##### Table of Contents

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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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QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For the Quarterly Period Ended March 31, 2005



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 Number)



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 ̈



At May 10, 2005, 4,074,630 shares of the issuers common stock, no par value, were outstanding.



Transitional small business disclosure format:    Yes ̈No  x.



Accelerated Filer:    Yes ̈No  x.



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

FORM 10-Q

March 31, 2005



INDEX



|                                                                    |  |   
|------------------------------------------------------------------- |  | --
|Part I. FINANCIAL INFORMATION                                       |  |   
|                                                                    | 
|Item 1. Financial Statements                                        |  |   
|                                                                    | 
|Consolidated Balance Sheets                                         |  | 3 
|                                                                    | 
|Consolidated Statements of Income                                   |  | 4 
|                                                                    | 
|Consolidated Statements of Cash Flows                               |  | 5 
|                                                                    | 
|Notes to Consolidated Financial Statements                          |  | 6 
|                                                                    | 
|Item 2. Managements Discussion and Analysis                        |  | 12
|                                                                    | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk  |  | 26
|                                                                    | 
|Item 4. Controls and Procedures                                     |  | 26
|                                                                    | 
|Part II. OTHER INFORMATION                                          |  |   
|                                                                    | 
|Item 1. Legal Proceedings                                           |  | 27
|                                                                    | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |  | 27
|                                                                    | 
|Item 3. Defaults Upon Senior Securities                             |  | 27
|                                                                    | 
|Item 4. Submission of Matters to a Vote of Security Holders         |  | 27
|                                                                    | 
|Item 5. Other Information                                           |  | 28
|                                                                    | 
|Item 6. Exhibits and Reports on Form 8-K                            |  | 28
|                                                                    | 
|SIGNATURES                                                          |  | 31
|                                                                    | 
|INDEX TO EXHIBITS                                                   |  | 32
|                                                                    | 
|CERTIFICATIONS                                                      |  | 35



2



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##### Table of Contents

PART 1  FINANCIAL INFORMATION



Item 1. Financial Statements.



VALLEY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)



|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                   |  | (Unaudited) March 31 2005 |         |   | December 31 2004 |  
|Assets                                                                                                                             |  |                           |         |   |                  |   |         |  
|Cash and due from banks                                                                                                            |  | $                         | 8,350   |   |                  | $ | 7,119   |  
|Money market investments:                                                                                                          |  |                           |         |   |                  |   |         |  
|Federal funds sold                                                                                                                 |  |                           | 2,671   |   |                  |   |        |  
|Interest-bearing deposits in other banks                                                                                           |  |                           | 436     |   |                  |   | 62      |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total money market investments                                                                                                     |  |                           | 3,107   |   |                  |   | 62      |  
|Securities available for sale                                                                                                      |  |                           | 42,676  |   |                  |   | 45,820  |  
|Securities held to maturity (approximate market values of $21,688 at March 31, 2005 and $22,084 at December 31, 2004)              |  |                           | 22,068  |   |                  |   | 22,154  |  
|Restricted equity securities                                                                                                       |  |                           | 3,402   |   |                  |   | 3,501   |  
|Loans:                                                                                                                             |  |                           |         |   |                  |   |         |  
|Commercial and industrial loans                                                                                                    |  |                           | 77,364  |   |                  |   | 71,580  |  
|Commercial real estate loans                                                                                                       |  |                           | 111,490 |   |                  |   | 107,186 |  
|Real estate construction loans                                                                                                     |  |                           | 28,918  |   |                  |   | 25,404  |  
|Residential real estate loans                                                                                                      |  |                           | 49,785  |   |                  |   | 43,848  |  
|Loans to individuals                                                                                                               |  |                           | 34,237  |   |                  |   | 34,758  |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total loans                                                                                                                        |  |                           | 301,794 |   |                  |   | 282,776 |  
|Less unearned income                                                                                                               |  |                           | (2      | ) |                  |   | (2      | )
|Less allowance for loan losses                                                                                                     |  |                           | (3,313  | ) |                  |   | (2,989  | )
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Net loans                                                                                                                          |  |                           | 298,479 |   |                  |   | 279,785 |  
|Premises and equipment, net                                                                                                        |  |                           | 6,281   |   |                  |   | 6,077   |  
|Bank owned life insurance                                                                                                          |  |                           | 6,201   |   |                  |   | 6,125   |  
|Accrued interest receivable                                                                                                        |  |                           | 1,595   |   |                  |   | 1,434   |  
|Other assets                                                                                                                       |  |                           | 2,255   |   |                  |   | 1,902   |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total assets                                                                                                                       |  | $                         | 394,414 |   |                  | $ | 373,979 |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Liabilities and Shareholders Equity                                                                                               |  |                           |         |   |                  |   |         |  
|Deposits:                                                                                                                          |  |                           |         |   |                  |   |         |  
|Non-interest bearing demand deposits                                                                                               |  | $                         | 51,970  |   |                  | $ | 47,108  |  
|Interest bearing demand deposits                                                                                                   |  |                           | 19,230  |   |                  |   | 19,690  |  
|Money market deposits                                                                                                              |  |                           | 40,572  |   |                  |   | 36,759  |  
|Savings deposits                                                                                                                   |  |                           | 4,845   |   |                  |   | 4,957   |  
|Certificates of deposits > $100,000                                                                                                |  |                           | 41,749  |   |                  |   | 38,059  |  
|Other time deposits                                                                                                                |  |                           | 147,689 |   |                  |   | 132,760 |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total deposits                                                                                                                     |  |                           | 306,055 |   |                  |   | 279,333 |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Federal funds purchased and securities sold under agreements to repurchase                                                         |  |                           | 6,488   |   |                  |   | 8,004   |  
|Short-term borrowings                                                                                                              |  |                           | 10,000  |   |                  |   | 15,000  |  
|Long-term borrowings                                                                                                               |  |                           | 37,000  |   |                  |   | 37,000  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures                                          |  |                           | 4,000   |   |                  |   | 4,000   |  
|Accrued interest payable                                                                                                           |  |                           | 1,046   |   |                  |   | 1,050   |  
|Other liabilities                                                                                                                  |  |                           | 1,271   |   |                  |   | 1,276   |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total liabilities                                                                                                                  |  |                           | 365,860 |   |                  |   | 345,663 |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Commitments and other contingencies                                                                                                |  |                           |        |   |                  |   |        |  
|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 4,074,630 at March 31, 2005 and December 31,
2004 |  |                           | 16,974  |   |                  |   | 16,974  |  
|Retained earnings                                                                                                                  |  |                           | 11,991  |   |                  |   | 11,321  |  
|Accumulated other comprehensive income                                                                                             |  |                           | (411    | ) |                  |   | 21      |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total shareholders equity                                                                                                         |  |                           | 28,554  |   |                  |   | 28,316  |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  
|Total liabilities and shareholders equity                                                                                         |  | $                         | 394,414 |   |                  | $ | 373,979 |  
|                                                                                                                                   |  |                           |         |   |                  |   |         |  



See accompanying notes to consolidated
financial statements.



3



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except
per share data)



|                                                                                                      |  |                                                       |       |                                                       |   |      
|----------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------- | ----- | ----------------------------------------------------- | - | -----
|                                                                                                      |  | For the Period January 1, 2005 Through March 31, 2005 |       | For the Period January 1, 2004 Through March 31, 2004
|Interest Income:                                                                                      |  |                                                       |       |                                                       |   |      
|Interest and fees on loans                                                                            |  | $                                                     | 4,279 |                                                       | $ | 3,320
|Interest on money market investments                                                                  |  |                                                       | 22    |                                                       |   | 10   
|Interest on securities  taxable                                                                      |  |                                                       | 584   |                                                       |   | 526  
|Interest on securities  nontaxable                                                                   |  |                                                       | 159   |                                                       |   | 168  
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Total interest income                                                                                 |  |                                                       | 5,044 |                                                       |   | 4,024
|                                                                                                      |  |                                                      
|Interest Expense:                                                                                     |  |                                                       |       |                                                       |   |      
|Interest on certificates of deposit > 100,000                                                         |  |                                                       | 301   |                                                       |   | 251  
|Interest on other deposits                                                                            |  |                                                       | 1,197 |                                                       |   | 806  
|Interest on long-term borrowings                                                                      |  |                                                       | 389   |                                                       |   | 393  
|Interest on federal funds purchased and securities sold under agreements to repurchase                |  |                                                       | 42    |                                                       |   | 17   
|Interest on guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                                                       | 57    |                                                       |   | 43   
|Interest on short-term borrowings                                                                     |  |                                                       | 112   |                                                       |   | 46   
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Total interest expense                                                                                |  |                                                       | 2,098 |                                                       |   | 1,556
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Net interest income                                                                                   |  |                                                       | 2,946 |                                                       |   | 2,468
|Provision for loan losses                                                                             |  |                                                       | 324   |                                                       |   | 98   
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Net interest income after provision for loan losses                                                   |  |                                                       | 2,622 |                                                       |   | 2,370
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Noninterest Income:                                                                                   |  |                                                       |       |                                                       |   |      
|Service charges on deposit accounts                                                                   |  |                                                       | 210   |                                                       |   | 183  
|Income earned on bank owned life insurance                                                            |  |                                                       | 76    |                                                       |   | 72   
|Other income on real estate loans                                                                     |  |                                                       | 16    |                                                       |   | 24   
|Other fee income                                                                                      |  |                                                       | 29    |                                                       |   | 37   
|Gains on sales of securities                                                                          |  |                                                       | 1     |                                                       |   | 4    
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Total noninterest income                                                                              |  |                                                       | 332   |                                                       |   | 320  
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Noninterest Expense:                                                                                  |  |                                                       |       |                                                       |   |      
|Compensation expense                                                                                  |  |                                                       | 1,044 |                                                       |   | 988  
|Occupancy expense                                                                                     |  |                                                       | 148   |                                                       |   | 116  
|Data processing and equipment expense                                                                 |  |                                                       | 241   |                                                       |   | 225  
|Franchise and purchased tax credit expense                                                            |  |                                                       | 47    |                                                       |   | 56   
|Deposit operation expenses                                                                            |  |                                                       | 53    |                                                       |   | 46   
|Loan operation expenses                                                                               |  |                                                       | 114   |                                                       |   | 112  
|Other expense                                                                                         |  |                                                       | 404   |                                                       |   | 295  
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Total noninterest expense                                                                             |  |                                                       | 2,051 |                                                       |   | 1,838
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Net income before taxes                                                                               |  |                                                       | 903   |                                                       |   | 852  
|                                                                                                      |  |                                                      
|Provision for income taxes                                                                            |  |                                                       | 233   |                                                       |   | 222  
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Net income                                                                                            |  | $                                                     | 670   |                                                       | $ | 630  
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Basic earnings per share                                                                              |  | $                                                     | 0.16  |                                                       | $ | 0.17 
|                                                                                                      |  |                                                       |       |                                                       |   |      
|Diluted earnings per share                                                                            |  | $                                                     | 0.16  |                                                       | $ | 0.16 
|                                                                                                      |  |                                                       |       |                                                       |   |      



See accompanying notes to consolidated
financial statements.



4



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands, except
per share data)



|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------- | ------- | - | ----------------------------------------------------- | - | ------- | -
|                                                                                                  |  | For the Period January 1, 2005 Through March 31, 2005 |         |   | For the Period January 1, 2004 Through March 31, 2004 |  
|Cash Flows From Operating Activities:                                                             |  |                                                       |         |   |                                                       |   |         |  
|Net income                                                                                        |  | $                                                     | 670     |   |                                                       | $ | 630     |  
|Adjustments to reconcile net income to net cash provided by operating activities:                 |  |                                                       |         |   |                                                       |   |         |  
|Provision for loan losses                                                                         |  |                                                       | 324     |   |                                                       |   | 98      |  
|Depreciation and amortization                                                                     |  |                                                       | 168     |   |                                                       |   | 154     |  
|Net gains on sale of securities                                                                   |  |                                                       | (1      | ) |                                                       |   | (4      | )
|Amortization (accretion) of premiums/discounts                                                    |  |                                                       | 50      |   |                                                       |   | 59      |  
|Decrease in unearned fees                                                                         |  |                                                       |        |   |                                                       |   | (1      | )
|Increase in interest receivable                                                                   |  |                                                       | (161    | ) |                                                       |   | (85     | )
|Increase in other assets                                                                          |  |                                                       | (162    | ) |                                                       |   | (25     | )
|Increase in value of life insurance contracts                                                     |  |                                                       | (76     | ) |                                                       |   | (72     | )
|Decrease in accrued interest payable                                                              |  |                                                       | (4      | ) |                                                       |   | (10     | )
|Increase (decrease) in other liabilities                                                          |  |                                                       | (5      | ) |                                                       |   | 327     |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Net cash provided by operating activities                                                         |  |                                                       | 803     |   |                                                       |   | 1,071   |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Cash Flows From Investing Activities:                                                             |  |                                                       |         |   |                                                       |   |         |  
|Increase in money market investments                                                              |  |                                                       | (3,045  | ) |                                                       |   | (11,867 | )
|Purchases of premises and equipment                                                               |  |                                                       | (340    | ) |                                                       |   | (173    | )
|Purchases of securities available for sale                                                        |  |                                                       |        |   |                                                       |   | (7,851  | )
|Purchases of securities held to maturity                                                          |  |                                                       | (215    | ) |                                                       |   | (1,000  | )
|Purchases of restricted equity securities                                                         |  |                                                       | (216    | ) |                                                       |   |        |  
|Principal repayments/sales/calls of securities available for sale                                 |  |                                                       | 2,465   |   |                                                       |   | 4,921   |  
|Principal repayments of securities held to maturity                                               |  |                                                       | 276     |   |                                                       |   | 826     |  
|Principal repayments of restricted equity securities                                              |  |                                                       | 315     |   |                                                       |   |        |  
|Proceeds from sale of fixed assets                                                                |  |                                                       |        |   |                                                       |   | 2       |  
|Proceeds from sale of foreclosed properties                                                       |  |                                                       |        |   |                                                       |   | 112     |  
|Increase in loans                                                                                 |  |                                                       | (19,018 | ) |                                                       |   | (9,241  | )
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Net cash used in investing activities                                                             |  |                                                       | (19,778 | ) |                                                       |   | (24,271 | )
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Cash Flows From Financing Activities:                                                             |  |                                                       |         |   |                                                       |   |         |  
|Increase in certificates of deposit > than $100,000                                               |  |                                                       | 3,690   |   |                                                       |   | 289     |  
|Increase in other time deposits                                                                   |  |                                                       | 14,929  |   |                                                       |   | 16,731  |  
|Increase in other deposits                                                                        |  |                                                       | 8,103   |   |                                                       |   | 6,414   |  
|Decrease in short-term borrowings                                                                 |  |                                                       | (5,000  | ) |                                                       |   | (2,556  | )
|Increase (decrease) in Federal funds purchased and securities sold under agreements to repurchase |  |                                                       | (1,516  | ) |                                                       |   | 615     |  
|Proceeds from issuance of common stock                                                            |  |                                                       |        |   |                                                       |   | 5       |  
|                                                                                                  |  |                                                      
|Net cash provided by financing activities                                                         |  |                                                       | 20,206  |   |                                                       |   | 21,498  |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Net Increase (Decrease) in Cash and Due from Banks                                                |  |                                                       | 1,231   |   |                                                       |   | (1,702  | )
|                                                                                                  |  |                                                      
|Cash and Due From Banks at Beginning of Period                                                    |  |                                                       | 7,119   |   |                                                       |   | 7,511   |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Cash and Due From Banks at End of Period                                                          |  | $                                                     | 8,350   |   |                                                       | $ | 5,809   |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Supplemental disclosure of cash flow information:                                                 |  |                                                       |         |   |                                                       |   |         |  
|Cash paid during the period for interest                                                          |  | $                                                     | 2,102   |   |                                                       | $ | 1,566   |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Cash paid during the period for taxes                                                             |  | $                                                     |        |   |                                                       | $ |        |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  
|Noncash financing and investing activities:                                                       |  |                                                       |         |   |                                                       |   |         |  
|Transfer of loans to foreclosed property                                                          |  | $                                                     |        |   |                                                       | $ | 283     |  
|                                                                                                  |  |                                                       |         |   |                                                       |   |         |  



See accompanying notes to consolidated
financial statements.



5



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

March 31, 2005 (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 2004 Annual Report on Form 10-KSB.



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.



|(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, 2005 was $1,935, less cash on hand in the amount of $1,037, or a net of $898. 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, 2005 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, 2005 are shown in the tables below. As of March 31, 2005, investments (including both available for sale and held to maturity) and restricted equity securities with amortized costs and fair values of $38,101 and $37,456,
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.



The following table sets forth the composition of securities
available for sale at March 31, 2005. Securities available for sale are carried at approximate market value.



6



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##### Table of Contents

Available for Sale Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       
|----------------------------------- |  | --------------- | ------ | ---------------- | - | ----------------- |  | - | ----------------------- | - |  | - | ------
|                                    |  | Amortized Costs |        | Unrealized Gains |   | Unrealized Losses |  |   | Approximate Fair Values
|U.S. Government agencies            |  | $               | 9,724  |                  | $ | 8                 |  | $ | (122                    | ) |  | $ | 9,610 
|Mortgage-backed securities          |  |                 | 6,730  |                  |   | 1                 |  |   | (202                    | ) |  |   | 6,529 
|Collateralized mortgage obligations |  |                 | 17,759 |                  |   | 6                 |  |   | (486                    | ) |  |   | 17,279
|States and political subdivisions   |  |                 | 8,885  |                  |   | 200               |  |   | (23                     | ) |  |   | 9,062 
|Corporate debt securities           |  |                 | 200    |                  |   |                  |  |   | (4                      | ) |  |   | 196   
|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       
|Total securities available for sale |  |                 | 43,298 |                  | $ | 215               |  | $ | (837                    | ) |  | $ | 42,676
|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       



The
following table sets forth the composition of securities held to maturity at March 31, 2005. Securities held to maturity are carried at amortized cost.



Held to Maturity Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       
|----------------------------------- |  | --------------- | ------ | ---------------- | - | ----------------- |  | - | ----------------------- | - |  | - | ------
|                                    |  | Amortized Costs |        | Unrealized Gains |   | Unrealized Losses |  |   | Approximate Fair Values
|U.S. Treasury                       |  | $               | 199    |                  | $ |                  |  | $ | (1                      | ) |  | $ | 198   
|U.S. Government agencies            |  |                 | 9,932  |                  |   |                  |  |   | (242                    | ) |  |   | 9,690 
|Mortgage-backed securities          |  |                 | 3,787  |                  |   |                  |  |   | (66                     | ) |  |   | 3,721 
|Collateralized mortgage obligations |  |                 | 732    |                  |   |                  |  |   | (32                     | ) |  |   | 700   
|States and political subdivisions   |  |                 | 7,418  |                  |   | 26                |  |   | (65                     | ) |  |   | 7,379 
|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       
|Total securities held to maturity   |  | $               | 22,068 |                  | $ | 26                |  | $ | (406                    | ) |  | $ | 21,688
|                                    |  |                 |        |                  |   |                   |  |   |                         |   |  |   |       



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



The following table summarizes the loan loss experience for the three-month periods ended March 31, 2005 and 2004.



Allowance for Loan Losses

(dollars in thousands)



|                                  |  |      |       |      |   |       |  
|--------------------------------- |  | ---- | ----- | ---- | - | ----- | -
|                                  |  | 2005 |       | 2004 |  
|Balance at January 1              |  | $    | 2,989 |      | $ | 2,566 |  
|Provision for loan losses         |  |      | 324   |      |   | 98    |  
|Recoveries  Loans to individuals |  |      |      |      |   |      |  
|Charged off loans                 |  |      |       |      |   |       |  
|Commercial                        |  |      |      |      |   |      |  
|Credit Cards                      |  |      |      |      |   |      |  
|Loans to individuals              |  |      |      |      |   | (1    | )
|                                  |  |      |       |      |   |       |  
|Balance at March 31               |  | $    | 3,313 |      | $ | 2,663 |  
|                                  |  |      |       |      |   |       |  



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|(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 table summarizes the shares utilized in the computations:



Weighted Average Shares Outstanding



|                              |  |           |  |          
|----------------------------- |  | --------- |  | ---------
|                              |  | Basic     |  | Diluted  
|Three months ending March 31: |  |           |  |          
|2005                          |  | 4,074,630 |  | 4,270,816
|                              |  |           |  |          
|2004                          |  | 3,666,148 |  | 3,950,834
|                              |  |           |  |          



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



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, 2005 and 2004, total comprehensive income was $238 and $852, respectively.



The information that follows discloses the reclassification adjustments and the income taxes related to securities available for sale that
are included in other comprehensive income (loss), net of income taxes for the three month periods ended March 31, 2005 and 2004.



|                                                                            |  |                                           |      |   |                                           |   |      |  
|--------------------------------------------------------------------------- |  | ----------------------------------------- | ---- | - | ----------------------------------------- | - | ---- | -
|                                                                            |  | For the Three Months Ended March 31, 2005 |      |   | For the Three Months Ended March 31, 2004 |  
|Net unrealized gains (losses) on securities available for sale:             |  |                                           |      |   |                                           |   |      |  
|Net unrealized holding gains (losses) during the year                       |  | $                                         | (654 | ) |                                           | $ | 341  |  
|Less reclassification adjustments for realized gains included in net income |  |                                           | (1   | ) |                                           |   | (4   | )
|Income tax benefit (expense)                                                |  |                                           | 223  |   |                                           |   | (115 | )
|                                                                            |  |                                           |      |   |                                           |   |      |  
|Other comprehensive income (loss), net of income taxes                      |  | $                                         | (432 | ) |                                           | $ | 222  |  
|                                                                            |  |                                           |      |   |                                           |   |      |  



|(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.



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##### Table of Contents

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, 2005,
outstanding commitments to extend credit were $125,886 as compared to $100,838 at December 31, 2004.



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, 2005 aggregate loans to directors, executive officers, and principal shareholders totaled $14,918. The primary increase from the
$10,449 level reported at December 31, 2004 is due to adding new directors during the first quarter of 2005. An analysis of loan activity to directors, executive officers and principal shareholders for the year ended December 31, 2004 is as follows:



Loans to Related Parties



|                                 |  |   |        |  
|-------------------------------- |  | - | ------ | -
|Balances as of January 1, 2004   |  | $ | 6,324  |  
|Advances                         |  |   | 5,308  |  
|Repayments                       |  |   | (1,183 | )
|                                 |  |   |        |  
|Balances as of December 31, 2004 |  | $ | 10,449 |  
|                                 |  |   |        |  



|(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, 2005.
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 flat. The $10.0 million convertible advance may be converted into a 3-month
LIBOR-based floating rate advance (ARC) at 3-month LIBOR flat 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, 2005.



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##### Table of Contents

LONG-TERM FEDERAL HOME LOAN BANK ADVANCES



|                |  |                   |  |                   |  |            |   |  |                               
|--------------- |  | ----------------- |  | ----------------- |  | ---------- | - |  | ------------------------------
|Advance Balance |  | Advance Date      |  | Maturity Date     |  | Fixed Rate |   |  | First Optional Conversion 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, 2004    |  | March 11, 2013    |  | 2.91       | % |  | March 11, 2008                



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



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



The
Trusts preferred securities and common securities may be included in the Companys Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of the Companys total Tier I capital excluding the
securities. Amounts in excess of this ratio will not be considered Tier 1 capital but may be included in the calculation of the Companys total risk-based capital ratio. The Companys obligations with respect to the issuance of the
Trusts preferred securities and common securities constitute a full and unconditional guarantee by the Company of the Trust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 the Trusts preferred trust securities and common securities.



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



The Company accounts for its stock-based compensation plan using the accounting prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.The Company is not required to adopt the fair value based recognition provisions prescribed under SFAS No. 123, Accountingfor Stock Based Compensation, but complies with the disclosure
requirements set forth in the Statement (as amended by SFAS No. 148), which include disclosing pro forma net income as if the fair value based method of accounting had been applied.



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##### Table of Contents

Stock Option Plans



The Company has an Incentive Stock Plan (the 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 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. There are options for 243,945 shares granted to officers and key employees currently outstanding as of March 31, 2005. All stock options 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. In addition to the Plan, certain other options for 182,196 shares (adjusted for stock splits), of which 82,098 are outstanding as of March 31, 2005, based on meeting certain past performance criteria have been granted to executive
officers. Information related to pro forma net income and per share amounts for the periods presented is as follows:



|                                                                               |  |                              |      |      |   |     
|------------------------------------------------------------------------------ |  | ---------------------------- | ---- | ---- | - | ----
|                                                                               |  | Three Months Ended March 31,
|                                                                               |  | 2005                         |      | 2004
|Compensation cost recognized in income for all stock-based compensation awards |  | $                            |     |      | $ |    
|Pro forma net income, based on SFAS No. 123                                    |  | $                            | 663  |      | $ | 615 
|Pro forma basic net income per share, based on SFAS No. 123                    |  | $                            | 0.16 |      | $ | 0.17
|Pro forma diluted net income per share, based on SFAS No. 123                  |  | $                            | 0.16 |      | $ | 0.16



At the
2005 Annual Meeting of Shareholders held on April 27, 2005, the Board of Directors recommended and the Shareholders approved The 2005 Key Employee Equity Award Plan. The new Plan will give 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 Non Qualified Stock Options, the Plan
permits the grant of Restricted Stock, Stock Appreciation Rights and Stock Units to persons designated as Key Employees. The Plan will remain in effect for ten years, subject to the right of the Board of Directors to terminate the 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 259,437 and includes 9,437 shares which were set aside for the 1995 Plan but which were unused when the 1995 Plan terminated. Within the maximum limits, the Plan specifies that Stock Appreciation Rights
may not be granted with respect to more than 500 shares per recipient (2,000 shares for a new employee recipient) per year; and Restricted Shares and Stock Units, respectively, may not be granted for more than 5,000 shares per year per recipient.



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##### Table of Contents

|(12) | Costs Associated with Originating or Acquiring Loans and Change in Accounting Principle
|---- | ---------------------------------------------------------------------------------------



On January 1, 2005, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. This statement requires loan origination fees and direct loan origination costs for a given loan to be offset
and the net amount deferred and recognized over the life of the loan as an adjustment of yield. This statement was applied prospectively to lending transactions entered into and commitments granted after December 31, 2004. Prior to January 1, 2005,
loan origination fees and costs were not capitalized and recognized as an adjustment to the yield on the loan as such deferrals were not material to the Companys financial position or results of operations.



For the three month period ending March 31, 2005, the net effect of the
implementation of SFAS No. 91 was an increase in net income of $35, no change in basic earnings per share and diluted earnings per share increased by $0.01.



Item 2. Managements Discussion and Analysis.



The following is 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, 2005 and 2004. The discussion should be
read in conjunction with the Companys Consolidated Financial Statements and Notes on the December 31, 2004 Form 10-KSB.



Forward-Looking Statements



This report contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from
those reflected in such forward-looking statements, which are representative only on the date hereof. Readers of this report should not rely solely on the forward-looking statements and should consider all uncertainties and risks discussed
throughout this report. The Corporation takes no obligation to update any forward-looking statements contained herein. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include,
among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions,
either nationally or regionally, may be less favorable than expected that could result in a deterioration of credit quality or a reduced demand for credit; (4) legislative or regulatory changes including changes in accounting standards, may
adversely affect the business.



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##### Table of Contents

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 seven full-service branch locations, operating in various locations throughout the Cities of Roanoke and Salem, Town of Vinton, and the County of Roanoke.



Total assets at March 31, 2005 were $394.4 million, up 5.5% from $374.0
million at December 31, 2004. The principal components of the Companys assets at the end of the period were $46.1 million in securities available for sale, including restricted equity securities, $22.1 million in securities held to maturity,
and $301.8 million in gross loans.



Total liabilities at March
31, 2005 were $365.9 million, up 5.8% from $345.7 million at December 31, 2004 with the increase represented by a $26.7 million growth in deposits and a $700,000 increase in securities sold under agreements to purchase, partially offset by the
repayment of the Federal Home Loan Bank of Atlanta daily rate credit of $5.0 million and a $2.2 million decrease in federal funds purchased .



Total shareholders equity at March 31, 2005 was $28.6 million consisting of $9.1 million in net proceeds from the 1995 Companys 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 and $865,000 in proceeds from the exercise of stock options, increased by accumulated
retained earnings of $12.0 million and $(411,000) of net unrealized losses on securities available for sale, net of related deferred tax liability. Total shareholders equity was $28.6 million at March 31, 2005 compared with $28.3 million at
December 31, 2004, an increase of $300,000 or 1.1%. Exclusive of unrealized gains (losses) on investment securities, shareholders equity was $29.0 million at March 31, 2005 and $28.3 million at December 31, 2004.



The Company had net income of $670,000 for the three months ended March 31,
2005, an increase of $40,000 or 6.3% over the $630,000 reported for the same period in 2004. An improved net interest income combined with increased noninterest income, offset by increases in noninterest expense in virtually all categories,
contributed to the 6.3% increase for the three months ended March 31, 2005 as compared to the three months ended March 31, 2004.



Profitability as measured by the Companys annualized return on average assets (ROA) was 0.71% for the three months ended March 31, 2005
compared to 0.79% for the same period in 2004. Annualized return on average equity (ROE) was 9.42% for the three months ended March 31, 2005 compared to 11.65% for the same period in 2004. The calculation of ROE excludes the effect of
any unrealized gains or losses on investment securities.



Net Interest
Income



Net interest income is the amount by which
interest and fees generated from loans and investments exceeds the interest expense associated with funding those assets, and represents the principal source of earnings for the Company. Changes in the volume and mix of earning assets and
interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Changes in the interest rate environment and the Companys cost of funds also affect net interest income.



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##### Table of Contents

Net interest income was $2.9 million for the three months ended March 31, 2005 and is attributable to
interest income from loans and securities exceeding the cost of interest paid on deposits and borrowed funds. Net interest income for the first three months of 2005 increased 19.4% from $2.5 million for the same period in 2004. The net interest
margin on a fully taxable equivalent (FTE ) basis was 3.38% for the first three months of 2005, a decrease of 4 basis points from the 3.42% reported for the same period in 2004. The Banks cost of funds ratio was 2.41% for the three
months ended March 31, 2005, up 30 basis points from the 2.11% reported for the first three months of 2004. The Banks yield on earning assets was 5.72% for the three months ended March 31, 2005, up 23 basis points from the 5.49% reported for
the three months ended March 31, 2004. Management is diligently working to maintain the net interest margin by reducing the cost of funds ratio.



Noninterest Income



Noninterest income for the three months ended March 31, 2005 was $332,000, an increase of $12,000 or 3.7% over the $320,000 reported for the same period
one year earlier. The largest components of the increase are service charges on deposit accounts in the amount of $27,000, tax-exempt income earned on bank owned life insurance in the amount of $4,000, offset by an $8,000 decrease in income earned
on real estate loans, and a $7,000 decrease in other fee income. Securities gains totaled $0 during the first three months of 2005 as compared to $4,000 for the first three months of 2004. With the increase in interest rates, mortgage originations
and refinancings have slowed down which is the primary reason for the decrease in income earned on real estate loans. Future levels of noninterest income are expected to increase as a direct result of business growth and expansion.



Noninterest Expense



Noninterest expense for the first three months of 2005 was $2.0 million, an increase of $200,000 or 11.6% over the
$1.8 million reported for the same period in 2004. Other expense was the largest contributor to the increase in the amount of $109,000, primarily related to the increase in legal and audit fees related to the Sarbanes Oxley Act of 2002. Likewise,
compensation expense increased by $56,000 due to the hiring of new employees in the 4thquarter of 2004 and the
officer merit increases which were effective on January 1, 2005. Noninterest expenses are expected to continue to increase in future years as a direct result of business growth and expansion.



Income Taxes



To reflect the Companys anticipated federal income tax liability, an expense of $233,000 and $222,000 at an
effective tax rate of 25.8% and 26.1% was recognized for the three months ended March 31, 2005 and 2004, respectively. 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



The Companys investment portfolio is used both for investment income and liquidity purposes. Funds not used for capital expenditures or lending
activities are invested in securities of the U.S. Government and its agencies, mortgage-backed securities, municipal bonds, corporate bonds, and restricted equity securities. Obligations of the U.S. Government and its agencies include treasury notes
and callable or noncallable agency bonds. Mortgage-backed securities and collateralized mortgage obligations include pools issued by government agencies and corporate mortgage pools. Municipal bonds include taxable and tax-exempt general obligation
and revenue issues. Corporate bonds are investment grade issue. Restricted equity securities include shares of the Federal Reserve Bank of Richmond, Federal Home Loan Bank of Atlanta, and Community Bankers Bank. The Company does 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.



Investment securities (available for sale and held to maturity), including
restricted equity securities, at March 31, 2005 were $68.1 million, a decrease of $3.3 million or 4.7% from their level of $71.5 million on December 31, 2004. The decrease of $3.3 million is primarily due to purchases in the amount of $431,000,
offset by principal repayments, sale proceeds, and decline in the market value of available for sale securities in the amounts of $1.6 million, $1.6 million, and $650,000, respectively. See Note 3 to the Consolidated Financial Statements.



Loan Portfolio



The Companys total loans were $301.8 million at March 31, 2005, an
increase of $19.0 million or 6.7% from the $282.8 million reported at December 31, 2004. The Companys 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 83.0% at March 31, 2005 and 82.4% at December 31, 2004. Management seeks to maintain the ratio of loans to
funding sources at a maximum of 85%.



The loan portfolio
primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. The Company adjusts its mix of
lending and the terms of its 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 the
Companys 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 thereto or
discussed below. The Company has not made any loans in excess of 1% of total assets to foreign entities, including governments, banks, businesses or individuals.



The following table summarizes the loan portfolio by category as of the three-month periods ended March 31, 2005 and 2004
and the year ended December 31, 2004.



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##### Table of Contents

Loan Portfolio Summary

(dollars in thousands)



|                          |  |                |         |                   |   |                |  |   |        
|------------------------- |  | -------------- | ------- | ----------------- | - | -------------- |  | - | -------
|                          |  | March 31, 2005 |         | December 31, 2004 |   | March 31, 2004
|Commercial and industrial |  | $              | 77,364  |                   | $ | 71,580         |  | $ | 54,161 
|Commercial real estate    |  |                | 111,490 |                   |   | 107,186        |  |   | 97,701 
|Real estate construction  |  |                | 28,918  |                   |   | 25,404         |  |   | 18,342 
|Residential real estate   |  |                | 49,785  |                   |   | 43,848         |  |   | 31,201 
|Loans to individuals      |  |                | 34,237  |                   |   | 34,758         |  |   | 30,155 
|                          |  |                |         |                   |   |                |  |   |        
|Total loans               |  | $              | 301,794 |                   | $ | 282,776        |  | $ | 231,560
|                          |  |                |         |                   |   |                |  |   |        



Loan Category Analysis



Commercial Loans. Commercial and industrial loans
accounted for 25.6% of the loan portfolio as of March 31, 2005 and stood at $77.4 million versus $71.6 million three months earlier. Such 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, and were 36.9% of total loans at March 31, 2005. Outstanding loans in this category equaled $111.5 million and
$107.2 million at March 31, 2005 and December 31, 2004, respectively. 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. Outstanding loans in
this category totaled $28.9 million (9.6% of total loans) at March 31, 2005 as compared to $25.4 million at December 31, 2004.



Residential Real Estate Loans. Residential real estate loans are secured by first deeds of trust on 1-4 family residential properties. This
category had $49.8 million in loans (16.5% of total loans) at March 31, 2005 and $43.8 million in such loans at December 31, 2004. 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.



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##### Table of Contents

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. Loans to individuals totaled $34.2 million (11.3% of
total loans) at March 31, 2005 compared to $34.8 million at December 31, 2004.



Summary of Allowance for Loan Losses



Certain credit risks are inherent in making loans. The Company seeks to prudently assess these risks and attempts to manage them effectively. Adhering to our internal credit policies and procedures reduces repayment risks. These
policies and procedures include officer and customer limits, periodic loan documentation review, and follow-up on exceptions to credit policies.



The allowance for loan losses is maintained at a level estimated to be adequate to absorb probable losses. Some of the factors which management considers
in determining the appropriate level of the allowance for loan losses are 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 the Company employs independent, third party loan reviewers as well. The
provision for loan losses is charged to income in an amount believed to be necessary to maintain an allowance for loan losses adequate to provide for expected losses in the loan portfolio. Loans deemed uncollectible are charged to the allowance for
loan losses and recoveries on loans previously charged off are added to the allowance for loan losses. The Company believes the allowance for loan losses is adequate to provide for expected losses in the loan portfolio.



A provision for loan losses of $324,000 was provided during the three
months ended March 31, 2005, an increase of $226,000 or 230.6% over the same period in 2004, in recognition of managements estimate of inherent risks associated with lending activities. The allowance for loan losses was $3.3 million as of
March 31, 2005 and represented approximately 1.1% of net loans outstanding versus 1.1% of net loans at December 31, 2004 (see Note 4 to the Consolidated Financial Statements). These estimates are primarily based on our historical loss experience,
portfolio concentrations, evaluation of individual loans and economic conditions. Almost two-thirds of the Companys loan loss provision for the period ended March 31, 2005 was the normal result of rapid growth in the loan portfolio. A total of
$491,000 in special reserves was included in the balance of the allowance for loan losses as of March 31, 2005 for impaired loans. Special reserves increased by $460,000 during the three months ended March 31, 2005.



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 the Company 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.



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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.



Each quarter, the board of directors will review all loans on the Banks
watch list to determine proper action and reporting of any loans identified as substandard by the credit quality review.



The total recorded investment in impaired loans was $2,478,000, $390,000 and $527,000, respectively at March 31, 2005, December 31, 2004 and March 31,
2004. The largest contributor to the increase in the investment in impaired loans is one commercially-oriented relationship that the Company had identified in 2004 as a workout situation. The special loan loss allowance related to impaired loans was
$491,000, $31,000 and $114,000, respectively for the above-referenced time periods. Management believes that the above allocated reserves are adequate for the impaired loans in the Companys 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.



Nonperforming assets at March 31, 2005, December 31, 2004 and March 31, 2004 are presented in the following table.



Nonperforming Assets

(dollars in thousands)



|                                             |  |                |       |                   |   |                |  |   |    
|-------------------------------------------- |  | -------------- | ----- | ----------------- | - | -------------- |  | - | ---
|                                             |  | March 31, 2005 |       | December 31, 2004 |   | March 31, 2004
|Nonaccrual loans                             |  |                | 2,473 |                   | $ | 150            |  | $ | 485
|Loans past due 90 days or more               |  |                | 5     |                   |   | 240            |  |   | 42 
|Restructured loans                           |  |                |      |                   |   |               |  |   |   
|                                             |  |                |       |                   |   |                |  |   |    
|Total nonperforming loans                    |  |                | 2,478 |                   |   | 390            |  |   | 527
|                                             |  |                |       |                   |   |                |  |   |    
|Foreclosed, repossessed and idled properties |  |                |      |                   |   | 1              |  |   | 172
|                                             |  |                |       |                   |   |                |  |   |    
|Total nonperforming assets                   |  | $              | 2,478 |                   | $ | 391            |  | $ | 699
|                                             |  |                |       |                   |   |                |  |   |    



If nonaccrual loans
had performed in accordance with their original terms, additional interest income in the amount of $9,000, $6,000, and $7,000, respectively would have been recorded for the three-month period ended March 31, 2005, the year ended December 31, 2004
and the three-month period ended March 31, 2004.



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Other Assets



The Company has 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 $6.2 million at March 31, 2005, an increase of $100,000 over the $6.1 million reported as of December 31, 2004. The increase is entirely due to the increase in
the cash surrender value of the life insurance contracts.



Other assets were $2.3 million at March 31, 2005, an increase of $400,000 from the $1.9 million level reported as of December 31, 2004.



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 those paid by the Company. Management attempts to identify and implement pricing and marketing
strategies designed to control the overall cost of deposits and to maintain a stable deposit mix.



As of March 31, 2005 total deposits were $306.1 million, an increase of $26.7 million or 9.6% from their level of $279.3 million at December 31, 2004.
Certificates of deposit increased by $18.6 million to a total of $189.4 million (61.9% of total deposits) at March 31, 2005, up from $170.8 million (61.2% of total deposits) at December 31, 2004. Non-interest bearing demand deposits and money market
accounts increased by $4.9 million and $3.8 million, respectively. Interest-bearing demand deposits and savings decreased by $500,000 and $100,000, respectively.



At March 31, 2005 noninterest-bearing demand deposits were $52.0 million or 17.0% of total deposits. On December 31, 2004
noninterest-bearing demand deposits were $47.1 million or 16.9% of total deposits. Nonmaturity deposits (noninterest bearing demand deposits, interest bearing demand deposits, money market accounts and savings accounts) were $116.6 million or 38.1%
of total deposits at March 31, 2005, compared with $108.5 million or 38.8% of total deposits at December 31, 2004. Total interest bearing deposits stood at $254.1 million at March 31, 2005, an increase of $21.9 million or 9.4% over their level of
$232.2 million at December 31, 2004.



Short-Term Borrowings



The Companys short-term borrowings decreased by $5.0 million from
its level of $15.0 million at December 31, 2004 to a total of $10.0 million as of March 31, 2005. Short-term borrowings at March 31, 2005 consist of a Federal Home Loan Bank of Atlanta daily rate credit in the amount of $0 million and a Federal Home
Loan Bank of Atlanta adjustable rate credit in the amount of $10.0 million. The decrease is due to the repayment of the Federal Home Loan Bank of Atlanta daily credit of $5.0 million.



The Federal Home Loan Bank of Atlanta daily rate credit borrowing matures daily and is rolled over on a daily basis at the
stated Federal Home Loan Bank of Atlanta daily rate. There is no stated maturity date. Interest is paid monthly on the daily rate credit.



The Federal Home Loan Bank of Atlanta adjustable rate credit in the amount of $10.0 million matures on December 16, 2005. The advance reprices quarterly
on the date of each quarterly interest payment. The current rate is 3.10%. See the liquidity section for further information on the preceding borrowings.



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The Company has in place a commercial sweep account program. The balance in the program increased by
$700,000 from its level of $5.8 million at December 31, 2004 to a total of $6.5 million as of March 31, 2005. The program consists of establishing a demand deposit account in which the Bank invests available balances daily in securities on an
overnight basis subject to repurchase. On the following business day, the Bank will 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. The contractual agreement states that a repurchase agreement is not a deposit and therefore is not insured by the Federal Deposit
Insurance Corporation. Therefore, these repurchase balances are not reported as deposits but as short-term borrowings.



Long-Term Borrowings



Federal Home Loan Bank advances are relatively cost-effective funding sources and provide the Company with the flexibility to structure borrowings in a
manner that aids in the management of interest rate risk and liquidity. Long-term convertible Federal Home Loan Bank advances totaled $37.0 million at March 31, 2005 and December 31, 2004. 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 I, a statutory business trust (the Trust), was created by the Company on June 26, 2003, at which time the Trust issued $4.0 million in aggregate liquidation amount of
$1 par value preferred capital trust securities which mature June 26, 2033. Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate (LIBOR) plus 3.10%, capped at 11.75%, and the
securities may be prepaid at par by the Trust at any time after June 26, 2008. The principal assets of the Trust 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 the Trusts common securities are held by the Company.



The Trusts preferred securities and common securities may be included
in the Companys Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of the Companys total Tier I capital excluding the securities. Amounts in excess of this ratio will not be considered Tier
1 capital but may be included in the calculation of the Companys total risk-based capital ratio. The Companys obligations with respect to the issuance of the Trusts preferred securities and common securities constitute a full and
unconditional guarantee by the Company of the Trust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 the Trusts preferred trust securities and common securities.



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Interest Rate Risk



Interest rate risk is the risk to earnings or capital generated by the effects of changes in interest rates on the Companys 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 potential 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 the overall interest rate risk to the Company.



The Company has established risk measures, limits, policy guidelines and internal control mechanisms for managing the overall asset/liability management
(ALM) position. The responsibility for interest rate risk control resides with Management, with oversight by the Board of Directors and its Investment Committee. The Company seeks to balance the return potential of the ALM position
against the desire to limit volatility in earnings.



At least
quarterly, the Company measures the ALM position using earnings simulation modeling to estimate what assets and liabilities would reprice, 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. The Companys 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 the earnings of the Company. Modeling the sensitivity of
earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates managements best estimate of interest rate and balance sheet dynamics under
various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.



The Company also estimates interest sensitivity by the Economic Value of Equity (EVE), which is the net present value of the balance sheets cash
flows or the residual value of future cash flows ultimately due to shareholders. EVE is generally considered a better measure of long-term interest sensitivity than is IRS. The Companys objective is for EVE to change 25% or less in an
immediate 300 basis point interest rate shock scenario.



Capital Adequacy



The Companys financial position at March 31, 2005
reflects liquidity and capital levels currently adequate to fund anticipated near-term business expansion. Capital ratios are in excess of required regulatory minimums for a well-capitalized institution. The adequacy of the Companys capital is
reviewed by management on an ongoing basis. Management seeks to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses.



At the 2005 Annual Meeting of Shareholders held on April 27, 2005, it was
announced that the Board of Directors had declared the third consecutive semi-annual cash dividend on the Companys common stock,



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in the amount of $.06 per share payable July 1, 2005 to shareholders of record June 1, 2005. Additionally, the Board of
Directors recommended and the Shareholders approved The 2005 Key Employee Equity Award Plan. The new Plan will give 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.



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Total shareholders equity increased by $300,000 during the first three months of 2005. The increase
is attributable to net income for the first three months of $670,000 offset by a decrease of $432,000 in accumulated other comprehensive income, resulting from unrealized losses on investment securities. Exclusive of unrealized gains (losses) on
investment securities, shareholders equity was $29.0 million at March 31, 2005 and $28.3 million at December 31, 2004.



For the periods indicated, the Company had the following risk-based capital and leverage ratios relative to regulatory minimums:



Capital Ratios



|         |  |         |   |  |          |   |  |         |   |  |         |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | - |  | ------- | -
|Ratio    |  | 3/31/05 |   |  | 12/31/04 |   |  | 3/31/04 |   |  | Minimum |  
|Tier 1   |  | 10.2    | % |  | 10.5     | % |  | 10.0    | % |  | 4       | %
|         |  |         |   | 
|Total    |  | 11.2    | % |  | 11.5     | % |  | 11.0    | % |  | 8       | %
|         |  |         |   | 
|Leverage |  | 8.6     | % |  | 8.8      | % |  | 8.2     | % |  | 4       | %



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 the Companys interest sensitivity position, to manage the impact of interest rate fluctuations on net interest income.



Liquidity measures the ability of the Company to meet its maturing
obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its 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.



Cash and due from banks, money market investments, investments available for sale including restricted equity securities, and through management of
investment maturities/prepayments and loan repayments, provide the Companys asset liquidity. The Companys ratio of liquid assets to deposits and short-term borrowings was 17.8% at March 31, 2005 and 18.7% at December 31, 2004. The
Company sells excess funds as overnight federal funds sold to provide an immediate source of liquidity. The Company had federal funds sold of $2.7 million and $0 at March 31, 2005 and December 31, 2004, respectively. During the first three months of
2005, deposit growth in the amount of $26.7 million surpassed loan growth in the amount of $19.0 million, providing $7.7 million in excess funds. The $7.7 million excess deposit over loan growth, combined with an increase in securities sold under
agreements to repurchase in the amount of $700,000, and the reduction in securities available for sale of $3.1 million was used to fund an increase in money market investments in the amount of $3.0 million and repay federal funds purchased in the
amount of $2.2 million and repay the Federal Home Loan Bank of Atlanta daily rate credit of $5.0 million.



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



In addition to asset liquidity, the Company would have liquidity available to it through increasing certain categories of
liabilities. It could purchase overnight federal funds, borrow from correspondent banks, sell securities under a repurchase agreement or obtain advances from the Federal Home Loan Bank. The Bank also has established a credit line through the
discount window of the Federal Reserve Bank of Richmond as an additional source of cash flow. As a result of the Companys management of liquid assets and the ability to generate liquidity through alternative funding sources, management
believes the Company maintains overall liquidity sufficient to meet its depositors requirements and satisfy its customers credit needs.



Impact of Inflation



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



Recent and Future Accounting Considerations



In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), which establishes guidance for determining when an entity
should consolidated another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a
majority of the expected residual returns, or both. Transferors to qualified special-purpose entities (QSPEs) and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB revised FIN
46 (FIN 46R) and deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31,
2003. The Interpretation had no significant effect on the Companys consolidated financial statements.



In May 2003 the Financial Accounting Standards Board (FASB) issued Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement dictates certain
instruments be classified as liabilities such as: 1) a financial instrument issued in the form of shares that is mandatorily redeemable  that embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at
a specified



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or determinable date or upon an event that is certain to occur; 2) a financial instrument, other than an outstanding
share, that, at inception, embodies an obligation to repurchase the issuers equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets; and 3) a financial
instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares. This
Statement does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. It also does not affect the classification or measurement of convertible bonds, puttable stock, or other outstanding shares
that are conditionally redeemable. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for
mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and
still existing at the beginning of the interim period of adoption. Restatement is not permitted.



In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS 123(R)), Share-Based Payments. SFAS 123(R) requires all entities to
recognize compensation expense in an amount equal to the fair value of share-based payments, such as stock options granted to employees. The Company will most likely apply SFAS 123(R) on a modified prospective method. Under this method, the Company
is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted stock option awards that remain outstanding at the date of adoption. In addition, the Company may elect to adopt SFAS
123(R) by restating previously issued financial statements, basing the amounts on the expense previously calculated and reported in the pro forma disclosures that had been required by SFAS 123, Accounting for Stock-Based Compensation. SFAS 123(R) is
effective for the interim financial statements filed with the Securities and Exchange Commission beginning with the first quarter of 2006.



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Item 3. Quantitative and Qualitative Disclosures about Market Risk



The principal goals of the Banks 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.



Management must ensure that adequate funds are available at all times to meet the needs of its 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 reprice or mature. Management attempts to maintain the portfolios of interest-earning assets and
interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates.



The Bank uses a number of tools to manage its 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.



Quantitative information about the Banks
interest rate risk is included in the Companys Annual Report on Form 10-KSB for the year ended December 31, 2004. There have not been any material changes since December 31, 2004.



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 the Companys 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 the companys internal control over financial reporting that occurred during the Companys 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 matters submitted to a vote of security holders during the quarter.



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Item 5. Other Information.



None.



Item 6. Exhibits and Reports on Form 8-K.



|(a) | The Company filed the following exhibits for the quarter ended March 31, 2005:
|--- | ------------------------------------------------------------------------------



Exhibits:



|      |  |                                                                                                                                                                                                                                                                                        
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                                                                       
|      | 
|3.2   |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                                                                                          
|      | 
|3.3   |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit 3.3 of Form 10-KSB filed March 30, 2005, File No. 000-28342).                                                                                                                                             
|      | 
|*10.2 |  | Employment Agreement dated April 8, 1994, by and between the Company and A.Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No. 33-77568, on Form
S-1, as amended).                                                                         
|      | 
|*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 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).                                                                        
|      | 
|10.5  |  | Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.5 of Registration
Statement No. 33-77568, on Form S-1, as amended).                                       
|      | 
|10.10 |  | First amendment dated August 5, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by
reference to Exhibit No. 10.10 of Form 10-K filed March 30, 1995, File No. 33-77568).    
|      | 
|10.12 |  | Second amendment dated December 14, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley
Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 30, 1995, File No. 33-77568).
|      | 
|10.13 |  | Lease agreement for office space dated September 20, 1996, by and between Valley Bank, N.A. and Betty J. Burrows (incorporated herein by reference to Exhibit No. 10.13 of Form 10-KSB filed
March 27, 1997, File No. 33-77568).                                                       



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|       |  |                                                                                                                                                                                                                                                
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|*10.6  |  | Severance agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No.
10.6 of Form 10-KSB filed March 30, 2000, File No. 33-77568).                                   
|       | 
|*10.7  |  | 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).             
|       | 
|*10.14 |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 (incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                                   
|       | 
|*10.15 |  | 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).                                   
|       | 
|*10.16 |  | 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).                        
|       | 
|*10.17 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.17 of Form 10-QSB filed November 14,
2003, File No. 33-77568).                           
|       | 
|*10.18 |  | 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).                         
|       | 
|*10.19 |  | Insurance Loan Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.19 of Form 10-KSB
filed March 30, 2004, File No. 000-28342).       
|       | 
|*10.20 |  | 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).
|       | 
|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).                                                                                                                              



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|     |  |                                                                                                                                                                 
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|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).
|- | ----------------------------------------------------------------------------------------------------------------------------------



|(b) | Reports on Form 8-K filed during the last quarter of the period covered by this report:
|--- | ---------------------------------------------------------------------------------------



The Company filed one report on Form 8-K during the quarter ended March 31, 2005. The report, dated January 23, 2005,
reported the Companys consolidated financial results for the quarter ended December 31, 2004.



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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 16, 2005 |  | /s/ Ellis L. Gutshall       
|Date         |  | Ellis L. Gutshall, President
|             |  | and Chief Executive Officer 
|             | 
|May 16, 2005 |  | /s/ A. Wayne Lewis          
|Date         |  | A. Wayne Lewis, Executive   
|             |  | Vice President and Chief    
|             |  | Financial Officer           



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##### Table of Contents

INDEX TO EXHIBITS



|               |  |                                                                                                                                                                                                                                                                                     |  |            
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------
|Exhibit Number |  | Description                                                                                                                                                                                                                                                                         |  | Page Number
|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           |  | Employment Agreement dated April 8, 1994, by and between the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No. 33-77568, on Form
S-1, as amended).                                                                     |  |            
|               |  |                                                                                                                                                                                                                                                                                    
|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 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).                                                                     |  |            
|               |  |                                                                                                                                                                                                                                                                                    
|10.5           |  | Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.5 of Registration
Statement No. 33-77568, on Form S-1, as amended).                                    |  |            
|               |  |                                                                                                                                                                                                                                                                                    
|10.10          |  | First amendment dated August 5, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by
reference to Exhibit No. 10.10 of Form 10-K filed March 30, 1995, File No. 33-77568). |  |            



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|      |  |                                                                                                                                                                                                                                                                                         |  | 
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.12 |  | Second amendment dated December 14, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein
by reference to Exhibit No. 10.12 of Form 10-K filed March 30, 1995, File No. 33-77568). |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.13 |  | Lease agreement for office space dated September 20, 1996, by and between Valley Bank, N.A. and Betty J. Burrows (incorporated herein by reference to Exhibit No. 10.13 of Form 10-KSB filed
March 27, 1997, File No. 33-77568).                                                        |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.6  |  | Severance agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.6 of Form 10-KSB filed March 30, 2000, File No.
33-77568).                                                                                |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.7  |  | 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).                                                      |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.14 |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 (incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                                                                            |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.15 |  | 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).                                                                            |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.16 |  | 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).                                                                 |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.17 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.17 of Form 10-QSB filed November 14,
2003, File No. 33-77568).                                                                    |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.18 |  | 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).                                                                  |  | 



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|      |  |                                                                                                                                                                                                                                                 |  |   
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --
|      |  |                                                                                                                                                                                                                                                
|10.19 |  | Insurance Loan Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.19 of Form 10-KSB
filed March 30, 2004, File No. 000-28342).        |  |   
|      |  |                                                                                                                                                                                                                                                
|10.20 |  | 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). |  |   
|      |  |                                                                                                                                                                                                                                                
|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).                                                                                                                               |  | 35
|      |  |                                                                                                                                                                                                                                                
|31.2  |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                               |  | 36
|      |  |                                                                                                                                                                                                                                                
|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).                                                                                |  | 37
|      |  |                                                                                                                                                                                                                                                
|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).                                                                                |  | 38



34