
|               |  |                                                                    
|               |  | Item 1.
Financial Statements                                        |  |   
|               |  |                                                                    
|               |  | Consolidated Balance Sheets                                         |  | 4 
|               |  | Consolidated Statements of Income                                   |  | 5 
|               |  | Consolidated Statements of Cash Flows                               |  | 6 
|               |  | Notes to Consolidated Financial Statements                          |  | 7 
|               |  |                                                                    
|               |  | Item 2.
Managements Discussion and Analysis                        |  | 17
|               |  |                                                                    
|               |  | Item 3.
Quantitative and Qualitative Disclosures about Market Risk  |  | 32
|               |  |                                                                    
|               |  | Item 4.
Controls and Procedures                                     |  | 32
|               |  |                                                                    
|Part II.       |  | OTHER INFORMATION                                                   |  |   
|               |  |                                                                    
|               |  | Item 1.
Legal Proceedings                                           |  | 33
|               |  |                                                                    
|               |  | Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds |  | 33
|               |  |                                                                    
|               |  | Item 3.
Defaults Upon Senior Securities                             |  | 33
|               |  |                                                                    
|               |  | Item 4.
Submission of Matters to a Vote of Security Holders         |  | 33
|               |  |                                                                    
|               |  | Item 5.
Other Information                                           |  | 33
|               |  |                                                                    
|               |  | Item 6.
Index to Exhibits                                           |  | 34
|               | 
|SIGNATURES     |  | 37                                                                 
|               | 
|CERTIFICATIONS |  | 38                                                                 



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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 1  FINANCIAL INFORMATION

Item 1. Financial Statements.

VALLEY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)



|                                                                                                                      |  |                     |         |   |                    |   |         |  
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------- | ------- | - | ------------------ | - | ------- | -
|                                                                                                                      |  | (Unaudited) 3/31/06 |         |   | (Audited) 12/31/05 |  
|Assets                                                                                                                |  |                     |         |   |                    |   |         |  
|Cash and due from banks                                                                                               |  | $                   | 6,642   |   |                    | $ | 9,746   |  
|Interest-bearing deposits in banks                                                                                    |  |                     | 137     |   |                    |   | 336     |  
|Securities available-for-sale                                                                                         |  |                     | 32,077  |   |                    |   | 33,206  |  
|Securities held-to-maturity (approximate market values of $20,160 at March 31, 2006 and $20,524 at December 31,
2005) |  |                     | 20,608  |   |                    |   | 20,796  |  
|Restricted equity securities                                                                                          |  |                     | 4,596   |   |                    |   | 3,987   |  
|Loans, net of allowance for loan losses of $4,709 at March 31, 2006 and $4,124 at December 31, 2005                   |  |                     | 429,451 |   |                    |   | 410,253 |  
|Premises and equipment, net                                                                                           |  |                     | 6,915   |   |                    |   | 6,590   |  
|Bank owned life insurance                                                                                             |  |                     | 10,165  |   |                    |   | 8,950   |  
|Accrued interest receivable                                                                                           |  |                     | 2,230   |   |                    |   | 2,073   |  
|Other assets                                                                                                          |  |                     | 3,358   |   |                    |   | 3,012   |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Total assets                                                                                                          |  | $                   | 516,179 |   |                    | $ | 498,949 |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Liabilities and Shareholders Equity                                                                                  |  |                     |         |   |                    |   |         |  
|Liabilities:                                                                                                          |  |                     |         |   |                    |   |         |  
|Noninterest- bearing deposits                                                                                         |  | $                   | 19,407  |   |                    | $ | 19,466  |  
|Interest-bearing deposits                                                                                             |  |                     | 356,033 |   |                    |   | 345,850 |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Total deposits                                                                                                        |  |                     | 375,440 |   |                    |   | 365,316 |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Federal funds purchased and securities sold under agreements to repurchase                                            |  |                     | 30,731  |   |                    |   | 27,829  |  
|Short-term borrowings                                                                                                 |  |                     | 26,000  |   |                    |   | 23,000  |  
|Long-term borrowings                                                                                                  |  |                     | 37,000  |   |                    |   | 37,000  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures                             |  |                     | 11,341  |   |                    |   | 11,341  |  
|Accrued interest payable                                                                                              |  |                     | 2,607   |   |                    |   | 2,129   |  
|Other liabilities                                                                                                     |  |                     | 1,690   |   |                    |   | 1,619   |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Total liabilities                                                                                                     |  |                     | 484,809 |   |                    |   | 468,234 |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Commitments and other contingencies                                                                                   |  |                     |        |   |                    |   |        |  
|                                                                                                                      |  |                    
|Shareholders equity:                                                                                                 |  |                     |         |   |                    |   |         |  
|Preferred stock, no par value. Authorized 10,000,000 shares; none issued and outstanding                              |  |                     |        |   |                    |   |        |  
|Common stock, no par value. Authorized 10,000,000 shares; issued and outstanding 4,102,193 at March 31,2006, and      |  |                     |         |   |                    |   |         |  
|4,076,993 at December 31, 2005, respectively                                                                          |  |                     | 17,135  |   |                    |   | 16,981  |  
|Retained earnings                                                                                                     |  |                     | 14,881  |   |                    |   | 14,181  |  
|Accumulated other comprehensive income (loss)                                                                         |  |                     | (646    | ) |                    |   | (447    | )
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Total shareholders equity                                                                                            |  |                     | 31,370  |   |                    |   | 30,715  |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  
|Total liabilities and shareholders equity                                                                            |  | $                   | 516,179 |   |                    | $ | 498,949 |  
|                                                                                                                      |  |                     |         |   |                    |   |         |  

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except
share and per share data)



|                                                                                                      |  |                |           |   |         |   |          
|----------------------------------------------------------------------------------------------------- |  | -------------- | --------- | - | ------- | - | ---------
|                                                                                                      |  | 3 Months Ended
|                                                                                                      |  | 3/31/06        |           |   | 3/31/05
|Interest Income:                                                                                      |  |                |           |   |         |   |          
|Interest and fees on loans                                                                            |  | $              | 7,204     |   |         | $ | 4,279    
|Interest on securities - taxable                                                                      |  |                | 484       |   |         |   | 584      
|Interest on securities - nontaxable                                                                   |  |                | 138       |   |         |   | 159      
|Interest on deposits in banks                                                                         |  |                | 5         |   |         |   | 22       
|                                                                                                      |  |                |           |   |         |   |          
|Total interest income                                                                                 |  |                | 7,831     |   |         |   | 5,044    
|                                                                                                      |  |                |           |   |         |   |          
|Interest Expense:                                                                                     |  |                |           |   |         |   |          
|Interest on deposits                                                                                  |  |                | 2,923     |   |         |   | 1,498    
|Interest on short-term borrowings                                                                     |  |                | 299       |   |         |   | 112      
|Interest on long-term borrowings                                                                      |  |                | 388       |   |         |   | 389      
|Interest on guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                | 183       |   |         |   | 57       
|Interest on federal funds purchased and securities sold under agreements to repurchase                |  |                | 241       |   |         |   | 42       
|                                                                                                      |  |                |           |   |         |   |          
|Total interest expense                                                                                |  |                | 4,034     |   |         |   | 2,098    
|                                                                                                      |  |                |           |   |         |   |          
|Net interest income                                                                                   |  |                | 3,797     |   |         |   | 2,946    
|                                                                                                      |  |               
|Provision for loan losses                                                                             |  |                | 587       |   |         |   | 324      
|                                                                                                      |  |                |           |   |         |   |          
|Net interest income after provision for loan losses                                                   |  |                | 3,210     |   |         |   | 2,622    
|                                                                                                      |  |                |           |   |         |   |          
|Noninterest Income:                                                                                   |  |                |           |   |         |   |          
|Service charges on deposit accounts                                                                   |  |                | 213       |   |         |   | 210      
|Realized gains (losses) on sale of securities available-for-sale                                      |  |                | (1        | ) |         |   | 1        
|Income earned on bank owned life insurance                                                            |  |                | 115       |   |         |   | 76       
|Other income on real estate loans                                                                     |  |                |          |   |         |   | 16       
|Other income                                                                                          |  |                | 129       |   |         |   | 29       
|                                                                                                      |  |                |           |   |         |   |          
|Total noninterest income                                                                              |  |                | 456       |   |         |   | 332      
|                                                                                                      |  |                |           |   |         |   |          
|Noninterest Expense:                                                                                  |  |                |           |   |         |   |          
|Compensation expense                                                                                  |  |                | 1,485     |   |         |   | 1,044    
|Occupancy expense                                                                                     |  |                | 157       |   |         |   | 148      
|Equipment expense                                                                                     |  |                | 135       |   |         |   | 111      
|Data processing expense                                                                               |  |                | 152       |   |         |   | 130      
|Advertising and marketing expense                                                                     |  |                | 84        |   |         |   | 41       
|Audit fees                                                                                            |  |                | 73        |   |         |   | 73       
|Franchised and purchased tax credit expense                                                           |  |                | 67        |   |         |   | 47       
|Business manager                                                                                      |  |                | 61        |   |         |   | 71       
|Deposit expense                                                                                       |  |                | 99        |   |         |   | 53       
|Loan expenses                                                                                         |  |                | 55        |   |         |   | 43       
|Computer software                                                                                     |  |                | 83        |   |         |   | 68       
|Other expense                                                                                         |  |                | 270       |   |         |   | 222      
|                                                                                                      |  |                |           |   |         |   |          
|Total noninterest expense                                                                             |  |                | 2,721     |   |         |   | 2,051    
|                                                                                                      |  |                |           |   |         |   |          
|Income before income taxes                                                                            |  |                | 945       |   |         |   | 903      
|                                                                                                      |  |               
|Income tax expense                                                                                    |  |                | 245       |   |         |   | 233      
|                                                                                                      |  |                |           |   |         |   |          
|Net income                                                                                            |  | $              | 700       |   |         | $ | 670      
|                                                                                                      |  |                |           |   |         |   |          
|Earnings per share                                                                                    |  |                |           |   |         |   |          
|Basic earnings per share                                                                              |  | $              | 0.17      |   |         | $ | 0.16     
|                                                                                                      |  |                |           |   |         |   |          
|Diluted earnings per share                                                                            |  | $              | 0.17      |   |         | $ | 0.16     
|                                                                                                      |  |                |           |   |         |   |          
|Weighted average shares                                                                               |  |                | 4,079,233 |   |         |   | 4,074,630
|                                                                                                      |  |                |           |   |         |   |          
|Diluted average shares                                                                                |  |                | 4,189,866 |   |         |   | 4,270,816
|                                                                                                      |  |                |           |   |         |   |          

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands, except
share and per share data)



|                                                                                                  |  |                |         |   |         |   |         |  
|------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ------- | - | ------- | -
|                                                                                                  |  | 3 months ended |        
|                                                                                                  |  | 3/31/06        |         |   | 3/31/05 |  
|Cash flows from operating activities                                                              |  |                |         |   |         |   |         |  
|Net income                                                                                        |  | $              | 700     |   |         | $ | 670     |  
|Adjustments to reconcile net income to net cash provided by operating activities:                 |  |                |         |   |         |   |         |  
|Provision for loan losses                                                                         |  |                | 587     |   |         |   | 324     |  
|Depreciation and amortization                                                                     |  |                | 187     |   |         |   | 168     |  
|Stock option expense                                                                              |  |                | 39      |   |         |   |        |  
|Deferred income tax                                                                               |  |                | (270    | ) |         |   |        |  
|Net losses on sale of securities                                                                  |  |                | 1       |   |         |   |        |  
|Amortization (accretion) of bond premiums/discounts                                               |  |                | 46      |   |         |   | 50      |  
|Increase in interest receivable                                                                   |  |                | (157    | ) |         |   | (161    | )
|Increase in other assets                                                                          |  |                | (90     | ) |         |   | (162    | )
|Increase in value of life insurance contracts                                                     |  |                | (115    | ) |         |   | (76     | )
|Increase (decrease) in accrued interest payable                                                   |  |                | 478     |   |         |   | (4      | )
|Increase (decrease) in other liabilities                                                          |  |                | 356     |   |         |   | (5      | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash provided by operating activities                                                         |  |                | 1,762   |   |         |   | 804     |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash flows from investing activities                                                              |  |                |         |   |         |   |         |  
|(Increase) decrease in interest bearing deposits in banks                                         |  |                | 199     |   |         |   | (3,045  | )
|Purchases of premises and equipment                                                               |  |                | (498    | ) |         |   | (340    | )
|Purchases of securities held-to-maturity                                                          |  |                |        |   |         |   | (215    | )
|Purchases of restricted equity securities                                                         |  |                | (834    | ) |         |   | (216    | )
|Proceeds from sales/calls/paydowns/maturities of securities available-for-sale                    |  |                | 907     |   |         |   | 2,464   |  
|Proceeds from paydowns on securities held-to-maturity                                             |  |                | 165     |   |         |   | 276     |  
|Principal repayments of restricted equity securities                                              |  |                | 225     |   |         |   | 315     |  
|Purchase of bank owned life insurance                                                             |  |                | (1,100  | ) |         |   |        |  
|Increase in loans, net                                                                            |  |                | (19,786 | ) |         |   | (19,018 | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash used in investing activities                                                             |  |                | (20,722 | ) |         |   | (19,779 | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash flows from financing activities                                                              |  |                |         |   |         |   |         |  
|Increase (decrease) in noninterest-bearing deposits                                               |  |                | (59     | ) |         |   | 4,862   |  
|Increase in interest- bearing deposits                                                            |  |                | 10,183  |   |         |   | 21,860  |  
|Increase (decrease) in short-term borrowings                                                      |  |                | 3,000   |   |         |   | (5,000  | )
|Increase (decrease) in federal funds purchased and securities sold under agreements to repurchase |  |                | 2,902   |   |         |   | (1,516  | )
|Cash dividends paid                                                                               |  |                | (285    | ) |         |   |        |  
|Proceeds from issuance of common stock                                                            |  |                | 115     |   |         |   |        |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash provided by financing activities                                                         |  |                | 15,856  |   |         |   | 20,206  |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Net Increase (decrease) in cash and due from banks                                                |  |                | (3,104  | ) |         |   | 1,231   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash and due from banks at beginning of year                                                      |  |                | 9,746   |   |         |   | 7,119   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash and due from banks at end of year                                                            |  | $              | 6,642   |   |         | $ | 8,350   |  
|                                                                                                  |  |               
|Supplemental disclosure of cash flow information:                                                 |  |                |         |   |         |   |         |  
|Cash paid during the period for interest                                                          |  | $              | 3,356   |   |         | $ | 2,102   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash paid during the period for taxes                                                             |  | $              | 5       |   |         | $ |        |  
|                                                                                                  |  |                |         |   |         |   |         |  

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

March 31, 2006 (Unaudited)

(In thousands,
except share and per share data)



|(1) | Organization and Summary of Significant Accounting Policies
|--- | -----------------------------------------------------------

Valley Financial Corporation (the Company) was incorporated under the laws of the Commonwealth of Virginia on March 15, 1994, primarily to serve as a holding company for Valley Bank (the
Bank), which opened for business on May 15, 1995. The Companys fiscal year end is December 31.

The consolidated financial statements of the Company conform to generally accepted accounting principles and to general banking industry practices. The interim period consolidated financial statements are unaudited; however, in the opinion
of management, all adjustments of a normal recurring nature which are necessary for a fair presentation of the consolidated financial statements herein have been included. The consolidated financial statements herein should be read in conjunction
with the Companys 2005 Annual Report on Form 10-K.

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

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 (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 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 11 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.



|(2) | Cash and Cash Equivalents
|--- | -------------------------

For purposes of
reporting cash flows, cash and cash equivalents include cash and due from banks. 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
March 31, 2006 was $106, less cash on hand in the amount of $1,035, or a net of $0.



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



|(3) | Securities
|--- | ----------

The carrying values,
unrealized gains, unrealized losses and approximate fair values of available-for-sale and held-to-maturity investment securities at March 31, 2006 are shown in the tables below. As of March 31, 2006, investments (including both available
for sale and held to maturity) and restricted equity securities with amortized costs and fair values of $42,708 and $42,747, respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank,
customer sweep accounts, and for other purposes as required or permitted by law. At March 31, 2006 we evaluated our investment portfolio and determined all unrealized losses presented in the table below 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 following table sets forth the composition of securities available for sale at March 31, 2006. Securities available for sale are carried at approximate market value.

Available for Sale Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                |        |                 |   |                  |  |                        |       |  |   |       
|----------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------------------- | ----- |  | - | ------
|                                    |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | ApproximateFair Values
|U. S. Treasury                      |  | $              | 199    |                 | $ |                 |  | $                      | 2     |  | $ | 197   
|U.S. Government agencies            |  |                | 6,489  |                 |   |                 |  |                        | 168   |  |   | 6,321 
|Mortgage-backed securities          |  |                | 5,044  |                 |   | 1                |  |                        | 253   |  |   | 4,792 
|Collateralized mortgage obligations |  |                | 14,077 |                 |   |                 |  |                        | 588   |  |   | 13,489
|States and political subdivisions   |  |                | 7,046  |                 |   | 84               |  |                        | 48    |  |   | 7,082 
|Corporate debt securities           |  |                | 200    |                 |   |                 |  |                        | 4     |  |   | 196   
|                                    |  |                |        |                 |   |                  |  |                        |       |  |   |       
|Total securities available for sale |  | $              | 33,055 |                 | $ | 85               |  | $                      | 1,063 |  | $ | 32,077
|                                    |  |                |        |                 |   |                  |  |                        |       |  |   |       

The following table sets forth the composition of securities held to maturity at
March 31, 2006. Securities held to maturity are carried at amortized cost.

Held to Maturity Investment Portfolio  Category
Distribution

(dollars in thousands)



|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|----------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------------------- | --- |  | - | ------
|                                    |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | ApproximateFair Values
|U.S. Government agencies            |  | $              | 9,940  |                 | $ |                 |  | $                      | 311 |  | $ | 9,629 
|Mortgage-backed securities          |  |                | 583    |                 |   |                 |  |                        | 34  |  |   | 549   
|Collateralized mortgage obligations |  |                | 2,747  |                 |   |                 |  |                        | 91  |  |   | 2,656 
|States and political subdivisions   |  |                | 7,338  |                 |   | 46               |  |                        | 58  |  |   | 7,326 
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|Total securities held to maturity   |  | $              | 20,608 |                 | $ | 46               |  | $                      | 494 |  | $ | 20,160
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       



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##### Table of Contents

|(4) | Allowance for Loan Losses
|--- | -------------------------

The following
table summarizes the loan loss experience for the three-month periods ended March 31, 2006 and 2005.

Allowance for Loan Losses

(dollars in thousands)



|                                  |  |      |       |   |      |   |      
|--------------------------------- |  | ---- | ----- | - | ---- | - | -----
|                                  |  | 2006 |       |   | 2005
|Balance at January 1              |  | $    | 4,124 |   |      | $ | 2,989
|Provision for loan losses         |  |      | 587   |   |      |   | 324  
|Recoveries  Loans to individuals |  |      |      |   |      |   |     
|Charged off loans:                |  |      |       |   |      |   |      
|Commercial                        |  |      | (2    | ) |      |   |     
|Credit Cards                      |  |      |       |   |      |   |     
|Loans to individuals              |  |      |       |   |      |   |     
|                                  |  |      |       |   |      |   |      
|Balance at March 31               |  | $    | 4,709 |   |      | $ | 3,313
|                                  |  |      |       |   |      |   |      



|(5) | 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 tables summarize earnings per share and the shares utilized in the computations:



|        |  |                                                    |           |         |   |          
|------- |  | -------------------------------------------------- | --------- | ------- | - | ---------
|        |  | Earnings per share 3 Months Ending                
|        |  | 3/31/06                                            |           | 3/31/05
|Basic   |  | $                                                  | 0.17      |         | $ | 0.16     
|Diluted |  | $                                                  | 0.17      |         | $ | 0.16     
|        | 
|        |  | Weighted Average SharesOutstanding 3 Months Ending
|        |  | 3/31/06                                            |           | 3/3105 
|Basic   |  |                                                    | 4,079,233 |         |   | 4,074,630
|Diluted |  |                                                    | 4,189,866 |         |   | 4,270,816



|(6) | Comprehensive Income
|--- | --------------------

On January 1,
1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income. This Statement establishes standards for reporting and presentation of comprehensive income and its components in a full set
of general purpose financial statements. This Statement was issued to address concerns over the practice of reporting elements of comprehensive income directly in equity.



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##### Table of Contents

The Company is required to classify items of Other Comprehensive Income (such
as net unrealized gains on securities available for sale) by their nature in a financial statement. It does not require a specific format for that financial statement but requires the Company to display an amount representing comprehensive income
for the period in that financial statement. The Company is required to present the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of a statement of financial
position. It does not require per share amounts of comprehensive income to be disclosed.

The adoption of Statement 130 on
January 1, 1998 did not have any effect on the consolidated financial position, results of operations or liquidity of the Company. However, Statement 130 does have an effect on financial statement displays presented by the Company since the
Company has net unrealized gains (losses) on available for sale securities, an item of other comprehensive income (loss). For the three months ended March 31, 2006 and 2005, total comprehensive income (loss) was $(198) and $(432) respectively.

The information that follows discloses the reclassification adjustments and the income taxes related to the net unrealized
gains (losses) on securities available for sale that are included in other comprehensive income (loss), net of income taxes for the three month periods ended March 31, 2006 and 2005.



|                                                                                        |  |                                      |      |   |         |   |      |  
|--------------------------------------------------------------------------------------- |  | ------------------------------------ | ---- | - | ------- | - | ---- | -
|                                                                                        |  | 3 Months Ended(dollars in thousands) |     
|                                                                                        |  | 3/31/06                              |      |   | 3/31/05 |  
|Net unrealized gains (losses) on securities available for sale:                         |  |                                      |      |   |         |   |      |  
|Net unrealized holding gains (losses) during the year                                   |  | $                                    | (301 | ) |         | $ | (654 | )
|Less reclassification adjustments for realized gains included in net income, net of tax |  |                                      |      |   |         |   |     |  
|Income tax benefit (expense)                                                            |  |                                      | 103  |   |         |   | 222  |  
|                                                                                        |  |                                      |      |   |         |   |      |  
|Other comprehensive income (loss), net of income taxes                                  |  | $                                    | (198 | ) |         | $ | (432 | )
|                                                                                        |  |                                      |      |   |         |   |      |  



|(7) | Financial Instruments With Off-Balance Sheet Risk
|--- | -------------------------------------------------

In the normal course of business to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance-sheet risk, which involve commitments to extend credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Companys
exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making
commitments as is used for on-balance-sheet risk. At March 31, 2006 outstanding commitments to extend credit were $138,775 as compared to $136,371 at December 31, 2005.



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##### Table of Contents

Commitments to extend credit are agreements to lend to a customer as long as there is no
breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without ever being drawn upon; therefore, the total
commitment amounts do not necessarily represent future cash outlays for the Company.



|(8) | Related Party Transactions
|--- | --------------------------

The Bank 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. As of March 31, 2006
aggregate loans to directors, executive officers, and principal shareholders totaled $18,798. An analysis of loan activity to directors, executive officers and principal shareholders is as follows:

Loans to Related Parties

(dollars in
thousands)



|                               |  |   |        |  
|------------------------------ |  | - | ------ | -
|Balances as of January 1, 2006 |  | $ | 17,090 |  
|Advances                       |  |   | 5,443  |  
|Repayments                     |  |   | (3,735 | )
|                               |  |   |        |  
|Balances as of March 31, 2006  |  | $ | 18,798 |  
|                               |  |   |        |  



|(9) | Long-Term Federal Home Loan Bank Advances
|--- | -----------------------------------------

The Company has outstanding long-term debt with the Federal Home Loan Bank of Atlanta in the amount of $37.0 million as of March 31, 2006. There are four convertible advances in the amount of $5.0 million each, one convertible advance
in the amount of $7.0 million, and one convertible advance in the amount of $10.0 million currently drawn. The Federal Home Loan Bank of Atlanta has the option to convert the $37.0 million 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 $5.0 million convertible advances and the one $7.0 million convertible advance will be converted into a 3-month London Interbank Offered
Rate (LIBOR) based adjustable rate credit (ARC) at 3-month LIBOR. The $10.0 million convertible advance may be converted into a 3-month LIBOR-based floating rate advance (ARC) at 3-month LIBOR only if 3-month LIBOR is greater than or
equal to 7.0%. The following table provides more information on the outstanding advances as of March 31, 2006:

LONG-TERM FEDERAL
HOME LOAN BANK ADVANCES

(dollars in thousands)



|                |  |                   |  |                   |  |           |   |  |                              
|--------------- |  | ----------------- |  | ----------------- |  | --------- | - |  | -----------------------------
|Advance Balance |  | Advance Date      |  | Maturity Date     |  | FixedRate |   |  | First OptionalConversion Date
|$5,000          |  | December 2, 1999  |  | December 2, 2009  |  | 5.46      | % |  | December 4, 2000             
|$5,000          |  | May 24, 2000      |  | May 24, 2010      |  | 6.49      | % |  | May 24, 2001                 
|$5,000          |  | February 9, 2001  |  | February 9, 2011  |  | 4.97      | % |  | February 9, 2005             
|$5,000          |  | November 7, 2001  |  | November 7, 2011  |  | 3.91      | % |  | November 7, 2006             
|$10,000         |  | September 4, 2002 |  | September 4, 2007 |  | 3.09      | % |  | September 4, 2004            
|$7,000          |  | March 11, 2003    |  | March 11, 2013    |  | 2.91      | % |  | March 11, 2008               



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##### Table of Contents

|(10) | Guaranteed Preferred Beneficial Interests in the Companys Junior Subordinated Debentures
|---- | -----------------------------------------------------------------------------------------

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 (VA) Statutory Trust I, a statutory business trust (Trust I), was
created by the Company on June 26, 2003, at which time Trust I 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 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 $4,124 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 Trust Is common securities are held by the Company.

The debenture proceeds from Trust I and Trust II are 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 including the securities. This amount totaled $10,670 (of the $11,000 outstanding) at
March 31, 2006. The remaining $330 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 and Trust IIs preferred securities and common securities
constitute a full and unconditional guarantee by the Company of the Trust I and Trust IIs 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 Trust I and Trust IIs preferred trust securities and common securities.



12



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##### Table of Contents

|(11) | Stock Based Compensation
|---- | ------------------------

Beginning with
our first quarter of fiscal 2006, we adopted SFAS 123R. See Note 1 for a description of our adoption of SFAS 123R. 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 $39 for the three-month period ended March 31, 2006. The Company currently has 82,098 nonqualified stock options outstanding at March 31, 2005, which were fully vested as of
January 1, 2006; therefore, there are no income tax implications for share-based compensation for the quarter ended March 31, 2006.

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 awards made prior to and outstanding on that date which remain valid in accordance with their terms. The maximum 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.

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.



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##### Table of Contents

Under the 2005 Plan, there are options for 46,400 shares granted to officers and key
employees currently outstanding as of March 31, 2006. Under the 1995 Plan, there are options for 215,682 shares granted to officers and key employees currently outstanding as of March 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 March 31, 2006. These RSGs will vest
100% on January 31, 2008 (Vesting Date) based upon successfully meeting certain performance criteria.

As
of March 31, 2006, there are 5,358 shares available for grant under the 1995 Plan and 188,525 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. Volatility is based on the volatilities of our trading history.
The expected life is based on the average life of the options of 10 years and the weighted average graded vesting period of 5 years, and forfeitures are estimated based on the Companys history. The following table illustrates the
assumptions for the Black-Scholes model used in determining the fair value of options granted to employees for the three months ended March 31, 2006.



|                        |  |                                  
|----------------------- |  | ---------------------------------
|                        |  | Three Months Ended March 31, 2006
|Dividend yield          |  | 0.53%                            
|Risk-free interest rate |  | 4.25%                            
|Volatility              |  | 23.17%                           
|Expected life           |  | 10 years                         



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##### Table of Contents

Total stock-based compensation recognized on our consolidated statement of income for the
quarter ended March 31, 2006 is as follows:



|                                |  |                        |    |                        |   |   
|------------------------------- |  | ---------------------- | -- | ---------------------- | - | --
|Income Statement Classification |  | OptionGrants           |    | Restricted StockGrants
|                                |  | (dollars in thousands)
|Compensation expense            |  | $                      | 19 |                        | $ | 19

The following table sets forth the pro forma amounts of net income and net income
per share, for the three months ended March 31, 2005, that would have resulted if we had accounted for our employee stock plans under the fair value recognition provisions of SFAS 123:



|                                                                               |  |                         |     
|------------------------------------------------------------------------------ |  | ----------------------- | ----
|                                                                               |  | 3 Months Ended 03/31/05
|                                                                               |  | (dollars in thousands) 
|Compensation cost recognized in income for all stock-based compensation awards |  | $                       |    
|Pro forma net income, based on SFAS No. 123                                    |  | $                       | 663 
|Pro forma basic net income per share, based on SFAS No. 123                    |  | $                       | 0.16
|Pro forma diluted net income per share, based on SFAS No. 123                  |  | $                       | 0.16

As of March 31, 2006, there was $443 of unrecognized compensation cost,
adjusted for estimated forfeitures, related to non-vested stock-based payments granted to employees. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

General Stock Option Information

A summary of option activity under the stock option plans during the three month period ended March 31, 2006 is presented below:



|                       |  |                     |   |  |                                    |       |                                   |           
|---------------------- |  | ------------------- | - |  | ---------------------------------- | ----- | --------------------------------- | ----------
|                       |  | Options Outstanding |   |  | WeightedAverage Exercise Price
($) |       | Weighted Average Contractual Term
|Balance, 12/31/05      |  | 365,380             |   |  | $                                  | 6.30  |                                   |           
|                       |  |                     |  
|Exercised              |  | (25,200             | ) |  | $                                  | 4.56  |                                   |           
|Authorized             |  |                    |   |  |                                    |      |                                   |           
|Forfeited              |  |                    |   |  |                                    |      |                                   |           
|Granted                |  | 4,000               |   |  | $                                  | 13.30 |                                   |           
|                       |  |                     |   |  |                                    |       |                                   |           
|Outstanding at 3/31/06 |  | 344,180             |   |  | $                                  | 6.51  |                                   | 4.53 years
|                       |  |                     |   |  |                                    |       |                                   |           
|Exercisable at 3/31/06 |  | 253,420             |   |  | $                                  | 4.73  |                                   | 4.53 years
|                       |  |                     |   |  |                                    |       |                                   |           



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##### Table of Contents

The weighted-average grant-date fair value of options granted during the three month
period ended March 31, 2006 was $5.37. The total intrinsic value of options exercised during the three month period ended March 31, 2006 was $219.

Cash received from option exercises under all share-based payment arrangements for the three month period ended March 31, 2006 was
$115.

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



|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      
|------------------------ |  | ------------------ |  | ------------------------------------------- |  | ------------------------------- | ----- | ------------------ | ------- | ------------------------------ | - | -----
|Range of Exercise Prices |  | Number Outstanding |  | Weighted Average Remaining Contractual Life |  | Weighted Average Exercise Price |       | Number Exercisable |         | Weighted Average ExercisePrice
|$  2.78     -  $  3.81   |  | 114,386            |  | 1.31 years                                  |  | $                               | 3.22  |                    | 114,386 |                                | $ | 3.22 
|$  4.25     -  $  5.94   |  | 132,095            |  | 4.16 years                                  |  | $                               | 5.32  |                    | 120,695 |                                | $ | 5.29 
|$  7.14     -  $12.85    |  | 71,350             |  | 7.32 years                                  |  | $                               | 11.29 |                    | 14,780  |                                | $ | 9.55 
|$13.00   -  $14.23       |  | 26,350             |  | 8.59 years                                  |  | $                               | 13.87 |                    | 3,560   |                                | $ | 14.20
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      
|Totals                   |  | 344,180            |  | 4.53 years                                  |  | $                               | 6.51  |                    | 253,420 |                                | $ | 4.73 
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      

The aggregate intrinsic value of options outstanding and options exercisable as of
March 31, 2006 was $2,316 and $2,157, respectively.

A summary of the status of the Companys non-vested
restricted stock as of March 31, 2006, and changes during the three months then ended is presented below:



|                       |  |                                        |  |                                       |      
|---------------------- |  | -------------------------------------- |  | ------------------------------------- | -----
|                       |  | Non-Vested RestrictedStock Outstanding |  | WeightedAverage Grant Date Fair
Value
|Balance, 12/31/05      |  | 14,675                                 |  | $                                     | 12.53
|                       |  |                                       
|Exercised              |  |                                       |  |                                       |     
|Authorized             |  |                                       |  |                                       |     
|Forfeited              |  |                                       |  |                                       |     
|Granted                |  | 400                                    |  | $                                     | 13.34
|                       |  |                                        |  |                                       |      
|Outstanding at 3/31/06 |  | 15,075                                 |  | $                                     | 12.56
|                       |  |                                        |  |                                       |      



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##### Table of Contents

|(12) | Subsequent Events
|---- | -----------------

On April 20, 2006,
the Company declared its fifth consecutive semi-annual cash dividend on the Companys stock, in the amount of $0.07 per share, payable on July 3, 2006 to shareholders of record June 1, 2006.

Item 2. Managements Discussion and Analysis.

Managements discussion and analysis of the
financial condition and results of operations of the Company as of and for the three months ended March 31, 2006 and 2005 is as follows. The discussion should be read in conjunction with the Companys Consolidated Financial Statements and
Notes on the December 31, 2005 Form 10-K.

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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------

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.



17



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##### Table of Contents

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. An unallocated component is maintained to cover uncertainties that could affect our estimate of probable losses. It also reflects the margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio. 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.

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. The Bank also has a
wealth management subsidiary, Valley Wealth Management Services, Inc. which markets investment and insurance products. Net income derived for the new subsidiary is not significant at this time.

Performance Summary

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

Key Performance
Ratios



|                               |  |                      |      |   |                        |   |       |                      |  |   |      |  
|------------------------------ |  | -------------------- | ---- | - | ---------------------- | - | ----- | -------------------- |  | - | ---- | -
|                               |  | 3 monthsEnded3/31/06 |      |   | 12 monthsEnded12/31/05 |   |       | 3 monthsEnded3/31/05 | 
|Return on average assets       |  |                      | 0.56 | % |                        |   | 0.79  | %                    |  |   | 0.71 | %
|Return on average equity (1)   |  |                      | 8.87 | % |                        |   | 11.42 | %                    |  |   | 9.42 | %
|Net interest margin (2)        |  |                      | 3.28 | % |                        |   | 3.42  | %                    |  |   | 3.38 | %
|Cost of funds                  |  |                      | 3.47 | % |                        |   | 2.76  | %                    |  |   | 2.41 | %
|Yield on earning assets        |  |                      | 6.69 | % |                        |   | 6.13  | %                    |  |   | 5.72 | %
|Basic net earnings per share   |  | $                    | 0.17 |   |                        | $ | 0.83  |                      |  | $ | 0.16 |  
|Diluted net earnings per share |  | $                    | 0.17 |   |                        | $ | 0.80  |                      |  | $ | 0.16 |  

---

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 was adversely affected by two major factors during the first quarter of 2006. As shown above, we have continued to see the net interest margin under considerable pressure from the relatively flat yield



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##### Table of Contents

curve. Additionally, one large commercially-oriented credit relationship slipped into the non-performing category as of
March 31, 2006 and a special loan loss provision amounting to $325,000 was made in recognition of the workout nature of the credit.

Growth

The following table shows our key growth indicators:

Key Growth Indicators

(dollars in thousands)



|                      |  |         |         |          |   |         |  |   |        
|--------------------- |  | ------- | ------- | -------- | - | ------- |  | - | -------
|                      |  | 3/31/06 |         | 12/31/05 |   | 3/31/05
|Investment securities |  | $       | 57,281  |          | $ | 57,989  |  | $ | 68,146 
|Loans, net            |  |         | 429,451 |          |   | 410,253 |  |   | 298,479
|Deposits              |  |         | 375,440 |          |   | 365,316 |  |   | 306,055
|Total assets          |  | $       | 516,179 |          | $ | 498,949 |  | $ | 394,414

Annualized growth rates for assets, loans and deposits in the first quarter of 2006 were
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 in the last 6 months and our ability to fund loan growth will be dependent
upon our ability to grow our deposit base at a reasonable cost. Based upon current market conditions, we do anticipate that the Companys asset, loan and deposit growth rates will show declines in 2006 when compared to 2005.

Total liabilities at March 31, 2006 were $484.8 million, up 4% from $468.2 million at December 31, 2005 with the increase primarily represented
by a $10.1 million growth in deposits, a $3 million increase in short-term borrowings and a $2.6 million increase in securities sold under agreements to purchase.

Shareholders Equity

Total shareholders equity at March 31, 2006 was $31.4 million consisting of $9.1
million in net proceeds from the Companys 1995 initial public offering, $3.2 million in net proceeds from the Companys 2000 secondary offering, $3.8 million in net proceeds from a private stock placement in 2004, $995,000 in proceeds
from the exercise of stock options, $39,000 from the expensing of restricted stock grants and incentive stock options, increased by accumulated retained earnings of $14.9 million and decreased by $646,000 of net unrealized losses on securities
available for sale, net of related deferred tax liability. Total shareholders equity (exclusive of unrealized gains (losses) on investment securities) was $32.0 million at March 31, 2006 compared with $31.1 million at December 31,
2005, an increase of $900,000 or 3%.

Net Income

We earned net income of $700,000 for the three months ended March 31, 2006, an increase of $30,000 or 4.5% over the $670,000 reported for the same period in 2005. Net earnings were adversely affected by two major
factors for the first quarter of 2006. First, we have continued to see the net interest margin under considerable pressure from the relatively flat yield curve. The net interest margin was 3.38%, down 10 basis points compared to the 3.38% reported
for the same period last year. Additionally, as discussed above, one large commercially-oriented credit relationship slipped into the non-performing category as of March 31, 2006 and a special loan loss reserve provision amounting to $325,000
was made in recognition of the workout nature of the credit.



19



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##### Table of Contents

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.

Net interest income was $3,797,000 for the three months ended March 31, 2006, an increase of 29% from the $2,946,000 reported for the same period in
2005.

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
| | - |  | ---------------------------------------------



| |  |  | prepayment 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 Investment Committee. We seek to balance the return potential of the ALM position against the
desire to limit volatility in earnings.

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 change. 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



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##### Table of Contents

various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.
Our cumulative repricing gap for the 90-day time period has shifted from a liability sensitive position at December 31, 2004 to an asset-sensitive position as of December 31, 2005 (the most recent date for which information is currently
available).

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 300 basis point interest rate shock scenario.

Derivative Financial Instruments

For asset/liability management purposes, we 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 interest rate flows are exchanged over a prescribed period. 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). The effective period of the Agreement is April 19, 2007 through April 19, 2009.

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 the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument, if any, is recognized currently in earnings.

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.

Further, if the underlying financial instrument differs from
the hedged asset or liability, there must be a clear economic relationship between the two prices of the two financial instruments. If periodic assessment indicates derivatives no longer provide an effective hedge, the derivative contracts would be
closed out and settled or classified as a trading activity.

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 that did
not offset changes in the value of the hedged asset or liability is recognized immediately in non-interest income.



21



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##### Table of Contents

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.

Noninterest Income

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

Noninterest Income

(dollars in
thousands)



|                                     |  |                      |     |   |                      |   |                       |  |     
|------------------------------------ |  | -------------------- | --- | - | -------------------- | - | --------------------- |  | ----
|                                     |  | 3 monthsEnded3/31/06 |     |   | 3 monthsEnded3/31/05 |   | % Increase/(Decrease)
|Service charges on deposits          |  | $                    | 213 |   |                      | $ | 210                   |  | 1%  
|Gain/(Loss) on disposal of equipment |  |                      |    |   |                      |   |                      |  | 0%  
|Other income                         |  |                      | 244 |   |                      |   | 122                   |  | 100%
|Realized securities gains/losses     |  |                      | (1  | ) |                      |   |                      |  | N/M 
|                                     |  |                      |     |   |                      |   |                       |  |     
|Total noninterest income             |  | $                    | 456 |   |                      | $ | 332                   |  | 37% 
|                                     |  |                      |     |   |                      |   |                       |  |     

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
| | - |  | ---------------------------

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 fee
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.



22



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##### Table of Contents

Noninterest Expense

Noninterest Expense

(dollars in thousands)

|                                           |  |                      |       |                      |   |                       |  |     |   
|------------------------------------------ |  | -------------------- | ----- | -------------------- | - | --------------------- |  | --- | --
|                                           |  | 3 monthsEnded3/31/06 |       | 3 monthsEnded3/31/05 |   | % Increase/(Decrease) | 
|Compensation                               |  | $                    | 1,485 |                      | $ | 1,044                 |  | 42  | % 
|Occupancy                                  |  |                      | 157   |                      |   | 148                   |  | 6   | % 
|Equipment                                  |  |                      | 135   |                      |   | 111                   |  | 22  | % 
|Data processing                            |  |                      | 152   |                      |   | 130                   |  | 17  | % 
|Advertising and marketing                  |  |                      | 84    |                      |   | 41                    |  | 105 | % 
|Audit fees                                 |  |                      | 73    |                      |   | 73                    |  | 0   | % 
|Franchise and purchased tax credit expense |  |                      | 67    |                      |   | 47                    |  | 43  | % 
|Business manager                           |  |                      | 61    |                      |   | 71                    |  | (14 | )%
|Deposit expense                            |  |                      | 99    |                      |   | 53                    |  | 87  | % 
|Loan expense                               |  |                      | 55    |                      |   | 43                    |  | 28  | % 
|Computer software                          |  |                      | 83    |                      |   | 68                    |  | 46  | % 
|Other expense                              |  |                      | 270   |                      |   | 222                   |  | 22  | % 
|                                           |  |                      |       |                      |   |                       |  |     |   
|Total noninterest expense                  |  | $                    | 2,721 |                      | $ | 2,051                 |  | 33  | % 
|                                           |  |                      |       |                      |   |                       |  |     |   

As seen in the tables above, advertising and marketing expense represents the largest percentage
increase in noninterest expenses and is primarily attributable to an increase in advertising for deposits as well as advertising costs associated with Valley Wealth Management, Inc. Deposit expense is up in the first quarter of 2006 primarily due to
the write-off of $30,000 related to a fraudulent check scheme. The increase in computer software expense is attributable to the amortization of new computer software programs installed and in use for regulatory purposes as well as for customer
relationship management. Compensation expense has increased over the prior year due to officer merit increases effective January 1, 2006; however it does not include any year-end performance bonus accruals due to the special loan loss provision
taken. Noninterest expenses are expected to continue to increase as a direct result of business growth and expansion.

Income Taxes

To reflect our anticipated federal income tax liability, an expense of $245,000 at an effective tax rate of 25.9% was recognized for the three months
ended March 31, 2006, compared to an expense of $233,000 at an effective tax rate of 25.8% recognized for the three months ended March 31, 2005. Factors contributing to the difference between the effective tax rate and the statutory rate
of 34% include tax-exempt interest income on municipal securities (net of disallowance) and tax-exempt income earned on bank-owned life insurance.



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##### Table of Contents

Investment Securities

Our investment portfolio is used both for investment income and liquidity purposes. At this time, we do not invest in derivatives or other types of high-risk securities. 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
| | - |  | ------------------------



| |  |  | 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 March 31, 2006 were $57.3 million, a decrease of $600,000 or 1% from their level of $57.9 million on December 31, 2005. The decrease is attributable to
the principal prepayments on mortgage-backed securities. See Note 3 to the Consolidated Financial Statements.

Loan Portfolio

Our total loans were $434.1 million at March 31, 2006, an increase of $19.7 million or 5% from the $414.4 million reported at December 31, 2005.
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 guaranteed preferred beneficial interests in the Companys
junior subordinated debentures) stood at 90.4% at March 31, 2006 and 89.2% at December 31, 2005. Management seeks to maintain the ratio of loans to funding sources at a maximum of 85%. The Board of Directors has approved the temporary
overage at March 31, 2006. Management will work diligently to bring the ratio back below the 85% level during 2006.

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.



24



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##### Table of Contents

The following table summarizes the loan portfolio by category, net of deferred fees, as of the
three-month periods ended March 31, 2006 and 2005 and the year ended December 31, 2005:

Loan Portfolio Summary

(dollars in thousands)

|                                                           |  |         |  |          |  |         |  |       |  |         |  |      
|---------------------------------------------------------- |  | ------- |  | -------- |  | ------- |  | ----- |  | ------- |  | -----
|                                                           |  | 3/31/06 |  | 12/31/05 |  | 3/31/05
|                                                           |  | $       |  | %        |  | $       |  | %     |  | $       |  | %    
|Commercial                                                 |  | 97,128  |  | 22.4     |  | 97,904  |  | 23.6  |  | 77,364  |  | 25.6 
|Commercial real estate                                     |  | 155,661 |  | 35.8     |  | 149,647 |  | 36.1  |  | 111,490 |  | 36.9 
|Real estate construction                                   |  | 64,122  |  | 14.8     |  | 55,810  |  | 13.5  |  | 28,918  |  | 9.6  
|Residential real estate                                    |  | 108,891 |  | 25.1     |  | 103,272 |  | 24.9  |  | 75,978  |  | 25.2 
|Loans to individuals (except those secured by real estate) |  | 8,358   |  | 1.9      |  | 7,744   |  | 1.9   |  | 8,044   |  | 2.7  
|                                                           |  |         |  |          |  |         |  |       |  |         |  |      
|Total loans                                                |  | 434,160 |  | 100.0    |  | 414,377 |  | 100.0 |  | 301,794 |  | 100.0
|                                                           |  |         |  |          |  |         |  |       |  |         |  |      

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. 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 first
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.Loans to individuals include installment loans, home equity lines of credit, and loans secured by junior liens on
residential real estate. The loan proceeds typically are used to purchase vehicles, finance home remodeling, higher education, or for other consumer purposes.



25



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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 $587,000 was provided during the three months ended March 31, 2006, an increase of
$263,000 or 81% over the same period in 2005, in recognition of our estimate of inherent risks associated with lending activities. The increase is a result of the loan growth in our portfolio as well as the special loan loss provision of $325,000
attributable to one large commercially-oriented credit relationship that slipped into the non-performing category as of March 31, 2006.

The ratio of the allowance for loan losses to total loans outstanding was approximately 1.1% at March 31, 2006, which compares to approximately 1.0% of net loans at December 31, 2005 (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 $1,420,000 in special reserves was included in the balance of the
allowance for loan losses as of March 31, 2006 for impaired loans, which compares to a total of $344,000 as of December 31, 2005. The $1,420,000 in special reserves was concentrated in two large relationships within our overall loan
portfolio.

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 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.)

Nonperforming Assets and Impaired Loans

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.

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.



26



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##### Table of Contents

For the quarter ended March 31, 2006, our non-performing assets to total assets ratio increased from
0.72% at December 31, 2005 to 1.69%. Additionally, our loans past due more than 90 days increased from 0.10% at December 31, 2005 to 0.25% at March 31, 2006. The increase in the non-performing asset ratio is primarily attributable to
the commercially-oriented credit relationship mentioned above. All related loans, aggregating approximately $4.4 million, were placed on nonaccrual status during the first quarter. A possible resolution of this problem credit is projected to occur
during the third quarter of 2006 and we believe we have reserved an amount that should be sufficient to cover any potential losses. Although we presently believe any unreserved loan balances are secured by customer assets pledged as collateral, it
is obviously a situation which can change, which we are constantly monitoring. Additionally, subsequent to March 31, 2006, one non-performing credit relationship did pay out in full without loss to either principal or interest and the removal
of this exposure as of March 31, 2006 would have reduced the non-performing assets to total assets ratio to approximately 1.30%. Nonperforming assets at March 31, 2006, December 31, 2005 and March 31, 2005 are presented in
the following table:

Nonperforming Assets

(dollars in thousands)



|                                             |  |         |       |          |   |         |  |   |      
|-------------------------------------------- |  | ------- | ----- | -------- | - | ------- |  | - | -----
|                                             |  | 3/31/06 |       | 12/31/05 |   | 3/31/05
|Nonaccrual loans                             |  | $       | 4,618 |          | $ | 104     |  | $ | 2,473
|Loans past due 90 days or more               |  |         | 1,081 |          |   | 423     |  |   | 5    
|Restructured loans                           |  |         |      |          |   |        |  |   |     
|Other nonperforming loans (1)                |  |         | 3,013 |          |   | 3,062   |  |   |     
|                                             |  |         |       |          |   |         |  |   |      
|Total nonperforming loans                    |  | $       | 8,712 |          | $ | 3,589   |  | $ | 2,478
|                                             |  |         |       |          |   |         |  |   |      
|Foreclosed, repossessed and idled properties |  |         |      |          |   |        |  |   |     
|                                             |  |         |       |          |   |         |  |   |      
|Total nonperforming assets                   |  | $       | 8,712 |          | $ | 3,589   |  | $ | 2,478
|                                             |  |         |       |          |   |         |  |   |      

---

|(1) | Other nonperforming loans include impaired loans which are not on nonaccrual status or 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 nonaccrual loans had performed in accordance with their original terms, additional interest income in the amount of $24,900 for the three-month period ended March 31, 2006; $1,230 for the year ended
December 31, 2005; and $9,000 for the three-month period ended March 31, 2005 would have been recorded.

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 as of March 31, 2006, December 31, 2005, and March 31, 2005:

Watch List Credits

(dollars in
thousands)



|                   |  |         |        |   |          |   |        |         |  |   |        |  
|------------------ |  | ------- | ------ | - | -------- | - | ------ | ------- |  | - | ------ | -
|                   |  | 3/31/06 |        |   | 12/31/05 |   |        | 3/31/05 | 
|Watch List Credits |  | $       | 19,552 |   |          | $ | 16,334 |         |  | $ | 20,688 |  
|% of Total Loans   |  |         | 4.50   | % |          |   | 3.94   | %       |  |   | 6.86   | %



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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). Bank owned life insurance was
$10.2 million at March 31, 2006, an increase of $1.3 million over the $8.9 million reported as of December 31, 2005. The increase is due to the $1.1 million purchase of additional life insurance contracts on key employees and a $200,000
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 three
months ended March 31, 2006 and for the year ended December 31, 2005:

Deposit Summary

(dollars in thousands)



|                                       |  |         |  |          |  |                     |  |       |  |        |   |  |       |  
|-------------------------------------- |  | ------- |  | -------- |  | ------------------- |  | ----- |  | ------ | - |  | ----- | -
|                                       |  | 3/31/06 |  | 12/31/05 |  | Increase/(Decrease) | 
|                                       |  | $       |  | %        |  | $                   |  | %     |  | $      |   |  | %     |  
|Time deposits                          |  | 254,675 |  | 67.8     |  | 234,809             |  | 64.3  |  | 19,866 |   |  | 8.5   |  
|Interest bearing demand & money market |  | 49,098  |  | 13.1     |  | 50,279              |  | 13.8  |  | (1,181 | ) |  | (2.4  | )
|Savings                                |  | 52,260  |  | 13.9     |  | 60,762              |  | 16.6  |  | (8,502 | ) |  | (14.0 | )
|                                       |  |         |  |          |  |                     |  |       |  |        |   |  |       |  
|Total interest bearing deposits        |  | 356,033 |  | 94.8     |  | 345,850             |  | 94.7  |  | 10,183 |   |  | 2.9   |  
|                                       |  |         |  |          |  |                    
|Noninterest demand & official checks   |  | 19,407  |  | 5.2      |  | 19,466              |  | 5.3   |  | (59    | ) |  | 0.3   |  
|                                       |  |         |  |          |  |                     |  |       |  |        |   |  |       |  
|Total deposits                         |  | 375,440 |  | 100.0    |  | 365,316             |  | 100.0 |  | 10,124 |   |  | 2.8   |  
|                                       |  |         |  |          |  |                     |  |       |  |        |   |  |       |  

We would prefer to have transaction accounts comprise a larger percentage of total deposits, but
in order to fund our loan growth, we often have to rely on higher-cost certificates of deposit. 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 March 31, 2006 were $13.1 million, a decrease of $3.4 million from the $16.5 million reported at December 31, 2005 and represent 5.15% of total CDs and 3.49% of
total deposits at March 31, 2006.



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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) increased by $5.9 million from their level of $50.8 million at December 31, 2005 to a total of
$56.7 million as of March 31, 2006. Short-term borrowings at March 31, 2006 include federal funds purchased of $17.3 million, Federal Home Loan Bank of Atlanta (FHLB) borrowings in the amount of $26.0 million, and a commercial
sweep account program in the amount of $13.4 million.

The FHLB borrowings include a $10 million adjustable rate credit which matures on
December 18, 2006 and reprices quarterly on the date of each quarterly interest payment (rate of 5.01% on March 31, 2006). The second FHLB credit matures on October 31, 2006 and reprices monthly at 1-month LIBOR + 10 basis points
(rate of 4.93% on March 31, 2006). The third FHLB borrowing is an $11 million daily rate credit which matures on September 27, 2006 (rate of 5.09% on March 31, 2006). See the liquidity section for further information on the preceding
borrowings.

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 by $2.6 million from its $10.8 million level at December 31, 2005. 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.

Long-Term
Borrowings

Federal Home Loan Bank advances are relatively cost-effective funding sources and provide us with the flexibility to
structure borrowings in a manner that aids in the management of interest rate risk and liquidity. Long-term convertible Federal Home Loan Bank advances totaled $37.0 million at March 31, 2006 and December 31, 2005. (See Footnote 9 of the
Companys Consolidated Financial Statements for more information on the long-term advances.)

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

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 the 3-month London Interbank Offered Rate (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 (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



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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.

The
debenture proceeds from Trust I and Trust II 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 $10,670,000
(of the $11,000,000 outstanding) at March 31, 2006. The remaining $330,000 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 and Trust IIs
preferred securities and common securities constitute a full and unconditional guarantee of Trust I and Trust II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 and Trust IIs preferred trust securities and common securities.

Capital Adequacy

Our financial position at
March 31, 2006 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.

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

Capital Ratios



|         |  |         |   |  |          |   |  |         |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | -
|Ratio    |  | 3/31/06 |   |  | 12/31/05 |   |  | 3/31/05 |  
|Tier 1   |  | 9.5     | % |  | 9.7      | % |  | 10.2    | %
|Total    |  | 10.6    | % |  | 10.8     | % |  | 11.2    | %
|Leverage |  | 8.3     | % |  | 8.8      | % |  | 8.6     | %

Total shareholders equity grew by $655,000 from December 31, 2005 to March 31,
2006. Earnings, proceeds from the exercise of incentive stock options, and the changes in unrealized gains and losses for securities available for sale accounted for the net increase. The Company paid its fourth consecutive semi-annual cash dividend
on the Companys common stock, in the amount of $.07 per share on January 3, 2006 to shareholders of record December 15, 2005.

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.



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Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and
non-pledged securities available-for-sale, at March 31, 2006 totaled $15.7 million. Our funding sources consist of an established federal funds lines with a regional correspondent bank totaling $12 million that had a $12 million
balance as of March 31, 2006, three established federal funds lines with third party banks totaling $21 million that had outstanding balances totaling $7.4 million as of March 31, 2006, and an established line with the FHLB
that had $63 million outstanding under a total line of $113.3 million as of March 31, 2006. We believe these arrangements will be renewed at maturity.

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

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 presented 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 our 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. We seek to manage the relationship between interest-sensitive assets and liabilities in order to protect against the effects of wide
interest rate fluctuations, including those resulting from inflation.

Recent and Future Accounting Considerations

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20 and FASB
Statement No. 3. SFAS No. 154 establishes retrospective application as the required method for reporting a change in accounting principle, unless it is impracticable, in which case the changes should be applied to the latest
practicable date presented. SFAS No. 154 also requires that a correction of an error be reported as a prior period adjustment by restating prior period financial statements. SFAS No. 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005.

In December 2005, the FASB issued FSP SOP 94-6-1, Terms of
Loan Products that May Give Rise to a Concentration of Credit Risk. The disclosure guidance in this FSP is effective for interim and annual periods ending after December 19, 2005. The FSP states that the terms of certain loan products may
increase a reporting entitys exposure to credit risk and thereby may result in a concentration of credit risk as that term is used in SFAS No. 107, either as an individual product type or as a group of products with similar features. SFAS
No. 107 requires disclosures about each significant concentration, including information about the (shared) activity, region, or economic characteristic that identifies the concentration. The FSP suggests possible shared



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characteristics on which significant concentrations may be determined which include, but are not limited to
(1) loans that subject borrowers to significant payment increases, (2) loans with terms that permit negative amortization, and (3) loans with high loan-to-value ratios. This FSP requires entities to provide the disclosures required by
SFAS No. 107 for loan products that are determined to represent a concentration of credit risk in accordance with the guidance of this FSP for all periods presented. The Bank adopted this disclosure standard effective December 31, 2005.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The principal goals of our asset and
liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors withdrawals or borrowers loans without significant
loss. Interest rate risk management balances the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from
interest rate changes.

We attempt to ensure that adequate funds are available at all times to meet the needs of our customers. On the
asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include
core deposits, the ability to increase large denomination certificates of deposit, federal fund lines from correspondent banks, borrowings from the FHLB and the Federal Reserve Bank, as well as the ability to generate funds through the issuance of
long-term debt and equity.

Interest rate risk is the effect that changes in interest rates would have on interest income and interest
expense as interest-sensitive assets and interest-sensitive liabilities either re-price or mature. We attempt to maintain the portfolios of interest-earning assets and interest-bearing liabilities with maturities or re-pricing opportunities at
levels that will afford protection from substantial erosion of net interest margin, to the extent practical, from changes in interest rates.

We use a number of tools to manage our interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap
between rate sensitive assets and rate sensitive liabilities over various time periods. (See Interest Rate Risk.)

Item 4. Controls and Procedures.

As of the end of the period covered by the 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. There have not
been any changes in our internal control over financial reporting that occurred during the last quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.



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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.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

There were no pending legal proceedings during the quarter.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

There were no unregistered sales of equity
securities during the quarter.

Item 3. Defaults Upon Senior Securities.

There were no defaults upon Senior Securities in the quarter.

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

There were no submission of matters to a vote of security
holders in the quarter.

Item 5. Other Information.

None.



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##### Table of Contents

Item 6. Index to Exhibits



|(a) | We filed the following exhibits for the quarter ended March 31, 2006:
|--- | ---------------------------------------------------------------------



|               |  |                                                                                                                                                                                                                                   
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                       
|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 3.3 of Form 10-KSB filed March 30, 2005, File No. 000-28342).                                                                                        
|               | 
|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*          |  | Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27,
1997, 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).                                                      



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##### Table of Contents

|       |  |                                                                                                                                                                                                                                                
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 L. 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).                                 
|       | 
|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. 000-28342).
|       | 
|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).                                 



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|       |  |                                                                                                                                                                                                             
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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).     
|       | 
|11     |  | Statement re Computation of Earnings per Share (filed herewith as Note 5).                                                                                                                                  
|       | 
|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-Q pursuant to Item 13(a).
|- | ----------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

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



|            |  |  |  |  |  |                                                         
|----------- |  |  |  |  |  | --------------------------------------------------------
|            |  |  |  |  |  | VALLEY FINANCIAL CORPORATION                            
|            |  |  | 
|May 9, 2006 |  |  |  |  |  | /s/ Ellis L. Gutshall                                   
|Date        |  |  |  |  |  | Ellis L. Gutshall, President and Chief Executive Officer
|            |  |  | 
|May 9, 2006 |  |  |  |  |  | /s/ Kimberly B. Snyder                                  
|Date        |  |  |  |  |  | Kimberly B. Snyder, Senior Vice President and           
|            |  |  |  |  |  | Chief Financial Officer                                 



37