UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  FORM 10-Q (Mark One) x
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the Quarterly Period Ended March 31, 2009
  o
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from ________________________to____________________  Commission File Number:  000-28342  VALLEY FINANCIAL CORPORATION (Exact name of registrant as specified in its charter)  VIRGINIA
        
        54-1702380(State or other jurisdiction of incorporation or organization)
        
        (I.R.S. Employer Identification No.)36 Church Avenue, S.W.Roanoke, Virginia
        
        24011(Address of principal executive offices)
        
        (Zip Code)(540) 342-2265(Registrants telephone number, including area code)
  Not Applicable (Former name, former address, and former fiscal year, if changed since last report)  Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YesxNoo  Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       YesoNoo  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.  (Check one):  Large accelerated filero
        Accelerated fileroNon-accelerated filero(Do not check if a smaller reporting company)
        Smaller reporting companyx
  Indicate by checkmark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act.) Yeso
        Nox
  At May 13, 2009, 4,680,251 shares of common stock, no par value, of the registrant were outstanding.    VALLEY FINANCIAL CORPORATION FORM 10-Q March 31, 2009  TABLE OF CONTENTS Part I.  FINANCIAL INFORMATIONItem 1
        Financial StatementsConsolidated Balance Sheets
        4Consolidated Statements of Income
        5Consolidated Statements of Cash Flows
        6Notes to Consolidated Financial Statements
        8Item 2
        Management's Discussion and Analysis of Financial Condition and Results of Operations
        19Item 3
        Quantitative and Qualitative Disclosures about Market Risk
        39Item 4
        Controls and Procedures
        40Part II.  OTHER INFORMATIONItem 1
        Legal Proceedings
        40Item 1A
        Risk Factors
        40Item 2
        Unregistered Sales of Equity Securities and Use of Proceeds
        40Item 3
        Defaults Upon Senior Securities
        40Item 4
        Submission of Matters to a Vote of Security Holders
        41Item 5
        Other Information
        41Item 6
        Exhibits
        41SIGNATURES
        42EXHIBITS INDEX
        43CERTIFICATIONS
        44
     2     Cautionary Statement RegardingForward-Looking Statements  This report contains statements concerning the Companys expectations, plans, objectives, future financial performance, and other statements that are not historical facts.  These statements may constitute forward-looking statements as defined by federal securities laws.  These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties.  Actual results could differ materially from historical results or those anticipated by such statements.  Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in:  1.
        interest rates
 2.
        general economic conditions, either nationally or regionally
 3.
        the legislative/regulatory climate
 4.
        monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board
 5.
        demand for loan products
 6.
        deposit flows
 7.
        competitive pressures among depository and other financial institutions
 8.
        demand for financial services in our market area
 9.
        technology and
 10.
        accounting principles, policies and guidelines.
  The above risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on our company.  During the past 12-18 months, the capital and credit markets have experienced extended volatility and disruption.  While there can be no assurance that these unprecedented recent developments will not materially and adversely affect our business, financial condition and results of operations, we did not participate in the subprime, Alt-A or third-party originated mortgage programs that have resulted in heavy loan losses at many banks throughout the country.  These risks and uncertainties and the other risks and uncertainties described in this quarterly report on Form 10-Q and from time to time in our other reports filed with the Securities and Exchange Commission, including in our 2008 annual report on Form 10-K, should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.   3    PART 1  FINANCIAL INFORMATION Item 1.  Financial Statements. VALLEY FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)  (Unaudited)
3/31/09
        
        
        (Audited)
12/31/08AssetsCash and due from banks
        $
        6,044
        
        $
        7,270Interest-bearing deposits in banks
        
        26
        
        
        26Federal funds sold
        
        10,572
        
        
        -Securities available-for-sale
        
        66,156
        
        
        77,243Securities held-to-maturity (approximate market values of $14,298 at March 31, 2009 and $10,039 at December 31, 2008, respectively)
        
        14,188
        
        
        10,001Restricted equity securities
        
        5,737
        
        
        5,607Loans, net of allowance for loan losses of $7,583 at March 31, 2009 and $7,592 at December 31, 2008
        
        560,164
        
        
        545,454Foreclosed assets, net
        
        1,846
        
        
        424Premises and equipment, net
        
        8,083
        
        
        8,121Bank owned life insurance
        
        12,525
        
        
        12,390Accrued interest receivable
        
        2,487
        
        
        2,634Other assets
        
        5,023
        
        
        5,309Total assets
        $
        692,851
        
        $
        674,479Liabilities and Shareholders EquityLiabilities:Noninterest-bearing deposits
        $
        18,546
        
        $
        14,550Interest-bearing deposits
        
        484,314
        
        
        451,785Total deposits
        
        502,860
        
        
        466,335Federal funds purchased and securities sold under agreements to repurchase
        
        29,500
        
        
        47,019Short-term borrowings
        
        17,000
        
        
        17,000Long-term borrowings
        
        63,000
        
        
        63,000Guaranteed preferred beneficial interests in the Companys junior subordinated debentures
        
        16,496
        
        
        16,496Accrued interest payable
        
        2,808
        
        
        2,908Other liabilities
        
        2,572
        
        
        3,216Total liabilities
        
        634,236
        
        
        615,974Commitments and contingencies
        
        -
        
        
        -Shareholders' equity:Preferred stock, no par value; 10,000,000 shares authorized; 16,019 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively
        
        15,225
        
        
        15,188Common stock, no par value; 10,000,000 shares authorized; 4,680,251 and 4,678,851 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively
        
        23,261
        
        
        23,232Retained earnings
        
        19,610
        
        
        19,596Accumulated other comprehensive income
        
        519
        
        
        489Total shareholders equity
        
        58,615
        
        
        58,505Total liabilities and shareholders equity
        $
        692,851
        
        $
        674,479
  See accompanying notes to consolidated financial statements  4    VALLEY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except share and per share data)  3 Months Ended3/31/09
        
        
        3/31/08Interest incomeInterest and fees on loans
        
        $
        7,196
        
        $
        8,332Interest on securities  taxable
        
        
        1,011
        
        
        1,017Interest on securities  nontaxable
        
        
        110
        
        
        105Interest on deposits in banks
        
        
        -
        
        
        5Total interest income
        
        
        8,317
        
        
        9,459Interest expenseInterest on deposits
        
        
        2,804
        
        
        4,085Interest on long-term borrowings
        
        
        656
        
        
        557Interest on short-term borrowings
        
        
        85
        
        
        152Interest on guaranteed preferred beneficial interests in the
Companys junior subordinated debentures
        
        
        150
        
        
        263Interest on federal funds purchased and securities sold under
agreements to repurchase
        
        
        28
        
        
        264Total interest expense
        
        
        3,723
        
        
        5,321Net interest income
        
        
        4,594
        
        
        4,138Provision for loan losses
        
        
        1,433
        
        
        291Net interest income after provision for loan losses
        
        
        3,161
        
        
        3,847Noninterest incomeService charges on deposit accounts
        
        
        271
        
        
        262Realized gains (losses) on sale of securities available-for-sale
        
        
        267
        
        
        (14)Income earned on bank owned life insurance
        
        
        135
        
        
        136Other income on real estate loans
        
        
        12
        
        
        6Loss on disposal of equipment
        
        
        (1)
        
        
        -Other income
        
        
        15
        
        
        126Total noninterest income
        
        
        699
        
        
        516Noninterest expenseCompensation expense
        
        
        1,782
        
        
        1,718Occupancy expense
        
        
        254
        
        
        214Equipment expense
        
        
        168
        
        
        152Data processing expense
        
        
        249
        
        
        208Advertising and marketing expense
        
        
        57
        
        
        147Insurance expense
        
        
        204
        
        
        101Audit fees
        
        
        85
        
        
        59Legal expense
        
        
        123
        
        
        25Franchise tax expense
        
        
        106
        
        
        100Business manager program expense
        
        
        36
        
        
        52Deposit expense
        
        
        94
        
        
        53Loan expense
        
        
        61
        
        
        33Foreclosed properties expense, net
        
        
        18
        
        
        13Computer software expense
        
        
        107
        
        
        107Other expense
        
        
        350
        
        
        330Total noninterest expense
        
        
        3,694
        
        
        3,312Income before income taxes
        
        
        166
        
        
        1,051Income tax expense
        
        
        18
        
        
        303Net income
        
        $
        148
        
        $
        748Preferred dividends accrued
        
        
        235
        
        
        -Net income available to common shareholders
        
        $
        (87)
        
        $
        748Earnings per shareBasic earnings per share
        
        $
        (0.02)
        
        $
        0.16Diluted earnings per share
        
        $
        (0.02)
        
        $
        0.16Weighted average shares
        
        
        4,680,142
        
        
        4,617,941Diluted average shares
        
        
        4,680,426
        
        
        4,651,967Dividends declared per share
        
        $
        -
        
        $
        -
  5   VALLEY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands, except share and per share data)  3 Months Ended3/31/09
        
        3/31/08Cash flows from operating activitiesNet income
        $      148
        
        $      748Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses
        1,433
        
        291Depreciation and amortization of bank premises, equipment and software
        222
        
        205Stock compensation expense
        36
        
        26Deferred income tax
        191
        
        507Net (gains) losses on sale of securities
        (267)
        
        14Net losses on foreclosed properties
        31
        
        -Net losses on equipment disposals
        1
        
        -Net amortization of bond premiums/discounts
        30
        
        29(Increase) decrease in unearned fees
        91
        
        (35)Decrease in accrued interest receivable
        147
        
        92Decrease in other assets
        153
        
        189Increase in value of life insurance contracts
        (135)
        
        (136)Increase (decrease) in accrued interest payable
        (100)
        
        170Decrease in other liabilities
        (272)
        
        (311)Net cash provided by operating activities
        1,709
        
        1,789Cash flows from investing activitiesIncrease in interest bearing deposits in banks
        -
        
        (2)Increase in federal funds sold
        (10,572)
        
        -Purchases of bank premises, equipment and software
        (243)
        
        (521)Purchases of securities available-for-sale
        (5,742)
        
        (15,313)Purchases of securities held-to-maturity
        (6,315)
        
        -Purchases of restricted equity securities
        (131)
        
        (779)Proceeds from sales/calls/paydowns/maturities of securities available-for-sale
        17,113
        
        8,275Proceeds from paydowns on securities held-to-maturity
        2,111
        
        3,146Principal repayments of restricted equity securities
        -
        
        315Purchase of bank owned life insurance
        -
        
        (200)Proceeds from sale of foreclosed assets
        585
        
        -Capitalized expenses on foreclosed assets
        (11)
        
        (665)Increase in loans, net
        (18,261)
        
        (10,143)Net cash used in investing activities
        (21,466)
        
        (15,887)Cash flows from financing activitiesIncrease in non-interest bearing deposits
        3,996
        
        1,937Increase (decrease) in interest bearing deposits
        32,529
        
        (7,891)Proceeds from short-term borrowings
        36,000
        
        7,000Principal repayments of short-term borrowings
        (36,000)
        
        -Increase (decrease) in securities sold under agreements to repurchase
        (6,193)
        
        576Increase (decrease) in federal funds purchased
        (11,326)
        
        7,278Proceeds from long-term borrowings
        -
        
        10,000Principal repayments of long-term borrowings
        -
        
        (7,000)Cash dividends paid
        (468)
        
        (322)Net proceeds from issuance of common stock
        (7)
        
        96Net cash provided by financing activities
        18,531
        
        11,674Net (decrease) in cash and due from banks
        (1,226)
        
        (2,424)Cash and due from banks at beginning of year
        7,270
        
        10,895Cash and due from banks at end of year
        $    6,044
        
        $    8,471
  6    Supplemental disclosure of cash flow informationCash paid during the year for interest
        $    3,823
        
        $    5,151Cash paid during the year for income taxes
        $       323
        
        $            -Noncash financing and investing activitiesTransfer of loans to foreclosed property
        $    2,028
        
        $      665Reclassification of borrowings from long-term to short-term
        $            -
        
        $           -
  See accompanying notes to consolidated financial statements.  7     VALLEY FINANCIAL CORPORATION Notes to Consolidated Financial Statements March 31, 2009 (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 2008 Annual Report on Form 10-K.  The Company reports its activities as a single business segment.  In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.  (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 two weeks including March 31, 2009 was $205, which was met by cash on hand.  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, 2009 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, 2009 are shown in the tables below. As of March 31, 2009, investments (including both available-for-sale and held-to-maturity) and restricted equity securities with amortized costs and fair values of $68,423 and $69,375, respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as required or permitted by law.  At March 31, 2009 we evaluated our investment portfolio and determined all unrealized losses presented in the table below are not related to an issuers financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.  The following table sets forth the composition of securities available for sale at March 31, 2009.  Securities available for sale are carried at approximate market value.  8      Available-for-Sale Investment Portfolio  Category Distribution (dollars in thousands)  Amortized
        Unrealized
        Unrealized
        ApproximateCosts
        Gains
        Losses
        Fair ValuesU. S. Government and federal agency
        $        598
        $ 12
        $               -
        $             610Government-sponsored enterprises
        16,924
        233
        15
        17,142Mortgage-backed securities
        25,595
        711
        -
        26,306Collateralized mortgage obligations
        15,515
        154
        198
        15,471States and political subdivisions
        6,738
        108
        219
        6,627Total securities available for sale
        65,370
        1,218
        432
        66,156
   The following table sets forth the composition of securities held to maturity at March 31, 2009.  Securities held to maturity are carried at amortized cost.  Held-to-Maturity Investment Portfolio  Category Distribution (dollars in thousands)  Amortized
        Unrealized
        Unrealized
        ApproximateCosts
        Gains
        Losses
        Fair ValuesMortgage-backed securities
        1,194
        23
        -
        1,217Collateralized mortgage obligations
        6,818
        41
        -
        6,859States and political subdivisions
        6,176
        115
        69
        6,222Total securities held to maturity
        14,188
        179
        69
        14,298
  (4)
        Allowance for Loan Losses
  The following table summarizes the loan loss experience for the three-month periods ended March 31, 2009 and 2008.  Allowance for Loan Losses (dollars in thousands) 3/31/09
        3/31/08Balance at January 1
        $7,592
        $4,883Provision for loan losses
        1,433
        291Recoveries:Commercial
        -
        7Charged off loans:Commercial
        1,440
        39Loans to individuals
        2
        -Commercial Real Estate
        -
        171Residential Real Estate
        -
        65Real Estate Construction
        -
        43Balance at March 31
        $7,583
        $4,863
   9     (5)
        Earnings Per Share
  Basic earnings per share is based upon the weighted average number of common shares outstanding during the period.  The weighted average shares outstanding for the diluted earnings per share computations were adjusted to reflect the assumed conversion of shares available under stock options.  The following tables summarize earnings per share and the shares utilized in the computations:  Earnings per share3 Months Ending3/31/09
        3/31/08Basic
        $(0.02)
        $0.16Diluted
        $(0.02)
        $0.16
   Weighted Average Shares Outstanding3 Months Ending3/31/09
        3/31/08Basic
        4,680,142
        4,617,941Diluted
        4,680,426
        4,651,967
   (6)
        Comprehensive Income
  For the three months ended March 31, 2009 and 2008, total comprehensive income was $178 and $1,087 respectively.  The information that follows discloses the reclassification adjustments and the income taxes related to the net unrealized gains on securities available-for-sale that are included in other comprehensive income, net of income taxes for the three-month periods ended March 31, 2009 and 2008.   3 Months Ended
(dollars in thousands)3/31/09
        
        3/31/08Net unrealized gains (losses) on securities available for sale:Net unrealized holding gains during the year
        $
        45
        $
        500Income tax expense
        
        (15)
        
        (161)Other comprehensive income, net of income taxes
        $
        30
        $
        339
   (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.  10     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, 2009 outstanding commitments to extend credit were $153,254 as compared to $141,436 at December 31, 2008.  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, 2009 aggregate loans to directors, executive officers, and principal shareholders totaled $33,881.  An analysis of loan activity to directors, executive officers, and principal shareholders is as follows:  Loans to Related Parties(dollars in thousands)Balances as of January 1, 2009
        $
        32,180Advances
        
        10,361Repayments
        
        (8,660)Balances as of  March 31, 2009
        $
        33,881
  (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 $63,000 as of March 31, 2009.  There are three convertible advances in the amount of $5,000 each, one convertible advance in the amount of $15,000, two convertible advances in the amount of $10,000 and one fixed-rate advance in the amount of $13,000.  The Federal Home Loan Bank of Atlanta has the option to convert the three $5,000 convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two business days notice.  If called, these convertible advances will be converted into a 3-month London Interbank Offered Rate (LIBOR) based adjustable rate credit (ARC) at 3-month LIBOR.  The Federal Home Loan Bank of Atlanta has the option to convert the $15,000 and the two $10,000 convertible advances on the conversion dates
below, with at least two business days notice.  If called, these advances will be converted into a 3-month LIBOR based adjustable rate credit at 3-month LIBOR plus or minus the then-current spread of such advance.  The following table provides more information on the outstanding advances as of March 31, 2009 and December 31, 2008:  11      LONG-TERM FEDERAL HOME LOAN BANK ADVANCES (dollars in thousands)  Advance
        Maturity
        Conversion
        Current
        
        3/31/09
        
        12/31/08Date
        Date
        Date
        Rate
        
        Balance
        
        BalanceMay 24, 2000
        May 24, 2010
        Quarterly
        6.490%
        
        5,000
        
        5,000February 9, 2001
        February 9, 2011
        Quarterly
        4.970%
        
        5,000
        
        5,000June 29, 2006
        June 29, 2016
        n/a
        5.030%
        
        13,000
        
        13,000November 9, 2006
        November 9, 2016
        May 11, 2009
        4.280%
        
        5,000
        
        5,000December 28, 2007
        December 28, 2010
        December 28, 2009
        3.785%
        
        15,000
        
        15,000March 31, 2008
        March 29,2018
        March 29, 2011
        2.625%
        
        10,000
        
        10,000July 22, 2008
        July 23,2018
        July 25, 2011
        3.530%
        
        10,000
        
        10,000TOTAL
        $
        63,000
        $
        63,000
   (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 London Interbank Offered Rate (LIBOR) plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by the Trust at any time after June 26, 2008.  The principal assets of the Trust are $4,124 of the Companys junior subordinated debentures which mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and which are callable by the Company after June 26, 2008.  All $124 in aggregation liquidation amount of the Trusts common securities
are held by the Company.  Valley Financial (VA) Statutory Trust II, a statutory business trust (Trust II), was created by the Company on September 26, 2005, at which time Trust II issued $7,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature December 15, 2035.  Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any time after December 15, 2010.  The principal assets of Trust II are $7,217 of the Companys junior subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%, and which are callable by the Company after December 15, 2010.  All $217 in aggregation liquidation amount of Trust IIs common securities are held by the Company.  Valley Financial Statutory Trust III, a statutory business trust (Trust III) was created by the Company on December 15, 2006, at which time Trust III issued $5,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature January 30, 2037.  Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any time after January 20, 2012.  The principal assets of Trust III are $5,155 of the Companys junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%, and which are callable by the Company after January 30, 2012. All $155 in aggregation liquidation amount of Trust IIIs common securities are held by the Company.  (11)
        Stock Based Compensation
  12    We account for stock-based compensation in accordance with, the Financial Accounting Standards
Boards (FASB) Statement of Financial Accounting Standards No 123  revised 2004 (SFAS 123R), Share-Based Payment, (SFAS No. 123R) which replaced SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees, and its related interpretations. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.  We currently use the Black-Scholes option pricing model to determine the fair value of stock options and restricted stock grants.  The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing
model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables.  These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.  The Company has two share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans was approximately $36 and $26 for the three-month periods ended March 31, 2009 and 2008, respectively.  The Company has no nonqualified stock options outstanding at March 31, 2009.  Stock Option Plans  The Company has a 2005 Key Employee Equity Award Plan (the 2005 Plan).  The 2005 Plan gives the Company flexibility in tailoring equity-based compensation awards for employees from time to time to the continuing objective of aligning employee incentives with the interests of shareholders as the Company grows and develops.  In addition to incentive and nonqualified stock options, the 2005 Plan permits the grant of restricted stock, stock appreciation rights and stock units to persons designated as Key Employees.  The 2005 Plan will remain in effect for ten years, subject to the right of the Board of Directors to terminate the 2005 Plan earlier, except with respect to awards made prior to and outstanding on that date which remain valid in accordance with their terms. The maximum aggregate number of shares of the Companys common stock (no par value) that may be issued
pursuant to awards made under the Plan may not exceed 250,000.  Accordingly, 250,000 shares of authorized but unissued common stock are reserved for use in the 2005 Plan.  Within the maximum limits, the Plan specifies that stock appreciation rights may not be granted with respect to more than 500 shares per recipient (2,000 shares for a new employee recipient) per year; and restricted shares and stock units, respectively, may not be granted for more than 5,000 shares per year per recipient.  Under the 2005 Plan, there are incentive stock options for 149,450 shares outstanding and 16,000 grants of restricted stock outstanding to officers and key employees as of March 31, 2009.  There are 82,779 shares available for grant as of March 31, 2009.  There are performance criteria associated with the grants of restricted stock, that if not met, will prevent the units from vesting.  Additionally, the Company has a 1995 Incentive Stock Plan (the 1995 Plan) pursuant to which the Human Resources Committee of the Companys Board of Directors may grant stock options to officers and key employees.  The 1995 Plan authorizes grants of options to purchase up to 311,850 shares (adjusted for stock splits) of the Companys authorized but unissued common stock.  Under the 1995 Plan, there are options for 73,182 shares granted to officers and key employees currently outstanding and 54,190 shares available for grant as of March 31, 2009.  All stock options (for both plans) have been granted with an exercise price equal to the stocks fair market value at the date of the grant.  Stock options under the Plan generally have 10-year terms, vest at the rate of 20 percent per year, and become fully exercisable five years from the date of the grant.  The share-based awards granted under the aforementioned Plans have similar characteristics, except that some awards have been granted in options and certain awards have been granted in restricted stock.  13    Therefore, the following disclosures have been disaggregated for the stock option and restricted stock awards of the Plans due to their dissimilar characteristics.  The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the volatilities of our trading history. The expected life is based on the average life of the options of 10 years and the weighted average vesting period of 5 years, and forfeitures are estimated based on the Companys history. The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees for the three-month period ended March 31, 2009.  There were no grants awarded during the three-month period ending March 31, 2008.  Three Months EndedMarch 31, 2009Dividend yield
        
        3.0%Risk-free interest rate
        
        2.6%Volatility
        
        37.1%Expected life
        
        7.3 years
   Total stock-based compensation recognized as compensation expense on our consolidated statement of income is as follows:  3 Months Ended
(dollars in thousands)3/31/09
        
        3/31/08Option Grants
        $
        30
        $
        26Restricted Stock Grants
        
        6
        
        -Total Compensation Expense
        $
        36
        $
        26
  As of March 31, 2009, there was $393 of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based payments granted to employees.  A maturity schedule of the unrecognized compensation cost as of March 31, 2009 is as follows:  Remaining
2009
        2010
        2011
        2012
        2013
        2014
        TotalCompensation Cost
        $108
        $116
        $94
        $50
        $25
        -
        $393
  Total unrecognized compensation cost will be adjusted for future grants and future changes in estimated forfeitures.  14     General Stock Option Information  A summary of option activity under the stock option plans during the three-month period ended March 31, 2009 is presented below:  Options
Outstanding
        
        Weighted Average
Exercise
Price
        
        Weighted Average Grant Date Fair Value
        
        Intrinsic Value of Options Exercised
        Weighted
Average
Contractual
TermBalance at 12/31/08
        256,982
        $
        8.79
        $
        2.66
        $
        302
        5.97 yearsExercised
        (1,400)
        
        5.08
        
        0.95
        
        -Forfeited
        (34,950)
        
        5.34
        
        1.10Granted
        2,000
        
        5.11
        
        1.49Expired
        -
        
        -
        
        -Balance at 3/31/09
        222,632
        $
        9.33
        $
        2.91
        $
        -
        6.66 yearsExercisable at 3/31/09
        110,182
        $
        9.53
        $
        2.64
        $
        n/a
        4.63 years
  Cash received from option exercises under all share-based payment arrangements for the three-month ended March 31, 2009 was $7.  Information regarding shares vested during the three-month periods ended March 31, 2009 and 2008 are as follows:  Three-Month Period Ending
        Number of Shares Vested
        Total Fair Value of Shares Vested
(dollars in thousands)March 31, 2009
        7,400
        $26March 31, 2008
        7,540
        $24
  Information regarding the stock options outstanding at March 31, 2009 is summarized below:
  Range of
Exercise Prices
        Number
Outstanding
        Weighted
Average
Remaining
Contractual
Life
        Weighted
Average
Exercise
Price
        Number
Exercisable
        Weighted
Average
Exercise Price$3.82 - $5.94
        41,582
        2.20 years
        $5.33
        39,582
        $5.34$5.95 - $12.85
        156,100
        7.94 years
        $9.67
        53,050
        $11.20$12.86 - $14.23
        24,950
        6.08 years
        $13.82
        17,550
        $13.93Totals
        222,632
        6.66 years
        $9.33
        110,182
        $9.53
   The aggregate intrinsic value of options outstanding and options exercisable as of March 31, 2009 was $0 and $0.  The aggregate intrinsic value of options outstanding and options exercisable as of March 31, 2008 was $608 and $608, respectively.  15    A summary of the status of the Companys non-vested options as of March 31, 2009 and changes during the three-month period then ended is presented below:  Non-Vested Options Outstanding
        Weighted Average Grant Date Fair ValueNon-vested options, 12/31/08
        119,551
        $3.24Granted
        2,000
        -Vested
        (7,400)Forfeited
        (1,700)Non-vested options, 3/31/09
        112,451
        $3.18
  A summary of the status of the Companys non-vested restricted stock as of March 31, 2009 and changes during the three-month period then ended is presented below:  Non-Vested Restricted Stock Outstanding
        Weighted Average Grant Date Fair ValueBalance, 12/31/08
        16,000
        $6.00Granted
        -Vested
        -Forfeited
        -Balance, 3/31/09
        16,000
        $6.00
  The fair value of each non-vested restricted stock grant is equal to the stock price on the date of grant and assumes the performance goals will be achieved.  (12)
        Fair Value
  The Company adopted Statement No. 157 at the beginning of our 2008 fiscal year and there was no material impact to our first quarter financial statements.  Statement No. 157 applies to all assets and liabilities that are being measured and reported on a fair value basis.  Statement No. 157 requires new disclosure that establishes a framework for measuring fair value in GAAP, and expands disclosure about fair value measurements.  This statement enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The statement requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:  Fair Value Hierarchy Under SFAS 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:  16    Level 1
        Valuation is based upon unadjusted quoted prices in active markets for identical assets to the instrument or security being valued, for example stocks trading on the New York Stock Exchange.
  Level 2
        Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
  Level 3
        Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
  In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to Statement No. 157.  At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.  The table below presents the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy:  Assets and Liabilities Recorded at Fair Value on a Recurring Basis at March 31, 2009  (in 000s)
        
        Total
        
        Level 1
        
        Level 2
        
        Level 3Investment securities available-for-sale
        $
        66,156
        $
        -
        $
        66,156
        $
        -Total assets at fair value
        $
        66,156
        $
        -
        $
        66,156
        $
        -Total liabilities at fair value
        $
        -
        $
        -
        $
        -
        $
        -
  Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis at March 31, 2009  The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below:   (in 000s)
        
        Total
        
        Level 1
        
        Level 2
        
        Level 3Impaired loans
        $
        40,093
        $
        -
        $
        40,093
        $
        -Foreclosed assets
        
        1,846
        
        -
        
        1,846
        
        -Total assets at fair value
        $
        41,939
        $
        -
        $
        41,939
        $
        -Total liabilities at fair value
        $
        -
        $
        -
        $
        -
        $
        -
  Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.  17    Investment Securities Available-for-Sale Investment securities available-for-sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are
measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions.  Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds.  Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities.  Securities classified as Level 3 include asset-backed securities in less liquid markets.  Loans receivable The Company does not record loans at fair value on a recurring basis.  However, from time to time, a loan is considered impaired and an allowance for loan losses is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired.  Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114).  The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in
such loans.  At March 31, 2009, all of the total impaired loans were evaluated based on the fair value of the collateral.  In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of the collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.  Foreclosed Assets Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  Fair value is based upon independent market prices, appraised values of the collateral or managements estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.  When the appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.  18    (14)    Common Stock Dividends  On January 1, 2009, the Company paid its tenth consecutive semi-annual cash dividend on the Companys stock, in the amount of $0.07 per share, payable on to shareholders of record December 15, 2008.  On April 29, 2009, the Company announced the Board of Directors reduced the semi-annual common stock dividend from $0.07 to $0.04 per share, effective for the dividend payable July 1, 2009 to shareholders of record on June 1, 2009.  The Board anticipates maintaining this level for 2009, and would hope to return dividend rates to a normalized level in 2010 as market conditions improve.  This action will enable the Company to retain an additional $281,000 in common equity for 2009.  (15)
        Preferred Stock Dividends
  On February 17, 2009, the Company paid its first preferred dividend totaling $140,000 to the U.S. Treasury in connection with the preferred stock instrument.  On April 29, 2009, the Board of Directors declared the second preferred dividend totaling $200,000 payable on May 15, 2009.  (16)
        Contingencies
  The Bank was named a party defendant in litigation filed by The Collection, LLC (The Collection) against the Bank and Scott Newcomb Motors, LLC, d/b/a Scott Newcomb Chrysler Jeep (Newcomb).  The litigation was filed in the United States District Court for the Western District of Virginia, Danville Division on or about March 23, 2009.  The suit is an action for breach of contract against Newcomb, tortious interference with contract against the Bank, conversion against the Bank, and misrepresentation, common law conspiracy and statutory conspiracy against Newcomb and the Bank.  The litigation relates to fifteen vehicles that Newcomb allegedly purchased from The Collection using floor-plan financing provided by the Bank.  The Complaint alleges that Newcomb never paid The Collection for the subject vehicles.  The Collection is requesting monetary damages for the alleged
cost of the fifteen vehicles (approximately $340,800), plus treble and/or punitive damages.  At this time, the outcome of the litigation is undeterminable, however, the Bank estimates the potential loss of $340,800 to be reasonably possible, and as such, has reserved for 100% of this loss in its loan loss reserve as of March 31, 2009.  The Bank estimates the potential loss of treble and/or punitive damages totaling $1,022,400 to be remote and therefore has not accrued for this loss as of March 31, 2009.  The Bank denies any allegations of wrongdoing and intends to vigorously defend itself.  Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations  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, 2009 and 2008 is as follows.  The discussion should be read in conjunction with the Companys Consolidated Financial Statements and Notes on the December 31, 2008 Form 10-K.  Critical Accounting Policies  The preparation of financial statements requires us to make estimates and assumptions.  Those accounting policies that require our most difficult, subjective or complex judgments and uncertainties include (1) the allowance for loan losses and (2) impaired loans.  Further information about these critical policies is described below.  19    Certain credit risks are inherent in making loans.  We seek to prudently assess these risks and manage them effectively.  We have internal credit policies and procedures in place to reduce repayment risks.  These policies and procedures include:  
        officer and customer limits;
 
        periodic loan documentation review; and
 
        follow-up on exceptions to credit policies.
  We establish the allowance for loan losses through charges to earnings through a provision for loan losses.  Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely.  Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb probable losses on existing loans that may become uncollectible. Some of the factors we consider in determining the appropriate level of the allowance for loan losses are as follows:  
        an evaluation of the current loan portfolio;
 
        identified loan problems;
 
        loan volume outstanding;
 
        past loss experience;
 
        present and expected industry and economic conditions and, in particular, how such conditions relate to our market area;
 
        problem loan trends over a 3-year historical time period; and
 
        loan growth trends over a 3-year historical time period
  The general component of the reserve covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect our estimate of probable losses. It also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The allowance for loan losses is evaluated on a regular basis by management.  On a quarterly basis, we perform a detailed analysis of the allowance for loan losses to verify the adequacy and appropriateness of the allowance in meeting possible losses in the loan portfolio.  In analyzing our current portfolio to determine the appropriate level of the allowance for loan losses, we first segregate our portfolio into loans within the scope of FAS 114 (potentially impaired loans) and FAS 5 (non-impaired loan pools).  Included in our potentially impaired loan category are our current watch list credits plus any additional credits which have been past due three or more times within the past 12-month period.  We individually review these potentially impaired loans under FAS 114 and make a determination if the loan in fact is impaired.  We consider a loan impaired when we determine that is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement.  We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due.  If it is found to be
impaired, an allowance is established when the collateral value, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan. We recognize any impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to bad-debt expense.  The valuation allowance becomes our specific reserve for the specific loan.  We take the balance of our portfolio and add back to it any loans that were included in the potentially impaired loan category but that were found not to be impaired.  We then segregate the remaining portfolio into specific categories based on type of loan and review the groups of loans to estimate loss under FAS 5 (accounting rules for loss contingencies).  We apply a specific loss factor to each category based upon our  20    historical loss experience for each category of loans over the current two years ending December 31, 2008.  The loss factor is multiplied by the outstanding balance in the loan category to estimate potential loss for our allowance for loan losses.  We then evaluate certain environmental and qualitative factors that are relevant to our portfolio and make a risk assessment of low, medium, or high for each factor.  An additional loss factor is assigned to the portfolio according to the risk assessment.  This evaluation is inherently subjective, because it requires estimates that may be significantly revised as more information becomes available.  Bank regulators also periodically review the loan portfolio and other assets to assess their quality, and we employ independent, third party loan reviewers as well.  This evaluation is inherently subjective because it requires estimates that may be significantly revised as more information becomes available.  We believe the allowance for loan losses is appropriate to provide for expected losses in the loan portfolio, but there are no assurances that it will be.  Overview  The Company was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of the Bank.  The Bank opened for business on May 15, 1995.  There are currently eight full-service branch locations, operating in various locations throughout the Cities of Roanoke and Salem, Town of Vinton, and the County of Roanoke.   The Bank also has a wealth management subsidiary, Valley Wealth Management Services, Inc. which markets investment and insurance products.  Net income derived for the wealth management subsidiary is not significant at this time.  Performance Summary  We are reporting first quarter 2009 earnings of $148,000 and a net loss available to common shareholders of $87,000, or $0.02 per diluted common share.  Those results compare to net income of $748,000, or diluted earnings per share of $0.16 during the same period in the prior year and reflect improvement on a linked quarter basis to the net loss to common shareholders of $530,000, or $0.11 per diluted common share, for the fourth quarter of 2008.  The results for the first quarter of 2009 included a provision for loan losses of $1.3 million related to additional specific reserves on one large customer operating in the automobile industry.  The additional reserves were needed due to significant adversarial actions taken by the borrower which increased the Companys total loss exposure over what was anticipated at December 31, 2008.  The following table shows our key performance ratios for the periods ended March 31, 2009, December 31, 2008 and March 31, 2008:  21      Year-to-DateKey Performance Ratios3 months
        
        12 months
        
        3 monthsEnded
        
        Ended
        
        Ended3/31/08
        
        12/31/08
        
        3/31/08Return on average assets
        0.09%
        
        0.27%
        
        0.50%Return on average equity (1)
        1.02%
        
        3.87%
        
        7.23%Net interest margin (2)
        2.89%
        
        2.90%
        
        2.92%Cost of funds
        2.45%
        
        3.26%
        
        3.84%Yield on earning assets
        5.20%
        
        6.05%
        
        6.63%Basic net earnings per share
        $(0.02)
        
        $0.35
        
        $0.16Diluted net earnings per share
        $(0.02)
        
        $0.35
        
        $0.16
  (1)  The calculation of ROE excludes the effect of any unrealized gains or losses on investment securities available-for-sale. (2)
        Calculated on a fully taxable equivalent basis (FTE)
  Non-GAAP Financial Measures The Company measures the net interest margin as an indicator of profitability. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax-equivalent net interest income is considered in the calculation of this ratio. Tax-equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2009 and 2008 is 34%. The reconciliation of tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.   Three Months Ended 3/31/09
        
        Three months Ended 3/31/08Net interest income, non tax-equivalent
        $
        4,594
        $
        4,138Less: tax-exempt interest income
        
        (110)
        
        (105)Add: tax-equivalent of tax-exempt interest income
        
        167
        
        159Net interest income, tax-equivalent
        $
        4,651
        $
        4,192
   22     Growth  The following table shows our key growth indicators:
  Key Growth Indicators(dollars in thousands)3/31/09
        
        12/31/08
        
        3/31/08Investment securities
        $
        86,081
        $
        92,851
        $
        85,738Loans, net
        $
        560,164
        $
        553,046
        $
        492,168Deposits
        $
        502,860
        $
        466,335
        $
        426,499Total assets
        $
        692,851
        $
        674,479
        $
        613,614
  In comparison to the same period last year, our total assets grew by $79.2 million or 13%, net loans grew by $68.0 million or 14% and total deposits grew by $76.4 million or 18%.  As can be seen from the numbers above, we continue to experience strong loan demand and strong core deposit growth from customers who prefer dealing with a local, established community bank.  We have made approximately $33 million in additional loans subsequent to the issuance of preferred stock to the U.S. Treasury last December.  Furthermore, during the first quarter of 2009, total deposits grew by $36.5 million, with increases in both our Prime Money Market account and our new checking product, My Lifestyle Checking, that was rolled out one year ago.  Valley Bank remains dedicated to finding innovative ways to compete against larger competitors in a crowded market.  Total liabilities at March 31, 2009 were $634.2 million, up 3% from $616.0 million at December 31, 2008 with an increase of $36.5 million in deposits offsetting a $11.3 million decrease in federal funds purchased and a $6.2 million decrease in securities sold under agreements to repurchase.  Shareholders Equity
  Total shareholders' equity at March 31, 2009 was $58.6 million compared to $58.5 million at December 31, 2008, an increase of $0.1 million.  The change in shareholders equity was impacted by earnings, proceeds from the exercise of incentive stock options and nonqualified stock options, employee stock compensation expense and the change in unrealized gains and losses for securities available-for-sale.  Total shareholders equity (exclusive of unrealized gains (losses) on investment securities and derivatives) was $58.1 million at March 31, 2009 compared with $58.0 million at December 31, 2008, an increase of $0.1 million.  Net Income  We earned net income of $148,000 for the three months ended March 31, 2009, a decrease of $600,000 or 80% under the $748,000 reported for the same period in 2008.  A discussion of the individual components making up net income follows.  Net Interest Income  Net interest income is our principal source of earnings and is calculated as the amount which loan and investment (earning assets) income exceeds the interest expense on deposits and borrowings (interest-bearing liabilities).  Changes in the volume and mix of earning assets and interest-bearing liabilities, as well as their  23    respective yields and rates, have a significant impact on the level of net interest income.  Total interest income amounted to $8,317,000 for the three months ended March 31, 2009, a decrease of 12% from the $9,459,000 reported for the same period in 2008. Offsetting that reduction in income, total interest expense was $3,723,000 for the three months ended March 31, 2009, a decrease of 30% over the $5,321,000 reported for the three months ended March 31, 2008.  The decline in both interest income and expense is due to the significant reduction in the interest rate environment compared to the same period in 2008.  As a result of the above, net interest income was $4,594,000 for the three months ended March 31, 2009, an increase of $456,000 or 11% over the $4,138,000 reported for the same period in 2008.  Our net interest margin was 2.89% for the three months ended March 31, 2009, a decrease of 3 basis points compared to the 2.92% reported for the same period last year.  The net interest margin for the first quarter compressed slightly due to the high volume of non-performing assets as compared to the prior year.  The bank is committed to resolving these non-performing assets as quickly as possible during 2009, which in turn should alleviate some of the net interest margin pressure.  Additionally, approximately 51% of our loan portfolio is tied to LIBOR and Prime rate indices.  Both of these indices declined significantly during the periods being compared and have triggered a lower rate of return on
the Companys variable rate loan products resulting in decreased yield. In an effort to combat these declining loan yields, we began inserting rate floors in all new and renewing credit facilities during the 4th Quarter of 2008 and as of March 31, 2009, 48% of our floating rate loans by dollar contained a floor rate and the weighted average floor rate was 4.32%. On the funding side, our overall cost of funds decreased 40 basis points from 2.85% for the fourth quarter of 2008 to 2.45% for the first quarter of 2009.  Interest Rate Risk  Interest rate risk is the risk to earnings or capital generated by the effects of changes in interest rates on our on- and off-balance sheet positions, and can take one or more of several forms: 
        Repricing riskcomes from timing mismatches in the ability to alter contractual rates earned on financial assets held or paid on interest-bearing liabilities.
 
        Basis riskrefers 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 riskarises from embedded options in many financial instruments such as:
 o
        interest rate options,
 o
        loan prepayment options,
 o
        deposit early withdrawal options,
 o
        callable Federal Home Loan Bank advances, and
 o
        prepayment of the underlying collateral of asset-backed securities.
 Embedded options are complex risk positions that are difficult to predict and offset, and are a large component of our overall interest rate risk.  We have established risk measures, limits, policy guidelines and internal control mechanisms for managing our overall asset/liability management (ALM) position.  The responsibility for interest rate risk control resides with management, with oversight by the board of directors and the ALCO Oversight Committee.  We seek to balance the return potential of the ALM position against the desire to limit volatility in earnings.  At least quarterly, we measure the ALM position using earnings simulation modeling to estimate what assets and liabilities would re-price, and to what extent, within a one-year period in response to an immediate 200 and 100 basis point change in the Prime Rate, as well as in response to more gradual interest  24    rate change.  Our objective is to keep the change in net interest income over twelve months at or below 5%, and the change in net income at or below 10%, under an immediate 200 basis point interest rate shock scenario.  The model also incorporates managements forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not necessarily represent managements view of future market movements.  Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to our earnings.  Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model.  While the earnings sensitivity analysis incorporates managements best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.  Our cumulative repricing gap for the 90-day time period indicates a liability-sensitive position as of
December 31, 2008 (the most recent date for which information is currently available).  We also estimate interest sensitivity by calculating the net present value of the balance sheets cash flows or the residual value of future cash flows ultimately due to shareholders.  This calculation is known as Economic Value of Equity or EVE and is generally considered a better measure of long-term interest sensitivity than is IRS.  Our objective is for the result to change 25% or less in an immediate 300 basis point interest rate shock scenario; 20% or less in an immediate 200 basis point interest rate shock scenario; and 15% or less in an immediate 100 basis point interest rate shock scenario.  Derivative Financial Instruments  For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates.  Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.   Noninterest Income  Noninterest income for the three months ended March 31, 2009 and 2008 is shown in the following table:   Noninterest Income(dollars in thousands)3 months
        
        3 months
        
        %Ended
        
        Ended
        
        Increase/3/31/09
        
        3/31/08
        
        (Decrease)Service charges on deposits
        $
        271
        $
        262
        
        3%Income earned on bank owned life insurance
        
        135
        
        136
        
        0%Gains/(losses) on sale of securities
        
        267
        
        (14)
        
        2007%Gains/(losses) on disposal of equipment
        
        (1)
        
        -
        
        N/MOther income
        
        27
        
        132
        
        (80%)Total noninterest income
        $
        699
        $
        516
        
        35%
   25    As can be seen from the table above, we experienced an increase in our noninterest income of $183,000, or 35% quarter over the quarter ended March 31, 2009.  To help offset anticipated increased levels
in our loan provisions, we transacted a swap of available-for-sale securities that accounted for $267,000 in realized gains.  The cash from the sale of these securities was reinvested in additional securities at an attractive rate based on todays bond market environment.  The significant reduction in other income is primarily due to a $77,000 loss related to a pass-thru partnership.  Service charges on deposit accountsconsist of a variety of charges imposed on demand deposits, interest-bearing deposits and savings deposit accounts.  These include, but are not limited to, the following: 
        Demand deposit monthly activity fees
 
        Service charges for checks for which there are non-sufficient funds or overdraft charges
 
        ATM transaction fees
 
        Debit card transaction fees
 The principal factors that may affect current or future income for service charges on deposit accounts are: 
        Internally generated growth
 
        Acquisitions of other banks/branches or de novo branches
 
        Adjustments to service charge structures
  Other fee incomeconsists of several categories, primarily the following:
 
        Fees for the issuance of official checks
 
        Fees for letters of credit
 
        Fees for wire transfers
 
        Safe deposit box rent
 
        Income from the sale of customer checks
 
        Income on real estate loans
 
        Extension fees, insurance premiums, and letter of credit fees
 
        Income earned from Valley Wealth Management, Inc.
  Levels of income derived from these categories vary.  For example, general market conditions and new insurance premiums purchased affect the income earned on bank owned life insurance.  Fees for the issuance of official checks and customer check sales tend to grow as new branches are added.  Fee schedules, while subject to change, generally do not alone yield a significant or discernable increase in income when they change.  Noninterest Expense  Noninterest expense for the three-month period ended March 31, 2009 and 2008 is shown in the following table:  26       Noninterest Expense(dollars in thousands)3 months
        
        3 monthsEnded
        
        Ended
        
        % Increase/3/31/09
        
        3/31/08
        
        (Decrease)Compensation expense
        $
        1,782
        
        1,718
        
        4%Occupancy expense
        
        254
        
        214
        
        19%Equipment expense
        
        168
        
        152
        
        11%Data processing expense
        
        249
        
        208
        
        20%Advertising and marketing expense
        
        57
        
        147
        
        (61%)Insurance expense
        
        204
        
        101
        
        102%Audit fees
        
        85
        
        59
        
        44%Legal fees
        
        123
        
        25
        
        392%Franchise tax expense
        
        106
        
        100
        
        6%Business manager expense
        
        36
        
        52
        
        (31%)Deposit expense
        
        94
        
        53
        
        77%Loan expense
        
        61
        
        33
        
        85%Computer software expense
        
        107
        
        107
        
        0%Foreclosed asset expense, net
        
        18
        
        13
        
        38%Other expense
        
        350
        
        330
        
        6%Total noninterest expense
        $
        3,694
        
        3,312
        
        12%
   In total, our noninterest expenses have increased by $382,000 or 12% for the three-months ended March 31, 2009 as compared to the three-months ended March 31, 2008.  A few items to note include:  
        Our compensation expenses have been managed tightly during this year resulting in a small increase of 4% from the same period last year.  We added a small number of planned staff members in the 1st quarter and are currently planning on holding our full-time equivalent staff level throughout the remaining year.  Also, our executive management team voluntarily agreed to freeze their salaries during 2009 in anticipation of the difficult environment surrounding the overall banking industry.  We will continue to monitor compensation expenses as we move forward, however it should be emphasized that we believe in our growth plans and will continue to add staff in strategic positions as the opportunities present themselves.  As a prime example, we have added two veteran mortgage lenders to the staff in 2009 to help meet demand in a market that we believe will
experience a rebound in the upcoming quarters and help create an additional revenue source.
  
        Occupancy and equipment expenses have risen primarily due to increased rent expense at our downtown office, the addition of a new full-service branch office in South Roanoke, as well as additional depreciation expense related to equipment.
  
        Data processing expenses have increased this quarter over the same period last year primarily due to increased debit card transaction costs as well as processing costs related to our new customer relationship management software that we believe will assist us in improving our net interest margin.
   27    
        Advertising and marketing expenses have declined significantly as compared to the same period last
year.  This reduction is primarily due to the launch of our new checking account product, MyLifeStyle Checking, which occurred in the first quarter of 2008.
  
        Insurance expense has more than doubled due to the increase in FDIC insurance assessment rates to help the FDIC rebuild the Deposit Insurance Fund as a result of the increased bank failures during 2008 and 2009.  This situation merits attention as there lies the possibility of an even greater increase in the upcoming months due to the proposed special, one-time assessment that is currently planned for the 3rd quarter of 2009.  This assessment could add as much as $250,000 to our noninterest expenses for the 3rd quarter of 2009.
  
        Due to the significantly increased compensation costs associated with running an in-house internal audit department, we made the strategic decision to move back to an outsourced model beginning January 2009.  Therefore, we will see an increase in audit fees for 2009 as compared to 2008 but we anticipate total savings from this move of approximately $200,000 for 2009 as compared to what it would have been had we remained with an in-house model.
  
        The increase in legal fees is due primarily to the credit related legal work performed on our problem assets as well as increased legal expenses related to our participation in the TARP program.  We anticipate our legal expenses to continue to grow due to the unusually high level of non performing assets as well as the current litigation that is underway.
  
        Our Business Manager program has seen a decline in number of customers over the past 12 to 18 months and as a result, expenses associated with the program have declined year over year.
  
        Deposit expenses have seen a large increase primarily due to the program fees that are associated with three new deposit products, including MyLifestyle checking, the CDARS program and our mild entry into the brokered certificate of deposit market.  We have recorded $24,000 in total fees related to these programs in the first quarter of 2009.
  
        Loan expenses have increased principally due to appraisal review fees and expenses related to the special assets consultant we engaged to assist with credit issues last year.
  Noninterest expenses are expected to continue to increase as a direct result of business growth, expansion, the potential special assessment by the FDIC to help refund the DIF and the overall complexity of banking operations as well as compliance with the Sarbanes-Oxley Act, which imposes additional management and reporting burdens on reporting companies such as this one.  Income Taxes  To reflect our anticipated federal income tax liability, an expense of $18,000 reflecting an effective tax rate of 10.8%, was recognized for the three months ended March 31, 2009, compared to an expense of $303,000, reflecting an effective tax rate of 28.8%, recognized for the three months ended March 31, 2008.  Investment Securities  Our investment portfolio is used both for investment income and liquidity purposes.  At this time, we do not invest in derivatives or other types of high-risk securities. Unrealized gains and losses on securities available-for-sale are recognized as direct increases or decreases in net shareholders equity.  Funds not used for capital expenditures or lending activities are invested in the following:  28    
        Securities of the U.S. Government and its agencies
  o
        Treasury notes
 o
        Callable agency bonds
 o
        Noncallable agency bonds
 
        Mortgage-backed securities and collateralized mortgage obligations
 o
        Pools issued by government agencies
 o
        AAA rated corporate mortgage pools
 
        Municipal bonds
 o
        Taxable general obligation and revenue issues
 o
        Tax-exempt general obligation and revenue issues
 
        Investment grade corporate bonds
 
        Restricted equity securities
 o
        Federal Reserve Bank of Richmond shares
 o
        Federal Home Loan Bank of Atlanta shares
 o
        Community Bankers Bank shares
  Investment securities (available for sale and held to maturity), including restricted equity securities, at March 31, 2009 were $86.1 million, a decrease of $6.8 million or 7% from their level of $92.9 million on December 31, 2008.  See Note 3 to the Consolidated Financial Statements.  Loan Portfolio  Our total loans were $567.7 million at March 31, 2009, an increase of $14.7 million or 3% from the $553.0 million reported at December 31, 2008.  Our ratio of total loans to total funding sources (customer deposits, securities sold under agreements to repurchase, federal funds purchased, Federal Home Loan Bank advances, and guaranteed preferred beneficial interests in the Companys junior subordinated debentures) stood at 90.3% at March 31, 2009 and 90.7% at December 31, 2008. Management seeks to maintain the ratio of loans to funding sources at or below 90%.  In addition to the funding sources noted above, at March 31, 2009 the Company has a secured line of credit with the Federal Reserve Discount Window for $74.6 million.  The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes.  We adjust the mix of lending and the terms of our loan programs according to economic and market conditions, asset/liability management considerations and other factors.  Loans typically are made to businesses and individuals located within our primary and secondary market area, most of whom maintain deposit accounts with the Bank.  There is no concentration of loans exceeding 10% of total loans, which is not disclosed in the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements or discussed below.  The following table summarizes the loan portfolio by category, net of deferred fees, as of March 31, 2009 and 2008 and December 31, 2008:   29      Loan Portfolio Summary(dollars in thousands)3/31/09
        
        12/31/08
        
        3/31/08$
        %
        
        $
        %
        
        $
        %Commercial
        
        104,402
        18.4
        
        103,036
        18.6
        
        89,735
        18.1Commercial real estate
        
        236,506
        41.7
        
        225,587
        40.8
        
        180,949
        36.4Real estate construction
        
        91,817
        16.2
        
        87,376
        15.8
        
        99,796
        20.0Residential real estate
        
        129,695
        22.8
        
        131,384
        23.8
        
        120,175
        24.2Loans to individuals (except those secured by real estate)
        
        5,327
        0.9
        
        5,663
        1.0
        
        6,376
        1.3Total loans
        
        567,747
        100.0
        
        553,046
        100.0
        
        497,031
        100.0
  Loan Category Analysis  Commercial Loans.Commercial loans generally are made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes.  The credit worthiness of the borrower is analyzed and re-evaluated on a periodic basis.  Most commercial loans are collateralized with business assets such as accounts receivable, inventory and equipment.  Even with substantial collateral, such as all the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.  Commercial Real Estate Loans.Commercial real estate construction and commercial real estate mortgages represent interim and permanent financing of commercial properties that are secured by real estate.  Real Estate Construction Loans.  Real estate construction loans represent interim financing on residential and commercial properties under construction, and are secured by real estate.  Once construction is completed and the loan becomes permanent, the loans are reclassified as either commercial real estate loans, which are secured by commercial property or residential real estate loans, which are secured by first deeds of trust.  Residential Real Estate Loans.Residential real estate loans are secured by first deeds of trust on 1-4 family residential properties.  To mitigate interest rate risk, the Company usually limits the final maturity of residential real estate loans held for its own portfolio to 15-20 years, although exceptions are made for competitive reasons and under special programs.  Residential real estate lending involves risk elements when there is lack of timely payment and/or a decline in the value of the collateral.  Loans to Individuals.Loans to individuals include installment loans, home equity lines of credit, and loans secured by junior liens on residential real estate.  The loan proceeds typically are used to purchase vehicles, finance home remodeling, higher education, or for other consumer purposes.  Asset Quality
  Summary of Allowance for Loan Losses  The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible, although there can be no assurance that this will  30    be so.  The provision for loan losses increases the allowance, and loans charged off (net of recoveries) reduce the allowance.  In recognition of our estimate of inherent risks associated with lending activities, a provision for loan losses of $1,433,000 was recorded during the three months ended March 31, 2009, an increase of $1,142,000 or 392% in comparison to the $291,000 reported during the same period in 2008.   Net charge-offs for the three-month period ended March 31, 2009 were $1,442,000 as compared to $311,000 for the three-month period ended March 31, 2008, an increase of $1,131,000 or 364%.  Of the $1,433,000 loan loss provision for the first quarter, $1,269,000 was related to additional specific reserves on one large customer operating in the automobile industry.  The additional reserves were needed due to significant adversarial actions taken by the borrower which increased the Companys total loss exposure over what was anticipated at December 31, 2008.  Additionally, $1,336,000 in charge-offs
recorded during the first quarter were the direct result of these adversarial actions.  The ratio of the allowance for loan losses to total loans outstanding was approximately 1.34% at March 31, 2009, which compares to approximately 1.37% of gross loans at December 31, 2008 (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.  We continue to be concerned about the general slowdown in economic activity and the overall weakness in the residential real estate market.  However, we are confident in our ability to navigate through the effects of the current economic and financial environment.  We regularly review asset quality and re-evaluate the allowance for loan losses.  However, no assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future.  Additionally, regulatory examiners may require us to recognize additions to the allowance based upon their judgment about the loan portfolio and other information available to them at the time of their examinations.  (See Allowance for Loan Losses under Critical Accounting Policies.)  Nonperforming Assets and Impaired Loans
  Nonperforming Assets.Nonperforming assets include nonaccrual loans, loans past due 90 days or more, restructured loans and foreclosed/repossessed property.  A loan will be placed on nonaccrual status when collection of all principal or interest is deemed unlikely.  A loan will automatically be placed on nonaccrual status when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of being collected.  In this case, the loan will continue to accrue interest despite its past due status.  A restructured loan is a loan in which the original contract terms have been modified due to a borrowers financial condition or there has been a transfer of assets in full or partial satisfaction of the loan.  A modification of original contractual terms is generally a concession to a borrower that a lending institution would not normally consider.  An impaired loan as defined in SFAS 114 is a loan when, based on current information and events, it is likely that a lending institution will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement.  Our non-performing asset ratio improved over the first quarter of the year.  As of March 31, 2009, total non-performing assets amounted to $7,586,000 or 1.09% of total assets, compared to $10,013,000, or  31    1.48% of total assets as of December 31, 2008, representing a $2,427,000 or 24% decrease.  This decrease is primarily due to the $1,442,000 of charged off notes in the first quarter of 2009 as well as $1,014,000 of repossessed vehicles sold during the quarter.  Our loans past due more than 90 days as a percentage of total loans were 0.01% at March 31, 2009 and December 31, 2008.  Our foreclosed, repossessed and idled properties were at $1,846,000 at March 31, 2009, an increase of $1,422,000, or 335% from the $424,000 reported on December 31, 2008.  The increase is attributable to a credit issue related to a local auto dealership whereby we have repossessed a large volume of vehicles.  A total of $2,157,000 in specific reserves is included in the balance of the allowance for loan losses as of March 31, 2009 for impaired loans, which compares to a total of $2,195,000 as of December 31, 2008 and $348,000 as of March 31, 2008.  Although we presently believe any potential loss exposure has been fully reserved for our impaired loans at March 31, 2009 and the remaining balances are secured by customer assets pledged as collateral, it is a situation which can change, and which we are constantly monitoring.  Nonperforming assets at March 31, 2009, December 31, 2008 and March 31, 2008 are presented in the following table:   Nonperforming Assets(dollars in thousands)3/31/09
        
        12/31/08
        
        3/31/08Nonaccrual loans
        $
        5,665
        $
        9,532
        $
        1,394Loans past due 90 days or more
        
        75
        
        57
        
        190Restructured loans
        
        -
        
        -
        
        -Total nonperforming loans
        $
        5,740
        $
        9,589
        $
        1,584Foreclosed, repossessed and idled properties
        
        1,846
        
        424
        
        1,110Total nonperforming assets
        $
        7,586
        $
        10,013
        $
        2,694
  Loans are assigned to the watch list based upon our internal risk rating system.  There are three levels of accountability in the risk rating process.  The primary responsibility for risk identification lies with the account officer.  It is the account officers responsibility for the initial and ongoing risk rating of all notes and commitments in his or her portfolio.  On a quarterly basis, each account officer signs a Credit Risk Rating Certification attesting to the accuracy of the credit risk ratings for the loans in his or her loan portfolio.  The Chief Credit Officer is responsible for periodically reviewing the risk rating process employed by the lending officers.  The Chief Credit Officer is responsible for the accuracy and timeliness of account officer risk ratings and has the authority to override account officer risk ratings and initiate rating
changes, if warranted.  Finally, the Bank has a loan review program to provide an independent validation of portfolio quality.  This independent review is intended to assess adherence to underwriting guidelines, proper credit analysis and documentation.  In addition, the loan review process is required to test the integrity, accuracy and timeliness of account officer risk ratings and to test the effectiveness of the credit administrations controls over the risk identification process.   Risk Management reports its findings to the Board of Directors.  On a quarterly basis, the Directors Loan Committee, composed of eight directors, will review all loans on our watch list to determine proper action and reporting of any loans identified as substandard by the credit quality review.   We believe that the above allocated reserves are appropriate for the impaired loans in our portfolio based upon a detailed review of the quality and pledged collateral of each individual loans considered impaired at each of the above-referenced periods.   (See Impairment of Loans under Critical Accounting Policies.)  32    If nonaccrual loans had performed in accordance with their original terms, additional interest income in the amount of $73,000 for the three-month period ended March 31, 2009; $149,000 for the year ended
December 31, 2008; and $75,000 for the three-month period ended March 31, 2008 would have been recorded.  Other Assets  We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Companys Supplemental Executive Retirement Plan (SERP) and other employee benefit costs including health insurance, dental insurance, life insurance, and 401(k) employer match.  Bank owned life insurance was $12,525,000 at March 31, 2009 an increase of $135,000 over the $12,390,000 reported as of December 31, 2008.  Deposits  The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges and the convenience of banking locations.  Competition for deposits is intense from other depository institutions and money market funds, some of which offer interest rates higher than we pay.  We attempt to identify and implement pricing and marketing strategies designed to control the overall cost of deposits and to maintain a stable deposit mix.  The following table summarizes our total deposits at March 31, 2009 and December 31, 2008:
  Deposit Summary(dollars in thousands)3/31/09
        
        12/31/08
        
        Increase/(Decrease)$
        %
        
        $
        %
        
        $
        %Time deposits
        
        306,232
        60.9
        
        283,808
        60.9
        
        22,424
        7.9Interest bearing demand & money market
        
        107,848
        21.4
        
        101,895
        21.9
        
        5,953
        5.8Savings
        
        70,234
        14.0
        
        66,082
        14.1
        
        4,152
        6.3Total interest bearing deposits
        
        484,314
        96.3
        
        451,785
        96.9
        
        32,529
        7.2Noninterest demand & official checks
        
        18,546
        3.7
        
        14,550
        3.1
        
        3,996
        27.5Total deposits
        
        502,860
        100.0
        
        466,335
        100.0
        
        36,525
        7.8
   We have experienced deposit growth among all categories during a time in which there is intense competition for deposits.  We have focused our attention on growing our core deposit base as the primary funding source of future loan expansion.  We are very pleased with the results of our new checking account product, MyLifeStyle Checking, launched in 2008.  This account has raised $21.3 million in core deposits since inception and increased 442% over the same period last year.  In addition to a competitive interest rate paid on the account, customers get free access to any ATM nation-wide along with many additional rewards.  Our Prime Money Market account, which has an interest rate tied to the Wall Street Journal Prime rate, continues to attract customers and has accumulated $89.9 million in deposits as of the end of the first quarter of 2009, an increase of 14% over the same period last year.  33    TARP Capital Purchase Plan Participation  On December 12, 2008, as part of the Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase AgreementStandard Terms (collectively, the Purchase Agreement) with the Treasury, pursuant to which the Company sold (i) 16,019 shares of the Companys Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, having a liquidation preference of
$1,000 per share (the Preferred Stock) and (ii) a warrant (the Warrant) to purchase 344,742 shares of the Companys common stock, no par value per share (the Common Stock), at an initial exercise price of $6.97 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $16,019,000 in cash.  The Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. The Company may not redeem the Preferred Stock during the first three years except with regulatory approval and with the proceeds from a Qualified Equity Offering (as defined in the Purchase Agreement). After three years, the Company may, at its option, redeem the Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Preferred Stock is generally non-voting. Prior to December 12, 2011, unless the Company has redeemed the Preferred Stock or the Treasury has transferred the Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital
securities, other than in certain circumstances specified in the Purchase Agreement.  The Warrant is immediately exercisable. The Warrant provides for the adjustment of the exercise price and the number of shares of Common Stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of Common Stock, and upon certain issuances of Common Stock at or below a specified price relative to the then-current market price of Common Stock. The Warrant expires ten years from the issuance date. If, on or prior to December 31, 2009, the Company receives aggregate gross cash proceeds of not less than the purchase price of the Preferred Stock from one or more Qualified Equity Offerings announced after October 13, 2008, the number of shares of common stock issuable pursuant to the Treasurys exercise of the Warrant will be reduced by one-half of the original number
of shares, taking into account all adjustments, underlying the Warrant. Pursuant to the Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.  Upon the request of the Treasury at any time, the Company has agreed to promptly enter into a deposit arrangement pursuant to which the Preferred Stock may be deposited and depositary shares (Depositary Shares), representing fractional shares of Preferred Stock, may be issued. The Company registered the Preferred Stock, the Warrant, the shares of Common Stock underlying the Warrant on January 12, 2009.  Short-Term Borrowings
  Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) decreased by $17.5 million, or 27% from their level of $64.0 million at December 31, 2008 to a total of $46.5 million as of March 31, 2009.   The decrease is due to a decrease of $11.3 million in federal funds purchased and a $6.2 million decrease in our commercial sweep account program.The commercial sweep program involves balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured.  The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight basis subject to repurchase. On the following business day, we repurchase from the customer the securities for an amount equal to the amount
of available balances invested in the securities.  Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only once per month.  34    Additionally, short-term borrowings at March 31, 2009 and December 31, 2008 included Federal Home Loan Bank of Atlanta (FHLB) borrowings in the amount of $17.0 million.  The FHLB borrowings include two fixed rate credits.  The first FHLB advance is a $12 million fixed rate credit at 0.47% that matures on April 13, 2009.  The second FHLB advance is a $5 million fixed rate credit at 5.46% that matures on December 2, 2009.  Long-Term Borrowings  Federal Home Loan Bank advances are relatively cost-effective funding sources and provide us with the flexibility to structure borrowings in a manner that aids in the management of interest rate risk and liquidity.  Long-term convertible Federal Home Loan Bank advances totaled $68.0 million at March 31, 2009, and $68.0 million at December 31, 2008.   (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 Statutory Trust III, a statutory business trust (Trust III) was created by the Company on December 15, 2006, at which time Trust III issued $5 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature January 30, 2037.  Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any time after January 20, 2012.  The principal assets of Trust III are $5.2 million of the Companys junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%, and which are callable by the Company after January 30, 2012.  All $155,000 in aggregation liquidation amount of Trust IIIs common securities are held by the Company.  Valley Financial (VA) Statutory Trust II, a statutory business trust (Trust II), was created on September 26, 2005, at which time Trust II issued $7.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature December 15, 2035.  Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any time after December 15, 2010.  The principal assets of Trust II are $7.2 million of the Companys junior subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%, and which are callable by the Company after December 15, 2010.  All $217,000 in aggregation liquidation amount of Trust IIs common securities are held by the Company.  Valley Financial (VA) Statutory Trust I, a statutory business trust (Trust I), was created on June 26, 2003, at which time the Trust issued $4.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature June 26, 2033.  Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by Trust I at any time after June 26, 2008.  The principal assets of Trust I are $4.1 million of the Companys junior subordinated debentures which mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and which are callable by the Company after June 26, 2008.  All $124,000 in aggregation liquidation amount of Trust Is common securities are held by the Company.  The debenture proceeds from Trust I, Trust II, and Trust III are included in our Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of our total Tier I capital including the securities.  Of the total $16,000,000 in trust preferred proceeds from all three trusts, the entire  35    $16,000,000 is included in Tier 1 capital at March 31, 2009.  Our obligations with respect to the issuance of Trust I, Trust II and Trust IIIs preferred securities and common securities constitute a full and unconditional guarantee of Trust I, Trust II and Trust IIIs obligations with respect to the preferred securities and common securities.  Subject to certain exceptions and limitations, we may elect from time to time to defer interest payments on our junior subordinated debentures, which would result in a deferral of distribution payments on Trust I, Trust II
and Trust IIIs preferred trust securities and common securities.  As a result of the Companys adoption of FIN 46, the Trusts common securities have been presented as a component of other assets.  Capital Adequacy  We seek to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses.  Our financial position at March 31, 2009 reflects liquidity and capital levels currently adequate to fund anticipated near-term business expansion.  We review the adequacy of our capital on an ongoing basis at the Company and Bank level and are committed to maintaining a total risk based capital ratio of 10% or greater at the Bank level, as is required for a well capitalized institution.  For the periods indicated, the Company had the following risk-based capital and leverage ratios:
  Valley Financial Corporation  Ratio
        
        Well Capitalized
        
        3/31/09
        
        12/31/08
        
        3/31/08Tier 1
        
        6.0%
        
        12.8%
        
        13.1%
        
        10.7%Total
        
        10.0%
        
        14.0%
        
        14.4%
        
        12.0%Leverage
        
        5.0%
        
        10.9%
        
        11.3%
        
        9.1%
  For the periods indicated, the Bank had the following risk-based capital and leverage ratios:
  Valley Bank Ratio
        
        Well Capitalized
        
        3/31/09
        
        12/31/08
        
        3/31/08Tier 1
        
        6.0%
        
        10.9%
        
        9.0%
        
        9.6%Total
        
        10.0%
        
        12.2%
        
        10.3%
        
        10.5%Leverage
        
        5.0%
        
        9.3%
        
        7.8%
        
        8.2%
   The Company paid its tenth consecutive semi-annual cash dividend on the Companys common stock, in the amount of $0.07 per share on January 2, 2009 to shareholders of record December 15, 2008.  On April 29, 2009, the Board of Directors
 reduced the Companys semi-annual common stock dividend from $0.07 to $0.04 per share, effective for the dividend payable July 1,
 2009 to shareholders of record on June 1, 2009.  The Board anticipates maintaining this level for 2009, and would hope to return  36    dividend rates to a normalized level in 2010 as market conditions improve.  This action will enable the Company to retain an additional $281,000 in
common equity for 2009.  This is the first reduction in the dividend that the Company has made since it started paying dividends in July
2004, and it was truly an agonizing decision.  However, considering the current state of the economy, the Board of Directors felt it was
prudent and responsible to take this action as one of several capital preservation initiatives being undertaken.  In conjunction with the
dividend reduction, the Board also
voted to rescind the 5% board and committee fee increase that was implemented for 2009.  Earlier this year,
the executive management team voluntarily deferred their 5% salary increases for 2009 until such time that market conditions improve.  Furthermore, it is important to note that the Boards dividend action is not directly related to our participation in the U.S. Treasurys Capital Purchase Program, which was established by the U.S. Treasury to attract participation byhealthyfinancial institutions to help stabilize the financial system and increase lending for the benefit of the U.S. economy.  We have made approximately $33 million in additional loans and have paid and accrued preferred dividends totaling $243,000 subsequent to the issuance of the preferred stock to the U.S. Treasury last December under this program.  However, the decision to preserve our common equity through restricting our dividend does help position our Company to repay this investment as soon as is prudent and still maintain a strong capital position.  Liquidity
  Asset/liability management activities are designed to ensure that adequate liquidity is available to meet loan demand or deposit outflows and, through the management of our interest sensitivity position, to manage the impact of interest rate fluctuations on net interest income.  Liquidity measures our ability to meet our maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund our operations and to provide for customers credit needs.  Liquidity represents a financial institutions ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds from alternative funding sources.  Liquid assets, which include cash and due from banks, federal funds sold, interest-bearing deposits at other banks and non-pledged securities available-for-sale, at March 31, 2009, totaled $27.7 million compared to $11.9 million at December 31, 2008.  The $15.8 million increase in liquid assets is primarily the result of the significant increase in deposits during the quarter which, in turn, resulted in a fed funds sold position of $10.6 million.  Our funding sources consist of an established federal funds line with a regional correspondent bank totaling $12.0 million that had a $0 balance as of March 31, 2009, three established federal funds lines with third party banks totaling $20.0 million that had a outstanding balances totaling $0 as of March 31, 2009, and an established line with the FHLB that had $80.0 million outstanding under a total line of $91.9 million
as of March 31, 2009.  Additionally, we had an established line with the Federal Reserve Discount Window that had no outstanding balance under a total line of $74.6 million as of March 31, 2009.  We believe these arrangements will be renewed at maturity.  We sell excess funds as overnight federal funds sold to provide an immediate source of liquidity.  We had federal funds sold of $10.6 million at March 31, 2009 and $0 at December 31, 2008.  As a result of our management of liquid assets and our ability to generate liquidity through alternative funding sources, we believe we maintain overall liquidity sufficient to meet our depositors requirements and satisfy our customers credit needs.   37    Recent and Future Accounting Considerations  In December 2008 the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) SFAS 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets, (FSP SFAS 132(R)-1).  This FSP provides guidance on an employers disclosures about plan assets of a defined benefit pension or other postretirement plan.  The objective of the FSP is to provide the users of financial statements with an understanding of: (a) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (b) the major categories of plan assets; (c) the inputs and valuation techniques used to measure the fair value of plan assets; (d) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and
(e) significant concentrations of risk within plan assets.  The FSP also requires a nonpublic entity, as defined in Statement of Financial Accounting Standard (SFAS) 132, to disclose net periodic benefit cost for each period for which a statement of income is presented.  FSP SFAS 132(R)-1 is effective for fiscal years ending after December 15, 2009.  The Staff Position will require the Company to provide additional disclosures related to its benefit plans.  FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20, (FSP EITF 99-20-1) was issued in January 2009.  Prior to the FSP, other-than-temporary impairment was determined by using either Emerging Issues Task Force (EITF) Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets, (EITF 99-20) or SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, (SFAS 115) depending on the type of security.  EITF 99-20 required the use of market participant assumptions regarding future cash flows regarding the probability of collecting all cash flows previously projected.  SFAS 115 determined impairment to be other than temporary if it was
probable that the holder would be unable to collect all amounts due according to the contractual terms. To achieve a more consistent determination of other-than-temporary impairment, the FSP amends EITF 99-20 to determine any other-than-temporary impairment based on the guidance in SFAS 115, allowing management to use more judgment in determining any other-than-temporary impairment.  The FSP was effective for reporting periods ending after December 15, 2008.  Management has reviewed the Companys security portfolio and evaluated the portfolio for any other-than-temporary impairments.  FSP SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, (FSP SFAS 115-2 and SFAS 124-2) categorizes losses on debt securities available-for-sale or held-to-maturity determined by management to be other-than-temporarily impaired into losses due to credit issues and losses related to all other factors.  Other-than-temporary impairment (OTTI) exists when it is more likely than not that the security will mature or be sold before its amortized cost basis can be recovered.  An OTTI related to credit losses should be recognized through earnings.  An OTTI related to other factors should be recognized in other comprehensive income.  The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.  Annual disclosures required in SFAS 115 and FSP SFAS 115-1 and SFAS
124-1 are also required for interim periods (including the aging of securities with unrealized losses).  FSP SFAS 157-4, Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not
 Orderly recognizes that quoted prices may not be determinative of fair value when the volume and level of trading activity has
significantly decreased.  The evaluation of certain factors may necessitate that fair value be determined using a different valuation
technique.  Fair value should be the price that would be received to sell an asset or paid to transfer a liability in an orderly
 transaction, not a forced liquidation or distressed sale.  If a transaction is considered to not be orderly, little, if any, weight
should be placed on the transaction price.  If there is not  38    sufficient information to conclude as to whether or not the transaction is
orderly, the transaction price should be considered when estimating fair value.  An entitys intention to hold an asset or liability is not relevant in determining fair value.
 Quoted prices provided by pricing services may still be used when estimating fair value in accordance with SFAS 157; however,
the entity should evaluate whether the quoted prices are based on current information and orderly transactions.  Inputs and valuation
techniques are required to be disclosed in addition to any changes in valuation techniques.  FSP SFAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments requires disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements and also requires those disclosures in summarized financial information at interim reporting periods  A publicly traded company includes any company whose securities trade in a public market on either a stock exchange or in the over-the-counter market, or any company that is a conduit bond obligor.  Additionally, when a company makes a filing with a regulatory agency in preparation for sale of its securities in a public market it is considered a publicly traded company for this purpose.  Also on April 1, 2009, the FASB issued FSP SFAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.  The FSP requires that assets acquired and liabilities assumed in a business combination that arise from a contingency be recognized at fair value.  If fair value cannot be determined during the measurement period as determined in SFAS 141 (R), the asset or liability can still be recognized if it can be determined that it is probable that the asset existed or the liability had been incurred as of the measurement date and if the amount of the asset or liability can be reasonably estimated.  If it is not determined to be probable that the asset/liability existed/was incurred or no reasonable amount can be determined, no asset or liability is recognized. The entity should determine a rational basis for subsequently
measuring the acquired assets and assumed liabilities.  Contingent consideration agreements should be recognized initially at fair value and subsequently reevaluated in accordance with guidance found in paragraph 65 of SFAS 141 (R).  The FSP is effective for business combinations with an acquisition date on or after the beginning of the Companys first annual reporting period beginning on or after December 15, 2008.  The Company will assess the impact of the FSP if and when a future acquisition occurs.  The Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 111 on April 9, 2009 to amend Topic 5.M., Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities and to supplement FSP SFAS 115-2 and SFAS 124-2.  SAB 111 maintains the staffs previous views related to equity securities; however debt securities are excluded from its scope.  The SAB provides that other-than-temporary impairment is not necessarily the same as permanent impairment and unless evidence exists to support a value equal to or greater than the carrying value of the equity security investment, a write-down to fair value should be recorded and accounted for as a realized loss.  The SAB was effective upon issuance and had no impact on the Companys financial position.  Item 3.  Quantitative and Qualitative Disclosures about Market Risk.  Not applicable.  39    Item 4.  Controls and Procedures.  As of the end of the period covered by the report, an evaluation was performed under the supervision and with the participation of the Companys management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.  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 has not been any change in our internal control over financial reporting that occurred during the last quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.  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.  As discussed in the Annual Report, Form 10-K for December 31, 2008, the Bank was named a party defendant in litigation filed by The Collection, LLC (The Collection) against the Bank and Scott Newcomb Motors, LLC, d/b/a Scott Newcomb Chrysler Jeep (Newcomb).  The litigation was filed in the United States District Court for the Western District of Virginia, Danville Division on or about March 23, 2009.  The suit is an action for breach of contract against Newcomb, tortious interference with contract against the Bank, conversion against the Bank, and misrepresentation, common law conspiracy and statutory conspiracy against Newcomb and the Bank.  The litigation relates to fifteen vehicles that Newcomb allegedly purchased from The Collection using floor-plan financing provided by the Bank.  The Complaint alleges that Newcomb never paid The Collection for the subject
vehicles.  The Collection is requesting monetary damages for the alleged cost of the fifteen vehicles (approximately $340,800), plus treble and/or punitive damages.  At this time, the outcome of the litigation is undeterminable, however, the Bank estimates the potential loss of $340,800 to be reasonably possible and has reserved for 100% of this loss in its loan loss reserve as of March 31, 2009.  The Bank estimates the potential loss of treble and/or punitive damages totaling $1,022,400 to be remote and therefore has not accrued for this loss as of March 31, 2009.  The Bank denies any allegations of wrongdoing and intends to vigorously defend itself.  Item 1A.  Risk Factors.  There were no material changes to the Companys risk factors as disclosed in the Annual Report Form 10K for December 31, 2008.  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.
  40     Item 4.  Submission of Matters to a Vote of Security Holders.  None.
  Item 5.  Other Information  None.
   Item 6.  Exhibits  Exhibit
Number
        
        Description31.1
        
        Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
        
        Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*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.*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.   41    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 13, 2009
        /s/ Ellis L. Gutshall
 Date
        Ellis L. Gutshall, President and Chief Executive Officer
   May 13, 2009
        /s/ Kimberly B. Snyder
 Date
        Kimberly B. Snyder, Executive Vice President and
 Chief Financial Officer
  42     EXHIBIT INDEX
   Exhibit
Number
        
        Description31.1
        
        Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
        
        Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*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.*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.   43