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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the Quarterly Period Ended March 31, 2007



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

For the transition period from  to

Commission File Number: 000-28342



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VALLEY FINANCIAL CORPORATION



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

36 Church Avenue, S.W.

Roanoke, Virginia 24011

(Address of principal executive offices)

(540) 342-2265

(Issuers telephone number, including area code)



---

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

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

Large accelerated filer ̈Accelerated filer ̈Non-accelerated
filer  x

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

Transitional small business disclosure format:    Yes ̈No   x.

At
May 7, 2007, 4,165,751 shares of common stock, no par value, of the registrant were outstanding.



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

FORM 10-Q

March 31, 2007

TABLE OF CONTENTS



|                                                                    |  |    |  | 
|------------------------------------------------------------------- |  | -- |  | 
|Part I. FINANCIAL INFORMATION                                       |  |   
|                                                                    | 
|Item 1. Financial Statements                                        |  |   
|                                                                    | 
|Consolidated Balance Sheets                                         |  | 4 
|Consolidated Statements of Income                                   |  | 5 
|Consolidated Statements of Cash Flows                               |  | 6 
|Notes to Consolidated Financial Statements                          |  | 7 
|                                                                    | 
|Item 2. Managements Discussion and Analysis                        |  | 17
|                                                                    | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk  |  | 33
|                                                                    | 
|Item 4. Controls and Procedures                                     |  | 34
|                                                                    | 
|Part II. OTHER INFORMATION                                          |  |   
|                                                                    | 
|Item 1. Legal Proceedings                                           |  | 34
|                                                                    | 
|Item 1A. Risk Factors                                               |  | 34
|                                                                    | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |  | 35
|                                                                    | 
|Item 3. Defaults Upon Senior Securities                             |  | 35
|                                                                    | 
|Item 4. Submission of Matters to a Vote of Security Holders         |  | 35
|                                                                    | 
|Item 5. Other Information                                           |  | 35
|                                                                    | 
|Item 6. Index to Exhibits                                           |  | 36
|                                                                    | 
|SIGNATURES                                                          |  | 39
|                                                                    | 
|CERTIFICATIONS                                                      |  | 40



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Cautionary Statement Regarding Forward-Looking Statements

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



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



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



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



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



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



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



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



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



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



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

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



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##### Table of Contents

PART 1  FINANCIAL INFORMATION



|Item 1. | Financial Statements.
|------- | ---------------------

VALLEY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)



|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- | ------- | - | ------------------ | - | ------- | -
|                                                                                                                                                            |  | (Unaudited) 3/31/07 |         |   | (Audited) 12/31/06 |  
|                                                                                                                                                            |  |                    
|Assets                                                                                                                                                      |  |                     |         |   |                    |   |         |  
|Cash and due from banks                                                                                                                                     |  | $                   | 8,887   |   |                    | $ | 9,778   |  
|Interest-bearing deposits in banks                                                                                                                          |  |                     | 91      |   |                    |   | 91      |  
|Federal funds sold                                                                                                                                          |  |                     |        |   |                    |   | 16,630  |  
|Securities available-for-sale                                                                                                                               |  |                     | 47,962  |   |                    |   | 48,405  |  
|Securities held-to-maturity (approximate market values of $19,837 March 31, 2007 and $19,940 at December 31, 2006)                                          |  |                     | 19,980  |   |                    |   | 20,133  |  
|Restricted equity securities                                                                                                                                |  |                     | 5,188   |   |                    |   | 5,079   |  
|Loans, net of allowance for loan losses of $6,379 at March 31, 2007 and $5,658 at December 31, 2006                                                         |  |                     | 468,597 |   |                    |   | 465,394 |  
|Premises and equipment, net                                                                                                                                 |  |                     | 6,712   |   |                    |   | 6,873   |  
|Bank owned life insurance                                                                                                                                   |  |                     | 11,244  |   |                    |   | 11,117  |  
|Accrued interest receivable                                                                                                                                 |  |                     | 3,048   |   |                    |   | 2,954   |  
|Other assets                                                                                                                                                |  |                     | 5,348   |   |                    |   | 5,482   |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Total assets                                                                                                                                                |  | $                   | 577,057 |   |                    | $ | 591,936 |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Liabilities and Shareholders Equity                                                                                                                        |  |                     |         |   |                    |   |         |  
|Liabilities:                                                                                                                                                |  |                     |         |   |                    |   |         |  
|Noninterest-bearing deposits                                                                                                                                |  | $                   | 16,513  |   |                    | $ | 18,663  |  
|Interest-bearing deposits                                                                                                                                   |  |                     | 400,767 |   |                    |   | 422,826 |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Total deposits                                                                                                                                              |  |                     | 417,280 |   |                    |   | 441,489 |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Federal funds purchased and securities sold under agreements to repurchase                                                                                  |  |                     | 29,538  |   |                    |   | 21,635  |  
|Short-term borrowings                                                                                                                                       |  |                     | 25,000  |   |                    |   | 25,000  |  
|Long-term borrowings                                                                                                                                        |  |                     | 48,000  |   |                    |   | 48,000  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures                                                                   |  |                     | 16,496  |   |                    |   | 16,496  |  
|Accrued interest payable                                                                                                                                    |  |                     | 3,957   |   |                    |   | 3,133   |  
|Other liabilities                                                                                                                                           |  |                     | 2,825   |   |                    |   | 2,782   |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Total liabilities                                                                                                                                           |  |                     | 543,096 |   |                    |   | 558,535 |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Commitments and other contingencies                                                                                                                         |  |                     |        |   |                    |   |        |  
|                                                                                                                                                            |  |                    
|Shareholders equity:                                                                                                                                       |  |                     |         |   |                    |   |         |  
|Preferred stock, no par value. Authorized 10,000,000 shares; none issued and outstanding                                                                    |  |                     |        |   |                    |   |        |  
|Common stock, no par value. Authorized 10,000,000 shares; issued and outstanding 4,126,839 at March 31, 2007, and
4,112,074 December 31, 2006, respectively |  |                     | 17,298  |   |                    |   | 17,212  |  
|Retained earnings                                                                                                                                           |  |                     | 16,962  |   |                    |   | 16,488  |  
|Accumulated other comprehensive income (loss)                                                                                                               |  |                     | (299    | ) |                    |   | (299    | )
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Total shareholders equity                                                                                                                                  |  |                     | 33,961  |   |                    |   | 33,401  |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  
|Total liabilities and shareholders equity                                                                                                                  |  | $                   | 577,057 |   |                    | $ | 591,936 |  
|                                                                                                                                                            |  |                     |         |   |                    |   |         |  

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except
share and per share data)



|                                                                                                      |  |                |           |         |   |           |  
|----------------------------------------------------------------------------------------------------- |  | -------------- | --------- | ------- | - | --------- | -
|                                                                                                      |  | 3 Months Ended |          
|                                                                                                      |  | 3/31/07        |           | 3/31/06 |  
|Interest Income:                                                                                      |  |                |           |         |   |           |  
|Interest and fees on loans                                                                            |  | $              | 8,574     |         | $ | 7,204     |  
|Interest on securities - taxable                                                                      |  |                | 762       |         |   | 484       |  
|Interest on securities - nontaxable                                                                   |  |                | 135       |         |   | 138       |  
|Interest on deposits in banks                                                                         |  |                | 108       |         |   | 5         |  
|                                                                                                      |  |                |           |         |   |           |  
|Total interest income                                                                                 |  |                | 9,579     |         |   | 7,831     |  
|                                                                                                      |  |                |           |         |   |           |  
|Interest Expense:                                                                                     |  |                |           |         |   |           |  
|Interest on deposits                                                                                  |  |                | 4,350     |         |   | 2,923     |  
|Interest on short-term borrowings                                                                     |  |                | 509       |         |   | 299       |  
|Interest on long-term borrowings                                                                      |  |                | 581       |         |   | 388       |  
|Interest on guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                | 293       |         |   | 183       |  
|Interest on federal funds purchased and securities sold under agreements to repurchase                |  |                | 4         |         |   | 241       |  
|                                                                                                      |  |                |           |         |   |           |  
|Total interest expense                                                                                |  |                | 5,737     |         |   | 4,034     |  
|                                                                                                      |  |                |           |         |   |           |  
|Net interest income                                                                                   |  |                | 3,842     |         |   | 3,797     |  
|                                                                                                      |  |               
|Provision for loan losses                                                                             |  |                | 720       |         |   | 587       |  
|                                                                                                      |  |                |           |         |   |           |  
|Net interest income after provision for loan losses                                                   |  |                | 3,122     |         |   | 3,210     |  
|                                                                                                      |  |                |           |         |   |           |  
|                                                                                                      |  |               
|Noninterest Income:                                                                                   |  |                |           |         |   |           |  
|Service charges on deposit accounts                                                                   |  |                | 291       |         |   | 213       |  
|Income earned on bank owned life insurance                                                            |  |                | 127       |         |   | 115       |  
|Other income on real estate loans                                                                     |  |                | 13        |         |   |          |  
|Realized (losses) on sale of securities available-for-sale                                            |  |                |          |         |   | (1        | )
|Realized gains on disposal of derivatives                                                             |  |                | 51        |         |   |          |  
|Other income                                                                                          |  |                | 149       |         |   | 129       |  
|                                                                                                      |  |                |           |         |   |           |  
|Total noninterest income                                                                              |  |                | 631       |         |   | 456       |  
|                                                                                                      |  |                |           |         |   |           |  
|Noninterest Expense:                                                                                  |  |                |           |         |   |           |  
|Compensation expense                                                                                  |  |                | 1,692     |         |   | 1,485     |  
|Occupancy expense                                                                                     |  |                | 198       |         |   | 157       |  
|Equipment expense                                                                                     |  |                | 142       |         |   | 135       |  
|Data processing expense                                                                               |  |                | 164       |         |   | 152       |  
|Advertising and marketing expense                                                                     |  |                | 43        |         |   | 84        |  
|Audit fees                                                                                            |  |                | 103       |         |   | 73        |  
|Franchise and purchased tax credit expense                                                            |  |                | 85        |         |   | 67        |  
|Business manager expense                                                                              |  |                | 83        |         |   | 61        |  
|Deposit expense                                                                                       |  |                | 65        |         |   | 99        |  
|Loan expenses                                                                                         |  |                | 32        |         |   | 55        |  
|Computer software                                                                                     |  |                | 76        |         |   | 83        |  
|Other expense                                                                                         |  |                | 459       |         |   | 270       |  
|                                                                                                      |  |                |           |         |   |           |  
|Total noninterest expense                                                                             |  |                | 3,142     |         |   | 2,721     |  
|                                                                                                      |  |                |           |         |   |           |  
|Income before income taxes                                                                            |  |                | 611       |         |   | 945       |  
|                                                                                                      |  |               
|Income tax expense                                                                                    |  |                | 136       |         |   | 245       |  
|                                                                                                      |  |                |           |         |   |           |  
|Net income                                                                                            |  | $              | 475       |         | $ | 700       |  
|                                                                                                      |  |                |           |         |   |           |  
|Earnings per share                                                                                    |  |                |           |         |   |           |  
|Basic earnings per share                                                                              |  | $              | 0.12      |         | $ | 0.17      |  
|                                                                                                      |  |                |           |         |   |           |  
|Diluted earnings per share                                                                            |  | $              | 0.11      |         | $ | 0.17      |  
|                                                                                                      |  |                |           |         |   |           |  
|Weighted average shares                                                                               |  |                | 4,124,904 |         |   | 4,079,233 |  
|                                                                                                      |  |                |           |         |   |           |  
|Diluted average shares                                                                                |  |                | 4,233,897 |         |   | 4,189,866 |  
|                                                                                                      |  |                |           |         |   |           |  

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands, except
share and per share data)



|                                                                                                  |  |                |         |   |         |   |         |  
|------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ------- | - | ------- | -
|                                                                                                  |  | 3 Months Ended |        
|                                                                                                  |  | 3/31/07        |         |   | 3/31/06 |  
|Cash flows from operating activities                                                              |  |                |         |   |         |   |         |  
|Net income                                                                                        |  | $              | 475     |   |         | $ | 700     |  
|Adjustments to reconcile net income to net cash provided by operating activities:                 |  |                |         |   |         |   |         |  
|Provision for loan losses                                                                         |  |                | 720     |   |         |   | 587     |  
|Depreciation and amortization of bank premises, equipment and software                            |  |                | 208     |   |         |   | 187     |  
|Stock option expense                                                                              |  |                | 44      |   |         |   | 39      |  
|(Increase) in deferred income tax                                                                 |  |                | (2      | ) |         |   | (270    | )
|Net (gains) on sale of securities                                                                 |  |                |        |   |         |   | 1       |  
|Net (gains) losses on disposal of derivative                                                      |  |                | (51     | ) |         |   |        |  
|Amortization of bond premiums/discounts                                                           |  |                | 39      |   |         |   | 46      |  
|(Increase) in unearned fees                                                                       |  |                | (4      | ) |         |   |        |  
|(Increase) in interest receivable                                                                 |  |                | (94     | ) |         |   | (157    | )
|(Increase)/ decrease in other assets                                                              |  |                | 187     |   |         |   | (90     | )
|(Increase) in value of life insurance contracts                                                   |  |                | (127    | ) |         |   | (115    | )
|Increase in accrued interest payable                                                              |  |                | 824     |   |         |   | 478     |  
|Increase in other liabilities                                                                     |  |                | 259     |   |         |   | 356     |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash provided by operating activities                                                         |  |                | 2,478   |   |         |   | 1,762   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash flows from investing activities                                                              |  |                |         |   |         |   |         |  
|Decrease in interest-bearing deposits in banks                                                    |  |                |        |   |         |   | 199     |  
|Decrease in federal funds sold                                                                    |  |                | 16,630  |   |         |   |        |  
|Purchases of premises and equipment                                                               |  |                | (47     | ) |         |   | (498    | )
|Purchases of securities available-for-sale                                                        |  |                | (507    | ) |         |   |        |  
|Purchases of restricted equity securities                                                         |  |                | (109    | ) |         |   | (834    | )
|Principal repayments/sales/calls/maturities of securities available-for-sale                      |  |                | 1,004   |   |         |   | 907     |  
|Principal repayments of securities held-to-maturity                                               |  |                | 130     |   |         |   | 165     |  
|Principal repayments of restricted equity securities                                              |  |                |        |   |         |   | 225     |  
|Purchase of bank owned life insurance                                                             |  |                |        |   |         |   | (1,100  | )
|(Increase) in loans, net                                                                          |  |                | (3,919  | ) |         |   | (19,786 | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash provided (used) in investing activities                                                  |  |                | 13,182  |   |         |   | (20,722 | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash flows from financing activities                                                              |  |                |         |   |         |   |         |  
|(Decrease) in noninterest-bearing deposits                                                        |  |                | (2,149  | ) |         |   | (59     | )
|Increase (decrease) in interest-bearing deposits                                                  |  |                | (22,059 | ) |         |   | 10,183  |  
|Increase in short-term borrowings                                                                 |  |                |        |   |         |   | 3,000   |  
|Increase (decrease) in federal funds purchased and securities sold under agreements to repurchase |  |                | 7,903   |   |         |   | 2,902   |  
|Cash dividends paid                                                                               |  |                | (288    | ) |         |   | (285    | )
|Proceeds from issuance of common stock                                                            |  |                | 42      |   |         |   | 115     |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Net cash provided (used) by financing activities                                                  |  |                | (16,551 | ) |         |   | 15,856  |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Net increase (decrease) in cash and due from banks                                                |  |                | (891    | ) |         |   | (3,104  | )
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash and due from banks at beginning of year                                                      |  |                | 9,778   |   |         |   | 9,746   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash and due from banks at end of year                                                            |  | $              | 8,887   |   |         | $ | 6,642   |  
|                                                                                                  |  |               
|Supplemental disclosure of cash flow information:                                                 |  |                |         |   |         |   |         |  
|Cash paid during the period for interest                                                          |  | $              | 4,913   |   |         | $ | 3,356   |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Cash paid during the period for taxes                                                             |  | $              |        |   |         | $ | 5       |  
|                                                                                                  |  |                |         |   |         |   |         |  
|Noncash financing and investing activities:                                                       |  |                |         |   |         |   |         |  
|Transfer of loans to foreclosed property                                                          |  | $              | 19      |   |         | $ |        |  
|                                                                                                  |  |                |         |   |         |   |         |  

See accompanying notes to consolidated financial statements.



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VALLEY FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

March 31, 2007 (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 2006 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, 2007 was $74, less cash on hand in the amount of $1,246, or a net of $0.

As a condition of our correspondent bank
agreement, the Bank is also required to maintain a target balance. The target balance as of March 31, 2007 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, 2007 are shown in the tables below. As of March 31, 2007, investments (including both available-for-sale and
held-to-maturity) and restricted equity securities with amortized costs and fair values of $61,298 and $61,117, 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, 2007 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, 2007. Securities available-for-sale are carried at approximate market value.



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Available-for-Sale Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|----------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------------------- | --- |  | - | ------
|                                    |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | ApproximateFair Values
|U. S. Government and federal agency |  | $              | 884    |                 | $ | 2                |  | $                      | 1   |  | $ | 885   
|                                    |  |                |        |                
|Government-sponsored enterprises    |  |                | 19,437 |                 |   | 31               |  |                        | 153 |  |   | 19,315
|                                    |  |                |        |                
|Mortgage-backed securities          |  |                | 8,031  |                 |   | 80               |  |                        | 141 |  |   | 7,970 
|                                    |  |                |        |                
|Collateralized mortgage obligations |  |                | 12,866 |                 |   | 23               |  |                        | 335 |  |   | 12,554
|                                    |  |                |        |                
|States and political subdivisions   |  |                | 7,097  |                 |   | 57               |  |                        | 14  |  |   | 7,140 
|                                    |  |                |        |                
|Corporate debt securities           |  |                | 100    |                 |   |                 |  |                        | 2   |  |   | 98    
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|Total securities available for sale |  | $              | 48,415 |                 | $ | 193              |  | $                      | 646 |  | $ | 47,962
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       

The following table sets forth the composition of securities held-to-maturity at March 31,
2007. Securities held-to-maturity are carried at amortized cost.

Held-to-Maturity Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|----------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | ---------------------- | --- |  | - | ------
|                                    |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  | ApproximateFair Values
|U. S. Government and federal agency |  | $              | 9,948  |                 | $ |                 |  | $                      | 119 |  | $ | 9,829 
|                                    |  |                |        |                
|Mortgage-backed securities          |  |                | 2.234  |                 |   |                 |  |                        | 56  |  |   | 2,178 
|                                    |  |                |        |                
|Collateralized mortgage obligations |  |                | 542    |                 |   |                 |  |                        | 24  |  |   | 518   
|                                    |  |                |        |                
|States and political subdivisions   |  |                | 7,256  |                 |   | 86               |  |                        | 30  |  |   | 7,312 
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       
|Total securities held to maturity   |  | $              | 19,980 |                 | $ | 86               |  | $                      | 229 |  | $ | 19,837
|                                    |  |                |        |                 |   |                  |  |                        |     |  |   |       



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

The following table summarizes
the loan loss experience for the three-month periods ended March 31, 2007 and 2006.

Allowance for Loan Losses

(dollars in thousands)



|                          |  |         |       |         |   |       |  
|------------------------- |  | ------- | ----- | ------- | - | ----- | -
|                          |  | 3/31/07 |       | 3/31/06 |  
|Balance at January 1      |  | $       | 5,658 |         | $ | 4,124 |  
|Provision for loan losses |  |         | 720   |         |   | 587   |  
|Recoveries:               |  |         |       |         |   |       |  
|Commercial                |  |         |      |         |   |      |  
|Loans to individuals      |  |         | 1     |         |   |      |  
|Charged off loans:        |  |         |       |         |   |       |  
|Commercial                |  |         |      |         |   | (2    | )
|Loans to individuals      |  |         |      |         |   |      |  
|                          |  |         |       |         |   |       |  
|Balance at March 31       |  | $       | 6,379 |         | $ | 4,709 |  
|                          |  |         |       |         |   |       |  



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##### Table of Contents

|(5) | Earnings Per Share
|--- | ------------------

Basic earnings per share is based upon
the weighted average number of common shares outstanding during the period. The weighted average shares outstanding for the diluted earnings per share computations were adjusted to reflect the assumed conversion of shares available under stock
options. The following tables summarize earnings per share and the shares utilized in the computations:



|        |  |                                                    |           |         |   |          
|------- |  | -------------------------------------------------- | --------- | ------- | - | ---------
|        |  | Earnings per share 3 Months Ending                
|        |  | 3/31/07                                            |           | 3/31/06
|Basic   |  | $                                                  | 0.12      |         | $ | 0.17     
|        |  |                                                   
|Diluted |  | $                                                  | 0.11      |         | $ | 0.17     
|        | 
|        |  | Weighted Average SharesOutstanding 3 Months Ending
|        |  | 3/31/07                                            |           | 3/3106 
|Basic   |  |                                                    | 4,124,904 |         |   | 4,079,233
|        |  |                                                   
|Diluted |  |                                                    | 4,233,897 |         |   | 4,189,866



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

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

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

The adoption of Statement 130 on January 1, 1998 did not have any effect on the consolidated financial position, results of operations or liquidity
of the Company. However, Statement 130 does have an effect on financial statement displays presented by the Company since the Company has net unrealized gains (losses) on available for sale securities, an item of other comprehensive income (loss).
For the three months ended March 31, 2007 and 2006, total comprehensive income (loss) was $475 and $502, respectively.



9



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##### Table of Contents

The information that follows discloses the reclassification adjustments and the income taxes related to
the net unrealized gains (losses) on securities available-for-sale and net unrealized gains (losses) on derivatives not held for trading that are included in other comprehensive income (loss), net of income taxes for the three month periods ended
March 31, 2007 and 2006.



|                                                                  |  |                                      |      |   |         |   |      |  
|----------------------------------------------------------------- |  | ------------------------------------ | ---- | - | ------- | - | ---- | -
|                                                                  |  | 3 Months Ended(dollars in thousands) |     
|                                                                  |  | 3/31/07                              |      |   | 3/31/06 |  
|Net unrealized gains (losses) on securities available for sale:   |  |                                      |      |   |         |   |      |  
|Net unrealized holding gains (losses) during the year             |  | $                                    | 107  |   |         | $ | (301 | )
|Net unrealized gains (losses) on derivatives not held for trading |  |                                      | (107 | ) |         |   |     |  
|Income tax benefit (expense)                                      |  |                                      |     |   |         |   | 103  |  
|                                                                  |  |                                      |      |   |         |   |      |  
|Other comprehensive income (loss), net of income taxes            |  | $                                    | 0    |   |         | $ | (198 | )
|                                                                  |  |                                      |      |   |         |   |      |  



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

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

The Companys exposure to credit loss in the
event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for
on-balance-sheet risk. At March 31, 2007 outstanding commitments to extend credit were $163,253 as compared to $173,379 at December 31, 2006.

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, 2007 aggregate loans
to directors, executive officers, and principal shareholders totaled $19,223. An analysis of loan activity to directors, executive officers and principal shareholders is as follows:



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##### Table of Contents

Loans to Related Parties

(dollars in thousands)



|                                    |  |   |        |  
|----------------------------------- |  | - | ------ | -
|Balances as of January 1, 2007      |  | $ | 20,255 |  
|Addition of new director/officer(s) |  |   |       |  
|Advances                            |  |   | 595    |  
|Repayments                          |  |   | (1,627 | )
|                                    |  |   |        |  
|Balances as of March 31, 2007       |  | $ | 19,223 |  
|                                    |  |   |        |  



|(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 $48.0 million as of March 31, 2007. There are four convertible advances in the amount of $5.0 million each and one convertible advance in the amount of $7.0
million. The Federal Home Loan Bank of Atlanta has the option to convert $27.0 million in convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two business days notice. If called,
the four $5.0 million convertible advances and the one $7.0 million convertible advance will be converted into a 3-month London Interbank Offered Rate (LIBOR) based adjustable rate credit (ARC) at 3-month LIBOR. There are two other
structured advances with the Federal Home Loan Bank of Atlanta. The first advance is a variable rate advance in the amount of $8.0 million, priced at the Prime Rate minus 2.855% per annum with a 2-year maturity date. The second advance is
convertible advance in the amount of $13.0 million at 3-month LIBOR minus 0.50% per annum. The advance may be called on the two-year anniversary date by the issuer. If it is not called, it will automatically convert to a fixed rate of 5.03% for
the remaining eight year maturity.

The following table provides more information on the outstanding advances as of March 31, 2007 and
December 31, 2006:

LONG-TERM FEDERAL HOME LOAN BANK ADVANCES

(dollars in thousands)



|                 |  |                  |  |                   |  |              |  |                 |  |                 
|---------------- |  | ---------------- |  | ----------------- |  | ------------ |  | --------------- |  | ----------------
|Advance Date     |  | Maturity Date    |  | Conversion Date   |  | Current Rate |  | 3/31/07 Balance |  | 12/31/06 Balance
|December 2, 1999 |  | December 2, 2009 |  | Quarterly         |  | 5.46%        |  | $5,000          |  | $5,000          
|May 24, 2000     |  | May 24, 2010     |  | Quarterly         |  | 6.49%        |  | $5,000          |  | $5,000          
|February 9, 2001 |  | February 9, 2011 |  | Quarterly         |  | 4.97%        |  | $5,000          |  | $5,000          
|March 11, 2003   |  | March 11, 2013   |  | March 11, 2008    |  | 2.91%        |  | $7,000          |  | $7,000          
|June 27, 2006    |  | June 27, 2008    |  | None              |  | 5.395%       |  | $8,000          |  | $8,000          
|June 29, 2006    |  | June 29, 2016    |  | June 29, 2008     |  | 4.85%        |  | $13,000         |  | $13,000         
|November 9, 2006 |  | November 9, 2016 |  | November 10, 2008 |  | 4.28%        |  | $5,000          |  | $5,000          
|                 |  |                  |  |                   |  |              |  |                 |  |                 
|                 |  |                  |  |                   |  | TOTAL        |  | $48,000         |  | $48,000         
|                 |  |                  |  |                   |  |              |  |                 |  |                 



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##### Table of Contents

|(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
|---- | ------------------------

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.



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##### Table of Contents

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 $44 and $38 for the three-month periods ended March 31, 2007 and 2006, respectively. The Company currently has 82,098 nonqualified stock options outstanding at March 31,
2007, which were fully vested as of January 1, 2007. There were no income tax implications for share-based compensation for the three-month period ended March 31, 2007.

Stock Option Plans

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

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

Under the 2005 Plan, there are options for 78,450 shares granted to officers and key employees currently outstanding as of March 31, 2007. Under the
1995 Plan, there are options for 190,445 shares granted to officers and key employees currently outstanding as of March 31, 2007. All stock options (for both plans) have been granted with an exercise price equal to the stocks fair market
value at the date of the grant. Stock options under the Plan generally have 10-year terms, vest at the rate of 20 percent per year, and become fully exercisable five years from the date of the grant. Additionally under the 2005 Plan, there are
15,075 restricted stock grants (RSGs) that have been granted to officers and key employees currently outstanding as of March 31, 2007. These RSGs will vest 100% on January 31, 2008 (Vesting Date) based
upon successfully meeting certain performance criteria. The Company determined as of December 31, 2006 that it is no longer probable that the Company will meet the performance criteria related to the vesting of the RSGs; therefore no
compensation expense for these RSGs has been recognized for the quarter ending March 31, 2007. There was an additional RSG grant made and vested during the first quarter of 2007 for 1,771 shares to a non Named Executive Officer of the
Company. As a result of this grant, $23 of compensation expense was recognized during the quarter ending March 31, 2007.

As of
March 31, 2007, there are 5,358 shares available for grant under the 1995 Plan and 154,704 shares available for grant under the 2005 Plan. In addition, certain other options for 182,196 shares (adjusted for stock splits), of which 82,098 are
outstanding, based on meeting certain past performance criteria have been granted.



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##### Table of Contents

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

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The
risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the volatilities of our trading history. The expected life is based on the Companys history of time to exercise 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 months ended March 31, 2007 and 2006.



|                        |  |                                  |  |                                 
|----------------------- |  | -------------------------------- |  | --------------------------------
|                        |  | Three Months EndedMarch 31, 2007 |  | Three Months EndedMarch 31, 2006
|Dividend yield          |  | 1.31%                            |  | 0.53%                           
|Risk-free interest rate |  | 4.47%                            |  | 4.25%                           
|Volatility              |  | 20.94%                           |  | 23.17%                          
|Expected life           |  | 7.34 years                       |  | 10 years                        

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



|                           |  |                                                      |    |                                                      |   |   
|-------------------------- |  | ---------------------------------------------------- | -- | ---------------------------------------------------- | - | --
|                           |  | 3 Months Ended March 31, 2007 (dollars in thousands) |    | 3 Months Ended March 31, 2006 (dollars in thousands)
|Option Grants              |  | $                                                    | 21 |                                                      | $ | 19
|Restricted Stock Grants    |  | $                                                    | 23 |                                                      | $ | 19
|                           |  |                                                      |    |                                                      |   |   
|Total Compensation Expense |  | $                                                    | 44 |                                                      | $ | 38
|                           |  |                                                      |    |                                                      |   |   

The restricted stock grant expense relates to one grant of 1,771 shares that was granted and fully
vested during the first quarter of 2007 to an officer of the Company who is not a Named Executive Officer.

As of March 31, 2007,
there was $325 of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based payments granted to employees. A maturity schedule of the unrecognized compensation cost (dollars in thousands) as of
March 31, 2007 is as follows:



|                  |  |                |    |      |   |      |  |      |    |      |   |      |  |       |    |  |   |   |  |   |    
|----------------- |  | -------------- | -- | ---- | - | ---- |  | ---- | -- | ---- | - | ---- |  | ----- | -- |  | - | - |  | - | ---
|                  |  | Remaining 2007 |    | 2008 |   | 2009 |  | 2010 |    | 2011 |   | 2012 |  | Total
|Compensation Cost |  | $              | 70 |      | $ | 90   |  | $    | 84 |      | $ | 53   |  | $     | 25 |  | $ | 3 |  | $ | 325

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



14



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##### Table of Contents

General Stock Option Information

A summary of option activity under the stock option plans during the three-month period ended March 31, 2007 is presented below:



|                       |  |                     |  |                                    |       |                                   |           
|---------------------- |  | ------------------- |  | ---------------------------------- | ----- | --------------------------------- | ----------
|                       |  | Options Outstanding |  | WeightedAverage Exercise Price
($) |       | Weighted Average Contractual Term
|Balance, 12/31/06      |  | 338,500             |  | $                                  | 6.68  |                                   | 3.99 years
|                       |  |                     | 
|Exercised              |  | 12,994              |  | $                                  | 3.25  |                                   |           
|Authorized             |  |                    |  |                                    |      |                                   |           
|Forfeited              |  | 4,000               |  | $                                  | 12.50 |                                   |           
|Granted                |  | 31,850              |  | $                                  | 12.20 |                                   |           
|Expired                |  | 2,363               |  | $                                  | 3.25  |                                   |           
|                       |  |                     |  |                                    |       |                                   |           
|Outstanding at 3/31/07 |  | 350,993             |  | $                                  | 7.27  |                                   | 4.42 years
|                       |  |                     |  |                                    |       |                                   |           
|Exercisable at 3/31/07 |  | 259,123             |  | $                                  | 5.45  |                                   | 2.93 years
|                       |  |                     |  |                                    |       |                                   |           

There were 31,850 options granted during the three month period ended March 31, 2007 with a
weighted average exercise price of $12.20 per option. There were 12,994 options exercised during the three month period ending March 31, 2007. The total intrinsic value of options exercised during the three month period ended March 31,
2007 was $123.

Cash received from option exercises under all share-based payment arrangements for the three-month period ended
March 31, 2007 was $42.

Information regarding the stock options outstanding at March 31, 2007 is summarized below:



|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      
|------------------------ |  | ------------------ |  | ------------------------------------------- |  | ------------------------------- | ----- | ------------------ | ------- | ------------------------------ | - | -----
|Range of Exercise Prices |  | Number Outstanding |  | Weighted Average Remaining Contractual Life |  | Weighted Average Exercise Price |       | Number Exercisable |         | Weighted Average ExercisePrice
|$3.18 - $3.81            |  | 91,548             |  | 1.04 years                                  |  | $                               | 3.24  |                    | 91,548  |                                | $ | 3.24 
|$5.08 - $5.94            |  | 129,695            |  | 3.04 years                                  |  | $                               | 5.32  |                    | 129,695 |                                | $ | 5.32 
|$7.14 - $12.85           |  | 99,200             |  | 6.86 years                                  |  | $                               | 11.53 |                    | 29,050  |                                | $ | 10.40
|$13.00 - $14.23          |  | 30,550             |  | 7.80 years                                  |  | $                               | 13.76 |                    | 8,830   |                                | $ | 14.00
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      
|Totals                   |  | 350,993            |  | 4.42 years                                  |  | $                               | 7.27  |                    | 259,123 |                                | $ | 5.45 
|                         |  |                    |  |                                             |  |                                 |       |                    |         |                                |   |      

The aggregate intrinsic value of options outstanding and options exercisable as of March 31,
2007 was $1,938 and $1,886, respectively.

A summary of the status of the Companys non-vested restricted stock as of March 31,
2007, and changes



15



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##### Table of Contents

during the three months then ended is presented below:



|                       |  |                                        |  |                                     |  |                                       |      
|---------------------- |  | -------------------------------------- |  | ----------------------------------- |  | ------------------------------------- | -----
|                       |  | Non-Vested RestrictedStock Outstanding |  | Vested Restricted Stock Outstanding |  | WeightedAverage Grant Date Fair
Value
|Balance, 12/31/06      |  | 15,075                                 |  |                                    |  | $                                     | 12.55
|                       |  |                                        | 
|Authorized             |  |                                       |  |                                    |  |                                       |     
|Forfeited              |  |                                       |  |                                    |  |                                       |     
|Granted                |  |                                       |  | 1,771                               |  | $                                     | 12.20
|                       |  |                                        |  |                                     |  |                                       |      
|Outstanding at 3/31/07 |  | 15,075                                 |  | 1,771                               |  | $                                     | 12.51
|                       |  |                                        |  |                                     |  |                                       |      

The Company determined at December 31, 2006 that the performance goals related to the vesting
of the non-vested restricted stock grants are no longer probable of being met, therefore no compensation expense has been recognized in relation to these grants.

Modifications

Effective March 30, 2007 the Human Resources Committee of the Board of Directors (HR
Committee) voted to accelerate the vesting of 3,000 stock options granted and outstanding to J. Randall Woodson so that the options outstanding would be fully vested as of March 31, 2007 as a part of his severance agreement. All other
outstanding and non-vested options were forfeited upon Mr. Woodsons resignation. In accordance with the severance agreement, Mr. Woodson has until June 30, 2007 to exercise all outstanding and vested options. Those options not
exercised on or before June 30, 2007 will be automatically forfeited. In accordance with FAS 123R, a change in the vesting terms of a stock option award falls under the definition of a modification to the award, and as such, the compensation
cost must be re-measured. The compensation cost resulting from the acceleration of Mr. Woodsons vesting schedule is $18.

Policy for issuing
shares upon option exercise

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



|(12) | Other Items
|---- | -----------

On January 3, 2007, the Company paid its
sixth consecutive semi-annual cash dividend on the Companys stock, in the amount of $0.07 per share, to shareholders of record December 1, 2006.



16



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##### Table of Contents

|(13) | Subsequent Events
|---- | -----------------

On April 25, 2007, the Company
declared its seventh consecutive semi-annual cash dividend on the Companys stock, in the amount of $0.07 per share, payable on July 2, 2007 to shareholders of record June 1, 2007.



|Item 2. | Managements Discussion and Analysis.
|------- | -------------------------------------

Managements discussion and analysis of the financial condition and results of operations of the Company as of and for the three months ended March 31, 2007 and 2006 is as follows. The discussion should be read in conjunction with
the Companys Consolidated Financial Statements and Notes on the December 31, 2006 Form 10-K.

Critical Accounting Policies

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

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



| |  |  | officer and customer limits
| | - |  | ---------------------------



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



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

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



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



| |  |  | identified loan problems
| | - |  | ------------------------



| |  |  | loan volume outstanding
| | - |  | -----------------------



| |  |  | past loss experience
| | - |  | --------------------



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

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.



17



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##### Table of Contents

Our internal loan and credit process review program is intended to reduce and control the risks
associated with the lending process on an ongoing basis. It includes monitoring the lending activities of all bank personnel and an assessment of the effectiveness, with respect to underwriting and processing new loans, preventing insider abuse,
minimizing lender liability risk exposure and ensuring timely follow-up and corrective action for loans showing signs of deterioration in quality. Bank regulators also periodically review the loan portfolio and other assets to assess their quality,
and we employ independent, third party loan reviewers (semi-annually) to complement our internal review as well. This evaluation is inherently subjective because it requires estimates that may be significantly revised as more information becomes
available. We believe the allowance for loan losses is appropriate to provide for expected losses in the loan portfolio, but there are no assurances that it will be.

Impairment of Loans: We consider a loan impaired when it is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired
during a period of delay in payment if we expect the ultimate collection of all amounts due. A specific allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the
carrying value of that loan.

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 subsidiary is not significant at this time.



18



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##### Table of Contents

Performance Summary

The following table shows our key performance ratios for the period ended March 31, 2007 and December 31, 2006 and March 31, 2006:

Key Performance Ratios



|                               |  |                      |      |   |                        |   |      |                      |  |   |      |  
|------------------------------ |  | -------------------- | ---- | - | ---------------------- | - | ---- | -------------------- |  | - | ---- | -
|                               |  | 3 monthsEnded3/31/07 |      |   | 12 monthsEnded12/31/06 |   |      | 3 monthsEnded3/31/06 | 
|Return on average assets       |  |                      | 0.33 | % |                        |   | 0.54 | %                    |  |   | 0.56 | %
|Return on average equity (1)   |  |                      | 5.58 | % |                        |   | 8.67 | %                    |  |   | 8.87 | %
|Net interest margin (2)        |  |                      | 2.86 | % |                        |   | 3.14 | %                    |  |   | 3.28 | %
|Cost of funds                  |  |                      | 4.29 | % |                        |   | 3.85 | %                    |  |   | 3.47 | %
|Yield on earning assets        |  |                      | 7.07 | % |                        |   | 6.93 | %                    |  |   | 6.69 | %
|Basic net earnings per share   |  | $                    | 0.12 |   |                        | $ | 0.70 |                      |  | $ | 0.17 |  
|Diluted net earnings per share |  | $                    | 0.11 |   |                        | $ | 0.68 |                      |  | $ | 0.17 |  

---

|All | percentage calculations are on an annualized basis.
|--- | ---------------------------------------------------

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

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

Our performance for the first quarter of 2007 was adversely impacted by the increase in our special reserves on two of our impaired loan relationships due to additional credit quality concerns. The first relationship had been placed on
non-accrual status during the first quarter of 2006 and we subsequently charged-off $1.2 million at December 31, 2006. Due to poor operational results for the first quarter of 2007, we have identified an additional $484,000 exposure on this
relationship and as such, have set aside this amount in our special reserves. The second relationship is a commercially-oriented relationship with loan balances in the aggregate of approximately $2.3 million. At this time, we believe the loans are
not adequately secured; therefore a special provision was made to the loan loss reserve in the amount of $716,000, to reflect the potential exposure that we deem exists. We previously had recorded a special provision of $274,000 related to this
relationship. The Companys total loan loss provision for the first quarter of 2007 amounting to $720,000 did include the special loan loss reserves. On the positive side, we were able to reduce our special reserves on the $4.1 million
relationship identified during the fourth quarter of 2006 by approximately $70,000. Additionally, due to a modification in our calculation of the Allowance for Loan and Lease Losses in accordance with the new interagency guidance issued in December
2006, we have reduced our general reserve to equal 0.90% of non-impaired loans, as compared to 1.00% at December 31, 2006.



19



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##### Table of Contents

Growth

The following table shows our key growth indicators:

Key Growth Indicators

(dollars in thousands)



|                      |  |         |         |          |   |         |  |   |        
|--------------------- |  | ------- | ------- | -------- | - | ------- |  | - | -------
|                      |  | 3/31/07 |         | 12/31/06 |   | 3/31/06
|Investment securities |  | $       | 73,130  |          | $ | 73,617  |  | $ | 57,281 
|Loans, net            |  |         | 468,597 |          |   | 465,394 |  |   | 429,451
|Deposits              |  |         | 417,280 |          |   | 441,489 |  |   | 375,440
|Total assets          |  |         | 577,057 |          |   | 591,936 |  |   | 516,179

In comparison to the same period last year, our total assets grew by $60,878 or 12%, net loans
grew by $39,146 or 9% and total deposits grew by $41,840 or 11%. During the first quarter of 2007, we made a strategic decision to allow higher cost certificates of deposits to run off at maturity due to our unusually large federal funds sold
position at December 31, 2006 and due to a softening in loan demand. As a result, we effectively reduced the size of the Bank by approximately $15 million. Based on current market conditions, we do anticipate that our growth rates will show
declines in 2007 when compared to 2006.

Total liabilities at March 31, 2007 were $543.1 million, down 3% from $558.5 million at
December 31, 2006 with the decrease primarily represented by a $24.2 million decrease in deposits, offset by a $2.1 million increase in securities sold under agreements to purchase, and a $5.8 million increase in federal funds purchased.

Shareholders Equity

Total
shareholders equity at March 31, 2007 was $34.0 million consisting of $9.1 million in net proceeds from the Companys 1995 initial public offering, $3.2 million in net proceeds from the Companys 2000 secondary offering, $3.8
million in net proceeds from a private stock placement in 2004, $1.1 million in proceeds from the exercise of stock options, $104,000 from the expensing of restricted stock grants and incentive stock options, increased by accumulated retained
earnings of $17.0 million and decreased by $299,000 of net unrealized losses on securities available-for-sale. Total shareholders equity (exclusive of unrealized gains (losses) on investment securities and derivatives) was $34.3 million at
March 31, 2007 compared with $33.7 million at December 31, 2006, an increase of $0.6 million or 2%.

Net Income

We earned net income of $475,000 for the three months ended March 31, 2007, a decrease of $225,000 or 32% under the $700,000 reported for the same
period in 2006. As discussed above, we have continued to see the net interest margin under considerable pressure from our increased level of non-performing assets as well as the relatively flat yield curve. Our non-performing assets for the first
quarter resulted in lost income in excess of $228,000. Additionally, we increased our special reserves on two of our impaired loan relationships during the first quarter of 2007 due to additional credit quality concerns. A successful resolution of
each of these credit issues remains the top priority of senior management for 2007.



20



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##### Table of Contents

Net Interest Income

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

Total interest income was $9,579,000 for the three months ended March 31, 2007, an increase of 22.3% over the $7,831,000 reported for the same
period in 2006.

Total interest expense was $5,737,000 for the three months ended March 31, 2007, an increase of $1,703,000 or 42%
over the $4,034,000 reported for the same period in 2006.

As a result of the above, net interest income was $3,842,000 for the three
months ended March 31, 2007, an increase of 1.2% from the $3,797,000 reported for the same period in 2006. Our net interest margin was 2.86% for the three months ended March 31, 2007, down 42 basis points compared to the 3.28% reported for
the same period last year, and down 28 basis points from the 3.14% reported at December 31, 2006. Our net interest margin has been adversely affected by our unusually high level of non-performing assets. While we have continued to see the net
interest margin under considerable pressure from the intense competition for deposits and the relatively flat yield curve, our non-performing assets accounted for a 19 basis point decline in our net interest margin for the first quarter of 2007.
Additionally, in comparison to the same period last year, we have additional interest expense related to the trust preferred offering completed in December 2006. We do believe managing our net interest margin will continue to be challenging,
however, anticipate we improvement as soon as we are able to resolve the credit quality issues related to our non-performing assets.

Interest Rate Risk

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



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



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



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



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



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



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



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



| |  |  | prepayment of the underlying collateral of asset-backed securities.
| | - |  | -------------------------------------------------------------------

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

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



21



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##### Table of Contents

At least quarterly, we measure the ALM position using earnings simulation modeling to estimate what
assets and liabilities would re-price, and to what extent, within a one-year period in response to an immediate 200 and 100 basis point change in the Prime Rate, as well as in response to more gradual interest rate 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 slight asset-sensitive position
as of December 31, 2006 (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.

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

During the first quarter of 2007, we terminated this interest rate swap
agreement due to the shift of the Banks balance sheet to a more liability-sensitive position and the changing interest rate environment as compared to when the Bank entered into the Agreement. The Bank recorded a realized gain on the
termination of the Agreement of $50,629.



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##### Table of Contents

Noninterest Income

Noninterest income for the three months ended March 31, 2007 and 2006 is shown in the following table:

Noninterest Income

(dollars in thousands)



|                                           |  |                        |     |                        |   |     |                        |  |     |  
|------------------------------------------ |  | ---------------------- | --- | ---------------------- | - | --- | ---------------------- |  | --- | -
|                                           |  | 3 months Ended 3/31/07 |     | 3 months Ended 3/31/06 |   |     | % Increase/ (Decrease) | 
|                                           |  |                       
|                                           |  |                       
|Service charges on deposits                |  | $                      | 291 |                        | $ | 213 |                        |  | 37  | %
|Income earned on bank owned life insurance |  |                        | 127 |                        |   | 115 |                        |  | 10  | %
|Other income                               |  |                        | 162 |                        |   | 129 |                        |  | 26  | %
|Realized securities gains/losses           |  |                        | 51  |                        |   | (1  | )                      |  | N/M |  
|                                           |  |                        |     |                        |   |     |                        |  |     |  
|Total noninterest income                   |  | $                      | 631 |                        | $ | 456 |                        |  | 38  | %
|                                           |  |                        |     |                        |   |     |                        |  |     |  

For periods above, the increase in other income is primarily attributable to an increase in income
earned from our investment subsidiary, Valley Wealth Management Services, Inc. Expenses for Valley Wealth Management Services, Inc. are included in other expenses in the noninterest expense category. Net income for the subsidiary is not significant
at this time. The realized securities gains/losses of $51,000 is the gain realized on the termination of the interest rate swap agreement. The increase in service charges on deposits is primarily due to a change in the overdraft limits per customer
as compared to the same period last year.

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



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



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



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



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

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



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



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



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

Other income consists of several categories, primarily the following:



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



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



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



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



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



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



| |  |  | Income earned from Valley Wealth Management, Inc.
| | - |  | -------------------------------------------------

Levels of income derived from these categories vary. For example, fees for the issuance of official checks and customer check sales tend to grow as new branches are added. Fee schedules, while subject to change,
generally do not alone yield a significant or discernable increase in income when they change. Additionally, with



23



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##### Table of Contents

rising interest rates, mortgage originations and re-financings have slowed down, which decreases the fee income earned on real estate loans.

Noninterest Expense

Noninterest expense for the
three-month periods ended March 31, 2007 and 2006 is shown in the following table:

Noninterest Expense

(dollars in thousands)



|                                           |  |                        |       |                        |   |                        |  |     |   
|------------------------------------------ |  | ---------------------- | ----- | ---------------------- | - | ---------------------- |  | --- | --
|                                           |  | 3 months Ended 3/31/07 |       | 3 months Ended 3/31/06 |   | % Increase/ (Decrease) | 
|                                           |  |                       
|                                           |  |                       
|Compensation                               |  | $                      | 1,692 |                        |   | 1,485                  |  | 14  | % 
|Occupancy                                  |  |                        | 198   |                        |   | 157                    |  | 26  | % 
|Equipment                                  |  |                        | 142   |                        |   | 135                    |  | 5   | % 
|Data processing                            |  |                        | 164   |                        |   | 152                    |  | 8   | % 
|Advertising and marketing                  |  |                        | 43    |                        |   | 84                     |  | (49 | )%
|Audit fees                                 |  |                        | 103   |                        |   | 73                     |  | 41  | % 
|Franchise and purchased tax credit expense |  |                        | 85    |                        |   | 67                     |  | 27  | % 
|Business manager                           |  |                        | 83    |                        |   | 61                     |  | 36  | % 
|Deposit expense                            |  |                        | 65    |                        |   | 99                     |  | (34 | )%
|Loan expense                               |  |                        | 32    |                        |   | 55                     |  | (42 | )%
|Computer software                          |  |                        | 76    |                        |   | 83                     |  | (8  | )%
|Other expense                              |  |                        | 459   |                        |   | 270                    |  | 70  | % 
|                                           |  |                        |       |                        |   |                        |  |     |   
|Total noninterest expense                  |  | $                      | 3,142 |                        | $ | 2,721                  |  | 15  | % 
|                                           |  |                        |       |                        |   |                        |  |     |   

Compensation expense has increased over the
prior year due to officer merit increases effective January 1, 2007 as well as the net post-employment obligation related to Mr. Woodsons resignation as Chief Operating Officer. Additionally, our salary deferral related to FAS 91 is
less for the first quarter of 2007 due to lower loan growth than in the same period last year. Occupancy and equipment expense increases are primarily attributable to the new occupancy (and related equipment purchases) of the 6thand 7thfloors of our main headquarters. We did not take occupancy of the new floors until the end of the first quarter of 2006. We have purposely slowed down our spending on advertising and marketing during the first quarter of 2007 while
we revamp our marketing campaign. We anticipate these expenses to increase back to their 2006 levels or higher over the next quarter as we begin to implement our new marketing campaign. Audit fees have increased due to anticipated additional
regulatory costs associated with compliance as well as the movement of internal loan review to an external party. The increase in franchise and purchased tax credit expense is a direct result of the significant deposit growth the Bank has
experienced year over year. Deposit expense is down due to the write-off of $30,000 related to a fraudulent check scheme that occurred during the first quarter of 2006. The decline in loan expense is due to lower loan growth than in the same period
last year. Finally, included in our other expense is the significant increase in our FDIC insurance premiums as compared to the prior year and current expenses associated with our network consultant which were charged to either equipment or computer
software expense categories in prior years, depending on the nature of his work. Also included in the other expense category for the first quarter of 2007 is consulting expense associated with our imaging initiative to be implemented later this
year. Noninterest expenses are expected to continue to increase as a direct result of business growth, expansion and complexity of banking operations.



24



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##### Table of Contents

Income Taxes

To reflect our anticipated federal income tax liability, an expense of $136,000 at an effective tax rate of 22.3% was recognized for the three months ended March 31, 2007, compared to an expense of $245,000 at an effective tax rate of
25.9% recognized for the three months ended March 31, 2006. Factors contributing to the difference between the effective tax rate and the statutory rate of 34% include provision for loan loss reserves not allowed for tax purposes, tax-exempt
interest income on municipal securities (net of disallowance), and tax-exempt income earned on bank-owned life insurance.

Investment Securities

Our investment portfolio is used both for investment income and liquidity purposes. At this time, we do not invest in derivatives or
other types of high-risk securities. Unrealized gains and losses on securities available-for-sale are recognized as direct increases or decreases in net shareholders equity. Funds not used for capital expenditures or lending activities are
invested in the following:



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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

Investment securities (available-for-sale and held-to-maturity), including restricted equity securities, at March 31, 2007 were $73.1 million, a decrease of $0.5 million or 1% from their level of $73.6 million on December 31,
2006. The decrease is attributable to investment maturities of $0.2 million, and investment purchases of $0.6 million offset by the principal prepayments on mortgage-backed securities. See Note 3 to the Consolidated Financial Statements.

Loan Portfolio

Our total loans were $475.0
million at March 31, 2007, an increase of $3.9 million or 1% from the $471.1 million reported at December 31, 2006. 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 88.6% at March 31, 2007 and 85.2% at December 31, 2006. Management seeks
to maintain the ratio of loans to funding sources at a maximum of 90%.

The loan portfolio primarily consists of commercial, real estate
(including real estate term loans,



25



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##### Table of Contents

construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. We adjust the mix of
lending and the terms of our loan programs according to economic and market conditions, asset/liability management considerations and other factors. Loans typically (in excess of 90%) are made to businesses and individuals located within our primary
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 the
three-month periods ended March 31, 2007 and 2006 and the year ended December 31, 2006:

Loan Portfolio Summary

(dollars in thousands)



|                                                           |  |         |  |          |  |         |  |       |  |         |  |      
|---------------------------------------------------------- |  | ------- |  | -------- |  | ------- |  | ----- |  | ------- |  | -----
|                                                           |  | 3/31/07 |  | 12/31/06 |  | 3/31/06
|                                                           |  | $       |  | %        |  | $       |  | %     |  | $       |  | %    
|Commercial                                                 |  | 88,285  |  | 18.6     |  | 93,400  |  | 19.8  |  | 97,128  |  | 22.4 
|Commercial real estate                                     |  | 173,665 |  | 36.6     |  | 174,882 |  | 37.2  |  | 155,661 |  | 35.8 
|Real estate construction                                   |  | 89,086  |  | 18.8     |  | 82,537  |  | 17.5  |  | 64,122  |  | 14.8 
|Residential real estate                                    |  | 116,108 |  | 24.4     |  | 112,022 |  | 23.8  |  | 108,891 |  | 25.1 
|Loans to individuals (except those secured by real estate) |  | 7,832   |  | 1.6      |  | 8,211   |  | 1.7   |  | 8,358   |  | 1.9  
|                                                           |  |         |  |          |  |         |  |       |  |         |  |      
|Total loans                                                |  | 474,976 |  | 100.0    |  | 471,052 |  | 100.0 |  | 434,160 |  | 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,



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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 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 $720,000 was provided during the
three months ended March 31, 2007, an increase of $133,000 or 23.0% over the $587,000 reported during the same period in 2006. As mentioned previously, we increased our special reserves on two of our impaired loan relationships during the first
quarter of 2007 due to additional credit quality concerns. The first relationship had been placed on non-accrual status during the first quarter of 2006 and we subsequently charged-off $1.2 million at December 31, 2006. Due to poor operational
results for the first quarter of 2007, we have identified an additional $484,000 exposure on this relationship and as such, have set aside this amount in our special reserves. The second relationship is a commercially-oriented relationship with loan
balances in the aggregate of approximately $2.3 million. At this time, we believe the loans are not adequately secured; therefore a special provision was made to the loan loss reserve in the amount of $716,000, to reflect the potential exposure that
we deem exists. We previously had recorded a special provision of $274,000 related to this relationship. We believe we have reserved an amount that should be sufficient to cover any potential losses. Although we presently believe any unreserved loan
balances are secured by customer assets pledged as collateral, it is obviously a situation which can change, which we are constantly monitoring.

The Companys total loan loss provision for the first quarter of 2007 amounting to $720,000 did include the special loan loss reserves. On the positive side, we were able to reduce our special reserves on the $4.1 million relationship
identified during the fourth quarter of 2006 by approximately $70,000. Additionally, due to a modification in our calculation of the Allowance for Loan and Lease Losses in accordance with the new interagency guidance issued in December 2006, we have
reduced our general reserve to equal 0.90% of non-impaired loans, as compared to 1.00% at December 31, 2006.

The ratio of the
allowance for loan losses to total loans outstanding was approximately 1.3% at March 31, 2007, which compares to approximately 1.2% of gross loans at December 31, 2006 (see Note 4 to the Consolidated Financial Statements). These estimates
are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $2,180,000 in special reserves is included in the balance of the allowance for loan losses as of
March 31, 2007 for impaired loans, which compares to a total of $1,050,000 as of December 31, 2006 and $1,420,000 as of March 31, 2006. The $2,180,000 in special reserves is concentrated in three large relationships within our overall
loan portfolio.

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



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Nonperforming Assets and Impaired Loans

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

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

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

For the three months ended March 31, 2007, our non-performing assets to total assets ratio decreased from 1.56% at
December 31, 2006 to 1.47%. Additionally, our loans past due more than 90 days as a percentage of total loans decreased from 0.13% at December 31, 2006 to 0.00% at March 31, 2007. Nonperforming assets at March 31,
2007, December 31, 2006 and March 31, 2006 are presented in the following table:

Nonperforming Assets

(dollars in thousands)



|                                             |  |         |       |          |   |         |  |   |      
|-------------------------------------------- |  | ------- | ----- | -------- | - | ------- |  | - | -----
|                                             |  | 3/31/07 |       | 12/31/06 |   | 3/31/06
|Nonaccrual loans                             |  | $       | 8,437 |          | $ | 6,343   |  | $ | 4,618
|Loans past due 90 days or more               |  |         |      |          |   | 616     |  |   | 1,081
|Restructured loans                           |  |         |      |          |   |        |  |   |     
|Other nonperforming loans (1)                |  |         |      |          |   | 2,265   |  |   | 3,013
|                                             |  |         |       |          |   |         |  |   |      
|Total nonperforming loans                    |  | $       | 8,437 |          | $ | 9,224   |  | $ | 8,712
|                                             |  |         |       |          |   |         |  |   |      
|Foreclosed, repossessed and idled properties |  |         | 19    |          |   |        |  |   |     
|                                             |  |         |       |          |   |         |  |   |      
|Total nonperforming assets                   |  | $       | 8,456 |          | $ | 9,224   |  | $ | 8,712
|                                             |  |         |       |          |   |         |  |   |      

---

|(1) | Other nonperforming loans include impaired loans which are not on nonaccrual status or past due 90 days or more.
|--- | ----------------------------------------------------------------------------------------------------------------

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

If nonaccrual loans had performed in accordance with their original terms, additional interest income in the amount of $228,086 for the three-month period ended March 31, 2007; $300,727 for the year ended
December 31, 2006; and $24,900 for the three-month period ended March 31, 2006 would have been recorded.



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Additionally, the Banks credit risk process provides ongoing assessment of the loan
portfolios risk profile in accordance with standard industry practices. Loan assets which do not support satisfactory risk ratings under this basis are subjected to a well-defined, ongoing management and reporting process. These
Watch-List loan assets were as follows as of March 31, 2007, December 31, 2006, and March 31, 2006:

Watch List Credits

(dollars in thousands)



|                   |  |         |        |   |          |   |        |         |  |   |        |  
|------------------ |  | ------- | ------ | - | -------- | - | ------ | ------- |  | - | ------ | -
|                   |  | 3/31/07 |        |   | 12/31/06 |   |        | 3/31/06 | 
|Watch List Credits |  | $       | 19,844 |   |          | $ | 19,562 |         |  | $ | 19,552 |  
|% of Total Loans   |  |         | 4.18   | % |          |   | 4.15   | %       |  |   | 4.50   | %

Other Assets

We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Companys Supplemental Executive Retirement Plan (SERP) and other employee
benefit costs including health insurance, dental insurance, life insurance, and 401(k) employer match. Bank owned life insurance was $11.2 million at March 31, 2007, an increase of $0.1 million over the $11.1 million reported as of
December 31, 2006. The increase is due to the $0.1 million increase in the cash surrender value of the life insurance contracts.

Deposits

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

The following table summarizes our total
deposits for the three months ended March 31, 2007 and for the year ended December 31, 2006:

Deposit Summary

(dollars in thousands)



|                                       |  |         |  |          |  |                     |  |       |  |         |   |  |       |  
|-------------------------------------- |  | ------- |  | -------- |  | ------------------- |  | ----- |  | ------- | - |  | ----- | -
|                                       |  | 3/31/07 |  | 12/31/06 |  | Increase/(Decrease) | 
|                                       |  | $       |  | %        |  | $                   |  | %     |  | $       |   |  | %     |  
|Time deposits                          |  | 247,177 |  | 59.2     |  | 263,123             |  | 59.6  |  | (15,946 | ) |  | (6.1  | )
|Interest bearing demand & money market |  | 98,964  |  | 23.7     |  | 93,444              |  | 21.2  |  | 5,520   |   |  | 5.9   |  
|Savings                                |  | 54,626  |  | 13.1     |  | 66,259              |  | 15.0  |  | (11,633 | ) |  | (17.6 | )
|Total interest bearing deposits        |  | 400,767 |  | 96.0     |  | 422,826             |  | 95.8  |  | (22,059 | ) |  | (5.2  | )
|                                       |  |         |  |          |  |                    
|Noninterest demand & official checks   |  | 16,513  |  | 4.0      |  | 18,663              |  | 4.2   |  | (2,150  | ) |  | (11.5 | )
|                                       |  |         |  |          |  |                     |  |       |  |         |   |  |       |  
|Total deposits                         |  | 417,280 |  | 100.0    |  | 441,489             |  | 100.0 |  | (24,209 | ) |  | (5.5  | )
|                                       |  |         |  |          |  |                     |  |       |  |         |   |  |       |  

We would prefer to have transaction accounts comprise a larger percentage of total deposits, but
in order to fund our loan growth, we often have to rely on higher-cost certificates of deposit. Additionally, during the first quarter of 2007, we purposely allowed our higher-cost certificates of deposit to run off at maturity due to our unusually
large federal funds sold position as well as a softening in loan demand. Within the certificate of



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deposit category, in the past, we have marketed CDs nationally to institutional depositors, primarily banks, thrift institutions and credit unions through an
Internet-based rate posting service. National market CDs at March 31, 2007 were $11.9 million, a decrease of $0.9 million from the $12.8 million reported at December 31, 2006 and represent 4.8% of total CDs and 2.9% of total deposits at
March 31, 2007.

Short-Term Borrowings

Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) increased by $7.9 million from their level of $46.6 million at December 31, 2006 to a total of $54.5 million as of
March 31, 2007. The increase is due to our federal funds purchased position of $5.8 million and an increase in our commercial sweep account program of $2.1 million. Short-term borrowings at March 31, 2007 include Federal Home Loan Bank of
Atlanta (FHLB) borrowings in the amount of $25.0 million and a commercial sweep account program in the amount of $23.7 million.

The FHLB borrowings include two adjustable rate credits. The first loan is a $10 million adjustable rate credit which matures on December 18, 2007 and reprices quarterly on the date of each quarterly interest payment (rate of 5.33% on
March 31, 2007). The second loan is a $5 million adjustable rate credit which matures on October 31, 2007 and reprices quarterly on the date of each quarterly interest payment (rate of 5.31% on March 31, 2007). The third FHLB
borrowing is a $10 million fixed rate credit at 3.09% that matures on September 4, 2007.

The commercial sweep program involves
balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured. The balance in the program is $23.7 million at March 31, 2007, an increase of $2.1 million from the
$21.6 million level at December 31, 2006. The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight basis subject to repurchase. On the following business day, we repurchase
from the customer the securities for an amount equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only
once per month.

Long-Term Borrowings

Federal Home Loan Bank advances are relatively cost-effective funding sources and provide us with the flexibility to structure borrowings in a manner that aids in the management of interest rate risk and liquidity. Long-term convertible
Federal Home Loan Bank advances totaled $48.0 million at March 31, 2007 and at December 31, 2006. (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.



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

Valley Financial (VA) Statutory Trust I, a
statutory business trust (Trust I), was created on June 26, 2003, at which time the Trust issued $4.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature June 26, 2033.
Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate (LIBOR) plus 3.10%, capped at 11.75%, and the 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, $11,420,000 is included in Tier 1 capital at March 31, 2007. The remaining $4,580,000 is included in Tier 2 capital at March 31, 2007. 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.

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, 2007 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. We will continue to monitor the Bank capital ratios very closely throughout 2007 due to the strain of
the non-performing assets, as our performance is substantially dependent upon the outcome of these credits.



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

Valley Financial Corporation



|         |  |         |   |  |          |   |  |         |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | -
|Ratio    |  | 3/31/07 |   |  | 12/31/06 |   |  | 3/31/06 |  
|Tier 1   |  | 9.3     | % |  | 9.1      | % |  | 9.5     | %
|Total    |  | 11.4    | % |  | 11.2     | % |  | 10.6    | %
|Leverage |  | 7.8     | % |  | 7.9      | % |  | 8.3     | %

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

Valley Bank



|         |  |         |   |  |          |   |  |         |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | -
|Ratio    |  | 3/31/07 |   |  | 12/31/06 |   |  | 3/31/06 |  
|Tier 1   |  | 9.3     | % |  | 9.1      | % |  | 9.0     | %
|Total    |  | 10.5    | % |  | 10.2     | % |  | 10.1    | %
|Leverage |  | 7.9     | % |  | 7.9      | % |  | 8.0     | %

Total shareholders equity grew by $560,000 from December 31, 2006 to March 31,
2007. Earnings, proceeds from the exercise of incentive stock options, the change in unrealized gains and losses for securities available-for-sale, and the reversal of unrealized gains and losses for derivatives not held for trading accounted for
the net increase. The Company paid its sixth consecutive semi-annual cash dividend on the Companys common stock, in the amount of $0.07 per share on January 3, 2007 to shareholders of record December 1, 2006.

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, interest-bearing deposits at
other banks and non-pledged securities available-for-sale, at March 31, 2007, totaled $14.5 million compared to $35.6 million at December 31, 2006. The decrease in liquid assets is due primarily to the run-off of our federal funds sold
position during the quarter and resulting increase in federal funds purchased. Our funding sources consist of an established federal funds lines with a regional correspondent bank totaling $12.0 million that had a $5.8 million balance as
of March 31, 2007, three established federal funds lines with third party banks totaling $21.0 million that had outstanding balances totaling $0 as of March 31, 2007, and an established line with the FHLB that had $73.0
million outstanding under a total line of $90.0 million as of March 31, 2007. We believe these arrangements will be renewed at maturity.



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We sell excess funds as overnight federal funds sold to provide an immediate source of liquidity. We had
federal funds sold of $0 at March 31, 2007 and $16.6 million at December 31, 2006.

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

Impact of Inflation

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

Recent and Future Accounting Considerations

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



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

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

We attempt to ensure that adequate funds are available at all times to
meet the needs of our customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the
balance sheet,



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liquidity sources include core deposits, the ability to increase large denomination certificates of deposit, federal fund lines from correspondent banks,
borrowings from the FHLB and the Federal Reserve Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.

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

We use a number of tools to manage our interest rate risk, including simulating net interest income under various
scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods. (See Interest Rate Risk in
Item 2.)



|Item 4. | Controls and Procedures.
|------- | ------------------------

As of the end of the
period covered by the report, an evaluation was performed under the supervision and with the participation of the Companys management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and
procedures were effective. There have not been any changes in our internal control over financial reporting that occurred during the last quarter that has materially affected, or is reasonably likely to materially affect, internal control over
financial reporting.

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

PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings.
|------- | ------------------

There were no pending legal
proceedings during the quarter.



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

There were no changes to the risk
factors identified in the Companys Annual Report Form 10-K for the year ended December 31, 2006.



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

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



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

There were no
defaults upon Senior Securities in the quarter.



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

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



|Item 5. | Other Information.
|------- | ------------------

None.



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##### Table of Contents

|Item 6. | Index to Exhibits
|------- | -----------------



|(a) | We filed the following exhibits for the quarter ended March 31, 2007:
|--- | ---------------------------------------------------------------------



|               |  |                                                                                                                                                                                                                                   
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                       
|3.1            |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                  
|               | 
|3.2            |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                                     
|               | 
|3.3            |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit 3.3 of Form 10-KSB filed March 30, 2005, File No. 000-28342).                                                                                        
|               | 
|10.2*          |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March 27, 1997, File
No. 33-77568).                   
|               | 
|10.3*          |  | Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27, 1997, File No.
33-77568).                      
|               | 
|10.4*          |  | Stock Option Agreement dated January 29, 2001 by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-K filed March 28, 2006, File No.
33-77568).                       
|               | 
|10.5*          |  | Stock Option Agreement dated January 10, 2002, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.5 of Form 10-K filed March 28, 2006, File No.
33-77568).                      
|               | 
|10.6*          |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.6 of Form 10-K filed March 28, 2006, File No.
33-77568).                          
|               | 
|10.7*          |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.7 of Form 10-K filed March 28, 2006, File No.
33-77568).                      
|               | 
|10.8*          |  | Employment agreement dated September 21, 2000, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.2 of Form SB-2, filed September 27, 2000, and Form
SB-2/A filed October 25, 2000).
|               | 
|10.9*          |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 (incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                      



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|       |  |                                                                                                                                                                                                                                                
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|10.10* |  | Employment agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.15 of Form 10-QSB filed November 14,
2002, File No. 33-77568).                                   
|       | 
|10.11  |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14,
2003, File No. 33-77568).                        
|       | 
|10.12* |  | Stock Option Agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                 
|       | 
|10.13  |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (incorporated herein by reference to Exhibit 10.18 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).                         
|       | 
|10.14* |  | Stock Option Agreement dated January 21, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.14 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                 
|       | 
|10.15* |  | Stock Option Agreement dated December 16, 1999, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.15 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                
|       | 
|10.16* |  | Stock Option Agreement dated January 29, 2001, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.16 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                 
|       | 
|10.17* |  | Stock Option Agreement dated January 10, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.17 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                 
|       | 
|10.18* |  | Stock Option Agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.18 of Form 10-K filed March 28, 2006, File No.
33-77568).                                  
|       | 
|10.19  |  | Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.20 of Form
10-KSB filed March 30, 2004, File No. 000-28342).
|       | 
|10.20* |  | Stock Option Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.20 of Form 10-K filed March 28, 2006, File No.
33-77568).                                     
|       | 
|10.21* |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.21 of Form 10-K filed March 28, 2006, File
No. 33-77568).                                 



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##### Table of Contents

|       |  |                                                                                                                                                                                                                                      
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.22* |  | Stock Option Agreement dated November 11, 2004, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.22 of Form 10-K filed March 28,
2006, File No. 33-77568).                         
|       | 
|10.23* |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and John T. McCaleb (incorporated herein by reference to Exhibit No. 10.23 of Form 10-K filed March 28, 2006, File No.
33-77568).                          
|       | 
|10.24* |  | Stock Option Agreement dated November 11, 2004, by and between the Company and Andrew B. Agee (incorporated herein by reference to Exhibit No. 10.24 of Form 10-K filed March 28, 2006, File No.
33-77568).                          
|       | 
|10.25* |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Andrew Agee (incorporated herein by reference to Exhibit No. 10.25 of Form 10-K filed March 28, 2006, File No.
33-77568).                              
|       | 
|10.26* |  | Letter agreement regarding retirement of A. Wayne Lewis dated July 22, 2005, by and among the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.21 of Form 10-Q filed
November 14, 2005, File No. 33-77568).
|       | 
|10.27* |  | Restricted Stock Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (incorporated herein by reference to Exhibit No. 10.27 of Form 10-K filed March 15, 2007, File
No. 33-77568).                       
|       | 
|10.28* |  | Stock Option Agreement dated July 5, 2005, by and between the Company and Kimberly B. Snyder (incorporated herein by reference to Exhibit No. 10.28 of Form 10-K filed March 15, 2007, File No.
33-77568).                           
|       | 
|10.29* |  | Restricted Stock Agreement dated August 10, 2005, by and between the Company and Kimberly B. Snyder (incorporated herein by reference to Exhibit No. 10.29 of Form 10-K filed March 15, 2007, File
No. 33-77568).                    
|       | 
|10.30* |  | Stock Option Agreement dated August 10, 2005 by, and between the Company and Kimberly B. Snyder (incorporated herein by reference to Exhibit No. 10.30 of Form 10-K filed March 15, 2007, File No.
33-77568).                        
|       | 
|11.0   |  | Statement re Computation of Earnings per Share (filed herewith as Note 10).                                                                                                                                                          
|       | 
|31.2   |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                    
|       | 
|32.1   |  | Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                     
|       | 
|32.2   |  | Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                     

---

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



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SIGNATURES

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



|             |  |                                                         
|------------ |  | --------------------------------------------------------
|             |  | VALLEY FINANCIAL CORPORATION                            
|             | 
|May 14, 2007 |  | /s/ Ellis L. Gutshall                                   
|Date         |  | Ellis L. Gutshall, President and Chief Executive Officer
|             | 
|May 14, 2007 |  | /s/ Kimberly B. Snyder                                  
|Date         |  | Kimberly B. Snyder, Executive Vice President and        
|             |  | Chief Financial Officer                                 



39